Just Another Day In Parliament House – R&D Bills Delayed and Something Else Happened
You could be forgiven for missing out on yesterday’s news that the R&D Tax Credit legislation was not considered by the Senate before it concluded its current sitting thereby ensuring that the Credit will not be law by 1 July 2010. After all, it was a pretty quiet day in Canberra yesterday and not much was going on.
However, even though the Tax Laws Amendment (Research and Development) Bill 2010 and Income Tax Rates Amendment (Research and Development) Bill 2010 (the Bills) were due to be debated yesterday, the Senate ran out of time and the Bill was removed from the order of business without comment.
Where does this leave the Bills?
For the moment the existing R&D Tax Concession will continue to apply until it is repealed and replaced by the Bills. This cannot occur before the next sitting of the Senate in late August. At this point, it is anyone’s guess whether it will be affected by the timing of the next election or by the restructuring of the Government under Prime Minister Gillard.
There is still the possibility that the legislation may be enacted to come into effect retrospectively on 1 July 2010 but only if it is before the election. However, the Opposition and minor parties, especially Family First would be likely to prefer a commencement date of 1 July 2011. If the Federal Election is called before the Bills are passed then the Bills will lapse and will need to be reintroduced in the new Parliament.
This is both good and bad. It is bad because it will delay the introduction of the positive changes in the Bills, especially the higher rates, the relaxing of the IP ownership rules and the removal of the 175% incremental amounts.
The good thing is that this delay can be used to overcome the difficulties with the Bills. It may provide opportunities to amend the Bills and for further consultation on their application. It will give the program administrators more time to provide guidance material and to work with businesses and advisors so they can prepare and plan for the changes prior to them come into force.
MJA will continue to send further updates with any news and we will be in touch soon with a more detailed analysis of the likely passage of the proposed Bills.
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
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