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
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.
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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