Are We There Yet? Are We There Yet? Are We There Yet?
“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.
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.
So what if the proposed R&D Tax Credit only supports failed R&D? Is that such a bad thing?
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.
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.
R&D Tax Credit Bill Reintroduced
The R&D Tax Credit has been reintroduced in the first sitting of the new Federal Parliament.
Senator Kim Carr’s press release summarising the Government’s position may be found at this link: INTRODUCTION OF THE R&D TAX CREDIT.
It contains two minor amendments from the previous version and all the main concerns we have previously expressed remain.
Two key issues are the attempt to make the legislation retrospective by applying a start date of 1 July 2010 and the voting intention of the Independent Members, Tony Windsor and Rob Oakeshott, who voted against the previous version of the Bill in June.
We will be in contact shortly with a primer on the issues and some suggestions for the way ahead. So it’s not just two Grand Finals that you have to look forward to!
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.
Senate Report on R&D Tax Credit Released
Report Contains a Series of Minor Recommendations Only but the Government Does Advocate Removal of Dominant Purpose Test for SMEs
The Senate Economics Legislation Committee (the Committee) released its Report into the R&D Tax Credit Bills (the Bills) yesterday. The Report sets up the debate in the Senate as to whether the Bills should become law prior to the proposed commencement date of 1 July 2010.
Overall, MJA is disappointed by the recommendations made by the Government in the Report and submits that the Dissenting Report of the Coalition Senators should be taken into account by the Senators on the cross-benches when the legislation comes to the vote.
When looked at in detail, the Government has recommended a series of minor changes to the Bill but has not undertaken any detailed analysis of most of the key concerns raised by so many of the stakeholders during the consultative process.
This is best illustrated by the Committee’s response to concerns raised regarding the proposed feedstock provisions which appeared for the first time when the Bills were read into Parliament on 13 May. At pages 61-63 of the Report, the proposed changes are outlined, followed by only one generally expressed concern made at the recent Senate hearings. The Committee goes on to note the concerns about the provisions without providing any details and then indicates that it “…does not believe this will be a problem for large companies.” It proceeds to recommend an advisory group be established to advise the administration on any “unforeseen consequences that emerge as the bill is implemented.”
Rather than dwell on whether this is a case of buck-passing of the highest order, we submit that it is a compelling example of the fact that the Committee simply didn’t have the time to absorb and analyse the feedstock issues in the same way that stakeholders were not afforded any time to undertake a similar process. Yet the new provisions stand to have a huge impact on eligible R&D for all claimants going forward. The same can be said for so many of the other concerns that have been raised regarding the Bills.
The content of the Report, spread very thinly over its 110 pages, underlines the rushed nature of the drafting process and the fact that the implications of the Bills in their current form have not been subject to anywhere near the requisite degree of scrutiny required for the making of good law.
Before setting out the recommendations and providing some further preliminary assessment of the Report, it is worth making particular note of the fact that the Government has recommended that the dominant purpose test be removed for companies with a turnover of less than $20 million. This would establish two distinct programs with separate definitions of R&D as well as levels of benefit. This takes the legislation even further away from the Government’s own announced policy, let alone the original position taken by the Cutler Report of a system that supported the same type of R&D within all organisations, large or small. It goes without saying that more compliance complexity and administrative uncertainty will follow.
We urge the Government to reconsider the passage of the Bills in the form recommended by the Committee. Policy on the run suits nobody and stakeholders have simply run out of time to consider the impact of the latest round of recommendations and amendments before the Bills need to be passed by 25 June.
The Government’s Recommendations
The Government Senators have made the following recommendations:
Recommendation 1
The Committee recommends that subsection 355-5(2) of the objects clause be
amended to clarify the reference to ‘new knowledge or information in either a
general or applied form’ by adding ‘new knowledge in an applied form includes
new or improved materials, products, devices, processes or services’.
Recommendation 2
The Committee notes that many of the concerns were raised by organisations
who want to maintain the status quo. Nevertheless, given the concerns raised, but
acknowledging the need to ensure that public support is targeted appropriately,
the Committee recommends that the definition of ‘core R&D activities’ in section
355-25 be amended to remove the word ‘about’ from paragraph 355-25(1)(b) so
that the paragraph reads as:
[talking about experimental activities] that are conducted for the
purpose of generating new knowledge (including about the creation of
new or improved materials, products, devices, processes or services).Recommendation 3
Given the scope of the changes proposed, the Committee is of the view that the
amended provisions, including the effect of the ‘dominant purpose’ test, be
reviewed after two years to ensure that the legislation is operating consistently
with the Government’s intent.Recommendation 4
The Committee recommends that companies with revenues under $20 million be
exempt from the dominant purpose test.
Recommendation 5
The Committee recommends that a broad–based working group including small
business and union representatives be established to advise Innovation Australia
and the Department of Innovation, Industry, Science and Research about any
unforeseen circumstances that emerge as the bill is implemented. This working
group would also inform the two year review of the bill (Recommendation 7).Recommendation 6
The Committee notes the claim of drafting errors. The Committee notes that
minor drafting errors are common when framing new legislation. The
Committee does not believe that these minor errors are of sufficient magnitude to
delay passage of the bill but considers it preferable that they be dealt with before
the bill is enacted.Recommendation 7
The Committee recommends that the Senate pass the bill, with the amendments
proposed in the earlier recommendations, before the end of June 2010. The
operation of the bill should be monitored on an ongoing basis and reviewed after
two years.
The Dissenting Report of the Coalition Senators
The Coalition Senators have made the following recommendations:
Recommendation 1:
The Coalition recommends that the start date for these Bills be amended to 1
July 2011.Recommendation 2:
The Coalition recommends that the passage of the Bills be delayed in order to
rectify the issue of drafting errors.Recommendation 3:
The Coalition recommends that the definitions of core and supporting R&D be
reconsidered to be more closely aligned to the Frascati model of R&D.Recommendation 4:
The Coalition recommends that the dominant purpose test be removed and be
reconsidered.Recommendation 5:
The Coalition recommends that the Object clause be amended to ensure that
both research and development are given equal tax benefits.
Our Preliminary Assessment
The spectre of the 2007 Productivity Commission Report (the PC Report) looms large over the Committee’s Report. In the opening to Chapter 6, the Committee states that:
“The bill will introduce aspects of the recommendations that came out of the Productivity Commission’s 2007 review;” (page 59).
This is a stunning admission given that the PC Report was so directly contradicted by the Cutler Report and it is Cutler that the Government has repeatedly quoted as the basis of its R&D tax policy. Again, remember that the PC Report advocated the closure of the basic concession for all but the smallest companies, leaving most with an incremental option only. Cutler advocated the polar opposite – enhance the basic incentive and close the incremental option and that is exactly what the Government announced in last year’s Budget.
The Committee is in the thrall of the additionality and spillover arguments of the PC Report and repeats much of the debate that had already been resolved in the Cutler Report. From MJA’s perspective, it is clear that the Committee could not follow the arguments we put forward regarding additionality involving the need to focus support on generating additional R&D activities from the R&D projects that companies do undertake rather than designing a subsidy aimed at getting otherwise marginal projects across the line.
The Government’s recommended amendments do very little to allay the concerns expressed by so many stakeholders since the consultation process began towards the middle of last year.
The changes to the Object Clause and the definition of core R&D activities appear designed to more explicitly acknowledge the eligibility of applied R&D but do nothing to address the restrictive impacts of the dominant purpose test and the new feedstock provisions. The express inclusion of new or improved products, processes, devices, materials and services in the definition of new knowledge actually doesn’t make grammatical sense. How is it that new knowledge includes the creation of new and improved products and processes as the Committee suggests?Traditionally, new knowledge has been seen as the output of basic and applied research whilst the creation of products and processes results from experimental development ie. the application of existing knowledge. The recommendation to equate the two is very confusing.
In discussing the extent of the restrictions associated with the definitional changes, the Committee indicates that these changes are really only seeking to limit ‘business as usual’ activities and ‘whole of project’ concerns. This is giving voice to some of Treasury’s recent defences of the changes but will offer no comfort to those faced with assessments of their production-based R&D claims in the new regime.
The discussion of the concerns regarding the dominant purpose test is perfunctory and, tellingly, avoids grappling with the conclusion expressed at the Senate hearings by the current Chair of Innovation Australia’s Tax Concession Committee that determining dominant purpose under the new legislation will be entirely a matter of judgement as opposed to a question of fact. At no time is any consideration given to the power of the current ‘directly related’ definition to regulate excessive claims but the impact of the change to dominant purpose is tacitly acknowledged by the Committee’s recommendation regarding the test and SMEs.
The removal of the dominant purpose test for SMEs is, in one sense, welcome but it does establish two distinct programs by legislating two different definitions of R&D. This feels like an innovation that we could all do without as it adds yet more complexity and uncertainty, particularly for taxpayers whose turnover is in the vicinity of $20 million. What such a change does do, is reinforce the notion that the dominant purpose test is a restrictive one that will see larger companies unable to receive support for an uncertain range of R&D activities that would have otherwise qualified had the organisation simply been smaller.
Many of the major concerns raised in the recent round of consultations – beyond feedstock, these included the splitting of core and supporting R&D activities; the quality of the Explanatory Memorandum, particularly its example projects used to demonstrate the operation of the new definition of R&D; the ‘expenditure not at risk’ provisions; the greatly enhanced administrative powers; the increased complexity of the compliance regime – did not result in any specific recommendations by the Government. Like all the other parties, the fact that the timeframe for considering all the issues has been so condensed has meant that it is apparent that the Committee did not have the opportunity to actively turn its mind to many of the concerns raised.
We are very concerned that the Government accepts the Treasury’s modelling without having seen it. As we pointed out in our last Update, it appeared from the Senate hearings that Treasury’s admitted reduction of claims by 15-20% did not take into account the closure of the 175% Premium Concession which we had demonstrated previously would save 30-35% of the current cost of the program. In the absence of any published modelling, the Committee steps into the breach and offers up its own “back-of-the-envelope” calculations in support of Treasury’s estimate (page 75).
In some breathtaking assumptions, the Committee suggests that the new regime will increase current program costs by one third to one half of current levels by the combination of higher rates and new program entrants and the savings associated with the combination of the changed definition and the closure of the Premium Concession will roughly offset these costs. We wish to strenuously challenge these assumptions, particularly as they are partially based on a submission we made regarding the impact on program participation back in 1996 where the number of registrants was no more than half the current number and when participation rates fell from around 4,000 to below 3,000. It is unreasonable to assume that program uptake by new entrants will be of a similar dimension given the user base now involves roughly 8,000 Australian companies.
Of course, there is no opportunity to do this prior to the vote and the Committee appears happy with its published back-of the-envelope numbers standing in the place of any need to publish Treasury’s elusive modelling. This is not acceptable.
Finally, we remain absolutely dumbfounded by the following statement on Page 1 of the report:
”It is neither sustainable nor in the national interest that 60 per cent of the total government support is consumed by 100 firms out of Australia’s two million enterprises”.
You will be growing tired of us pointing out that this figure is consistent with ABS statistics on the profile of Australia’s corporate innovation activity and is in line with international practice. We have continued to emphasise throughout the consultative process that large corporates are prepared to negotiate some limits on their R&D tax benefits provided they continue to be acknowledged as performing legitimate R&D on the same basis as their smaller cousins.
However, once more, we feel compelled to point out in the strongest manner possible that the R&D tax incentive is not a finite pie, 60 per cent of which is consumed by 100 firms. Rather, it is a self-assessment program in which 60 per cent of claims are currently made by the top 100 firms. Smaller firms are not crowded out by the claims of the top 100 firms. All firms claim their entitlements against the prevailing rules. No firm’s access to the available benefit is impacted in any way by the claiming behaviour of any other company. In 25 years of consulting on the R&D Tax Concession, MJA has never met a company that does not claim or has a reduced claim because of a claim being made by another company of any size.
If this is the justification for the gutting of the incentive as the Coalition describes it, then it should be shown for the fallacy that it is. The Cutler Report called for reform to R&D taxation support for all Australia’s corporate citizens in the National Innovation System. It never intended for this reform to be the ushering in of an era where large corporates are seen as doing a lesser class of R&D when serving Australia.
What Next?
The Bills need to get through the Senate by 25 June. The Coalition appears ready to vote against the legislation so the focus now shifts to the standpoints of the Greens and the Independents.
Keep an eye out for MJA Updates in the next few days regarding the impending vote as well as any additional issues that emerge from a closer consideration of the report.
As always, 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
-
Archives
- September 2011
- August 2011
- July 2011
- June 2011
- March 2011
- February 2011
- December 2010
- October 2010
- June 2010
- May 2010
- April 2010
- March 2010
- February 2010
- January 2010
- December 2009
- October 2009
- September 2009
- July 2009
- May 2009
- April 2009
- March 2009
- February 2009
- January 2009
- December 2008
- September 2008
- August 2008
- July 2008
- June 2008
- May 2008
- April 2008
- March 2008
- February 2008
- December 2007
- November 2007
