Select Committee on European Scrutiny Seventh Report

10 Tax incentives for research and development

(28121) 15503/06 + ADD 1 COM(06) 728

Commission Communication: Towards a more effective use of tax incentives in favour of R & D

Legal base	—
Document originated	22 November 2006
Deposited in Parliament	7 December 2006
Department	HM Treasury
Basis of consideration	EM of 18 December 2006
Previous Committee Report	None
To be discussed in Council	Not known
Committee's assessment	Politically important
Committee's decision	Cleared

Background

10.1 In February 2005 the Commission undertook, as part of its Community Lisbon Programme, to consider how to improve conditions for investment in research and development through fiscal incentives, with guidelines or recommendations so as to ensure an optimal Community-wide use of such incentives, identifying best practices and constraints in Community law and, where appropriate, recommending tax measures.[23] The undertaking was reiterated in the Commission Communications The Contribution of Taxation and Customs Policies to the Lisbon Strategy and Putting knowledge into practice: a broad-based innovation strategy for the EU.[24]

The document

10.2 The Commission presents this Communication in fulfilment of its undertaking. The Commission focuses on guidance or guidelines both on the application of Community law and on good design features for research and development tax treatment, which Member States are invited to take into account when introducing or developing research and development tax measures. On the application of Community law the Commission sets out its view of legal conditions arising from Community law for Member State research and development tax incentives. It notes this is "the Commission's view of the existing ECJ case law regarding R&D tax incentives" and adds explicitly that "the assessment of the compatibility of a specific R&D tax incentive with EU law depends on the circumstances of the case". It discusses compatibility with:

• the fundamental freedoms, such as freedom of establishment; and
• Community state aid rules, drawing attention to the 1998 Commission notice on the application of state aid rules to measures relating to direct business taxation[25] and the new revised Community Framework for state aid for research, development and innovation, under which the Commission will assess State aid measures for research and development and innovation, including research and development tax incentives.[26]

10.3 As for design features for research and development tax treatment and incentives, the Commission draws attention to reports of the Scientific and Technical Research Committee (CREST), developed as part of Member States' work under the open method of coordination, as providing an overview and analysis of research and development tax incentives in Member States and some other countries.[27] The Commission acknowledges that "There is no single answer as to how R&D tax incentives should be designed, implemented or evaluated". But, nevertheless, invites Member States take into account the guidelines set out in the annex to the Communication when "introducing new or adapting existing R&D tax incentives" and in carrying out work on evaluation. The Commission notes in the annex itself that its work in this area relies to a large extent on insights from CREST work in support of the target for the Community to raise research and development investment towards 3% of GDP by 2010, in particular a CREST report of 17 March 2006 on the "Evaluation and design of R&D tax incentives".

10.4 In a third section of the Communication the Commission also sets out its views on a number of other tax issues. It says "some of these issues are research-related aspects of the general taxation system while others concern R&D issues of common interest". It invites Member States to discuss them at Community level and to consider them when reviewing their tax policies. The issues outlined concern:

• supporting large-scale trans-national research and development projects;
• Young Innovative Enterprises;[28]
• promoting philanthropic funding of research;
• cross-border mobility of researchers;
• facilitating cross-border outsourcing of research and development;
• research and development and VAT, noting a forthcoming review of exemptions, public authorities and subsidies; and
• research and development treatment in a common consolidated corporate tax base.[29]

The Government's view

10.5 The Paymaster General (Dawn Primarolo) first outlines the Government's own policies in relation to investment in research and development. She says:

• the Government is committed to encouraging public and private investment in research and development;
• its Science and innovation investment framework 2004-2014[30] set out a challenging ambition for this to rise from 1.9 per cent to 2.5 per cent of GDP, in partnership with business, by 2014, together with medium-term and long-term policies to underpin this;
• research and development tax credits for small and medium enterprises (SMEs) were introduced in 2000;
• since then there has been continuous dialogue with business and others which has influenced both the design of the SME scheme and a large company scheme which was introduced in 2002;
• in the Budget of 2006 the intention to extend additional research and development tax credit support for companies with 250-500 employees, subject to the outcome of state aid discussions with the Commission, was announced;
• the Government's initial evaluation of the research and development tax credit shows that the measure does affect companies' research and development spending decisions; and
• the Department for Trade and Industry's research and development "scoreboard"[31] also shows further strong growth in the number of smaller research and development intensive companies in the UK.

10.6 More directly in relation to the Commission's Communication the Minister says that the Government:

• remains clear that, except where specifically within Community competence,— the matters touched on in the document remain a national preserve and welcomes the Commission's recognition of this;
• agrees with the Commission that there is no single answer as to how research and development tax incentives should be designed, implemented or evaluated and that assessment of the compatibility of a specific research and development tax incentive with Community law depends on the circumstances of the case;
• is clear that it is a matter for Member States to exercise their competence to ensure that their national tax systems are compatible with Community law, including the case law of the ECJ; and
• does not share the Commission's view that the diversity of Member States' research and development tax schemes is a hindrance to trans-European collaboration.

Conclusion

10.7 We concur with the Minister's robust assertion of the primacy of Member State competence in many of the taxation matters touched on by the Commission in its Communication and clear the document.

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23   (26351) 5990/05 + ADDs 1 & 2: see HC 38-x (2004-05), para 4 (2 March 2005) and HC 38-xii (2004-05), para 12 (23 March 2005). Back

24   (26989) 14042/05: see HC 34-xii (2005-06), para 23 (30 November 2005) and (27816) 12940/06: see HC 34-xxxvii (2005-06), para 64 (11 October 2006). Back

25   OJ C 384, 10.12.1998, p3. Back

26   The RDI Framework adopted on 22 November 2006: see http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/06/441&format=HTML&aged=0&language=EN&guiLanguage=en. Back

27   CREST advises the Commission and the European Council, for its reports see http://ec.europa.eu/invest-in-research/coordination/coordination01_en.htm. Back

28   As defined in the RDI Framework. Back

29   (27425) 8231/05: see HC 34-xxix (2005-06), para 2 (17 May 2006) and HC 34-xxxiii (2005-06), para 17 (28 June 2006). Back

30   http://www.hm-treasury.gov.uk/spending_review/spend_sr04/associated_documents/spending_sr04_science.cfm. Back

31   http://www.innovation.gov.uk/rd_scoreboard/. Back

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Prepared 5 February 2007