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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 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.
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.
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.
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:
Let’s dive into what this means.
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.
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.
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 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.
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.
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.