Alas, poor R&D project, we knew you well

4:04 pm by Kris Gale · Comments Off

As we write this current MJA Update, the R&D Tax Credit (the Credit) legislation is (very) patiently awaiting debate in the Senate. We understand that the Bills may go up next Monday (22 August) but, whenever they do, it is expected that they will pass without great difficulty owing to the hard-won support of the Greens. The MJA Update will alert you regarding these events as they occur.

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.

Filed under: MJA Update Articles
Tagged: AusIndustry, Government Consultation, R&D Activities, R&D Project, R&D Tax Concession, R&D Tax Credit, R&D Tax Incentive, Registration

Are We There Yet? Are We There Yet? Are We There Yet?

3:53 pm by Kris Gale · Comments Off

“If you kids don’t keep quiet, I’ll turn this car around and there will be no Duff Gardens for you!”

Sound familiar? I guess we all have a time where we are the impatient passenger or the beleaguered driver.

Well, it’s no different for those on the R&D Tax Credit bandwagon.

The answer regarding the Credit is, of course, no. We’re not there yet. But now is a good time to review the situation as the entrance gates loom into view.

Flicking the On Switch

The Credit will be available for Australian taxpayers for their first income year from 1 July 2011 onwards. As indicated in a previous MJA Update, the Bill is expected to shortly pass the Senate with cross-bench support. Our current understanding is that the Bill will be introduced by the Minister for Innovation, Industry, Science and Research, Senator Kim Carr, in the week commencing 15 August 2011. The only certain change to the current form of the Bill will be the introduction of quarterly payments for the Refundable Credit from 1 January 2014. But more on that later.

I Need To Change My Systems And I Need To Change Them Now

This Credit has been a long time coming and it’s understandable that companies are anxious to get cracking with training and shiny new systems. We counsel against this. We have been dealing closely with AusIndustry and the Australian Tax Office (ATO) in recent weeks and it is fair to say that detailed guidelines for the new program are several months away. Further, there may well be revisions to the scope and operation of certain aspects of the program such as the feedstock provisions. That currently leaves us with the legislation and an Explanatory Memorandum of somewhat dubious quality. And a whole stack of questions. Now, we will be resolving to ensure that those questions are fully answered in that guidance material. In the meantime, we suggest that intending claimants continue to operate their current R&D identification systems.

The overall impact of the changes to the definitions of eligible R&D activities and expenditures is likely to preserve the breadth of eligible projects but wind back the extent of expenditures that attract the support. As such, we strongly recommend that you continue with your current approach and then review what proportion of your documented claim qualifies as the rules of the Credit begin to be fleshed out. MJA will be running briefing seminars when real flesh is on the bones. Right now, information sessions would be interesting speculative exercises but nothing definitive can be said. We hate to put it this way but we need to wait until we see the (Government) paperwork.

What Was That Again About Quarterly Payments?

It has been somewhat bemusing to observe the excitement being generated in some quarters about Senator Carr’s announcement that the 45% Refundable Offset will be available in a quarterly payment form. Bemusing because it was a proposal initially suggested in the Cutler Report that was quickly dismissed as being totally unworkable. Even more bemusing in terms of the fact that, after a National innovation System review that began three and a half years ago, we have to wait another two and a half years for this feature to activate. No explanation has been offered about why we have to wait so long or how the system might work. Yet some are heralding this announcement as a triumph. Talk about your delayed gratification!

Diving into the blogosphere on this question about the delayed start date turned up two explanations – the system would take that long to design or someone might be having a lend of us. We’ll leave you to draw your own conclusion on that one.

Letters From The Front

We will be moving shortly into a detailed series of consultations with AusIndustry and the ATO regarding the design of the Credit and new features such as Advance Findings and sectoral guidelines. We will keep you fully informed of all developments as they happen in this new chapter in Australian innovation.

Filed under: MJA Update Articles
Tagged: Cutler Review, Government Consultation, Innovation, National Innovation System Review, R&D Tax Concession, R&D Tax Credit, Senator Kim Carr

R&D Tax Credit Opens For Business

4:14 pm by Kris Gale · Comments Off

Great News For SMEs Down The Road

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.

Filed under: MJA Update Articles
Tagged: AusIndustry, Government Consultation, R&D Tax Concession, R&D Tax Credit, Senator Kim Carr, Treasury

R&D Tax Credit Is On The Runway

3:01 pm by Kris Gale · Comments Off

The Minister for Innovation, Industry, Science and Research, Kim Carr, has given a strong indication that the R&D Tax Credit is set to effectively commence on 1 July 2011.

Questioned earlier this week in a Senate Estimates hearing, Senator Carr stated that the matter will be brought on for debate in the new Senate where the Bill is likely to attract majority support. The composition of the Senate changes on 1 July 2011 when the Greens will assume the balance of power in the Upper House.

Senator Carr has also apparently backed down from his position of making the R&D Tax Credit legislation retrospective to 1 July 2010. As we have been suggesting for some time, the revised start date is likely to be 1 July 2011.

Filed under: MJA Update Articles
Tagged: Government Consultation, R&D Tax Concession, R&D Tax Credit, Senator Kim Carr

So what if the proposed R&D Tax Credit only supports failed R&D? Is that such a bad thing?

3:55 pm by Kris Gale · Comments Off

In this edition of the MJA Update, we examine the ways in which the major changes proposed in the R&D Tax Credit (the Credit) reduce the eligibility of R&D where it is done in a production environment. We contend that the changes are driven by a philosophical position that the only production-based R&D that is worthy of being encouraged is R&D that is unsuccessful or otherwise fails to produce something.

We ask whether this in line with announced Government policy and query whether the reforms are logical or even desirable?

It is Government policy to increase profitability by the R&D Tax Credit

The R&D Tax Credit Bill (the Bill) proposes to replace the current 125% and 175% R&D Tax Concessions, split by growth in R&D expenditure, with 40c and 45c R&D Tax Credits, split by company turnover.

The objective of the Bill is to implement the Government’s policy in Powering Ideas, especially with respect to industrial R&D including R&D in a production environment. This policy seeks to substantially increase the number of businesses undertaking R&D activities in Australia for the benefit of the economy, jobs and the environment.

According to the policy, it is supposed to achieve this by being simpler, more certain and by providing benefits “with the added advantage that companies can access the credit whether they are in tax profit or tax loss”. It seeks to overcome the market failure that businesses are too reluctant to invest enough in R&D in Australia to sustain our future economy.

The policy is explicit in that it wants more businesses to succeed and be more profitable as result of their R&D activities:

“The empirical evidence is clear: Australian businesses that innovate are more than twice as likely to report increased productivity and 63 per cent more likely to report increased profitability than businesses that don’t. Innovation makes them more competitive by enabling them to differentiate their products and services, target niche markets at home and abroad, and participate effectively in global supply chains.”
Powering Ideas, Chapter 5

It is Government policy to encourage successful, commercially-based R&D

It is also explicit Government policy that it wants businesses to come here, stay here and do R&D here so that it is commercialised here. This makes perfect sense. The Government cannot achieve its goals in securing our future by encouraging R&D that does not result in profitable outcomes.

If the Government only encourages research that does not improve business performance then this will change the program from one that, by every measure, creates more economic growth and tax revenue than it costs to one that drains revenue by rewarding failure and turning the program into an R&D insurance policy of last resort.

Should R&D in a production environment be supported?

Despite this, the question regularly arises about whether the Government should provide an advantage to businesses that will also make a profit on the output of the R&D. To a layman, this question makes sense; however, it is counterintuitive.

The objective is to make Australian businesses more profitable, more efficient and better able to commercialise technologies developed in Australia; that is, to make more money by doing more R&D so the economy benefits and the Government collects increased tax revenues. No business does R&D for the tax benefit. They do it for the commercial benefit. However, businesses do not carry out enough R&D in Australia so we need an internationally competitive R&D incentive system to encourage this behaviour and overcome the market failure.

Both the current and proposed legislation have caveats to restrict this encouragement to just the R&D activities. For example, the benefit can only be received by the business that bears the risks and costs of the R&D. The definitions seek to limit the programs to only the necessary activities to do the R&D. So far, so good.

Does the Credit’s collar match the cuffs?

However, the Credit’s addition of a dominant purpose test and the expansion of the feedstock provisions seek to withdraw the benefit from otherwise legitimate and necessary R&D activities in the mistaken belief that R&D performed in a production environment is not as worthy of support. This is a poor outcome and does not match the stated Government policy. It assumes that making a profit from your R&D is undesirable when the whole idea of the program is make Australian businesses more profitable. It introduces horizontal inequities. It discourages R&D focused on process improvements and discourages R&D for environmental purposes.

What are the horizontal inequities?

Different treatment of tax payers who otherwise share identical capacity and responsibility to pay tax is a horizontal inequity. If the only difference between two taxpayers is that one is able to perform R&D offline and one is required to do its R&D whilst making saleable product and both will generate the same net economic benefit from the successful completion of the R&D, then both should be able to access the same R&D tax benefit. However, the Explanatory Memorandum accompanying the draft Bill suggests that only the business that is able to conduct all its R&D offline will not be subject to either the dominant purpose test or the expanded feedstock clawback provisions.

This inequity reduces the R&D incentive for two main types of businesses – those where the scale of the project requires that the R&D be done on production facilities and those where the business does not have spare assets to do the R&D separately from the other activities of that business. The former discourages experimental development and the steps necessary to develop something sufficiently to allow it to be commercialised. The latter may have a larger impact on SMEs and may encourage inefficiency in capital asset utilisation.

What are the adverse impacts on manufacturing and environmental projects?

Process improvements are a large part of R&D especially in the embattled manufacturing sector. With established products, this is where the majority of R&D will occur. Even with new products, R&D is frequently required to developing new manufacturing processes to bring the new product to market. Undertaking process developments on existing production lines frequently requires the use of the production line whilst it is making saleable product. This is especially true for significant improvements in processing efficiency and for projects aimed at reducing greenhouse gases, water or other inputs consumption or to increase production from the same or improved inputs.

The expanded feedstock and dominant purpose tests will apply more pervasively to the manufacturing sector than to many other sectors. The nature of the Credit will add to the emerging viewpoint of many Australian businesses that our tax system is less favourable than overseas alternatives. As a result, rather than encouraging more businesses to do more R&D in Australia, the introduction of the Credit may instead be the last straw encouraging them to move production and related R&D offshore.

Our Conclusion

In conclusion, the simplistic notion that a business does not deserve encouragement to undertake R&D in Australia just because they can sell the immediate output from an R&D activity that was necessarily done in a production environment is illogical and undesirable:

It assumes that businesses do not do R&D for the commercial benefit if that benefit is not received from the direct sale of the product made during the experimental development and that businesses do not deserve an R&D credit if they get a commercial benefit. This is counter to the clearly-stated objective of the Credit to make Australian businesses more profitable by encouraging them to do more R&D for commercial benefit.
It assumes that businesses are more likely to undertake experimental development by their own volition if they are forced by circumstances to do it on production equipment than other businesses that have dedicated R&D equipment or are able to do R&D offline so that the first type of businesses deserve less encouragement than the second.
It assumes that industrial R&D, which is primarily Development, is less worthy of being encouraged than lab R&D, which is primarily Research. This is despite Australia’s research achievements frequently outstripping our ability to extend and complete this research so that we can commercialise it here.
It is also counter to the policy objective to see more R&D done in Australia for the benefit of the Australian economy.

Where to from here?

The debate about the contentious aspects of the Bill continues apace.

The Bill could go before the Senate anytime from 28 February through to the first session of the new Senate in July. It is unlikely that the Credit will be introduced retrospectively. The most likely commencement date for the program is 1 July 2011.

This gives us three potential outcomes:

The Bill passes before 1 July 2011 with issues like the expansion of feedstock and dominant purpose tests corrected by way of upfront Government, Opposition or Minor Party amendments. This is the best possible solution for business R&D in Australia;
The Bill passes as is but the Government considers and passes amendments to correct for these issues before the expected 1 July 2011 start date. This would be a good solution but it is a high risk strategy reliant on the majority of Parliament finally being responsive to the concerns expressed by stakeholders; or
The Bill passes as is and is operational from 1 July 2011 with all its fundamental flaws. This option includes the possibility that the Bill will apply retrospectively if it is passed by the new Senate. Corrections will need to occur on the fly to limit damage to the economy and Australian businesses wishing to conduct R&D. This will result in significantly higher levels of uncertainty and risk than with either of the other alternatives.

MJA will keep you informed of all major developments with the Credit legislation as they occur.

Filed under: MJA Update Articles
Tagged: Cutler Review, Dominant Purpose Test, Feedstock Offset, Government Consultation, Industrial R&D, National Innovation System Review, Powering Ideas, R&D Tax Concession, R&D Tax Credit