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 Issues Paper. It’s arrived and it’s a worry….but don’t panic just yet
The much-anticipated R&D Tax Credit issues paper finally arrived last Friday. The consultation paper is available on the Treasury website. And like the refrain of the old song, given that we have been waiting for the paper to appear since the Federal Budget in May, one would be justified in crooning “Is that all there is?”
The New Research and Development Tax Incentive
The first thing to note is that the paper, entitled “The new research and development tax incentive”, has been issued by the Treasury. This is a big surprise as Treasury officials did not attend the consultation sessions on the R&D tax concession held last year as part of the National Innovation Review. Furthermore, the two pre-consultation sessions held in June this year were headed up by a representative of the Department of Innovation, Industry, Science and Research rather than a Treasury official.
The impression that Treasury has taken control of the process is reinforced by the fact that responses to the paper, due by Monday, October 26, are to be submitted to the Business Tax Division of the Treasury. This is all a great worry. Is it now the case that the destiny of the Federal Government’s flagship innovation program is no longer in the hands of the government department actually responsible for innovation? This matter will need to be pursued with vigour. The process is subject to a tight timeframe as draft legislation is mooted by the end of the year.
The paper itself is an odd amalgam of decisions apparently already made and areas for discussion where there is no guidance as to what the thoughts of the authorities actually are. It includes a series of unsubstantiated assertions about the operation of the current R&D tax concession and betrays an extremely poor understanding of how business R&D (BERD) occurs. It is easy to get carried away by the disappointing quality of the paper’s analysis and it will predictably attract a firestorm of criticism from the business community with regards to the number of restrictions to eligible activities and expenditures that the Treasury appears to be advocating.
However, now is not the time to panic.
Firstly, there a number of positives to reflect on:
- Increased rates of benefits
- Removal of the complexities associated with the premium
- Extension of the rebate concept
- More generous provisions relating to overseas R&D
- Allowing foreign ownership of generated IP
- Improvements to R&D software rules
Achieving Workable Outcomes
Secondly, the huge concerns raised by the discussion regarding ‘Eligible R&D activity’ in the report need to be vented but then channelled into achieving workable outcomes. The Government needs to be reminded of the main policy game here – improving Australia’s overall R&D effort. There is a need to learn from the lessons from 1996 where the Coalition’s introduction of significant reductions to the R&D Tax Concession led to a collapse of Australia’s BERD over the next 5 years. We are already behind our competitors. Unnecessary restrictions will run the risk of Australia dropping off the back of the pack.
Businesses and Stakeholder Organisations to Have Their Say
Finally, the consultation process must be approached as a real opportunity to turn around the poor performance of the administration in program delivery in recent years. The new Credit, however defined, will fail if it is delivered by the same administrative mindset currently associated with the R&D Tax Concession. The experiences of taxpayers need to be submitted directly to the authorities so that this message is clearly heard.
MJA will be working with its clients, industry bodies and other interested parties to ensure that all the relevant issues are raised in the consultation process. We would be delighted to assist you in this regard in whatever manner you deem appropriate.
To discuss the matters raised in this MJA Update in greater detail, please contact Kris Gale on (02) 9810 7211 or using our contact form
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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.
Budget 2009: Innovation Policy Announced
R&D tax credits to offer higher rates of benefit to broader range of companies
MJA’s Managing Director, Kris Gale, was invited to attend a budget lock down hosted by the Minister for Innovation, Industry, Science and Research, Senator Kim Carr and the Minister for Small Business, Craig Emerson. The highlight was the announcement of a new R&D tax credit system which, along with a range of other initiatives, is a positive response to the Cutler Report. At the same time, the government released a new white paper, Powering Ideas: An Innovation Agenda for the 21st Century (PDF).
In an overall sense this is a pro-innovation and pro-business budget
In an economic environment that has required some cuts to some government programs, balanced with appropriate stimulus activities, innovation investment has clearly been recognised for its economic benefits.
The government has announced an R&D tax credit with two levels of assistance:
- a 45% refundable credit for companies with turnover of less than $20 million (we assume that this will be calculated on a group basis, similar to the current R&D tax offset), equivalent to a 150% tax concession; and
- a 40% non-refundable credit for companies with turnover of more than $20 million and for companies with foreign-owned intellectual property arrangements that conduct R&D in Australia. This is equivalent to a 133% tax concession.
Reacting to these announcements, MJA’s managing director, Kris Gale reflected, “in meeting with Senator Carr, he said he wanted an R&D tax program with ‘winners with no losers’, and that’s essentially what’s been delivered.”
R&D tax credit announcements
The new R&D tax credits take effect for income years commencing after 1 July 2010. Of particular significance, the change to an R&D tax credit system means that the rate of support will be decoupled from the corporate tax rate, whether that increases or decreases in future.
In addition, there will be a review of the program eligibility criteria in developing the new legislation and a consultation paper will be released in the next few months. This is a positive process, and we welcome the fact that changes to eligibility were not a part of tonight’s announcements.
One of the strengths of the current R&D definition is that it is based on industrial concepts of R&D. MJA looks forward to working with government to preserve this critical feature of the program.
Groups with turnover less than $20 million
Where a group’s annual turnover is less than $20 million, companies will be eligible for a 45% refundable credit. This is equivalent to a 150% tax concession which is double the rate of support currently available under the base 125% program. This is a significant increase, as the current refundable offset has a group turnover limit of $5 million, and Aggregate R&D Expenditure capped at $1 million.
For the R&D tax credit the turnover limit has been increased to $20 million, and the cap abolished.
As a transitional measure, for the 2009/10 income year, the Aggregate R&D Expenditure cap will be lifted to $2 million to provide more support and flexibility for organisations that currently do not qualify.
The government estimates that 5,500 firms will benefit under these new arrangements.
Groups with turnover great than $20 million
Where group turnover is over $20 million, companies will be eligible for a 40% non-refundable credit, equivalent to a 133% tax concession, again one-third higher than the current basic rate of support.
Further, companies conducting R&D in Australia where intellectual property rights are held offshore (as for the current international premium R&D concession) will also able to access this credit.
Reform to existing programs
Both the current 175% premium and international premium will be abolished in line with the introduction of the new credit system, and the 2009/10 income year will be the last for claims under those programs. It appears that the government definitely reacted to feedback that these programs were unpredictable, didn’t dramatically influence new projects or provide a compelling reason to locate foreign-owned R&D in Australia.
No new competitive grants
In an overall sense the value of the support under these announcements is approximately $1.4 billion, however there were no new announcements in relation to competitive grants for R&D. Whilst there are initiatives for other areas (Commonwealth Commercialisation Institute and Clean Energy), there is no replacement for Commercial Ready and no commentary on additional funding for Climate Ready.
This means that discretionary grant-based R&D funds for classic projects appear to be at an end under the current government.
What questions do you have?
It’s always helpful to have your feedback on the articles we prepare, and the approach we’re taking in dealings with the government. This is particularly the case with a time-sensitive announcement such as the outcomes on budget night.
You can help us by filling out a Comment below this article on our website, and giving us any feedback you have on this initial summary of innovation policy as it relates to the 2009/10 federal budget.
If you post a question relevant to the area we’ll do our best to answer it in the more detailed analysis we will be preparing over the next 24 hours.
Update on Whole of Mine R&D tax issue
An update on the Whole of Mine issue from the last MJA Update: both the Minerals Council of Australia and the Australian Institute of Mining and Metallurgy (AusIMM) have included this issue in their pre-budget submissions.
Both of these submissions provide very good reasoning on why the term “whole of mine” is a dangerous shorthand, and warn the government to be cautious in response to Venturous Australia.
