IRAS issues a circular on research and development (R&D) tax measures

On 31 October 2008, the Inland Revenue Authority of Singapore (IRAS) issued a circular on the R&D tax measures introduced during the 2008 Budget Speech. The circular also includes guidelines provided by the Ministry of Finance (MOF) on the interpretation of legislative amendments to the definition of R&D included in the Income Tax (Amendment) Act 2008. The qualifying period for the R&D tax measures is from the Years of Assessment (YAs) 2009 to 2013.

Changes to the definition of R&D

In August 2008, the MOF issued and sought public feedback on draft guidelines on the interpretation of the proposed amendments to the definition of R&D in the Income Tax Act. The guidelines were finalised and issued as Annex A to the IRAS circular dated 31 October 2008, and the MOF published its response to the feedback received on 10 November 2008.

The definition of R&D has been amended to incorporate the requirements that the R&D study must be systematic, investigative and experimental. During the public consultation exercise, the MOF received feedback that taxpayers were concerned that the definition would be too restrictive. In response, the MOF clarified that their intention is not to make the definition more restrictive than before. Rather, the change is in response to calls from taxpayers for a more descriptive phrase, as the previous definition was ambiguous.

Another change is that the R&D project must involve novelty or technical risk and be undertaken with the object of acquiring new knowledge or using the results of the study for the production or improvement of materials, devices, products, produce or processes.

The list of specifically excluded activities in the definition of R&D has also been expanded so that routine modifications, cosmetic modifications or stylistic changes, as well as the development of software that is not intended for sale, lease or license to third parties are excluded. However, an exception is introduced for research in the social sciences and humanities and for software development that is undertaken wholly or mainly to support a qualifying R&D project. In these cases, the expenditure can be included as part of the qualifying R&D project expenditure.

The circular provides summaries of R&D tax benefits, how to determine what is a qualifying R&D project and a checklist. Examples of qualifying and non-qualifying activities are also provided.

The MOF also provides guidance on determining the start and end of an R&D project, since only expenditure incurred between those dates is eligible for the following R&D tax measures.

Removal of the "trade or business" requirement

The requirement that the taxpayer must carry on a manufacturing or service trade or business, and that the R&D must be in respect of that trade or business in order to qualify for a tax deduction under section 14D of the Income Tax Act has been removed for R&D carried out in Singapore (inhouse or outsourced).

With this change, it is no longer immediately obvious which source of income the R&D expenses, capital allowances and balancing allowances should be set-off against. The circular therefore clarifies that if a company's income is taxed at more than one tax rate (e.g. prevailing corporate tax rate and a concessionary tax rate), the expenses, capital allowances and balancing allowances should be set-off against taxable income in order of descending tax rate (i.e. basic tax rate followed by highest concessionary tax rate, etc). However, the set-off against concessionary income is subject to adjustments for the tax rate differential. Any balancing charge is taxable at the prevailing corporate tax rate.

Although this liberalisation is a welcome change, there are still companies that fall down the cracks. Singapore companies that outsource their R&D overseas do not get tax deductions for the R&D expenses if the R&D is not in relation to their existing trade or business. This may be a concern for MNCs seeking to locate their IP ownership in Singapore if the R&D is in highly innovative or specialised fields for which the capability or expertise to conduct the research does not yet exist in Singapore.

Enhanced deduction under section 14DA

The Income Tax (Amendment) Act 2008 introduces a new section 14DA which provides for an automatic further deduction of 50% of qualifying R&D expenditure where the R&D is carried out in Singapore (inhouse or outsourced).

For the purpose of this enhanced deduction, however, the definition of qualifying R&D expenditure is more restrictive than under sections 14(1) or 14D of the Income Tax Act as only staff costs, consumables and other prescribed expenses qualify for the further deduction. Any amount funded by government grants or subsidies is also specifically excluded. In the case of payments to Singapore R&D organisations, the further deduction is restricted to the amount of qualifying expenditure incurred by the R&D organisation. The MOF recognises that companies may not be able to obtain details of the expenses incurred by R&D organisations; therefore as a concession, the MOF will accept that 60% of the payment made to the R&D organisation comprises qualifying expenditure. However, taxpayers are allowed to claim a deduction for a higher amount if they are able to substantiate the claim with copies of invoices issued by the R&D organisation which identify the amounts claimed as qualifying expenditure.

R&D tax allowance scheme

This scheme allows a company a tax allowance of 50% of its assessable income, subject to a cap of $150,000 per year of assessment. The allowance is available for set off against the company's assessable income in subsequent years, subject to the amount of qualifying incremental qualifying R&D expenditure incurred in those years. Incremental qualifying R&D expenditure refers to expenditure deductible under section 14D, net of government grants or subsidies in excess of the company's R&D expenditure for the base year (i.e. YA 2008 or the first year of assessment for companies incorporated after YA 2008). The R&D must also be carried out in Singapore.

In any year, the cumulative R&D tax allowances available cannot exceed $450,000 and any excess is disregarded. In addition, any amount unutilised by YA 2016 will be disregarded. These allowances are not available for group relief or carry back.

Interestingly, no adjustment for different rates is required when the tax allowance arises or when it is utilised. The circular also does not prescribe the order of set off, but helpfully points out that the company will derive the maximum benefit if it sets off the allowances against taxable income in order of descending tax rate (i.e. highest tax rate first).

Tax allowances must be credited to an R&D account, and the company must declare its base year and base qualifying R&D expenditure in myTaxPortal - this new e-Service will be launched in April 2009, and companies will also be able to view their R&D balances there.

R&D incentive scheme for start-up enterprises (RISE)

The RISE scheme allows loss-making companies to convert the lower of $225,000 of unutilised current year tax adjusted losses or the equivalent of the amounts claimable under sections 14D and 14DA of the Income Tax Act, to a cash grant at a conversion rate of 9% (i.e. maximum grant of $20,250). Obviously, tax losses converted will no longer be available for carry forward.

The scheme applies to companies within their first three YAs from incorporation which are beneficially held, throughout the basis period, by no more than 20 persons, all of whom are individuals or at least one of whom is an individual holding at least 10% of the total number of issued ordinary shares. Other qualifying conditions apply.

All amounts qualifying for conversion must be converted to cash grant - partial conversion is not allowed, and the taxpayer must undertake to repay any cash grant recoverable within one month from the date IRAS issues a notice to the company. Interestingly. IRAS gives no indication of when taxpayers can expect to receive the cash payout.

Election for the scheme is final and irrevocable and the company must submit the project details specified in the circular to IRAS together with its tax return. Otherwise, the company's claims will be disqualified. The company must also be carrying on the same qualifying R&D activities in Singapore when the application is filed with IRAS.

Given the possible additional cost of compliance (e.g. audit fees for private exempt companies), the cap of $20,250 and the uncertainty surrounding the timing of cash disbursement, it may be more beneficial for taxpayers that expect to be profitable in the next year to simply carry forward the losses.

Administrative procedures for the R&D tax measures (except RISE)

Taxpayers must make a claim in the tax return and submit a completed R&D Claim Form.

Only taxpayers who incur R&D expenditure of $150,000 or more (net of government grants) in a basis period are required to submit details of the R&D projects together with their tax returns. Other taxpayers are advised to maintain records of their R&D projects, but need not submit them unless requested to do so by IRAS. In addition, if project details have been submitted in earlier years, only an update or confirmation that there have been no changes to the details furnished is required.

Taxpayers utilising R&D tax allowances must also provide a breakdown of the R&D expenditure incurred during the basis period, highlighting items of expenditure qualifying for the enhanced deduction under section 14DA of the Income Tax Act and a computation of the R&D tax allowance utilised against its assessable income. Supporting documentation is required only when the allowances are utilised.

R&D service providers

IRAS has clarified that the above R&D measures do not apply to R&D service providers. This seems to suggest that the government is implicitly incentivising companies which retain or intend to retain the ownership of the resulting intellectual property in Singapore, since the companies affected would mainly be R&D organisations providing services to overseas beneficiaries. Those performing R&D for Singapore beneficiaries would in any case have been precluded from a double dip under the old rules.

It should be noted though that there has not been any change to the tax deductions available to R&D service providers under sections 14(1) and 14E of the Income Tax Act. This means that R&D organisations can still deduct up to 200% of their R&D expenditure, albeit subject to pre-approval.

Writing down allowances for acquired intellectual property

The circular also highlights that the Income Tax (Amendment) Act 2008 has introduced a restriction on the availability of writing down allowances under section 19B of the Income Tax Act where the intellectual property is sold to a related party by a taxpayer who had previously claimed tax deductions on the original R&D expenses, and where the sales proceeds are not taxable.

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