Tax incentives and intra-group shifting of R&D activities

This paper investigates tax-motivated shifting of R&D activities within business groups. We examine firms’ behavioural responses to a tax incentive program in China that grants preferential treatment conditional on meeting an R&D intensity threshold. The results reveal a sharp decline in subsidiary firms’ R&D expenses when their parent firms’ R&D intensity surpasses the eligibility threshold, providing clear evidence of strategic expense shifting. This shifting is characterised as a coordinated strategy involving the concentration of R&D inputs and patent outputs to unlock preferential tax treatment and profit shifting to minimise tax liability. We quantify the extent of this shifting, showing that these strategic behaviours cause significant tax revenue losses and undermine the program’s effectiveness. Our findings underscore the importance of accounting for strategic group-level responses when designing and implementing R&D tax incentive programs.