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R&D is important for technological and medical advances, but it involves greater risk for companies. Governments offer R&D credits for tax purposes, with the US offering credits for energy, medical, and generic drug development, and a special credit for rare diseases. Other countries also offer R&D credits, with some offering the best credits for small and medium-sized enterprises.
Research and development (R&D) is a phase of technological development that involves a greater risk for companies than the production costs for the established products; however, it is an indispensable activity if technological and medical advances are to continue. For some businesses, ongoing R&D is necessary for continued prosperity. In an effort to encourage and support new developments, many governments offer an R&D credit for both individual and business taxes.
For tax purposes, a credit is different from a deduction. A tax deduction is an expense that is deducted from your income before your tax liability is calculated. For example, if a person or business has adjusted gross income (AGI) of $50,000 US Dollars (USD) and deductions of $15,000 USD, the deductions are subtracted from the AGI to determine taxable income and tax liability. Conversely, a tax credit is a reduction in your tax liability, so if your tax liability is $5,000 USD and there is an R&D credit of $1,500 USD, your taxes are reduced to $3,500 USD.
In the United States, the federal government offers an R&D credit for research and technology development activities in many applications, such as energy development, medical advances, and the development of generic prescription drugs. Generic drugs are the bioequivalent of drugs already approved by the Food and Drug Administration (FDA) that have an expired patent. This general drug credit does not apply to the development of new drugs. The U.S. Tax Code offers a variety of choices in how to apply for credit, and anyone who qualifies for research and development credit should calculate it using all methods to find out which one will be most beneficial.
The United States generally does not offer credit for most new drug development, as patent laws allow drug companies exclusive rights to any drug they develop long enough to recoup R&D expenses and turn a profit . However, there is a tendency for companies to undertake drug research only for diseases that are sufficiently prevalent that their risks of not recovering the costs are negligible. As a result, little research could be attempted to find treatments for rare diseases or conditions. In the United States, a rare disease is defined as a condition that affects 200,000 people or fewer in the country, or a disease that affects more than 200,000 people, but for which it is not reasonable to expect the company to recoup its costs. To support this type of research, a special research and development credit, called the Orphan Drug Credit, was developed.
Some states in the US also offer an R&D credit for certain designated activities. For example, an R&D income tax credit is available in Colorado to taxpayers who invest in research and testing in one of the state’s business zones. A corporate zone is an economically depressed, state-designated area where special tax treatment is given to corporations that will aid business development and job creation in that zone.
In addition to the United States, research and development credit is offered by Australia, Austria, Canada, France, Germany, Ireland, Mexico, the Netherlands, New Zealand, South Africa and the United Kingdom. In some cases, these are not actually credits, but take the form of a special deduction or accelerated method of amortization of capital investments made for R&D purposes, while countries offer an actual credit that is applied to the debt tax. In some regions, such as Canada, the most attractive credits go to small and medium-sized enterprises. Recent tax law changes in France have resulted in that country offering some of the best R&D credit for large corporations. Other countries, such as Brazil, do not offer national research and development credit, but do have research and development credits available at the state or provincial level.
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