Placing taxation at the service of research and development

Outline of the Community (European Union) legislation about Placing taxation at the service of research and development

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Placing taxation at the service of research and development

Document or Iniciative

Commission Communication of 22 November 2006 to the Council, the European Parliament and the European Economic and Social Committee: “Towards a more effective use of tax incentives in favour of R&D” [COM(2006) 728 final – Not published in the Official Journal].

Summary

In line with its commitment to promote a more consistent and favourable tax environment for R&D, while recognising national prerogatives, the European Commission, through this new Communication, intends:

• to clarify the rules on the compatibility of tax incentives with Community law;
• to identify good practices in designing tax incentives for research;
• to present a number of possible future initiatives aimed at improving consistency in Europe with regard to questions of common interest to do with the taxation of R&D.

Community law and R&D tax incentives

This section focuses on the legal parameters for all R&D tax incentives and provides guidance on the design features of such incentives to avoid incompatibility with Community law.

Territorial restrictions * are the main reason why such incentives are incompatible with Community law. They can be explicit * or implicit * restrictions. In practice, any territorial restriction, whether explicit or implicit, has, in the Commission’s view, to be regarded as infringing upon the fundamental freedoms (freedom of establishment, freedom to supply services) laid down in the EC Treaty.

However, certain restrictions may, under certain conditions, be justified:

• either by virtue of exemptions expressly provided for by the Treaty (see Articles 46 and 55);
• or on grounds recognised as “overriding requirements in the general interest”.

The Commission identifies a number of arguments already invoked by the Member States in defence of their territorial restrictions before the Court of Justice of the European Communities (ECJ):

• fiscal supervision;
• loss of tax revenue;
• prevention of tax avoidance;
• promotion of national R&D and competitiveness.

To sum up existing case law, there is ample evidence that territorial restrictions on the application of R&D task incentives are unlikely to be accepted by the ECJ. Thus, when designing R&D tax incentives, Member States should take into account the fact that any explicit, and in some cases implicit, form of territorial restriction would not be considered to be in accordance with the EC Treaty. This does not, however, preclude territorial restrictions which simply reflect the territoriality of the tax competence of Member States. For example, a wage tax or social security incentive for R&D personnel might, by its nature, be limited, de facto, to persons performing R&D activities in the Member State in which they are taxed or pay social security contributions.

Another aspect to be taken into consideration is the compatibility of tax incentives with Community state aid rules. According to Article 87 (formerly Article 92) of the EC Treaty, “any aid granted by a Member State or through state resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the common market”.

Tax incentives may constitute state aid if they:

• meet the criteria laid down in Article 87;
• are covered by the relevant case law of the ECJ;
• do not fall under the de minimis Regulation.

One of the main criteria for determining whether or not a tax incentive * constitutes state aid is its selectivity.

Since exemptions are possible, the Commission will assess state aid for research, development and innovation (RDI) that is brought to its attention, and in particular R&D tax incentives, in the light of the Community framework for state aid for research, development and innovation. It also calls on Member States to take into account this framework when designing R&D tax incentives.

Good design features for R&D tax treatment and incentives

In recent years, a growing number of Member States have introduced some form or other of R&D tax incentive. Currently, 15 Member States have acted. Experience has shown that there is no single answer as to how R&D tax incentives should be designed and implemented as circumstances differ from one country to another (general tax policy, industrial structure, level and nature of private-sector R&D performance, etc.),

Nevertheless, despite these differences, a number of guiding principles can be defined.

The tax incentives must:

• reach more firms;
• include all current expenses;
• consider certain types of R&D-related capital expenditure.

It is essential:

• to focus on ascertaining the direct additionality of tax incentives and their behavioural additionality;
• to consider evaluation criteria and data from the design stage;
• to test, a posteriori, the impact of incentives, the efficiency of the delivery mechanism and their wider societal effects.

The detailed guidance annexed to the Communication has been drawn up on the basis of the work of an expert group under the aegis of the Scientific Advisory Committee to the European Council and the Commission (CREST). The Commission will continue to promote the sharing of experience and good practices by setting up a network of national experts in 2007.

Guidelines for tackling problems of common interest

In addition to the need for Member States to take into account the fundamental principles set out above, the Commission sheds light on a number of desirable initiatives for reconciling tax policy and the knowledge economy at EU level.

The Commission calls on Member States to discuss the introduction of a consistent tax framework that:

• is conducive to supporting large-scale transnational R&D projects;
• is favourable to young innovative enterprises;
• promotes philanthropic funding of research;
• facilitates cross-border mobility of researchers;
• facilitates cross-border outsourcing of R&D within the EU;
• simplifies VAT rules and their application to R&D as regards public entities;
• lays down a common tax definition of R&D;
• provides for R&D tax treatment in the common consolidated corporate tax base (CCTB).

Background

Against the background of the relaunch of the Lisbon Strategy, at the beginning of 2005, the European Union (EU) set a target of 3% of GDP for R&D spending by 2010, of which two thirds should come from the private sector. The trend to provide more favourable tax treatment for R&D is becoming more common in the Member States. However, the growing diversity of R&D tax incentives risks further fragmenting the fiscal landscape but could be prejudicial to transnational cooperation within the EU.

Key terms used in the act

Territorial restrictions: measures or factors that, explicitly or implicitly, favour domestically performed R&D over that performed elsewhere in the EU. Explicit territorial restriction: this may be, for example, a legal provision which restricts the benefit of an R&D tax incentive to activities performed domestically. Implicit territorial restriction: this includes, for example, a tax incentive covering the costs of subcontracted R&D but limiting the proportion of R&D that can be subcontracted to non-resident entities. Selectivity of the tax incentive: a tax incentive is considered selective if its potential beneficiaries are restricted notably in terms of size (e.g. SMEs), location or sector and, as such, is likely to constitute state aid.

Related Acts

Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions of 13 September 2006 – Putting knowledge into practice: A broad-based innovation strategy for the EU [COM(2006) 502 final – Not published in the Official Journal].

Communication

from the Commission to the Council and the European Parliament of 25 October 2005 – The contribution of taxation and customs policies to the Lisbon Strategy [COM(2005) 532 final – Non published in the Official Journal]

Communication

from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions of 12 October 2005 – More research and innovation – Investing for growth and employment [COM(2005) 488 final – Official Journal C 49, 28.02.2006]

Communication

from the Commission: – Investing in research: an action plan for Europe [COM(2003) 226 final – Non published in the Official Journal].