Innovation and Science Australia Has Its Latest Say On The R&D Tax Incentive: In Developing Software, Innovation Isn’t Good Enough To Support A Claim

January 30, 2018 Kris Gale

Today’s release by Innovation and Science Australia (ISA) of its report, “Australia 2030 Prosperity through Innovation”, sees the ISA take three key positions about the R&D Tax Incentive (the Incentive) and its protracted reform process.

The relevant commentary appears at page 44 of the Report:

“With the benefit of this feedback, and new data gathered as part of the ISA performance review and the development of the 2030 Plan, ISA has identified two opportunities to improve the impact of the recommendations in the Review of the R&D Tax Incentive: The cap referred to in Recommendation 3 of the review of the R&DTI should be set at $4 million per year, and a maximum cumulative refund of $40 million per company should be applied.

The threshold referred to in Recommendation 4 of the review of the R&DTI should be replaced with a trigger set at 1 per cent of total annual expenditure, such that all R&D expenditure is claimable (subject to any other limits) once the trigger level is reached.

ISA is also aware that digital transformation projects have resulted in an increasing number of companies making claims for software-related activities under the R&DTI. However, although such software development projects may be innovative, in many cases R&D activities may form only a small part of the overall project. The definition of R&D in the Industry Research and Development Act 1986 is specific and drawn from the OECD Frascati Manual.”

Taking the commentary regarding software R&D first, the ISA is mistaken in saying that the relevant definition of eligible R&D activities is contained in the Industry Research and Development Act 1986. The definition actually appears in the Income Tax Assessment Act 1997. The clear assertion from the ISA is that innovative software development may not qualify under the definition no matter what Act it is contained in. Where does this leave taxpayers attempting to identify eligible R&D under the Incentive? The Prime Minister discussed the need to innovate, assisted by the Incentive, in his National Innovation and Science Agenda. Yet, apparently, developing innovative software isn’t enough under the law according to Innovation Science Australia. Surely the current software guidance being developed by AusIndustry (in which MJA is an active participant) must involve a public consultation about what the law passed in 2011 means in 2018. MJA argues that it means the same thing now as it did then and that it clearly embraces innovative software development.

In terms of the reform recommendations, the ideas around caps relating to the Refundable R&D Tax Offset are thoughtful and worth exploring further.

And while the 1% ‘trigger’ R&D expenditure test is a softening of the ‘Triple F’ threshold recommendation, it retains all the fundamental problems associated with the original model.

To recap,

• It’s punitive: If you do R&D but not enough in the Government’s estimation, then it doesn’t want you. For many mature businesses, 1% (however measured) represents a huge ramp up.
• It’s uncertain and is not a planning tool: Given the denominator is a yet-to-be-defined group expenditure measure, you don’t know until after the fiscal year is completed whether you get anything at all. You can incur all the compliance cost and can end up with nothing. For example, if you end up $1 short of the 1% trigger, you have no claim. $1 extra and you can get all your R&D expenditure claimed.
• It’s fundamentally flawed in its design: You can’t base an incentive on an element that will not be influenced by the calculation basis of that incentive ie. group operating expenditure. Businesses will not control overall expenditure to achieve an R&D result. Further, you may lose a claim because of changes in cost structures outside the control of the business eg. labour costs of software programmers. You could ramp up R&D spend significantly in any given year but, if costs of programmers increase in greater proportion, you may end up with no claim despite your lift in R&D efforts.

Enacting such a regime would mortally wound the credibility of the Incentive and should be rejected by the Australian innovation community as a priority.

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