One step forward, two steps back for the R&D Tax Incentive in this year’s Federal Budget

As part of the 2026 Federal Budget, the Government has announced major reforms to Australia’s flagship innovation support program, the R&D Tax Incentive (RDTI), purportedly seeking to simplify the scheme, reduce administrative burden, and better target support for business research and development (R&D) activities. These changes will take effect from 1 July 2028 and will adjust offset rates as well as program delivery and eligibility criteria.

Overall, these changes will reduce what qualifies as R&D and significantly reduce refundability but provide a higher rate of benefit in respect of expenditure that does qualify. The proposed changes will also move Australia out of step with the rest of the Organisation for Economic Co-operation and Development (OECD) regarding the definition of eligible R&D and may have unintended consequences by making compliance activities significantly more complex.

There will be winners in respect of the increased benefit rates, decreased intensity threshold, and expanded program cap, so we recognise that this will enhance the attractiveness of the program for some taxpayers. However, these changes are accompanied by a suite of broader structural changes that risk fundamentally and arbitrarily reshaping eligibility, rather than ‘target’ the scheme based on any quantifiable measure of R&D or productivity.

A number of measures were first flagged in the Ambitious Australia: Strategic Examination of Research and Development (SERD) report, which contemplated targeted, incremental refinements developed through consultation with stakeholders and industry. Despite this, the scale of the proposed measures diverges significantly from the outcomes of SERD and this package has been introduced without any consultation.

At their core, the proposed reforms risk narrowing the definition of R&D and reduce the practical accessibility of R&D support for Australian businesses. The removal of supporting R&D expenditure and the restriction of refundability collectively shift the program away from its original intent of encouraging broad-based, high-risk innovation.

Combined with the regulators’ onerous evidentiary focus, these changes may create a more constrained and compliance-heavy regime that may disincentivise or disallow participation, particularly for early-stage and research-intensive industries. Without further consultation and refinement, it is our view that these measures will undermine both the integrity and the intent of the RDTI, rather than strengthening it.

The proposed changes are summarised below.

Increase in core R&D offset rates

From 1 July 2028, the Government will increase the offset rate for expenditure incurred on core R&D activities by 4.5 per cent. Currently, this is between 8.5 per cent and 18.5 per cent above an entity’s corporate tax rate, but it will be increased to between 13 per cent and 23 per cent. This change will boost the tax benefit (i.e. the offset received less the tax impact of ordinary deductions foregone) by approximately 25 per cent to 50 per cent, depending on a company’s circumstances, providing stronger financial incentives for expenditure incurred on core R&D activities.

Reduction in intensity threshold

The eligibility threshold for the intensity premium will be reduced from 2 per cent to 1.5 per cent. This adjustment, combined with the increased rates, will enable companies that are eligible for the non-refundable offset and spend more than 1.5 per cent of total business expenditure on R&D to access a premium rate of up to 21 per cent above their corporate tax rate.

Removal of supporting R&D expenditure eligibility

The Government will remove the eligibility for expenditure incurred on supporting R&D activities from the RDTI. This means that only expenditure incurred on ‘core’ R&D activities will qualify as a notional deduction for the RDTI.

Turnover threshold and refundability changes

The turnover threshold for the highest offset rate (which will be 23 per cent above the corporate tax rate) will increase from $20 million to $50 million. This will allow growing companies to retain access to the higher offset rate.

For firms below this $50 million turnover threshold, older firms will continue to be eligible for the higher offset rate, but eligibility for the refundable tax offset will be limited to companies under 10 years old. It is currently unclear whether this will be based on the age of the R&D entity or on the age of the corporate group as a whole.

Changes to expenditure thresholds

The maximum R&DTI expenditure threshold will be raised from $150 million to $200 million, and the minimum threshold will be raised from $20,000 to $50,000. Research activities valued below this minimum threshold must be undertaken with a registered Research Service Provider or Cooperative Research Centre to be eligible for the RDTI.

Potential issues and recommendations

We welcome the increased benefit rates, the lowered intensity threshold and the higher program cap, and view these changes as beneficial to the program. Certain taxpayers (particularly those who are currently tax payable with aggregated turnover between $20 million and $50 million) will see a significant uplift in their R&D benefit, which may incentivise more R&D investment.

However, we are concerned with a number of the proposed measures, and the implications of these changes in their current state. In particular, we are concerned with the Government’s response to the SERD process and the identified refinements to the R&D framework. Whilst the outcomes of SERD contemplated measured, incremental adjustments, the proposed budget changes extend far beyond these suggestions and introduce significant changes that were neither foreshadowed nor subjected to consultation.

Removal of supporting R&D expenditure

The removal of expenditure incurred on supporting R&D activities from eligibility will significantly reduce the scope of qualifying activities and risks turning the RDTI into the ‘Development Tax Incentive’. This is out of step with the rest of OECD and could push companies to invest in other jurisdictions, rather than Australia. It also abandons the definition of research and development established by the Frascati Manual, on which OECD countries, including Australia, based their RDTIs.

This will also have flow on impacts.

One impact may be on the definition of R&D itself. The legislation requires R&D entities to undertake a ‘systematic progression of work’ which is ‘based on the principles of established science’ as a prerequisite for a core R&D activity. Whilst not legislated, current regulator guidance expects claimants to be able to substantiate the technical knowledge gaps in the relevant industry which requires some form of background research or literature review, and that the activities were conducted in a systematic way. There is a significant risk that the proposed changes will create a myopic view of R&D where these types of activities are completely excluded from the claim, even though an entity must undertake them for the activities to be eligible. This stands against the intent of the program, which was legislated to encourage companies to undertake risky activities they may not otherwise have attempted due to an uncertain return. Companies may be disincentivised from claiming the RDTI if substantiating eligibility requires significant resources not able to be included in the claim

Further to the above, it is ambiguous as to whether certain activities (such as the iteration and formulation of an idea or hypothesis) constitute part of a ‘core activity’ or a ‘supporting activity’. Currently, this ambiguity has little impact on the overall function of the scheme. However, if expenditure incurred on supporting activities becomes excluded, this will create significant regulatory burden in assessing exactly where the delineation between these types of activities sits. This burden will in turn act as a further disincentive for taxpayers to invest in R&D, as disputes take significant time and cost to resolve.

The current core activity exclusions and supporting activities conducted in a production environment (such as production of prototype components) can be eligible as supporting activities, provided that they are undertaken for the dominant purpose of supporting a core R&D activity. Removing eligibility for expenditure incurred on supporting activities makes this legislation redundant and could discourage some established businesses from accessing the program

There may also be impacts on the validity of Advanced Overseas Finding - these Findings provide certainty on the eligibility of core and supporting activities which is binding on the commissioner of taxation. Some companies have sought a Finding on a supporting activity, such as overseas drug manufacturing, before committing to a significant investment in those activities. It is unclear how the proposed changes will interact with existing Findings.

Whilst the rationale is unclear behind the proposed exclusion of supporting activities and their associated expenditure, mechanisms used in other jurisdictions exist to limit the expenditure to certain cost categories such as under the UK R&D tax credit program.

Refundability limited to companies less than 10 years old

Limiting refundability to companies less than 10 years old is a highly arbitrary threshold that has no relationship with the value of their R&D, which can progress at different rates, such as in the case of biotechnology and pharmaceutical companies. It is not uncommon for R&D conducted by companies within these industries to take over 10 years to complete, and the 10-year limit on refundability is inconsistent with the reality of R&D considering the technical uncertainty faced. It also neglects the fact that an existing business may choose to invest in R&D for the first time at any time in its journey. Punishing companies from choosing to invest in R&D later into their life cycle does not align with the purposes of the program, and may push companies to consider different business models to qualify for the refundable offset.

Additionally, the reintroduction of loss carry back rules, also announced in the Budget, could lead to situations where it may be more favourable for companies to carry back the full loss rather than claim the non-refundable tax offset for the relevant financial year.

Minimum expenditure of $50,000

We also note that lifting the minimum expenditure threshold to $50,000 will make some 6 per cent of claimants ineligible per the most recent transparency data. This will also have flow-on impacts to the Early-Stage Innovation Company (ESIC) regime, which is designed to encourage capital investment in high-risk innovative businesses.

As it is currently administered, a significant portion of the eligibility points for ESIC can be met by claiming the R&D Tax Incentive. However, early-stage companies seeking to raise capital may be locked out due to the higher expenditure threshold and the exclusion of supporting activities, including preliminary research and planning, further increasing the difficulty of reaching this threshold. This exclusion of companies will disproportionately impact very early-stage businesses who contribute significant sweat equity in terms of unpaid founder time to their R&D activities, even though the underlying research may be no less valuable than that of a larger business.

What happens next?

Whilst a number of changes to the R&D tax incentive are welcome, some of the proposed changes appear to be designed as cost recovery measures without considering the impact on businesses and the regulatory burden associated with the program. We will be urging the Government to reconsider the impact of these changes, and their flow-on effects to Australia’s ailing business expenditure on R&D and overall productivity. Whilst the proposed changes are yet to be drafted into legislation and may not make it into law, we recommend that businesses review their R&D strategies prior to the proposed 1 July 2028 implementation and start early planning to navigate these proposed changes effectively.

How BDO can help

BDO in Australia is closely monitoring developments relating to the proposed reform of the R&D Tax Incentive.

If you would like to discuss how potential changes may affect your organisation or explore strategies for managing R&D investment under evolving policy settings, please contact BDO’s R&D and government incentives specialists.