R&D tax incentives: the Skattefunn

In 2002, Norway introduced the R&D tax incentive (Skattefunn) described in Box 3.2. Despite the hurdles facing applicants (not all firms are aware that they can benefit even if they do not pay much, or any, tax, and many firms’ tax accountants are unhappy with the extra burden of responsibility), the Skattefunn proved very popular upon its introduction. It quickly became the most important individual source of fiscal support to private-sector R&D (some Research Council grants were phased out when the Skattefunn was introduced). Nevertheless, the amounts finally paid out each year have been consistently below the amounts initially budgeted (i.e. the estimatedex ante value of tax rebates for qualifying projects), and by a widening margin (82% in 2003, 73% in 2005), possibly because

enterprises had difficulty in finalising all approved projects within the annual time limits. Furthermore, the ex ante amounts requested have also been falling, certainly in real terms. On average, 1.3% of all Norwegian enterprises (except public sector and agricultural) had Skattefunn projects under way in 2005, and the total tax expenditure amounted to about 0.1% of GDP.

Box 3.2. The NorwegianSkattefunn

The Skattefunn is a tax credit scheme for supporting innovation in Norwegian enterprises. It was introduced in 2002, and originally applied only to SMEs. In 2003 it was extended to all enterprises subject to taxation in Norway. Its main features are:

x Claims for the Skattefunn tax rebate can only be made for projects approved by the RCN; approval by the RCN applies only to R&D content, and must be achieved before end of the first year for which a tax credit will be claimed.

x Enterprises must submit their proposed projects online to the Skattefunn Secretariat in the Research Council of Norway by 1 September to have a guarantee that the application will be processed in the current year. Applications are evaluated by project officers in regional offices of Innovation Norway, who make recommendations to the Skattefunn Secretariat, whose project officers make the final decision. However, the RCN’s decisions can be appealed to a special complaints body that considers only Skattefunn applications (three members). Legally the scheme operates pursuant to tax law under the Ministry of Finance, and the tax authorities may control the tax credit claims as part of the enter-prise’s tax statement. However, tax authorities can only verify whether costs are correctly specified and belong to the approved project and that total subsidies do not infringe state aid regulations. They are not authorised to question the R&D content.

x There are no regional or sector constraints or any constraint on conducting projects jointly with R&D institutions abroad (after certification by the RCN).

x There is no ceiling on the Skattefunn tax expenditure budget at the national level.

x Applications must describe:

o The main goal, specific and demonstrable, of the project, together with any individual intermediate sub-goals.

o A summary of the project describing its objectives, how the results will improve or develop new products, services or processes, and how the project will be carried out, including which partners and R&D institutes will be involved.

o Expected milestones (prototypes, reports etc.).

o Expected costs, broken down into salaries and overheads, purchase of R&D services, purchase of equipment, and other operating costs. …/…

Box 3.2. The NorwegianSkattefunn (continued)

o Financing, broken down into own funding, EU funding, other public funding, other private funding, and the estimated Skattefunn rebate.

o R&D challenges, relative to the competences of the applicant.

o How acquired competences (e.g.from an R&D institute) will be transferred to the applicant enterprise.

o How the project will raise the level of knowledge within the applicant enterprise.

o The R&D experience in the applicant enterprise: number of R&D projects in the past three years, including with co-operating R&D institutes, how R&D activities are organised within the applicant enterprise, and the numbers and competence levels of their R&D staff.

x Two levels of tax rebates are available, depending on the size of the applicant enterprise:

o A 20% rebate for firms employing fewer than 250 persons and with an annual turnover not exceeding EUR 40 million, or balance sheet total not exceeding EUR 27 million, and not more than 25% owned by a large enterprise.

o An 18% rebate for large enterprises.

x There is no limit on the number of projects for which an enterprise can claim the rebate, but the maximum tax rebate per enterprise is NOK 4 million for R&D projects conducted entirely within the enterprise, and NOK 8 million for projects conducted jointly with an R&D institute.

x If the rebate exceeds the assessed taxes (income tax, wealth tax, including social security contribution) of the enterprise, the difference (which can be as high as 100%) is paid to the enterprise as a grant (about three-quarters of the total tax expenditure under the Skattefunn was distributed as grants in 2005).

Initially, the Skattefunn was confined to SMEs, perhaps on the grounds that SMEs need more state aid because they demonstrably perform less R&D (adjusted for turnover, employment, sectoral effects etc.) than large firms. Although the scheme was soon extended to large enterprises, their maximum benefit is lower (restricted by EU/EEA regulations on state aid), and its maximum absolute size (less than EUR 1 million even for a co-operative R&D venture) must be considerably lower relative to turnover and average R&D spending for larger firms. This does not mean that there is no incentive effect at the margin, but if there is an incentive effect, it would be larger if the ceiling were higher.⁵⁸

58. The R&D tax credit is tax exempt, so that 18% equals the maximum pre-tax subsidy of 25% for experimental development in large enterprises.

It is possible, but difficult to prove, that applications from manu-facturing enterprises are more likely to be accepted than applications from service enterprises. This is because of the inherently greater difficulty in defining precisely the goals, challenges, and perhaps even the distinction between research staff and high-level line staff. According to Statistics Norway data, the number of manufacturing firms that applied for Skattefunn credits in 2006 was about the same as those in the private services sector, and together, these two sectors accounted for about 80% of the total. It is striking that the average size of the projects for which Skattefunn tax credits are requested is only about NOK 2 million (less than a quarter of a million euros), well below the maximum allowable.

All tax expenditure schemes have disadvantages as well as advantages, and the Skattefunn is no exception. It is worthwhile essentially if the on-going value of the extra innovation created by the scheme exceeds the costs of the distortions elsewhere in the economy created by the higher taxes needed to compensate the Skattefunn tax expenditures. Estimating the net effect of the Skattefunn is a challenge, but Statistics Norway has recently published a detailed evaluation of the Skattefunn scheme, based on an advanced statistical and econometric analysis. The main conclusion is that for SMEs, the Skattefunn does stimulate additional R&D spending, and to an extent significantly greater than other fiscal incentives, such as grants and subsidies. The best estimate (although subject to wide error margins) is that every krone of Skattefunn tax credit results in R&D spending of 2-3 krone, compared with between 0.5 and 1.5 for alternative fiscal incentives.

However, the structure of the Skattefunn, especially as initially conceived, left something to be desired, as recognised by the authorities, who have taken some measures to combat distortions. It contains inherent rent-seeking incentives, given that the size of the tax rebate (or grant in lieu) is based on firms’ reported costs for specific projects approvedex ante (i.e. through the first project year), which may be difficult to verify ex post. In order to qualify for the maximum possible tax rebate, it is easier for firms to inflate their cost estimates on a small number of projects, rather than present correct cost estimates for a larger number of projects. The deadweight tax loss to the economy is higher, and the potential benefits from successful innovation are lower. Investigations by the authorities showed that some firms were claiming very large numbers of hours worked by R&D personnel, as well as wage rates for them which also seemed unusually high.

In addition, the standard procedure applied by the Research Council for calculating personnel costs, including overheads – nearly triple the wage level – gave firms further incentives to inflate their wage cost estimates.⁵⁹

59. This is the same procedure as used by the Research Council for costing grant requests.

Some indirect evidence that Norwegian firms may have been operating in this way comes from Eurostat data on the reported wage share in business-sector R&D expenditure, which puts Norway at the top, at about 65%. This is the case even though Norwegian wage levels for researchers are not parti-cularly high by international standards. A report by the European Industrial Research Management Association (EIRMA)⁶⁰ puts the average annual salary for Norwegian researchers at about EUR 60 000, a figure which is broadly comparable with researcher salaries in Austria, Denmark, Germany, Ireland, Sweden and the United Kingdom, but well below those in Switzer-land and Japan. The wage share is less than 50% in the United States, where wage rates for researchers are about the same as in Norway in dollar terms, while the reported wage share in Switzerland is under 60%. When adjusted for living costs, the EIRMA data puts Norwegian researcher salaries well below those in most comparable industrialised countries.⁶¹

In response to the possibility that some firms were taking unfair advantage of the particular design of the Skattefunn, the rules were changed as from the 2007 fiscal year. The maximum hourly rate that can be claimed for R&D personnel has been set at NOK 500 and the maximum annual number of hours worked that can be claimed has been set at 1 850. This combination gives a maximum annual personnel cost of NOK 925 000 com-pared with a Norwegian average wage for all employees (full-time equivalent) of under NOK 400 000. The Ministry of Finance estimated that this modifi-cation – which was bitterly opposed by industry – together with improved administrative procedures in the RCN and the tax authorities, would save about 12% of the total tax expenditure. It is possible also that firms will have a greater incentive to embark on more projects.

Nevertheless, the Skattefunn has several desirable features in theory, especially its neutrality in accepting proposals for review irrespective of their sector, region and the tax liability position of applying enterprises. But given that projects have to be approvedex ante (i.e. through the first project year), and by staff who work in the Research Council, which derives its finance from several ministries, there is a possibility that consciously or not, the selection of projects is influenced by regional and sectoral biases. At least, there may be a tendency to favour firms with a good track record of innovation – or at the other extreme to be overly generous with firms that have yet to prove their commercial viability. The fact that 75% of the tax

60. www.eirma.org/f3/local_links.php?action=jump&doi=eiq-2007-011-0002.

61. Another particularity of Norwegian researcher salaries is their relatively flat structure across working lives. Experienced researchers in most countries typically earn two to three times as much as those embarking on their careers. In Norway, the differential is about 50% (www.cpu.fr/telecharger/Bruxelles/PCNM-salaires-chercheurs-europe.pdf).

credits are disbursed in effect as grants to firms that have no taxable income supports this reading.⁶²

In international comparisons, fiscal support for innovation in Norway is not exceptionally generous (Table 3.3 and Figure 3.9). The OECD’s “B-index” measures the generosity of tax incentives to invest in R&D on the basis of the pre-tax income necessary to cover the initial costs of one dollar of R&D spending and pay corporate taxes on one dollar of profit. The B-index measures only the tax subsidy element for qualifying firms and projects, and may overstate generosity in cases, e.g.Norway, where the ceiling on qualifying projects is comparatively low.

Table 3.3. R&D tax incentives in OECD countries, 2005

Large firms Special treatment for SMEs

Tax credit Tax allowance Tax credit Tax allowance

Volume Canada (20%)

Bold indicates incentive introduced after 2000.

1. Only for enterprises that obtain at least 50% of their income from the sale of their R&D results.

62. The comparable UK scheme also shares this feature: most of the disbursements are grants to firms that have no or insufficient taxable income to qualify for the tax rebate.

Figure 3.9. Generosity of fiscal support to R&D in OECD countries

A. Tax subsidies, average small and large firms, 2004 Rate of tax subsidies for 1 USD of R&D

DEU

3.4.2. Public institutions and programmes for the promotion of