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.
R&D Tax Credit – We’re Not in Kansas Anymore
With memories of the Christmas/New Year break rapidly becoming the stuff of legend, the R&D community is now able to focus on the Draft Bill and Explanatory Materials (released immediately prior to Christmas) that set out the design and operation of the new R&D Tax Credit.
What has become very clear is that the Treasury has delivered a package that fundamentally changes the form of government support for R&D. Should the Bill become law, we will certainly find ourselves in the Land of Oz.
Changes to the Nature of the R&D Tax Benefit
The main surprise with the package is that the “augmented feedstock rule” and related provisions fundamentally alter the nature of the R&D tax benefit. The Bill changes the R&D tax incentive from a largely guaranteed upfront concession at the time R&D expenditure decisions are made to an after-the-fact compensation measure for R&D that fails partially or totally. How all this works is complicated and open-ended and the available benefits can only be calculated after the market value of the R&D can be assessed. Given that companies will plan for most of their R&D to generate a valuable output, they will therefore intend in most cases to not access the Credit, rendering it as a form of relief that will only be considered after the R&D has been completed. If the R&D succeeds, then none of the R&D costs can be recovered except those that relate to conceptual design. In addition, the costs of compliance would not be recoupable so that the result of keeping records for a potential Credit claim would make the R&D more expensive than if the potential Credit had been ignored.
This fundamental change occurs irrespective of the definition of R&D. Of course, the package also significantly restricts what constitutes eligible R&D and radically changes the compliance regime. These changes combine to render the program effectively useless in the commercial R&D marketplace.
The Credit actually rewards failure and has no real role to play in successful R&D. We believe that the introduction of the Credit will reduce government support for R&D to at least 25% of current levels (i.e. $300-400 million per annum cf. the current $1.4 billion). The package does not accord with announced government policy.
MJA is working with industry lobby groups, other advisory firms and its clients to alert the Government to the fact that the Bill does not reflect its announced policy.
In the past week, the responsibility for the package has moved from the Office of the Assistant Treasurer to the Office of the Treasurer. We see this as a direct reflection of the growing awareness in the Government that the announced package has fundamentally changed the character of the R&D tax incentive and is not in line with the Government’s Budget announcement and stated policies. Kris Gale, Managing Director of MJA, is engaging directly with Ministerial representatives to discuss the impacts of the Bill.
Furthermore, MJA has met with officials from the Treasury, the Department of Innovation, Industry, Science and Research and AusIndustry to discuss the matters at hand. We were given an excellent hearing and were able to explain the grave concerns we hold regarding the impact and operation of the changes. We have been given a direct request to provide practical examples of the problems we envisage and it was agreed that these will be treated separately from the public submissions which close on 5 February. We will be responding accordingly and value any input you might wish to provide in this regard.
Moving Forward
MJA will continue to update you regarding this critical issue. We remain committed to addressing the severe shortcomings with the current proposals so that we can all move forward with a valuable and workable R&D incentive to help meet the upcoming technical challenges facing your businesses.
We want something that works for the real Australia rather than for the mythical Land of Oz.
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: A Chance To Be Heard
The Federal Government held two “pre-consultation” sessions in Melbourne (19 June) and Sydney (26 June) to help prepare a discussion paper regarding the new R&D Tax Credit legislation announced in the May Federal Budget. Following the release of the discussion paper in mid-July, a formal consultation process will commence.
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.
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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.
Why ‘whole of mine’ fails the interpretation test
The floor of the United Nations General Assembly buzzes with the languages of its 192 member states.
Yet, as each representative rises to speak in their native tongue, they are confident that what they say will be faithfully interpreted to the balance of the assembly. They understand that a verbatim translation of what is said may make no sense in a foreign tongue, and so rely upon the interpreters to communicate the meaning as best they can. This transfer of meaning is the interpretation test.
But, no one is present to interpret English to English, or Spanish to Spanish.
Sometimes you need interpretation even in your native tongue
When the Cutler Review of the National Innovation System published its report Venturous Australia in September 2008, one shorthand phrase in the analysis of the R&D tax concession stood out, the reference to ‘whole of mine’ claims. This is what was recommended:
appropriate measures be taken to heavily constrain ‘whole of mine’ and similar claims against the existing R&D Tax Concession program or proposed Tax Credit program.
Unfortunately, from literally interpreting the phrase, many people think they know what ‘whole of mine’ claims are, but the term has no legislative, policy or administrative meaning. In fact, the government has said nothing about the phrase or policy issue at all.
Yet, we have already started to receive questions from AusIndustry on behalf of Innovation Australia as to whether or not particular projects or claims are ‘whole of mine’ claims.
In one case the applicant has been asked why a claimed project is not a ‘whole of mine’ claim, despite the claim being for a very small fraction of one year’s operating costs.
This is the problem of shorthand, and of administrative decision makers interpreting a policy signal from a review document.
We need to focus on context for interpretation
In our response to the Cutler Review Report we said:
The term, ‘whole of mine’, has recently emerged as a type of shorthand for describing large claims and needs to be removed from the lexicon of the discussion. It adds an emotive element that clouds discussion as to the role that can be played by a tax instrument in innovation policy. A mythology has been built up around these claims that needs to be moved on from in the current debate.
Large claims are definitely made within these industries from time to time but MJA suggests that this is not routinely the case. Our profiling of our client base suggests that large one-off projects are an occasional feature of large, diversified groups such as mining houses and engineering firms. They make up but one component of their substantial, constantly evolving portfolio of innovation activities. Even when they occur, total R&D claims will invariably fall well below 10% of group turnovers in the relevant years.
This context is critically important. Just because large claims are made they do not necessarily demand further scrutiny. Moreover, many smaller companies, including those in the biotechnology, medical research and software sectors routinely have periods of R&D intensity that equal or exceed those of larger firms.
But you don’t hear an outcry about ‘whole of cure for cancer’ claims.
We need to focus on eligible R&D and eligible expenditures
In either case, ‘whole of mine’ or ‘whole of cure for cancer’, what advisers, government assessors and decision makers need to come back to is an assessment of the principles of eligibility of both the R&D being undertaken and the associated, eligible expenditures.
Under the present rules, R&D is neither more nor less eligible for government support because of the size of the expenditure on the project. This is one of the benefits of having the administration of eligibility of activities separated from the administration of the eligibility of expenditures.
Innovation Australia, in looking at the eligibility of activities, should reach the same outcome as to eligibility regardless of the expenditure involved. In fact, the quantum of expenditure should be irrelevant to the decision making process, and the provision of such information should be optional.
Similarly, the ATO should reach decisions as to the eligibility of expenditures without regard to the nature of the R&D activities undertaken. Whether they assume an activity to be eligible or request assessment of eligibility by Innovation Australia, the outcome should be no different for the taxpayer.
We need an end to the innovation policy vacuum
The Minister for Innovation, Industry, Science and Resources has repeatedly said that “in the twenty-first century, innovation policy is industry policy“. To date, though, most of his actions have been around very traditional industry policy areas: automotive; textile, clothing and footwear; and university research.
The current global financial crisis has affected the speed with which a cogent response to the recommendations of Venturous Australia can be prepared. But if we are going to see a ten year innovation policy announcement from the government it’s going to need some level of consultation and analysis.
Ideally, there will be an opportunity to engage on topics that span policy, politics and administration, as a ten year policy will likely need some level of bipartisan, industry and administrative support to be well received and executed.
Most of all we need fair interpretation for program certainty
It is unfair that applicants for the R&D tax concession need to address a loaded and vague term like ‘whole of mine’ when defending their claims.
It is even more unfair when they need to do so because administrative decision makers are interpreting future policy signals from a government-initiated review of the National Innovation System when there is no policy response.
Just imagine if this level of misinterpretation was at work in the United Nations General Assembly.
Perhaps there would be demand for people to interpret English to English after all!
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 peforming, or how we could improve.
Do you know what happened 4,279 days ago today?
Something happened 4,279 days ago that changed the relationship between government and industry significantly. Do you know what it was?
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!
