» The end of the world’s most generous tax regime?
07.08.2017 - Natural Sciences Sector

The end of the world’s most generous tax regime?

© Noppasin / Shutterstock.com, Bagmane software technology park in Bangalore.

When India introduced a weighted tax deduction in April 2010 of 200% on company expenditure on in-house research and development, it became one of only 16 countries to offer this kind of ‘super deduction’, defined as a tax incentive exceeding 100% of a firm’s expenditure on research. This year, a new fiscal policy enters into force which considerably reduces the size of this tax rebate. Sunil Mani, Director of the Centre for Development Studies in Trivandrum and author of the chapter on India in the UNESCO Science Report (2015), analyses the potential repercussions for India’s high-tech industry of a fiscal package that was originally designed to encourage companies to innovate.

According to the UNESCO Science Report (2015), the 200% tax rebate on company research expenditure gave India ‘one of the most generous tax regimes for R&D in the world’(1). The report observed, however, that ‘this regime has failed to spread an innovation culture across firms and industries’, since ‘innovation is still ‘concentrated in nine industrial sectors’. In 2010, more than half of business research expenditure concerned just three industries: pharmaceuticals (28%), automotive (14%) and computer software (10%). Moreover, most of the firms active in information technology were foreign-owned. Innovative firms were also geographically concentrated, being largely circumscribed to just six of India’s 29 states.

The alluring 200% tax incentive had the perverse effect of encouraging firms to relabel their non-research expenditure as research expenditure, although there are no clear estimates of the extent of this phenomenon.

The 200% tax break for businesses was to be short-lived, though, as the Union budget announced by the Minister of Finance in February 2016 reduced it to 150% of research expenditure from 2017 onwards and to 100% from 2020 onwards. This means that only genuinely innovative firms will henceforward be able to apply for the tax break.

Most industries seem to have taken the drop in their stride but it has come as a rude shock to the pharmaceuticals and life sciences industry, which had been lobbying the government to adopt a budget proposing a 250% tax break. Companies had also been lobbying to expand the scope of the benefit to include expenses incurred outside research facilities, such as bio-equivalence studies, clinical studies, patent filings and product registrations.

The move thus came as a double blow to the pharmaceuticals industry. Saumen Chakraborty, president and chief financial officer of Dr Reddy’s Laboratories Ltd, reacted by saying that ‘the decrease in R&D weighted deduction to 150% may have an impact on innovation, as it could de-incentivise the industry to spend more on R&D’. Venkat Jasti, CEO of Suven Life Sciences Ltd, opined that the cut in the R&D tax break goes against the government’s “Make in India” slogan.(2)

The finance minister sweetened the pill by simultaneously announcing a patent box-type of incentives for the first time, wherein income received by Indian companies in the form of royalties and technology license fees would be taxed at a reduced rate of 10% from fiscal year 2016–2017 onwards. This move was designed to stimulate innovation by raising the revenue that companies could earn from their intellectual property.

The government has packaged its less generous tax policy as a means of simplifying the tax code. As the new policy sets out a predictably lower tax rate for the years to come, this fiscal stability should enable firms to plan their research budgets more effectively over the coming years. It will, of course, also allow the government to recoup some of the Rs 68 billion in lost taxes over 2015–2016.

The government’s revised tax policy would not seem to have been inspired by any empirical analysis of the situation, however, despite evidence-based policy-making having become a catchword in government policy circles. In 2015, the UNESCO Science Report itself had recommended that the government assess the effectiveness of existing tax incentives for R&D.

In 2011, public enterprises contributed 6% of total expenditure on research and development, compared to 30% for private enterprises, according to the UNESCO Science Report. The business sector as a whole has been playing a greater role in research, since it only contributed 29% of research expenditure in 2005. Four out of five patents granted to investors went to private enterprises in 2013. High-tech products accounted for 7% of manufactured exports at the time, a figure that was rising. Pharmaceuticals and aircraft parts accounted for two-thirds of these high-tech exports.

Over the past decade, Indian companies have acquired state-of-the-art technology through a series of cross-border mergers and acquisitions. The UNESCO Science Report tells how, in the first wave in 2007, Tata acquired the Corus Group plc (today Tata Steel Europe), giving Tata access to car-grade steel technology. Two years later, Suzlon Energy Ltd acquired German wind turbine manufacturer Senvion. More recently, Glenmark Pharmaceuticals has supplemented its in-house research capacity by opening a new monoclonal antibody manufacturing facility in Switzerland in 2014.

How will the new fiscal policy affect private sector investment in R&D? The move comes at a time when India’s domestic research effort is falling for the first time in over a decade: between 2011 and 2015, research spending shrank from 0.83% to 0.63% of GDP, according to the UNESCO Institute for Statistics. This translates into a drop in expenditure per researcher (in full-time equivalents) from PPP$ 206 to PPP$ 149. This means that the country is not on track to reach its target of devoting 2% of GDP to research and development by 2018.

Technology transfer fostering new industries

In addition to the tax rebate, government policy has been fostering new technology-based industries in other ways. In 2009, the government removed the ceiling on royalty payments and fees for technical expertise, the two major payments made by companies to import technology through licensing agreements. Quantitative restrictions on technology imports had been removed even earlier. This deregulation seems to have encouraged foreign multinational companies to transfer more of their state-of-the-art technologies to Indian firms, even though it could result in higher prices for technology and, thus, increase the cost of technology licensing.

One industry that seems to have benefited from the deregulation of technology imports is solar energy, which is attracting both foreign and domestic investment. Some 40% of the new 250 MW solar tender in Rajasthan in May this year at the Bhadla Phase IV solar park was won by SBG Cleantech, a joint venture between Bharti Enterprises of India, Softbank of Japan and Foxconn of the Taiwan Province of China.(3)

Greater energy efficiency is fostering the development of renewable technologies like solar, wind and hydropower. Indians are now able to store renewable energy for longer, thanks to high-performance LED lighting, technological advances in pumped hydro-storage and the lower cost of lithium ion batteries.(3)

The government has plans to make India a leader in solar energy. In June 2015, the Cabinet raised the target for grid-connected solar power projects from 20 to 100 gigawatts by 2022 within the government’s National Solar Mission, which was launched in 2010. Over the past decade, the government has been investing in the construction of solar parks and helping cites across the country adopt solar power, such as by revising their by-laws.(4)

In December 2016, the government released its ten-year Draft National Electricity Plan, which recommends installing 275 GW of renewable energy capacity by 2027. The plan forecasts a drop in thermal power capacity from 69% of the country’s electricity mix in March 2016 to 43% by 2027.(3)

That drop is already occurring. The lower cost of solar energy is not only making it a more commercially viable endeavour. It is also making it uneconomical to build costly coal-fired power plants. In May this year, plans to build nearly 14 gigawatts (GW) of coal-fired power plants across India were cancelled. Other existing plants may no longer be viable.(3)

(1) See also Mani, Sunil (2014) Innovation: the world’s most generous tax regime. In Bimal Jalan and Pulapre Balakrishnan (eds) Politics Trumps Economics, The Interface of Economics and Politics in Contemporary India. New Delhi: Rupa, pp. 155-169.

(2) Pilla, Viswanath (2016) Budget 2016-17: Cuts in R&D tax breaks disappoints life sciences industry. The Mint

(3) Buckley, Tim (2017) India’s Electricity-Sector Transformation Is Happening Now. Institute for Energy Economics and Financial Analysis, 17 May.

(4) See Ministry of New and Renewable Energy.

Source : Sunil Mani and Susan Schneegans, with exerpts from the chapter on India in the UNESCO Science Report : towards 2030 (2015)

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