Overhaul of the R&D tax incentive
As predicted, the Government has announced a number of proposed changes to overhaul the R&D tax incentive. These changes are based on the recommendations that came out of its 2016 review of the R&D tax incentive and the subsequent ‘Australia 2030: Prosperity through Innovation Report’ released in January this year by the Board of Innovation and Science Australia (ISA).
However, despite its considerable investment in these two reviews, the Government has chosen to go further with additional complexity that it believes will reduce the ‘exploitation’ of the R&D tax incentive by large (>$20m turnover) companies. In particular, the Government will introduce a tiered intensity threshold system to the non-refundable offset.
Notably, the Government has chosen to ignore the recommended premium incentive for collaboration with publically funded research organisations – a measure which was strongly endorsed in the Board of ISA’s report.
These changes are due to take effect from 1 July 2018.
Proposed changes to the refundable tax offset (applicable to companies with <$20m turnover)
- Tie the offset rate to the claimant company’s tax rate and fix the offset rate at 13.5% above the relevant company tax rate
- Introduce a $4 million cap on the annual cash refund payable under the R&D tax incentive, with remaining offsets to be treated as non-refundable tax offset carried forward for use against future taxable income
- Clinical trials will be exempt from the $4 million cap.
Proposed changes to the non-refundable offset
For companies with aggregated annual turnover of $20 million or more, the Government will introduce an R&D premium that ties the rates of the non-refundable R&D tax offset to the incremental intensity of R&D expenditure as a proportion of total expenditure for the year. As explained in the table below, the marginal R&D premium will be the claimant’s company tax rate plus:
- Four percentage points for R&D expenditure between 0% to 2% R&D intensity
- Six and a half percentage points for R&D expenditure above 2% to 5% R&D intensity
- Nine percentage points for R&D expenditure above 5% to 10% R&D intensity
- Twelve and a half percentage points for R&D expenditure above 10% R&D intensity.
R&D premium example for a company with an annual turnover greater than $20 million dollars
The Budget papers contain an example of a company with a 30% tax rate that has incurred $120 million of R&D expenditure as part of its total $300 million of expenditure for the year. The company will have an overall R&D intensity of 50%. It claims the non-refundable R&D tax offset at a rate of:
- 34% for the first $6 million of R&D expenditure (equating to a 4% net after tax benefit)
- 36.5% for the next $9 million of R&D expenditure
- 39% for the next $15 million of R&D expenditure
- 42.5% for the final $90 million of its R&D expenditure.
We note that there is no comment as to how taxable subsidiaries of tax exempt entities will be treated. These entities are currently only entitled to the non-refundable offset.
- The expenditure threshold will increase from $100 million to $150 million so that large R&D-spend companies retain an incentive to increase R&D in Australia
- Other changes include improving the transparency of the program by enabling the ATO to publicly disclose claimant details and the R&D expenditure they have claimed, limits on time extensions to complete R&D registrations and amendments to technical provisions (such as the feedstock and clawback rules and the general anti-avoidance rules).
Other measures relating to science and innovation
Although the Government is making cuts to the R&D tax incentive, this is being offset somewhat by additional measures in other areas of technology and science. Such measures include:
- Providing $29.9 million to support Artificial intelligence (AI) and Machine Learning (ML) via targeted Cooperative Research Centres Programs, PhD scholarships and education, and frameworks for future investments
- Allocating $41 million to promote the Australian Space Industry via the establishment of a National Space Agency and International Space Investment project
- Attempting to increase export capability and cooperation between Australian businesses by allocating $20 million to the establishment of a Small and Medium Enterprise Export Hubs program
- Providing $20 million to expand the Global Innovation Strategy grant program, including the establishment of a funding stream targeted at Asia
- Providing $36 million to enable widespread access to standardised satellite data
- Contributing $70 million to replace and improve components at the Pawsey Supercomputing Centre
- Providing a total of $1.3 billion for a National Health and Medical Industry Growth Plan, which will utilise proceeds from the Medical Research Future Fund to promote areas such as genomics research, clinical trial programs and industry research collaborations.
BDO is disappointed that the Government is seeking to reduce its investment in the R&D tax incentive in a time of rapid change and increasing globalisation. According to ISA, the top priority of Australia’s innovation policy should be to increase business expenditure on R&D to push us to the forefront of the global innovation race. It remains BDO’s view that the most efficient and fairest way to support business R&D is through the tax system and not through discretionary direct funding.
Capping the refundable offset
Whilst BDO is pleased the Government has increased the proposed refundable cap to $4 million from the originally proposed $2 million, concerns remain for how this cap will impact entities already heavily invested in large R&D projects. Whilst only a small number of applicants will be impacted by the proposed cap to the refundable offset, these are companies that generally achieve the high levels of R&D intensity that are the target of promotion by the Government. In addition, these are the companies that are the most responsive to fiscal incentives in regards to generating additionality and spill overs.
Further, BDO is concerned that the exemption of clinical trials from this cap suggests partiality in the otherwise broad based, industry agnostic programme.
The changes to the non-refundable offset could provide a benefit to larger R&D intensive entities. However, we have significant concerns that the non-refundable offset constitutes a move away from a focus on the qualitative features of the R&D being conducted to the extent of the businesses investment in R&D as a proportion of total cost.
The intensity thresholds for larger businesses add significant uncertainty and complexity to an already complex area of the tax law. If this measure is passed, all companies with a turnover greater than $20 million will need to reassess whether there is sufficient incentive to comply with the rigorous substantiation requirements of the program. Such a measure may lead to some companies dropping out of the system or to conduct their R&D in more favourable jurisdictions. Complexity can also lead to manipulation – something the measures are purportedly designed to fix.
In particular, BDO notes that:
- The thresholds will reduce certainty around quantum of a claimant’s benefit as the threshold triggers have to be calculated on a retrospective basis at year end and cannot be determined in advance of conducting R&D activity
- A tiered system adds additional administrative burden to all stakeholders, and the design of the mechanism could be open to manipulation - such as the method used for calculating the total annual expenditure. It is unclear from the budget papers whether the threshold is based on the company, R&D entity or group expenditure. We suspect the proposed changes to the anti-avoidance measures might be designed to address any concern here
- We could now have a scenario where two large companies are conducting similar R&D programs and depending on (presumably) group expenditure, one may only get a 4% cost underwrite whilst another will get up to 12.5% cost underwrite due to factors completely unrelated to the R&D itself.
In light of the above, the introduction of the thresholds should be avoided, as they discriminate against high turnover low margin businesses and, in doing so, would unfairly target some of Australia’s most globally competitive industries. It also disadvantages existing businesses diversifying into new areas of technology development investment, substantially increases administrative burden, and further reduces certainty around the R&D tax incentive programme for all claimants.
Increase the expenditure threshold
BDO welcomes the proposed increase in the expenditure threshold. However, it is our view that despite the proposed increase in the expenditure threshold to $150 million, the introduction of the intensity thresholds is likely to reduce the appeal of Australia’s R&D tax incentive programme, especially for large companies who have the discretion of choosing where to conduct their R&D activities.
Transparency of the programme
We understand the Government will give the ATO the power to publicly disclose claimant details and the R&D expenditure they have claimed. We recommend the Government carefully consider the full array of implications that could arise from releasing R&D expenditure values to the general public. Simply releasing financial information without greater context could place undue attention on legitimate claimants.