From our perspective, we had attended two Government workshops about the Incentive in August and nothing substantive could be said by the authorities about matters of interpretation as the law was not yet in place. The tax manager went on to say that if the company’s technical staff heard that you may not have a claim if your predominant purpose was commercial, not R&D, a number of them would grab hold of this red card being offered and send themselves off so they didn’t have to help claim an R&D project ever again. We concluded that it would be best to learn a little more about the Incentive rulebook before we launched a whole new strategy for winning in the R&D game.

As we write this MJA Update, the Incentive is waiting patiently for Royal Assent. The word on the street is that this will be achieved around the middle of next week.

The understandable reaction from companies after such a long wait would be to get cracking and attend any briefing session on offer; start assessing what R&D now qualifies and begin installing new identification and costing systems. How else do you win the Grand Final?

Well, as any coach will tell you, you don’t get ahead of yourself, you play each game on its merits, you take the season one week at a time, and a litany of other sporting clichés in devising a successful approach.

And so we believe it should be with your response to the Incentive. Right now, we think that the best thing you can do is keep on doing what you’ve been doing with regards to the R&D Tax Concession. Keep identifying and tracking the same projects and the same costs.

And here’s why.

To Know the Rules, You Must Know the Umpire

You would be aware that the Incentive is to be jointly administered by AusIndustry, the Innovation Australia Board and the ATO. They are the refs and umpires and we all know that we need to work cooperatively with these bodies to achieve an effective transition to the Incentive regime. Right now, it is their views of the operation of the new legislation that we need to reference and understand before we can meaningfully respond as to how the Incentive affects taxpayers. The fact of the matter is that they have yet to publish their interpretations of the rules, let alone blow their whistles. Until they do, MJA believes it is way too premature to be attempting to determine a finalised approach to successfully claiming the Incentive.

As such, we advocate that you retain your current approach to identifying and documenting R&D that is currently eligible under the R&D Tax Concession (the Concession). Ultimately, the narrower definitions of the Incentive will mean that some of your R&D activities and costs that you track may not be eligible, but this can be reconciled towards the end of the first year of the Incentive, by which time the views of the administrators will be much better understood. Remember that nothing substantive about the interpretations of the new rules has been tabled by Government since the second Explanatory Memorandum back in the first half of 2010. If you speak directly to AusIndustry and the ATO at the moment, they can only respond with the fact that they can’t comment as the Bills are not yet law. All the rest of us can do right now is speculate on the impact of matters such as dominant purpose and feedstock and how the Government will interpret these new concepts.

What Is the Schedule for the Rest of the Season?

Through MJA’s membership of the R&D Tax Incentive National Reference Group (NRG), we have come to understand that the planned Government roll out will go along these lines:

• A national series of AusIndustry/ATO information briefing sessions which have just been announced for each of the capital cities from mid-September. Click on the link for the dates and to register your attendance. Initial guidance material will accompany these sessions.
• A discussion paper entitled “R&D Tax Incentive Guidance Discussion Paper” will be released in late October 2011 and a period of active feedback and comment will follow.
• Following the passage of the Regulations and Decision-making Principles, application forms for Advance and Overseas Findings will be released. This should occur before Christmas.
• In the first half of 2012, detailed guidance material will be published including sectoral guidelines covering manufacturing, mining, information technology, biotechnology, agribusiness and construction.
• The Registration application form is most likely to appear in the New Year.

As you can see, there will be several months to digest the Government’s viewpoints and requirements and the great unanswered questions will finally start to receive some useful answers.

Keeping Your Eyes on the Prize

At the appropriate time, MJA will run a series of free seminars to assist you in preparing to make your first claim. But we only intend to do that when we have something meaningful to discuss. In the interim, we will keep you posted courtesy of this Update. Remember, we want all of your team out there on the R&D paddock with everyone fully committed and enthused. Don’t get them looking for those red cards right now so they can risk taking you out of the game for the ultimate R&D prizes.

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.

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We do not expect there to be any impediment to the amendments being accepted. Outstanding issues such as the unworkability of the Feedstock provisions remain but MJA will continue to work for a workable solution or amendment.

 More information on the details of the new R&D incentive will follow shortly.

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 passage of the Bills had been a long and tortuous one. Most of the heat and light coming from the critics (of which MJA has been one) has been directed at the dramatically revised definition of eligible R&D activities and the changed feedstock provisions. However, an additional concern that is now emerging more clearly is the vast increase in administrative powers connected with the Bills and this was reflected in the recently-tabled  Credit Regulations and Decision-making Principles.

MJA has recently had two major interactions with AusIndustry and the Australian Tax Office that have provided an initial insight into the proposed regime for accessing the Credit. We attended a roundtable in Canberra on 12 August as an inaugural member of the R&D Tax Incentive National Reference Group (NRG) and also participated in a Canberra workshop for advisory firms during the previous week.

What we learned was that the first public statements from the program administrators will be made at a series of Australia-wide briefing sessions in September. Detailed guidance material and application forms will be released progressively in the months that follow.

But we were also left with a genuine concern that the program will be one that companies will need to administer on an R&D activities basis, rather than by continuing to utilise the well-understood concept of an R&D project.

You Don’t Know What You’ve Got ‘Til It’s Gone

Since 1985, the R&D Tax Concession has operated with an activities-based definition. However, companies have been able to register, claim and cost their R&D activities on a project basis. This makes perfect sense. Technical people think in terms of projects. Accountants do not cost at an activity level. And the Government has always had the right to “drill down” further to an activity level in an assessment environment. Companies have understood that they need to be able to respond accordingly in respect of selected R&D projects. This is where advisers have played a key role and all parties have acknowledged that it entails a significant amount of additional work.

However, the early indications with respect to the Credit is that taxpayers will need to operate all aspects of their claims on an activities basis from registering through to costing prior to being selected for any audit activity. Currently, the Concession has one type of eligible activity – R&D activities – with the two limbs of ‘systematic, investigative and experimental’ and ‘directly related’. By way of contrast, the Credit has five distinct categories of eligible activities – core R&D activities and four types of supporting activities, all with new concepts attached to them.

At the recent consultations with Government, a draft Advance/Overseas Findings application form was discussed. The form required separate descriptions of all five categories, an indication of which supporting activities supported which core activities and cost estimates for each individual activity.

Now imagine a full registration and project costings schedule on the same basis! Take a very simple example.

Under the Concession, you register an eligible R&D project and describe all the R&D activities under the project heading.

Say 8 people work on that project. You capture their eligible time and submit a claim with the cost of the 8 people identified.

Moving to the Credit, if the project has 10 activities, an activities-based approach will require you to separately describe all 10 activities including identification of the linkages. Then you will need to split the costs of the 8 people across all 10 activities resulting in potentially 80 pieces of cost information.

Same project, same claim, same benefit, exponentially more work. Yet the Credit was meant to be simpler for taxpayers and encourage more SMEs into the program. How’s that again?

There is no doubt that the new law will necessitate that this additional information be provided in an assessment environment and all stakeholders need to work together to make sure that this can be effectively done when required. However such a task should be confined to that part of the self-assessment system involved with audits. Accessing the program at the registration and tax schedule stages must remain on an R&D project basis. We cannot drown a program that is already trending as narrower and more complex in a deluge of paperwork. Government concerns about the level of detail of the information provided and the prevention of fraud must be counter-balanced by administrative convenience and a true sense that this is an incentive program. One should never design a system to better target the minority that misuse it at the expense of the responsible majority and the overall program objectives.

We urge the Government to establish that the law and regulations simply enable them to request activities-based information at appropriate times such as in audit environments rather than compel them to require it at all stages of a claim. Following that, all stakeholders should be engaged to assist in the delivery of a workable approach to help boost Australia’s innovation stocks. Let’s keep the concept of the good ol’ R&D project front and centre. The Australian innovation community cannot afford to see it confined to the pages of history.

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 Federal Government has confirmed that the revised start date of the R&D Tax Credit will be 1 July 2011 in a joint release from the Treasurer and the Minister for Innovation, Industry, Science and Research.

In a sweetener for SMEs, loss-making claimants will be eligible for quarterly payments of their Credit entitlements from 1 January 2014. Something to look forward to!

 The text of the press release appears below.

CROSSBENCH SUPPORT MEANS NEW R&D TAX CREDIT WILL START ON 1 JULY 2011

Australian companies will become more innovative and globally competitive thanks to the new R&D tax incentive.

The Gillard Labor Government’s $1.8 billion R&D Tax Credit will deliver more funding to innovative firms – including manufacturers, ICT and biotech – increasing productivity and Australia’s national income.

This builds on Labor’s policy reform agenda of the past four years and will be a major benefit for businesses that innovate and use R&D as a platform for future growth.

Today we welcome crossbench Senators announcing their support which means the parliamentary road-block put in place by the Coalition will finally be removed.

The new and improved Credit will target more funds to genuine R&D deserving of public support – good news for industry and better value for taxpayers.

It will deliver a 45 per cent refundable tax credit to companies with an aggregated turnover of less than $20 million and a 40 per cent non-refundable offset to all others.

This will allow more firms to benefit from our massive boost to the innovation, science and research budget, helping them grasp the opportunities of our transition to a cleaner economy.

We welcome the commitment of industry, the Greens and independent parliamentarians who have put good policy ahead of political posturing in supporting this reform. 

The development is the culmination of an extensive consultation and negotiation process.

Following discussions with the Greens, the Government will introduce quarterly payments for small and medium businesses from 1 January 2014. These firms will get their credit sooner, significantly improving their cash flow and incentive to invest in R&D.

The deferral of the start date to 1 July 2011 has an overall impact of $40m, with a negative impact of $310m in 2011-12 and a positive impact in 2012-13 of $270m.

The Government will continue to work in partnership with the business community to get the most from this landmark reform. An advisory group will be established through the Innovation Australia Board to monitor the implementation and operation of the Credit. The Government, through AusIndustry, will run an extensive education program to ensure firms are kept up to date.

MJA will keep you informed of all major developments as the Credit legislation becomes law.

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.

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 principal concern is that the new provisions are a major extension of the concept of feedstock offsets and, when combined with the narrower definition of R&D activities, result in a drastic reduction in support for any operations-based R&D that generates a commercial value.

Feedstock is a tough one. It’s a bit of a reach for the politicians. The technical bodies – Department of Innovation, Industry, Science and Research; AusIndustry; Innovation Australia Board – all seem to adopt a “not my pigeon, guv” approach. The Senate Committee ran out of puff before it got to feedstock in its report back in May. Financial journos glaze over when you try and explain it to them.

Yet, if we are to believe the Government, feedstock is a non-issue as nothing has supposedly changed regarding the feedstock offset contained in the current R&D Tax Concession and that proposed for the R&D Tax Credit. Bill Shorten, the Assistant Treasurer, in his Lower House speech on November 22 on the Bills said: “The feedstock provisions in the bills have the same scope as the feedstock rule in the existing legislation.” Paul McCullough from Treasury said in his appearance before the May Senate Economics Legislation Committee that he was “aghast” at suggestions that the real problem with the Bills was the feedstock provisions “…because the feedstock provisions are not changing.”

Simply put, MJA disagrees with these two statements. 100%.

The proposed provisions are materially different and their potential scope has greatly expanded.

In summary, the two main differences are as follows:

Scope

Concession – The adjustment applies to the cost of all goods or materials transformed or processed in R&D activities if they are inputs made into saleable goods.

Credit – The adjustment applies to the cost of all goods or materials transformed or processed in R&D activities.

Calculation Methodology

Concession – Exclude feedstock inputs on production trials and only add back the loss if the production trial fails to make profitable outputs via a single adjustment at the conclusion of the trial.

Credit – Always include feedstock inputs but make multiple adjustments to exclude the inputs based on each and every final sale connected with the production trial whenever they occur.

The credit process is a reversal of the current calculation methodology and is vastly more complicated. The adjustments may be required years after the R&D occurs and at points that may be several additional production steps after the trial. Further, relevant sales may include several R&D trials which require taxpayers to undertake a form of product cost tracking that is far in excess of current IFRS accounting standards or tax law requirements.

In addition, the design of the legislation contains a serious flaw in that the proposed provisions can be used to make multiple deductions for the one cost as you are obligated to include feedstock input costs for each trial even if you have already included these costs in prior trials duplicating the deduction and yet you can only adjust this once for the final sale of finished product.

You Can Easily Glaze Over In This Particular Furnace But A Solution Is At Hand

Hopefully, you haven’t glazed over like a Krispy Kreme and you are still with us.

If we can get the Bills into the consultation process, this program-crippling cause of concern can be readily fixed. The proposed changes should be dropped and replaced with a set of better-drafted provisions that more clearly spell out the operation of the current legislation. And, in late-breaking news, MJA has drafted a set of revised provisions which we believe will see everyone on the same page. You are more than welcome to a copy of them and need only reply to this email with ‘Please Send Provisions’ in the Subject line and they will be heading to your inbox.

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.

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:

1. Registration Profile Review – review of registration documentation involving no contact with the registrant company.
2. Registration Desk Assessment – the company receives a letter requesting specific information on a project’s R&D activities and their eligibility.
3. Compliance Activity Review – will involve a site visit to the claimant company to discuss potential eligibility issues.
4. 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.

The Senate Economics Legislation Committee (the Committee) released its Report into the R&D Tax Credit Bills (the Bills) yesterday. The Report sets up the debate in the Senate as to whether the Bills should become law prior to the proposed commencement date of 1 July 2010.

Overall, MJA is disappointed by the recommendations made by the Government in the Report and submits that the Dissenting Report of the Coalition Senators should be taken into account by the Senators on the cross-benches when the legislation comes to the vote.

When looked at in detail, the Government has recommended a series of minor changes to the Bill but has not undertaken any detailed analysis of most of the key concerns raised by so many of the stakeholders during the consultative process.

This is best illustrated by the Committee’s response to concerns raised regarding the proposed feedstock provisions which appeared for the first time when the Bills were read into Parliament on 13 May. At pages 61-63 of the Report, the proposed changes are outlined, followed by only one generally expressed concern made at the recent Senate hearings. The Committee goes on to note the concerns about the provisions without providing any details and then indicates that it “…does not believe this will be a problem for large companies.” It proceeds to recommend an advisory group be established to advise the administration on any “unforeseen consequences that emerge as the bill is implemented.”

Rather than dwell on whether this is a case of buck-passing of the highest order, we submit that it is a compelling example of the fact that the Committee simply didn’t have the time to absorb and analyse the feedstock issues in the same way that stakeholders were not afforded any time to undertake a similar process. Yet the new provisions stand to have a huge impact on eligible R&D for all claimants going forward. The same can be said for so many of the other concerns that have been raised regarding the Bills.

The content of the Report, spread very thinly over its 110 pages, underlines the rushed nature of the drafting process and the fact that the implications of the Bills in their current form have not been subject to anywhere near the requisite degree of scrutiny required for the making of good law.

Before setting out the recommendations and providing some further preliminary assessment of the Report, it is worth making particular note of the fact that the Government has recommended that the dominant purpose test be removed for companies with a turnover of less than $20 million. This would establish two distinct programs with separate definitions of R&D as well as levels of benefit. This takes the legislation even further away from the Government’s own announced policy, let alone the original position taken by the Cutler Report of a system that supported the same type of R&D within all organisations, large or small. It goes without saying that more compliance complexity and administrative uncertainty will follow.

We urge the Government to reconsider the passage of the Bills in the form recommended by the Committee. Policy on the run suits nobody and stakeholders have simply run out of time to consider the impact of the latest round of recommendations and amendments before the Bills need to be passed by 25 June.

The Government’s Recommendations

The Government Senators have made the following recommendations:

Recommendation 1
The Committee recommends that subsection 355-5(2) of the objects clause be
amended to clarify the reference to ‘new knowledge or information in either a
general or applied form’ by adding ‘new knowledge in an applied form  includes
new or improved materials, products, devices, processes or services’.

Recommendation 2
The Committee notes that many of the concerns were raised by organisations
who want to maintain the status quo. Nevertheless, given the concerns raised, but
acknowledging the need to ensure that public support is targeted appropriately,
the Committee recommends that the definition of ‘core R&D activities’ in section
355-25 be amended to remove the word ‘about’ from paragraph 355-25(1)(b) so
that the paragraph reads as:
[talking about experimental activities] that are conducted for the
purpose of generating new knowledge (including about the creation of
new or improved materials, products, devices, processes or services).

Recommendation 3
Given the  scope of the changes proposed, the Committee is of the view  that the
amended provisions,  including  the effect of the ‘dominant purpose’ test,  be
reviewed  after two years to ensure that the  legislation is operating consistently
with the Government’s intent.

Recommendation 4
The Committee recommends that companies with revenues under $20 million be
exempt from the dominant purpose test.   
 
Recommendation 5
The Committee recommends that a broad–based working group including small
business and union representatives be established to advise Innovation Australia
and the Department of Innovation, Industry, Science and Research about any
unforeseen circumstances  that emerge as the bill is implemented. This working
group would also inform the two year review of the bill (Recommendation 7).

Recommendation 6
The Committee notes the claim of drafting errors.  The Committee notes that
minor drafting errors are common when framing new legislation.  The
Committee does not believe that these minor errors are of sufficient magnitude to
delay passage of the bill but considers it preferable that they be dealt with before
the bill is enacted.

Recommendation 7
The Committee recommends that the Senate pass the bill, with the amendments
proposed in the earlier recommendations, before the end of June 2010. The
operation of the bill should be monitored on an ongoing basis and reviewed after
two years.

The Dissenting Report of the Coalition Senators 

The Coalition Senators have made the following recommendations:

Recommendation 1:
The Coalition recommends that the start date for these Bills be amended to 1
July 2011.

Recommendation 2:
The Coalition recommends that the passage of the Bills be delayed in order to
rectify the issue of drafting errors.

Recommendation 3:
The Coalition recommends that the definitions of core and supporting R&D be
reconsidered to be more closely aligned to the Frascati model of R&D.

Recommendation 4:
The Coalition recommends that the dominant purpose test be removed and be
reconsidered.

Recommendation 5:
The Coalition recommends that the Object clause be amended to ensure that
both research and development are given equal tax benefits.

Our Preliminary Assessment

The spectre of the 2007 Productivity Commission Report (the PC Report) looms large over the Committee’s Report. In the opening to Chapter 6, the Committee states that:

“The bill will introduce aspects of the recommendations that came out of the Productivity Commission’s 2007 review;” (page 59).

This is a stunning admission given that the PC Report was so directly contradicted by the Cutler Report and it is Cutler that the Government has repeatedly quoted as the basis of its R&D tax policy. Again, remember that the PC Report advocated the closure of the basic concession for all but the smallest companies, leaving most with an incremental option only. Cutler advocated the polar opposite – enhance the basic incentive and close the incremental option and that is exactly what the Government announced in last year’s Budget.

The Committee is in the thrall of the additionality and spillover arguments of the PC Report and repeats much of the debate that had already been resolved in the Cutler Report. From MJA’s perspective, it is clear that the Committee could not follow the arguments we put forward regarding additionality involving the need to focus support on generating additional R&D activities from the R&D projects that companies do undertake rather than designing a subsidy aimed at getting otherwise marginal projects across the line.

The Government’s recommended amendments do very little to allay the concerns expressed by so many stakeholders since the consultation process began towards the middle of last year.

The changes to the Object Clause and the definition of core R&D activities appear designed to more explicitly acknowledge the eligibility of applied R&D but do nothing to address the restrictive impacts of the dominant purpose test and the new feedstock provisions. The express inclusion of new or improved products, processes, devices, materials and services in the definition of new knowledge actually doesn’t make grammatical sense. How is it that new knowledge includes the creation of new and improved products and processes as the Committee suggests?Traditionally, new knowledge has been seen as the output of basic and applied research whilst the creation of products and processes results from experimental development ie. the application of existing knowledge. The recommendation to equate the two is very confusing.

In discussing the extent of the restrictions associated with the definitional changes, the Committee indicates that these changes are really only seeking to limit ‘business as usual’ activities and ‘whole of project’ concerns. This is giving voice to some of Treasury’s recent defences of the changes but will offer no comfort to those faced with assessments of their production-based R&D claims in the new regime.

The discussion of the concerns regarding the dominant purpose test is perfunctory and, tellingly, avoids grappling with the conclusion expressed at the Senate hearings by the current Chair of Innovation Australia’s Tax Concession Committee that determining dominant purpose under the new legislation will be entirely a matter of judgement as opposed to a question of fact. At no time is any consideration given to the power of the current ‘directly related’ definition to regulate excessive claims but the impact of the change to dominant purpose is tacitly acknowledged by the Committee’s recommendation regarding the test and SMEs.

The removal of the dominant purpose test for SMEs is, in one sense, welcome but it does establish two distinct programs by legislating two different definitions of R&D. This feels like an innovation that we could all do without as it adds yet more complexity and uncertainty, particularly for taxpayers whose turnover is in the vicinity of $20 million. What such a change does do, is reinforce the notion that the dominant purpose test is a restrictive one that will see larger companies unable to receive support for an uncertain range of R&D activities that would have otherwise qualified had the organisation simply been smaller.

Many of the major concerns raised in the recent round of consultations – beyond feedstock, these included the splitting of core and supporting R&D activities; the quality of the Explanatory Memorandum, particularly its example projects used to demonstrate the operation of the new definition of R&D; the ‘expenditure not at risk’ provisions; the greatly enhanced administrative powers; the increased complexity of the compliance regime – did not result in any specific recommendations by the Government. Like all the other parties, the fact that the timeframe for considering all the issues has been so condensed has meant that it is apparent that the Committee did not have the opportunity to actively turn its mind to many of the concerns raised.

We are very concerned that the Government accepts the Treasury’s modelling without having seen it. As we pointed out in our last Update, it appeared from the Senate hearings that Treasury’s admitted reduction of claims by 15-20% did not take into account the closure of the 175% Premium Concession which we had demonstrated previously would save 30-35% of the current cost of the program. In the absence of any published modelling, the Committee steps into the breach and offers up its own “back-of-the-envelope” calculations in support of Treasury’s estimate (page 75).

In some breathtaking assumptions, the Committee suggests that the new regime will increase current program costs by one third to one half of current levels by the combination of higher rates and new program entrants and the savings associated with the combination of the changed definition and the closure of the Premium Concession will roughly offset these costs. We wish to strenuously challenge these assumptions, particularly as they are partially based on a submission we made regarding the impact on program participation back in 1996 where the number of registrants was no more than half the current number and when participation rates fell from around 4,000 to below 3,000. It is unreasonable to assume that program uptake by new entrants will be of a similar dimension given the user base now involves roughly 8,000 Australian companies.

Of course, there is no opportunity to do this prior to the vote and the Committee appears happy with its published back-of the-envelope numbers standing in the place of any need to publish Treasury’s elusive modelling. This is not acceptable.

Finally, we remain absolutely dumbfounded by the following statement on Page 1 of the report:

 ”It is neither sustainable nor in the national interest that 60 per cent of the total government support is consumed by 100 firms out of Australia’s two million enterprises”.

You will be growing tired of us pointing out that this figure is consistent with ABS statistics on the profile of Australia’s corporate innovation activity and is in line with international practice. We have continued to emphasise throughout the consultative process that large corporates are prepared to negotiate some limits on their R&D tax benefits provided they continue to be acknowledged as performing legitimate R&D on the same basis as their smaller cousins.

However, once more, we feel compelled to point out in the strongest manner possible that the R&D tax incentive is not a finite pie, 60 per cent of which is consumed by 100 firms. Rather, it is a self-assessment program in which 60 per cent of claims are currently made by the top 100 firms. Smaller firms are not crowded out by the claims of the top 100 firms. All firms claim their entitlements against the prevailing rules. No firm’s access to the available benefit is impacted in any way by the claiming behaviour of any other company. In 25 years of consulting on the R&D Tax Concession, MJA has never met a company that does not claim or has a reduced claim because of a claim being made by another company of any size.

If this is the justification for the gutting of the incentive as the Coalition describes it, then it should be shown for the fallacy that it is. The Cutler Report called for reform to R&D taxation support for all Australia’s corporate citizens in the National Innovation System. It never intended for this reform to be the ushering in of an era where large corporates are seen as doing a lesser class of R&D when serving Australia.

What Next?

The Bills need to get through the Senate by 25 June. The Coalition appears ready to vote against the legislation so the focus now shifts to the standpoints of the Greens and the Independents.

Keep an eye out for MJA Updates in the next few days regarding the impending vote as well as any additional issues that emerge from a closer consideration of the report.

As always, 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.

In the wider media, it’s hard to get a run in these times of super profits taxes and the highest paid AFL player being someone who’s never played the game. However, the issues with the R&D Tax Credit (the Credit) remain of utmost importance, particularly with the Senate Inquiry’s report due early next week. So here we are again. We apologise for the length and current frequency of these Updates but there continues to be much to discuss and debate.

In this edition, we would like to draw your attention to some of the hot buttons in play and remind you of where we think the Credit reform process needs to go.

Bills Digest Released and it Proves to be Compelling Reading

The Department of Parliamentary Services released its Bills Digest on the Credit legislation yesterday. The Digest seeks to dispassionately summarise proceedings to date. This is not the time to pick apart some of the statements that it makes about certain matters and the overall summation it provides is a fair one.

However,the concluding comments it provides regarding the draft legislation cannot be ignored in the current context.

Specifically,

“The proposed new incentive is a significant departure from the existing incentive and could be described as an entirely new measure.” (Page 26)

“In adopting only the research elements of the Frascati definition, the proposed incentive focuses more on research and less on development. Development activities of some large entities which qualify for the existing incentive will not qualify for the proposed incentive.” (Page 26)

“The tightened definition of ‘core’ and ’supporting R&D’ will mean that some non-scientific industrial research activities will not be eligible activities.” (Page 27)

And

“Significant uncertainty still surrounds the Bill.” (Page 27)

MJA agrees with all these conclusions. We would add that the industrial research activities and the development activities of SMEs will be equally affected by the wholesale changes being made.

We also note that the Digest details the active input from manufacturing companies and associated industry associations and bodies in the recent Senate processes. This was a strong theme that unequivocally emerged at the Senate hearings, where many of those who appeared highlighted that the impact of changes would be felt across all areas of business not just the resources and infrastructure sectors.

The question for the Senate is whether it can recommend passage of the Bill in its current form. The conclusions reached in the Digest have underpinned the vast majority of public submissions that strongly oppose the proposed changes to eligibility criteria and administrative powers that have appeared in the context of hasty drafting and a questionable consultation process.

We recommend the Bills Digest as compulsory reading for all those interested in the current debate.

Additional Concerns

By dint of being a summary, the Bills Digest couldn’t cover all the live issues so we would like to briefly mention three other active concerns.

Dominant Purpose

The current Chair of the Tax Concession Committee (the TCC) of the Innovation Australia Board (the Board), Mr Peter Thomas, gave evidence in support of the introduction of the dominant purpose test with respect to relevant supporting R&D activities on the second day of the Senate hearings. The TCC is the principal decision making authority regarding eligible R&D activities. In discussing the likely application of the dominant purpose test, Mr Thomas had the following to say in suggesting that dominant purpose means the “main reason you carried it out” (i.e. the more than 50 per cent purpose),

“How do you judge whether something is a 51 per cent test or a 49 percent. In the end, it is all judgement.”

By way of contrast, the Credit’s Explanatory Memorandum (the EM) says that establishing the dominant purpose of supporting activities is a matter of the context and overall circumstances of the activities i.e. a question of fact. We wholeheartedly agree with Mr Thomas’ views and believe that they dramatically illustrate the practical difficulties of a test where administrators will be testing the veracity of a claimant’s statements about its corporate intent.

Surely this is a flawed basis for operating a self-assessment incentive and should be rejected as such.

Feedstock

Treasury maintains that the new provisions (which appeared for the first time in the Bill and were not subject to any public consultation) are a simple rewrite and consolidation of the current provisions. Again, we wish to emphasise that this is incorrect in four key respects:

1. The notion of feedstock inputs has been extended and has been extended in an uncertain manner
2. The provisions are to be applied to depreciating asset expenditure for the first time
3. The point of calculation has moved from the feedstock output at the end of the financial year to an assessment of the value of the contribution of the R&D to marketable output and this may involve a series of calculations that need to be carried out over multiple years.
4. The calculation has changed from adding a net benefit to the R&D expenditure as the expenditure is incurred to a gross calculation that inflates R&D expenditure with a separate clawback calculation when the final finished products are sold.

Yet Treasury persists with this fiction that the new rules are the same as the existing ones.

The passage of the feedstock provisions is an outstanding example of the overarching concerns with the Credit design process- there is a huge divergence of opinion about the meaning of the provisions from various stakeholders with respect to hastily drafted legislation with little or no opportunity being provided for real public consultation.

Revenue Neutrality

It has been an oft-made point in this debate that Treasury has not provided any modelling in support of its position that the overall package will be revenue neutral in outcome. Many commentators have suggested that this will not be the case and we include ourselves among them. Close examination of the Senate hearing transcript associated with Treasury’s appearance indicates that a serious flaw has emerged in Treasury’s position.

In its appearance in front of the Senate, Treasury admitted for the first time publicly that 15-20% of currently-eligible expenditure would be eliminated under the Credit and that this shortfall would be made up by new entrants, albeit with no supporting evidence as to who would comprise said entrants. What Treasury failed to acknowledge at the hearing was the saving associated with the immediate closure of the 175% Premium R&D Tax Concession. MJA has repeatedly submitted to Treasury that, on the publicly available figures,shutting down this aspect of the programwould save 30-35% of the current cost of the program. 

Treasury’s continuing failure to make any modelling available simply reinforces the widely-held view that the overall Credit package is, in fact, severely contractionary and will prove to be a massive saving to the Government in contrast to the current R&D Tax Concession.

Where Does This Leave Things?

Throughout this process, MJA has maintained that the majority of the features of the Credit should be enacted as at 1 July 2010 – the move to the credit format; the higher base rates of deduction; the introduction of foreign-owned intellectual property; and the immediate closure of the 175% Premium Tax Concession. We are still of this view. However, we cannot support the wholesale changes to the eligibility provisions and the sweeping reforms to the compliance framework and associated administrative powers and procedures in the supposed pursuit of a tightening to ensure only “genuine R&D” is supported.

Too much is at stake to stand to one side and see the cruelling of a proud program.

The Credit does not reflect announced Government policy. The Government has been let down by those who assembled the legislative package under review.

We again call for a one year delay in the implementation of changes to program definitions and administrative procedures to allow real consultation to occur and appropriate transition mechanisms to be made available prior to a 1 July 2011 commencement date.

It was very welcome to finally hear the discussion of concerns surrounding excessive claims and, indeed, rorts at the Senate hearings. Prior to that, the administration would not engage in consultation around those concerns. After all, large eligible claims were what prompted the original remarks in the Cutler report that kick started this reform process in the first place. Virtually all the key stakeholders have repeatedly submitted that they are open to negotiate a solution to the large claims that occur under the current program by the introduction of a feature such as an annual consolidated group claim cap. Iflarge claims arethe Government’s real concern, it can be dealt with in a straightforward manner. Yet Treasury will simply not engage in any meaningful discussion about various solutions. We are left to ask the simple question, ‘Why not?’

We look forward to the Senate’s reflections on that question and all the above issues in its report due next week.

We will let you know what has been said as soon as the report becomes available.

In the meantime 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 Research and Development Tax Incentive

The first thing to note is that the paper, entitled “The new research and development tax incentive”, has been issued by the Treasury. This is a big surprise as Treasury officials did not attend the consultation sessions on the R&D tax concession held last year as part of the National Innovation Review. Furthermore, the two pre-consultation sessions held in June this year were headed up by a representative of the Department of Innovation, Industry, Science and Research rather than a Treasury official.

The impression that Treasury has taken control of the process is reinforced by the fact that responses to the paper, due by Monday, October 26, are to be submitted to the Business Tax Division of the Treasury. This is all a great worry. Is it now the case that the destiny of the Federal Government’s flagship innovation program is no longer in the hands of the government department actually responsible for innovation? This matter will need to be pursued with vigour. The process is subject to a tight timeframe as draft legislation is mooted by the end of the year.

The paper itself is an odd amalgam of decisions apparently already made and areas for discussion where there is no guidance as to what the thoughts of the authorities actually are. It includes a series of unsubstantiated assertions about the operation of the current R&D tax concession and betrays an extremely poor understanding of how business R&D (BERD) occurs. It is easy to get carried away by the disappointing quality of the paper’s analysis and it will predictably attract a firestorm of criticism from the business community with regards to the number of restrictions to eligible activities and expenditures that the Treasury appears to be advocating.

However, now is not the time to panic.

Firstly, there a number of positives to reflect on:

• Increased rates of benefits
• Removal of the complexities associated with the premium
• Extension of the rebate concept
• More generous provisions relating to overseas R&D
• Allowing foreign ownership of generated IP
• Improvements to R&D software rules

Achieving Workable Outcomes

Secondly, the huge concerns raised by the discussion regarding ‘Eligible R&D activity’ in the report need to be vented but then channelled into achieving workable outcomes. The Government needs to be reminded of the main policy game here – improving Australia’s overall R&D effort. There is a need to learn from the lessons from 1996 where the Coalition’s introduction of significant reductions to the R&D Tax Concession led to a collapse of Australia’s BERD over the next 5 years. We are already behind our competitors. Unnecessary restrictions will run the risk of Australia dropping off the back of the pack.

Businesses and Stakeholder Organisations to Have Their Say

Finally, the consultation process must be approached as a real opportunity to turn around the poor performance of the administration in program delivery in recent years. The new Credit, however defined, will fail if it is delivered by the same administrative mindset currently associated with the R&D Tax Concession. The experiences of taxpayers need to be submitted directly to the authorities so that this message is clearly heard.

MJA will be working with its clients, industry bodies and other interested parties to ensure that all the relevant issues are raised in the consultation process. We would be delighted to assist you in this regard in whatever manner you deem appropriate.

To discuss the matters raised in this MJA Update in greater detail, please contact Kris Gale on (02) 9810 7211 or using our contact form

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