Section 11D – Research & Development Incentive
1/12/2010

The South African Government introduced Section 11D of the Income Tax Act (No. 58 of 1962) in order to encourage and incentivise private sector investment towards the research and development of scientific or technological activities. The Act assists in ensuring that research and development (R&D) activities are conducted within South Africa. Conducting R&D in SA will ultimately result in a positive economic growth in South Africa.

Section 11D provides for two types of incentives. Under Section 11D (1) a 150% deduction of operating expenses is discussed, and section 11D (2) addresses accelerated depreciation of any building or part thereof, machinery, plant, implements, utensil or article. For the purposes of this article, section 11D (1) will be the area of focus.

Section 11D (1) provides that “For the purposes of determining the taxable income derived by a taxpayer from carrying on any trade there shall be allowed as a deduction from the income of such taxpayer so derived, an amount equal to 150% of so much of any expenditure actually incurred by that taxpayer directly in respect of activities undertaken in the Republic directly for purposes of –
a) The discovery of novel, practical and non-obvious information; or
b) The devising, developing or creation of any –
a. Invention as defined in section 2 of the Patents Act, 1978 (Act No.57 of 1978);
b. Design as defined in section 1 of the Designs Act, 1993 (Act No.195 of 1993) that qualifies for registration under section 14 of that Act;
c. Computer programs as defined in section 1 of the Copyright Act, 1978 (Act No.98 of 1978); or
d. Knowledge essential to the use of such invention, design or computer program,

If that information, invention, design, computer program or knowledge is of a scientific or technological nature, and is intended to be used by the taxpayer in the production of his or her income or is discovered, devised, developed or created by the taxpayer for purposes of deriving income.” It is evident from the provisions of section 11D (1) that in order for the incentive to apply, a taxpayer has to meet various requirements. The requirements relate to the taxpayer, the particular expenditure and the R&D activities. Further to these requirements (explained below), the particular R&D activity must not be directed towards advancing scientific or technological knowledge in general.

Prior to explaining the requirements in detail, it is vital to note that the intention of the taxpayer must be clear from the onset. The intention should be to achieve at least one of the above-mentioned objectives, even if the objective is not eventually met. In order to prove this intention, the taxpayer may produce evidence such as project plans, minutes of meetings wherein the taxpayer’s intention is clearly stipulated.

Turning to the requirements, the taxpayer must be carrying on any trade and must intend to use the subject of the R&D for purposes of deriving or in the production of income. Moreover, the taxpayer must have actually incurred the expenditure and the expenditure must have been directly for R&D activities. For example, accommodation costs incurred by a researcher while attending a conference, even though the conference related to the research and development of a qualifying activity are not deductible. Furthermore, expenditure incurred prior to the commencement of trade is deductible under another section (and not under this section).

Another batch of requirements includes that the activities must have been undertaken in South Africa. For example, costs for activities incurred outside of SA, even if the activities related to the R&D activity undertaken in SA and/or are necessary for the advancement/continuation of the R&D activities in SA, are excluded. The R&D activity must also constitute a qualifying activity. A qualifying activity comprises an activity that is aimed at the discovery of novel and non-obvious information or at creating an invention, design, computer program of scientific or technological nature or knowledge essential to the use thereof. As mentioned above, the aim need not be achieved. The qualifying activities are discussed briefly below:
• A discovery is the ascertainment of an existing fact of nature. A pre-existing intangible asset that has not been previously available in the public domain. For example, discovering the characteristics of compound which already exists in nature but which are, prior thereto, unidentified.
• The invention must be novel and, have an inventive step and be capable of being used in trade, industry or agriculture. The developed invention need not form part of a patent application, but must be protectable by way of a patent. It is worth noting that certain inventions are not patentable under SA Patent Law.
• A design must be a functional design and not an aesthetic design, and should qualify for registration under the Designs Act.
• Knowledge essential to the use thereof refers to the know-how which enables the use of a particular design, invention etc.

Another qualifying activity is where the R&D resulted with the development or creation of a computer program. The Act provides that the computer program must be defined in terms of the Copyright Act. The Copyright Act defines a computer program as “a set of instructions fixed or stored in any manner and which, when used directly or indirectly in a computer, directs its operation to bring about a result”. If this definition is followed, the costs associated with the research and development of a computer program will be deductible on condition that the computer program is original and of a scientific and technological nature.

This broad scope of section 11D (1) (b) (iii) has been limited by section 11D (5) and this section provides that expenditure related to management or internal business processes amongst others will not qualify for the R&D incentive. It is understandable that if the limitation was not included, any costs associated with the development of the computer program, regardless of the insignificance of the program would be deductible. The broad scope of section 11D (1) (b) (iii) would have been susceptible to abuse. However, even though the exclusion is welcomed in order to control the abuse, the main hurdle is the interpretation of the words “management or internal business processes”. Bear in mind that many computer programs are developed for management and for business processes.

The South African Revenue Service (SARS) on the Interpretation Note provides that “...software packages developed for administration, human resources or accounting purposes” are excluded from the tax incentive as they constitute management or internal business processes. Moreover, SARS’s view is that all computer programs which are aimed at automating internal business processes or creating management efficiencies do not qualify. This view is maintained even if the developed program is to be sold to third parties and not for the company’s internal use. However, this view has a negative effect in that it warrants that most software development companies are excluded from claiming the R&D deduction. This is a litigious issue and relevant stakeholders can only hope that SARS will in due course alter its view. Despite this, it is crucial to note that the onus is on the taxpayer to explain to SARS how the claimed activities fall within the qualifying activities.

Section 11D(5) further provides that no deduction is allowed in respect of costs relating to exploration or prospecting, trade marks, market research, legal and financial activities, sales or marketing promotion.

It is also worth noting that registration expenses incurred in obtaining or renewing a patent or design are deductible. Also note that research funded by a third party is limited to 100% not 150% deduction (e.g. commissioned work). If research is funded through a taxable government grant, expenditure equal to twice the grant amount is deductible at 100% and costs incurred in excess of twice the grant is deductible at 150%. If the grant is tax exempt, expenditure equal to twice the grant amount will be disallowed, however excess of twice the grant amount will be deductible at 150%.

In the light of the above, it is clear that the interpretation and implementation of section 11D claim requires the knowledge on the principles of tax law as well as an intense knowledge of Intellectual Property Law. Taxpayers should feel free to consult with Patent Attorneys, who would be able to assist in documenting the relevant technical information required by SARS in order to support the R&D claim. Furthermore, Patent Attorneys should inform and encourage their clients to make use of this incentive.

For more enquiries please contact
Tumelo Tshaya on 012 432 6302 or TumeloTs@adamsadams.co.za