Under WP3, the researchers reviewed current practices in, and studied the governance of, R&D tax credits and incentives. Following some initial desk research, two empirical studies were carried out, providing better insight into R&D tax incentives in ten selected EU countries.
For one study, primary data was gathered via an open-ended qualitative survey aimed at government agencies, interested stakeholders (such as consultants/accountants, university and research centres) and SME representative organisations in ten selected EU Member States in order to gain knowledge on issues and barriers to innovation, as well as stakeholder aspirations for the future of R&D tax incentives. Three principal themes are identified: internal, external and informal barriers.
Barriers to innovation, and obstacles to SMEs accessing R&D tax incentives, include:
- Lack of government/public funding (seen as the main barrier)
- Lack of private funding which could help SMEs to invest in R&D activities.
- Lack of awareness of R&D tax incentives.
- Lack of qualified personnel able to be involved in R&D activities
Evident in a majority of responses is a sense of the deficiency of R&D schemes across Europe and authorities are blamed for the level of support they offer. The survey identified three main weaknesses in R&D and innovation policy in the participant’s respective countries:
- Weakness of policy, including a high perception of the complexity of bureaucracy together with a lack of ex-post evaluation of research projects financed by public bodies.,
- Weakness of funding to support R&D policies,
- Weakness of the surrounding environment, including limited SME support from public institutions, limited knowledge of R&D tax relief opportunities for SMEs, and the uncertainty of the long-term results of R&D leading to long term profit (hard to measure and perceived as a drag on profits).
The questionnaire investigated the suggestions and expectations that participants have for improvement of future R&D tax incentives and innovation policy in their respective countries. Three main expectations emerged:
- Expectations in terms of increased investment by SMEs and expansion of the R&D tax incentives schemes
- Expectations in terms of simplifying the administrative procedures and guidelines, and a need for increased government support
- Expectations in terms of clarification of the definition of innovation, which is seen as vague, and coverage of more sectors such as the creative sector.
For the second study, the impact of R&D tax credits and incentives on SME innovation was researched by quantitative analysis of primary data gathered from innovative SMEs. To be consistent with the prior qualitative study, the research was administered in the same ten EU states, according to their position on the European Scoreboard 2018. Building on the CIS survey, the questionnaire investigated awareness and use of R&D tax incentives, and the input and output of innovation of innovative SMEs. Using a segmentation profiled by country, company size, occupation and primary role in the company, 819 valid questionnaires were collected.
Most participants were young companies with highly educated employees which is in line with the current literature highlighting Young Innovative Companies (YIC) which are small and highly insensitively engaged in innovation activities. In fact, young companies are more inclined to exploit a new concept and to be more productive. In addition, the high level of education of employees is unsurprising as innovative companies require high human capital, creative and innovative thinking.
50.5% of SMEs surveyed declared that they had received R&D tax relief during 2015-2017.
Of those companies who did not receive R&D tax relief and incentives:
28.8% believe the process is too complicated
23.9% state they do not have enough time to apply
17.4% state that the guidelines are not clear
22.8% are unsure what the schemes are about
20 % argue that the incentives do not cover the firm’s R&D activities
9.9% believe R&D incentive consultants are too expensive.
15.5% were told their R&D did not qualify
62% of participants declared that they would carry out R&D activities even if they did not receive incentives.
Only 18% of participants became aware of R&D incentives through information provided by government advertisement, newsletter, etc. This result is particularly interesting in that it highlights how governments do not fully invest in promoting R&D incentives opportunities, thus potentially losing a driver for economic growth.
The political agenda of most European countries aims to support SMEs to invest in innovation. As emerged from the initial qualitative study, financial constraints such as lack of private funding, informal asymmetries, such as non-awareness of R&D tax incentives opportunities and positive R&D spill-over, are market failures that can lead SMEs to under-invest in R&D. Many EU countries have decided to correct these market failures by supporting SMEs through R&D tax incentives. Although several studies have examined the effect of these policies, to measure the effectiveness of R&D tax incentives on innovation is not an easy task.
A fundamental issue when trying to evaluate R&D tax incentives is the absence of a directly observable counterfactual since the implementation of an experiment would imply that only some randomly selected firms receive the tax credit. To circumvent this limitation, the surveys employed a counterfactual by asking the beneficiary firm directly “What if you did not benefit from tax incentives?”, and vice versa. Considering this, the central hypothesis tested in this study was to examine whether differences exist between companies who have received R&D tax incentives and those who have not in terms of the final innovation implemented by companies. After running non-parametric tests of SMEs who received R&D tax incentives and SMEs who did not, the result confirms that there is a statistical difference between the two groups of companies, in respect to final innovation.
To summarise, companies who have received R&D tax incentives in the sample have developed more innovative products/service, or an improved version of the previous one, compared to companies who did not receive the incentives. Although a positive correlation was found between innovation and benefit from tax incentives, the direction of causality was not established. It could be that innovation is spurred by tax incentives, but it could also be that firms that innovate spend more on R&D and are therefore more inclined to apply for tax incentives.
Conclusions and Policy Recommendations from Both Surveys
Government funding emerged as a prominent issue for stakeholders, specifically a lack of funding available for innovative SMEs. This was emphasised by nearly all participants who agreed that governments need to fund innovation, creating an expectation for R&D funding. This was matched by responses highlighting the lack of private funding, indicating that innovative SMEs are underwhelmed with the options available for their technically challenging endeavours.
With lack of funding, SMEs struggle to carry out R&D, risking working on a ‘question-mark product’ that may or may not reap financial returns. Moreover, creating innovative products and processes requires heavy investment and time, something few SMEs have or can access. R&D constrains SME finances, especially if relief is given in retrospect. As it is costly to carry out R&D, a trade-off needs to be executed which only larger companies have the capacity to float. Due to their requirements, grants are considered niche, not practical relief that is for the ‘many’. Governments have the power to enhance R&D funds and the relief currently given. A higher percentage of relief will motivate SMEs to carry out R&D. It is beneficial that both profit-making and loss-making companies can use this scheme. However, money has to be spent before any relief is given as opposed to specific grants. Budget cuts are lessening the chance of innovative culture, and overall this is a point of contention.
Quality of funding support is another aspect of R&D tax relief. Although enhancement and tax credit rates could become high, the support surrounding the funding and its availability to aid SMEs undertaking R&D are debatable. SMEs require networking and the forming of connections alongside financial relief, so it would be helpful to build bridges between industry and academia through networking and creating relationships, in addition to the help already provided. This could also facilitate innovation.
Although all stakeholders argued that they were familiar with R&D tax relief, they proclaim a lack of awareness in SMEs regarding what R&D tax relief entails. Therefore, a gap exists between the information the government wants stakeholders to use and work with and what is actually being retained by SMEs needing the service. Many SMEs are not sufficiently aware of the benefits they can gain from R&D tax incentives.
Participants declared that the definition of innovation itself is ambiguous and understanding of it is contentious and confusing across SMEs, nationally and on a European level. This vagueness in the definition of innovation translates to the SME R&D schemes implemented by governments and this confusion is fed into how the schemes are then used by SMEs. The SMEs then do not understand whether their innovation is classified as innovative, causing a cyclical effect.
Much of the bureaucracy surrounding R&D tax relief schemes contributes to preventing applications from potentially qualifying innovative SMEs across Europe. This includes the quality of personnel assisting the claim, as well as the actual process of applying for the relief. How these interactions are played can determine how companies navigate with their R&D in the future. Although some guides currently exist in specific countries, it is not easy to find legitimate and synthesised jargon-free ‘how-to’ documents provided by government. This makes it difficult for stakeholders to understand schemes or point SMEs towards the correct, coherent SME-friendly information. Governments could do better by providing how-to guides without using too much technical and financial jargon on how to complete an R&D tax relief claim effectively. They could highlight this information to SMEs themselves, accountants and/or SME representative organisations.
For more detail on this qualitative and quantitative research see Kapitalise’s report D3.2 R&D Tax Incentives