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A “Better Than Ever” R&D Tax Incentive?

By Kris Gale

Some advice for the government as it sets its sights on revamping support for innovation.

In its first 2 years of life, the R&D tax incentive has struggled for clear air. Delayed for a year by an unfavourable Senate, the program has been subject to constant scrutiny and tinkering since it took effect on 1 July 2011.

September’s victory by the Coalition did not have an immediate impact but the Coalition promised it will be subject to a review with a “better than ever” offering to emerge as a result. Much of the review will occur in the context of the Coalition’s announced taxation White Paper. The new government has undertaken to consider the following:

  • reversing the decision to remove the R&D Incentive from very large companies;
  • the operation of the program’s rules, principles and definitions;
  • the possible creation of a second program stream based more closely on the definition and eligibility criteria of the previous R&D tax concession; and
  • the possible applicability of the “patent box” model to businesses commercialising Australian-developed patents.
  • The R&D incentive is best looked at as an investment measure, not a cost. It should also be considered in the international context where many developed economies offer a tax-based incentive for R&D.

    The review should focus on making systemic improvements rather than wholesale changes or returning to a blank sheet of paper. Program performance data is only appearing for the first time, and residual uncertainty remains about the program’s viability and its detailed application. The review offers a chance to resolve these uncertainties and put the program on a sounder footing.

    Overall, the current program demonstrates some institutional biases that need to be addressed. In a broad sense, the incentive can be said to be an incredible boon for knowledge-based, early-stage, loss-making speculative R&D companies and somewhat of a damp squib for larger, mature, taxpaying companies that make and process things.

    Some specific issues should be considered.

    • Cost Control: The previous Labor government’s Targeting Access legislation, which did not pass through Parliament, sought to remove large taxpayers based on turnover size. No other program internationally has such a feature. If the case for cost control can be made, other parameters such as rates of benefit and group claim caps offer better alternatives.
    • 45% Refundable Offsets: Public announcements of the level of refunds being paid out suggest that the cash payment aspect of the program is “running hot”. For example, two exploration companies announced cash refunds in excess of $20 million in 2011–12. Along with the proposal to move to quarterly payment of refunds in 2014, the uncapped nature of the refundable offset should be considered in terms of the positive impacts of the benefits against the risks to the revenue.
    • R&D Activities: The tax incentive has not yet reached a landed position on the real basis for the distinction between core and supporting R&D activities. The highly subjective dominant purpose test remains unexplained and is causing great concern in the marketplace. The overseas R&D provisions are insufficiently defined and could be greatly improved in terms of certainty.
    • R&D Expenditure: The feedstock provisions appear punitive and add a huge tax administration burden for large-scale producers and processors. The guaranteed return provisions remain unexplained.
    • Program Administration: Some aspects of the program, such as registration, are functioning well. However, there are many issues of concern, including inconsistent program messaging across the AusIndustry network, the simplistic nature of available guidance material, slow response times for advance/overseas finding applications, and the decline in advisory mechanisms such as the National Reference Group.

    We look forward to the rapid commencement of the proposed review so the Australian innovation community can formulate their ongoing R&D plans with renewed certainty that they can access meaningful support from the government’s flagship innovation program.

    Kris Gale is Managing Partner of Michael Johnson Associates.