All I Want For Christmas Is A R&D Tax Credit That Works?
There is no better way to get a reality check on your viewpoint than when you are presented with a clearly opposing position. Such is the case with this week’s announcement that the Australian Information Industries Association (AIIA) has written to Minister Carr to support passage of the draft R&D Tax Credit (the Credit) legislation. While the AIIA concedes that the Bills are not perfect, it is attracted to a more rapid cash-back for SMEs and the fact that the legislation recognises that R&D in the Information, Communications and Telecommunications (ICT) sector is not a laboratory exercise comprising experiments and test tubes. The AIIA goes on to predict that the Bills will be re-introduced into Parliament in the Autumn sittings with a view to a July 2011 commencement.
In responding to these statements, we would note that the Credit definitely increases the number of candidate company groups able to access the cash-back aspect of the program but there is no indication that the ATO will be sending out its cheques more rapidly. Further, we are unclear as to how the AIIA has reached its conclusion that the new package recognises that ICT R&D is not a laboratory exercise, inferring that the current R&D Tax Concession (the Concession) takes that position. Previous MJA Updates have demonstrated our concern that the proposed changes to the definition of R&D activities run the risk of all corporate R&D being subject to a narrower lab-like regime, irrespective of the industry sector involved.
For starters, the new definition of core R&D activities requires them to be experimental as an isolated requirement. And supporting R&D activities will be subject to the new complexities of the dominant purpose test. Let’s take a closer look at this issue.
Dominant Purpose – Don’t Worry. Be Happy
When the Bills recently passed through the Lower House, the Assistant Treasurer, Bill Shorten, said “The dominant purpose test is a well-defined concept commonly used in tax law.” In short (no pun intended), there was no cause for concern about how the test would work in practice. This was in response to the Opposition amendment on dominant purpose. Yet the Opposition amendment, in common with the Greens amendment, the majority and minority opinions of the Senate Economics Committee and the vast majority of over 380 submissions referenced by the Assistant Treasurer all agree that the dominant purpose test in the Bill is a new, onerous and subjective test that will increase compliance costs and uncertainty and reduce encouragement for businesses to do genuine R&D. Further, Peter Thomas, Chair of Innovation Australia, confirmed in his evidence to the Senate Economics Legislation Committee that determination of which of any of the driving purposes of an activity is the dominant purpose is all a matter of judgement.
Given the extent of the concerns expressed, how does Mr Shorten reach his conclusion?
The dominant purpose test is present in a number of anti-avoidance provisions in tax law. Primarily, it is in Part IVA, the General Anti-Avoidance Rules (GAAR). In this regime, “the dominant purpose” is determined by a set of eight expressly defined and legislated rules that are used to determine which of all the possible dominant purposes in an arrangement is the dominant one. All the other anti-avoidance provisions either have rules to determine the dominant purpose or apply even if tax avoidance is not the dominant purpose.
Since its introduction in 1981, the Part IVA GAAR have been, to say the least, contentious, especially in the application of the dominant purpose tests. It has been a major focus of tax law court activity with notable cases like Hart’s case, Spotless and Macquarie Finance. It has been a major focus of ATO activity with rulings and taxpayer alerts aplenty. Interestingly, Bill Shorten announced a review of the GAAR on 18 November 2010 to focus on rewriting these rules to “improve the integrity, certainty and simplicity of the income tax laws”.
Hardly a ringing endorsement of a “well-defined concept”.
Unlike the GAAR and other tax law dominant purpose tests, the Bills contain nothing to determine how the dominant purpose is to be determined in relation to supporting R&D activities. It is not linked to any of the eight tests in the GAAR, so any of the court cases around these tests will have limited value as precedents. We will be starting with an essentially clean sheet if the Bills enact the proposed definition.
In the light of the above, MJA suggests that you should be worried about dominant purpose but you should always stay happy!
The New Assessment Regime – Don’t Worry. Be Happy
Well, actually, even the AIIA is worried about this one. They have commented on the increased audit and compliance activities associated with Concession claims directed towards the ICT sector, especially SMEs.
Again, we would suggest that this is a program-wide development. The Government’s recent consultative meetings about the new regime revealed that the program commenced back in July with, in fact, no consultation and no announcement. The new step of requiring written responses to questions on projects has massively increased the compliance burden on taxpayers selected for review.
Already, we are observing a number of problems with the approach. There is a lack of standardisation in the types of questions being asked, resulting in misleading questions and a number of inaccurate statements of the law. The responses are generally required within thirty days but AusIndustry will not commit to a timeframe within which they will process the received responses, thereby adding to uncertainty.
A key concern is that there is no guidance as to how much information should be provided in the responses. At the consultative sessions, AusIndustry indicated that many taxpayers are providing too much information. Given the lack of guidance and the fact that the types of questions are those normally attributable to s39L full audits, this is hardly surprising.
Of great concern is that taxpayers are being processed to the next step – a site visit – with no reasons being provided as to why the written responses provided did not satisfy AusIndustry’s requirements.
It seems that a new assessments industry might have sprung up to justify the large increase of resources announced in the 2009 Budget to deal with a Credit that failed to commence in July 2010.
MJA will follow up these concerns up with the Government with a view to getting parties around the table to assess the early performance of the new regime resulting in the introduction of equitable reforms in the process.
It’s The Festive Season – Don’t Worry. Be Happy
This brings to an end our trilogy of somewhat gloomy MJA Updates in the wake of the failure of the Bills to be enacted in 2010.
However, this failure creates opportunity anew to address the problems. It was a year ago when the first draft of the Credit arrived as an early Christmas present and we have all gone some way towards improving the Credit before it becomes law. The basic program remains a great idea. We still need to fix up the details for it to be a successful one.
Our agenda for 2011 is clear but right now is the time for us all to relax and catch our breath. We wish you and your family all the very best for Christmas and 2011. We look forward to alleviating all our worries about the Credit in the New Year so it can be a truly happy one for Australian innovation.
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.
The New R&D Tax Compliance Framework
Over the last few months, AusIndustry has begun the roll-out of a new R&D Tax Compliance Framework. This framework is being applied to existing R&D Tax Concession claims and will be adopted by AusIndustry if a new R&D Tax Credit comes into operation.
AusIndustry recently conducted the first in a series of state based consultative forums to discuss operational issues related to the new compliance framework. This forum was held in Sydney on November 18 with a similar forum planned for Melbourne on Monday November 29.
The new compliance framework involves both State and National Office delivery with the process tailored to the nature and value of the R&D.
Small and Medium R&D Claimants
Small and medium R&D claims will be primarily managed by AusIndustry’s State and Territory Offices through a series of compliance activities that will escalate in intensity if issues remain unresolved and may ultimately lead to a statutory assessment. This process is collectively known as the Compliance Continuum and involves the following four stages:
- Registration Profile Review – review of registration documentation involving no contact with the registrant company.
- Registration Desk Assessment – the company receives a letter requesting specific information on a project’s R&D activities and their eligibility.
- Compliance Activity Review – will involve a site visit to the claimant company to discuss potential eligibility issues.
- Statutory Assessment – undertaken by the State and Territory Offices. Their decisions are legally binding but the claimant has the right to appeal. This will escalated to the National Office.
During each stage of the Compliance Continuum a company is judged to be either a ‘low’ or ‘high’ risk of meeting compliance. A ‘high’ risk rating will lead to the next stage of the compliance continuum.
Large R&D Claimants
Companies with large projects and high R&D expenditure will need to work with AusIndustry under an Active Case Management Strategy being managed by the National Office in Canberra. This process will involve a review of registrations by sector with the intent to seek independent expert advice on registered activities and on R&D in the sector generally. The key aspects of this framework will include:
- Larger matters to be progressed in close cooperation with the Australia Tax Office
- An independent expert opinion sought for each sector
- Projects or activities considered to have a high likelihood of ineligibility will be subject to statutory assessment to be undertaken by the National Office
AusIndustry has not provided any detail on the quantum of R&D expenditure which will determine whether a claimant gets assessed under the Compliance Continuum or Active Case Management framework.
Taxpayers should continue to approach their R&D claims with the same business as usual attitude. MJA looks forward to providing feedback and discussion on the compliance culture with AusIndustry and the ATO to ensure that it is effective and does not create an overly cumbersome compliance burden for companies.
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.
Why ‘whole of mine’ fails the interpretation test
The floor of the United Nations General Assembly buzzes with the languages of its 192 member states.
Yet, as each representative rises to speak in their native tongue, they are confident that what they say will be faithfully interpreted to the balance of the assembly. They understand that a verbatim translation of what is said may make no sense in a foreign tongue, and so rely upon the interpreters to communicate the meaning as best they can. This transfer of meaning is the interpretation test.
But, no one is present to interpret English to English, or Spanish to Spanish.
Sometimes you need interpretation even in your native tongue
When the Cutler Review of the National Innovation System published its report Venturous Australia in September 2008, one shorthand phrase in the analysis of the R&D tax concession stood out, the reference to ‘whole of mine’ claims. This is what was recommended:
appropriate measures be taken to heavily constrain ‘whole of mine’ and similar claims against the existing R&D Tax Concession program or proposed Tax Credit program.
Unfortunately, from literally interpreting the phrase, many people think they know what ‘whole of mine’ claims are, but the term has no legislative, policy or administrative meaning. In fact, the government has said nothing about the phrase or policy issue at all.
Yet, we have already started to receive questions from AusIndustry on behalf of Innovation Australia as to whether or not particular projects or claims are ‘whole of mine’ claims.
In one case the applicant has been asked why a claimed project is not a ‘whole of mine’ claim, despite the claim being for a very small fraction of one year’s operating costs.
This is the problem of shorthand, and of administrative decision makers interpreting a policy signal from a review document.
We need to focus on context for interpretation
In our response to the Cutler Review Report we said:
The term, ‘whole of mine’, has recently emerged as a type of shorthand for describing large claims and needs to be removed from the lexicon of the discussion. It adds an emotive element that clouds discussion as to the role that can be played by a tax instrument in innovation policy. A mythology has been built up around these claims that needs to be moved on from in the current debate.
Large claims are definitely made within these industries from time to time but MJA suggests that this is not routinely the case. Our profiling of our client base suggests that large one-off projects are an occasional feature of large, diversified groups such as mining houses and engineering firms. They make up but one component of their substantial, constantly evolving portfolio of innovation activities. Even when they occur, total R&D claims will invariably fall well below 10% of group turnovers in the relevant years.
This context is critically important. Just because large claims are made they do not necessarily demand further scrutiny. Moreover, many smaller companies, including those in the biotechnology, medical research and software sectors routinely have periods of R&D intensity that equal or exceed those of larger firms.
But you don’t hear an outcry about ‘whole of cure for cancer’ claims.
We need to focus on eligible R&D and eligible expenditures
In either case, ‘whole of mine’ or ‘whole of cure for cancer’, what advisers, government assessors and decision makers need to come back to is an assessment of the principles of eligibility of both the R&D being undertaken and the associated, eligible expenditures.
Under the present rules, R&D is neither more nor less eligible for government support because of the size of the expenditure on the project. This is one of the benefits of having the administration of eligibility of activities separated from the administration of the eligibility of expenditures.
Innovation Australia, in looking at the eligibility of activities, should reach the same outcome as to eligibility regardless of the expenditure involved. In fact, the quantum of expenditure should be irrelevant to the decision making process, and the provision of such information should be optional.
Similarly, the ATO should reach decisions as to the eligibility of expenditures without regard to the nature of the R&D activities undertaken. Whether they assume an activity to be eligible or request assessment of eligibility by Innovation Australia, the outcome should be no different for the taxpayer.
We need an end to the innovation policy vacuum
The Minister for Innovation, Industry, Science and Resources has repeatedly said that “in the twenty-first century, innovation policy is industry policy“. To date, though, most of his actions have been around very traditional industry policy areas: automotive; textile, clothing and footwear; and university research.
The current global financial crisis has affected the speed with which a cogent response to the recommendations of Venturous Australia can be prepared. But if we are going to see a ten year innovation policy announcement from the government it’s going to need some level of consultation and analysis.
Ideally, there will be an opportunity to engage on topics that span policy, politics and administration, as a ten year policy will likely need some level of bipartisan, industry and administrative support to be well received and executed.
Most of all we need fair interpretation for program certainty
It is unfair that applicants for the R&D tax concession need to address a loaded and vague term like ‘whole of mine’ when defending their claims.
It is even more unfair when they need to do so because administrative decision makers are interpreting future policy signals from a government-initiated review of the National Innovation System when there is no policy response.
Just imagine if this level of misinterpretation was at work in the United Nations General Assembly.
Perhaps there would be demand for people to interpret English to English after all!
How are we doing?
It’s always helpful to have your feedback on the articles we prepare, and the approach we’re taking in dealings with the government. You can help us by filling out a Comment below this post on our website, and giving us any feedback you have on how we’re peforming, or how we could improve.
- The R&D Tax Incentive – Like the Footy Finalists, Take It One Week at A Time
- R&D Tax Credit finally passed through the Senate
- Alas, poor R&D project, we knew you well
- Are We There Yet? Are We There Yet? Are We There Yet?
- MJA on Switzer
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