A Survey of Taxation and Corporate Innovation - PwC · Fig. 2 Input-based R ... of taxes in the R&D...

A Survey of Taxation and Corporate Innovation

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The role of tax considerations in R&D related business decisions of multinational groups.

© August 2015 PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, which is a member firm of PricewaterhouseCoopers International Limited (PwCIL). Each member firm of PwCIL is a separate and independent legal entity.

A Survey of Taxation and Corporate Innovation

Published by PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft

By Prof. Dr. Jost H. Heckemeyer, Dr. Katharina Richter, Dipl.-Vw. Margarete Schätzler, Dr. Frank Schmidt, Prof. Dr. Christoph Spengel

August 2015, 28 Pages, 19 Figures, Soft cover

All rights reserved. This material may not be reproduced in any form, copied onto microfilm or saved and edited in any digital medium without the explicit permission of the editor.

This publication is intended to be a resource for our clients, and the information therein was correct to the best of the authors’ knowledge at the time of publication. Before making any decision or taking any action, you should consult the sources or contacts listed here. The opinions reflected are those of the authors. The graphics may contain rounding differences.

A Survey of Taxation and Corporate Innovation 3

Preface

Preface

In times of constrained public budgets and moderate economic growth, the challenge for policy-makers is – more than ever – to find the right set of measures to maintain social welfare standards. There is no single recipe for economic stimuli and/or government spending cuts.

It is our opinion that well-conceived R&D tax incentives are a means for effectively fostering private investment in R&D. One of their big advantages is that they can trigger multiple positive investment effects with a low administrative burden and at a low cost to the state budget. Numerous studies have shown that tax incentives for R&D are very effective in encouraging private spending on R&D and that R&D investments themselves create positive spillover effects for other market participants. Not for nothing it is widely accepted that R&D investments are drivers of economic growth and social welfare.

The specific design of any R&D tax incentive scheme is crucial to its success. Different countries take different approaches to suit their own circumstances. Depending on the specific attributes of the tax incentive, they generate different incentives to firms. Some incentives subsidize R&D activity itself, while others relieve the tax burden on the income from the R&D results, thereby attracting R&D output (e.g. intellectual property rights) from abroad. R&D tax incentives, therefore, fall within a broad range of goals between stimulating economic growth and – possibly even undesirable – tax competition.

The aim of this study is to gain a deeper understanding of the attitude of firms to their R&D investment decisions. In particular, we were interested in whether and to what extent the R&D and tax departments liaise and the importance they attach to tax incentives when taking R&D location decisions. What factors impact on the decisions as to how much to invest and where to hold the resulting IP rights? How should an R&D tax incentive be conceived in order to be most effective? Our survey addresses these and other vital questions and reveals some highly significant insights into firms’ considerations and motives. Knowledge of firms’ typical behaviour can help policy makers to design effective R&D tax incentives. We are convinced that the results of this survey can be a substantial contribution to the efficient design of an innovation-friendly tax system.

Lastly, but importantly, the Centre for European Economic Research (ZEW) and PwC wish to thank all participants for their contributions to this study.

Prof. Dr. Christoph Spengel Dr. Frank Schmidt

4 A Survey of Taxation and Corporate Innovation

Table of contents

Table of contents

Table of figures.........................................................................................................5

A Executive Summary ..........................................................................................6

B Innovation as Driver of Economic Growth .........................................................7

C Tax Incentives for R&D ......................................................................................8

D The Survey ......................................................................................................11

E Insights from R&D Intensive Multinationals .................................................... 14

F Summary ........................................................................................................25

Contacts .................................................................................................................26


Table of figures

Table of figures

Fig. 1 R&D tax incentives .....................................................................................8

Fig. 2 Input-based R&D tax incentives ..................................................................9

Fig. 3 IP box regimes ..........................................................................................10

Fig. 4 Characteristics of companies included in the study ...................................11

Fig. 5 Selected descriptive statistics of respondent firms ....................................12

Fig. 6 The use of tax incentives for R&D ............................................................. 14

Fig. 7 Attributes of R&D tax incentives ...............................................................15

Fig. 8 The importance of factors influencing the amount of R&D spending ........16

Fig. 9 Countries where R&D activity is performed ..............................................17

Fig. 10 Countries where patents are held .............................................................. 17

Fig. 11 The importance of taxes in the R&D location decisions: Input versus Output ..................................................................................18

Fig. 12 The importance of general factors in the R&D location decision ...............18

Fig. 13 The importance of general factors in the IP location decision....................19

Fig. 14 The importance of tax factors in the R&D location decision ......................20

Fig. 15 The importance of tax factors in the IP location decision ..........................21

Fig. 16 Has your firm considered holding patents in a country other than where the R&D activity took place?...........................................................21

Fig. 17 The percentage of patents held in the same country in which the associated R&D expense was incurred ................................................22

Fig. 18 Has your firm considered locating patents at an affiliate that is subject to comparatively low tax rates? ...........................................22

Fig. 19 Tax planning considerations in the IP location decision ............................24


Executive Summary

R&D tax incentives play an increasing role in international tax policy.

PwC together with the University of Mannheim and the Centre for European Economic Research (ZEW) in Mannheim conducted a joint survey of PwC Global clients.

The key goal of this survey was to find out whether and if yes, how R&D tax incentives impact decisions of multinationals on where to locate R&D activities.

Our survey reveals interesting results:Most important drivers of the effectiveness of R&D tax incentives are an immediate impact on liquidity, planning certainty and simplicity. Respondents therefore listed the availability of internal funds followed by the pressure to meet earnings benchmarks and the availability of R&D tax incentives.

Our survey distinguished between the decision on where to locate R&D activity (i.e. R&D input) and on where to hold resulting IP (i.e. R&D output). We find that taxes are more important in the IP location decision than they are in the location decision of R&D input.

Our survey also investigated R&D tax planning considerations by multinationals. The majority of respondents said that they had considered holding patents in a different country than where the R&D was performed.

A Executive Summary


Innovation as Driver of Economic Growth

Innovation is of key importance for the economic development of a country. It is the source of economic growth and social welfare. Economists suggest that technological progress alone is responsible for sustained increases in the standard of living. From a company’s perspective, corporate innovation is crucial to increased productivity and, hence, market success. As the European continent is short of natural resources, constant innovation is a precondition of maintaining Europe’s growth potential, global competitiveness and wealth. Accordingly, the EU set R&D goals in its Europe 2020 strategy and the European Council member states agreed to make every effort to raise R&D spending to 3% of their gross domestic product (GDP). In doing so, private R&D expense should amount to 2% and public R&D expense to 1% of GDP.

European governments use different innovation policy instruments to achieve this aim. These instruments are designed to boost public and private business R&D expenditure. Private innovation in particular is subject to market failure and this can lead to an underinvestment in R&D from a society’s point of view. Firstly, the creation and dissemination of knowledge, e.g. through labour mobility between employers, can create positive spillovers on other market participants that are unaccounted for by the market and thus not priced. Secondly, the technical and market risk associated with innovative activity, coupled with asymmetric information between the innovator and financial investors, tends to drive up the cost of external finance. As a result, only businesses with sufficient internal finance will engage in R&D. Market risks and competition considerations prompt governments to encourage national R&D activities with grants, tax incentives and other policy instruments.

There are various forms of public support for R&D. On the one hand, public funds for basic and applied research by universities are on the increase. This research is often linked to commercial activities via additional stimuli for technology transfer, e.g. matching grants for collaborative R&D projects.1 On the other hand, government R&D policies are increasingly oriented towards market signals and competition in order to keep compliance costs low and funding neutral with respect to the choice and structure of R&D projects.2 This has led several countries to introduce tax-based R&D incentives in addition to direct subsidies. In the following, an overview is given of the various existing forms of tax incentives for R&D.

B Innovation as Driver of Economic Growth

1 These matching grants for R&D imply a cost sharing of total R&D project expenditures by the applicant and the government. They are directed to thematic programmes, adoptions of programme structures based on technology foresight, regular tenders and peer review-based selections, and special approaches (e.g. joint projects between science and industry represented by large companies, SMEs, regional networks, or start-ups). The administration of such business-related funding is for example in Germany delegated to special project managing agencies (“Projektträger”), acting on behalf of federal or state ministries of education and research. For a description and empirical evaluation of the effectiveness of these policy instruments, see Czarnitzki D., B. Ebersberger and A. Fier (2007) The Relationship between R&D Collaboration, Subsidies and R&D performance: Empirical Evidence from Finland and Germany, Journal of Applied Econometrics, Vol. 22 No. 7, pp. 1347–1366.

2 One of the most important arguments for R&D tax incentives is the belief that they are neutral as to the structure and the choice of R&D projects, e.g. Atkinson R. (2007) Expanding the R&D Tax Credit to Drive Innovation, Competitiveness and Prosperity, Journal of Technology Transfer, Vol. 32, pp. 617–628. The incentive effect should then be equal for all participants and projects, reflecting a policy decision aimed at increasing the amount spent on R&D rather than trying to direct it. The incentive can also be structured to favour smaller business, or, for that matter, to exclude them altogether.


Tax Incentives for R&D

Conceptually, the R&D process can be divided into two phases: development and exploitation. During the development phase, the company completes the necessary research and development to create an intangible asset and, thus, incurs costs (R&D input phase). In the second phase, the company exploits the profit potential of the intangible asset created (R&D output phase). Different countries apply different forms of R&D tax incentives which all reduce taxes borne by the company, be they corporation tax, local business taxes, or employee income taxes withheld by the employer. Depending on their specific design R&D tax incentives can be classified as to whether they apply during the first or the second phase of the R&D process.

Firstly, a common form of incentive is to reduce the company’s tax base by allowing an additional expense deduction over and above the actual R&D expenditure, or by accelerated depreciation of R&D-related assets. Secondly, R&D expense-based credits may be available against the tax due. The credit complements the expense deduction claimed against taxable income. The amount of the credit is either determined from the total R&D expenditure (with a possible distinction between the cost taken to expense in the accounts and those capitalised) or from the incremental expense over the previous reporting period. A third form of incentive is to reduce income taxes for R&D personnel and thus to enable the employer to reduce his employment costs. Fourthly, special tax rates, or even zero rates, can be granted to companies meeting set criteria, e.g. for young innovative corporations. In recent years, several countries have introduced so-called intellectual property (IP) box regimes. These regimes offer a low or even zero corporation tax rate for IP income assigned to the box.

The first three types of R&D tax incentives all relate to R&D expenditures incurred during the first phase of the innovation process and are thus considered to be input-based R&D tax incentives. In contrast, special tax rates for the proceeds from innovation are designed output-based R&D incentives. Figure 1 illustrates the diverse forms of R&D tax incentives and classifies them according to their input or output orientation.

C Tax Incentives for R&D

Fig. 1 R&D tax incentives

R&D input

R&D output

R&D input

Determination of a Tax

Tax base: super deductions, tax free amounts, accelerated depreciation

Tax rate: reduced tax rate

Tax payable: tax credits, deferral of tax

Source: ZEW/PwC.



Many countries grant input-based R&D tax incentives as tax deductions over and above current R&D expense, or as tax credits – or as both (see the overview in Figure 2). In Singapore, for example, tax deductions can be claimed for up to 400% of R&D costs. 19 countries offer tax credits only, while 6 countries have both regimes in place. The amount of the credit is either determined by the total volume of R&D expenditure or by the increase over the previous reporting period. Both regimes are found in practice with the amount of tax credit varying between 8–35% of qualifying R&D expenditure in volume-based regimes, and between 20–50% of qualifying expenditure in incremental regimes.

Fig. 2 Input-based R&D tax incentives

Source: ZEW/PwC. Information is based on statutory law as of the fiscal year 2014 in the EU 28, Liechtenstein, Norway, Switzerland, Australia, Canada, the US, China, India, Japan and Singapore. AT = Austria, AU = Australia, BE = Belgium, CA = Canada, CN = China, CZ = Czech Republic, DK = Denmark, ES = Spain, FI = Finland, FR = France, GB = Great Britain, GR = Greece, HR = Croatia, HU = Hungary, IE = Ireland, IN = India, IT = Italy, JP = Japan, LT = Lithuania, LU = Luxemburg, LV = Latvia, MT = Malta, NL = Netherlands, NO = Norway, PL = Poland, PT = Portugal, RO = Romania, SI = Slovenia, SG = Singapore, SK = Slovak Republic, US = United States.

BE, CN, CZ, FI, GB, GR, HR, HU, IN, LT, LV, MT, NL, PL, RO, SI, SGup to 400%

AT, AU, BE, CA, DK, ES, FR, GB, HU, IE, IT, JP, LV, MT, NL, NO, PT, SK, USVol: 8–35%Inc: 20–50%

Tax base (tax deduction) Tax payable (tax credit)

Measures

Apart from the amount of the subsidy, the effect of an R&D tax incentive crucially depends on: • Some countries offer the option of claiming the subsidy in cash. This important in

loss situations, when the company cannot use an incentive deduction or tax credit, because it does not pay any tax at all. Instead of a cash payout, countries may also grant a carry-forward of the tax incentive for a set period.

• The eligibility for the tax incentive may be tied to pre-approvals from a governmental authority. This, however, reduces planning certainty for the companies.

• Some countries require that the subsidised R&D activity be performed at home and not abroad. In the same vein, they may make the subsidy conditional on the costs being paid to local suppliers or institutes.

• Some tax incentives may be recovered at a later stage, if the IP is eventually transferred abroad. This restriction discriminates against the cross-border transfer of assets. Turning to output-based R&D tax incentives, several countries have introduced IP box regimes in recent years (see Figure 3). These regimes offer a lower or even zero corporation tax rate for income from IP that is assigned to the box regime. Cyprus, Liechtenstein, Luxembourg and the Swiss Canton of Nidwalden have IP box regimes in place without offering further input-based R&D tax incentives. All other countries that introduced IP boxes also offer input-based R&D tax incentives in addition.



IP boxes can be designed in various ways. Typical considerations are:• Some countries restrict the scope of the IP box to patents only, while others allow

various kinds of intangible assets to qualify for the patent box. The scope may range from patents and trademarks to designs, software copyrights and beyond.

• Many countries restrict the IP box to self-created IP and do not allow acquired IP to benefit from preferential treatment.

• Qualifying income may be the net or the gross income from qualifying IP. This determines the tax deductibility of the expenses associated with the qualifying IP. If the IP box tax rate applies to the net income from IP, the expenses of earning it are deductible against the low IP box tax rate. However, if gross income is granted the preferential treatment, expenses relating to the IP are deductible from the remaining income taxed at the standard corporation tax rate. So in this case, companies deduct expenses at a high tax rate and at the same time benefit from a lower income tax rate on the IP income earned.

Fig. 3 IP box regimes

2007

2003

2000–2006 2008 2009 2010 2011 2012 2013

France 16.8%

Hungary 9.5%

Belgium 6.8%

Netherlands 5.0%

Luxembourg 5.8%

Spain 12.0%

Malta 0.0%

Nidwalden (Switzerland) 8.8%

Liechtenstein 2.5%

Cyprus 2.5%

UK 10.0%

Source: ZEW/PwC.


The Survey

D The Survey

To gain deeper insights into the effect of R&D tax incentives on the business decisions of R&D intensive multinationals, PwC and the Centre for European Economic Research (ZEW) in Mannheim conducted a survey of selected PwC Global clients. The selection was based on size of the company and the scale of its R&D activity. The main purpose was to provide an insight into extent to which senior management personnel allowed R&D incentives (or lack of them) to affect their business decisions. The point was that if policy makers want to implement an innovation-friendly tax system, it is essential for them to understand the perspective of the target decision-makers. The survey questionnaire was sent to the preselected respondents. It was closed in October 2013.

Fig. 4 Characteristics of companies included in the study

Australia

Austria

Finland

Germany

Hong Kong

Israel

Mexico

South Africa

Switzerland

United Kingdom

United States

1

1

1

25

1

1

2

1

6

1

7

Public administration

Health, pharmaceuticals, biotechnologies

Information technologies

Banking, finance, insurance, real estate

Wholesale and retail trade

Transport and utilities

Heavy industries

Manufacturing: food, textiles and chemicals

Mining, construction

Agriculture, forestry, fishing

2

4

4

3

1

3

16

9

4

1

Other 2%

Private 23%

Public 75%

Notes: In this figure, responding companies are grouped according to the place of residence of the ultimate (top) holding company of the group to which they belong. The industries in which the responding companies operate are also depicted. Industry classification is based on the US Securities and Exchange Commission's (SEC) standard industrial classification (SIC). Finally, responding companies are classified as publicly or privately owned.


The Survey

Figure 4 provides an overview of the characteristics of the survey respondents. Half of them are located in Germany, followed by the US and Switzerland. The sample also includes companies from Australia, Austria, Finland, Hong Kong, Israel, Mexico, South Africa and the UK. Most groups are publicly traded (35 groups), but the sample also includes eleven privately held groups and one group that indicated some other ownership structure, although without specifying it any further. The largest share of the respondents operate in heavy industries (16 firms), followed by 9 in manufacturing industry.

On average, the respondents have total assets of $70.8 billion, total liabilities of $52.3 billion and total annual sales of $30 billion. The average net income is $1.8 billion and the return on assets is 6.19%. The average respondent firm employs 61,537 people (full-time equivalents), 5,537 of which are in R&D, and has been in business for approximately 87 years. The average balance sheet amount of intangible assets is slightly more than one-tenth of the total assets ($8 billion) and the average spending on R&D is $1.2 billion per year (see Table 1).

Fig. 5 Selected descriptive statistics of respondent firms

Variable No. of responses Mean Median

Total assets 47 70.8 22.8

Total liabilities 47 52.3 14.2

Total sales 47 30.0 18.0

Net income 46 1.8 0.7

Return on assets 45 6.19% 6.10%

Intangible assets 45 8.0 1.4

R&D expenses 43 1.2 0.2

Total employees 47 61,537 44,000

R&D employees 35 5,537 1,000

Firm age 47 87 100

Notes: All financial statement information is in billion US dollars. Firm age is measured in years.

“Our sample contains 30 companies that are among the top 2,000 Scoreboard firms (EU Industrial R&D Investment Scoreboard published by the European Commission covering 90% of worldwide R&D expenditure spent by private businesses), and even 15 that are among the top 200 R&D investors worldwide. Moreover, 9 respondents are among the top 50 applicants to the European Patent Office. The total R&D spending of all sample businesses amounts to approximately $53.4 billion. This corresponds to approximately 8% of the total business R&D spending within the OECD in 2012.”


The Survey

3 The total business R&D spending within the OECD in 2012 amounts to $649.2 billion. The figures are taken from the OECD database on business enterprise expenditure on R&D (BERD). The figures are measured at constant prices and purchasing power parity (PPP).

Although the sample of 47 firms is small, their volume in R&D spending and, thus, their share in the overall amount of R&D spending is very important. The distribution of R&D expenditure across companies worldwide is highly skewed, meaning that the majority of R&D spending is concentrated in the hands of only a small number of companies. This is highlighted by the EU Industrial R&D Investment Scoreboard published by the European Commission (EC), which covers the top 2,000 investors in R&D worldwide. These 2,000 companies represent more than 90% of the total R&D expenditure by private businesses. Our sample contains 30 companies that are among the top 2,000 Scoreboard firms, and even 15 that are among the top 200 R&D investors worldwide. Moreover, 9 respondents are among the top 50 applicant firms to the European Patent Office in 2013. The total R&D spending of all sample businesses amounts to approximately $53.4 billion. This corresponds to approximately 8% of the total business R&D spending within the OECD in 2012.3

The survey is unique in this field in that it relies on the expert knowledge of the respondents. From the 47 respondents, 29 respondents are tax department heads, one is the vice president of the tax department, four are the CFO of their company, one is the vice president of the CFO, six are local tax managers, one is the chief executive officer (CEO) of the company, one the assistant to the CEO and another the assistant to the CFO. Three interviewees did not disclose their job title.

“The survey reveals many interesting results. Among others, the survey respondents answered that the most important driver of the effectiveness of R&D tax incentives are an immediate impact on liquidity, planning certainty and simplicity. Another key finding is that taxes are more important in the IP location decision than they are in the location decision of R&D input. Moreover, the majority of respondents said that they had considered holding patents in a different country than where the R&D was performed.”


Insights from R&D Intensive Multinationals

E Insights from R&D Intensive Multinationals

Scientific studies confirm the positive relationship between R&D tax incentives, like tax credits or additional allowances, and the amount of R&D spending by companies.4 On average, a 1$ tax incentive leads to an additional 1$ spending on R&D.5 When firms were asked whether they are confident to make use of all available R&D tax incentives, only 35.89% of the respondents feel confident or very confident. The great majority (41.03%) is neutral and 23.08% are not confident or not at all confident they had exploited available R&D tax incentives to their fullest extent.

One reason for the low exploitation of R&D tax incentives may lie in actual or perceived difficulties of making the claim. These difficulties may be external or internal. However, an unclaimed tax incentive will not foster R&D efforts. Thus, the survey contained a question on the attributes of tax incentives. Companies were asked to rank the top three attributes which make a tax incentive most appealing to their group. They answered that an immediate impact on liquidity (i.e. that a refund is granted in loss situations) is the top attribute of an R&D tax incentive. The second most important is planning certainty. It is important to companies that the continuity of a tax incentive is assured. Third most important factor is simplicity of administration. The two least important factors ae restrictions on the location of R&D activity and patents. These restrictions disbar the tax incentive if the R&D activity or the resulting patent is located abroad. Nonetheless, the answers to this question show that respondents are little worried about such restrictions, indicating that their R&D is not carried out abroad.

4 Hall B. and J. van Reenen (2000) How effective are fiscal incentives for R&D? A review of the evidence, Research Policy, Vol. 29, pp. 449–469. They provide an overview of the scientific literature in this field of research.

5 See Spengel C. et al., Steuerliche Förderung von Forschung und Entwicklung (FuE) in Deutschland, Berlin 2009 (p. 13–21). The authors find this elasticity from the evaluation of around 60 empirical studies.

Fig. 6 The use of tax incentives for R&D

Source: ZEW/PwC.

Not at all important

Not importantVery important

Important

Neutral

Confidence that all available R&D

tax incentives are made use of

10%13%41%21%15%



A number of factors influencing the decision of businesses on how much they spend on R&D. The following figure presents results to a survey question that tries to assess these factors. In particular, the question aims at comparing tax, accounting and financial concerns of companies. The first two determinants of the scale of R&D spending – the availability of internal and external funds – are financial concerns and relate to the common notion that R&D investments are financially constrained. The second and third factors – the tax rate on profits and the availability of R&D tax incentives – are tax matters. The last factor – the pressure to meet earnings benchmarks – is an accounting concern and relates to previous scientific studies that have documented R&D expense cuts by managers motivated by the achievement of earnings benchmarks.

The figure clearly highlights that the availability of internal funds is the most important factor in the decision how much is spent on R&D. All other factors presented here are considerably less important. Still, the second most important factor is the pressure to meet earnings benchmarks. Both tax factors are on average not important. But the availability of R&D tax incentives is the third most important factor among the five factors listed (33.33% indicated that R&D tax incentives are important or very important). We conclude that R&D tax incentives may promote R&D investments if they mitigate the liquidity constraints on companies.

Fig. 7 Attributes of R&D tax incentives

Source: ZEW/PwC.

The tax incentive immediately impacts on

liquidity.

The tax incentive enables planning certainty.

The administration of the tax incentive is simple.

The tax incentive is applied without restrictions on the

location of patents.

The tax incentive is applied without restrictions on the

location of R&D activity.



A major concern on the European and OECD policy agenda is tax competition targeting intellectual property rights, fuelled by the trend towards the implementation of IP box regimes in many European countries (see Figure 3). A great part of the survey is therefore attributed to questions about where companies locate their R&D activity and the associated intellectual property rights. Figures 9 and 10 depict where respondent companies are engaged in R&D and where their patents are held. Not surprisingly, the most important countries both for R&D activity and for the holding of patents are Germany, the United States and Switzerland, because the majority of respondents are resident in these countries.

A few examples confirm the notion that patents tend to be held in low-tax jurisdictions. For example, Luxembourg is not listed among the countries where R&D activity is performed, but is among the countries where patents are located. Furthermore, the Netherlands is less often listed as a research country than as a holding location for patents. Both Luxembourg and the Netherlands have IP box regimes, indicating that these regimes might attract patents from abroad. Conversely, Japan, as a high-tax jurisdiction, is one example where more R&D activity takes place than where patents are held.

Fig. 8 The importance of factors influencing the amount of R&D spending

27%37%15%22%

24%29%14%26%7%

19%24%24%21%12%

12%10%39%27%12%

14% 7%33%41%The availability of internal funds

The availability of external funds

The tax rate on profits, including IP box regimes

The availability of R&D tax incentives in the location(s) where your group conducts R&D activity

The pressure your group faces to meet earnings benchmarks

Source: ZEW/PwC.



Important

Neutral

5



5 10 15 20 25 30 35

Fig. 9 Countries where R&D activity is performed

Source: ZEW/PwC.

Australia

Austria

Belgium

Brazil

Canada

China

Croatia

Czech Republic

Finland

France

Germany

Hungary

India

Ireland

Israel

USA

UK

UAE

Turkey

Switzerland

Sweden

South Africa

Singapore

Russia

Poland

Norway

Netherlands

Japan

Italy

Korea

Mexico

0 5 10 15 20 25 30 350

Fig. 10 Countries where patents are held

Source: ZEW/PwC.

Australia

Austria

Belgium

Brazil

Switzerland

Sweden

South Africa

Singapore

Norway

Netherlands

Mexico

Jersey

Japan

Italy

Israel

Ireland

India

Germany

France

Finland

Czech Republic

China

Canada

Luxembourg

Russia

USA

UK

Notwithstanding this evidence, taxes are generally seen as important in location decisions for R&D investments. Respondents were asked to indicate the importance of taxes in both the location decision of R&D activity and the location decision of IP on a five-point scale. In both cases, the majority of respondents said that taxes are not important or not at all important.



Nevertheless, taxes are more important in the IP location decision than they are in the location decision for the R&D activity, as depicted by Figure 11. Regarding R&D input, 82.93% of respondents said that taxes are not important or neutral while only 57.89% thought so with respect to R&D output, i.e. IP location. On the other hand, only 17.07% said that taxes are important in the R&D location decision, while in the IP location decision 42.11% considered taxes to be important.

A closer examination reveals which country characteristics are most important in the R&D location decision (see Figure 12 below) for the respondents of the survey. Accordingly, 87.5% answered that the skills and the availability of the workforce is important or very important, 73.17% said that legal stability and security of IP are important or very important and 63.42% said that for the environment, infrastructure and culture of a country. 21.95% of the interviewees considered wage costs to be an important location factor and 17.07% think that taxes are important. Interestingly, no interviewee answered that wage and tax costs are very important.

Fig. 11 The importance of taxes in the R&D location decisions: Input versus Output

Source: ZEW/PwC.

17%

42%

83%

58%

R&D input

R&D ouput

Important Not important or neutral

Fig. 12 The importance of general factors in the R&D location decision

Source: ZEW/PwC.



Important

Neutral

Skills and availability of workforce

8%13%75%

Legal stability and security of IP

7%15%46% 27%

Country environment, infrastructure, culture

7%24%27% 37%

Wage costs 7%24%46%22%

Tax costs 17%34%31%17%

5%

5%

5%



The ranking of country characteristics as determinants for IP location is slightly different (see Figure 13 below). Legal stability and security of IP is clearly the most important factor for the IP location decision (as many as 92.31% said this country characteristic is important or very important). The second most important factor is the country environment, infrastructure and culture, where 60.53% answered that this characteristic is important or very important. Thirdly, 45.95% of respondents indicated that skills and the availability of the workforce are an important or very important country characteristic. Overall, wage and tax costs are not important factors in the IP location decision. This is similar to the R&D location decision. Tax costs are more important in the IP location decision (more than twice as many respondents as in the R&D location decision or 42.11% said taxes are important or very important) than they are in the R&D location decision (only 17.07% said taxes are important).

A follow-up question tried to shed more light on specific tax factors and examine the relative importance of various tax related concerns in the R&D and IP location decisions. In general, the previous questions show that taxes are of secondary or even tertiary importance over other country characteristics such as the legal stability, the infrastructure or the skills of the workforce. Nevertheless, all else being equal, tax factors may be decisive when it comes to the choice between two potential jurisdictions. For this reason, the aim is to find out which specific tax aspects are relevant to firms’ location decisions.

Fig. 13 The importance of general factors in the IP location decision

Source: ZEW/PwC.



Important

Neutral

Skills and availability of workforce

Legal stability and security of IP

Country environment, infrastructure, culture

Wage costs

Tax costs

22%

5%

5%5%

3

33

5%27%30%16%

28%64%

29%13% 47%

34%42%18%

16%29%13%13% 29%



When considering the tax factors in the decision on the jurisdiction where the IP is to be held, the picture looks slightly different. Here, the most important aspect is the double tax treaty network, where 57.9% answered that it is important or very important to the IP location decision. The second most important tax aspect is transfer pricing regulation. Issues regarding the imposition of an exit tax upon the cross-border transfer of assets were rated third most important by the interviewees (51.28% said it is an important or very important issue). But almost equally important are tax regulations on R&D expenditure and the statutory tax rate applicable to income from IP. Generally not important are loss-offset provisions.

Looking at the decision of where to set up R&D activity, the most important tax factor is the regulation relating to the tax consequences of R&D expenditure, including specific tax incentives like additional tax allowances or tax credits. 56.09% of the respondents answered that these regulations are important or very important. The second and third most important items are the double tax treaty network of a country (47.5% said this is important or very important) and its transfer pricing regulations (46.34% said this is important or very important). Tax factors that are not generally felt to be important in the R&D location decision are exit tax provisions, the statutory tax rate and loss-offset regulations.

Fig. 14 The importance of tax factors in the R&D location decision

Source: ZEW/PwC.



Important

Neutral

The applicable tax rate on profits

Tax regulations relating to R&D expenditure (tax credits,

deductions)

Imposition of exit tax upon the cross-border transfer of assets

Loss-offset provisions

Transfer pricing regulations

Double tax treaty network

17%

12%

17%

18%

12%

15%

17%

7%

15%

28%

10%

39%

24%

32%

30%

32%

28%

17%

12%

15%

20%

22%

39%

24%

20%

32%

28%

5

5

10%



The responses to the previous questions give some indication that companies rank location factors differently in the decision on where to engage in R&D activity than on where to hold the IP. The two decisions are, therefore, distinct from each other. This also becomes clear in the question on companies’ consideration of holding patents in a country other than that in which the corresponding R&D activity took place. The majority of respondents, 62.79%, said that they had considered holding patents in a country different to where the R&D was performed.

Fig. 16 Has your firm considered holding patents in a country other than where the R&D activity took place?

Source: ZEW/PwC.

Yes

No

63%

37%

Fig. 15 The importance of tax factors in the IP location decision

Source: ZEW/PwC.

The applicable tax rate on profits

Tax regulations relating to R&D expenditure (tax credits,

deductions)

Imposition of exit tax upon the cross-border transfer of assets

Loss-offset provisions

Transfer pricing regulations

Double tax treaty network

15%15%26%18% 26%

10%18%23%13% 36%

13%

8%

8%

21%

15%

18%

18%

21%

16%

29%

18%

26%

24%

18%

33%

32%

21%

23% 36%3



Important

Neutral



From a tax perspective, it is, however, interesting that patents might be held in a country other than that in which the R&D expenses were incurred, because the expenses would then be deducted from income taxed at a different rate from that charged on the profits from the innovation. However, the following figure shows that the majority of patents are held in the country where the development was actually financed. 11.63% of respondents answered that all their IP is located in the same countries in which the associated R&D expenses were incurred and 44.19% indicated that this was the case for more than 80% of their IP rights. On average, the firms that are included in this study, hold approximately 60% of their IP in the same country in which R&D expenses were incurred.

Fig. 17 The percentage of patents held in the same country in which the associated R&D expense was incurred

0% 1–20% 21–40% 41–60% 61–80% 81–99% 100%

12%

33%

12%

19%

9%

5%

12%

Source: ZEW/PwC.

Exploring the tax planning topic further, the survey investigates the decision to locate patents away from where the R&D activity took place and tries to discover why firms considered locating patents at a low-tax affiliate. In the sample of respondents, only 36.36% have actually considered transferring patents to a low-tax affiliate. Thus, while 62.79% considered a geographical separation of R&D and IP location, only 36.36% thought of locating the IP in a low-tax jurisdiction.

Fig. 18 Has your firm considered locating patents at an affiliate that is subject to comparatively low tax rates?

Yes

No

36%

64%

Source: ZEW/PwC.



Figure 19 presents the considerations and motives of companies in their decision to locate patents away from where R&D took place, in a low-tax jurisdiction. Of the companies that considered a geographical separation of the R&D and IP locations, the respondents generally agree that contracting out R&D activity to an affiliate abroad is a technique for achieving a geographical separation of IP location and R&D activity. An alternative way of migrating patents away from where the product was developed is an explicit transfer cross-border, e.g. if the patent is sold to a foreign affiliate. Such a transfer, however, triggers an exit tax in most countries.

Not surprisingly, the respondents, generally, agree with the notion that exit taxes are an important obstacle to the cross-border transfer of patents within a multinational enterprise. These answers reveal that firms identified contract R&D as an alternative structure to a transfer of the intangible after the event in order to achieve a geographical separation of R&D activity and the ownership of the resulting IP rights. However, the interviewees generally disagreed with the idea that they transfer R&D activity to countries that are attractive for holding patents in order to avoid a costly transfer of patents later. Thus, it can be concluded that the respondents’ R&D activities are rather immobile factors. Lastly, the respondent companies deny having considered spreading IP ownership over several countries with cost-sharing agreements. This indicates that cost-sharing agreements are less likely to be considered as an alternative to contract R&D agreements or an explicit transfer.

Regarding the motives for companies considering locating patents in low-tax affiliates, the most important motive the expected high rate of return on a patent. A significant differential between country tax rates is almost equally important. Thirdly, the relocation of patents to low-tax affiliates reduces the overall tax burden of the multinational firm. All three answers clearly indicate that tax-saving considerations are the main driver in the decision to migrate patents to low-tax jurisdictions. Lastly, it is important that the separation can be achieved in a simple manner. Interestingly, the average rating of all four answers lies considerably above 2, indicating that all four answers are important or even very important considerations for the respondent companies.

Finally, the companies indicated how they actually moved patents to low-tax countries. They answered that they prefer to sell patents to affiliates in low-tax countries rather than conducting R&D activity there and the registering the patent in local ownership. These insights suggest that companies indeed view IP to be more mobile than the R&D activity. Thus, the answers suggest that the respondents view tax planning as simpler and less costly when done with IP than with real R&D activity.



Fig. 19 Tax planning considerations in the IP location decision

How well do the following statements reflect your group’s considerations in the decision to locate patents away from where R&D took place?

Average rating

Our group uses contract R&D to locate patents in countries different from where the associated R&D activity took place.

2.74

If exit taxes are in place, they pose an important obstacle to the cross-border transfer of patents within our group.

2.35

Transferring patents is expensive. Therefore our group transfers R&D activity to countries that are attractive for holding patents.

1.73

By using cost-sharing agreements, patents may be spread across several countries.

1.65

How well do the following statements reflect why your group considered locating patents at an affiliate that is subject to comparably low tax rates?

Average rating

Because the expected return related to a patent is high. 3.06

Because there is a large difference in tax rates between countries. 3.00

Because this reduces our group’s overall tax burden. 2.88

Because patents are internationally mobile assets that can be separated easily from other production affiliates in our group at low cost.

2.75

How does your group achieve locating patents in low tax countries?Average

rating

By selling patents to affiliates in low tax countries. 2.40

By conducting R&D in low tax countries. 1.47

Notes: The table presents answers to the questions stated in bold, where respondents were asked to indicate on a five-point scale whether they ‚strongly disagreed‘ or ‚strongly agreed‘ with a statement. Therefore, a ‚4‘ indicates that respondents strongly agreed and a ‚0‘ indicates that they did not agree at all. The figure presents average ratings of the statements across all respondents.


Summary

F Summary

• To sum up, an immediate impact on liquidity, planning certainty and simplicity are among the most important drivers of the effectiveness of R&D tax incentives.

• The availability of internal funds is the most important factor in the decision how much is spent on R&D, followed by the pressure to meet earnings benchmarks and the availability of R&D tax incentives.

• Taxes are more important in the IP location decision than they are in the location decision of R&D input. Regarding R&D input, 82.93% of respondents said that taxes are not important or not at all important while only 57.89% thought so with respect to R&D output. On the other hand, only 17.07% said that taxes are important or very important in the R&D location decision, while in the IP location decision even 42.11% said that taxes are important or very important.

• Regarding the R&D location decision, the most important country characteristic is the skill and the availability of the workforce. Surprisingly, tax costs are the least important factor. With respect to the IP location decision, the most important country characteristic is the legal stability and the security of IP, while tax costs are rated second least important.

• Looking at tax aspects only, the most important factor in the R&D location decision are the R&D incentives, such as additional allowances or tax credits. By contrast, the most important tax aspect in the IP location decision is the double tax treaty network of a country, followed by transfer pricing regulations and exit tax concerns.

• The majority of respondents, 62.79%, said that they had considered holding patents in a different country than where the R&D was performed.

• Even so, the majority of patents is located in the same country where its development was financed. 11.63% of respondents even replied that all their IP is located in the same countries in which the associated R&D expenses were borne and 44.19% indicated that this was the case for more than 80% of their IP rights.

• In the sample of respondents, only 36.36% have actually considered transferring patents to a low-tax affiliate.

• The respondent firms identified contract R&D as an alternative structure to the explicit transfer in order to achieve a geographical separation of R&D activity and the ownership of the resulting IP rights. However, cost-sharing agreements are less popular.

• Respondents confirm that the relocation of patents to low-tax affiliates reduces the overall tax burden of the multinational firm.

• To the question on how they would actually relocate patents to low-tax countries, there is a preference to sell patents to affiliates in low-tax countries, rather than conducting R&D activity in that country and then applying for patent protection locally.


Contacts

Contacts

About usOur clients face diverse challenges, strive to put new ideas into practice and seek expert advice. They turn to us for comprehensive support and practical solutions that deliver maximum value. Whether for a global player, a family business or a public institution, we leverage all of our assets: experience, industry knowledge, high standards of quality, commitment to innovation and the resources of our expert network in 157 countries. Building a trusting and cooperative relationship with our clients is particularly important to us – the better we know and understand our clients’ needs, the more effectively we can support them.

PwC. 9,400 dedicated people at 29 locations. €1.55 billion in turnover. The leading auditing and consulting firm in Germany.

Prof. Dr. Jost H. HeckemeyerLeibniz Universität HannoverInstitut für Betriebswirtschaftliche SteuerlehreKönigsworther Platz 130167 Hannover, GermanyTel: +49 511 [email protected] MannheimCorporate Taxation and Public FinanceL7, 168161 Mannheim, Germany

Dr. Katharina RichterPwC Austria, ViennaErdbergstraße 2001030 Vienna, AustriaTel +43-1-501 [email protected] MannheimCorporate Taxation and Public FinanceL7, 168161 Mannheim, Germany

Dipl.-Vw. Margarete SchätzlerPwC Frankfurt, Germany Friedrich-Ebert-Anlage 35–3760327 Frankfurt am Main, GermanyTel: +49 69 [email protected]

Dr. Frank SchmidtPwC Frankfurt, Germany Friedrich-Ebert-Anlage 35–3760327 Frankfurt am Main, GermanyTel: +49 69 [email protected]

Prof. Dr. Christoph SpengelUniversity of Mannheim Chair for Business Administration and Taxation IISchloss, Ostflügel, 68131 Mannheim, Germany Tel +49 621 181-1705 [email protected] MannheimCorporate Taxation and Public FinanceL7, 168161 Mannheim, Germany

www.pwc.com

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