Questionable changes to the R&D Tax Incentive

11 May 2018

Dave Smith, Associate Director, Research & Development |

As predicted, on Tuesday’s Federal Budget the Government announced a number of proposed changes to the R&D Tax Incentive. 

It is the first budget after the 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).

Amongst a back-drop of recent media releases about the ‘exploitation’ of the R&D Tax Incentive by a select few, it was expected that the Government would try and tighten some aspects of the program. Thankfully they took on board one of the key recommendations by the ISA, not to change the definition of R&D for the Incentive.

Unfortunately, the Government has instead tried to reduce the incentive available for both those that receive the refundable tax offset and those that would receive the non-refundable offset.

These changes will, in my opinion, only favour an elite few and will likely achieve the opposite of the industry collaboration goals of the ISA review and lead to some companies dropping out of the system or moving to conduct their R&D in more favourable jurisdictions.

Whilst the changes to the refundable tax offset includes a cap on the refund available, which is probably long overdue, the tying of the incentive component to the company’s tax rate goes against the original intention of the R&D Tax Incentive in 2011, which was to decouple the offset available from the corporate tax rate.

Initially, claimants were able to access a 45% refundable tax offset, before changes to the rates were introduced for income years after 1 July 2016 reducing the offset available to 43.5%. However, for those companies with a corporate tax rate of 27.5%, they have been able to receive a net tax benefit of 16% since the rate changes were introduced.

In this latest budget, the Government has cleverly hidden the fact that the offset will be fixed at 13.5% above the company’s tax rate. This will mean that companies with a 27.5% tax rate, which will be all companies under $25M in the 2018-19 year, will only receive a 41% refundable offset.

This reduction can still be significant for those that rely on the refundable cash component to further finance their R&D activity and will represent an overall reduction in the refundable offset by 4% from when it was first introduced in the 2011-2012 year.

Interestingly, most of the media seems to have misunderstood or accepted this drop in benefit as reasonable.

For companies with aggregated annual turnover of $20M or more, the proposed changes 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.

This approach moves the focus from the qualitative features of the R&D being conducted to an approach that focuses on 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 and unfairly target industries with low profit margins and high operational expenses, such as our globally competitive industries of agribusiness, mining and manufacturing.

If this measure is passed, all companies with a turnover greater than $20M 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.

Furthermore, whilst it is unclear if this is on an entity or group basis, the complexity could also lead to manipulation – something the measures are purportedly designed to fix. If it is intended to apply on an entity basis, could a company decide to start up a separate high R&D intensity company?

If it is to apply on a grouped basis, it would essentially deny the incentive for companies to spin out from universities and provide little incentive for international companies wanting to conduct any R&D activity in Australia.

We could now have a scenario where two large companies are conducting similar R&D programs, and depending on the group expenditure, one may get only a 4% cost underwrite whilst another will get up to 12.5% cost underwrite due to factors completely unrelated to the R&D itself!
Finally, these changes are set against the backdrop created by the Government that the costs of the R&D Tax Incentive are climbing. However - recent data from the ABS shows that the cost of the Incentive is falling (the combined effect of the $100M annual claim cap and the 1.5% offset rate cut) including Business Expenditure on Research & Development (BERD) (by 12% in 2015/16).

This budget disregards one of the recommendations of the ISA to redirect any savings from any changes to the program into innovation programs. It is pretty clear that the proposed changes to the R&D Tax Incentive in this budget are poorly drafted and will in fact be detrimental to Australia’s ability to remain globally competitive in the innovation race.