• p. 02 9810 7211

MJA Updates

The R&D Tax Incentive Review – What Happens When You Start Unpacking The Messages

October 6, 2016 Kris Gale

The recent release of the R&D Tax Incentive Review (the Review) has again seen the R&D Tax Incentive (the Incentive) hit the headlines and, as usual, for a mixture of the right and wrong reasons. The innovation community has been given an opportunity to respond to the recommendations of the Review by 28 October. We urge you to consider making a submissionbut recognise the very real phenomenon of review fatigue. MJA has been taking its fatigue medication and will be making a submission.

Over the next three MJA Updates, we will attempt to unpack the Review and share the conclusions we have reached. We will provide an overview of the Review in this MJA Update and then fall to consider the integrity and the effectiveness/additionality recommendations in the subsequent editions.

In this summary, we outline the context in which the recommendations are made which is crucial in assessing the viability of what is being proposed. We highlight that the Review is calling for a major reduction of R&D support in Australia but did so without the knowledge of the passing of the recent 1.5% R&D offset tax rate cut which has lowered support across the economy by somewhere between 10-15%. Further, the Review makes its recommendations on the basis of a confused idea of what a large business actually is. Allied to this is a failure to recognise that connecting the benefits available to a significant class of participants based on a variable such as total business expenditure (the Intensity test in Recommendation 4 set out below) will undermine the value of the Incentive as an R&D planning tool and effectively disenfranchise whole sectors of the mature economy.

Having said that, we find much to admire in the philosophical stance taken by the Review as it seeks to remedy some of the recent imbalance in the Incentive that has seen it as being too generous for start ups at the expense of incentivising our large innovators. Yet the failings alluded to above run the risk of diverting attention away from many of the sound recommendations being made.

What Is The Review Proposing?

Turning to the detail, the Review provides the following recommendations:

Recommendation 1. Retain the current definition of eligible activities and expenses under the law, but develop new guidance, including plain English summaries, case studies and public rulings, to give greater clarity to the scope of eligible activities and expenses.

Recommendation 2. Introduce a collaboration premium of up to 20 percent for the non-refundable tax offset to provide additional support for the collaborative element of R&D expenditures undertaken with publicly-funded research organisations. The premium would also apply to the cost of employing new STEM PhD or equivalent graduates in their first three years of employment. If an R&D intensity threshold is introduced (see Recommendation 4), companies falling below the threshold should still be able to access both elements of the collaboration premium.

Recommendation 3. Introduce a cap in the order of $2 million on the annual cash refund payable under the R&D Tax Incentive, with remaining offsets to be treated as a non-refundable tax offset carried forward for use against future taxable income.

Recommendation 4. Introduce an intensity threshold in the order of 1 to 2 percent for recipients of the non-refundable component of the R&D Tax Incentive, such that only R&D expenditure in excess of the threshold attracts a benefit.

Recommendation 5. If an R&D intensity threshold is introduced, increase the expenditure threshold to $200 million so that large R&D-intensive companies retain an incentive to increase R&D in Australia.

Recommendation 6. That the Government investigate options for improving the administration of the R&D Tax Incentive (e.g. adopting a single application process; developing a single programme database; reviewing the two-agency delivery model; and streamlining compliance review and findings processes) and additional resourcing that may be required to implement such enhancements. To improve transparency, the Government should also publish the names of companies claiming the R&D Tax Incentive and the amounts of R&D expenditure claimed.

The Report has indicated Recommendations 1, 3 and 6 seek to improve program integrity. Recommendations 2, 4 and 5 are related to improving the effectiveness and level of additionality associated with the Incentive.

The Bottom Line?

In short, it needs to be recognised that the Report is calling for a significant cut in the support provided under the Incentive, both in substance and form.

The reduction in substance relates to companies with a group turnover of $20 million or more. Under the Review’s proposal, they will only receive the Incentive on their annual incremental R&D expenditure over the defined intensity threshold. For example, take a company spending 3% of its total business expenditure on R&D. Currently, it receives the Incentive on all its R&D expenditure up to an annual limit of $100 million (which the Review suggests could be lifted to $200 million if an intensity testy was introduced). Now, assume an annual intensity test is introduced (R&D expenditure divided by total business expenditure per annum) and the eligibility threshold is set at 2%. Under the intensity test, the company would only receive the benefit on a third of its R&D expenditure (3% – 2%). If its annual result fell to 1.95%, it would receive absolutely nothing.

In terms of form, under the Review’s proposal, loss making companies turning over less than $20 million that are currently able to access the unlimited cash back option under the Incentive will be restricted to $2 million cash back per annum with the balance available only as carried forward losses.

It’s All About The Context

The next two MJA Updates will look at these restrictions in greater detail, along with the other positive aspects of the recommendations such as the boost for private/public sector collaboration..

In order to do that, we submit that the Review needs to be put into a clearer context to facilitate that analysis. We see that context as being the following:

1. R&D Tax Benefits Have Just Been Cut

Since the report was delivered in April, the Government has passed legislation that reduces the level of support from somewhere between 10 and 15%. The recent Omnibus Bill passed an ‘across the board’ R&D tax offset rate cut of 1.5% effective from 1 July 2016.
The Review acknowledged the existence of the rate cut proposal but delivered its findings in an environment where it was not legislated. Adopting the recommendations for cash caps and intensity tests will be a reduction in support on top of the rate cuts.

2. According to the Review, “large companies” have a turnover of $20 million or more.

The recommendation of an intensity test (and the doubling of the spend cap to $200 million) are discussed in the context of the desired impact on the R&D performance of “large companies”. However, the Review simply assumes that large companies have a turnover of $20 million or more.
This means that the recommended policy changes apply equally to a company with a turnover of $21 million as to one with a $3 billion turnover. This would be an absurd result and will be further analysed in an upcoming MJA Update.
It must be remembered that the $20 million turnover limit in the Incentive was solely introduced to limit the availability of the cash refund option for loss making companies. Even the ATO defines SMEs as having a turnover of $250 million or less.
The design of an intensity test to apply to companies with turnover of greater than $20 million will disqualify a huge number of mature companies from the Incentive entirely.
It should also be noted that the impact of the intensity test is not modelled in any way in the Review’s findings.

3. According to the Review, access to the Incentive for non-refundable claimants can only be determined after the fiscal year concludes.

The intensity test assumes a calculation at year end whereby R&D expenditure is divided by total business expenditure. This effectively negates the ability of the Incentive to be used as a planning driver in determining the level of R&D expenditure undertaken by non-refundable claimants.
It is fair to say that companies have a reasonable level of control over their R&D budgets. Controlling total business expenditure is a far more challenging affair. For example, a global price increase in a key input for a company can blow annual budget estimates out of the water. A company may well increase its R&D above the defined intensity test only to find that this increase is proportionally outstripped by overall operating costs leaving it with less or no R&D support.
The proposed intensity test is reminiscent of the old R&D Premium proposal based on increasing R&D spend relative to turnover that was announced in the 2001 Innovation Statement. That proposal didn’t see out the week and was replaced with a ‘R&D spend history’ model.

These three matters of context are important in turning to analyse the six recommendations in detail.

In the next MJA Update, we will dive further in to the integrity recommendations to see what we can learn.

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

Keep informed

MJA updates keep you informed on how government decisions will effect your business. This is a must if you want to know the latest on business and company insights without having to read and decipher complicated law and tax manuscripts.

* indicates required