R&D Tax Credit March 2010 Exposure Draft – A Brief Summary of Features

1 April 2010 by Kris Gale

The release of the second Exposure Draft of the R&D Tax Credit Legislation after the close of business on Wednesday 31 March, just prior to the Easter break, is disappointing, with a scant 9 days left in which to prepare a response. Given the tightness of this timetable, coupled with the new legal concepts, as highlighted below, MJA would suggest that the best course of action is to stay the introduction of this legislation until full consideration can be given to its merits. We would not support the timetable currently being mooted by Government for a commencement date effective 1 July 2010. We agree with other advisors and industry groups that rushing this legislation through will ultimately be counter-productive to the program.

Below is a brief overview of the new legal concepts proposed.

Rates of deduction

The R&D Tax Credit (the Credit) is designed to provide a greater incentive for SMEs to undertake R&D by providing a higher tax offset than that available to larger companies. Foreign owned R&D will also be eligible. The rate, and whether it is refundable, will be dependent upon company turnover:

A 45% refundable tax offset (equivalent to a 15% after-tax benefit) will be available to SMEs (companies with an aggregated annual turnover of less than $20 million) undertaking eligible R&D; and
A 40% non-refundable tax offset (equivalent to a 10% after-tax benefit) will be available for companies with an aggregated turnover greater than $20 million undertaking eligible R&D. Unused non-refundable tax offsets can be carried forward.

Changes to the definition of R&D activities

As in the first draft, companies will now need to clearly distinguish between core and supporting activities, identifying not just two but three types of activities, including two subsets of supporting activities. Additionally, the Explanatory Materials appear to indicate the potential for Innovation Australia to differentially apply the definition depending on the circumstances.

(1) Core R&D Activities

Core R&D activities are will now be defined as experimental activities whose outcome cannot be known and are conducted for the purpose of acquiring new knowledge. So it appears that although the words technical risk and innovation will no longer be used, these concepts will still remain, and both elements will be required to be demonstrated. The list of excluded activities will only apply to core R&D activities.

(2) Dominant purpose supporting activities

These dominant purpose supporting activities will be defined as activities that do not meet the definition of core R&D activities and

are for the production of (or directly related to) the production of goods and services; or
would fall under the exclusions list

These activities will need to be undertaken for the dominant purpose of supporting the core R&D activities. Importantly, production activities have not been defined in the ED. This new subset of supporting activity will have the potential to significantly reduce claims across all industries, as the technical and financial risks in demonstrating any technology in a full scale environment are almost always going to be the biggest expense a company incurs in undertaking R&D.

(3) Directly related supporting activities

A directly related supporting activity will be defined as any activity undertaken for a purpose directly related to the core R&D that is not a production activity or one that would fall under the exclusions list. The exclusions list will not apply to directly related supporting activities. It appears that there would be only a small amount of expenditure that would fall under this subset of supporting activities.

Software development activities

Software development will be subject to the same eligibility tests as other types of R&D with the exception of in-house, business administration style software. This exception has been incorporated into the exclusions list, however it will not extend to “applied” software that forms part of a device or equipment, nor to software activities that may qualify as supporting a core R&D activity. The existing multiple sales provision for core R&D software development has been removed.

Feedstock

The feedstock rules will change, however it is not yet known whether there will be any surprise additions to the current definition of “feedstock”. What is clear is that the notion of augmented feedstock introduced in the first draft has been dropped.

Expenditure not at risk

A company will not be able to claim expenditure on activities where the expenditure is not at risk. This will apply where a company has a reasonable expectation that it will receive consideration irrespective of the results ie receive consideration even if the R&D fails to deliver a result or a successful result. Expenditure not at risk will not necessarily apply to all product development projects where a company could receive consideration under a contract for the development and sale of a product. It will only apply if the contract provides that the company will receive consideration, irrespective of whether it delivers a product.

Administrative powers

The Credit will continue to operate on a self-assessment basis for companies. However, Innovation Australia will have “enhanced” powers in registering and assessing eligibility of R&D activities. R&D activities can be unilaterally reclassified and rejected based solely on the detail provided by companies in the registration application. This means companies will not always get the opportunity to meet and discuss with the government on their activities and may only get an opportunity to present their case in a formal appeals process.

Object clause

The new provisions will be interpreted by having regard to the Object clause which will be more restrictive than the promotional Object clause of the existing program. The clause defines the object of the legislation as encouraging industry to conduct R&D where the knowledge gained is likely to have a benefit for the wider national economy and might not otherwise have been conducted without the Credit. As such, this more restrictive clause will lead to a more restrictive interpretation of the Credit provisions.

Should you wish to discuss this matter any further, please do not hesitate to contact Kris Gale directly on (02) 9810 7211 or using our contact form to discuss the matters raised in this MJA Update in greater detail.

Filed under: MJA Update Articles
Tagged: Government Consultation, National Innovation System Review, R&D Tax Concession, R&D Tax Credit, R&D Tax Credit Issues Paper, The new research and development tax incentive, Treasury

Comments

One Response to “R&D Tax Credit March 2010 Exposure Draft – A Brief Summary of Features”

Richard Krista on 6 April 2010 9:52 pm

Clearly Barry Jones and the NIS are not yet in place, as they have only just advertised (Australian 27/3/10) for a General Manager for the Industry and Small Business Policy Division. I believe you have a strong case against the legislation being effective, until all the issues you raise can be thrashed out with the general manager to be.

Richard Krista
Director
ClAus*1 Art & Science Business Enterprises