Will Union Budget 2025 deliver on tax reforms and R&D incentives?

With Union Budget 2025 scheduled to be presented on February 1, 2025, there is much expectation from various quarters on the need for the government to extend its initiatives in tax reforms and to be able to push innovation in industry.

The government’s month-long in-person connect with various stakeholder groups including representations from various associations, industry sectors, economists and investors, ended on 6 January and all eyes will now be on what the Budget will offer.

In recent years, the government has undertaken several commendable initiatives to reform the direct tax landscape in India. Key measures include reduction of corporate tax rates, rationalising withholding tax rates and simplifying compliances, clarity on capital gains taxation, measures to reduce litigation and quicker dispute resolution, etc. While these reforms have strengthened the foundation of the tax system, there remains more scope to promote ease of doing business and to achieve greater administrative efficiency.

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While individual taxpayers expect the Budget to introduce modifications to the existing tax slabs as also for tax relief measures to enhance savings, the industry is expecting the Government to announce incentives that will attract more investments across sectors.

One such sector which missed any tax incentives in the previous couple of Budgets is R&D. India’s spend on R&D is around 0.7 per cent of its GDP which in comparison to developed economies (whose spend is around 3% of their GDP) is much lower. The statistics on the spend towards innovation from the government vis-à-vis private sector, is glaring - the government spend for innovation accounts for around two-thirds of the spend, which is way too high in comparison to the about quarter of the spend, in other economies.

With the removal of the weighted deduction on R&D spends and tax holidays for companies engaged in scientific research, currently, companies investing in or in R&D business do not enjoy any tax incentives. Further, companies involved in R&D as a service, do not enjoy any tax incentive as was enjoyed before grandfathering of the tax holiday benefits for units in Special Economic Zones or as Export Oriented Units.

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While the government has focused on providing incentives in the form of production-linked incentives, reduced tax rates, etc., to push the manufacturing sector, attracting investments in R&D is equally important for advancing manufacturing processes and technologies. This can then spur innovation and strengthen the sector’s capabilities. The government should consider introducing incentives for innovation to attract investments in India to drive innovation and technological advancement and participation from the private sector.

One of the incentives that may be considered is extend the production-linked incentive to innovation sector. With the success of the PLI scheme in sectors such as electronics, automotive, pharmaceuticals, etc., similar scheme may be rolled out for investments in R&D, based on certain parameters such as capital investment, job creations etc.

Another area to consider could be the patent box regime. Under the current patent box norms, royalty income arising from patents registered by Indian residents under the Patent Act, shall be subject to a lower tax rate of 10 per cent, subject to 75 per cent of expenditure/the development being undertaken in India.

The current patent regime has a limited scope - it does not cover other Intellectual Properties (IP), such as know-how, copyrights, designs and trademarks. Additionally, the regime is applicable only to Indian residents and does not extend concessions to subsequent owners (transferees) of the patent; it is restricted to the first inventor of the invention. As a result, this regime has not found favour with the industry. Considering its potential of attracting foreign funding, the government may consider extending the regime to non-residents as well, with some checks like restricting the development of IP within India and allowing the benefits to the subsequent owner (transferee) of the patent, subject to conditions to prevent misuse.

Further, the benefits under the current regime can be extended to income from designs, copyrights, models and process innovations which can enable incentivising cutting edge solutions and fostering growth. In addition, under the extant law, companies are not allowed to claim any expenditure as a tax-deductible expense. The Government may consider allowing certain R&D expenses and amortisation as a tax-deductible expense and tax the resultant income at the concessional rate. Likewise, losses incurred during the initial period of R&D efforts may be allowed to be carried forward and set off in future years against royalty income, which currently is not permitted.

Granting of incentives such as tax holidays to global delivery centres set up in India and supporting global R&D operations of multinationals, is also a major ask of the industry. Over the last decade, India has emerged as a global powerhouse for Engineering R&D (‘ER&D’) and innovation. Many GCCs in India are increasingly performing complex R&D functions and developing digitally innovative products.

To encourage diversification of GCCs into tier 2 and tier 3 cities and to create job opportunities, certain specified areas can be identified as Innovation hubs which can enjoy the status of a free trade jurisdiction with preferential tax rates, duty benefits and ease of doing business and foreign investments.

While the government has taken certain policy decisions like setting up the National Research Foundation, to act as an umbrella body to fund research across a range of disciplines and setting aside Rs1 lakh crore corpus to extend interest-free finance for R&D activities, introduction of the incentives for the R&D sector will enable strengthening India’s global competitiveness by creating a more robust innovation ecosystem.

The author is Partner, Deloitte India. Views expressed in the above piece are personal and solely those of the author. They do not necessarily reflect Firstpost’s views.