Big changes to important tax break for South African businesses

Significant changes have been made to the Research and Development (R&D) tax incentive in South Africa, which has been a vital policy instrument to promote investment in the country and reduce companies’ tax burdens.

First implemented in 2006, the policy has been a strategic instrument to increase private-sector investment in scientific and technological innovation. 

The incentive aimed to drive economic growth and job creation through promoting this investment, while also providing tax relief to companies. 

PwC’s tax team explained in its latest Synopsis that substantial changes were made to the incentive in 2023, which came into effect last year. 

These changes were driven by the need to simplify the application process, enhance clarity around what qualifies for investment for the incentive, and align it with international best practice. 

“Prior to these amendments, the incentive was often criticised for being administratively burdensome and conceptually vague,” PwC said. 

This was particularly true around the definition of R&D and the requirement for innovation to occur, not merely basic research. 

The government also widened the scope of the legislation to include a wider range of activities and business models. 

PwC explained that the new definition was simplified to focus on activities resolving scientific or technological uncertainty. 

It also introduced a higher hurdle for receiving the incentive, adding that if a skilled professional could resolve the uncertainty without systematic investigation or experimentation, the incentive does not apply. 

Prior to the changes, the legislation also had a hard ‘end result’ approach, where research had to lead to outcomes such as patents. 

This has been replaced with a more flexible framework, which says that activities must be novel, uncertain, systematic, and transferable or reproducible. 

Furthermore, internal business processes are no longer excluded. If they meet the qualifying activities, they are eligible for the incentive regardless of whether the outcome is intended for sale or internal use. 

These changes have been coupled with increased oversight from SARS, which is now allowed to share taxpayer information with the Department of Higher Education, Science, and Innovation to support improved monitoring. 

The tax benefits

While significant changes have been made to the legislation surrounding qualifying activities and definitions, the tax benefits have remained the same. 

Companies approved under the legislation are entitled to a 150% income tax deduction for qualifying R&D expenditure. 

This applies to costs directly and solely incurred in the production of income and in the carrying on of a trade. 

Companies can also claim an accelerated capital allowance on capital assets used in approved R&D activities. 

While this incentive has created immense benefits, PwC’s research has also shown that similar incentives have not had their desired effect. 

The financial services firm analysed the impact of the National Treasury’s solar panel tax incentive for individuals and businesses. 

Individuals who pay personal income tax were able to claim a rebate of 25% of the cost of new and unused solar photovoltaic panels, up to a maximum of R15,000.

Businesses, on the other hand, were able to claim an upfront deduction of 125% of the cost of qualifying assets used in generating electricity from renewable sources. 

While this plan was meticulously thought out, it did not have the desired effect, with the National Treasury revealing that uptake of the incentives was low. 

Only 27% of eligible respondents claimed the individual incentive, with the vast majority of these households stating that they would have installed solar panels regardless of the incentive. 

In effect, for every five individuals that received the tax credit, four were being rewarded for an action they were already committed to taking. 

PwC said this points to a high level of deadweight loss. In other words, tax revenue was foregone to reward decisions already made or that would have been made regardless of the incentive. 

With regard to the business incentive, 49% of eligible business respondents claimed the deduction.