Five need-to-knows on income-based tax incentives for R&D and innovation

Income-based tax incentives (IBTIs) provide a preferential tax treatment to the income from R&D and innovation related efforts in the form of a reduced tax rate or tax exemption. They target the outcome of the R&D activity, in contrast to expenditure-based tax incentives such as R&D tax credits, which target R&D expenditures, i.e. R&D inputs. The implication is that in the case of IBTIs tax benefits are only conferred to successful R&D investments.

There are two broad categories of IBTIs: Intellectual Property (IP) tax regimes and dual category tax regimes. IP regimes provide preferential tax treatment solely to the income that is attributable to specific IP assets. Dual category regimes provide preferential tax treatment to the entirety of business income (i.e. including non-IP income) of eligible businesses that are deemed to be engaged in R&D or other innovation-related activities.

The Deduction for Innovation Income in Belgium and the Patent Box in the United Kingdom are examples of IP regimes, whereas the Merit-based Incentives for Competitiveness Enhancement in Thailand that entail tax exemptions for R&D businesses is an example of dual category regimes. IP regimes represent the most common type of IBTI, accounting for 73% of IBTIs in OECD countries and 90% in the EU area in 2023. 

IBTIs were available in 21 OECD countries and six other major economies in 2023, provided either by central government or subnational authorities (e.g. regional governments). This includes Argentina, Belgium, Canada (provinces of Québec and Saskatchewan), the People’s Republic of China, Cyprus, Czechia, France, Greece, Hungary, Ireland, Israel, Japan, Korea, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovak Republic, Spain (central government and País Vasco and Navarra), Switzerland (all Suisse cantons), Thailand, Türkiye, the United Kingdom and the United States. With the exception of Argentina, Israel, Luxembourg and Malta, countries provided IBTIs in combination with expenditure-based tax incentives provided by central or subnational government authorities.

Over the past two decades, the number of OECD countries offering IBTIs has increased fourfold from five in 2000 to 21 in 2023 (Figure 1); and sixfold in the case of EU countries, from three in 2000 to 16 in 2023. However, there are signs of stabilisation in the number of countries offering IBTIs in recent years.

Governments may introduce IBTIs to support firms over the lifecycle of the innovation process, from conception to commercialisation, and to help address failures in the market for R&D leading to a potential underinvestment in R&D by business, e.g., due to knowledge spillovers. However, IBTIs may also be introduced by governments due to competitive pressures to retain the intangible assets resulting from R&D and related efforts, as well as the taxing rights over those profits. Tax competition for intangibles may be particularly acute given the highly mobile nature of intangibles and concentration of R&D and IP ownership among large firms, which are typically MNEs. Compared to other firms, MNEs have a greater ability to move functions in response to tax differences or changes. 

There are differences in the types of intangible assets and income that qualify for income-based tax support. Overall, 37 IBTIs are listed as available in the 27 countries that provided IBTIs in 2023. In most cases, qualifying assets need to benefit from formal IP protection. Patents, copyrighted software and plant variety rights are the most common type of qualifying IP assets (Figure 2). In around one third of IBTIs, the requirement of formal IP protection for certain small taxpayers is waived. Qualifying income tends to cover income arising from all forms of IP commercialisation (licensing, sale or use for own production, i.e., embedded IP). In some cases, tax benefits are provided to the income arising from the protection of the IP, e.g., income from infringement (63% of IBTIs for which qualifying incomes are listed). Variation in the types of qualifying assets and income lead to a variation in the scope of IBTIs.

Access to tax benefits is often conditional on the taxpayers’ R&D activity and this link has been strengthened since 2015. In 2015, the Action 5 minimum standard of the Base Erosion and Profit Shifting (BEPS) project through the nexus ratio introduced a common set of conditions to benefit from support. The nexus ratio ensures that tax benefits can only be granted to the amount of qualifying income that is proportional to the taxpayer’s contribution to the creation of the intangible asset. This means that under the Action 5 minimum standard, if the taxpayer did all R&D itself or outsourced it to an unrelated party, all qualifying income can benefit from relief but if they acquired the intangible asset from other firms, none of the income can benefit from the tax incentive. 

The degree of tax benefit that IBTIs provide to businesses may depend on three key factors: the tax rate applicable under the incentive, the calculation of the tax base, and the general tax system. All three factors vary across jurisdictions. Effective average tax rates (EATRs) provide a stylised representation of the impact of taxation over the investment lifecycle and can help compare the benefits provided to firms through IBTIs across countries. The diamonds in Figure 3 show the EATR that a firm would face if it invested in an R&D intangible asset that is profitable under the standard tax system in a given country. The circles show the EATRs when IBTIs are accounted for. The difference between the two rates – with IBTIs and without IBTIs – gives a measure of the ‘implicit tax subsidy’ to firms.

IBITs can deliver significant tax benefits, but there is considerable cross-country variation in the implicit tax subsidies that IBTIs deliver to firms due to design differences. At the sample average, IBTIs reduce the overall tax liability that the firm faces on an internally generated R&D investment by 68% from an average EATR of 19.4% with no IBTIs to an EATR of 6.2% with IBTIs for countries with such incentives in place. In 2023, EATRs range from 7.86% to 30.6% in the absence of IBTIs, and from -9% to 25.78% in the presence of IBTIs. 

The financial cost that governments incur when providing IBTIs can be measured in terms of forgone tax revenue. This value depends not only on how generous the tax incentives are, but also on the extent to which eligible businesses use them. By design, IBTIs are only available to profitable firms, i.e. firms that generate income from R&D or related efforts (IP regimes) or firms that are deemed to be engaged in R&D or other innovation-related activities and generated positive business income (dual category regimes). In the case of IP regimes – the most common form of IBTI –, successful R&D outcomes typically must be formally protected through patents or other patent-equivalent rights.

The level of income-based tax support for R&D and innovation tends to be modest in most jurisdictions with some notable exceptions. Latest estimates of the cost of income-based tax support for R&D and innovation for 2021 (Figure 4) suggest that the cost of IBTIs for R&D and innovation is very small in most OECD countries and EU economies. In 2021 (or latest year), IBTIs amounted to less than 0.01% of GDP in nearly half off all countries covered (i.e. 10 out of 23 reporting countries). As percentage of GDP, this level is largest in the Cyprus (0.72% of GDP), Israel (0.23% of GDP), and the Netherlands (0.22% of GDP), and in absolute terms (USD million) in the United States (~USD 23 500 million.), followed by the Netherlands (~USD 2600 million.) and the United Kingdom (~USD 2100 million). Absolute subsidy amounts are prone to be higher for larger countries such as the United States. 

The latest policy information and indicators on IBTIs represent one output the OECD IPTAX project (formerly KNOWINTAX) launched in 2020 with the support from the EU Horizon programme. This project seeks to builds up comprehensive the evidence base on this class of tax instruments. It is a joint undertaking of the Directorate of Science, Technology and Innovation (STI) and the Centre for Tax Policy and Administration (CTP), which draws upon the contribution of members of the OECD IPTAX network – a multidisciplinary group of national tax and STI experts. 

Key country-by-country indicators and information are available for download in the STI OECD R&D Tax Incentives Database and the CTP Corporate Tax Statistics Database. Also explore our related publications below.