There is a deep sense of concern within the Australian business community that the long awaited revamp of the Federal Government’s R&D Tax Concession is actually little more than a thinly disguised mechanism for reigning in the Government’s estimated annual $1.4 billion spend on the program.
When changes to the program were first announced by Treasurer Swan as part of the 2009 Budget, the Government indicated that its intention in redesigning the current R&D Tax Concession system was to develop a program that provided more support for innovation in Australia.
The Government promised the new R&D Tax Credit system would take some of the complexity out of the current R&D Tax Concession program and deliver a more predictable, streamlined R&D tax incentive that would entice business decision makers, particularly those in small-to-medium enterprises, to undertake additional R&D activities.
However, in order to fund this higher R&D rebate/credit, the Government warned the business community that there would be a ‘tightening up’ of the definition of R&D activities and a few changes to the current feedstock provisions to essentially close down some claims (such as ‘whole of mine’ or ‘one off’ infrastructure projects) as R&D activities.
At the time, the proposed changes were lauded as a step forward, a great bonus for SMEs (due to the significantly increased rates of benefit) and evidence of the Federal Government’s continued support for innovation. When the actual draft legislation was released just before Christmas, the business community and its advisers were, to say the least, disappointed with the Government’s apparent sledgehammer approach to addressing some of the perceived shortcomings of the previous program.
The actual legislation produced by the Government has fundamentally changed the proposed nature of the R&D tax credit system. It does not deliver the promised more predictable, streamlined R&D tax credit aimed at providing SMEs with greater access to Government funding. Instead, the changes appear to be more about reducing the number of companies able to access the new scheme or, at the very least, reducing the size of claims able to be made.
Fundamental to the failure of the draft R&D Tax Credit legislation to deliver the Federal Government’s stated intention is the fact that it actually rewards or compensates failure. Under the new program, if an SME is smart enough to solve a complex technical issue and then commercially savvy enough to make money out of the solution (via higher production rates, new products etc), the proposed legislation will not provide any support whatsoever for the company’s investment in innovation. This is regardless of the fact that new technology may have been developed and the Australian economy will reap the rewards of the successful innovation via increased royalties and employment, for example.
The exception to this rule relates to circumstances whereby intellectual property generated by the R&D activities is sold. Success plays no part in the Federal Government’s proposed R&D tax credit; a concept that does not sit comfortably for most Australian businesses that enter into R&D activities with the intention to succeed developing technical outcomes and to then exploit the results of their R&D activities.
When the changes to the R&D Tax Concession were first mooted, one of the selling features was that the new program would allow SMEs (businesses with a grouped turnover of less that $20 million) to access 45 percent refund tax credit in respect of their R&D spend. For SMEs, the new R&D Tax Credit program is significantly more generous than the current R&D Tax Concession, effectively returning 15 cents in the dollar, compared to 7.5 cents in the dollar under the current R&D tax concession scheme.
While the new program is more generous, it is only more generous to those SMEs that are eligible to claim. A review of the draft legislation reveals that the types of activities and costs eligible to be rebated appears to have been significantly reduced, which will result in a significant reduction in the companies eligible to make a claim under the new program.
Recent discussion in the Senate indicates that the number of companies eligible to make a claim under the proposed R&D Tax Credit system may fall by 50-to-80 percent. This is despite claims by the Government that the changes to the old R&D Tax Concession program are supposed to be revenue neutral.
The main changes to the proposed legislation likely to impact an SMEs’ eligibility to the new R&D Tax Credit are:
- Introduction of a dominant purpose test with respect to supporting activities
- An expanded feedstock concept that effectively requires the cost of conducting R&D activities to be netted off against the market value of the output of the R&D activities
- Eligibility to the proposed R&D tax credit can really only be assessed in retrospect, making it difficult for decision makers to assess the value of the R&D Tax Credit.
Due to the proposed requirement to net off costs against market value, the manner in which the Government supports innovation in Australia has changed from a guaranteed, merit-based program (whereby a company can assess its eligibility to the R&D incentive prior to the conduct of the R&D activities) to an ‘end of project’ reimbursement that effectively ‘compensates’ companies that have failed to succeed in their R&D endeavours or that have failed to commercialise the results of their activities.
This type of R&D program will no doubt lead to a situation whereby a company has assessed that a specific project is eligible to the R&D tax credit program and due to the generous nature of the R&D Tax Credit (which is a 45 percent refundable tax credit for most SMEs) and embarks on innovative and technically risky activities in anticipation that such costs will be the subject of an R&D tax credit.
One of the results of the new legislation is that the available tax credit can only be determined after the market value of the R&D activities have been assessed, which could result in none of the company’s costs being eligible under the proposed system. This type of retrospective assessment, where eligibility to the proposed tax credit system can only be determined after all activities are completed, seems counter to the Government’s claim that the new program is expected to deliver more predictable results to key decision makers.
This concept may also lead to a scenario where a company believes it is eligible for the R&D Tax Credit program at the outset of the project and instigates a program of documentation and reports in order to generate the documentation required to evidence eligibility (such as dominant purpose, innovation etc). If the project is successful and the results of the R&D activity have value, then none of the costs associated with the R&D activities (including the added documentation/compliance costs) are eligible for the proposed R&D Tax Credit Program.
In such instances, a company will be worse off financially (re the cost of preparing documentation to support a claim under the R&D Tax Credit program) than if the R&D Tax Credit Program had not been considered.
This is a farcical situation and surely not the outcome intended by the legislators. If, however, changes are not made to the proposed legislation, the Australian Government will be responsible for the single biggest retrograde step in the history of Government support for innovation. The Australian business community can only hope that the Government yields to the chorus of condemnation of their proposed flagship R&D policy and actually changes the draft legislation to deliver the policy intent, the creation of a better targeted, more generous, more predictable and less complex incentive for genuine R&D.
–Tracey Murray is a Partner in the R&D team within the corporate and international tax division at BDO Kendalls (www.bdo.com.au).
