The research tax credits and other forms of Research and Development (R&D) incentives are granted by a country to companies that perform research activities within their territory. The aim is to support research and innovation while bolstering employment and the economy.
Such tax incentives foster companies to locate their R&D expenses in a specific country. In return, the country expects wealth creation in the form of intangible assets, patents, new or improved manufacturing processes or products as well as job creation (particularly for researchers).
Thus, R&D tax incentives are a key tool for a country’s economic attractiveness, which, like in transfer pricing matters, are in competition for the most effective means of attracting (and retaining) the greatest number of companies.
Given the global economic context, however, international groups can and should assess the consequences that the localization of their research activities will have. This can be done from various perspectives, such as the following:
- The availability of R&D tax incentives or other assistance
- Consideration of the consequences related to the re-invoicing of intragroup research costs and/or the intangibles generated by research, which means what is the treatment of this R&D activity in terms of Transfer Pricing.
In recent years, the countries have multiplied all sorts of documentation requirements from businesses. This is done to facilitate tax auditing, combat fraud and tax evasion, and also to fight against Base Erosion and Profit Shifting (BEPS). The OECD (Organization for Economic Cooperation and Development) and G20 (the G20 has 20 member states, 19 countries plus the European Union) countries, which are deeply concerned with the BEPS issue, have now committed to a common, coherent action plan to the deal with this phenomenon.
Even if companies today are well aware of the importance of thorough transfer-pricing documentation, they rarely verify the consistency of such documentation with the one provided to support their research tax credit (RTC) or R&D tax incentives. Nevertheless, these two types of documents are often audited by the national tax agencies.
A lack of cohesion and consistency can negatively impact a company. While the goals of the transfer-pricing policy and the supporting documents for research tax credit are different, it is still necessary to:
- Justify the fair “price” of its intercompany flows
- Substantiate the research tax credit and/or R&D tax incentive eligibility
Both documents contain critical information about the company’s operations, strategy, research-and-innovation policy, and value creation. Alternatively, the supporting documentation used to obtain research tax assistance (tax credit or super-deduction) in a third country can also serve to reinforce the transfer pricing policy. It is, therefore, necessary to ensure that information contained in the two documents is not contradictory.
Paradoxically, this is even more important when we consider that the same information can be extremely advantageous in terms of RTC/R&D tax incentives but unfavorable in terms of transfer pricing or vice versa!
One difficulty that companies often face is the need to ensure fair remuneration for the findings of their research activities, namely by placing high enough value on the intangibles without “suffocating” the other group members with high royalty payments.
In some cases, the know-how arising from research activity can only be used on a local market or in some cases only by group members working in a similar market or using the same technologies. Thus, the issue of charging back group members for research findings (and the valorization of this know-how) should be addressed on a case-by-case basis, supported by thorough analysis of both the R&D performing company and the group members using the know-how.
Theoretically, in terms of transfer pricing, the R&D performing company should be compared to an independent research company, charging fees or royalties to other third parties.
However, the remuneration of an R&D performing company within a group never matches what an independent profit-based research entity would receive.
Within a group context, the company that undertakes research work eligible for RTC or R&D assistance generally doesn’t consider profit to be an end-objective. In many cases the R&D performing company is only marginally profitable, if at all. Instead, it provides essential support to other group member companies (trading companies, distribution, marketing, etc.).
The research performing company rarely initiates any of the research projects it undertakes. Instead, it usually takes direction from the group’s management or responds to the needs of other operating entities or marketing/strategic teams within the group.
The company doing the research isn’t necessarily self-funded, either. Basically, it’s a link in the company’s value-creation chain; a cost center with no independent management capability.
With respect to risk, the company performing the research should thus bear the technological risks related to its R&D activity, product technical failures, formulation errors, etc. However, it should never assume the commercial risks. It can develop the “ideal perfect product” from a technical standpoint, but such a product should have no commercial value (in other words, a flop) and its remuneration should stay the same.
These issues aren’t that new at all, but are currently becoming hot topics in light of the OECD Action Plan on the BEPS.
In the case of an audit, the company must be able to justify its policy on transfer pricing, particularly with respect to the intercompany chargeback of intangibles. You also have to prepare and maintain very specific documentation to this effect.
If your company takes research tax credits or other R&D tax assistance, you also have to prepare and maintain a specific supporting documentation for the tax authorities. These two types of documentation are now more likely than not to be scrutinized by the same tax authority who will search for discrepancies and needs coherence.
With our pragmatic methodology, based on over thirty years of experience in research tax incentives, our team of tax experts and engineers is available to support your company in preparing or reviewing this documentation. Our objective is to ensure the clarity and cohesion of such documentation to ensure a proper readability by the tax agency.
Operating in the OECD member countries, large companies must now ensure that their tax policies and practices with regard to transfer pricing and research tax credits are coherent at the national and international levels. Our extensive experience also allows us to provide services to assist you in better integrating your R&D activities into the international tax and transfer pricing strategies of your group.
Our first-hand expertise in the area of R&D tax incentives in several countries (Brazil, Canada, the United States, France, Great Britain and Ireland) allows us to effectively support you in the development of a coherent tax strategy; one with which you can manage and effectively leverage your R&D activities in compliance with the applicable rules.
AGNÈS DECENCIÈRE is an associate in transfer-pricing consulting at Braithwaite Global Inc. She holds a graduate degree in international taxation from the University Paris II Panthéon-Assas – HEC. She has been working a tax specialist for 15 years, including 10 years within large international groups such as Hewlett-Packard, Alstom and l’Oreal.
As a corporate tax specialist, she has developed technical and practical expertise with respect to transfer pricing and research tax credits. Her experience with the organizational complexity of large groups, against a backdrop of increasing transnational flows (especially of intangibles), has enabled her to develop an efficient, pragmatic approach to tax consulting in compliance with the applicable rules.
SERGE DE BLOIS is the CEO of Braithwaite Global Inc. (headquartered in Houston, Texas). In this role, he has managed all the U.S.-based group operations since 2012. Since joining the Braithwaite Global group in 1994, he has headed up a diverse group of companies in Canada and has launched group subsidiaries in England, Brazil and the United States. A graduate of the University of Montreal in mathematics and economics, he launched his career in one of the “Big Four” accounting firms.
A recognized expert in tax incentives for innovation and research, Mr. de Blois has for more than 28 years served as a consultant to large companies throughout the Americas and Europe, assisting them in the optimization of their research tax credits and other related tax incentives. He has given presentations on research tax incentives at several conferences in Canada, the United States, and Brazil, and has published numerous technical studies related to tax measures for innovation financing.