Tax incentives for research and development

1. Introduction

Recent years have seen the amendment of multiple tax regulations that have introduced numerous incentives for a variety of taxpayers. These tax breaks have made Serbia a highly attractive country for foreign investment, which has in turn led to the development of a start-up ecosystem, job creation and more benefits for employees, and growth in several industries, most notably information technology (IT).

Incentives aimed at promoting research and development (R&D) include: (i) R&D double deduction; (ii) personal incentives for R&D staff; (iii) income tax exemption for an eligible portion of income (IP Box); and (iv) incentives when investing in innovative start-ups. This article will cover each of these forms of tax relief in greater detail below.

2. Definition of R&D

Any discussion of R&D will, firstly, benefit from a clear definition of the concepts of ‘research’ and ‘development’ and the key features of R&D activities. The Serbian Corporate Income Tax Law[1] defines ‘research’ as ‘any original or planned research undertaken with the purpose of gaining new scientific or technical knowledge or understanding’, whereas ‘development’ is to be construed as ‘application of the results of research or other scientific achievement or design, or the production of new, substantially improved materials, devices, products, processes, or systems, before the commencement of commercial production or utilisation’. These definitions suggest that R&D activities must be:

• novel: the activities must be novel, meaning aimed at making new discoveries;
• systematic: the activities must be undertaken and financed pursuant to a pre-existing organisational arrangement;
• uncertain: there must be uncertainty as to whether any resulting products will be suitable for commercialisation;
• creative and original; and
• transferable and reproducible: once gained, the knowledge may be transferred to other persons who should be able to reproduce the results of the research.

For an activity to be an R&D activity, it must satisfy all of these five criteria cumulatively. The absence of one or more of these qualities means the effort is not deemed an R&D activity. Therefore, this category includes, for instance, developing a new computer programming language or a car based on a novel technology, but excludes designing or adding new functions to an existing product, arts, and the like.

 

3. R&D double deduction

The R&D double deduction allows a corporate income tax (CIT) payer to double deduct the direct costs of R&D performed in Serbia for CIT purposes. To claim this incentive, the applying company must prove the existence of a direct link between the costs incurred and the R&D activity, including having a project description or specification that includes but is not limited to the objectives and planned stages of the project, as well as any activities planned at every individual stage of the project.

Another requirement readily apparent from this definition is that the double deduction may be claimed only if the costs are incurred for R&D performed in Serbia. This may be misleading as it may imply that all activities of an R&D project must take place exclusively in Serbia. However, the Regulation on the double deduction of costs directly associated with research and development for corporate income tax purposes[2] brings clarity to the issue by allowing some R&D activities to take place outside of Serbia if due to specific physical, geographical, or natural considerations that cannot be met in the country. For instance, to complete a new product, the company developing it may require resources that are not available in Serbia. In this case, it is absolutely justifiable for the firm to move some research to the country where these resources can be obtained if doing so would result is substantial cost savings, and the project may be deemed to have taken place in Serbia. Another requirement of the Regulation is that at least 90 percent of any R&D staff engaged on the project must work in Serbia.

The following costs may be double deducted: salaries (including any and all social insurance contributions); materials directly associated with R&D; expert consultancy, advisory services, and know-how obtained for use in R&D; protection of intellectual property in Serbia and abroad (safeguarding copyright and ancillary rights and patent protection); intangible assets; production services obtained for use in R&D; and purchase and lease of real estate, plant, equipment, and biological assets for use in R&D; and the like.

This incentive may significantly reduce a firm’s CIT base, as will be shown in the example below. Say a business has earned a taxable income of RSD 5 million. The company has been allowed to deduct RSD 2 million in costs, of which R&D costs account for RSD 500,000. Without the R&D double deduction, the taxable base amounts to RSD 3 million (5 million less 2 million), and the CIT for this tax period will be assessed at RSD 450,000 (3 million ⨉ 15 percent).

Let us now assume the firm has claimed the R&D double deduction. In that case, the company will be entitled to deduct RSD 1 million for R&D (2 ⨉ 500,000), so the taxable base will stand at RSD 2.5 million, and the CIT will be assessed at RSD 375,000.

4. Incentives for R&D staff

Another form of tax relief is available to staff engaged directly on R&D activities. Here, a company that engages in R&D in Serbia as part of its business activity is entitled to a 70 percent exemption of payroll taxes for these staff in proportion to the time spent by these employees on R&D relative to their full working hours. Entitlement to this incentive is governed by the Regulation on payroll tax deductions for R&D employees.[3] The same option also allows a firm to deduct the totality of pension and disability contributions for this category of staff, with these costs instead met by the government. This deduction is not available for healthcare and unemployment insurance contributions.

Any firm that employs staff and engages in R&D in Serbia may use this incentive. The same rules as described above in the R&D double deduction section apply to assessing whether a project meets the requirements to be deemed based in Serbia. The byelaw regulating R&D staff incentives bars foreign firms or representative offices in Serbia from accessing these tax breaks.

The company must also engage in R&D on its own behalf rather than for other entities and must retain title in any intangible property produced as a result of the R&D activities. For instance, a firm that develops a new programming language to an order from a client cannot benefit from R&D incentives for its staff because it is deemed to be providing services rather than doing R&D as part of its own business. Moreover, in this case the client will acquire all rights in the software, which violates the requirement for the R&D company to remain owner of the end product of its research.

Any staff for which the R&D incentive can be claimed must be directly engaged on R&D projects, which is defined as participating ‘actively in (…) a variety of procedural or technical tasks directly related to the specific project’. This approach means the tax relief is not available for project management staff (such as project planners and HR officers) or those who provide support services (such as technical support for R&D equipment). As such, any eligible employee must have an employment agreement clearly identifying their position as R&D, regardless of whether the agreement is open-ended or fixed-term, or full or part-time. Even if all these requirements are met, an employee is not eligible for R&D staff tax relief if the company accessed any other incentives when entering into the R&D employment agreement with that staff member.

According to the Regulation, time spent directly on R&D activities does not include: (i) annual leave; (ii) public holidays that are non-working days; (iii) paid leave; (iv) absence from work due to army reserve training or in response to any other government summons; (v) sick leave; and (vi) temporary suspension of operations.

To be able to claim this tax relief, businesses are required to keep a record of their R&D staff that should be updated with all information necessary to determine eligibility, such as working hours (total working hours, working hours spent on R&D activities, annual leave, and the like), as well as salary data.

Lastly, companies wishing to benefit from these incentives must keep a file at their head offices with project-specific documentation that includes a description of each R&D project indicating its objectives and stages, annual budget, total approved budget, report by R&D staff (including but not limited to timesheets showing total working hours and working hours spent on R&D activities on the particular project), progress reports reflecting achievement of objectives, and the like. These documents should be provided to the tax authorities only when specifically requested: there is no requirement for an R&D company to submit this information on its own initiative after being granted this form of tax relief.

 

5. IP Box

The IP Box option allows companies to deduct 80 percent of eligible income from the CIT base. Eligible income is income derived from the licensing of registered intellectual property or ancillary rights, excluding any income earned from transfer of intellectual property in its entirety. The deduction entails first subtracting from total revenue any R&D costs incurred in generating the intellectual property (‘eligible costs’). This incentive may significantly reduce payable CIT, as it cuts the tax rate to 3 percent from the statutory 15 percent. Companies may even pay zero tax if they also claim R&D double deduction.

This tax incentive may be used by firms that hold registered intellectual property or ancillary rights. To claim relief, these companies have to register intellectual property at the latest by the end of the tax period in which they first intend to apply the incentive. The intellectual property must also be the product of R&D performed in Serbia and the company must earn revenue from licensing that intellectual property. Derivative works can also be used to claim relief if such derivative works contain recognisable characteristic features of the original work or work subject to ancillary rights. In addition, the firm must also have registered the derivative work by the tax return deadline.

This relief is also available, under the same conditions, to companies that have patented their intellectual property or applied for a patent before the expiry of the time limit for intellectual property registration. Where a patent application is denied after the tax incentive is granted, the company is required to add the total amount of the relief to its taxable base for the tax period in which its patent application was denied.

Companies that transfer their intellectual property in its entirety to other entities are not entitled to claim tax relief under the IP Box scheme. This restriction also applies to businesses that provide R&D services to other entities, including their own affiliates.

The following formula is used to assess revenue eligible for this tax incentive. Firstly, eligible costs are deducted from intellectual property licensing income. These eligible costs are any and all R&D expenses incurred in the creation of the intellectual property (the work or invention in question). This amount is multiplied by the percentage share of these eligible costs in the total expenditures incurred in the creation of the intellectual property. The product of these two figures is the eligible income, 80 percent of which is then deduced from the CIT base. This procedure requires any companies seeking to benefit from this tax incentive to retain documentation allowing precise determination of the amounts to be in assessing total eligible income, such as records of income and expenses, invoices, bills, licensing agreements covering its works and/or patents, and the like.

6. Incentives for investing in innovative start-ups

The final type of tax incentives can be claimed by investors in innovative start-ups. These firms are defined as any and all companies ‘engaged in innovation activity as their primary line of business’ (and registered as such with the Serbian Business Registers Agency). For an investor to be able to access this relief, the start-up it invests in must have been incorporated not more than three years before the last day of the tax period in which the investment is made. ‘Innovation activity’ means ‘any development-oriented activity undertaken for the purpose of creating new products, technologies, processes, and services, or introducing major changes to existing products, depending on the needs and interests of the market at the time under consideration’. Spin-offs of other businesses are not considered to be innovative start-ups.

Access to this form of tax relief requires a set of conditions to be met cumulatively. Firstly, the start-up that is the target of the investment must have its centre of main interest in Serbia. Secondly, its annual income, as evidenced in its latest financial statements available as of the date of the investment, must not exceed RSD 500 million. Moreover, the company must not have paid out any dividends or profit-based bonuses since its incorporation and will also be barred from doing so for three years after the investment is made. The final requirement is that R&D must account for at least 15 percent of the start-up’s total expenditures. This condition is deemed to be met if more than 80 percent of the start-up’s employees are university graduates or if the start-up owns or licences for its use registered intellectual property associated with its innovation activity. These final considerations suggest the last requirement allows alternatives, whereby the start-up can fulfil any of the three conditions to be eligible.

An investor in an innovative start-up is entitled to tax credit amounting to 30 percent of the investment. To access this incentive, the investor must not have held more than 25 percent of the shares, equity interests, or voting rights in the start-up before the eligible investment is made. The investment must be fully paid-in and the equity interest held by the investor in the start-up must not decrease for three consecutive years following the investment.

The tax credit for investing in start-ups is capped at RSD 100 million. Moreover, regardless of the number of investments made, the investor may be granted a CIT deduction not exceeding RSD 50 million in any given tax year, whereas the remaining unused tax credit can be used to offset tax liabilities in future tax periods but expire in five years. Lastly, if the investor has any affiliates, the actual tax credit is capped at the difference, if any, of subtracting the sum of tax credits granted to those affiliates for investing in the same start-up and the general cap of RSD 100 million. The investor may use any approved tax credit starting from the first tax period after three years have elapsed from the date the investment is made.

From 1 March 2020, innovative start-ups are exempt from payroll tax and associated social contributions on the salaries of its founders. This incentive was initially available only to start-ups incorporated before 31 December 2021, but this restriction was since removed. Start-ups are eligible for this payroll tax relief for the first 36 months from incorporation, provided the founder holds at least 5 percent of the company’s stocks or equity interests and does not earn a salary of more than RSD 150,000 a month. Where the salary is greater than this cap, the tax and contributions relief applies to the first RSD 150,000. The founder must also have an employment agreement with the start-up and be registered for compulsory social insurance. Unlike other types of tax relief that exempt taxpayers only partially, this incentive makes a company wholly free of tax and contributions liability.

Start-ups that are affiliates of other businesses, as defined by CIT legislation, may not use this incentive. This means that no other firm may exercise control or dominant influence over the decisions of the start-up and must not hold more than 25 percent of the equity interests, shares, or voting rights in the start-up and/or its governing bodies. The relief is also not available to a start-up that derives more than 30 percent of its total income from business with other entities connected to a founder of that start-up. Where the same person is the founder of two or more start-up, only one of those start-ups will be eligible for this relief. A start-up that has successfully claimed this tax incentive for a particular person will also be barred from accessing any other tax breaks for which it is eligible by virtue of employing that person.

7. Conclusion

The above considerations suggest Serbia has recognised the importance of promoting R&D activities, including the benefits of growing its R&D sector. This area was initially largely neglected and under-regulated, which often caused confusion as to how the various forms of tax relief could be accessed. However, the subsequent enactment of regulations and other byelaws has brought greater clarity, making it much easier for R&D companies to navigate this exceedingly complicated field. Finally, we hope these tax incentives become firmly bedded down and promote expansion of the R&D industry whilst also motivating existing R&D firms to continue operating in this particularly significant area.

[1] Official Gazette of the Republic of Serbia Nos. 25/2001, 80/2002, 80/2002 – Other Law, 43/2003, 84/2004, 18/2010, 101/2011, 119/2012, 47/2013, 108/2013, 68/2014 – Other Law, 142/2014, 91/2015 – Authentic Interpretation, 112/2015, 113/2017, 95/2018, 86/2019, 153/2020, and 118/2021.

[2] Official Gazette of the Republic of Serbia No. 50/19.

[3] Official Gazette of the Republic of Serbia No. 48/2022.