Aurifer’s reply to the Public Consultation initiated by the UAE Ministry of Finance (MoF)

Several of the questions in this public consultation are aimed at collecting information from businesses regarding their existing R&D activities and we are therefore ill suited to respond in our capacity as a tax consulting firm. As such, we have chosen to address some of the queries separately.

The United Arab Emirates (UAE) government is currently exploring the implementation of R&D tax incentives to promote innovation and further diversify the national economy. The proposed tax incentive under the UAE CIT law is considered an indirect instrument to support R&D to be developed in the UAE. The initiative fits into the wider policy of the UAE’s Ministry of Industry and Advanced Technology which has made strengthening the UAE’s R&D ecosystem a crucial part of its strategic objectives to fortify the UAE’s position as a global leader in industries of the future.

A guidance paper was provided offering a comprehensive definition of R&D, which builds upon available OECD standards, specifically referencing the “Frascati Manual.” Notably, the guidance paper categorizes R&D into three primary types: 

• Basic Research: This includes theoretical and practical investigations aimed at broadening knowledge about phenomena without immediate commercial applications.
• Application-Oriented Research: This includes research that focuses on specific, practical aims to develop new products or services.
• Experimental Research: This involves the systematic exploration of past research and experiences to discover new knowledge that can lead to the creation or enhancement of products and processes.

From an economic perspective, the proposed tax incentives intend to encourage private sector investment in innovation, a key component for ensuring the UAE’s long-term economic resilience while enhancing its competitive stance on the global stage.

To this end, the guidance paper delineates a clear framework for eligibility. The eligibility seems to be suggested based on OECD standards. It would allow easier tracking of the development and investment in R&D, and easier reporting.

However, certain activities are not included. For example, routine engineering and quality control activities are not eligible, which may restrict the incentive’s applicability to some sectors, such as manufacturing. Certain scientific activities are also excluded.

MoF is considering basing its policy principles on this guidance. In this regard, while the Frascati Manual provides useful guidelines for the classification of R&D activities, the measurement of R&D expenditure etc, it is primarily aimed at the collection of statistics and does not provide clear guidance in the context of R&D tax incentives.

R&D Tax Credits are applicable in many other jurisdictions, and are a tool often used by governments to encourage investment in research. The OECD is currently tracking 43 R&D Tax Credit Regimes.

Some regimes and their description include:

– Ireland: 30% credit on R&D expenditures; Up to 32% credit of qualifying expenditure relating to digital game development.
– Belgium: part of the withholding required for Personal Income Tax purposes for specific profiles such as researchers is not required to be paid to the tax authority, and effectively results in a grant to the business employing the staff. This is referred to as the payroll withholding tax credit, although technically speaking it is not a credit.
– Australia has a tiered R&D tax credit, granting a higher tax credit for SMEs which can go up to 43.5%.
– France has amongst others accelerated depreciation for R&D Capital Assets (as do many other countries).

The successful implementation of R&D tax incentives will depend greatly on the simplicity of the application process and the efficiency of its administration. A cumbersome process could deter businesses from applying, undermining its effectiveness. We would recommend that the auditing process is not different from other aspects of the CIT law, however some aspects may require specialized input.

In relation to outsourcing arrangements, it is important to be conscious that R&D activities in practice often involve collaborations with other institutions or bodies. This can be done with the aim of benefitting from synergies and to avail of certain resources which might not be immediately available to all companies (particularly in the SME space). For example, start-ups may collaborate with universities that have better facilities, greater access to funding from the State etc.

As such, although the preference should always be for R&D activities to be conducted internally by the relevant applicant company or within the UAE, it is important to be cognizant of the realities of such arrangements and activities for certain organizations.

In this regard, the Irish R&D tax credit regime has a limitation on relief in scenarios where companies engage in outsourcing activities. The relief will be restricted to 15% of the expenditure incurred by the company itself on R&D activities or €100,000, whichever is the greater. This is subject to the company incurring at least the same level of expenditure on qualifying activity which it carries out itself. It is also worth noting that outsourcing is not permitted to connected persons i.e. related parties.

We would consider this to be a reasonable approach. However, it may be worth to consider the introduction of a slightly less restrictive provision in relation to outsourcing to ensure that there is sufficient uptake of the new R&D tax incentive. Following a period of assessment, the FTA can then assess whether the relevant thresholds or restriction percentages need to be modified accordingly.

In general, indirect costs would not be considered qualifying R&D expenditure unless they directly relate to the activity being undertaken. For example, any rent incurred on a lab facility being used to conduct R&D activities or the energy consumption required to perform the relevant activities. An advantage of allowing a certain allocation of indirect costs would be that it may offer a greater tax incentive for companies to establish their operations in the UAE. However, the allocation of indirect costs can often be an imprecise exercise which will depend on the relevant allocation key and could lead to manipulation by taxpayers in order to inflate the amount of qualifying expenditure.

If R&D tax incentives are implemented, we would recommend MoF and the FTA to develop guidelines around how to address cost sharing agreements with public and private authorities in the UAE. Such agreements are important in the UAE as much of the R&D activities in the UAE are initially driven by governmental initiatives.

The UAE may consider that its tax regime is already very attractive. At 9%, with multiple exemptions, it is already one of the most beneficial tax regimes in the world. Moreover, for Free Zone entities, the QFZP regime also has provided that income derived from the ownership or exploitation of intellectual property (potentially produced as a result of R&D) constitutes a qualifying activity, even granting an up-lift of 30% on qualifying expenditures.

The application of R&D tax incentives with respect to qualifying income from intellectual property would not lead to a reduction of the tax liability, but may be relevant, depending on the design for the non-qualifying income. The combination of a low rate and income from qualifying intellectual property being able to benefit from a more favorable regime in the free zones, already makes the UAE very attractive.

In the framework of Pillar Two, it is advisable that if R&D tax incentives are implemented, that they are structured as so-called Qualifying Refundable Tax Credits (“QRTC”), and that they are structured in such a way to have a positive effect on the Substance Based Income Exclusion (“SBIE”). For them to be considered “refundable”, according to the OECD’s Model Rules on Pillar 2, the refundable tax credit needs to be designed in a way such that it must be paid as cash or available as cash equivalents within four years from when a Constituent Entity satisfies the conditions for receiving the credit under the laws of the jurisdiction granting the credit.

The result of a tax credit being considered a QRTC is that it does not reduce the Covered Tax for the purposes of calculating the ETR of an in-scope Constituent Entity of an MNE under Pillar Two, contrary to a traditional tax credit. Rather, it will increase the denominator when calculating the ETR. It is therefore generally speaking more favorable. When a QRTC is granted for expenses which would increase the SBIE, which is a deduction from the excess profits subject to the topup tax based on a percentage granted on the value of qualifying tangible assets and payroll expenses, this would be seen as an additional advantage to taxpayers.

One of the few benefits in place under the GloBE rules is the application of the SBIE. The SBIE, when combined with QRTC’s which aim to reinforce the SBIE, is a recommended approach. While the availability of tax benefits impacting the tax liability as a regular tax credit is severely restricted, expenditure-based tax incentives that target payroll or tangible assets may be less affected than income-based tax incentives.

Although the above considerations need to be considered from an MNE perspective, it is also important to bear in mind that there is a rich ecosystem of start-ups engaging in R&D activities. As such, it may be worth allowing an option for taxpayers to elect either for their eligible R&D tax credit to be repaid in cash or cash equivalents (i.e. as a QRTC) or to request for it to be offset their tax liabilities (i.e. in a more traditional tax credit). This would allow greater flexibility and potential benefits for both categories of taxpayers.

Prepared by Thomas Vanhee (thomas@aurifer.tax) and Liam Purcell (liam@aurifer.tax), on behalf of Aurifer.