Tax Incentives in the Video Game Industry – R&D on Salaries (part one)

In previous texts, we discussed reducing the tax burden for individuals who independently develop and publish their games, through different forms: freelancer, entrepreneur – flat-rater, full entrepreneur, as well as a single-member limited liability company.

This time, we will look at how teams with multiple employees can manage the tax costs their company pays (in our example, a limited liability company – LLC, as the most common form of organization in Serbia) in order to ensure that the funds available to them last longer.

What incentives exist?

For teams working on product development, two main incentives for research and development —  R&D — are available, namely:

• An incentive that reduces taxes and contributions – payroll burdens – for employees engaged in development – R&D on salaries;
• An incentive that reduces corporate income tax, paid by the legal entity engaged in development – R&D on corporate tax.

Both R&D incentives share certain common features, namely:

1. It is required that the product being developed, whether it already exists in some form or is still in the ideation stage, is being developed for the needs and (current or future) ownership of the local team. In other words, work performed for another entity — outsourcing, work for hire and the like — are not supported by these incentives: we must have a product, i.e., intellectual property (IP) in Serbia (formal registration of such a product is not of decisive importance).
2. At least 90% of the employees must physically carry out the development in Serbia.
3. Certain project documentation and tax records must be maintained for as long as the incentives are applied.
4. No prior verification or confirmation from the tax authorities is required. In other words, the incentives are applied independently by the team, with lower levies being paid immediately, while any potential tax authority audits may occur later.

In today’s text, we will cover R&D on salaries, while in the next one we will discuss R&D for corporate tax and the interactions between these two incentives during the development phase.

What is R&D on salaries?

This incentive is applied by employers (and only legal entities, such as limited liability companies, i.e., LLCs — it does not include entrepreneurs). Through this, savings are realized in the form of a 70% reduction in calculated income tax and a 100% reduction in calculated pension and disability insurance contributions on employees’ salaries.

The reduced PIO contributions are still credited to the employee, but not paid by the employer — instead, they are covered by the state, so employees are not disadvantaged. However, in practice, the state has not yet begun to make these remaining contributions on a regular and complete basis, so while employees definitely have the right to these contributions, exercising this right is currently somewhat complicated.

Employees included in the incentive may be registered on either full-time or part-time contracts, as well as fixed-term or indefinite ones, and the exact amount of savings is determined by the time each employee spends on qualified R&D activities in a given month.

In other words, the more time spent on R&D activities, the greater the savings; but even employees who spend only part of their time on R&D activities (and, for example, the rest on a separate outsourcing project) can still be included in the incentive.

What are R&D activities?

Generally speaking, R&D activities include work on direct research or development of some aspect of a product, which may include:

• design (audio/video/game),
• development or improvement of functionalities,
• bug fixing,
• establishing interoperability with other systems necessary for the product to function, etc.

On the other hand, R&D activities do not include indirect work on research or development, which may include:

• meetings,
• managing or leading teams,
• preparing ancillary documentation, etc.

How is the incentive applied?

Based on the ratio between R&D time and non-R&D time in a given month, a so-called R&D coefficient (%) is determined. The calculated tax and PIO contributions are then split according to this coefficient: the portion of tax relating to R&D time is reduced by 70%, while the PIO contributions are reduced by 100%.

Thus, determining the R&D coefficient is the core part of the incentive. In practice, this is most often done by preparing some form of an employee time-tracking report, commonly known as a timesheet — either manually or generated from a project management tool. The exact format for presenting this data is not prescribed, so it is compiled freely depending on the type of records each team has at its disposal.

Below is a hypothetical example of such a timesheet for a team member, which includes several types of activities in game development:

Looking at the example, we see that out of 184 working hours available in the given month (a figure published by the state at the beginning of each year and used for payroll calculations), 134 hours were allocated to R&D activities.

By dividing 134 by 184, we get an R&D coefficient of 72.83%. In practice, for teams that are dedicated exclusively to development, the average coefficient can be around 75–80%. In theory, the coefficient can be even higher (up to 100%) if a team member does not perform any activities that are not considered R&D activities.

This coefficient serves as the basis for applying the incentive, i.e., for calculating the duties that need to be paid.

What additional documentation is required?

In addition to the previously mentioned timesheets for each participating team member, teams that wish to apply the R&D salary incentive must also prepare certain documentation:

1. Project description with expert opinions at the beginning of each year/initial application and at the end of each year – this presents the work plan for the project for the given year, while at the end of the year, a recap of the completed project tasks is prepared.
2. Project budget with procurement plan and projected results at the beginning of each year/initial application and at the end of each year – this provides a rough financial plan for the project, planned expenditures and projected revenues for the given year, while at the end of the year, a recap of actual expenditures is prepared.
3. Signed statement by the legal representative on the accuracy of the data from the timesheets for each month of application – through this, the legal representative confirms that the data in the timesheets for the given month is correct.
4. Signed statements by employees on the accuracy of the data from the timesheets for each year of application – through this, the employees included in the incentive confirm during the year that the data on their working time is correct.
5. Tax-analytical record for each month of application – this consolidates in one place the data on the calculation of levies for each month in which the incentive is applied.

Items 1 and 2 are, as a rule, simple to prepare for any team that has had to present their idea to investors, publishers, or other partners (e.g., government funds). Certain content elements are prescribed, but the format is not, so it is up to the teams to decide how they want to present the key information.

Items 3 and 4 are also straightforward: these are statements in which specific individuals confirm, under criminal and financial liability, that the data in the timesheets is accurate.

Finally, item 5 essentially represents a recap of the data already available in the pay slips of the included employees and the timesheet, but the purpose of this document is to consolidate that information so it can be more easily verified.

All of the above documentation must be ready in the first month of applying for the incentive!

What kinds of savings are possible?

In a specific example, let us assume that a team member has a net salary of EUR 2,500. In that case, the calculation would be as follows:

In the case where the incentive is not applied, for a salary of EUR 2,500, the total levies would amount to approximately 63% of the net salary (which corresponds to the ETR item in the table, i.e., the effective tax rate), or roughly EUR 1,567.

However, if we were to apply the R&D on salaries, with the previously determined R&D coefficient of 72.83%, savings of EUR 785 would be achieved, reducing the ETR from 62.67% to 31.27%.

In other words, a team applying the R&D salary incentive could achieve monthly savings of EUR 785 for one team member during payroll and, naturally, more if multiple team members were included.

However, the exact savings would likely vary from month to month, depending on fluctuations in the R&D coefficient. For example, in cases of vacations, absences, sick leave, non-working days, etc., there would be fewer working hours available in the given month, and the R&D coefficient would likely be lower.

Challenges in applying the incentive

Potential challenges in applying this incentive may include:

• Timely preparation of the required initial documentation (project description and budget),
• Consistent completion of timesheets by team members during the application of the incentive, particularly with respect to differentiating between R&D and non-R&D activities,
• Lack of established practice on the part of the Tax Administration, which may lead to disputes regarding the application of the incentive in the future,
• Inability to use the incentive for employees whose salaries are financed with state funds,
• Still uncertain status of the portion of PIO contributions that should be paid by the state.

Conclusion

Looking at the potential savings for one employee over one month, as shown in the previously analyzed example (summarized in the table below), it is clear that the R&D salary incentive offers significant potential for substantial savings, even for small teams. 

Having worked with more than 20 companies on the implementation and administration of these incentives since their introduction in 2022, my experience is that teams developing their own products do not face significant difficulties in applying the incentive, and that the effects of its application are immediately tangible.

Therefore, my advice to all teams is to take advantage of the benefits offered by these incentives as soon as possible, because every month without applying them is a month with higher costs than necessary.