WASHINGTON D.C. - 21 SEPTEMBER 2011

PUBLISHED BY HENLEY MEDIA GROUP LTD IN ASSOCIATION WITH THE COMMONWEALTH SECRETARIAT

WASHINGTON D.C. - 21 SEPTEMBER 2011

PUBLISHED BY HENLEY MEDIA GROUP LTD IN ASSOCIATION WITH THE COMMONWEALTH SECRETARIAT

TAX RELIEFS AND CREDITS FOR RESEARCH AND DEVELOPMENT

SPECIAL REPORT BY

PKF International is a contributor to the Commonwealth Finance Ministers Reference Report 2011,

produced by Henley Media Group.

1

AUSTRALIA

New definition of R & D brings uncertaintyOn 24 August 2011 the Australian Parliament approved

legislation to change the taxation incentive regime for companies

conducting R&D activities in Australia. Effective for income years

commencing from 1 July 2011, the new provisions provide an

increased level of financial assistance to an expanded range of

companies. The downside for existing claimant companies is

that the legislation defining what is R&D for tax purposes has

been changed considerably and has introduced uncertainty as

to how the scheme will be administered.

From Tax Deductions to Tax CreditsOne of the fundamental changes to the R&D tax incentive

regime involves changing the nature of the tax benefit from

additional tax deductions to a tax credit. Under the existing

incentive, companies were allowed a 125 per cent tax

deduction on eligible R&D expenditure with up to 175 per cent

tax deduction on increased R&D expenditure. For tax loss

companies with group turnover under Aus$5 million and R&D

expenditure under Aus$2 million, the R&D tax deductions were

refundable at the 30 cents in the dollar company tax rate.

Under the new credit regime, R&D expenditure will become

non tax-deductible but subject to a tax credit at either the 45

per cent or 40 per cent rate. The rate of tax credit will depend

on whether group turnover is less than Aus$20 million (45 per

cent credit) or more than Aus$20 million (40 per cent credit).

This equates to 150 per cent and 133 per cent rates of tax

deductions under the current scheme, hence the increased

level of headline financial assistance.

For sub Aus$20 million group turnover companies, the 45 per cent

credit is refundable if the companies are in a tax loss position. Unlike

the existing tax concession rules, access to the refundable tax

credit is not restricted by a maximum R&D expenditure threshold.

Further, there is no limit on the amount of R&D expenditure for which

the R&D Tax Credit can be claimed. This will be of particular benefit

to start up technology companies that will now be able to effectively

‘cash out’ their R&D expenditure at the 45 per cent rate. Many of

these companies were previously precluded from the refundable

benefit because of the previous Aus$2 million R&D expenditure

thresholds applied to the refund criteria.

Access for Foreign CompaniesThe new regime also expands the range of entities that can

access the R&D tax benefit. The concession will be expanded

to encompass foreign companies operating in Australia through

a permanent establishment. This will bring in foreign companies

carrying on R&D through a branch in Australia. Foreign ownership

of the results of the R&D activity is specifically accommodated

under the new regime.

Changes to the R&D Activities Eligibility CriteriaWhile the benefits of the new regime are obvious, there are also a

number of areas where the eligibility criteria have been tightened

to potentially exclude a range of activities that are currently eligible

for the tax incentive. The definition of what constitutes R&D for tax

purposes has been completely overhauled with the introduction of

new terminology.

The previous focus for ‘core R&D’ on ‘systematic, investigative and

experimental activities involving innovation or high levels of technical

risk’ has been replaced with ‘experimental activities for the purpose

of creating new knowledge’. While there would appear to be little

substantive difference in the application of the new terminology, it

TAX RELIEFS AND CREDITS FOR RESEARCH AND DEVELOPMENTWith many of the developed world’s economies still struggling to recover from the global economic crisis, governments are looking at

targeted fiscal incentives for high-tech industries as a potential engine for future growth. Some of the most popular measures adopted

in many territories are tax reliefs and credits for research and development (R & D) expenditure.

In this report, tax experts from PKF International member firms in four of the key Commonwealth nations – Australia, Canada, South

Africa and the United Kingdom summarise the latest R & D developments in their countries while the Indian firm gives an introduction

to transfer pricing legislation in India.

2

will be in the administrative interpretation where uncertainty is likely

to be introduced, with the Government flagging the intent for a

tighter interpretation of eligibility.

Areas targeted for specific tightening are those where the

Government considers the activities to be part of ‘business

as usual’ of certain businesses. Those targeted include

businesses engaged in some form of production such as

manufacturers and mining companies, together with certain

computer software developments.

Changes to the definition of supporting R&D in the new R&D Tax

Credit will subject companies to a ‘dominant purpose’ test if they

conduct activities that produce or are directly related to producing

goods or services. Such activities will need to support core

experimental development. Production activities that are core

experimental activities will continue to be eligible R&D.

New feedstock rules will also be applied to producers where R&D

results in the production of goods of value. The new rules do not

impact on the deductions for material inputs, however, they may be

deemed assessable income, depending on the value of the output

of the R&D. There is concern amongst the business community that

an unsupportable and narrow interpretation of the new legislation

will confine assistance to companies whose R&D is a failure, with

limited entitlement for successful R&D conducted by productive

companies. While the terms of the legislation are fairly innocuous,

according to the Government’s stated position in published material

associated with the new legislation, there is an intent to move away

from supporting applied ‘industry R&D’ towards supporting more

basic and early stage development activities.

Computer SoftwareComputer software developers are also subject to a new

‘dominant purpose’ test applying to their core experimental

activities. Computer software development whose main

purpose is for performing internal administrative functions,

including the administration of business functions, is precluded

from eligibility as ‘core R&D activities’. This test replaces the

‘multiple sale’ criterion as a means of excluding development

of ‘internal’ software from the scope of the R&D Tax Incentive.

For further information please contact:

CANADA

Longstanding program to promote the advancement of technologyCanada has a longstanding tax incentive program aimed

at promoting the advancement of technology in Canada.

Companies making qualified expenditures in connection

with Scientific Research and Experimental Development

(SR&ED) activities in Canada are entitled to receive a federal

investment tax credit. The credits reduce federal tax payable

but, for certain entities, the credits are fully refundable where

there is no federal tax liability. The refunds assist emerging

businesses and others that are not taxable in the year. The

federal program is administered by the Canada Revenue

Agency (CRA). Most provinces offer parallel programs with

tax credits for qualifying activities in the particular province.

Available Tax BenefitsQualifying current and capital expenditures are fully deductible

in computing taxable income.

The federal credit rate and the availability of a cash refund

are dependent upon the nature of the entity and, in the case

of a corporation, its tax status and associated group’s prior

year taxable income and prior year taxable capital employed

in Canada.

A Canadian-controlled private corporation (CCPC) is essentially

a private corporation that is not controlled by one or more

non-residents of Canada or one or more public corporations

or a combination of those parties. A CCPC can earn a federal

investment tax credit of 35 pet cent on up to Can$3 million of

qualified current expenditures and that credit is 100 per cent

refundable. For current expenditures in excess of the Can$3

million limit, the credit rate is 20 per cent and that credit is 40

per cent refundable.

The corporation’s expenditure limit will be eroded on a pro-

rata basis by the aggregate of its associated group’s taxable

income over the threshold amount (Can$500,000 in 2010)

or the aggregate of its associated group’s taxable capital

employed in Canada above the threshold amount (Can$10

million in 2010). Slightly different rules apply for capital

expenditures relating to computers, equipment and machinery

used in SR&ED.

A corporation which is not a CCPC will receive a 20 per cent credit

on all qualifying expenditures. This credit can only be applied

to reduce taxes payable and is not refundable. Individuals,

partnerships and trusts carrying out qualifying SR&ED activities

will also receive a non-refundable 20 per cent credit.

Provincial tax credits are generally at a lower rate than the

federal credit. The combined federal and provincial tax credits

range from:

Graham Wakeman,

Partner - Government Incentives,

PKF East Coast Practice

Tax Consulting Group,

Sydney,

NSW 2000,

Australia

Tel: +61 2 9251 4100

Direct Line: +61 2 9240 9901

Email: graham.wakeman@pkf.com.au

www.pkf.com.au

3

• 35percentto48percentforCCPCs

• 20 per cent to 32 per cent for non-CCPCs and non-

corporate entities.

Federal investment tax credits claimed in a particular year

reduce the SR&ED expenses used to compute taxable

income in the following year. Provincial tax credits and other

government assistance generally reduce the SR&ED expenses

in the current year. Provincial tax credits on the proxy amount

used to substitute for overhead expenses reduce SR&ED

expenses in the following year.

Qualifying Expenditures and ProjectsFrom the CRA’s perspective, the particular project must meet

three main criteria to qualify for SR&ED incentives:

1. Technological advancement or advancement of scientific

knowledge

2. Technological uncertainty

3. Systematic investigation.

Work that qualifies for the SR&ED program specifically includes:• Basic research where there is no specific practical

application in view

• Applied research where there is a specific practical

application in view

• Experimental development to achieve technological

advancement to create new materials, devices, products

or processes or to improve existing ones

• Support work in engineering, design, operations research,

mathematical analysis, computer programming, data

collection, testing or psychological research but only if the

work is commensurate with, and directly supports, the eligible

experimental development or applied or basic research.

The following activities are specifically NOT eligible for benefits under the program:• Marketresearchorsalespromotion

• Quality control or routine testing of materials, devices,

products or processes

• Researchinthesocialsciences(psychology,economics,

business, law, history, archaeology, literature, philosophy)

and humanities research

• Prospecting,exploringordrillingfororproducingminerals,

petroleum or natural gas

• Commercial production of a new or improved material,

device or product, or the commercial use of a new or

improved process

• Stylechangestoanexistingproduct

• Routinedatacollection.

Expenditures incurred for SR&ED may include wages, materials,

contract services, equipment lease costs, third party payments

and certain capital expenditures. Overhead expenses may

be claimed either on a specifically identifiable cost basis or by

electing to use the simplified ‘proxy method’ which substitutes

the actual overhead expenses with a proxy amount determined

by multiplying eligible SR&ED wages by 65 per cent.

For further information please contact:

Bill Macaulay, CA

Tax Partner,

SmytheRatcliffe LLP,

Vancouver,

Canada

Email:

bmacaulay@smytheratcliffe.com

Direct Telephone:

+1 604 694 7536

4

INDIA

An introduction to Transfer Pricing Law in IndiaThe law on Transfer Pricing (TP) has evolved in India as

a logical consequence of the exponential increase in

international transactions post-globalisation. The participation

of multinational groups in the economic activities of India has

given rise to complex issues, particularly so when it involves

transactions between two enterprises belonging to the same

multinational group.

The Finance Act 2001, which introduced an entire gamut of

provisions dealing with TP, came into force on 1 April 2002

and was applicable to the assessment year 2002–03 and

subsequent years.

The law essentially mandates arm’s length pricing of

international transactions between associated enterprises,

specifies the methods for determining the arm’s length price

(ALP), details the documentation requirements for companies

entering into international transactions, and stipulates

penalties for non-compliance.

Key Features of Transfer Pricing RegulationsThe Transfer Pricing law in India requires that pricing of

international transactions between two Associated Enterprises

(AEs), either or both of whom are non-residents, should be at

arm’s length, a detailed definition of which has been given in the

law. The definition is given based on certain objective parameters

to assess the relationship between two entities and include:

• ShareCapitalCriterion:WhenoneAEholds26percent

or more of share capital in the other or when a third party

holds 26 per cent or more share capital in both AEs

• Loan-basedCriterion:LoanadvancedbyoneAEconstitutes

51 per cent or more of total assets of another AE

• Management Control Criterion: More than half of the

directors or one or more executive directors are actually

appointed by one AE in the other AE.

If the TP provisions are applicable, the ALP of the international

transaction(s) has to be determined. The pricing at arm’s

length would need to be established by internationally

accepted transfer pricing methods including:

1. Comparable Uncontrolled Price Method (CUP)

2. Resale Price Method (RPM)

3. Cost Plus Method (CPM)

4. Profit Split Method (PSM)

5. Transactional Net Margin Method (TNMM)

To date, judicial pronouncements indicate a bias towards the

CUP method.

Safe Harbour Provisions‘Safe harbour’ refers to circumstances in which the tax authorities

will accept the transfer price declared by the assessee. The

principle is that, where the application of the most appropriate

method results in more than one price, a price which differs

from the average of such prices within a permissible range

may be taken as the ALP. The allowable variation will be such

percentage as may be notified by the Central Government. As

of now, no percentage has been notified.

Penalties for Non-compliance Assessees with international transactions of the value

exceeding Rs.1 core are statutorily required to maintain

and submit the prescribed documents with regard to the

international transactions entered into by them. A report from

aCharteredAccountant, asprescribed in Form3CEB, also

needs to be provided before the due date for filing the return

of income.

Non-compliance with these statutory requirements attracts a

levy of penalties under the law.

The penalty can be waived if the assessee can prove that the

default is due to a reasonable cause.

Advance Pricing Agreement (APA) An APA is an arrangement between the taxpayer and the taxing

authority whereby the two parties agree on the transfer pricing

policy for specified transactions of the taxpayer over a given period

of time. Such a ruling would be binding on the taxpayer and the

tax authorities. The scheme is intended to bring certainty in the tax

Nature of Default Penalty Prescribed

Failure to maintain

prescribed information /

documents

2 per cent of value of

international transaction

Failure to provide

information / documents

during audit

2 per cent of value of

international transaction

In case of adjustment to

taxpayer’s income by AO

consequent to determination

of ALP and assessee not

being able to explain the

genuineness (leading to

inference of concealment)

100 – 300 per cent of the

tax on adjustment amount

Failure to provide certificate

inForm3CEB

Rs. 1,000,000

5

liability of the transacting parties but, as the concept is not yet in the

current law, the provisions are still at the conceptual stage.

In summary, Transfer Pricing Law in India is in an evolving stage

and, considering the practical issues, there is considerable

scope for litigation in this area. Hopefully, in the near future,

the law would become streamlined by means of amendments

to remove the difficulties in application and also by way of

judicial pronouncements.

For further information please contact:

S. Santhanakrishnan

PKF Sridhar & Santhanam, Chennai, India

Tel: +91 44 2811 2895 -

Email: sk@pkfindia.in

Website: www.pkfindia.in

SOUTH AFRICA

R&D incentive to help maintain South Africa’s position as economic powerhouseSouth Africa’s (SA) existing R&D incentive aims to promote

increased private sector R&D investment in SA, enhance its

role as an R&D and innovation location and generally promote

R&D and innovation-led industrial development and job

creation. The main features of the R&D incentive are:

Operational ExpenditureA 150 per cent deduction is allowed for operating expenses

(for example: salaries, overheads, materials and such like)

directly incurred for the purposes of:

• discoveringnovel,practicalandnon-obviousinformation

• devising, developing or creation of an invention, design,

computer program or knowledge essential to the use of

such invention, design or computer program of a scientific

or technological nature.

Taxpayers must carry on a trade and must either intend to

use the information, invention, design, computer program or

knowledge in the production of income or such items must be

discovered, devised, developed or created by the taxpayer

for the purposes of deriving income.

Interest and expenditure incurred for the right of use of any

property do not qualify for the 150 per cent deduction.

It is not a requirement for a person to physically carry out the

R&D activities – the activities can be contracted to a third

party. However, the R&D activities must be undertaken in

SA and qualifying expenditure must be directly related to the

R&D activity.

Where a connected person in relation to the taxpayer carries

out the R&D activities on behalf of the taxpayer, the taxpayer

can only claim the 150 per cent deduction to the extent of

expenditure incurred by the connected person in carrying out

qualifying R&D activities.

A deduction of only 100 per cent of qualifying operational R&D

expenditure may be claimed to the extent that such expenditure is

funded by a third party through a fee or a non-government grant

paid to the taxpayer. Should the funder not be entitled to claim a

R&D deduction in respect of the amount paid, for whatever reason,

the taxpayer will be allowed to claim a 150 per cent deduction.

Where funding is received in the form of a taxable government

grant, the 150 per cent deduction may only be claimed in

respect of qualifying operational expenditure that exceeds

twice the amount of the government grant received. Should

a non-taxable government grant be received, a deduction

(equal to 150 per cent) may only be claimed in respect of

qualifying operational expenditure that exceeds the amount of

the government grant received.

Capital ExpenditureThe cost of any new and unused building or part thereof,

machinery, plant, implement, utensil or article or improvement

thereto owned by the taxpayer, which is used solely and

directly for carrying out qualifying R&D activities is depreciable

over three years on a 50 per cent: 30 per cent: 20 per

cent basis. Any building or part thereof must be specifically

equipped and regularly used for R&D purposes.

Excluded ActivitiesExpenditure related to the following activities does not qualify

for the R&D tax incentive:

• explorationorprospecting

• managementorinternalbusinessprocess

• trademarks

• thesocialsciencesorhumanities

• marketresearch,salesormarketingpromotion.

R&D expenditure incurred by any person carrying on any

banking, financial services or insurance business falls outside

the R&D regime.

Proposed Amendments to the R&D Tax RegimeNo pre-approval is currently required to claim a deduction

in terms of the R&D tax incentive. Taxpayers are required to

annually submit information about their R&D claims to the

Department of Science and Technology and to the South

African Revenue Service.

In terms of proposed amendments applicable to R&D

expenditure incurred on or after 1 April 2012 but before 1

April 2017, a pre-approval process will be introduced. More

precise definitions of R&D activities, clarification of qualifying

expenditure and streamlining of the calculation of R&D tax

deductions are also proposed.

6

ConclusionThere is a clear link between the intensity of R&D expenditure

and competitiveness. SA was ranked 54th out of 139 countries

in the 2010/2011 Global Competitiveness Report of the World

Economic Forum, the second-highest ranked African country

after Tunisia (ranked 32nd). SA’s R&D tax incentive not only

aims to increase its productivity and competitiveness through

increased local innovation, research and technological

development but also to maintain its position as the economic

powerhouse of Africa.

For further information please contact:

UNITED KINGDOM

Changes proposed to remove current restrictions on qualifying expenditureThe UK Government has taken significant measures this

year to encourage innovation and research & development

activity in the UK through a series of proposed reforms to the

corporate tax system.

R&D Tax ReliefThe UK has had a special tax relief for R&D expenditure

since2000.Broadlyspeaking,reliefisavailabletosmalland

medium-sized companies (SMEs) for 175 per cent (130 per

cent for large companies) of eligible expenditure (including

staff costs, computer software and consumable items) on

projects that seek an advance in science or technology

through the resolution of uncertainties. Loss-making SMEs

are able to claim a payable tax credit instead of claiming an

enhanced tax deduction.

The rate of relief is increased from 175 per cent to 200 per

cent from 1 April 2011 and to 225 per cent from 1 April

2012. These increases are subject to EU state aid approval.

Further changes, also proposed to apply from 1 April 2012,

are intended to remove some current restrictions on qualifying

expenditure and to make the rules easier to apply. The

changes are expected to be of most benefit to SMEs.

• The existing requirement for the company to spend at

least £10,000 in the year concerned on qualifying R&D

expenditure is to be abolished.

• Thecurrentcapontheamountofpayabletaxcreditistobe

removed. At present, the credit cannot exceed the income

tax and National Insurance payments made by the company

in respect of all its employees during the year concerned.

• TheGovernment isconsideringhowitcould implementa

system whereby the benefit of the tax relief is recognised

‘above the tax line’ in the company’s accounts. This would

probably require the extension of the payable tax credit to

large companies.

• Changes are proposed to the rules for allowing relief

for expenditure on sub-contractors and externally

provided workers.

• There iscurrentlyuncertaintyas to theamountofeligible

expenditure where R&D is carried out in the course of

production activities. Draft guidance has been published

which will hopefully clarify the boundaries in this area.

• Anewupfrontclearanceprocedurehasbeenproposedfor

smaller companies and new start-ups.

If you have any queries regarding the availability of R&D tax

relief in the UK, please contact Denise Roberts, PKF (UK)

LLP’s leading expert in this area (denise.roberts@uk.pkf.com).

Patent BoxThe Government has also proposed that a new patent box

regime, based on the Dutch model, will be introduced from

1 April 2013. Although all UK resident companies (and UK

branches of overseas companies) will be able to apply the

regime, it is expected to be of most benefit to larger companies

with significant patent and similar income.

The regime would apply a reduced rate of tax on income

from patents granted by the UK’s Intellectual Property Office

and the European Patent Office. It may also apply to patents

granted by selected national patent offices of some other

European countries.

In addition, the Government proposes to include other

forms of intellectual property (IP) within the regime that have

a strong link to R&D and high-tech activity and are subject

to examination by an independent authority. These include

regulatory data protection and certain plant variety rights.

It is proposed that the rate of tax on eligible income will

eventually fall to 10 per cent by 2017 but this will be preceded

by a gradually reducing rate year-on-year from 2013 onwards.

The reduced rate is intended to apply both to the legal owner

of the IP and anyone holding an exclusive licence to exploit

it commercially. However, the company concerned must

have performed significant activity in developing the patented

invention or its application. In addition, it must remain actively

involved in the ongoing decision making connected with

exploitation of the IP.

Eugene du Plessis

Director – Tax, PKF

Johannesburg, South Africa

Tel: +2711 384 8116

Email: eugene.duplessis@pkf.

co.za

Website: www.pkf.co.za

7

The regime would cover worldwide income earned by UK

businesses from inventions covered by a currently valid

qualifying patent. This would include both royalties and

income from the sale of any products incorporating at least

one of such inventions.

Companies will be free to opt in and out of the regime at any

time and some companies may choose to remain outside if

the prospective tax saving is small and the administration cost

in identifying that saving is comparatively high.

For further information please contact:

A world of tax advice for the Commonwealth of Nations from PKF

From Adelaide to Cape Town, Mumbai to Vancouver - wherever

you are in the Commonwealth, you are never far from good

tax advice. With tax experts in 34 Commonwealth nations,

the PKF International network of accounting and business

advisory firms can provide you with the answers to your local

and international tax questions.

PKF Tax Guides for Commonwealth Nations

For any business moving into international markets, a key deciding

factor will be the target country’s tax regime. What is the corporate

tax rate? Are there any tax incentives or grants? Are there double

tax treaties in place? How will foreign source income be taxed?

You can find answers to all these questions for the 25 starred

Commonwealth Nations on the map by visiting http://www.pkf.

com/publications/tax-guides to download a free PKF Tax Guide.

(You can also download the PKF Worldwide Tax Guide 2011 plus

country tax guides for a further 74 countries around the world.)

PKF International Tax Alerts

Keep up with the latest global tax information with the PKF

International Tax Alert published three times a year. Written by

PKF tax experts across the world, it’s a useful free resource

for any international business. Just visit http://www.pkf.com/

publications/tax-alerts to download a free copy.

About PKF International Limited

PKF International Limited (PKFI) administers the PKF network

of legally independent member firms. There are over 245

member firms and correspondents in 440 locations in around

125 countries providing accounting and business advisory

services. PKFI member firms employ around 2,200 partners

and more than 21,000 staff.

PKFI is the 10th largest global accountancy network and its

member firms have US $2.4 billion aggregate fee income (year

end June 2010). The network is a member of the Forum of

Firms, an organisation dedicated to consistent and high quality

standards of financial reporting and auditing practices worldwide.

For further information about PKF International or its member

firms, please visit www.pkf.com

The PKF International network of legally independent firms does not accept any

responsibility or liability for the actions or inactions on the part of any individual

member firm or firms.

Jon Hills

Partner - Tax services,

PKF(UK)LLP, Accountants and

business advisers,

London, United Kingdom

Tel: +44 (0) 20 7065 0000 -

Email: jon.hills@uk.pkf.com

Website: www.pkf.co.uk

“Tax experts from

around the PKF

International network at

the Madrid International

Tax Meeting in

November 2010.’

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