Getting your first “cap”. The R&D Tax Incentive: The $100 million expenditure cap and what it means.

February 22, 2015 Kris Gale

With the 2015 Cricket World Cup underway, several players are enjoying the fact that they have received their first World Cup “cap”. It’s a time for personal and national pride and for celebration by family and friends. We’re not sure that the R&D Tax Incentive (the Incentive) has cause for a similar-style celebration in the wake of receiving its first expenditure cap in its 30 year history.

The Tax Laws Amendment (Research and Development) Bill 2013 (Targeting Access) with the PUP amendment has now passed through the House of Representatives.

For taxpayers whose income year begin on or after 1 July 2014, their eligible group R&D expenditure will be capped at $100 million.

The rapid process by which the cap became law after Parliament resumed last week has surprised many in the innovation community. There was no public consultation on the measure. There is no clear indication of who will be affected but it is certain that it is a different list than those who were subject to the originally proposed $20 billion exclusion clause. There is no practical guidance as to how affected taxpayers should go about their claims. There are concerns about the imminent double whammy of the Tax & Superannuation Laws (2014 Measures No.5) Bill 2014 (the Budget Bill) which introduces an across-the-board cut of 1.5% to the R&D Tax Offset Rates of 40% and 45%. Throw in the recent guidance concerning feedstock (which will be the subject of another MJA Update) and taxpayers are being asked to absorb a huge amount of change and work their way through all the attendant uncertainties.

This Update will try and set out the main issues that fall to be considered. In a subsequent Update, we will respond to some of the recent public commentary that suggests that the cap is, in fact, a positive change for the program. We have a contrary view and we are very concerned about its impact when combined with the Budget Bill.

The basic methodology underpinning the imposition of the $100 million cap on R&D expenditure involves the application of the R&D Tax Offset at two rates. The first rate will apply to the first $100 million of R&D expenditure at the R&D Tax Offset rate appropriate to the business group. This almost certainly will be the 40% Non-Refundable rate. Once total group R&D expenditure in a year exceeds $100 million, the R&D Tax Offset rate falls to the corporate tax rate which is currently 30%. As such, under the new provisions, all R&D expenditure remains not deductible as it eligible for the applicable R&D Tax Offset rate (see the new subsection 355-100(3) of the Income Tax Assessment Act 1997 (ITAA 1997)). In the case of R&D partnerships, the cap would apply to the each partner’s R&D expenditure including their share of the partnership’s R&D expenditure.

The calculation of the available Incentive benefit is complicated if the business needs to make feedstock adjustments, government funding clawbacks or depreciating asset balancing adjustments. The new provisions have unavoidably added complexity in attempting to deliver a solution that ensures that an 10% additional tax is not imposed on the component of R&D Offset claims that are only claimable at the corporate tax rate, in other words, on the expenditure in excess of $100 million.

Beyond the simple case, questions associated with the treatment of expenditure clawbacks and adjustments by the amendment yet to be answered include:

What if there are different adjustments in the same year?

The taxpayer can determine the order in which these are taken, but that order, once made through the tax return, is irrevocable
What if the additional tax is payable in a year after the R&D expenditure was incurred?

This will commonly occur with the feedstock adjustment. It will also apply to balancing adjustment income for assets used exclusively for R&D since the Incentive commenced (s355-315, ITAA 1997), assets partly used for R&D since the commencement of the Incentive (ss40-292 and 40-293), assets used exclusively for R&D under the Incentive and under the R&D Tax Concession (s355-325 of the Transitional Provisions) or assets partly used for R&D under both programs (s40-293 of the Transitional Provisions).

The new provisions provide for the additional taxes to not apply in the year the tax would otherwise be payable unless the business has received an R&D Tax Offset above the corporate tax rate for that R&D expenditure even if this expenditure occurred in a prior year. This will require a business to track their R&D Tax Offset expenditures which will involve splitting between those that received an increased offset and those that received an offset at the corporate tax rate only.
What happens if the offset rate reduces to only 8.5% above the tax rate as is proposed in the Budget Bill, given the current belief that the effective large company tax rate may stay at 30%?

Currently, it is not proposed to change the 10% rate applicable to the additional taxes associated with identified clawbacks and adjustments despite the Budget Bill retrospectively reducing the Non-Refundable Offset rate to 38.5% from 1 July, 2014. This could led to a situation where companies performing R&D pay tax at a higher effective tax rate than those who carry out no R&D at all!

Further analysis is likely to uncover other complications not identified at the time that the amendment was hastily cobbled together.

One outstanding practical question that has not been addressed to date is how affected company groups approach the matter of registration. Given the self-assessment nature of the program, it can be several years before AusIndustry and/or the Australian Taxation Office risk assess R&D claims. What are the implications if a company only receives an R&D benefit on $100 million worth of R&D activities as per the cap, yet they believed they carried out R&D to the value of, say, $200 million? The question becomes one of “Which $100 million do I register?” Or perhaps it’s one of “Is registering $150 million enough of a buffer against a bad audit outcome?” One can imagine taxpayers debating the competing merits of registering a small number of high dollar projects against a spread portfolio of a more diverse range of projects in terms of technology and cost.

Clearly, the regulators have much to consider in delivering a workable system. We believe that it is critical that the politicians remain plugged in to the consequences of this decision, particularly as they fall to consider the even deeper cuts potentially associated with the Budget Bill.

The fallout from the PUP amendment and the concerns around the Budget Bill will inform the next MJA Update which will be issued later this week.
In the meantime, should you wish to discuss this matter any further, please do not hesitate to contact Kris Gale on (02) 9810 7211 or kris.gale@mjassociates.com.au