Opinion of the European Economic and Social Committee on the Communication from the Commission to the Council, the European Parliament and the European Economic and Social Committee — Towards a more effective use of tax incentives in favour of R&D COM(2006) 728 final
Date: 2007-09-26
Institutions: European Economic and Social Committee
Subjects: fiscal policy, industrial enterprise, research and development, small and medium-sized enterprises, tax incentive

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Official Journal of the European Union

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Opinion of the European Economic and Social Committee on the ‘Communication from the
Commission to the Council, the European Parliament and the European Economic and Social
Committee — Towards a more effective use of tax incentives in favour of R&D’

COM(2006) 728 final

(2008/C 10/21)

On 22 November 2006 the European Commission decided to consult the European Economic and Social
Committee, under Article 262 of the Treaty establishing the European Community, on the abovementioned
communication.

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible
for preparing the Committee's work on the subject, adopted its opinion on 21 June 2007. The rapporteur
was Mr Morgan.

At its 438th plenary session, held on 26 and 27 September 2007 (meeting of 27 September), the European
Economic and Social Committee adopted the following opinion by 134 votes to 2 with 5 abstentions.

1. Conclusions and recommendations

1.1
This Communication forms part of the Commission's
programme in support of the Lisbon objective that the value of
EU R&D expenditure should be equal to 3 % of GDP by 2010,
of which 2 % should come from the private sector. The focus of
this Communication is on the methods used by Member States
to incentivise company R&D through the tax system. The
purpose of the Communication is to clarify the legality of R&D
tax incentives in the context of EU law and to give advice to
Member States regarding best practice. This Communication is a
welcome response to the EESC request that ‘the Community
should work to encourage Member States to frame their tax and
liability laws so that they do more to provide incentives for
industry to invest in Research and Development’ (1).

1.2
Some examples of best practice are described in Section 3
of the Opinion. It is, however, necessary to recognise that there
are limitations to the incentives which can be provided through
the tax system. The higher the rates of corporate taxation, the
higher the incentive while lower rates provide less incentive.
The higher the social charges, the more the incentive to give
relief from them. If companies are not profitable there is less
scope, since the general concept is to provide relief from taxes
it goes without saying that relief must be
on profits. Finally,
based on actual R&D investment made and not in respect of
future plans.

1.3
The recommendations for the establishment of an incen-
tive system include the requirement that the effectiveness of
each scheme should be measured. This is clearly important in
the case of large profitable companies which could very well
carry any tax rebates into the bottom line instead of the R&D
budget. To avoid this moral hazard some countries only allow
incentives on incremental R&D expenditure but this may be self
defeating because an important effect of these incentives is to

(1) See the Opinion of the EESC on Unlocking and strengthening Europe's
research, development and innovation, OJ C 325 of

for

potential
30.12.2006, p. 5, paragraph 3.5.

retain R&D activity in the EU and prevent it going off shore.
Accordingly an effective measurement system for large compa-
nies is likely to be more beneficial than restricting relief to incre-
mental expenditure.

1.4
By far the most important impact of these programmes
is the way in which they can support the development of R&D
focussed SMEs during the early years of their existence. The
recommendations include a powerful range of incentives which
provide extra tax relief as a multiple of R&D investment,
refunds in the absence of profits and relief from social charges.
Given the strategic role of SMEs in the EU economy, the EESC
recommends that each Member State uses an optimum mix of
possible tax incentives to facilitate the survival and growth of
SMEs in its economy.

In this context,

the Committee is surprised that

the
1.5
Communication makes no reference to tax relief designed to
help the formation of capital for new companies. This point is
further developed in paragraphs 4.9 to 4.12. The EESC recom-
mends that the Communication be expanded to include capital
formation.

A further issue of great importance to SMEs is the treat-
1.6
ment of patents and licences. The law is not clear and there is
an element of competition between Member States in respect of
the tax treatment. The EESC recommends that the Communica-
tion be extended to cover patents and licensing.

1.7
The Communication raises questions about a number of
related issues on which action could be taken. The EESC recom-
mendations are as follows:

1.7.1 Member States should improve the use of R&D tax
incentives for industrial participants in transnational research
projects.

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1.7.2 Member States should explore ways in which state
imposed costs can be lowered for young R&D businesses
following the example of
the very successful French Young
Innovative Enterprise (YIE) regime.

1.7.3
In respect of public benefit private sector research orga-
nisations, Member States should develop a common approach
so that both donations and research funds can flow freely
within the EU.

The cross border mobility of researchers should be
1.7.4
encouraged by Member State agreements to prevent double
taxation on short term assignments.

The Commission is encouraged to develop a common
1.7.5
structure for the mutual recognition of R&D certificates for
those countries which use them. At the same time the Commis-
sion might consider whether such certificates are needed in the
single market.

1.7.6
The Committee welcomes the Commission's proposal
to simplify and modernise the rules for the recovery of VAT by
private entities on R&D expenditure incurred in public/private
projects.

Europe's potential
for research development and innovation
culminating in the 7th Framework Programme. In its Opinions
the EESC has consistently urged the Commission and the
Member States to remove the barriers which hold back both the
quantity and quality of R&D in Europe while at the same time
taking organisational,
initiatives to
promote a sufficient critical mass of R&D activity in Europe.

institutional and financial

2.3
The Communication provides guidance to help Member
States improve their R&D tax treatment and to help develop
mutually consistent solutions to common problems. Therefore it
is not a EU programme targeted at specific R&D projects or
objectives. It is a programme for Member States to promote
R&D in the private sector and it will work to the extent that the
private sector, company by company, is incentivised to under-
take R&D. The Communication aims to help Member States in
three ways:

— clarifying the legal conditions for Member State R&D tax

incentives arising from EU law;

— highlighting general design features for R&D tax treatment
and incentives based on expert analysis of good practice;

1.7.7
It is essential to the debate on tax incentives and R&D
to seek an EU wide tax definition of R&D and innovation. This
will be a further step towards the creation of the Single Market.

— presenting for discussion a number of possible future initia-
tives aimed at addressing issues of common interest in a
consistent way.

1.8
The Lisbon objective of 3 % was set by reference to the
R&D investment made by competitor regions. It is a feature of
the EU economy at the macro-sector level that it is not as
involved in highly R&D intensive industry sectors as competitor
countries such as Japan and the USA. Therefore, in addition to
stimulating private sector R&D, it would make sense to increase
public sector
in universities and State funded
research institutes. Environmental projects should provide an
appropriate stimulus (2).

investment

2.4
The Open Method of Coordination applies to this policy
domain. The decisions lie with Member States. The guidelines
provided in the Communication are derived from best practice
by Member States. A critique of Member State policies lies
outside the scope of the Opinion. The Opinion is therefore
confined to observations on the guidelines and comments on
the possible future initiatives highlighted in 2.3 above.

2. Introduction

3. Gist of the Commission's Communication

2.1
The context of this Communication is the Lisbon strategy
which calls for R&D investment in the EU to approach 3 % of
GDP by 2010, of which 2 % should come from the private
In 2005 the Commission announced its intention to
sector.
promote a more consistent and favourable tax environment for
R&D, while recognising Member State competence for
tax
policy. (COM(2005) 488 and COM(2005) 532).

3.1
All R&D tax incentives implemented by Member States
must conform to the fundamental Treaty freedoms and the prin-
ciple of non discrimination. The Commission considers both
implicit and explicit territorial restrictions to be incompatible
with Treaty freedoms. There is ample and consistent evidence
that territorial restrictions on the application of R&D incentives
are unlikely to be accepted by the ECJ.

2.2 Within this Lisbon framework there have been a series of
Commission initiatives aimed at increasing EU R&D spend to
the target of 3 % of GDP while at the same time developing the
European Research Area. There has been a drive to unlock

(2) See also the Opinion of the EESC on Unlocking and strengthening Europe's
research, development and innovation, OJ C 325 of

potential
30.12.2006, p. 5, paragraphs 14.2-14.4.

for

3.2
In principle, State aid rules apply regardless of the form
of the aid so R&D tax incentives could constitute State aid.
However, an R&D tax incentive which is not selective, i.e. one
that applies irrespectively to all shapes and sizes of company in
any sector would not be seen as selective and so would be
treated as part of general corporate taxation.

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3.3
Article 87(3)(c) of the Treaty states that the following
may be considered to be compatible with the common market:
‘aid to facilitate the development of certain economic activities
… where such aid does not adversely affect trading conditions
to an extent contrary to the common interest’. The Commission
has adopted an RDI Framework to cover selective tax incentives
which might qualify under this Article. The framework has been
developed in the public interest to correct what is perceived as
market failure in the R&D sphere.

In applying the framework the Commission will take

3.4
into account the following framework elements:

— the R&D category, whether

fundamental,

industrial or

experimental;

— the application of the incentive to eligible costs;

— the limitation of

the aid intensity to the maximum

threshold.

Furthermore the Commission will assume, on the basis of the
case made by the Member State, that the incentive will address
market failure by stimulating higher R&D spending by compa-
nies.

3.5
The European Council has called for the Open Method
of Coordination to be used in support of research policy
making and the Council subsequently invited the Committee for
Scientific and Technical Research (CREST)
to oversee this
method of support. In this Communication the Commission
has relied heavily on the report ‘Evaluation and design of R&D
tax incentives’ produced by CREST in March 2006.

Due to varying economic and industrial structures, R&D
3.6
capacity, level of R&D spending and overall tax environment,
the mix of R&D and innovation policy instruments vary greatly
between Member States. The majority of the existing schemes
are general
in nature and about half of these have an upper
limit or cap. This works to the advantage of SMEs as their level
of expenditure is not usually affected by the cap. About one
third of tax incentives provide specific benefits for SMEs and a
growing number of schemes cater specifically for young innova-
tive SMEs.

3.7
The three basic types of tax relief are tax deferral, tax
allowance and tax credit. The impact of the incentives used by
each Member State is a function of
the overall tax system.
Depending on the purpose of
the incentive, some schemes
apply to total R&D expenditure, others apply only to incre-
mental expenditure resulting from the scheme. In other cases
both classes of expenditure are relieved, but at different rates.
the incentives varies considerably across
The generosity of
Member States. As a relief of tax,
it is also affected by the
prevailing levels of corporation tax.

3.8
Tax deferral generally means the 100 % deduction of
R&D expenditure from taxable profits. In this scheme, every
Euro of R&D expense can be claimed in full against tax. Where
the R&D expenses are not 100 % deductible, they can usually
be capitalised and subsequently be depreciated. In particular, this
will be the case for capital expenditure.

3.9
Tax allowances are used to allow more than 100 % of
R&D expenditure to be relieved. Where allowances apply, the
uplift is usually between 125 % and 300 %. For example, with a
general corporation tax rate of 30 %, a company would be able
to claim EUR 3 000 tax relief on every EUR 10 000 of R&D
expenditure. With an uplift of 50 %, the company could claim
EUR 4 500 relief on every EUR 10 000 of R&D spent.

3.10 When the incentive is given in the form of a tax credit,
it takes the form of a tax or cash refund. The credit is usually
tax payable, but where no tax is
given on the amount of
payable the credit may be calculated as a percentage of the R&D
spend. A credit in cash payable where a company is not making
profits can provide a very welcome injection of funds for early
stage companies.

3.11 While most schemes, as described above, are related to
corporation tax, other schemes target wage tax and social
contributions, or personal income tax. These options decrease
research staff costs with immediate effect, thus reducing the
most important component of R&D expenses. These options
will have most effect where social charges are high.

3.12
For targeting loss making firms, such as young innova-
tive SMEs, design options range from wage tax exemption to
corporation tax refund to R&D tax credits to unlimited carry
forward of losses incurred for future corporation tax relief.

3.13
In 2004 France was the first EU country to introduce a
tax incentive specifically to support Young Innovative Enter-
prises (YIE). The aim is to stimulate private sector research and
create real growth by reducing the start up costs of new busi-
nesses oriented towards research and innovation. The incentives
include corporation tax exemption for the first three profitable
years followed by a 50 % exemption for the next two years. In
addition, social security payments for highly qualified personnel
are exempted for eight years. Eligibility criteria apply to the YIE
scheme.

3.14
incentives
concludes that Member States should:

Based on the experience of the application of R&D tax
the Communication

in fifteen Member States,

— use general measures as far as possible because these will
reach more firms, maximising the increase in R&D and
minimising market distortion;

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— allow full deductibility for all R&D expenses (no capitalisa-
tion or accelerated depreciation of
these expenses) with
adequate carry-forward and carry-back provisions for losses
incurred.

3.15
States should clearly define their objectives:

As far as the design of schemes is concerned, Member

— focus on the additional R&D spend to be achieved;

— focus on the behavioural change in firms;

— evaluate the wider societal effects of these changes;

— consider evaluation criteria from the design stage;

— test whether specific incentives meet their objectives.

Beyond the scope of R&D incentives for companies, the
3.16
Communication also raises a number of
issues affecting
described as orientations for measures of common interest and
mutual benefit: The EESC position on these issues is given in
section 5 below.

4. Observations on the guidelines

4.1
The guidelines provide a wide range of options for the
promotion of R&D via tax incentives. The EESC encourages all
Member States to adapt
these guidelines to their particular
circumstances to create an R&D friendly regime. The Open
Method of Coordination, facilitated by CREST, and driven by the
Lisbon agenda should give all Member States the opportunity to
apply best practice.

4.2
The impetus provided by R&D tax incentives will vary
according to the size of the enterprise, whether, large, SME or
start up.

4.3
In many Member States, tax incentives for R&D invest-
ments are relatively recent and the effect on large companies
cannot yet be accurately tracked. It is possible that in some
cases the tax savings will be reflected in the bottom line rather
than the R&D department. Hence the interest in certain Member
States to give greater incentives for incremental investment. At
the same time Member States have an interest
in retaining
domestic R&D presence and straight forward incentives will
encourage enterprises to keep their R&D activities where they
are.

Larger firms have a greater critical mass of engineers and
4.4
scientists and consequently they are well placed to send work
off-shore. If, for example, Member States decide to use R&D
incentives to retain software engineering jobs on shore, the

most powerful incentive could be to make the associated costs
100 % deductible as per 3.8 above.

4.5
SMEs do not have the resources of larger companies and
relatively greater pressure.
so their finances may be under
Options adopted by some Member States to give larger allow-
ances so SMEs and set scheme upper limits beyond the scale of
SMEs will give SMEs relatively more financial flexibility for R&D
investment.

replacement and product

4.6
It is for start ups that tax incentives have the greatest
potential leverage and this is important because such companies
are vital elements in the promotion of enterprise and innova-
tion. Innovations in the service economy, as well as in science
and technology very often emerge via start up companies. The
R&D departments of established enterprises often seem better
adapted to product
improvement
rather than break through invention. New companies exploiting
inventions in science and technology are vital because if they
can survive the difficulties of the start up phase (unfortunately
most small companies do not survive), they may either develop
into wealth creating SMEs or become a valuable acquisition for
a larger enterprise. The M&A budgets of many technology enter-
prises may be of no less importance than the R&D budgets of
Indeed, many large technology enterprises
those same firms.
have established investment arms modelled on venture capital.

4.7
Since the acquisition of small companies by large is a
feature of the enterprise economy, it makes sense that the trans-
actions should be as tax transparent and tax neutral as possible.
This means that exit
taxes for founders and entrepreneurs
should be minimised while distorting penalties should not be
imposed on acquiring companies.

4.8 While R&D incentives may be appropriate for YIEs in the
technology sector, general incentives for start up companies are
equally important. This is because such incentives will encou-
rage new business formation in all industry sectors, thus contri-
buting to the overall growth of Member State economies.

funding. So called venture capital

In the context of general tax incentives to encourage new
4.9
business formation, the Communication is strangely silent on
capital taxes. The problem for a start up business is to secure its
initial
is not eager to be
involved in early stage businesses and so the seed money usually
has to come from private investors, business ‘angels’ and the
friends and family of the founder(s). The capital tax regime
which applies to these investors is a vital ingredient in business
formation.

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4.10
The UK has a reasonably well developed system of tax
incentives in this area which may serve as an example. Invest-
ment may be made directly via the Enterprise Investment
Scheme (EIS) or via a Venture Capital Trust (VCT) which is a
collective investment vehicle quoted on the Alternative Invest-
ment Market (AIM). Companies qualifying for either scheme
have to meet relevant eligibility criteria.

In each scheme,

income tax relief is available on the
4.11
sum invested at 20 % (EIS) or 30 % (VCT). No capital taxes are
payable on gains after a qualifying period. No income tax is
payable on VCT dividends and no death duties are payable on
VCT holdings in the investor's estate. While tax advantages
should never be the reason for making an investment, these
schemes do significantly mitigate the risks of investing in start
up companies. They have succeeded in their objective of making
it easier for British entrepreneurs to raise the money.

An important omission from the Communication is
4.12
any guidance on the treatment of patents and licensing. There is
confusion in respect of the law and evidence of competition
between Member States in the tax treatment available in respect
of patents. The EESC proposes that the Communication be
expanded to include patents and licensing.

5. Orientations for measures of common interest and

mutual benefit

The Committee supports the proposal

5.1
that Member
States should address the obstacles in the way of transnational
research projects by, inter alia, improving the use of R&D tax
incentives for industrial participants.

5.2
The Committee encourages Member States to explore
ways in which state imposed costs can be lowered for young
R&D businesses following the very successful French example of
the YIE regime.

Brussels, 27 September 2007.

5.3
The Communication notes that while there are in the EU
a few private sector public benefit research foundations which
aim to enhance scientific knowledge by funding research, typi-
cally in universities, other regions such as the USA have very
many more. Formal and informal obstacles appear to inhibit
both donations by individuals and corporations (which should
qualify for income and corporation tax relief) and the subse-
quent flow of funds to research. The Committee endorses the
proposal that Member States develop a common approach so
that both donations and research funds can flow freely within
the EU.

The cross border mobility of

5.4
researchers should be
encouraged by Member State agreements to prevent double
taxation on short term assignments. Member States are also
encouraged to extend these arrangements to countries within
the EU orbit such as the Ukraine, Israel and Turkey which are
involved in a significant R&D exchange with the EU.

5.5
Some Member States allow firms to request a certificate
recognising their capacity to perform R&D. In some Member
States, public entities performing R&D are automatically granted
such certificates.
In order to facilitate mutual recognition of
the Commission will propose a possible
these certificates,
common structure. This seems a sensible step for Member
States which rely on these certificates.

5.6
The Commission has identified concerns where public
and private firms interact in the R&D arena because of the
problems created for the recovery of VAT on R&D expenditure
by private entities. The Commission's proposal to simplify and
modernise the rules and their application is very welcome.

Finally, the Communication states that in the long term
5.7
it is desirable to seek EU wide tax definition of R&D and inno-
vation and to give such expenditure favourable treatment in the
common consolidated corporate tax base. This would be a
further step towards the completion of the single market.

The President

of the European Economic and Social Committee

Dimitris DIMITRIADIS