Tax Disputes over Investment Credits for R&D Expenses

At the present time, the main piece of tax preference legislation for Taiwan's industries is the "Statute for Upgrading Industries" (hereafter, the "Statute"). According to Article 6 of this Statute, up to 35% of the amount spent on investment in R&D and training can be credited against the tax payable in the five years beginning with the then current year. As to the scope of investments to which the tax credits apply, the Statute authorized the Executive Yuan to establish "Guidelines for the Application of Investment Credits for Expenditures on Research, Development and Training" (hereafter referred to as the "Investment Credit Guidelines"), and the Ministry of Finance also issued a set of key audit points addressing the content of creditable expenditures and accounting recognition principles. In practice, however, when it comes to determining what meets the criteria for claiming the credits, differences of interpretation have cropped up repeatedly between the business community and its regulatory bodies, the taxation authorities, and the administrative courts. The following are a couple of the disputes that have emerged over R&D-related definitions:

Does the R&D have to be "highly innovative" for R&D tax credits to apply?

As interpreted in a ruling by the Supreme Administrative Court, in order to fall within the scope of the Statute's incentives, a research activity must be highly "forward-looking", "risky" and "pioneering", and be of direct benefit to national economic development and industrial upgrading. The court ruled that the area of production engaged in by the appellant in the case was essentially just a refinement based on technical foundation already possessed by predecessors, and the activity in question constituted routine activity - "ordinary product quality testing, alterations and prototype development" and the "improvement, testing and correction of existing product specifications and models" - that only increases the appellant's own competitive strength in the market, and so expenses for such activity may not be claimed as R&D expenditures for tax credits. In practice, moreover, the tax authorities and the Executive Yuan have both provided similar interpretations, maintaining that any taxpayer activity that is only "routine market development work" or "preparation for mass production" does not constitute R&D activity.

Who can be claimed as R&D personnel?

In the past, the tax authorities have assumed that employees with less education - elementary school or vocational high school graduates - are not professional research personnel, whereas businesses have taken "non-research personnel" to mean anyone involved in administrative work, or who is described as "support" or "help" staff in the documents presented to the authorities. Given these different positions, businesses are likely to have their original claims turned down, leading to administrative litigation.

Both of the above sources of disputes over claimed R&D expenses could be cleared up if the regulations were amended to make the definitions clearer. According to the literal definition of R&D expenditure in the Investment Credit Guidelines, activity to "improve performance of equipment" or "raise the efficacy of existing machinery and equipment" seems not to have been excluded from "basic" R&D. Even if you consider the intent of the Statute, it must be that such activity directly contributes to industrial upgrading, which means it should be eligible for incentives. Whether or not the boosting of a company's own competitive strength has a structurally direct or indirect benefit for industrial upgrading is open to debate.

If lawmakers and the competent authorities all feel think that R&D must possess a relatively high degree of innovativeness for related expenses to merit tax incentives, then the law should be clarified, including clear criteria for R&D to be considered "forward-looking" and "pioneering". And in the Investment Credit Guidelines, the authorities should also make explicit the recognition standards and supporting documentary evidence needed. That would reduce the number of businesses that fail to get their claimed credits approved and end up seeking administrative remedies through the courts.

As for identifying employees as dedicated full-time to R&D work, more concrete reasoning needs to be used to approve or deny claims, subject to inspection and verification, of who is and who isn't actually engaged in such R&D work.

Although the Statute for Upgrading Industries provides concrete rules for a tax incentive policy - an important link in Taiwan's tax system - the tax authorities (under the Ministry of Finance) are in charge of reviewing and imposing taxes, and when application of the regulations results in uncertainties, the Ministry of Finance no doubt has the authority to interpret the regulations. However, application of the Statute must also be informed by a firm grasp of the conditions under which industries operate. If taxation in practice is grounded on this kind of understanding, there seems to be room to discuss how the tax authorities and the agencies governing industries might harmonize their interpretations by establishing a more proactive and effective communication mechanism. In addition, there needs to be a discussion of how the tax authorities might first solicit the views of the agencies that govern industries before determining what kind of R&D is highly innovative or contributes to industrial upgrading.