R&D Tax Credit – The Shock of The New
Hopefully, in amongst the Easter chocolate blitz and trips with the kids to see “Nanny McPhee And The Big Bang” (the only G-rated movie on these school holidays), you’ve had time to prepare a compelling submission in response to the 2nd Exposure Draft and Explanatory Materials (the Easter package) detailing the New R&D Tax Incentive. If not, don’t worry. You have until Monday. OK, maybe you can worry just a bit.
Here at MJA, we have had to dispense with our usual practice of circulating our draft response to interested parties well in advance of the submission closing date as only 10 working days were provided to put thoughts together. As a second best alternative, we have decided to make use of the MJA Update to give you a snapshot of the main conclusions that will be contained in our submission.
In a Nutshell
We believe that the Easter package should be treated as though it was the first response to the May 2009 Budget announcement.
We have concluded that the package is legislating a brand new business R&D support program that is a fundamental departure from the established principles and framework of the existing R&D Tax Concession (the Concession) and that 25 years of institutional experience and memory related to the Concession is at real risk of being jettisoned.
We submit that the Easter package is introducing a different type of support for corporate R&D that dramatically narrows the range of eligible activities and expenditures. In doing so, the program has shifted from supporting corporate research and development to corporate research only. This shift is reinforced by the replacement of the current Objects clause with its five promotional objectives with a new Object clause containing one restrictive premise that only business R&D reflecting additionality and spillover merits support.
The eligibility requirements for core and supporting R&D activities have been changed, not clarified, and have added several layers of complexity and uncertainty for program participants. In addition, new legal concepts have been introduced such as ‘production’ and ‘business as usual’ R&D for the first time in the Easter package. The previewed compliance framework shifts the Credit away from the principles of self-assessment to a program controlled by administrators through a range of sectoral guidelines and position statements so that it takes on a form resembling a discretionary grants program delivering support based on the perceived merits, rather than the eligibility, of the R&D.
Further, there are a number of unresolved features of the draft legislation such as expenditure not at risk, overseas expenditure requirements and core technology transition provisions. Critically, the redrafted feedstock expenditure provisions announced in the Easter package have not been made available to stakeholders.
Finally, after a legislative development process that has long been characterised by delay and a lack of true consultation, the Easter package now provides a miniscule amount of response time followed by a rapid timetable by which it becomes operative law on 1 July. For the vast majority of claimants, there will be no transitional process in place for taxpayers to absorb the new legislation and establish new plans and procedures. Rather, there is a hard changeover from the old system to the supposedly brave new world.
Overall, we submit that there is an unacceptable risk that the Easter package will harm Australia’s innovation system by withdrawing critical support for commercially-focused R&D. And remember that it is this aspect of R&D that Australia traditionally lags behind our competitors. There is an urgent need to provide for a comprehensive review of this legislation including a realistic process for its implementation in an orderly fashion. This may well involve a need to delay the introduction of a number of features of the Credit to ensure a smooth transition for taxpayers.
How New is New?
Given the above, it is worth demonstrating as briefly as possible why we agree with the Government that it is a brand new program, rather than a reform of the old one, thereby leading us to conclude that the timetable to convert this draft package into legislation is simply too rushed and likely to involve unintended consequences and outcomes.
Since the consultation process began in earnest, all the Treasury releases have been headed “The new research and development tax incentive”. Recent consultations with Government officials have reinforced the idea that the R&D Tax Credit (the Credit) is being treated as a new program by outlining a different style of administration based upon industry sector-specific guidelines and a compliance framework that will be built from the ground up.
This Government’s emphasis of the fact that the program is a new one stands somewhat in contrast to the policy announcements in last year’s Budget which referred to a tightening of eligibility criteria of the current Concession to better support “genuine R&D”. There was a sense that there would be a significant carryover of the principles and understandings associated with the Concession and the Budget announcement reinforced this notion.
It is now clear that this is not the case. The fact that this is a very brave new world is even more starkly set out in the Easter package than with the 1st Exposure Draft and Explanatory Materials (the Christmas package).
To demonstrate this, take the new definition of R&D activities contained in the Easter package as an example.
A New Definition of R&D
The Treasury’s consultation guide to the Easter package refers to a “clearer” definition of core R&D activities by its use of clear language in the place of ambiguous concepts such as ‘considerable novelty’ and ‘high levels of technical risk’. What they should go to say is that the intended definition of both core and supporting R&D is fundamentally different to the very stable definition that has been in place since 1985.
As you would be aware, eligible activities have been separated into two categories –core and supporting – with separate qualification tests. Previously, activities qualified as eligible R&D activities collectively through the ‘SIE’ or ‘directly related’ pathways. Now they are split into two distinct baskets.
As Treasury has indicated, the new definition of core R&D requires taxpayers to be seeking new information (to solve problems or develop new or improved products and processes) and to need an experiment to uncover that knowledge.
The concepts of systematic, investigative, innovation and technical risk have all been dispensed with. These are concepts that are useful to taxpayers in qualifying their R&D activities and are well understood as opposed to ambiguous. Ten of the current technical objectives – the creation of new or improved products, processes, devices, material and services – have been eliminated and subsumed into the new knowledge objective.
This is an unequivocal narrowing of the definition of core R&D compared to the current Concession and, in fact, to the one contained in the Christmas package. Add the four new classifications of supporting R&D activities and the new restrictive Object clause and you end up with a very different definition of eligible business R&D.
The September 2009 Treasury Consulation Paper stated that the Government was altering the definition to bring it more in line with the Frascati definition. They could no longer credibly maintain that this is the case. The proposed definition reflects the first two elements of Frascati – basic and applied research – but experimental development has been removed.
The new Explanatory Materials confirm the narrowing of the definition. In paragraph 2.16, they indicate that it is not enough to be doing experimental activities if they “merely confirm what is already known”. As displayed in the example projects provided, the suggestion is that the taxpayer will need to be able to prove in a retrospective assessment that the knowledge did not exist anywhere else. Not only is this highly impractical. It also flies in the face of encouraging an innovation system where several companies in an industry pursue the development of new and improved products and processes and the associated knowledge in parallel.
The guidance given to taxpayers as to how to interpret the definition is very open-ended. The Explanatory Materials indicate that qualifying the eligible purpose of the activities is a question of fact based on the overall circumstances of the conduct of the work (paragraph 2.32) without detailing what the key determining criteria might be. It appears as though the Government is seeking to preserve as much discretion as possible when assessing claims. This is apparent from the statement in paragraph 2.32 that says that “…it is possible that activities that are similar in appearance might qualify as supporting activities in one context but not in another.”
As we have been saying all along, the Credit is seeking to institute a scientific definition of R&D that gives voice to the Productivity Commission’s world view of what is “genuine R&D”. Yet that view was not the one put forward in the Cutler Report, the Government’s Innovation White Paper or the May 2009 Budget announcement which all reflected the existing industrial definition.
Suddenly, we are at ground zero and you’ve been given 10 working days to get your head around what it all means!
More Work For Us All To Do
The proposed Credit is new, uncertain and even a bit scary.
We urge you to use the April 19 response and the highly likely Senate Committee as your last remaining opportunities to elicit the Government to pause and take stock of whether the proposed Credit really aligns with its previously announced policy. Hopefully, we can all then move on in a spirit of true consultation to ensure the right R&D outcomes for Australia’s innovation future.
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.
R&D Tax Credit – We’re Not in Kansas Anymore
With memories of the Christmas/New Year break rapidly becoming the stuff of legend, the R&D community is now able to focus on the Draft Bill and Explanatory Materials (released immediately prior to Christmas) that set out the design and operation of the new R&D Tax Credit.
What has become very clear is that the Treasury has delivered a package that fundamentally changes the form of government support for R&D. Should the Bill become law, we will certainly find ourselves in the Land of Oz.
Changes to the Nature of the R&D Tax Benefit
The main surprise with the package is that the “augmented feedstock rule” and related provisions fundamentally alter the nature of the R&D tax benefit. The Bill changes the R&D tax incentive from a largely guaranteed upfront concession at the time R&D expenditure decisions are made to an after-the-fact compensation measure for R&D that fails partially or totally. How all this works is complicated and open-ended and the available benefits can only be calculated after the market value of the R&D can be assessed. Given that companies will plan for most of their R&D to generate a valuable output, they will therefore intend in most cases to not access the Credit, rendering it as a form of relief that will only be considered after the R&D has been completed. If the R&D succeeds, then none of the R&D costs can be recovered except those that relate to conceptual design. In addition, the costs of compliance would not be recoupable so that the result of keeping records for a potential Credit claim would make the R&D more expensive than if the potential Credit had been ignored.
This fundamental change occurs irrespective of the definition of R&D. Of course, the package also significantly restricts what constitutes eligible R&D and radically changes the compliance regime. These changes combine to render the program effectively useless in the commercial R&D marketplace.
The Credit actually rewards failure and has no real role to play in successful R&D. We believe that the introduction of the Credit will reduce government support for R&D to at least 25% of current levels (i.e. $300-400 million per annum cf. the current $1.4 billion). The package does not accord with announced government policy.
MJA is working with industry lobby groups, other advisory firms and its clients to alert the Government to the fact that the Bill does not reflect its announced policy.
In the past week, the responsibility for the package has moved from the Office of the Assistant Treasurer to the Office of the Treasurer. We see this as a direct reflection of the growing awareness in the Government that the announced package has fundamentally changed the character of the R&D tax incentive and is not in line with the Government’s Budget announcement and stated policies. Kris Gale, Managing Director of MJA, is engaging directly with Ministerial representatives to discuss the impacts of the Bill.
Furthermore, MJA has met with officials from the Treasury, the Department of Innovation, Industry, Science and Research and AusIndustry to discuss the matters at hand. We were given an excellent hearing and were able to explain the grave concerns we hold regarding the impact and operation of the changes. We have been given a direct request to provide practical examples of the problems we envisage and it was agreed that these will be treated separately from the public submissions which close on 5 February. We will be responding accordingly and value any input you might wish to provide in this regard.
Moving Forward
MJA will continue to update you regarding this critical issue. We remain committed to addressing the severe shortcomings with the current proposals so that we can all move forward with a valuable and workable R&D incentive to help meet the upcoming technical challenges facing your businesses.
We want something that works for the real Australia rather than for the mythical Land of Oz.
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 R&D Tax Credit Exposure Draft
Has Treasury Given Us What We Always Wanted or Just Another Pair Of Socks?
The Treasury Consultation Paper, The new research and development tax incentive, released in September 2009 was a great disappointment to the Australian R&D community.
How do we know this?
Because 165 submissions to the Treasury were made publicly available and they virtually all rejected the proposal to tighten the definition of R&D.
We then sat back and waited to see Treasury’s response. Well, it arrived last Friday just in time for Christmas in the form of the Exposure Draft of the Tax Laws Amendment (Research and Development) Bill 2010. Naturally, we couldn’t wait a week to see what was inside and so we opened it up, hoping that the views of the community had been heeded. Sad to say, there wasn’t a shiny new toy inside. Rather, a pair of socks was all to be found. And not very colourful ones at that.
The key proposals are detailed below and, while the news is not all bad, the new R&D Tax Credit proposed by the Treasury seeks to legislate a considerable narrower definition of R&D coupled with augmented feedstock provisions that would combine to remove any real incentive effect at the critical phases of all R&D projects – the times where decisions are made as to how much expenditure to commit to a project. Along with this minimised incentive effect, the new legislation introduces a slew of new concepts and requirements that add a huge amount of complexity to the program, couching it in language that is confusing and not relevant to technical personnel and again dropping the responsibility for the claim squarely in the lap of the company’s taxation team.
Ironically, lack of incentive effect and complexity were the very forces that drove the Cutler Review in recommending changes to the current R&D Tax Concession such as the removal of the incremental concession. The proposed new R&D Tax Credit fails in both these regards. In short, it is an incentive designed to encourage companies to do R&D outside their normal operating environments and only reward failures which can only be determined after the fact. It is not interested in assisting companies that seek successful R&D outcomes in commercially-driven environments. As such, the policy drivers expressed in the Exposure Draft become impossible to understand.
The Treasury has given interested parties until 5 February 2010 for responses to be submitted.
Interested parties are invited to comment on the exposure draft legislation and associated explanatory material. While submissions may be lodged electronically or by post, electronic lodgement is preferred. For accessibility reasons, please submit responses sent via email in a Word or RTF format. An additional PDF version may also be submitted.
Address written submissions to:
General Manager
Business Tax Division
The Treasury
Langton Crescent
PARKES ACT 2600
Email: rdtaxcredit@treasury.gov.au
MJA will be making its own submission and is fully available this week and then from January 4 onwards to discuss any questions and concerns that you may have. We will also be liaising with companies and their industry representatives in their direct dialogues with the relevant politicians and their offices. We will keep you updated regularly on progress.
In the meantime, we wish you all the best for the Christmas season and for a very successful 2010.
Here’s hoping that you don’t receive too many more pairs of socks!!
Key Proposals in the Exposure Draft and Explanatory Materials
The release of the Exposure Draft and Explanatory Materials in respect of the Tax Laws Amendment (Research and Development) Bill 2010 confirms the Treasury’s policy intent that first appeared in its September 2009 consultation paper regarding the new R&D Tax Credit. The new incentive will replace the R&D Tax Concession for income years commencing from 1 July 2010 onwards. It is immediately apparent that the draft legislation has paid scant attention to the concerns expressed by the overwhelming majority of Australian stakeholders who responded to the Treasury’s previous paper.
As promised, the proposed amendments to the current R&D Tax Concession legislation will deliver a 45% refundable tax credit to small firms (group turnover less than $20 million per annum) and a 40% credit to companies with a group turnover more than $20 million per annum.
The new program will be extended to support R&D activities undertaken in Australia by foreign-owned firms and the complex 175% premium and international premium concessions will be abolished. Importantly, it will provide better certainty in respect of the level of support by its detachment from the corporate tax rate and through the introduction of an amendment period of 4 years which will be binding on the Commissioner.
Where the proposed new R&D Tax Credit falls short is in its failure to address the drivers that will deliver a meaningful and effective program to stimulate R&D in Australian businesses operating in a commercial environment and within a broad range of industry sectors.
This inherent failure is immediately evident in the revised “Objects” clause which states: The object of this Division is to encourage industry to conduct R&D activities that might otherwise not be conducted because of technical uncertainty, in cases where the knowledge gained is likely to spillover to the benefit of wider Australian economy.
To any company operating in a dynamic, competitive, consumer-driven market within a global context, this statement falls well short of the mark in describing how R&D decisions are made. Any credibility is further eroded by the proposed introduction of a “dominant purpose” test in respect of supporting activities as outlined in the following Objects clause: The tax offset is also available for directly related activities that are conducted for the dominant purpose of supporting such core experimental activities (rather than for a broader commercial or other purpose).
This myopic view of industry R&D will undermine any tax incentive for the conduct of applied research by Australian businesses. Essentially, the program focus will be on the conduct of “research” phase activities and not the “development” phase of activities. This equates to a meaningless incentive for companies (large and small) engaged in process technologies where downstream development costs and risks vastly outweigh the initial research effort involved, especially in manufacturing and mining.
The following is a brief summary of the new legislative elements that will transition the current R&D Tax Concession to the new R&D Tax Credit :
Change to the definition of Research and Development Activities: Claimants will need to qualify activities as either core or supporting. Core activities will need to display considerable novelty and high levels of technical risk. Supporting activities will need to demonstrate that their dominant purpose was to support the core R&D. This will add complexity, greater uncertainty and a heightened compliance burden for most companies.
Restrictions on claim value: A broader list of excluded activities is proposed and the exclusion will apply to these activities irrespective of whether they are core or supporting. Software development has been hit particularly hard with a significant extension of the ‘multiple sale’ requirement along with other new restrictions. New augmented feedstock rules seek to clawback the majority of claimable expenditures wherever the R&D outputs generate value beyond their inherent worth as IP. The proposed feedstock adjustments will require the exclusion of R&D expenditure (currently other than for conceptual design) and depreciation amounts that directly relate to the production of a feedstock output. There is also a concern about the operation of an “expenditure not at risk” exclusion.
Innovation Australia’s role: The proposed amendments to the function of the Innovation Australia Board will provide it with much wider powers in respect of program administration. While R&D plans will no longer form part of the definition of R&D, the amount of information apparently required from companies to ensure registration will impose a severe compliance burden. A mechanism for advance findings regarding R&D eligibility has been announced. The introduction of program fees is also contemplated.
Conclusion
The draft legislation has paid scant attention to the concerns expressed by the overwhelming majority of Australian businesses who responded to the Treasury’s earlier consultation paper. The result is an R&D tax incentive that is far more complex and greatly reduced in value as rather than “simplified and enhanced”.
The deadline for the next round of submissions is Friday 5 February 2010.
MJA’s Tax Credit Submission
MJA’s response to the Treasury Consultation Paper – The new research and development tax incentive.
The R&D Tax Credit Issues Paper
Window For Responses Is Closing Rapidly
Submissions regarding the Treasury consultation paper, “The new research and development tax incentive”, close on Monday, October 26.
The public consultation sessions were completed in Sydney yesterday. It seems apparent that an Exposure Draft of the legislation is already advanced and is likely to be released next month. This makes submissions vital if you are concerned by the direction taken in the Treasury paper. The time to raise your issues is NOW.
To assist you, MJA is delighted to give you access to our draft submission.
If you would like to see it, reply to this update using our contact form and we will email a copy to you immediately.
Our submission is consistent with the viewpoint expressed in the MJA Updates initially circulated in the wake of the consultation paper. In concluding that the proposals contained in the paper will not result in a less complex and more predictable R&D tax program, our submission makes the following points:
- By proposing to change the definition of R&D activities, the Federal Government is seeking to restrict the breadth of R&D support at the very time that corporate Australia is being asked to lift its R&D effort in areas of vital national significance such as the Carbon Pollution Reduction Scheme and the National Broadband Network
- The Treasury’s case for reform is not made out either in terms of R&D policy or Budget revenue neutrality
- Changing the definition of R&D activities and asking taxpayers to split claims into core and supporting activities will add the single greatest layer of complexity, uncertainty and compliance burden in the history of the program
- Changing the definition disproportionately impacts on SMEs
- The changes will have an immediate negative impact on BERD
In short, the Treasury proposals will result in a much more complicated program and run the risk of severely curtailing R&D support in Australia at a most inopportune time.
We look forward to continuing to share views on this vital matter.
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 performing, or how we could improve.
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- MJA on Switzer
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