Background on the tax increase for Smoltek

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.

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.