Open road ahead for innovation thanks to research allowances from the German tax office

The importance of research and development in terms of innovative capacity is difficult to deny. But, until now, companies have usually been left to their own devices when it comes to answering the question:

“And who is going to pay for it?”

But this all looks set to change in the future, if a draft bill for the Research Allowance Act (Forschungszulagengesetz – FZulG) proposed by the German Federal Ministry of Finance (Bundesministerium für Finanzen – BMF) is anything to go by. In this article, you can find out how the audit department can contribute to this process and why an innovation audit makes sense based on the draft bill.

In the past, our guest author Jan Schnedler has already cited various reasons for the failure of corporate start-ups as a result of company spin-offs. You can find these two articles here and here.

In summary, when it comes to driving innovation, corporate start-ups are not always an adequate solution. But this is no reason to neglect or even block innovation.

In fact, quite the opposite is true, because research and development (R&D) is an important investment for many companies in order to increase their productivity and competitiveness. In a fast-moving environment, R&D must be medium- and long-term oriented. Due to their plannability, tax incentives for R&D can provide significant and valuable support, which is where the draft bill proposed by the Federal Ministry of Finance (BMF) for the FZulG comes in. The Law on Tax Incentives for Research and Development (Gesetz zur steuerlichen Förderung von Forschung und Entwicklung – FZulG) – to give it its full title – provides for the introduction of a tax allowance for research. This allowance will not depend on the assessment basis of the income calculation and neither will it be based on the tax to be determined. It is intended to have the same effect on all companies regardless of the particular profit situation. The plan is to introduce a new tax incentive scheme for R&D with its components of basic research, industrial research and experimental development, which will be applied to personnel expenses and will apply to all taxable enterprises regardless of their size or the type of activity carried out in the enterprise (as defined by the classification of economic sectors). The aid is governed by a separate tax law which is ancillary to the German Income Tax and Corporation Tax Acts.

I have already had the chance to examine the bill on at least one occasion and the most important facts can be summarized as follows:

  • The Ministry expects to grant the allowance to research companies from 2021 onwards.
  • Both persons with full and restricted and tax liability within the meaning of the Income Tax Act and the Corporation Tax Act shall be entitled to the allowance, insofar as they are not exempt from tax.
  • Research and development projects in the following areas shall be eligible: Basic research, industrial research or experimental development (see definition below). Expenses for simple product development or marketing and sales expenses are not eligible.
  • The allowance amounts to 25% of the salary expenses for employees conducting research (gross salary) multiplied by 1.2. The allowance is completely independent of the profit or tax base of the company conducting the research.
  • There are maximum limits for the allowance per company and per financial year (a max. of € 2 million of salary expenses for employees conducting research multiplied by 1.2 is eligible to be taken into account for the incentive).
  • The tax office will grant the allowance based on a certificate issued by a Federal office which is to decide on the eligibility of the R&D project. Which Federal agencies are to perform this function still an open question.
  • An allowance received is not considered to be taxable income for the research company. Nonetheless, the salary expenses for employees conducting research are tax operating expenses. The R&D allowance itself can thus be considered to be a completely tax-free source of income.

The draft bill has the following to say on the definition of eligible research and development projects (see Annex 1):

“Basic research”: experimental or theoretical activities primarily aimed at the acquisition of new basic knowledge without any identifiable direct commercial applications.

“Industrial research” means planned research or critical investigation aimed at the acquisition of new knowledge and skills to develop new products, processes or services or of bringing about substantial improvements in existing products, processes or services. It includes the development of parts of complex systems and, where appropriate, the construction of prototypes in a laboratory environment or an environment with simulated interfaces to existing systems, as well as pilot lines where necessary for industrial research and in particular for the validation of technological bases.

“Experimental development” means the acquisition, combination, design, and exploitation of existing scientific, technical, economic and other relevant knowledge and skills to develop new or improved products, processes or services. This development includes, for example, activities relating to the design, planning, and documentation of new products, processes, and services. Experimental development may include the development of prototypes, demonstration activities, pilot projects and the testing and validation of new or improved products, processes and services in an environment representative of the real conditions of use, where the main objective of such activities is to improve essentially undefined products, processes or services further. Experimental development may include the development of commercially viable prototypes and pilot projects if this necessarily concerns the final commercial product and its production would be too expensive for demonstration and validation purposes alone. Experimental development does not include routine or periodic changes to existing products, production lines, production processes, services or other ongoing operational processes, even if such changes constitute improvements.

And how can auditing contribute?

Do you already know which projects in your company might fall within the scope of the new law?

– You don’t’?

In which case, preparing a matrix of projects would be exactly the right way to proceed. This will allow you to identify potentially eligible projects within the company, and thus to determine the overall entitlement to research funding. With up to a maximum of € 2 million in salary expenses for employees conducting research being eligible, this could be a nice contribution to added value, right?

And did you know that we at zapliance were the first software company in Hamburg to receive funding from the Investitions- und Förderbank Hamburg (IFB) as part of the PROFI innovation promotion program?

– You didn’t know that either?

Then why not read more about our company’s background and how we did so here.

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