OECD Taxation Working Papers N. 24 – Taxation of Knowledge-Based Capital: Non-R&D Investments, Average Effective Tax Rates, Internal Vs. External KBC Development and Tax Limitations. This paper extends the tax analysis of knowledge-based capital (KBC) in several dimensions. The paper analyses non-R&D KBC: computer software, architectural and engineering designs, and economic competencies which account for over 70% of total KBC.
The paper analyses the tax treatment of internally-developed KBC which is used in production by the developer versus KBC sold to third-party producers. The current tax rules generally favour internally- developed KBC, which disadvantages many SMEs and start – up companies specializing in innovation. The analysis reports two average effective tax rates (ETRs) depending on investors’ considerations of their investment opportunities. When KBC is unique, earns excess returns due to market power, or involves financing – constraints, ETRs are high despite immediate expensing. The paper also analyses the effects of tax limitations, where many SMEs and start-up companies can’t benefit from tax credits and deductions until having sufficient tax liability. Analysis of the taxation of knowledge-based capital (KBC) has focused primarily on research and development (R&D) investments. While R&D investment has important positive externalities encouraged in many countries by tax credits, favourable deductions and/or lower tax rates, R&D represents less than 30% of total KBC. Computer software, architectural and engineering designs, and economic competencies including advertising and organisational management, are important contributors to higher labour – productivity growth rates. The overall o bjective of this paper is to extend the tax analysis beyond R&D investments to other forms of KBC to assist countries in their efforts to assess whether and how tax policy can most cost – effectively encourage investment in KBC. In combination with the earlier extension of KBC tax analysis to the international tax planning of MNEs, it is also important to focus on the domestic tax issues affecting many small – and médium – sized enterprises which have a limited portfolio of KBC investment and often sell their KBC to larger enterprises rather than develop and produce the goods or services with embedded or complementary KBC themselves. The paper analyses effective tax rates to measure the actual tax burden faced by companies on different types of KBC. The analysis reports two average effective tax rates depending on investors’ considerations of their investment opportunities. In the case of KBC investments that are unique, earn excess returns due to market power, or involve investment or finance – constraints, investors are more likely to view the income tax system as having an adverse effect on KBC investment despite having the ability to immediately write – off the investment. The paper shows that there can be considerable variation in the tax treatment of different types of KBC domestic investments. The paper analyses the tax treatment of internally – developed KBC which is used in production by the developer versus KBC that is sold to a third – party producer. The current tax rules generally favour internally – developed KBC. This disadvantages many firms, particularly small and médium – sized enterprises (SMEs) and start – up companies that don’t have the capability to both innovate and manufacture the projects, but rather specialise just in innovation. The paper also analyses the effects of tax limitations, where tax credits and tax deductions may need to be deferred until the firm has sufficient tax liability. This is often the case for SMEs and start – up companies, which don’t benefit from tax credits or immediate expensing since they don’t have taxable income and tax liability. Prior analysis examined important KBC international tax issues in the context of multinational enterprises’ tax planning. These tax considerations may disadvantage smaller or start – up companies from und ertaking KBC investments, and have long – term consequences on the amount and types of innovation resulting from KBC investment in an economy.
Modica, A. and T. Neubig (2016), “Taxation of Knowledge-Based Capital: Non-R&D Investments, Average Effective Tax Rates, Internal Vs. External KBC Development and Tax Limitations”, OECD Taxation Working Papers, No. 24, OECD Publishing, Paris, https://doi.org/10.1787/5jm2f6sfz244-en.
