The New R&D Tax Incentive: Refundable R&D Tax Offset – Some Value Trimming And A Fascinating Change

May 10, 2018 Kris Gale

In yesterday’s MJA Update, we focused on the announced changes to the Non-Refundable R&D Tax Offset based on an R&D Intensity measure. The market in the past 48 hours has indicated strongly that these changes are not welcomed (once it was able to unravel the complex detail), particularly as the base rate of tax benefit offered (4%) sets a new world record as the lowest R&D tax “incentive” rate offered anywhere.

Today, we look at the Refundable R&D Tax Offset which is accessed by the majority of the program claimants as their annual group turnover is less than $20 million.

Context

As we have highlighted in many previous Updates, the proposed cuts to the R&D Tax Incentive (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 the Budget savings will be returned to consolidated revenue as opposed to their 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

From 1 July 2018, the Government intends to:

• Introduce a $4 million annual cap on cash refunds for R&D claimants with aggregated annual turnover less than $20 million. Amounts that are in excess of the cap will become a non-refundable tax offset and can be carried forward into future income years;
• Exclude R&D tax offsets for clinical trials from the $4 million cap on cash refunds, recognising the critical role of R&D expenditure on clinical trials in developing life changing drugs and devices; and
• Amend the Refundable R&D Tax Offset so it is a premium of 13.5 percentage points above the claimant’s company tax rate for that year.

Analysis

Prior to the introduction of the Incentive in 2011, MJA advocated for an annual cap on cash rebates available under the Refundable R&D Tax Offset to maintain a degree of discipline in the program. Our concern has been that an uncapped offering is too generous and doesn’t place sufficient pressure on start ups to make the hard-nosed commercial decisions about completing/continuing/failing the funded R&D activities. The $4 million cap appears reasonable and generous and it is pleasing to see the confirmation that excess amounts can be carried forward into future years.

We have felt the open-ended refund has been a real issue in the biotechnology sector and we are fascinated by the fact that clinical trials have been specifically excluded from the cap because, in the Government’s words, it recognises ” the critical role of R&D expenditure on clinical trials in developing life changing drugs and devices”.

A strong feature of Australia’s R&D tax regimes since 1985 has been that they have clearly excluded certain activities from eligibility and, beyond that, they have been technologically agnostic. If the clinical trials exclusion is legislated, it can be argued, for the first time, that  a moral dimension has been introduced to the program. In other words, we think R&D to save lives is more meritorious than getting 3% out of the cost of your blast furnace by technical innovation. The risk is that you put the program on a slippery slope because you start to legislate additions and exceptions to the support mechanism based on the perceived “goodness” of the work. Obviously, there are strongly held views in this regard and we welcome debate around them.

Finally, there has been some confusion about the final aspect announced regarding the amendment that sets the tax benefit to 13.5% above the prevailing company tax rate. This means that the offset rate is no longer a set number (currently 43.5%). Your rate is the addition of your company tax rate plus the 13.5%. So, refundable claimants with a 30% company tax rate continue to have a rate of 43.5% while those with a company tax rate of 27.5% will now have a rate of 41% so the eligible cash back on claimed R&D spend will be lower than currently. MJA understands the thinking behind this move as, ultimately, the Incentive should be considered as a cost that reflects the “permanent difference” in the long run for a recipient that ultimately starts paying tax. Ironically, Treasury never takes this view when they cost the Refundable R&D Tax Offset. But, no surprises there.

We look forward to the Opposition’s response to these proposed changes as we start to get a sense of the chance to test the quality of the announcements via the Senate Committee process.

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