BRIEFING ON R&D TAX INCENTIVE PROGRAMME AND OTHER DSI INITIATIVES TO STIMULATE R&D

1. BRIEFING ON R&D TAX INCENTIVE PROGRAMME AND OTHER DSI INITIATIVES TO STIMULATE R&D Presentation to Portfolio Committee on Higher Education, Science and Technology 18 September 2019

2. Presentation Outline • Introduction • Trends on business sector R&D in South Africa • Business sector contribution to R&D in South Africa • Support for business R&D through the R&D Tax Incentive • Uptake by companies • Impact of the incentive • Administration of the incentive • 2017/18 report on R&D Tax Incentive • Other DSI initiatives to stimulate business sector R&D: • Conclusion

3. Purpose of the presentation • The purpose of this presentation is to provide a briefing to the Portfolio Committee on “the levels of private sector R&D and uptake of the R&D tax incentive by companies and its impact on the development of new products and processes as well as DSI’s administration of the R&D tax incentive”. • The DSI also uses this presentation to briefs the Portfolio Committee about the 2017/18 Report on the R&D Tax Incentive programme, as required in terms of Section 11D(17) of the Income Tax Act (1962) as amended.

4. Trend on business sector R&D in South Africa • Trend of gross R&D investment • Business sector contribution to R&D in South Africa • Factors impacting on private sector R&D investment

5. Trend of gross expenditure on research and development (GERD) in South Africa • Gross Expenditure on Research and Development (GERD) in South Africa was estimated at R35.6 billion in 2016/17 (the latest available data). GERD aggregates the in-house R&D expenditure in five sectors, namely government, science councils, higher education institutions, business sector, and the not-for-profit sector. • In nominal terms, R&D expenditure has expanded over the past two decades. However, closer examination of the data in constant 2010 rand over 10 years (2006/07 to 2016/17) shows an average annual growth rate of 1,4%, a rather modest long-term growth in GERD, especially when compared to the Medium-Term Strategic Framework (MTEF) targets and GERD performance of comparable economies. • GERD/GDP was 0.82% in 2016/17. For a 4th consecutive period, this indicator increased under conditions of slowing GDP growth rate. • Government and the business sector are the largest sources of funding for R&D, contributing 42,9% and 41,4% respectively in 2016/17. Foreign sources funded 12,9% while other local sources funded 1,8% of GERD.

6. Characteristics of business sector R&D in South Africa • Business expenditure on research and development (BERD) measures the amount of R&D spending by the business sector in an economy. BERD is a widely used measure of business investment in technological innovation. In businesses, R&D adds to competitive strength by improving the capability for producing new technology or absorb external knowledge. • Highly competitive economies tend to attract larger shares of global business R&D. Business R&D also tends to be more susceptible to competition for investment, hence the increased use of R&D incentives and their generosity. • The business sector remains the largest R&D performing sector in South Africa, contributing 41% to GERD – but this has reduced compared to 2006/07 (10 years before), where it was about 56%. • Business sector includes both the privately-owned companies and the state-owned companies. SOCs in-house R&D was about 17,7% of BERD in 2016/17. Just more than 80% of BERD was of privately-owned companies.

7. Characteristics of business sector R&D in South Africa • The bulk (more than 90%) of BERD comprises applied research and experimental development, as opposed to higher education institutions which spends more on basic research. These differences point toward the importance of connections between private sector and public sector driven research. • There have been shifts in the composition of BERD per major industrial categories over time, mostly in line with the broader changes in the structure of the economy. The financial intermediation and Business Services R&D now dominates, contributing about 44,3% of BERD in 2016/17. This sector’s R&D spend has surpassed that of the manufacturing sector since 2011/12. Manufacturing R&D constituted 27,8% of BERD in 2016/17. Mining R&D expenditure has been declining for the three consecutive years leading to 2016/17. • A recent study using the National Treasury/SARS panel data revealed the level of concentration of R&D-active firms (within a small number of larger and older firms in manufacturing, mining, utilities and business services). It also found that the R&D-active firms allocate a relatively small share of their resources to R&D (i.e. low R&D intensity) compared to firms in OECD countries; and that the estimated return to R&D in South African manufacturing firms is high compared to OECD countries.

8. GERD as percentage of GDP (1993/94 – 2016/17) GERD % of GDP

9. Major flows of funding for R&D per sector in 2016/17 Higher Education R11.659 b (32,7%) Other local R1.048 b (2,8%) Government R16.428 b (42,9%) Business R 14.046 b (41,4%) * Government R8.235 b (23,1%) Not for Profit R1.018 b (2,9%) Business R14.781 b (41,4%) Foreign R4.172 b (12,9%) Source 11 385 (89,6%) 56 (0,5%) 770 (6,5%) 368 (3,4% SC) 9 222 (56,1%) 454 (2,8%) Performer 6 348 (30.9% SC) 162 (0.9%) *Government include Science Councils (SC)

10. The graph indicates some recovery in nominal BERD from 2011/12 onwards, following the declines in 2009 and 2010. However, business R&D as proportion of GERD has been declining over the years. Trend in business expenditure on R&D (BERD) and its contribution to GERD

11. The business sector remains the largest R&D performing sector in South Africa, contributing 41% to GERD – but this has reduced compared to 2006/07 (10 years before). Higher education increased its contribution from 20% to 33% over the same period. Changes in BERD contribution to GERD (Ten years from 2006/07 to 2016/17) 2006/07 2016/17

12. Factors impacting on private sector R&D in South Africa Recent studies have noted factors that hinder R&D in South Africa. Government’s role is to create an environment conducive to productive investment and innovation. Efforts to stimulate R&D Factors hampering private sector R&D Slow demand conditions Investor uncertainties, Inadequate human resources, Generally slowing private rates of investment Tight fiscal conditions (public sector) General state of technological development in the country • Measures to improve the investment climate • Government support for innovation • R&D incentives • DSI partnerships with private sector on innovation programmes • Intellectual property policy certainty • New driver of growth (e.g. digitalisation, bioeconomy, etc.) • Human capital development • Scientific infrastructure

13. Support for business sector R&D through the R&D Tax Incentive • Uptake by companies • Impact of the incentive • Measures to improve administration of the incentive • 2017/18 report on R&D Tax Incentive

14. Overview of R&D Tax Incentive • Companies undertaking R&D in South Africa qualify for a 150% tax deduction on their R&D expenditure in terms of Section 11D of the Income Tax Act (1962), as amended. • At a corporate tax rate of 28%, the incentive translates into a benefit of 14 cents per rand spent on R&D, reducing the user cost of R&D. • For a company to benefit from the incentive, it must be an incorporated entity, recognised as a company under the Income Tax Act and engaged in eligible R&D activities within South Africa. • R&D is generally expensive and risky. The programme logic is that: • with reduced tax liability, companies can be encouraged to make the investment. At times, making such investment sooner, or at a larger scale, or involving other partners in the national system of innovation. • R&D builds capacity for new products, processes, etc. • R&D from private investment may have positive spillover to the rest of society through knowledge transfer and skills development.

15. Uptake of the R&D Tax Incentive: • (Summary of 2018/19 performance) • In the period from March 2018 to February 2019, the DST received 115 R&D tax incentive applications containing 388 projects from 91 companies, of which 50 (54%) were first-time applicants. • The applications had an estimated R3.3 billion in R&D expenditure.

16. Processing of applications (as at 28 February 2019) • The DSI’s Strategic Plan sets a target of providing a decision within 90 days of receiving R&D Tax Incentive applications. Turnaround time has improved gradually over time to an average of 94 days on 2018/19 applications. • Quality of information provided by applicants enables efficient processing of applications. Information and guidance is provided to applicants to achieve this. • Manufacturing make 47% of total applications, followed by financial and business services with 30%. Manufacturing has the highest approval rate while the financial and business services a higher rate of non-approvals. • Applications from big companies tends to receive approvals than applications from smaller-sized companies.

17. Procedure followed in case of non-approval of projects • A process consistent with the Promotion of Administrative Justice Act (PAJA) is followed in case of likely non-approvals. An applying company is given 15 days to make further representations before a non-approval recommendation is made to the Minister. • Typical reasons of non-approval are: • Information provided failing to demonstrate the resolution of scientific and technological uncertainty to meet the requirements of section 11D(1). • Envisaged outcomes on the project can reasonably be achieved by a competent professional in the field using existing knowledge. • The proposed activities not meeting the definition of R&D as outlined in the Act. • The proposed activities seeming to be aimed at overcoming a technical problem, rather than a technological resolution. • R&D activities not undertaken within the Republic of South Africa. • R&D activities completed before the DST receiving the application.

18. Uptake of the R&D Tax Incentive: • (November 2006 to February 2019) • In cumulative terms, from November 2006 to February 2018, a total of 1 141 companies applied for support, and 941 received it (478 under the preapproval system and 628 under the retrospective system). Some companies have benefited under both systems. • Over the same period, about R50 billion in R&D expenditure had been supported by the incentive since November 2006 (R24,6 billion under the pre-approval system and R25,4 billion under the retrospective system). • The incentive has provided most of its support in industrial policy (IPAP) priority areas.

19. Number of companies supported per turnover size (Nov. 2006 to Feb. 2019) 941 • Of the 941 companies that have received support from the incentive up to February 2019: • 41,8% are SMEs (those with latest year turnover of R40 million and below). • 36,2% are Very large enterprises (turnover of R100 million and above). • 12,6% are Large enterprises (turnover of R41 million to R100 million). • 9,4% did not disclose their turnover size. • The 941 companies include the 478 that received support under the preapproval system and 628 under the retrospective system. Some companies have benefited under both systems.

20. Companies supported per provincial location (Nov. 2006 to Feb. 2019) • 93% of the supported companies are in three provinces, namely Gauteng, followed by the Western Cape and then KwaZulu-Natal. The rest of the companies are spread across the other six provinces. This profile is generally in line with the provincial distribution of BERD as reported in the national R&D Survey. • Provincial location, in this presentation, refers to the physical address of the applying company, and not necessarily the location where the R&D activities are performed.

21. Companies supported per industry categories (Nov. 2006 to Feb. 2019)

22. Impact: • The reported outputs of supported R&D • Data drawn from 193 progress reports that were submitted by companies receiving R&D tax incentive support.

23. Impact: • The reported outcomes arising from supported R&D • Data drawn from 193 progress reports that were submitted by companies receiving R&D tax incentive support.

24. Presentation of the 2017/18 annual report on the R&D Tax Incentive programme • A memorandum on has been approved by the Minister for tabling the 2017/18 report at Cabinet. • Section 11D(17) of the Income Tax Act requires the Minister of Science and Technology to report to Parliament, annually, on the direct benefits of the R&D activities through this incentive towards economic growth, employment and other broader government objectives. • The attached 2017/18 annual report track the activities of the incentive based on identified performance indicators, such as: • Uptake, profile and provincial distribution of participating companies. • Number of applications processed. • Amount of R&D expenditure supported. • Tax revenue foregone. • Contribution to industrial policy priority areas. • The 2018/19 annual report is still being processed in the Department and will be presented to the PC once approved.

25. Other DSI initiatives to stimulate R&D

26. Government support for R&D and technological innovation There is a number of programmes in place to support R&D and technological innovation, i.e. grants, loans, public-private partnerships, tax breaks, etc. under the oversight of DSI. • Sector Innovation Funds - a co-funding model to drive innovation partnerships in specific sectors, namely sugar, citrus, wine, paper, minerals processing, forestry, etc. • Public-private partnerships (PPPs) - e.g. • Strategic Health Innovation Programmefocusing on drug development for priority diseases Malaria, HIV and TB; • Agricultural Bio-Innovation Programme which drives consortia for R&D on new cultivars, crop protection methods, climate resilience, etc. on wheat, maize, soybean, etc.; • Farmer Development Support to find alternative crops as sources of nutrition in communities; Indigenous-Knowledge based innovations, which drives consortia to facilitate product development and commercialization. innovation in industrial bio-refinery (sugar and forestry), bio-health, animal vaccine development, indigenous knowledge system, etc.

27. Government support for R&D and technological innovation • Technology for new industry development – e.g. Hydrogen and Fuel Cell Technology Development, etc. • Small Business Innovation Fund (forthcoming), DSI working with Department of Small Business Development and National Treasury to introduce this new programme to improve chances of successful commercialization of innovations. • Activities of the national intellectual property management office (NIPMO) in providing policy certainty on IP matters and technology transfer. • Private sector can also access the support of agencies such as the CSIR on their R&D. • The DSI also creates opportunities for domestic private sector firms to participate in international platforms for innovation, capacity building, R&D resources, etc.