Topics Value-added Creation and Contribution of R&D-Oriented Manufacturing Industry -From a tax-bearing perspective

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Naoto Murakami, Senior Researcher, Pharmaceutical Industry Policy Institute

Industrial Activities and Value Added

GDP (Gross Domestic Product), one of the indicators of a country's economic scale and growth, is defined as the total value added of goods and services produced domestically within a certain period of time1). Value-added is created from various industrial activities. For example, manufacturing companies, especially R&D-oriented companies, create value-added by demonstrating their innovative capabilities to create and provide new products and services. In other words, they not only satisfy customer satisfaction through their products and services as the output of their business activities, but also directly contribute to the economic growth of their own countries. The greater the value added, the greater the contribution to the country's economic growth .

Value added is recognized as a monetary amount, and although several approaches have been proposed for its calculation, it basically consists of five elements: (1) labor costs, (2) rent, (3) interest, (4) taxes and other public charges (including direct taxes, hereinafter referred to as taxes and other public charges), and (5) surplus profit3). These elements can then be categorized as follows in terms of how the value-added generated is distributed.

Distribution to labor providers
(1) Labor costs
Distribution to providers of capital
(2) Rent, (3) Interest
Distribution to national and local governments
(4) Taxes, etc.
Distribution to shareholders
(5) Surplus profit

Taxes and other taxes as a percentage of value added

Companies have legal obligations to their customers, shareholders, and employees, as well as tax obligations to society4), and their raison d'etre depends on how they fulfill these obligations. In particular, taxes are considered to make a more direct contribution to the nation and its citizens in terms of supporting revenue (financial resources), and the degree of contribution can be measured by the ratio of taxes to the amount of value added generated5). We therefore attempted to understand the situation in the industry, particularly in the manufacturing sector, and to make comparisons between industries.

Survey Method

The percentages of each factor, including taxes, etc., that make up the amount of value added were taken from the Handbook of Financial Data by Industry 2018 (Development Bank of Japan Inc. The target companies were selected from nine manufacturing industries, including pharmaceuticals, 6) and were compared to companies in manufacturing industries that aim to create and provide high value-added products and services through aggressive R&D investment. The value-added in the data handbook is calculated based on the following equation, using financial data from non-consolidated accounts.

Value Added = Operating Profit + Labor Costs + Rent + Taxes and Public Dues + Patent Royalties + Depreciation

Standard Taxes as a Percentage of Value Added

As shown in Table 1, the average ratio of taxes to value added for all industries (1,961 firms), manufacturing (1,022 firms), and non-manufacturing (939 firms) was roughly similar in 2017 (fiscal year), at 12.4%, 14.2%, and 12.4%, respectively. to 2017, the percentage tended to be higher in the non-manufacturing sector than in the manufacturing sector in the five years from 2008, but in the most recent five years, the percentage has generally increased, more so in the manufacturing sector, and as a result, there is no significant difference between the two, with 12% to 14% of value added The results suggest that the average tax rate in recent years has been between 12% and 14% of value added. The tax rate is thought to reflect the fact that a fixed rate is imposed, except that the rate varies depending on the size of the company.

Table 1 Comparison of the ratio of taxes, etc. to the amount of value added

Comparison of Taxes as a Percentage of Value Added between Manufacturing Industries

The nine industries covered in this paper, including pharmaceuticals, are all known as R&D-oriented manufacturing industries that are active in R&D investment, with the core companies within each industry providing highly technologically advanced and innovative products and services. The Ministry of Economy, Trade and Industry's Industrial Statistics Survey indicates that the total value added created in FY2017 by these nine industries, which roughly correspond to these nine industries, accounted for 30% of the total value added of all manufacturing industries ( approximately 103.5 trillion yen7), although this does not exactly match the industry classification in the Handbook of Financial Data by Industry This indicates that companies actively investing in R&D are contributing to the maintenance and expansion of Japan's economic strength.

We wonder, then, how much of the value-added created is returned to the national and local governments in the form of taxes and other forms of compensation. We investigated this point by measuring the ratio of taxes to value-added, and compared the results among industries. Table 1 shows that the percentage of taxes and other payments varied significantly from year to year between 2008 and 2017, and that the majority of industries were below the average for the manufacturing industry in all years compared to the average for the manufacturing industry. Table 1 shows that the majority of industries were below the manufacturing industry average in all survey years.

In that context, the pharmaceutical industry was the only one of the nine industries that consistently exceeded the industry average composition ratio of 15% or more throughout the 10 years studied, and was more than 5 percentage points above the average in all survey years except 2015 and 2016. Thus, among Japan's leading R&D-oriented manufacturing industries, the pharmaceutical industry not only creates value-added, but also contributes significantly to the national government, local governments, and the people of Japan by returning a very high percentage of the value added (more than 15%) in the form of taxes and other contributions.

Conclusion

R&D-oriented manufacturing industries play an important role in maintaining the size of Japan's economy and serving as a driving force for growth by actively investing in R&D and creating significant added value. At the same time, they make more concrete contributions to the national government, local governments, and citizens by returning the added value in the form of taxes. The pharmaceutical industry, in particular, is one of Japan's nine leading R&D-oriented manufacturing industries, and as a stable industry with a particularly high ratio of taxes to value-added, it makes a significant contribution.

As mentioned earlier in this report, the ratio of taxes to value added varied significantly by industry, despite the fact that tax rates, including corporate income tax, were almost constant. In addition, the extent to which special tax measures are applied and whether or not subsidies are applied are also assumed to be related.

With regard to special taxation measures, the special tax credit for corporate tax in the case of experimental research based on Article 42-4 of the Special Taxation Measures Law (so-called R&D taxation) is a major investment incentive for industries that actively promote R&D, and is one of the important drivers of value-added creation and expansion.

The results of this review suggest that the extent of the preferential treatment received may depend on whether the scope and conditions of application of this system fit the scale and pattern of R&D investment unique to each industry sector. Figure 1 shows the relationship between the ratio of R&D expenditures to sales and the corporate tax credit rate for testing and research expenses in 2018 for those firms selected from the firms comprising the nine industries covered in this study (classified in the Handbook of Financial Data by Industry 2018), which are the top 10 firms8) in terms of income before taxes and other adjustments in 2018 for each industry.

Although more detailed study is needed, one of the reasons why the pharmaceutical industry has maintained a relatively high ratio of taxes to value added for a long period of time compared to other industries is that, as can be seen in Figure 1, the corporate tax credit rate is kept low despite a high level of R&D investment, and the effect of the R&D tax regime on R&D investment is less effective than in other industries. This is because the effect of the R&D tax credit on R&D investment is less effective than in other industries.

Figure 1 Relationship between the ratio of R&D expenditures to sales and the corporate tax credit rate for R&D expenditures (2018)
  • 1) Number of reports and countries from which data was obtained
    Q&A on National Accounts (GDP Statistics), Cabinet Office, Government of Japan, January 6, 2017 edition. (Reference: 09/30/2019)
  • 2)
    Cabinet Office National Accounts for Fiscal Year 2017 (2011 Base, 2008 SNA) Reference; Key Points of the National Accounts for Fiscal Year 2017 (Reference: 2019/09/30)
  • 3)
    Hisakatsu Sakurai, "Financial Statement Analysis," 2nd edition, Chuokeizai-sha (March 30, 2003), In addition, fixed asset depletion (depreciation) may be added to the above five elements (gross added value), and GDP is the total amount as gross added value. Sakurai recommends using gross value added when comparing value added among firms, considering the differences in accounting treatment of depreciation and amortization among firms.
  • 4)
    （Japan Business Federation Keidanren Charter of Corporate Behavior Implementation Guide (1996-12-17) (Reference: 09/30/2019)
  • 5)
    Although the size of value added is also a measure of the degree of contribution, it is not discussed in this paper because it depends on the size of the company and target market in each industry or sector and is therefore not suitable for cross-industry comparisons.
  • 6)
    Pharmaceutical Industry Policy Institute, "Business Models of R&D-Oriented Domestic Pharmaceutical Companies - To Sustainably Fulfill Their Social Mission," in Policy Research Institute News No. 52 (November 2017), of all 16 R&D-oriented domestic manufacturing industries selected, industry-specific financial Nine industries for which value-added breakdown data are available from FY 2008 to FY 2017 in Data Handbook 2018.
  • 7)
    Ministry of Economy, Trade and Industry, Industrial Statistics Table for the year 2018 (2018), Industrial Statistics Table [Summary Version], the total for all manufacturing industries is the sum of about 150 industries as Japan Standard Industrial Classification subcategories industries. In the Survey of Industrial Statistics, value added is calculated as follows.
    Value added = Shipment of manufactured goods + (Year-end inventory of manufactured goods - Beginning inventory of manufactured goods) + (Year-end value of semi-finished goods and work in process - Beginning value of semi-finished goods and work in process) - (Estimated liquor tax, cigarette tax, gasoline tax and local gasoline tax + Estimated consumption tax) ) - Raw materials used, etc. - Depreciation
  • 8)
    The classification relies on the classification in the Handbook of Financial Data by Industry 2018. Figure 1 is a scatterplot of data for all 62 firms, since some firms do not disclose the ratio of R&D expenditures to sales or the percentage of corporate tax credits for R&D expenditures. We also include those firms that do not specify that the (special) tax credit is for R&D expenses (14 firms, including 2 firms in the pharmaceutical industry).

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