The Covid-19 pandemic exposed the global economy to an unprecedented recession. placing governments and businesses in vulnerable situations because of future uncertainty. For many businesses in the U.S., finding alternative ways of increasing cash flow became necessary for survival. Taking advantage of the government’s injection of cash into the economy through various CARES Act provisions was one way, obtaining tax credits is another. Tax credits and incentives can also help reduce effective tax rates for many companies at a time when many countries are looking to raise revenue to balance budgets.
If there is a lesson to be learned from the impact of Covid-19 in early 2020, it is that businesses may consider diversifying their manufacturing and R&D operations beyond one country or one region to minimize business and supply chain disruptions. According to Cushman & Wakefield’s Global Manufacturing Risk Index (MRI) report, India is ranked third, behind the U.S. and China, as a site for global manufacturing hubs and R&D centers. The rise of digital economy and big data, India has become an ideal location for R&D hubs, because of the abundance of talented professionals and substantially lower hiring costs compared to the U.S. and other countries. India provides R&D tax incentives in the form of reduced customs and goods and services tax rates and exemptions.
In this article, I explore the key features and advantages in the Indian R&D program.
Introduction to India research tax incentive
India encourages R&D investment through a variety of government programs and incentives such as Make in India, Startup India, and Faster Adoption and Manufacture of Hybrid and Electric Vehicles (FAME). Generally, the programs fall into one of three types of financial support: Research grants, tax incentives, or venture capital. The first two are funded entirely by government agencies. The third is quickly gaining popularity as a private source of funding for businesses investing in R&D and innovation by providing funding via private corporations or charitable foundations. Such financial backing can be in diverse forms including grant funding or soft loans.
Procuring government funding usually entails a stringent application process, with specific requirements from the boards and bodies that approve the funding in a competitive process. The boards and bodies are established by the Indian government, including the Biotechnology Industry Partnership Program (BIPP), the Support for International Patent Protection in Electronics & Information Technology (SIP-EIT), the Council of Scientific and Industrial Research (CSIR), the Department of Biotechnology (DBT), the Department of Science and Technology (DST), the Department of Scientific and Industrial Research (DSIR), and the R&D Funding Scheme and Global Innovation and Technology Alliance.
Income tax initiatives overview
The Indian tax regulations provide an allowance for expenses (both revenue and capital) incurred for in-house scientific research and development where the research relates to the business of the entity undertaking such research. Further, such expenses incurred during the three years prior to commencement are also allowed as an expense for the entirety of the first year of business.
Deductions are also allowed for payments made to scientific research organizations, including approved research consortia, universities, colleges, or other research institutions. The deduction may also be approved for accepted privately-owned Indian companies and government laboratories such as the National Laboratory/University/Indian Institute of Technology under an approved concessional program.
India also instituted a patent box-regime in 2016, giving tax residents a reduced tax rate for income earned from the worldwide exploitation of patents developed and registered in the country. The income earned in the form of a royalty from such patents is eligible for a 10% tax on the gross basis at the option of the taxpayer. The patent is construed to be developed in India for the purpose of the concessional regime if at least 75% of related expenditures were incurred in India by the Indian resident. Under the former regime, there was no separate rate on royalty income streams, and the same would have been taxable on a net basis as per the respective applicable tax rates.
Under the Startup India program, startups engaged in eligible activities or with a high potential of employment generation or wealth creation are eligible for various tax exemptions and other support by the government, including a deduction of 100% of profits for three out of 10 years. Eligible activities include innovation, development, and improvement of products, processes, and services.
Other Tax incentives
Aside from the income tax incentives listed above, the Indian government also provides benefits of concessional customs duty, and goods and services tax (GST) (including customs and GST reduced rates or exemptions) for research purposes. For instance, registered research institutions are exempted from customs duty on the purchase of any goods (equipment, consumables, computer software, prototypes etc.) for R&D activities. Recognized in-house R&D units in the pharmaceutical/bio-technology sector are also eligible for duty-free import of specified goods based on certain conditions. Further, there are subsidized GST rates for research institutions (other than hospitals) on the purchase of specified goods for R&D activities.
India is an attractive, and I daresay, strategic R&D and innovations hub for global players, considering the immense opportunities outlined below.
Access highly-skilled and scalable human capital and at exceptional value
India is an established base for high-quality scientific and engineering talent. And while the initial proposition was talent cost arbitrage, over time the ecosystem has matured with leading practices. India is now a leader in technology product development and is making rapid strides in high-tech manufacturing. The share scale of this talent base and very favorable economics makes it an enviable troika of quality, scalability, and cost.
Long term market
India’s vast and expanding market has made it a strategic location for global companies with a goal of geographic expansion. It is imperative that these companies set up local R&D centers in India to cater to the Indian consumer. Moreover, R&D centers—whether for domestic or global products—provide a base for global companies to develop a nuanced understanding the complex, strategic market that is India.
Collaborative research and low-cost innovative ideas
The primary reason for companies moving their core R&D operations to India is no longer just cost. International firms are running R&D (product or technology development) through India by setting up Indian facilities or outsourcing their corporate R&D to Indian R&D-focused entities, and now increasingly through investing in India’s local technology start-ups to innovate and achieve breakthroughs. Such collaborations mitigate risks and reduce overall costs while creating immense innovation opportunities.
Government support
Apart from the tax incentives and other government policy level/funding support highlighted above, the Indian government is supporting R&D development by setting up centers of excellence and offering fiscal incentives to both foreign and domestic firms.
India offers unique opportunities to capture global market share, cost efficiency, proactive government support, technical competencies, and a talented low-cost workforce, making it a lucrative destination for international players to establish core R&D operations. However, the global manufacturers evaluating India as an R&D destination should also consider the challenges of setting up business operations there—such as establishment fees, registration fees, and various approval requirements—which are being rationalized through the Ease of Doing Business initiative.
Accordingly, India as an R&D destination is more efficient if the intended investment outlay is large. This is apparent from the recent surge in global companies flocking to India for R&D and making a substantial investment.
Importance of R&D Increased During Pandemic
Throughout the pandemic, numerous businesses have sought to restructure their manufacturing processes to produce items needed to fight Covid-19. This list includes Ford repurposing production lines to produce ventilators; local distilleries producing hand sanitizer; and clothing manufacturers producing PPE and face masks. The response by U.S. companies has been astounding and a vital part of the U.S.’s path out of the pandemic. But for companies looking to help, the process of repurposing production facilities can be fraught with numerous complexities and significant expenses. As T.R. Reid, a Ford executive, put it, “We’re looking at feasibility … It may be possible, but it’s not [like] you go from Rangers (small pickups) one day to ventilators the next. We’re figuring out what is possible now.” (Krishner, Factories pivot to fight coronavirus, but challenges abound, Associated Press 2020).
The reality is that any restructuring of manufacturing processes to fill a need created by Covid-19 will require a large overhaul, shaped by R&D activities financed internally by the company. While the repurposing of the facilities may help some companies in the short term, as sales in their respective industries may have grown stagnant, the upfront cost of the restructuring can significantly reduce return on that investment. This is where the R&D tax credit can have a large impact, helping companies that are looking to make a production switch better cope with the costs such changes entail. A recent letter to Congress written by a group of over 50 business advocate associations, stated that “while the country begins to reopen, the need for liquidity [will] remain as urgent as ever.” (Association Letter on General Business Tax Credits, June 2020). The R&D tax credit can help by providing companies with the financial resources they need to fund innovative solutions to the problems created by Covid-19.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Author Information
Anshu Khanna is a partner at Nangia Andersen LLP in San Francisco.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.
