R&D Tax Credit –The Clock Is Ticking, The Engine Is Revving

4:17 pm by Kris Gale · Comments Off

As the proposed commencement date of 1 July 2010 draws ever nearer, the process by which the Federal Government is seeking to kick start the new R&D Tax Credit (the Credit) continues to accelerate at an alarming rate. You can hear the clock ticking and the engine revving from here.

Following the 19 April close date for public submissions regarding the Second Exposure Draft, the Bills and Explanatory Memorandum (EM) were introduced into Parliament on 13 May in advance of any submissions appearing on the Treasury website. The Bills and EM contained the new feedstock provisions which were not made available in the Second Exposure Draft along with some significant changes in areas such as the examples used to explain the definition of R&D and the rules surrounding the grouping provisions. The EM also contained several erroneous technical references to the Bills.

Main Issues With the Proposed Legislation

The majority of the legislation and the EM was consistent with the Second Exposure Draft but, as indicated above, there were some significant changes. Of greatest concern are the feedstock provisions. Treasury is maintaining that there has been a simple rewrite and consolidation of the existing provisions. This is patently not the case as the new provisions extend the notion of feedstock inputs in an uncertain manner, apply the offset to depreciating asset expenditure for the first time and change the point of required calculation from the feedstock output to an assessment of the value of the contribution of the R&D to the marketable output. This last point transforms the calculation from a single year to a multiple year process and introduces a level of potential complexity that may not be able to be resolved in some circumstances. The overall impact of the new provisions is not far from the deleterious impacts on claims associated with the ‘augmented feedstock rule’ abandoned following the outcry after the release of the First Exposure Draft.

The other major problem lies with the final version of the examples used in the EM to explain the definition of R&D. A series of alterations and omissions have been made to the examples in comparison to the revised versions that appeared in the Second Exposure Draft, presumably in response to some of the criticisms received. The result is a series of examples that are internally inconsistent, contradictory and that bear little connection to the real world practicalities of commercial R&D.

MJA has gone to great lengths to detail the problems associated with the above issues in our written submission that has been lodged with the Senate Standing Committee on Economics (the Committee) and our submission is available on request.

Having A Say In The Senate

The Committee was formed rapidly in response to the introduction of the legislation and its public hearings were conducted a mere week later on 20 and 21 May. These hearings actually preceded the closing date for written submissions (28 May) which is unusual in our experience and another likely reflection of the tight turnaround being attempted by the Government.

Kris Gale (20 May) and Melanie Reen (21 May) appeared in front of the Senators. The hearings also provided an opportunity for interested parties to share views more informally over the course of the two days.

The Senators focused on the impact of the changes to the definition of R&D with a particular emphasis on the dominant purpose test and on the issues surrounding the feedstock provisions. Other substantive matters discussed included the existence of so-called “rorts” under the current R&D Tax Concession, the rushed timetable for the introduction of the new legislation and the quality of the consultation process to date.

One key theme to emerge at the hearings was the fact that the proposed restrictions will extend beyond the claims of miners and civil engineers. A series of manufacturing companies appeared in front of the Committee and all argued that they would no longer be able to claim much of their production-based R&D under the proposed rules. One major company estimated that its claims would be reduced by around 80%

Consistent with the written submissions made available at previous stages of the consultative process, there was a strong coincidence of expressed viewpoints amongst the companies, industry bodies and advisers. All those who appeared pointed to real concerns surrounding the negative impacts that would flow from the introduction of the Credit in its current form. And these views were consistently at odds with the views expressed by the Government’s administrative bodies in the hearings that all the real problems with the Credit had been fixed and the balance of concerns stemmed from misunderstandings.

The Senate needs to resolve the polarised positions by 15 June when it has to deliver its report to the Parliament.

At the heart of this resolution will be assessing the true extent of the restrictive effects of the changes that the Government now admits will occur under the Credit. Treasury made a first-time admission to the Committee that 15-20% of currently-eligible R&D expenditure would be eliminated under the Credit. They did not offer any modelling to assure stakeholders that this shortfall would be made up by new entrants and claims to keep the program revenue neutral. Of course, many other commentators have estimated that the restrictive effect will be much larger. This matter must be resolved before the Credit becomes law.

The Engine Is Revving But Will The Lights Go Green On 1 July?

In order for the Credit to become law, it needs to be passed by 25 June which is only 10 days after the Committee delivers its report. Given the wide range of concerns raised in the Senate hearing, we would be surprised to imagine that the Committee will recommend that the Bills be passed in their current form. In fact, we hear that the Opposition has indicated that it would seek to block passage of the Bills as they currently stand.

MJA has maintained its position that the issues associated with the eligibility of activities and expenditure should be made the subject of a real consultation and that the package should be deferred for a year. Due consideration can be given to sensible constraints on large production-based claims in such a consultation. In the interim, the Government could still introduce the credit regime including the new rates, adjust the software provisions and maintain fiscal restraint by closing the 175% Incremental Concession on 1 July of this year.

We will keep you posted regarding all developments.

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.

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

R&D Tax Credit: A Chance To Be Heard

3:50 pm by Kris Gale · Comments Off

The Federal Government held two “pre-consultation” sessions in Melbourne (19 June) and Sydney (26 June) to help prepare a discussion paper regarding the new R&D Tax Credit legislation announced in the May Federal Budget. Following the release of the discussion paper in mid-July, a formal consultation process will commence.

Most Significant Outcome of the Sessions

The consultation is being headed by a team organised by the Department of Innovation, Industry, Science and Research (DIIRS). MJA has been given an explicit invitation to supply the names and contact details of all interested parties who would like to be involved in the planned face-to-face meetings that will form part of the consultation process. We have direct access to the team leader, Tony Weber, who has agreed to respond personally to all such requests. Please contact Kris Gale using our contact form if you would like to be included in the list of organisations that would like to participate.

The following is a summary of the main aspects of the sessions.

Legislation Timetable

July 2009 Release of consultation paper

Winter/Spring 2009 Release of draft legislation

February 2010 Bill released into Parliament

1 July 2010 Program commences

Attendees

The meetings were chaired by Tony Weber of DIISR. Peter Thomas, the Chair of the Tax Concession Committee of the Innovation Australia Board, was also in attendance along with officials from AusIndustry, the Australian Tax Office and Treasury.

Over the two sessions, three companies, five industry associations and six advisory firms were involved. This is a small representation and it is to be hoped that a broader cross-section of views is canvassed following the release of the discussion paper.

Summary of Discussion

The Credit will be placed in the 1997 Tax Act.

The government has directed that the program be drafted so that it is simpler and more predictable than the current R&D tax concession. The government also directed that, to keep the new program revenue neutral at a cost of $1.4 billion per year for the medium term, the eligibility criteria need to be “tightened” in order to support only “genuine” R&D.

It was agreed that ‘revenue neutral’ really means ‘kept at the same cost’.

Four approaches are being considered:

Rewriting/fine tuning the definition of R&D activities
Extending the concept of expenditure offsets
Introduction of special sectoral rules
Introduction of various forms of claim caps.

A key theme of the discussions concerned whether this exercise should be carried out from first principles (i.e. a “clean sheet of paper”) or a reshaping of the existing tenets of the R&D tax concession. A strong consensus emerged from non-government attendees that the latter is preferable. The strongest theme from the floor was that the major strength of the current program was the relative stability of the definition of R&D and that this should not be unnecessarily altered.

The main conclusions that emerged appear to be as follows:

Sectoral rules and claim caps are unlikely to fly.

Definitional change is hard to achieve in terms of the key concepts. Explicitly excluding certain activities was seen as a preferable way to go.

Considerable discussion focused on the SIE/directly related meanings and differences. The attendees fed back to government that the easiest place to rule out “non-genuine” R&D activities is in the list of excluded activities. The hope was expressed that the discussion paper will provide such a list for specific comment and response. The concern was expressed that the negative statements contained in the Cutler Report regarding mining and heavy engineering in terms of “whole of mine ” claims and receipt of “disproportionate assistance” has greatly unsettled the current program. The paper needs to detail what are the real concerns, beyond the numerical dollars involved, that the government harbours about this R&D. If it is truly non-genuine, reasons need to be given.

The extension of the current feedstock expenditure offset definitely appeals to the policy makers.

There is a battle to be fought here. It appears that this is seen as the best way to restrict R&D claims conducted in the production environment by large organisations. The group pointed out that the current offset (introduced in 1996 for political reasons) applies to expenditure on eligible R&D activities, genuine R&D if you will, under the Act. Further incursions may lead to a program that incentivises only R&D that is not seen as likely to commercialise as companies will not ultimately access the incentive in production trials except in the (hopefully) rare instances of technical failure.

A wide range of other issues was canvassed in the two meetings. These included unlimited amendment powers, guaranteed returns provisions, on own behalf provisions, R&D planning requirements and program delivery (including an AusIndustry charter).

Conclusion

The more specific the involvement of companies and industry bodies in the post-July consultation, the better.

There is an accumulation of assumptions, assertions and unsubstantiated opinions that the government administrative bodies are bringing to this process that, if not carefully refuted, could easily result in an R&D tax credit that is available on such a restrictive basis that it will fail to impact the R&D planning processes of corporate Australia, particularly in the large company sector. It needs to be remembered that the Top 100 company groups conduct 75% of Australian business R&D expenditure. These corporates will receive a lower rate of support (10 cents) than SMEs (15 cents) under the proposed credit, they are to be excluded from the refundable component and they are to lose the premium component. If the industrial nature and the commercial focus of the support is lost through definitional change or wide-ranging offsets, the damage to Australian corporate R&D culture could be immense.

We look forward to working with you in shaping a truly effective R&D tax credit through the consultation process.

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Filed under: MJA Update Articles
Tagged: Cutler Review, Feedstock Offset, Government Consultation, Innovation, National Innovation System Review, Policy, R&D Tax Credit, Venturous Australia, Whole of Mine