Aiming to boost R&D performance by businesses and drive innovation and economic growth and social well-being, governments use the tax system to provide financial incentives for companies to invest in R&D. This additional investment in cutting-edge knowledge and its applications, which exhibit spillovers and high uncertainty, can provide benefits beyond those that the firms themselves can appropriate and can justify the subsidy.  

While governments can also use other instruments such as targeted grants or contracts for R&D services, tax incentives have risen in popularity because they can be designed to let eligible companies choose which R&D projects to invest in. This makes tax support relatively easy to administer and compliant with trade and competition rules that constrain the use of state aid. However, a downside of excess reliance on R&D tax incentives is the reduced scope for targeting R&D funding to specific policy priority areas.

Countries differ in the extent to which they rely on tax measures to support R&D, and those that do design tax relief measures in substantially different ways. Key design features relate to:

• The scope and definition of R&D for tax purposes
• The choice of eligible R&D expenditure and tax instrument
• Provisions for firms with insufficient tax liability
• Provisions for the limitation of R&D tax benefits
• Preferential tax relief provisions for certain types of firms (e.g. SMEs), R&D activity (e.g. collaborative R&D) or R&D in specific priority areas (e.g. green R&D)

These design features influence the level of R&D tax subsidy available to different types of firms and the cost of R&D tax relief to government. They shape the extent to which firms can make use of tax benefits in the loss-making vis-à-vis profit case, and the degree to which specific types of firms such as SMEs, young firms, and start-ups benefit from a preferential tax treatment. 

OECD analyses show that the effect of R&D tax incentives on business R&D investment tends to be more pronounced for small firms which, driven by their lower level of initial R&D performance, are on average more responsive to the availability of R&D tax subsidies than large companies.

R&D tax incentives and direct support measures are on average equally effective in stimulating business R&D investment, but they have different strengths. While R&D tax incentives are particularly effective in encouraging experimental development, direct government funding is comparatively more effective in stimulating basic and applied research. R&D tax incentives and direct funding measures therefore complement each other.

Effective monitoring and evaluation provide the basis for policy learning, prioritisation and improvement over time. As an integral part of innovation policy, they are crucial for demonstrating transparency, accountability and value for money in public spending.

OECD contributes to the monitoring and assessment of R&D tax incentives and direct government funding of business R&D through its development of dedicated data and analytical infrastructure on R&D tax incentives, enabling international policy comparisons and analysis. Moreover, it supports countries in their national evaluation efforts through the OECD microBeRD project – an internationally coordinated OECD study on the impact of R&D tax incentives and direct government funding of business R&D, in addition to country-specific, distributed impact analysis such as the 2023 OECD study on the R&D tax credit in Iceland.