Small firms need special incentives

Aug 15 2014, 01:31 IST
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SummaryPolicies that support start-up and growth of new enterprises are crucial

Governments play a key role in fostering investment in R&D and innovation. Fiscal incentives to support business R&D is common among countries. Most countries provide fiscal incentives through tax credits or allowances and capital expensing. Some of these incentives can be emulated in India to support innovation.

According to OECD studies (Measuring Innovation: A New Perspective, and The OECD Innovation Strategy: Getting A Head Start On Tomorrow) in countries like Belgium, France, Korea and Spain, additional fiscal incentives are provided through reductions in R&D workers’ wage taxes and social security contributions. Austria provides both R&D tax credit and R&D allowances. Belgium’s tax incentives include a deduction for patent income.

India is among the countries that provide a generous tax environment for investment in R&D (see chart, Tax Subsidy...) But it hardly makes a distinction between large and small industries in providing incentives. Empirical evidence shows that firms that are in the process of catching up with the technological frontier are particularly affected by corporate taxes. That means, corporate taxes may have a particularly negative effect on innovation incentives for catch-up firms by disproportionately reducing their after-tax return to innovation.

Tax policies targeted to small businesses, especially those engaged in innovative activities, include favourable depreciation rules for capital expenditures and reduced capital gains taxes after the initial public offerings of qualified small business stock.

Such targeted tax preferences may offset the high tax compliance costs relative to their size that small businesses face and are considered a more market-oriented approach (than direct support measures) for dealing with market failures and information asymmetries that might be particularly burdensome for young and often small innovative companies.

In many countries R&D tax credits are more generous for smaller firms (e.g. Belgium, Canada, the Netherlands, Norway and the United Kingdom), since the problems of asymmetric information that affect financing of R&D activities by banks or outside investors are likely to be particularly great for young innovative companies.

Some countries offer preferential tax treatment to young innovative companies (see box). These additional tax measures include immediate cash payment rather than use of carry-forward and carry-backwards provisions (Canada, France, Norway and the UK); and exemption from social costs for all researchers and technicians (Belgium and France). Within the European Union, governments can give extra incentives to firms less than six years old which spend more than 15% of their total revenues on R&D across all regions and sectors without breaking EU state

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