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MJA Updates

The New R&D Tax Incentive: Non-Refundable R&D Tax Offset – The Winners (an elite few) and The Losers (everyone else)

May 9, 2018 Kris Gale

All Budgets need to crack down on areas of concern to help pay for things like income tax cuts and the like. Reading last night’s Budget Papers, it seems like the three areas where the Federal Government needed to act were the age old enemies of illicit tobacco, cash-in-hand payments (ie. the Black Economy) and the R&D Tax Incentive (the Incentive). So it looks like our flagship innovation program is being held in very high regard right now.

Has it really come to this? What a sad day of the Australian innovation community as the Government announces changes that are set to disenfranchise potentially thousands of Australian companies performing valuable R&D.

As the innovation community starts to unpack the complicated changes announced regarding the Incentive in last night’s Federal Budget, it has become crystal clear that the vast majority of the more than 15,000 program users are negatively affected by the fiscal affordability and integrity measures set out in the Budget Papers.

Only an elite few company groups will be better off as a result of the mooted legislation. They are the Non-Refundable Offset companies whose R&D intensity measure is greater than 13.25%, a figure that characterises said companies as ultra high-tech and companies with a high enough R&D intensity to benefit from the proposed sliding scale regime of benefit applied to $150 million of eligible R&D expenditure as opposed to the 8.5% benefit currently capped at $100 million.

Confused already? We’re not surprised. Take it as given that the company groups who are better off are as rare as the proverbial hen’s teeth. For the rest, the news ranges from disquieting to devastating. Over a series of three MJA Updates, we will try and help make sense of what’s proposed.

The changes break down into three areas: Program Integrity; the Refundable R&D Tax Offset: and the Non-Refundable R&D Tax Offset. In this Update, we will look at the huge cuts in support proposed under the Non-Refundable R&D Tax Offset as this is the major concern for the Australian innovation community.


As we have highlighted in many previous Updates, the proposed cuts to the Incentive are being made in an environment where the cost of the Incentive is falling (the combined effect of the $100 million annual claim cap and the 1.5% offset rate cut) and where Business Expenditure on Research & Development (BERD) is falling (12% in 2015/16 according to the ABS figures).

Now the Government believes that further “reform” is necessary to reward additional investment in R&D while also ensuring the integrity and fiscal affordability of the Incentive. And that “reform” is designed to save an additional $2.4 billion in the next four years. So, in other words, the Government is seeking to make a huge cut in support which is tantamount to legislating a further fall in BERD.

The measures announced are seeking to give voice to the 2016 Review Of The R&D Tax Incentive (the ‘Triple F’ report) with a passing nod to the recent Innovation and Science Australia report, “Australia 2030  Prosperity Through innovation”. It is interesting to note in that context that the Treasury has indicated that the Budget savings will be returned to consolidated revenue as opposed to the redirection to other innovation measures recommended in the Triple F report. Further, the Triple F’s legacy recommendation of a collaborative premium for Non-Refundable R&D Tax Offset companies has been completely ignored.

The Announced Changes

The Triple F report concluded that the Incentive was not achieving its objective of encouraging additionality so it has decided to link the level of tax benefit to the ‘R&D intensity’ of the company groups eligible for the Non-Refundable R&D Tax Offset. We understand that the R&D intensity will be calculated by dividing group R&D expenditure by group Australian operating expenditure but this is yet to be confirmed. The annual eligible claim limit will also be lifted from $100 million to $150 million. Both measures are to take effect from 1 July 2018.

Non-Refundable R&D Tax Offset company groups are those with an aggregated annual turnover of $20 million or more.

The regimen of available tax benefits are the claimant’s tax rate for the year, plus:

  • 4 percentage points for R&D expenditure between 0 per cent and 2 per cent R&D intensity (inclusive);
  • 6.5 percentage points for R&D expenditure above 2 per cent to 5 per cent R&D intensity (i.e. not including R&D expenditure falling within the first 2 per cent of the claimant’s total expenses for the year);
  • 9 percentage points for R&D expenditure above 5 per cent to 10 per cent R&D intensity (i.e. not including R&D expenditure falling within the first 5 per cent of the claimant’s total expenses for the year); and
  • 12.5 percentage points for R&D expenditure above 10 per cent R&D intensity (i.e. not including R&D expenditure falling within the first 10 per cent of the claimant’s total expenses for the year).

    The Government has provided a worked example:

“A company with a 30 per cent tax rate that has $120 million of R&D expenditure for the year and $300 million of total expenditure will have an overall R&D intensity of 40 per cent. It claims R&D tax offsets at a rate of 34 per cent for the first $6 million of R&D expenditure, 36.5 per cent for the next $9 million of R&D expenditure, 39 per cent for the next $15 million of R&D expenditure and 42.5 per cent for the final $90 million of its R&D expenditure. It also benefits from the increased $150 million R&D expenditure threshold as it can claim concessional R&D tax offsets for its R&D expenditure that exceeds $100 million, rather than claiming these offsets at the company tax rate.”

Analysis Of The Changes

The worked example is a great place to start. It considers a company with an R&D intensity of 40%. Let’s call that company Unicorn Pty Ltd. You don’t meet companies that spend $120 million on R&D that often and you meet those who do so on a total expenditure budget of $300 million even less often. What can’t be denied is that Unicorn will be better off under the new regime compared with the current flat rate of 8.5% with an annual claim cap of $100 million.

But what if Unicorn had an intensity of “just” 10% (ie. $30 million over $300 million ), a measure that would see it regarded as a very high tech R&D spender? Because the new measures attach the benefits to the various tiers of support, Unicorn gets 2% of its spend at a 4% tax benefit, 3% at 6.5% and 5% at 9%. If you’re still following, a $30 million spend generates a permanent tax benefit of $2.175 million under the new provisions. Under the current regime, the tax saving is $2.55 million so Unicorn is worse off, even at a comparatively high R&D intensity of 10%.

In fact, in order to be better off under the new provisions, your intensity must be greater than 13.25%. Most of the approximately 4,000 companies currently claiming the Non-Refundable Tax Offset are nowhere near that level of intensity. In fact, it is possible that the majority will be in the less than 2% intensity range. The 4% on offer is below the minimum viable rate of 5% that has historically driven discussions about the affordable level of support. When you factor in compliance costs, an offer of an incentive rate of 4% is, in fact, no incentive at all.

The Government needs to urgently reconsider the offer it is making to this sector. At 4%, you won’t be driving innovation behaviour. You will be driving companies out of the program.

In addition, we have repeatedly pointed out the problems with the R&D intensity idea. To summarise:

  • The Triple F’s assertion that R&D intensity delivers better innovation outcomes is unsubstantiated. A start up can spend 100% of its expenditure on R&D. If it never commercialises, its R&D intensity delivers nothing sustainable. It appears the concept is being used as a way of masking a deep budget cut affecting all but a rarefied elite of huge R&D spenders.
  • The application of the R&D intensity measure to companies with a turnover of $20 million is based on a false premise that this turnover threshold defines larger companies. Even the ATO regards SMEs as having a turnover of $250 million or less. Again, the only intended significance of the $20 million threshold legislated in 2011 was to limit eligibility for the cash back aspect of the Incentive. That’s it. To expect R&D intensity levels above 2% from many companies is fantasy, given the nature of their industries such as mainstream manufacturing and their positioning in terms of maturity and life cycle. Many of these companies could double or triple their R&D spend and still fall way short of a 2% intensity test. And at a 4% tax benefit, they are not being offered a true government incentive to encourage a lift in R&D effort.
  • You cannot design a behaviour incentive that is dependent on a factor that you can’t incentivise ie. Australian operating expenditure. Companies cannot control many aspects of their costs at all (eg. inputs such as raw materials; third party costs such as power; government imposts etc.) As such, the Incentive loses its value as a planning tool, condemning it to be an after-the-fact tax calculation with all the attendant uncertainties.

Overall, we are confident that a base offering of 4% would be the least attractive offering available by any R&D tax regime globally. And we continue to highlight that the two regimes offering an Incentive based on a notion of R&D intensity – Belgium and Japan – do so on an opt-in basis to incentivise companies over and above a viable base rate. The key expression here is opt-in.

The urgent need for a rethink is palpable.

We will back in contact shortly to discuss the other announced changes.

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

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