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Estonia is among the few OECD countries where tax derogations facilitating research and development are not granted to businesses, a brief report by the Foresight Centre reveals. The grant of tax derogations would become particularly topical if Estonia were to go along with global corporate taxation and to restore the classical corporation tax. With a derogation, profit reinvested in research and development could continue to be exempt from tax.

“Long-term economic development is fundamentally based on the innovation capacity of businesses, and countries facilitate it with both tax derogations and direct payments,” expert of the Foresight Centre Magnus Piirits said. “Direct payments enable better targeting of the aid, but tax incentives have a greater impact on the widespread of research and development among businesses.”

In Piirits’s words, therefore, a majority of the countries of the Organisation for Economic Co-operation and Development (OECD) use both tax derogations and direct payments in order to facilitate their business sector investments in research and development. “In Estonia, research and development of businesses have been facilitated through state subsidies, and the grant of tax derogations has been avoided,” Piirits said.

In his words, the subsidies granted by the Estonian state to private-sector research and development are more than five times smaller than the average in OECD countries, and investments are also very variable from year to year. “This does not allow businesses to make long-term plans in terms of state subsidies when making innovation investments. Tax derogations facilitating research and development would encourage businesses to contribute to innovation more boldly,” he added.

According to the brief report “The Use of Stimuli Facilitating Research and Development in the Tax System”, 30 OECD countries out of 36 used some tax solutions facilitating research and development in 2019. That is, Estonia is among the few countries that do not use them to increase the competitiveness of their businesses.

OECD countries support private-sector research and development to the extent of an average of ca 0.2% of GDP, which is more or less equally divided between subsidies and tax incentives. In Estonia, the support to private sector R&D amounted to just 0.03% of GDP, that is, 8 million euro, in 2018. “A level corresponding to the OECD average would presume 50 million euro,” Piirits noted.

When granting tax derogations for research and development, deduction of the relevant expenses from the income tax total or base is preferred in international practice. Incentives in the taxation of labour costs are less common because they presume complex assessment of employees’ qualifications and may lead to a pay rise for the research staff without increasing the volume of research and development in the economy.

In Piirits’s opinion, the issue of the use of tax derogations will become more relevant particularly in the case when Estonia fails to protect its current corporate tax policy and will have to go along with the plan of the seven leading industries (G7) to set a global minimum corporate tax rate of 15 per cent, published this June. “At present, in Estonia, business income is taxed only in respect of dividends paid, which facilitates investment. If the financial year profit is taxed, this will, among other things, reduce motivation to invest in research and development,” Piirits noted. “In such a case, the tax credit would enable to retain the tax exemption of the profit reinvested in research and development, thereby facilitating businesses’ investments in more innovation-intensive activities.”

You can find the brief report in Estonian here:

In 2021, the research focuses of the Foresight Centre include a “Future-proof Tax Structure”, which seeks solutions for covering the costs in an ageing society, and the opportunities to change the tax system over the next 15 years.

The Foresight Centre is a think tank at the Chancellery of the Riigikogu that analyses long-term developments in society and the economy. The Centre conducts research projects to analyse the long-term developments in Estonian society, and to identify new trends and development directions.