Is the Government Justified in Reducing R&D Tax Incentives?

Since 2019–20, the union government provides a weighted tax deduction of 200% for any capital and revenue expenditure incurred on in-house research and development (R&D) by a company. In that year India joined a growing number of countries in offering what is referred to as “super deductions”¹ for encouraging additional investments in R&D by firms. In fact Mani (2014) had shown that India had the distinction of having the most generous tax regime for R&D investments.

This was not to last long as the Union Budget for 2016–17 reduced the tax incentives for performing R&D in business enterprises from the current 200% to 150% in the period 2017–18 onwards including 2019–20. From 2020–21, the tax incentive will be further reduced to just 100% of R&D. Simultaneously, the finance minister has also announced a patent box type of incentive for the first time wherein income received in the form of royalties and technology licence fees received by Indian companies are taxed at a reduced rate of 10% from the fiscal year 2016–17 onwards. The introduction of patent box which encourages output of R&D while the reduction of R&D tax incentives reduces the incentives for input to innovation. While an advance announcement of an R&D tax policy is creditworthy as it makes the policy a stable one, is the government justified in becoming less generous towards R&D investments by firms in that process? The only negative reaction to this reduction, hitherto, has come from the pharmaceutical and life sciences industry, which together account for over a quarter of the total business enterprise R&D expenditure in the country.² The proposed streamlined reduction came as a rude shock because as part of its pre-budget lobbying the industry had been clamouring for an even more generous incentive: an increase in weighted tax deduction on R&D from 200% to 250% and expansion of the scope of the benefit to include R&D expenses incurred outside the facility like bioequivalence studies, clinical studies, patent filings and product registrations. So for the industry it was a double blow. The cliché “evidence-based policymaking” has been doing the rounds in government circles recently, but is this policy of a graduated reduction based on any empirical analysis?