Background on the tax increase for Smoltek

A few days ago, we sent a press release inform­ing that the Swedish Tax Agency assessed us with 1.5 mil­lion SEK (approx. 130,000 Euro). It stings. Espe­cial­ly since the tax agency jus­ti­fies its deci­sion by claim­ing that what we do is not qual­i­fied R&D. We strong­ly dis­agree with this mis­char­ac­ter­i­za­tion, but the pur­pose of this blog post is not to polemi­cize against the tax agency – there are bet­ter venues for that – but rather to explain what this is all about. So, if you expect this to be a vit­ri­olic retort or satir­i­cal rant, you will be disappointed.

The situation

The Swedish government’s bud­get bill 2014 includ­ed a pro­pos­al to reduce employ­er con­tri­bu­tion for employ­ees who sys­tem­at­i­cal­ly car­ry out qual­i­fied research and devel­op­ment (R&D) for com­mer­cial pur­pos­es. The Swedish Par­lia­ment adopt­ed the bud­get bill, and this option has been avail­able ever since.

Smoltek, which almost only has PhDs who sys­tem­at­i­cal­ly con­duct qual­i­fied R&D for com­mer­cial pur­pos­es, has used this oppor­tu­ni­ty to reduce the employ­er contribution.

How­ev­er, in a tax audit for 2021 and 2022, the Swedish Tax Agency has con­clud­ed that Smoltek does not meet the require­ments for the reduc­tion. At first, they said we did not meet any of the three con­di­tions, but after much back-and-forth, the tax agency was con­vinced that we con­duct sys­tem­at­ic R&D for com­mer­cial pur­pos­es. How­ev­er, they do not think that our R&D is suf­fi­cient­ly qualified.

This is, of course, bollocks.

Never mind the bollocks, here’s Smoltek

Smoltek has its roots in research at the Depart­ment of Microtech­nol­o­gy and Nanoscience at Chalmers Uni­ver­si­ty of Tech­nol­o­gy. There, Shafiq Kabir stud­ied the pos­si­bil­i­ties of grow­ing car­bon nanofibers to a spe­cif­ic diam­e­ter and length, plac­ing them with extreme pre­ci­sion, and doing so direct­ly on CMOS semiconductors.

His research efforts bore fruit, and in Decem­ber 2005, while fin­ish­ing his Ph.D. the­sis, he start­ed Smoltek to devel­op the meth­ods fur­ther and make them avail­able to the industry.

For near­ly two decades, Smoltek has con­tin­ued to explore meth­ods to grow car­bon nanofibers with extreme pre­ci­sion and desired prop­er­ties and explore their use in the semi­con­duc­tor, hydro­gen, bio­med­ical, and oth­er fields. So far, this has result­ed in more than 80 patents and an addi­tion­al 30 pend­ing patents.

So, nev­er mind the bol­locks, here’s Smoltek – to para­phrase the most icon­ic  punk band of all time.

The challenges

Smolteks is not alone in hav­ing prob­lems get­ting the tax author­i­ty to approve the research deduc­tion. A long list of re-tax­a­tion deci­sions bears wit­ness to this.

The tax author­i­ty sets up a high bar­ri­er for research-inten­sive com­pa­nies to make the deduc­tion. They require com­pa­nies to show each month how each employ­ee has con­tributed to research that leads to new knowl­edge or par­tic­i­pat­ed in devel­op­ment that sig­nif­i­cant­ly improves a prod­uct. This is at odds with the way R&D is conducted.

More­over, the tax author­i­ty has a rig­or­ous inter­pre­ta­tion. For fur­ther prod­uct devel­op­ment to count, they require that it result in a prod­uct that bare­ly resem­bles the orig­i­nal. In addi­tion, they require the com­pa­ny to show pre­cise­ly what research results have been used in the development.

In prac­tice, the tax agency’s appli­ca­tion of the law coun­ter­acts its aim of stim­u­lat­ing R&D.

Reasons for the deduction

In Jan­u­ary 2011, the gov­ern­ment appoint­ed a com­mit­tee to review the Swedish tax rules for R&D and pro­pose how tax incen­tives could stim­u­late R&D.

On Sep­tem­ber 26, 2012, the com­mit­tee sub­mit­ted its report. The com­mit­tee finds two rea­sons to intro­duce tax incen­tives for R&D:

1. To com­pen­sate for oth­ers prof­it­ing from the new knowl­edge R&D creates.
2. To com­pen­sate for the high­er cost of financ­ing R&D,

Let’s dive into what this means.

Leakage of R&D

A com­pa­ny that invests in R&D can­not whol­ly pre­vent oth­ers from prof­it­ing from the new knowl­edge it cre­ates, accord­ing to the Committee.

Pos­si­ble ways in which this knowl­edge “leaks” are through patent appli­ca­tions, research papers, and employ­ees mov­ing from one employ­er to anoth­er, to men­tion a few.

This is good for soci­ety as a whole but can be dis­cour­ag­ing for the com­pa­ny behind the research. Hence, there is a need for tax incen­tives for R&D.

Higher cost of R&D

The cost of cap­i­tal for financ­ing R&D is high­er than for oth­er investments.

Research cit­ed by the com­mit­tee shows that investors have dif­fi­cul­ty assess­ing research and, there­fore, require a sig­nif­i­cant risk pre­mi­um to invest in research-inten­sive com­pa­nies. This means that the cost of cap­i­tal for financ­ing R&D is often sig­nif­i­cant­ly high­er than for oth­er investments.

More­over, the com­mit­tee writes that the tax sys­tem treats dif­fer­ent sources of finance dif­fer­ent­ly. For exam­ple, financ­ing with retained earn­ings, a source of financ­ing that large and estab­lished com­pa­nies can use, is favored for tax pur­pos­es. Small and new com­pa­nies usu­al­ly have less retained earn­ings than larg­er and estab­lished com­pa­nies. The lack of retained earn­ings fur­ther rais­es the cost of cap­i­tal for new and small busi­ness­es look­ing to grow.

Why employer contribution deductions

The com­mit­tee con­sid­ered sev­er­al dif­fer­ent forms of tax incen­tives. Some pro­pos­als were linked to com­pa­nies’ expen­di­tures, and oth­ers to their income.

In the end, the com­mit­tee con­sid­ered intro­duc­ing a tax incen­tive for R&D through a direct employ­er con­tri­bu­tion reduc­tion as the most appro­pri­ate option. With employ­er con­tri­bu­tion as a basis, it is pos­si­ble to ensure that a com­pa­ny can take part in the incen­tive regard­less of whether it is prof­itable or not and to obtain sup­port only for R&D work car­ried out in Sweden.

The requirements

The work must be qual­i­fied and car­ried out sys­tem­at­i­cal­ly to be eli­gi­ble for the deduction.

Qual­i­fied work means actu­al and direct work with real research or devel­op­ment con­tent. Sup­port and ancil­lary func­tions are thus excluded.

Sys­tem­at­ic work means that facts must be imple­ment­ed, inves­ti­gat­ed, or fol­lowed up accord­ing to a plan. The work must also have a com­mer­cial pur­pose to qual­i­fy for a deduc­tion, which most prof­it-mak­ing com­pa­nies meet.

Deduc­tions can only be made if the per­son has worked on research or devel­op­ment for at least half their actu­al work­ing time and at least 15 hours dur­ing the cal­en­dar month.

The deduc­tion is 19.59 per­cent of the tax base for a per­son work­ing on research or development.

Wishful thinking

The com­mit­tee sug­gest­ed that the rules must be easy to under­stand and legal­ly clear. They stressed the need for admin­is­tra­tive­ly and tech­ni­cal­ly straight­for­ward, con­sis­tent, clear leg­is­la­tion. In par­tic­u­lar, they stressed the need for an unequiv­o­cal def­i­n­i­tion of R&D based on the OECD’s Fras­cati man­u­al.

This would turn out to be wish­ful think­ing. Now, many com­pa­nies are being reassessed by the tax author­i­ty and ordered to pay back a few years’ worth of deduc­tions. So also Smoltek.

Going forward

So what hap­pens now?

Of course, our knee-jerk reac­tion was to fight the wrong deci­sion. How­ev­er, there are more impor­tant things to do than fight for the sake of it. So, we keep a cool head and con­sid­er our options. One thing is sure: We will not tilt at wind­mills, but we will request recon­sid­er­a­tion or file an appeal.