The Munich-based ifo Institute recently published a new study on the state of research spending in the German economy. While the number of industrial companies involved in research and development (R&D) increased to 68.5% last year - compared to the average for the years between 2016 and 2019 - there was a noticeable decline in their research expenditure (measured as a proportion of turnover). The share of expenditure on R&D activities amounted to just 3.2% in 2020. In the comparative period, however, it was still 3.5% on average.

The decline can undoubtedly be explained by the economic upheaval caused by the coronavirus pandemic. However, for over a year now, companies in Germany have had the opportunity to receive government funding for their R&D expenditure - through the 'Act on Tax Incentives for Research and Development', or Research Allowance Act for short.

No competition for funding sums

In contrast to almost all of the hundreds of funding programs currently available in Germany, companies do not have to compete with other companies for a share of a capped total amount. Instead, the legislator allows funding for R&D expenditure of 25% of the personnel costs for product or process development plus ancillary wage costs, and 15% for external R&D contracts. The maximum amount per group of companies is limited to one million euros. This is an attractive offer, especially for innovative companies in the mechanical engineering sector, but there are a few things to bear in mind.

The research allowance is a substantial grant to which companies acquire legal entitlement through certification of a research or development project. The two-stage procedure is corresponding: The first step is a precise technical analysis of the project, the second is the allocation of the corresponding funds.

First the technical experts

This means that, particularly in the first step, it is important to precisely identify and present the projects in order to convince technical experts that this is a (further) development. To this end, it is important to know that the responsibility for the technical review has been placed in the hands of the Federal Ministry of Education and Research by the legislator. The Ministry's partners who carry out the technical review are either the VDI Technology Center, the German Aerospace Center or AIF Projekt GmbH. Following their approval, the companies have taken the first important step and acquired a legal claim.

What can be supported?

In general, all research and development projects that correspond to the classification of various measures based on the definitions of the OECD's Frascati Manual 2015 can be supported. In short, this means that in principle all types of research are considered. This includes, among other things

• Basic research as the acquisition of new knowledge with no specific application,
• Industrial research with a focus on the application-oriented acquisition of new knowledge with a practical purpose,
• and experimental development with the systematic use of existing, subject-specific knowledge to generate additional knowledge and produce new or improved products/services or processes.

In principle, this is not restricted to certain sectors, but is open to all companies. However, the last two points in particular are of great importance for mechanical engineering. For example, an environmentally friendly casting process for aluminium engine blocks could be submitted in the same way as the optimization of a grinding plant in the metal industry. Improving product quality or sorting systems or scaling up production can also be considered worthy of funding.

In this respect, it is very important to work with technical experts in advance who can really understand the technologies and processes behind the innovations. Companies should carefully consider whether a tax consultant is the right expert to provide advice that can actually add value.

Cooperation with specialized management consultancies such as Ayming appears to make much more sense. These usually provide far more comprehensive technical expertise - from engineers and scientists, for example - which is necessary here. In addition, the companies can then also expect that the technical description will not exceed the very narrow framework of a maximum of 4,000 characters for an application.

The role of the tax office - tax and tax audit

The application is only submitted to the tax office after a successful review by the technical experts. The tax office can then no longer reject the basic eligibility of the projects, but can review the amount of the allowance again. It is therefore also important here to very carefully compile which expenses have actually been incurred as part of a project. These can be expenses for employees as well as expenses for external support, e.g. from universities or technical institutes.

The highest possible funding that a group of companies can then receive is 25% of the expenses, 15% for external partners, up to an amount of one million euros per year. In this context, a group of companies means that all parent and subsidiary companies with a stake of more than 50% must share the amount.

The payment is then made by offsetting it against the group's tax liability. This means that if a company receives 40,000 euros in subsidies for its innovative project but has to pay 100,000 euros in taxes at the same time, these amounts are offset. As a result, only the difference, in this example 60,000 euros, has to be paid to the tax office.

If, on the other hand, the tax burden is only 30,000 euros, these taxes do not have to be paid and the company receives 10,000 euros as a refund.

No waiting time

Another distinguishing feature of the Act on Tax Incentives for Research and Development compared to many other measures is the option to submit the application retrospectively. This means that companies can also apply for funding for projects that have already begun or even been completed as of January 1, 2020. This eliminates the waiting time for funding approval in order to develop the idea into a successful innovation. This is an important aspect in a fast-moving market.

In addition, the use of resources is also playing an increasingly important role in manufacturing. It is definitely in the public interest if innovations that increase efficiency in production do not have to wait six or eight months for approval.

Don't forget the tax audit

The author Marcus Arens works as Director Sales and Marketing at Ayming

© Ayming

Finally, it should be noted that this form of innovation funding requires proper documentation. It therefore makes sense to keep the entire process, from the internal analysis of the innovation to the applications to the partners of the Ministry of Research and the tax office, in one hand in order to ensure consistent and qualified documentation from A to Z. This is particularly important as, in the event of a tax audit, funds received without justification must be repaid.