The Proposed Intensity Measure for the Non-Refundable R&D Tax Offset: At The Risk Of Sounding Like A Broken Record…

May 3, 2018 Kris Gale

Recent media reports suggest that next week’s Federal Budget will introduce an intensity measure that will restrict access to the Non-Refundable R&D Tax Incentive to those company groups whose R&D intensity (group R&D expenditure divided by group total business expenses) exceeds a certain percentage. The figure mooted is 1%. There is no detail available around the proposal. The Triple F report proposed an intensity test that only afforded the incentive to the expenditure above the threshold. More recently, Innovation and Science Australia (ISA) proposed a 1% ‘trigger’ test which would provide the Incentive to all the expenditure of the qualifying company. Neither report explored the design and impact of their recommendations at any detail and additional explanation and analysis has not been forthcoming.

The 2008 National Innovation Review, commonly known as the Cutler Report, described the Australian innovation system as a doughnut which needed policy measures to fill the hole to deliver a true innovation network. Well, the introduction of the Intensity Measure will just mean that we will be building a bigger hole as thousands of Australian companies face exclusion from the government support framework. And this would be happening at a time where Business Expenditure on R&D (BERD) is falling (12% in 2015/16) and the overall cost of the R&D Tax Incentive is declining.

At the risk of sounding like a broken record, the following is a slightly modified analysis of the Intensity Measure that we provided in an MJA Update in 2016. We have restricted this critique to the problems that apply commonly to either of the versions proposed by Triple F and the ISA.

In the Triple F Report, the Incentive is characterised as a blunt instrument because it is volume-based, accessible to all and “necessarily includes the subsidisation of R&D that would have taken place anyway”.

The essential premise the Review puts forward for the intensity requirement is that better R&D outcomes flow from more R&D-intense companies so only those companies of a sufficient intensity should be able to participate in the program. In other words, the Review wants to sharpen the so-called blunt instrument by reducing the number of users and the costs of participation all in the name of effectiveness and additionality. Where we come from, that type of sharpening usually involves a razor and is usually called a budget cut. And, we submit, a very significant one.

The additionality argument has become so tiresome. Again, no company will do R&D simply to access a tax incentive so you can’t design an incentive that only supports R&D that otherwise wouldn’t have occurred. All a well-designed incentive can do is provide a sufficiently strong cost signal that lowers relative risk of doing R&D, leading to a company doing more R&D in terms of depth, quality and speed and most will be on areas that the company would have pursued without the presence of an incentive. The R&D Tax Incentive must operate as a planning incentive, not an after-the-fact reward.
Further, the Treasurer’s recent comments that misuse of the program necessitates a relaunch don’t make sense. Why should you rework the R&D Tax Incentive to permanently exclude thousands of companies that are using the program responsibly because others are not, particularly where the evidence suggests much of the misuse comes from claimants of the Refundable R&D Tax Offset.

The early returns in the analysis we have been party to suggests that, even at a 1% intensity level, the vast majority of the approximately 3,700 users of the Non-Refundable R&D Tax Offset would drop out of the program. Many would simply fall short of the minimum intensity requirement. Further, of the companies that may technically qualify, the inherent design flaws of the mechanism would see them completely discount the R&D Tax Incentive as a relevant factor in influencing their R&D investment behaviour.

The criticisms of the proposal being tabled are becoming legion and we will briefly itemise some of them here:
Policy – The Intensity Measure will effectively exclude R&D performers who, for a variety of reasons related to their sector, life cycle and expenditure conditions, can never meet even a 1% threshold test. They will become an innovation underclass, unable to access the Incentive for structural reasons with no assistance from the government even in circumstances where they may have dramatically increased their R&D spend.  The Intensity Model rewards some but is punitive to others.
Principles – The proposal obviates two key principles of designing an incentive. A key element of the intensity calculation is a variable not able to be directly influenced by the incentive ie. total business expenses. It is stating the obvious that a range of factors such as global markets and government imposts, which are out of a company’s direct control, contribute to its annual operating cost and the Incentive has no real influence in that arena. Given that, with all the attendant uncertainties, the Incentive loses the ability to be used as a planning tool, condemning it to be an after-the-fact tax calculation. These matters of principle plagued the R&D Tax Concession Premium program throughout its life and ultimately saw its removal in 2011.
Definitional – As it is set out in the Review, the Intensity Measure is justified on the basis of “large” company behaviour in aspects such as they are seen as being better users of basic research and more likely to deliver higher levels of innovation. The Review’s discussion seems to be talking about the very large innovation spenders and this is reinforced by Recommendation 5 to lift the $100 million R&D expenditure threshold to $200 million. Yet, the Non-Refundable R&D Tax Offset kicks in at a group turnover of only $20 million. The proposal becomes a very blunt instrument indeed at that level as R&D conditions are vastly different at the entry level turnover range. Other definitional questions that have quickly emerged relate to the grouping provisions, the exact definition of “total business expenses” and the impact of feedstock expenditure on the Intensity calculations. The net result is more uncertainty and complexity.
Evidence – No modelling has been offered as to the impact of the Measure, even on the simplest basis of who would qualify if the measure was applied to the current claiming community. We are certain that the vast majority of company groups would fail the 1% test with even more being effectively excluded because they are not sufficiently above the mark. Interestingly, the Review did not offer any international precedents displaying examples of such a measure working successfully. MJA understands that only two regimes – Belgium and Japan – operate an intensity regime but these are opt-in programs that offer a higher level of support than the standard regime available. Intensity does not restrict access in these regimes. Rather, it incentivises exceptional performance.

MJA will continue to push the case for an Incentive that remains inclusive for all Australian companies. We are happy to canvass other means of tightening the terms of access (eg. higher minimum spend thresholds) to support program integrity. Overall, if program costs need to be reduced as a political reality, the only fair way is to drop the head offset rates.

All this makes for what will be a lively innovation debate following the delivery of the Budget next Tuesday night.

Should you wish to discuss this matter further, please do not hesitate to contactKris Gale on 02 9810 7211 or email kris.gale@mjassociates.com.au