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.

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 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:

1. 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.)
2. 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.)
3. 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.

 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 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

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.

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.

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.

We will bring you news of the highlights (and any lowlights) as they relate specifically to innovation policy, R&D tax concessions (or credits), grant funding and other government incentives shortly after the lock-up has completed at 7.30pm.

You can look forward to an MJA Update Article and email (if you’re a subscriber) tomorrow night, followed by a more detailed look at the changes within 24 hours of the budget.

Our initial reactions have been written up here: http://mjassociates.com.au/mja-update/budget-2009-innovation-policy-announced/

Perhaps that’s what we could do with a dose of now?

You can read the Innovation is Industry Policy blog entry here.

In order to answer that question, you need to know some history.

You need to have a sense of the budget deficit inherited by the brand new coalition government in 1996. You need some understanding of the lengths they needed to go to in order to balance the books. In fact, we need to go back a little further.

28 days earlier…

4,307 days ago the government achieved a major limitation to the types of claims under the R&D tax concession by simultaneously introducing:

• the obligation for companies to offset their expenditure on feedstocks processed or transformed in R&D against any products derived,
• changes to the arrangements for interest, pilot plant, and core technology; and
• a clarified definition of R&D.

On 23 July 1996 these changes were set in place.

And these changes were understood

The business lobby had played a significant role in the coalition’s victory, and clearly understood from the outset that it would need to give something up in order to help balance the budget. Through a process of consultation and discussion these areas were identified and agreed, the merits of change debated and the benefits weighed against the costs, and the R&D tax concession was amended.

But 28 days later, at 7.30pm on 20 August 1996 the government acted unilaterally to slash the R&D tax concession from 150% to 125%. This change broke the trust and certainty around the R&D tax concession that had slowly allowed it to enter into corporate long range planning at a rate where it could change project economics. This trust taken time to establish, and was crowned by the permanent extension of the R&D tax concession in 1992/93.

Why does this history lesson matter?

Fast forward to budget time 2008. Just as in 1996 a new government is at the reins. Just as in 1996 there is a need for prudent fiscal judgement. And just as in 1996 a process of consultation around R&D, innovation and tax is underway (www.innovation.gov.au/innovationreview).

The economic picture looks different this time: it is now the surplus that is the problem, and the spectre of inflation the issue. But what’s similar is that the government is putting the final touches on a budget with a clear need to make cuts.

It’s all about the consequences…

In 1996 the drop in R&D investment was immediate and significant, and it came at a time when the economy really needed industry to be making counter-cyclical investments. Instead of R&D changing due to market forces what happened was that the certainty that industry needed from the R&D tax concession had disappeared.

In fact, 12 years later the 125% rate continues to have an impact with few project capital proposals before Australian boards taking into account any permanent cash saving from the concession. At 7.5% it doesn’t significantly change project economics.

Further, the 175% incremental concession (aside from its practical challenges) is still “new” to industry. It has not yet been bedded down and fully accepted, and given that the introduction of the 175% international tax concession came at a time before the 175% incremental concession was settled in the mind of industry this change adds up to uncertainty and risk on the planning horizon.

What are the similarities between 2008 and 1996?

But surely this is just scaremongering. Although there are some similarities, such as the change in government, the budget challenge, there is consultation going on. And the Cutler Review’s website suggests that over 600 submissions have been received (although from those on the website at present, few are from industry. Australia’s powerful science lobby is in full flight). Innovation is at the front of mind at the moment.

After all, we’re in the middle of the National Innovation Festival.

But there is always the seed of doubt, a grain of uncertainty, the germ of an idea at that at budget time what is a powerful, market driven R&D tax concession could be seen as a form of industry assistance for incremental innovation. But that of itself is not a bad thing.

At the level of benefit currently derived by the majority of program participants, the R&D tax concession is a vital business environment variable that has some level of certainty around it.

Conclusion

This is the time for government to listen to industry’s submissions, to learn from the mistakes of that first Howard-Costello budget in 1996, and to address all industry R&D and innovation programs from a position of consultation and vision, rather than applying the spending scalpel to cure a patient still ravaged by the unnecessary and imprudent cut 4,279 days ago.

Visit www.innovationisindustrypolicy.com and vote on the level of after-tax benefit you would need to put R&D tax benefits into your company’s capital and project planning processes.

And if you’re already using the benefit of the program in your approval calculations let me know!