Notwithstanding these encouraging factors, the South African economy is facing strong headwinds and businesses are currently navigating a challenging landscape. Despite some positive developments, such as the government of national unity that was established in the weeks following South Africa’s May 2024 National Election, reduced load shedding and a slight recovery in household spending, the overall economic growth is still sluggish. The GDP growth rate was projected to be around only 1,3% in 2024, but it turned out to be closer to 0,8%. This is not sufficient to significantly reduce high levels of unemployment and poverty.

Businesses in South Africa continue to face financial pressures. Additionally, structural issues such as operational inefficiencies in postal services, freight rail and ports continue to disrupt economic activity.

As the saying goes – necessity is the mother of invention. There’s no getting around it. South African businesses must innovate to survive – so it’s a good thing innovation is incentivised. 

Innovation should be an important part of any South African company’s survival (turnaround) plan, because the South African government encourages innovation through tax incentives, particularly for research and development (R&D). Companies that qualify for these tax benefits will see a reduction in their tax liabilities and may as a result enjoy improved cashflows.

Tax incentives for research and development

Section 11D of the Income Tax Act offers tax deductions for investments in “scientific or technological research and development.” These deductions are designed to incentivise innovation, which is critical to driving South Africa’s economic growth.

R&D, as defined under Section 11D, includes systematic investigative or experimental activities aimed at addressing scientific or technological uncertainties. Qualifying activities include discovering new scientific or technological knowledge, creating or significantly improving products, processes, or services, and developing multisource (generic) pharmaceutical products that meet the World Health Organization’s guidelines. However, the outcomes of these activities should not be obvious to someone skilled in the relevant field.

This definition is incredibly broad, and every South African company is (or should be) involved in significantly improving their products, processes, or services. And, as long as the intended outcomes are not obvious, the associated costs may qualify for a tax deduction.

Exclusions from the Definition of R&D

However, not all activities qualify as R&D under the Income Tax Act.

Market research, product testing, and sales promotions, while valuable for business growth, are not considered R&D under this section. Studies in social sciences, arts, and humanities are also excluded, as they fall outside the technical scope.

Oil, gas, and mineral exploration do not qualify unless they involve new technology specifically related to extraction. Additionally, developing financial products, trademarks, and goodwill doesn’t meet the R&D criteria, as these focus more on business assets than on advancing scientific knowledge.

R&D expenses funded by the government, public entities, or municipalities are also not eligible for deduction, and any grants or allowances must be subtracted from the total expenditure for tax purposes.

The Tax Deduction

But, for those R&D activities that do qualify, a significant deduction equal to 150% of expenditure incurred directly for R&D, and an accelerated depreciation deduction (that is, 50:30:20 as per section 12C(gA)) for capital expenditure incurred on machinery or plant used for R&D, may be allowed, provided that the expenditure was incurred in the production of income and in carrying on a trade. Furthermore, the R&D activity must be approved by the Minister of Science and Innovation; and the expenditure must be incurred within six months before, or after, the application was received by the Department of Science and Innovation.

Tax Allowance for Buildings

Under Section 13 of the Income Tax Act, companies may claim a 5% tax allowance on buildings used for R&D purposes, subject to certain conditions being met, including that the building was erected (or construction commenced) on or after 1 January 1989.

Furthermore, the building must be bought or constructed specifically for R&D as part of the company’s trade. The building must also be predominantly used by the taxpayer for R&D activities during the year of assessment. Buildings leased to tenants for R&D purposes are eligible for this allowance as well.

The importance of innovation for growth

The largest and most stable economies in the world are also leading innovators. For example, countries like Switzerland, Sweden, the United States of America, Singapore and Germany ranked highest amongst the World Intellectual Property Organization’s Global Innovation Index (GII) on their innovation capabilities.

Historically, innovation has been driven by curiosity, necessity, and crises. For companies, innovation is essential for staying competitive and adapting to market changes.

Failure to innovate can lead to stagnation, decline, and eventually corporate demise.

An oft cited example of innovation inertia is Blockbuster. During the 1990s it had over 9,000 stores and massive brand recognition. But Blockbuster did not adapt well to technological change. The rise of on-demand streaming video services threatened its business model. Blockbuster tried imitating Netflix’s DVD-by-mail service in 2004, while Netflix and others kept innovating their streaming technology and content. Blockbuster’s CEO famously dismissed Netflix as no threat. Blockbuster did not evolve with industry changes. It clung to physical stores and did not embrace the digital shift - underestimated disruption from new technologies. Almost all of its stores worldwide were closed by 2014. However, on March 23, 2023, the Blockbuster web page was re-activated, with the message “We are working on rewinding your movie” – who knows…a tiny slither of its former self may be innovating now.