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Don Quixote tilting at a windmill

Background on the tax increase for Smoltek

The Swedish Tax Agency has ordered Smoltek to repay two years of research deduction from the employer contribution. The tax agency believes that Smoltek does not conduct sufficiently qualified research and development, which is untrue. This blog post explains the research deduction and why it is so difficult to obtain.

A few days ago, we sent a press release inform­ing that the Swedish Tax Agency assessed us with 1.5 mil­lion SEK (approx. 130,000 Euro). It stings. Espe­cially since the tax agency jus­ti­fies its decision by claim­ing that what we do is not qual­i­fied R&D. We strongly dis­agree with this mis­char­ac­ter­iz­a­tion, but the pur­pose of this blog post is not to polem­i­cize against the tax agency – there are bet­ter ven­ues for that – but rather to explain what this is all about. So, if you expect this to be a vit­ri­ol­ic retort or satir­ic­al rant, you will be disappointed.

The situation

The Swedish government’s budget bill 2014 included a pro­pos­al to reduce employ­er con­tri­bu­tion for employ­ees who sys­tem­at­ic­ally carry out qual­i­fied research and devel­op­ment (R&D) for com­mer­cial pur­poses. The Swedish Par­lia­ment adop­ted the budget bill, and this option has been avail­able ever since.

Smol­tek, which almost only has PhDs who sys­tem­at­ic­ally con­duct qual­i­fied R&D for com­mer­cial pur­poses, has used this oppor­tun­ity to reduce the employ­er contribution.

How­ever, in a tax audit for 2021 and 2022, the Swedish Tax Agency has con­cluded that Smol­tek does not meet the require­ments for the reduc­tion. At first, they said we did not meet any of the three con­di­tions, but after much back-and-forth, the tax agency was con­vinced that we con­duct sys­tem­at­ic R&D for com­mer­cial pur­poses. How­ever, they do not think that our R&D is suf­fi­ciently qualified.

This is, of course, bollocks.

Never mind the bollocks, here’s Smoltek

Smol­tek has its roots in research at the Depart­ment of Micro­tech­no­logy and Nanos­cience at Chalmers Uni­ver­sity of Tech­no­logy. There, Shafiq Kabir stud­ied the pos­sib­il­it­ies of grow­ing car­bon nan­ofibers to a spe­cif­ic dia­met­er and length, pla­cing them with extreme pre­ci­sion, and doing so dir­ectly on CMOS semiconductors.

His research efforts bore fruit, and in Decem­ber 2005, while fin­ish­ing his Ph.D. thes­is, he star­ted Smol­tek to devel­op the meth­ods fur­ther and make them avail­able to the industry.

For nearly two dec­ades, Smol­tek has con­tin­ued to explore meth­ods to grow car­bon nan­ofibers with extreme pre­ci­sion and desired prop­er­ties and explore their use in the semi­con­duct­or, hydro­gen, bio­med­ic­al, and oth­er fields. So far, this has res­ul­ted in more than 80 pat­ents and an addi­tion­al 30 pending patents.

So, nev­er mind the bol­locks, here’s Smol­tek – to para­phrase the most icon­ic  punk band of all time.

The challenges

Smol­teks is not alone in hav­ing prob­lems get­ting the tax author­ity to approve the research deduc­tion. A long list of re-tax­a­tion decisions bears wit­ness to this.

The tax author­ity sets up a high bar­ri­er for research-intens­ive com­pan­ies to make the deduc­tion. They require com­pan­ies to show each month how each employ­ee has con­trib­uted to research that leads to new know­ledge or par­ti­cip­ated in devel­op­ment that sig­ni­fic­antly improves a product. This is at odds with the way R&D is conducted.

Moreover, the tax author­ity has a rig­or­ous inter­pret­a­tion. For fur­ther product devel­op­ment to count, they require that it res­ult in a product that barely resembles the ori­gin­al. In addi­tion, they require the com­pany to show pre­cisely what research res­ults have been used in the development.

In prac­tice, the tax agency’s applic­a­tion of the law coun­ter­acts its aim of stim­u­lat­ing R&D.

Reasons for the deduction

In Janu­ary 2011, the gov­ern­ment appoin­ted a com­mit­tee to review the Swedish tax rules for R&D and pro­pose how tax incent­ives could stim­u­late R&D.

On Septem­ber 26, 2012, the com­mit­tee sub­mit­ted its report. The com­mit­tee finds two reas­ons to intro­duce tax incent­ives for R&D:

  1. To com­pensate for oth­ers profit­ing from the new know­ledge R&D creates.
  2. To com­pensate for the high­er cost of fin­an­cing R&D,

Let’s dive into what this means.

Leakage of R&D

A com­pany that invests in R&D can­not wholly pre­vent oth­ers from profit­ing from the new know­ledge it cre­ates, accord­ing to the Committee.

Pos­sible ways in which this know­ledge “leaks” are through pat­ent applic­a­tions, research papers, and employ­ees mov­ing from one employ­er to anoth­er, to men­tion a few.

This is good for soci­ety as a whole but can be dis­cour­aging for the com­pany behind the research. Hence, there is a need for tax incent­ives for R&D.

Higher cost of R&D

The cost of cap­it­al for fin­an­cing R&D is high­er than for oth­er investments.

Research cited by the com­mit­tee shows that investors have dif­fi­culty assess­ing research and, there­fore, require a sig­ni­fic­ant risk premi­um to invest in research-intens­ive com­pan­ies. This means that the cost of cap­it­al for fin­an­cing R&D is often sig­ni­fic­antly high­er than for oth­er investments.

Moreover, the com­mit­tee writes that the tax sys­tem treats dif­fer­ent sources of fin­ance dif­fer­ently. For example, fin­an­cing with retained earn­ings, a source of fin­an­cing that large and estab­lished com­pan­ies can use, is favored for tax pur­poses. Small and new com­pan­ies usu­ally have less retained earn­ings than lar­ger and estab­lished com­pan­ies. The lack of retained earn­ings fur­ther raises the cost of cap­it­al for new and small busi­nesses look­ing to grow.

Why employer contribution deductions

The com­mit­tee con­sidered sev­er­al dif­fer­ent forms of tax incent­ives. Some pro­pos­als were linked to com­pan­ies’ expendit­ures, and oth­ers to their income.

In the end, the com­mit­tee con­sidered intro­du­cing a tax incent­ive for R&D through a dir­ect employ­er con­tri­bu­tion reduc­tion as the most appro­pri­ate option. With employ­er con­tri­bu­tion as a basis, it is pos­sible to ensure that a com­pany can take part in the incent­ive regard­less of wheth­er it is prof­it­able or not and to obtain sup­port only for R&D work car­ried out in Sweden.

The requirements

The work must be qual­i­fied and car­ried out sys­tem­at­ic­ally to be eli­gible for the deduction.

Qual­i­fied work means actu­al and dir­ect work with real research or devel­op­ment con­tent. Sup­port and ancil­lary func­tions are thus excluded.

Sys­tem­at­ic work means that facts must be imple­men­ted, invest­ig­ated, or fol­lowed up accord­ing to a plan. The work must also have a com­mer­cial pur­pose to qual­i­fy for a deduc­tion, which most profit-mak­ing com­pan­ies meet.

Deduc­tions can only be made if the per­son has worked on research or devel­op­ment for at least half their actu­al work­ing time and at least 15 hours dur­ing the cal­en­dar month.

The deduc­tion is 19.59 per­cent of the tax base for a per­son work­ing on research or development.

Wishful thinking

The com­mit­tee sug­ges­ted that the rules must be easy to under­stand and leg­ally clear. They stressed the need for admin­is­trat­ively and tech­nic­ally straight­for­ward, con­sist­ent, clear legis­la­tion. In par­tic­u­lar, they stressed the need for an unequi­voc­al defin­i­tion of R&D based on the OECD’s Fras­cati manu­al.

This would turn out to be wish­ful think­ing. Now, many com­pan­ies are being reas­sessed by the tax author­ity and ordered to pay back a few years’ worth of deduc­tions. So also Smoltek.

Don Quixote Tilting At Windmills 6
The expres­sion “tilt­ing at wind­mills” describes attack­ing ima­gin­ary enemies or extreme ideal­ism. It is derived from the icon­ic wind­mill scene in Miguel de Cer­vantes’s book Don Quix­ote de la Man­cha (1605–1615).

Going forward

So what hap­pens now?

Of course, our knee-jerk reac­tion was to fight the wrong decision. How­ever, there are more import­ant things to do than fight for the sake of it. So, we keep a cool head and con­sider our options. One thing is sure: We will not tilt at wind­mills, but we will request recon­sid­er­a­tion or file an appeal.

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