Welcome Back My Friends To The Show That Never Ends : The R&D Tax Credit
And welcome, albeit belatedly, to 2011. In our first MJA Update of the year, we will look at the comments made by Senator Carr in last Friday’s AFR (click to view) urging for the current R&D Tax Credit Bill (the Bill) to pass through the Senate unmolested in the name of fiscal consolidation. It is possible that the Bill could be presented to the Senate as early as next week.
Thar She Blows!
Senator Carr has urged that the Senate pass the Bill as the current scheme was unsustainable based on new government projections that see the cost of the program blowing out to $2.4 billion in 2012/13. Senator Carr states: “At a time when the government is looking at fiscal consolidation we are maintaining expenditure of R&D, but we can’t sustain that unless there is reform of the system for genuine research and development.”
We welcome the new focus on program cost as a driver of the reforms. It now seems that the Government’s rationale for the proposed regime does include an explicit recognition that the Credit will significantly limit R&D claims owing to the altered definitions of R&D activities and expenditures. The question remains : to achieve the Budget targets, do we need to fundamentally rewrite the eligibility criteria?
Working Without A Net
The new government projections have arrived without any available modelling to test the assumptions. So we are again working without a net but we think that the following may be safely said.
The “blow out” figure must include the 175% Incremental Concession (the Premium) which we have previously shown to be contributing about 30-35% of the cost of the current program. In opposing the definitional changes to R&D activities/expenditures, no-one has called for the retention of the Premium. Any “blow out” attributable to retaining the current definitions will have much of the wind taken from its sails once the closure of the Premium is taken into account in the projections.
We have consistently argued that closing the Premium is likely to completely pay for the higher base rates of the Credit and the introduction of foreign-owned IP claims. We welcome the release of Treasury modelling that shows that further change is necessary either to achieve revenue neutrality or even a degree of fiscal windback.
Let’s Keep It Simple
Let’s assume that the case for further cost control can be made out in the current government spending climate.
There are two simple options that would be saleable in the marketplace that would avoid all the uncertainty and angst associated with the proposed rewrites contained in the Bill:
- Introduce a reviewable annual claim cap at the company group level. The cap could be calculated on available claim data and could seek to limit the ability of, say, the top 25-50 claiming groups to access the Credit.
- Wind back the proposed rates from 10c/15c to a more modest combination of levels.
Clean and simple. Yet the Government seems unwilling to engage in any dialogue regarding either of these suggestions. This is why so many commentators are concerned that the Bill actually reflects a philosophical shift that seeks to end support for business R&D, introducing a more tightly controlled regime based around supporting business research only.
Now is the time to reignite this debate. With cost control now to the forefront of the discussion, we need to see the Treasury modelling and to explore the above cost-saving alternatives to a fundamental rewrite of the R&D definitions with all the well-documented issues and concerns.
The fact that the current Bill appears to establish a world where the Credit only supports unsuccessful commercial R&D has led many to ask whether the new program contains any real incentive effect at all. This will be the subject of our next MJA Update.
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.
All I Want For Christmas Is A R&D Tax Credit That Works?
There is no better way to get a reality check on your viewpoint than when you are presented with a clearly opposing position. Such is the case with this week’s announcement that the Australian Information Industries Association (AIIA) has written to Minister Carr to support passage of the draft R&D Tax Credit (the Credit) legislation. While the AIIA concedes that the Bills are not perfect, it is attracted to a more rapid cash-back for SMEs and the fact that the legislation recognises that R&D in the Information, Communications and Telecommunications (ICT) sector is not a laboratory exercise comprising experiments and test tubes. The AIIA goes on to predict that the Bills will be re-introduced into Parliament in the Autumn sittings with a view to a July 2011 commencement.
In responding to these statements, we would note that the Credit definitely increases the number of candidate company groups able to access the cash-back aspect of the program but there is no indication that the ATO will be sending out its cheques more rapidly. Further, we are unclear as to how the AIIA has reached its conclusion that the new package recognises that ICT R&D is not a laboratory exercise, inferring that the current R&D Tax Concession (the Concession) takes that position. Previous MJA Updates have demonstrated our concern that the proposed changes to the definition of R&D activities run the risk of all corporate R&D being subject to a narrower lab-like regime, irrespective of the industry sector involved.
For starters, the new definition of core R&D activities requires them to be experimental as an isolated requirement. And supporting R&D activities will be subject to the new complexities of the dominant purpose test. Let’s take a closer look at this issue.
Dominant Purpose – Don’t Worry. Be Happy
When the Bills recently passed through the Lower House, the Assistant Treasurer, Bill Shorten, said “The dominant purpose test is a well-defined concept commonly used in tax law.” In short (no pun intended), there was no cause for concern about how the test would work in practice. This was in response to the Opposition amendment on dominant purpose. Yet the Opposition amendment, in common with the Greens amendment, the majority and minority opinions of the Senate Economics Committee and the vast majority of over 380 submissions referenced by the Assistant Treasurer all agree that the dominant purpose test in the Bill is a new, onerous and subjective test that will increase compliance costs and uncertainty and reduce encouragement for businesses to do genuine R&D. Further, Peter Thomas, Chair of Innovation Australia, confirmed in his evidence to the Senate Economics Legislation Committee that determination of which of any of the driving purposes of an activity is the dominant purpose is all a matter of judgement.
Given the extent of the concerns expressed, how does Mr Shorten reach his conclusion?
The dominant purpose test is present in a number of anti-avoidance provisions in tax law. Primarily, it is in Part IVA, the General Anti-Avoidance Rules (GAAR). In this regime, “the dominant purpose” is determined by a set of eight expressly defined and legislated rules that are used to determine which of all the possible dominant purposes in an arrangement is the dominant one. All the other anti-avoidance provisions either have rules to determine the dominant purpose or apply even if tax avoidance is not the dominant purpose.
Since its introduction in 1981, the Part IVA GAAR have been, to say the least, contentious, especially in the application of the dominant purpose tests. It has been a major focus of tax law court activity with notable cases like Hart’s case, Spotless and Macquarie Finance. It has been a major focus of ATO activity with rulings and taxpayer alerts aplenty. Interestingly, Bill Shorten announced a review of the GAAR on 18 November 2010 to focus on rewriting these rules to “improve the integrity, certainty and simplicity of the income tax laws”.
Hardly a ringing endorsement of a “well-defined concept”.
Unlike the GAAR and other tax law dominant purpose tests, the Bills contain nothing to determine how the dominant purpose is to be determined in relation to supporting R&D activities. It is not linked to any of the eight tests in the GAAR, so any of the court cases around these tests will have limited value as precedents. We will be starting with an essentially clean sheet if the Bills enact the proposed definition.
In the light of the above, MJA suggests that you should be worried about dominant purpose but you should always stay happy!
The New Assessment Regime – Don’t Worry. Be Happy
Well, actually, even the AIIA is worried about this one. They have commented on the increased audit and compliance activities associated with Concession claims directed towards the ICT sector, especially SMEs.
Again, we would suggest that this is a program-wide development. The Government’s recent consultative meetings about the new regime revealed that the program commenced back in July with, in fact, no consultation and no announcement. The new step of requiring written responses to questions on projects has massively increased the compliance burden on taxpayers selected for review.
Already, we are observing a number of problems with the approach. There is a lack of standardisation in the types of questions being asked, resulting in misleading questions and a number of inaccurate statements of the law. The responses are generally required within thirty days but AusIndustry will not commit to a timeframe within which they will process the received responses, thereby adding to uncertainty.
A key concern is that there is no guidance as to how much information should be provided in the responses. At the consultative sessions, AusIndustry indicated that many taxpayers are providing too much information. Given the lack of guidance and the fact that the types of questions are those normally attributable to s39L full audits, this is hardly surprising.
Of great concern is that taxpayers are being processed to the next step – a site visit – with no reasons being provided as to why the written responses provided did not satisfy AusIndustry’s requirements.
It seems that a new assessments industry might have sprung up to justify the large increase of resources announced in the 2009 Budget to deal with a Credit that failed to commence in July 2010.
MJA will follow up these concerns up with the Government with a view to getting parties around the table to assess the early performance of the new regime resulting in the introduction of equitable reforms in the process.
It’s The Festive Season – Don’t Worry. Be Happy
This brings to an end our trilogy of somewhat gloomy MJA Updates in the wake of the failure of the Bills to be enacted in 2010.
However, this failure creates opportunity anew to address the problems. It was a year ago when the first draft of the Credit arrived as an early Christmas present and we have all gone some way towards improving the Credit before it becomes law. The basic program remains a great idea. We still need to fix up the details for it to be a successful one.
Our agenda for 2011 is clear but right now is the time for us all to relax and catch our breath. We wish you and your family all the very best for Christmas and 2011. We look forward to alleviating all our worries about the Credit in the New Year so it can be a truly happy one for Australian innovation.
Should you wish to discuss this matter any further, please do not hesitate to contact Kris Gale directly on (02) 9810 7211 or using our contact form to discuss the matters raised in this MJA Update in greater detail.
If We’re Turning Up The Heat, Let’s Put Feedstock Into The Furnace
As calls continue for the R&D Tax Credit Bills to be put into an independent consultation process as soon as possible so that a workable new R&D Tax Credit can be in place and open for business by 1 July 2011, it is worth remembering that all parties need to appreciate that hammering out a workable definition of R&D activities will mean little unless the concerns regarding the eligibility of feedstock expenditure (along with other issues we have highlighted previously) are resolved at the same time.
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.
It’s Not Easy Being Green
Not one person has said that all they want for Christmas is more MJA Updates on the R&D Tax Credit (the Credit). Yet we feel compelled to send you some as many critical issues still need to be resolved in order for the initiative to move forward successfully.
The best we can offer is to break up our discourse in to 3 bite-size chunks over the next 2 weeks so that we don’t add too much Christmas cheer to your inbox all at once. And then we will leave you alone to rest up over your New Year break.
First up, some reflections on the emergent role of the Greens. We will follow with a reinforcement of the key forgotten issue of feedstock and a rumination about what the new Ausindustry assessment procedures might be saying about the future operation of the Credit.
It’s Not Easy Being Green
Or so Kermit the Frog would have us believe. Well, it’s a proposition that is getting well tested early in the life of the minority Labor Government by the twists and turns in the ongoing Credit saga. As the dust settles from the latest failure of the Bills to reach the Senate before the close of Parliament for the year, the role of the Greens has emerged as pivotal.
This was always expected to be the case from 1 July 2011 as the Greens assume the balance of power in the Senate. If the independent Senators, Fielding and Xenophon, cannot be relied upon to support the Bills between February 8 (the first sitting day for the Senate next year) and June 30, then a fresh opportunity to get them through will commence on 1 July if the Government can get the Greens on board.
Let’s consider what we know about the Greens position so far.
More Argy Bargy About What Qualifies As Eligible R&D
So much of the debate to date has been about the restrictive impact of the introduction of the dominant purpose test on R&D claims. Of particular concern to the Greens might be the limitations imposed by the new regime on the development of climate change process technologies. Well, if they are, they certainly are keeping their cards close to their chest as nothing is being said publicly.
The first real indication of their position was the 150 words or so spoken by Lower House Greens MP Adam Bandt in his recent Second Reading Speech on November 22 in the debate that saw the Bills pass the Lower House. In stating that the Greens are strong advocates for government support for R&D, particularly where it reaches SMEs, he indicated that his party would support the Bills in the Lower House but would be seeking to move some amendments having engaged in “some significant consultations”.
Though the Bills didn’t reach the Senate, we did get to see the Greens amendments. Again, the focus was almost entirely on what should constitute eligible R&D activities. In summary, the Greens proposed to amend the Bills as follows:
- Limit the dominant purpose test to companies with a group turnover of greater that $20 million. (This was proposed by the Senate Economics Legislation Committee’s majority report in May 2010.)
- Restrict, by note, deductions for eligible supporting activities to those only in the year the core activity occurs thereby eliminating supporting costs that occur in the period before or after the core activities. (This a first-time proposal that would further curtail support available under the R&D Tax Credit.)
- Some “clean up” items that tidy up the Bills.
A cynic might suggest that the proposed amendments may have equally come from Treasury or the Government that would be seeking to exact some compensation (the new limits on deductions for supporting activities) for a rollback of the dominant purpose test in respect of SMEs.
So not very encouraging for critics of the Bills but at least a precedent has been set that the Greens are purporting to adopt an independent voice.
Let’s Make It Less Easy By Turning Up The Heat
Calls continue for the Bills to be put into an independent consultation process as soon as possible so that a workable new Credit could be in place and open for business by 1 July 2011. Again, we remain attracted to the idea put forward by Heather Ridout, Chief Executive, Australian Industry Group, that such a process be headed up by the Board Of Taxation. If the Government decides that its best bet is to wait until the new Senate kicks in on the same 1 July, then the heat needs to be put on all stakeholders now, and on the Greens in particular, to come the table early in the New Year.
We will be turning up the heat with respect to this proposition by continuing to push for the establishment of the consultation process as a priority. As Kermit would tell you, just because you might have the balance of power, you can’t expect life to be all fly-catching and lily pads.
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 – The Waiting Game Continues
The R&D Tax Credit Bills have failed to reach the Senate before the close of Parliament for 2010. The earliest that the Bills can now be voted on is February 2011.
MJA sees this as an ideal opportunity for the Government to put the Bills into an independent consultation process to address the continuing criticisms of the proposed legislation. We remain attracted to the proposal put forward by Heather Ridout, Chief Executive, Australian Industry Group, that such a review should be conducted by the Board of Taxation.
We will provide an analysis of the most recent chapter in this ongoing saga in an MJA Update next week.
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 R&D Tax Incentive – Like the Footy Finalists, Take It One Week at A Time
- R&D Tax Credit finally passed through the Senate
- Alas, poor R&D project, we knew you well
- Are We There Yet? Are We There Yet? Are We There Yet?
- MJA on Switzer
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