Pharma and Life Sciences Tax News - Vol 7, No. 5
Context of the reform
R&D is becoming increasingly strategic for the pharmaceutical and biotechnology industries, constantly under pressure to innovate. In response to the “brain drain” experienced by France due to an obvious lack of R&D tax incentives and the fact that big pharmaceutical groups recently closed their French R&D facilities, the French government has undertaken a major reform of the R&D tax credit to maintain and promote R&D in France and make France an attractive country for innovation.
Against this background, the French Finance Act for 2008 (effective as from January 1, 2008) includes various measures intended to boost innovation and productivity and enhance the French R&D tax credit system.
Reminder of R&D tax credit regime
The R&D activities which can benefit from the regime are defined as:
- fundamental research,
- applied research, and
- development research.
The main categories of expenses which can give right to the tax credit are:
- depreciation of assets dedicated to R&D projects (including patents acquired);
- costs of employees with the appropriate technical skills (including social charges) dedicated to R&D projects;
- operating expenses dedicated to R&D assessed at 75% of the former amount;
- subcontracted research activities (even within the EU);
- certain type of expenses related to compliance with regulatory standards.
From a practical standpoint, the R&D tax credit can be directly offset against corporate income tax owed by the companies (or can be refunded after 3 years).
Main differences between the previous and the new regime
Prior to the 2008 Finance Act, the R&D tax credit was based on (i) a “variation” component representing 40% of the differential in R&D qualifying expenses between the current year and the average of the two preceding years and (ii) a “volume” component equal to 10% of the qualifying R&D expenses of the current year. The total of these two components was capped at a maximum of €16 million (i.e. maximum corporate tax savings in the range of €5.5 million).
The new regime has been simplified since there is no more variation component and the volume component increased from 10% to 30% of the qualifying R&D expenses of the year up to €100 million of expenses. Above this €100 million threshold, the rate is reduced to 5%. It also eliminates the €16 million R&D tax credit ceiling, which means in practice that any amount of R&D tax credit can be offset against corporate income tax.
In addition, a company eligible for a R&D tax credit for the first time or which was not eligible for R&D tax credit within the past five years can benefit from a R&D tax credit rate of 50% versus 30% in the past. This 50% rate is applicable during the first year and is decreased to 40% for the second year. Only companies which were not related to other companies eligible for R&D tax credit in the five preceding years can benefit from these rates.
The new regime also intends to reduce uncertainty since it will allow the taxpayer to get a pre-ruling from French tax authorities in order to secure the eligibility of the various R&D projects. The tax authorities have three months to respond, after which eligibility is assumed. This is an obvious progress since there was a strong tendency from tax authorities to systematically challenge the benefit of the tax credit during on-field audits.
Conclusion
The French government has clearly demonstrated its strong willingness to promote and encourage R&D in France by enhancing France’s R&D tax credit.
Other tax incentives, applicable prior to the Finance Act 2008, can also be used. For instance, in addition to the R&D tax credit, a reduced corporate tax rate will be applied to income arising from IP located in France (i.e., taxation at 15% versus the standard rate notwithstanding a full deduction for foreign subsidiaries), so there is some room for tax planning.
However, such a reform has to be viewed as an intermediate step in a long term process to develop R&D incentive programs. It has made France an attractive country for innovation although said system still needs to be improved in the coming years if France wants to keep a top player status in this area.
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