This study investigates the impact of tax incentives such as R&D tax credit and reserve on R&D spending among small and medium-sized companies. Tax incentives often intend to achieve specific economic objectives, one of which is to encourage firms to invest more in R&D. Since 1994 the tax incentives for R&D in small and medium-sized firms had been kept without any changes for fifteen years. The tax incentives for R&D in large firms had diminished in the early to mid 2000s. However, the tax policy for R&D was changed to give more tax incentives to major companies in 2008 and to small and medium-sized firms in 2009 to help expand their growth potential. In spite of increased government’s monetary support through tax incentives and the major changes of tax policies, there has not been a study that analyzes the effectiveness of tax incentives for R&D among small and medium-sized enterprises.
There were two changes in tax incentives for small and medium-sized firms between 2005 and 2009. Until 2006, small and medium-sized firms could deduct the greater amount of either 15% of the year’s R&D expenditure or 50% of R&D expenditure which exceeded the average spending occurred during the immediately preceding four business years. In addition, they could reserve 3% of sales revenue. However, reserve for R&D was abolished in 2007 and therefore the tax incentive for R&D was curtailed between 2006 and 2007. In 2009, tax incentives were boosted unlike the previous years. Tax credit rate on the year’s R&D expenditure increased from 15% to 25% and reserve for R&D came into effect again. In short, tax incentives were cut down in (2007∼2008), but were expanded in (2009). I hypothesize that R&D spending of small and medium-sized firms would increase (or decrease) as tax incentives for R&D expand (or are cut down).
I use 1,525 firms-years collected from Korean stock market between 2005 and 2009. For the purpose of this study, small and medium-sized manufacturing companies which invest more than 50 million Korean won per year in R&D are chosen, unlike some of the previous studies that included medium-sized and large companies that invested no money into R&D, which might have produced misleading results. Most tax incentives for R&D are targeted to encourage manufacturing companies to increase R&D investment, so the sample of the study includes companies that fall into manufacturing industry. In addition, I use R&D data collected from annual reports instead of Balance Sheets and Income Statements in order to measure R&D expenditures more accurately. To analyze the impact of changes in tax incentives on the firms' R&D expenditure, control variables such as R&D expenditure of the previous year, operating cash flow (scaled by beginning of year total assets), leverage ratio, Tobin's q ratio, profitability (measured by return on asset), size (measured by natural log of total assets), export rate, and industry dummy variables are incorporated into the multiple regression analysis model.
The annual R&D spending of the sample firms is 1.82 billion Korean won on average, and the median is 1.12 billion Korean won. There is wide variation in R&D spending. While maximum R&D spending is 23.6 billion Korean won, minimum spending is just 60 million Korean won. The mean of R&D intensity (R&D scaled by sale) is 4.21%, and the median is 2.45%. The distribution of total R&D expenditure and R&D is intensity skewed to the right. R&D intensity of small and medium-sized firms is higher than that of large firms. However, total R&D spending is lower among SMEs than large firms.
Some of the findings include that the two changes in tax incentives between 2005 and 2009 do not have statistically significant effects on R&D investment among the small and medium-sized firms. According to <Table 6>, the coefficients of and are positive, but they are not statistically significant. These results imply that the curtailment in tax incentives for R&D in 2007 does not decrease the R&D spending among small and medium-sized firms, and expansion in tax incentives in 2009 is not sufficient to increase R&D expenditure of SMEs to the point where it is statistically significant. These results may be due to the global financial crisis in 2008. The Korean economy experienced a serious recession in the following year when the nominal GDP growth rate was 3.6% and the real GDP growth rate was 0.2%. The global financial crisis and subsequent economic depression cause small and medium-sized firms to hesitate to invest more in R&D even though the government tries to provide a boost to R&D spending through tax incentives. It is also speculated that the unexpected results of the present study is due to a variation in tax burden of the sample firms at the point of R&D investment. The reaction of an individual company toward tax incentives varies according to its tax status.
To further investigate why this study does not achieve the predicted results, I examine if the tax status of an individual firm affects R&D spending when tax incentives are given by the government. I classify firms into low and high tax burden groups based on the effective tax rate. <Table 7> shows that the coefficient of is significantly positive in the high tax burden group, but it is not significant in the low tax burden group. Expansion in tax incentives significantly increases the R&D investment in the high tax burden group. However, expansion in tax incentives does not increase R&D investment significantly among the low tax burden group. These results imply that the firms in the high tax burden group increase their R&D expenditure because they would like to take advantage of additional tax incentives. On the other hand, the firms in the low tax burden group are not interested in the reduction of tax because their existing tax burden is sufficiently low. In spite of the global economic recession, the expansion in tax incentives for R&D may stimulate R&D spending of the firms with a high tax burden.
This study has several limitations. The R&D spending of a firm may be affected by the macroeconomic situation, so it is necessary to incorporate variables which reflect the macroeconomic situation. Even though the research model of this study includes control variables such as profitability and Tobin’s q ratio, they may not be sufficient. In addition, there may be a time gap between changes in tax policy and their fruits. Issues regarding this time gap are not taken into account in this study. However, firms can have time to adjust their R&D investment according to the predicted changes of tax policy because the discussions about changes in tax policy usually start in the middle of the previous year. Thus, the effect of a time gap on the results may be small.
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