Use of the deduction for research and development

How is the research and development deduction applied?

If the taxpayer wishes to deduct from the tax base the costs incurred for research and development, it is necessary to notify the Tax Authority of this fact. The taxpayer must identify precisely the costs incurred for the deduction. Such costs include, for example, salaries of researchers, costs of materials and services related to research and development. In addition, project documentation should be provided which should include clearly defined projects, a description of the objectives, methods, time schedule and benefits of the projects. The projects must be approved internally by the company's management and recorded in the accounts.

What is the reason for frequent tax inspections?

In recent years, the most common contentious issues in tax inspections relating to research and development deductions have proven to be the existence of technical uncertainty and an appreciative element of novelty, the quality of the project and the subsequent project documentation. The Tax Authority not only verifies the existence of the content of the project documentation but also comment on its detail and sufficiency, although the Income Tax Act ("ITA") specifies the elements of the project documentation in a rather general manner. It can be challenging for taxpayers to meet the subjective standards of sufficiency of content set by the Tax Authority. If a taxpayer is interested in whether it has sufficient documentation to claim the research and development deduction, the ITA unfortunately does not provide detailed requirements.

Amendment to §34c of the Income Tax Act

As of 1 January 2024, an amendment to §34c of the ITA came into force, which allows the taxpayer to supplement and prove the project documentation with additional evidence in case the Tax Authority has doubts or the project documentation is not specific enough. It should be added that this rule does not remove the need to produce project documentation, including all the information specified in it, but it should help to reduce the uncertainty that exists in this area and reduce the risk of the deduction being disallowed on formal grounds.

Another possible change that could take place is the cooperation of the Tax Authority with independent experts in the assessment of the research and development project. The relevant experts would develop an assessment using a questionnaire or "technical card" that would provide information on the intent of the deduction, the technical description of the activities, the description of the objectives in the project documentation, the phasing of project implementation, and the evaluation of the results of the activities. The professional's assessment should provide the taxpayer with assurance that the project meets the criteria for claiming the deduction.

The changes described above show the efforts of the Tax Authority to motivate companies to use the deduction for research and development and at the same time to make tax procedures more efficient. However, it is always important to compare the costs of preparing all the necessary documentation (including setting up internal systems and processes) and any lower tax liability when applying this deductible item.