The R&D Tax Incentive: There Is A Tunnel. Is There Light At The End Of It?

July 31, 2019 Kris Gale

The past year has been a tough one for the R&D Tax Incentive (the Incentive).

The Federal Government’s attempt in 2018 to introduce an R&D intensity test for larger claimants courtesy of the Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 (the Bill) failed. Stakeholders (including Government Senators) rejected the measure as being fatally flawed. The Bill was recently reintroduced without the R&D tax provisions and MJA understands that the process has commenced to reconsider what changes should be made to the program going forward. (Cue criticism that this contributes to further uncertainty to any company who would like to see the Incentive as a stable longer term investment consideration but that is a discussion for another time).

Further, the mainstream press for more than a year has been reporting the plight of companies who have suffered through very negative audit experiences as the regulators seem to have been adopting positions across a range of issues around eligibility that stand in stark contrast to the delivery and administration of the program in the early years of the Incentive.

The above factors, when combined with the introduction of an annual claim cap in 2015 and offset rate cuts in 2016, have seen a precipitous decline in program participation in recent years and a significant fall in the amount of R&D support being accessed by Australian companies. This has translated in the program’s main KPI, business expenditure on R&D (BERD) as a percentage of GDP, fall below 1%. And there is the recent news that Australia has dropped out of the Top 20 on the Global Innovation Index.

One would be entitled to think that stakeholders should be gathering as we type to get the Incentive back to doing its job. In fairness, however, the focus on the regulators has appeared to be to continue to deliver the program according to their recently improved understanding of what the legislation allows. Many commentators have characterised that “improved” view as being more accurately described as “narrowed” and “restrictive”. How often have we been hearing that refrain that the Incentive is no longer seen as providing any real incentive or encouragement to Australian innovation.

Well, there is a strong light now glimmering at the end of the tunnel for those stakeholders who have significant misgivings about the approach of the regulators with the recent publication of a decision of the Full Federal Court, Moreton Resources Ltd v Innovation and Science Australia [2019] FCAFC 120 . The decision allows an appeal made by Moreton Resources Ltd, with the matter remitted back to the Administrative Appeals Tribunal (the AAT) for determination.

The case concerned the question of whether activities undertaken in relation to an underground coal gasification pilot facility were core or supporting research and development activities pursuant to the provisions in Division 355 of the Income Tax Assessment Act 1997 (Cth) (the ITAA 1997).

The substantive issue on appeal was whether the Tribunal erred in its narrow construction of “core R&D activities” and, in doing so, had implicitly rejected Moreton’s alternative submission that if the activities were not core, they were nonetheless “supporting R&D activities” because they were directly related to core R&D activities registered during an earlier income year.

The Full Court held that the Tribunal’s narrow construction of “core R&D activities” was in error and that the decision be set aside.

The key findings of the judges were as follows:
The object of Division 355 of the ITAA 1997 is to encourage industry to conduct R&D activities and this object is advanced by supporting the eligibility of R&D activities that have the purpose of generating new knowledge with respect to the application of an existing technology at a new site.
The words ”experimental activities” in the opening line of subsection 355-25(1) are not intended to narrow the interpretation of the provisions setting out what constitutes eligible R&D activities and these words have “have very little, if any, work to do” beyond reflecting the types of activities in paragraphs (a) and (b) which are the familiar eligibility requirements around hypothesis through to logical conclusions, systematic progression of work, unknown outcomes and the purposes associated with new knowledge.
The Tribunal looked at the text, context or purpose of the provision and the extrinsic materials including the Explanatory Memorandum (the EM) in reaching its decision.

In other words, the Full Court determined that the AAT and the Innovation and Science Australia Board were applying a narrower interpretation of core R&D activities than intended by the legislation. It highlighted that the AAT’s position departed from a dictionary definition of an “experiment” which says that an experiment can be “a test or trial;…an act or operation for the purpose of discovering something unknown or testing a principle”. Many will be familiar that AusIndustry has being disallowing activities on the basis that the company was conducting tests or engaging in trial and error activities (something specifically contemplated as being eligible in the EM), as opposed to “eligible experiments”. That approach must now be subjected to detailed scrutiny as the concern is that legitimate claims have been rejected across many fields including computer software, mining, manufacturing, agriculture and business and construction on an inappropriately narrow interpretation of the eligibility criteria.

To its credit, the Department of Industry, Innovation and Science was very proactive in publishing a link to the case in its R&D Tax Incentive Information Bulletin last Friday. It acknowledged that these court decisions “…can provide useful interpretive guidance”. Amen to that.

It is possible that the decision could be appealed. MJA trusts that it is accepted by all parties as an accurate reflection of the legislation and that it helps drive a process where a consensus can be reinstated about what constitutes an eligible R&D tax claim and we can get working on restoring our domestic BERD levels and our international R&D reputation. We need to keep heading towards the light.

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