How the 175% International Tax Concession Reflects the Burden of Complexity
The new 175% international tax concession provides an incentive to direct R&D investment into Australia.
It shows that the government is less concerned with “on own behalf” than it is with where the R&D is performed.
It demonstrates that the primary public benefit of R&D investment is the economic spillover generated by the activity, not the uncertain future commercial benefits.
And it shows the government’s commitment to incentivising R&D tax, right?
Wrong.
The “International” Concession had a sound origin
International companies, such as the global pharmaceutical and IT firms, evaluate many factors in deciding where to locate their R&D activities. Factors such as the intellectual property regime, the skills of the research base, the suitability of clinical test markets and the opportunities of time zones have for years pointed to as a solid location for these types of R&D.
Yet for the past 21 years many of these companies have not been able to access the R&D tax concession due to the commercial treatment of their intellectual property. Other R&D tax programs, such as the one in England, don’t discriminate on this issue. They are very clear: what matters is where the R&D is performed, not where the intellectual property resides.
Finally, in the May 2007 Industry Statement the Howard Government announced the extension of the R&D tax concession to multi-national enterprises whose intellectual property was not domiciled in Australia, opening the opportunity to encourage further R&D.
But the Productivity Commission had complicated the
situation
Encouraging R&D, however, was not enough. The announcement of the extension of this program was made after the Productivity Commission released its report criticising support mechanisms that fail to incentivise “additionality”.
Additionality is a seductive concept, but is a nightmare to implement mechanically in a fair way because it discriminates against companies.
How do additionality programs discriminate against
firms?
The most common additionality programs are “volume” or “intensity” based.
Volume incentives increase rewarding dollar investments either in absolute terms or in reference to a past average. The current 175% Premium R&D concession operates in this way.
Intensity incentives operate to reward increasing R&D expenditure as a proportion of turnover. These mechanisms naturally favour smaller enterprises, but present planning and mechanical challenges that are seldom overcome.
Problems occur for firms based on the interaction between market linked incentives, such as the 125% R&D tax concession, which provides an environment to encourage risk-based activities, and these additionality programs.
Additionality programs reward market-timed investments
Anecdotally, the current mining boom has led to an increase in 175% Premium claims.
Far from being a negative, this type of result is the program operating as designed: companies are undertaking risky activities in pursuit of lucrative commercial outcomes attune their investment to the market. They receive positive discrimination under present legislation because “everything in mining is expensive”, and they are operating in a booming environment.
Yet this R&D does not necessarily represent the ‘additionality’ the program is intended to incentivise.
In fact, the true test of the additionality is whether the higher incentive will induce counter-cyclical investments.
So, what is wrong with the 175% International
Concession?
In addition to the problematic policy basis for the 175% International Concession, and despite an investment in consultation with advisers and consultants, the program as implemented is significantly more complex than it needs to be and disturbs some fundamental elements of the R&D tax concession.
First, the 175% international Concession introduces a significantly different definition of R&D activities, meaning that companies cannot simply assess activities that may be eligible for 125% treatment and assume they will be operating in the same way in the new program. It is possible that this is reflective of an emergent policy bias that will need to be explicitly addressed.
Second, instead of being delivered as a new, optional program (as originally promoted) the 175% International Concession requires companies to consider their position as part of the existing 175% process.
Third, the 175% International Concession relies upon complex history provisions (for up to 10 years) to establish eligibility. This is necessary in order to build a history for the incremental concession in the absence of general eligibility for a 125% concession. This is an issue that could have been more fully explored during the consultation process.
Finally, the implementation of the legislation represents a new height in complex legal drafting. Although the concepts involved need strong anti-avoidance considerations, and the interaction with existing provisions is also problematic, it removes the program from the domain of many companies without a considerable budget for advisers.
These factors when taken together actually provide a disincentive for companies to address this program, except in order to attract significant concessional funding.
The opportunity exists to improve this situation
The recent change in government provides a clear opportunity to address this issue.
Senator Carr, as Minister for Innovation, Industry, Science and Research, has already flagged a consultation process around the R&D tax concession and the 175% premium and international concessions need to form a logical part of that review.
We are committed to engaging the new ministry in discussion on these issues and ensuring that consultation with companies and government is undertaken in the best interests of the Innovation Community.
Summary
1. Providing R&D tax concessions to companies to undertake R&D in Australia is desirable, even if subsequent commercialisation is dependent on intellectual property domiciled in another country
2. Poor consultation and a need to legislate policy announced prior to the federal election meant that the consultation process was not as complete as it could have been
3. The change in government provides a crystallizing event in order to address these policy issues in order to increase the commercial suitability of the tax concession.
