Mischiefs and the New R&D Tax Credit
What has Loki been up to lately?
Last week’s announcement that changes were being made to the draft legislation and explanatory materials associated with the New R&D Tax Credit (the Credit) was very welcome.
MJA has expressed its concern that the Bill’s attempt to legislate additionality and spillover in the Object Clause (something the Government publically assured stakeholders would not happen) creates a fundamentally flawed platform from which all the identified problems flow. These problems include the expenditure not at risk provision, the augmented feedstock rule, the severely restricted definition of R&D, the software changes and the radically changed compliance framework. Further details about these concerns are contained in our submission to the Treasury.
However, what gets lost somewhat in the debate about the impact of the changes is a clear understanding of why the changes need to be made in the first place.
This MJA Update wants to review some aspects of the debate with a view to contributing to a rational discussion when the revised legislation and associated materials appear. A future Update will tackle the numbers issue around the need to maintain revenue neutrality in the program.
It’s Blockbuster Time
Students of popular culture know that the onset of the Northern hemisphere summer heralds a new wave of “tentpole” or blockbuster movies. These days, you can count on a comic book movie or two to be among them. This is, of course, a good and bad thing. For every “Iron Man” to enthral us, we can be sure to be burdened with an “X-Men Origins: Wolverine” (Sorry, Hugh). Looking ahead, “The Mighty Thor” is in the pipeline and you can bet that there will be a role for his half-brother and arch nemesis, Loki, the God of Mischief. And if we are to believe the Federal Government, Loki has been wreaking his handiwork amongst the R&D Tax Concession (the Concession).
Throughout the recent consultations, government representatives repeatedly highlighted that the restrictive changes to the program were necessary because of various mischiefs.
Well, what are some of the mischiefs associated with the Concession and are they really, in fact, myths that shouldn’t be put forward as justification for the sweeping changes that have been attempted?
Mischief 1 – The current Concession facilitates bogus, illegitimate claims against the taxpayer
All incentive schemes may be subject to misuse and the Concession is no different. That is why the legislation includes a number of checks and balances including penalty regimes. Audit programs are in place to ensure that taxpayers do the right thing. In fact, all the evidence over the history of the program is that it is responsibly used by the vast majority of users and very few risk assessments proceed to prosecutions. Removing benefits from all taxpayers for the inappropriate behaviour of the few is not a rational response to the issue of alleged misuse.
Mischief 2 – The Concession provides assistance to non-genuine R&D
This was a can of worms that was opened up by the Cutler Report on the National Innovation System which raised concerns about “whole of mine” claims which were characterised as large, one-off claims made by mining and civil engineering companies involving significant operating costs.
The inference that has emerged in the consultative process is that these claims do not involve genuine R&D and should be stopped or severely limited in the new Credit. These sentiments fit in with a world view that certain types of R&D (e.g. biotech, medical performed by SMEs) merit support and others have a weaker case (e.g. large company resources and engineering projects).
This is not what Cutler said. Cutler stated that the so-called “whole of mine” projects were R&D but that they were expensive and that the government might look at putting some reasonable limits on the amount of support that goes to these legitimate R&D activities.
The real mischief here is when one starts to import a moral dimension to what is genuine R&D. The strength of the current Concession is that it delivers an internationally-competitive definition of eligible industrial R&D. The proposed definition in the Credit, in seeking to narrow the definition to limit assistance to “genuine R&D”, manages to disqualify the vast majority of R&D actually conducted by Australian businesses, large or small.
Mischief 3 – The criticism of the Credit has come from those with a vested interest in the status quo
The initial observation to be made here is that responses such as the recent public submissions to the Treasury will always come in the main from those with a vested interest. That is the usual driver for a party to respond at all.
If a submission comes in arguing for the status quo, does it automatically follow that the submission can be discounted because it is designed to protect a vested interest?
Speaking for MJA, our February submission to the Treasury essentially argued for the status quo. Further, we believe that the proposed Credit was not going to be good for our business. But that did not form the basis of our submission. We have always approached our submissions from a primary standpoint of what will deliver good program outcomes.
As recently as the Cutler review, we campaigned vigorously for the closure of the 175% Premium on the grounds that it was a high cost element of the Concession that did little to influence R&D behaviour. Yet every month we billed clients to prepare premium claims. We were happy to see this business go if the result was a simpler, more effective R&D tax incentive. We were pushing for a major change to the status quo.
Our views have been echoed by many other advisers, industry groups and taxpayers and the closure of the 175% Premium has raised nary a voice in protest.
So why is it that our critiques can now be dismissed as being hostile and reflecting vested interests? Is the real mischief here the fact they don’t concur with the views of the Government?
Mischief 4 – 80% of the Concession goes to 100 companies
For decades, Australian Bureau of Statistics on R&D have indicated that the vast majority of innovation spend is incurred by a handful of Australian companies. This is, and will always be, a matter of fact. The current trends in the Concession simply reflect this fact. Given that the Concession is open-ended, the share of those 100 companies will be determined by the prevailing rules and the amount they identify and claim. When added to the spend and claim of the other 7,900 firms in the program, the proportions will then be determined as a matter of mathematics.
There is not a finite amount of claims and assistance available. The proportions are only determined after the claims are identified and made against the rules.
The thinking behind the restrictions in the new Credit is that the rules can be changed to alter these proportions. This is entirely possible. You can rewrite the rules so that the proportion of assistance accessed by the other 7,900 is a much larger figure. The problem comes in when the rules are so restrictive that the proportion is larger but the overall value of the assistance to those 7,900 companies falls.
This is exactly the concern being reflected by the commentators regarding the Credit. We are being offered a program that wipes out assistance across-the-board. A larger slice of the cake might go to SMEs but so what if we are now cutting up a cup cake as opposed to a passionfruit sponge.
So, has Loki got something to answer for?
A recent editorial in the Australian Financial Review called for the draft Bill to be withdrawn or thrown out on the basis that the Government’s arguments for the major restrictions could not be made out. MJA agrees wholeheartedly. The mischiefs aren’t real. They are really more akin to myths (perhaps like the Treasury modelling that shows the changes to be revenue neutral?!) and Loki is off the hook on this one.
So don’t expect Thor to be wielding his mighty Uru hammer against the Credit in a multiplex anywhere near you soon. Not enough legs in that plot.
Looks like it’s up to us mere mortals to keep up the fight as we await the revised legislation.
If the suspense is too much in the interim and you would like to discuss the issues, feel free to contact Kris Gale directly on (02) 9810 7211 or using our contact form.
News Flash: R&D Tax Credit Is Being Rewritten
The Treasury has announced that the draft legislation that delivers the new R&D Tax Credit is being rewritten to make it clearer and less complex.
The letter below sets out the scope of the review including five major concerns that have been reflected in the recent submission process:
- Definition of Core R&D Activities
- Definition of Supporting R&D Activities and the extension of the Excluded Activities list
- R&D activities involving software
- Registration of core and supporting activities
- Augmented Feedstock rule
To that list, MJA will be highlighting concerns regarding the Object clause, the “expenditure not at risk” provision and the changed compliance regime.
The Treasury is seeking examples of “genuine R&D” that are believed not to be entitled to support under the proposed regime and any other suggestions that parties may have. These can be submitted directly via rdtaxcredit@treasury.gov.au or MJA would be happy to facilitate any responses that you might have.
We are greatly encouraged by this news and strongly urge you to have your voice heard.
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 - Treasury R&D Letter
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.
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