Singapore Budget 2018: Measures to bolster R&D and IP tax regime are heartening

FINANCE Minister Heng Swee Keat stressed early in his Budget 2018 speech on the importance of encouraging pervasive innovation throughout the economy, as well as the key role intellectual property (IP) plays for companies operating in today's highly competitive and rapidly-changing business environment.

It is thus heartening to note that Budget 2018 has introduced several measures to bolster Singapore's research and development and IP tax regime. From a tax perspective, these include increasing existing tax deductions for payments made by businesses to license an IP for commercial use, IP registration costs as well as expenditure incurred on R&D activities carried out in Singapore.

The last measure is perhaps the most significant as it grants a 250 per cent deduction on qualifying expenditure incurred on eligible R&D activities performed in Singapore. Without such an enhancement, the tax deduction rate would have fallen from 400 per cent to 150 per cent following the cessation of the Productivity and Innovation Credit (PIC) Scheme at the end of 2017. It is doubtful whether a 150 per cent deduction rate would be sufficiently attractive to businesses, given Singapore's already low corporate headline tax rate of 17 per cent.

At a macro level, the 250 per cent tax deduction helps Singapore keep pace with the R&D regimes of regional economies. Thailand, for example, offers enhanced deductions of up to 300 per cent on qualifying R&D expenditure. Our perennial competitor, Hong Kong, has most recently decided to take a leaf out of Singapore's playbook by introducing R&D incentives that almost mirror the PIC scheme - 300 per cent enhanced deduction for the first HK$2 million (S$336,000) in eligible R&D expenditure and a double-deduction (200 per cent) thereafter.

At a micro level, the enhanced deduction for locally-conducted R&D activities is a welcome boost for businesses, especially small and medium enterprises that need support to fund their research projects. But whether the enhanced benefits will trickle down to these recipients will depend on whether they can meet the detailed documentary requirements for a successful deduction claim as well as the strict definition of what constitutes qualifying R&D.

In particular, we note that smaller businesses tend not to fare well in meeting the documentary requirements to substantiate that the activities they conduct constitute eligible R&D, either due to insufficient understanding of such requirements or a lack of manpower. Sufficient documentation, among other things, is vital in demonstrating that an activity is systematic, investigative and experimental in nature and thus considered as eligible R&D. The authorities could look at clarifying or fine-tuning such requirements so as to realise the vision of pervasive innovation throughout the economy.

In the alternative, a separate incentive category can be introduced for spending incurred on "lower tier" R&D or activities that are deemed less innovative because they fall outside the ambit of eligible R&D as defined in the tax legislation.

Integration of technologies

These include activities that lead to the creation of new and improved products or services such as the integration of two (or more) existing technologies, as in the case of Uber, or the complex integration of numerous disparate systems operating on vastly different technologies. Such innovations are no less vital in today's knowledge-based economy and the benefit for such activities could be watered down to a tax deduction of perhaps 200 per cent, coupled with a spending cap, commensurate with the perceived reduced risks that such activities carry.

Mr Heng did not provide an estimate of how much the enhanced suite of R&D and IP measures will cost. On this note, we observe that tax benefits enjoyed by businesses under the partial and startup tax exemption schemes will, for the first time since their respective introductions in 2001 and 2004, be watered down.

Briefly, in its current guise, the partial and startup tax exemptions schemes have the effect of reducing the effective tax rate of the first S$300,000 of chargeable income derived by qualifying businesses from 17 per cent to about 8.4 per cent and 5.7 per cent, respectively. The effective tax rates will then be increased to 11.2 per cent and 9.9 per cent for a similar level of chargeable income.

Viewed from this lens, businesses that do not undertake R&D activities will soon find themselves paying more taxes. The move to reduce benefits under the startup and partial tax exemptions schemes is also in line with the government's change in policy to favour targeted support measures over broad-based ones.

Beyond the perceived need to balance the books, there are also several compelling reasons to tweak the partial and startup tax exemption schemes.

First, the raison d'etre for introducing a full tax exemption scheme in Budget 2004 was to "give startups every opportunity to thrive and succeed". It is open to debate whether reduced corporate taxes have the effect of encouraging entrepreneurship, and one may also argue that startups tend to be unprofitable in the initial years of operation. This being the case, the revisions to the full tax exemption scheme may not have a pervasive adverse impact on startups.

Second, personal income tax rates have been increased recently and there is now a significant gap between the top-tier personal income tax rate (22 per cent) and the corporate income tax rate (17 per cent). The Inland Revenue Authority of Singapore has begun to monitor "corporatisation" trends, which is a move by high-income earners to set up companies so as to avoid higher income taxes. The reduced benefits under the partial and full tax exemption schemes may then reduce instances of tax avoidance through "corporatisation", including situations where multiple companies are set up without business substance just to take advantage of the above tax exemption schemes.

Lastly, the tweaking of the startup and partial tax exemption schemes appears to be an innovative way of raising additional corporate taxes without increasing the headline corporate tax rate, which will not send the right signal amid the global environment of declining corporate tax rates. Other than funding the specific tax deduction benefits in Budget 2018, this also leaves the door open for further scaling down of such tax exemption schemes in future.

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