Tax Exemptions and R&D Expenditures in Iran Saeed Dorokhshi Moghaddam

The belief that innovation is a crucial factor in driving economic growth has led governments worldwide to increase investment in research and development (R&D). Many countries intervene in the R&D process of the private sector by utilizing policy tools such as tax credits, subsidies, direct financing, and research and development cost subsidies. Data shows a significant rise in the use of tax incentives in recent years. In Iran, there has been a particular interest in implementing tax exemptions for knowledge-based companies and providing tax credits for all firms.
Empirically, the existing literature in this field is still underdeveloped, particularly in the context of developing countries. This report aims to contribute to the existing knowledge by evaluating the impact of tax exemptions on R&D expenditures in Iran as a developing country.

To assess the effect of tax exemptions, we are interested in the R&D intensity index, which represents the ratio of R&D expenditures to GDP at the national level and the ratio of R&D costs to company income at the company level. The variable in question is a ratio between 0 and 1, like many other economic variables such as participation rates, market shares, debt-to-finance ratios, etc. The limited nature of such variables - and in some cases the large and significant accumulation of data at one or both limits - leads to limitations in estimates and inferences, and its economic modeling should be done with special approaches. In particular, the usual use of linear models is not a very accurate and correct method because it does not guarantee that the values predicted by these estimates are in the range of 0 and 1. In recent years, this concern has led researchers to focus on functional forms resulting from such data and develop models called Fractional Regression Models (FRMs).
In the model, the dependent variable is the share of a company's current R&D costs relative to total costs, which serves as a proxy for R&D intensity. The explanatory variables include the following:Researchers: The number of researchers in the company, logged.
Size: The sum of current and capital expenses of the company, used as an index of the size of the company in logarithmic form.
Avalibility of External Finance: For each company which used any financial resources rather than its internal resources, the value of this variable is 1, and in cases where the financing is completely internal, it is considered as 0.
The level of knowledge-based development (KBEDev): A variable based on previous studies, ranging from 1 (lowest level) to 3 (highest level).
Tax incentive: For those companies subject to this exemption, the variable amount is 1, and for the rest, it is 0.
Technology Intensity (Tech Level): According to the industry in which companies operate and using the categories used for technology leveling in the two leading organizations in this field, UNCTAD and OECD, number 3 represents the high level, number 2 represents the medium level, and number 1 represents the low level.

Using a fractional logistic regression approach on the data of 2,678 knowledge-based and industrial companies collected in 2020, the effects of tax exemptions for knowledge-based companies have been evaluated. The results of this article confirm the positive and significant effects of this exemption on research and development costs of companies. At the same time, it is indicated that, compared to other variables in the model, the presence of researchers, the level of knowledge-based development of the location of the company, and the opportunity for access to external financial resources have had a greater effect on the share of research and development expenses. However, these incentives have been more effective than the company's technology level. Additionally, the size of the company has a significant negative relationship with the interest ratio.

While our study supports the use of tax incentives, it is crucial to consider the broader economic landscape. Our findings highlight the importance of human resources and external funding. To effectively support knowledge-based companies and to create a more R&D-intensive country, it is not enough to solely provide tax exemptions for firms. However, mechanisms must be in place to foster reaching much more qualified human resources and to a greater extent finance. Financial incentives should be utilized in a manner that minimizes costs and maximizes economic growth and productivity. Future research can explore how to optimize the use of these tools, offering valuable insights to policymakers