Boosting Investment in R&D in Australia

via the tax systemDept presentation 24 June 2011

Nance Frawley

Our tax system contains many provisions that aim to stimulate certain behaviour or alternatively provide benefits/support for certain taxpayers

Tax expenditures – not for revenue raising; in fact reduce potential revenue (similarities to direct govt spending, but administered thru tax system)

2010/11 year estimates- $243 billion will be raised in taxes; approx. $49 billion will be forgone in tax expenditures (v. difficult to accurately measure)

Using the tax system for purposes beyond revenue raising

Income tax payable = taxable income x tax rate – tax offsets

(ie assessable income- deductions)

A tax expenditure connected to income tax* can be considered as any tax provision that reduces the amount of income tax payable.

Ie1. Income exemptions (ie making certain types of income non-assessable

either because of category of income or category of tax payer)

2. Concessional deductions (ie allowing greater than 100% deductions for certain expenditures- limited benefit for t/ps in tax loss position)

3. Providing tax offsets/tax credits (apply directly to reduce tax liability - can be refundable or non-refundable; decoupled from the tax rate)

4. Applying a lower tax rate to certain tax payers

types of tax expenditures

Currently Australia provides R&D tax deductions ( either 125% or 175% ) for eligible R&D.

Effective from 1 July 2011 -> R&D tax Credits NOT deductions

-SMEs (grouped t/o less than $20m) -> 45% refundable tax credit (to be paid quarterly from 2014).

-Larger companies -> 40% non-refundable tax credit. Note: importance of grouping rules as integrity measure

Tax expenditures for R&D

current estimate of cost of R&D tax concession for 2010/11 financial year- $1.563 billion

Approx. 8000 claimants

Most of the $ goes to large companies

Small number of very large claims- particularly from mining & construction industries

Some stats

2009-10 budget Rudd govt announced the change to R&D tax credits in (to take effect from 1 July 2010) – consequence of several years of investigations & reports

The new R&D Bill has twice been passed by the House of Representatives BUT not yet passed by the Senate (Coalition opposed)

Last week (15/6/11) - joint media release by Treasury & DIISR- crossbench support achieved (ie a deal done with the Greens; some conditions imposed) ; change in Senate composition 1/7/11

R&D credit will become law by second half of year; retrospective to 1 July 2011

Parliamentary Process & the new R&D tax credit

R&D stimulates generation of new knowledge, new technology & new processes spillover benefits to community

Market forces alone result in suboptimal levels of business R&D

Only one part of innovation theory

Tax incentives only one form of govt support for R&D

Basis for govt support of business R&D

BERD intensity- important measure of R&D performance Latest available figures 08/09- Australia’s BERD was

$16,858. BERD : GDP was 1.34% ( OECD average is 1.63%) Australia currently 11th out of 30 OECD countries

(08/09- now 34 countries in OECD) Large businesses accounted for 71% of BERD

Note: OECD Frascati Manual – internationally accepted definition of R&D-covers pure basic research, strategic basic research, applied research & experimental development- most of Australia’s BERD relates to experimental development and applied research. In 08/09 basic research only accounted for 5.7%

How does Australia perform on the world stage?

BERD in 70s & 80s- very low & declining- upward trend in most OECD nations

1986- R&D tax concession introduced BERD = Strong upward trend from 1991 to 1996

1996 – R&D tax concession rate dropped from 150% to 125%BERD= substantial decline between 1996 to 2000 (dropped to 0.64%)

2001- changes to R&D tax concession, particularly intro of R&D tax offset for small companiesBERD- steadily rising since 2001

BUT BERD figures should not be viewed in isolation- in some instances Australia’s productivity growth was growing rapidly even though BERD intensity was low

BERD & the R&D tax concession

4 elements:1. Basic 125% tax deduction2. 175% incremental premium deduction-

introduced in 2001; aimed at encouraging companies to increase their R&D expenditure above a rolling 3 year average; modelled on OS systems. Not very successful

3. 175% international premium- introduced 2007; multinationals with Australian subsidiaries; to encourage choice of Australia as location for R&D. Not very successful.

4. Refundable tax offset for small coys (t/o < $5m, R&D spend limited to $2m)- introduced 2001; very successful but very restricted access.

A bit more detail on our current R&D tax incentives

Self assessment; but high use of specialised consultants

Jointly administered by ATO and Innovation Australia interesting issues re compliance, division of powers etc

ATO tends to deal with costs issues; Innovation Australia tends to deal with technical issues. Applicants can be audited by either or both

Registration of R&D activities with Innovation Australia, compulsory- must be registered within 10 months of end of financial year after R&D activities carried out.

NOTE: New R&D Bill- gives significantly greater powers to Innovation Australia than currently exist

Administration of the R&D tax concession

The benefits are more generous, especially for SMES More robust & stable incentive with greater certainty for business Budget neutrality- clearer definition of R&D activities & simpler for claimants Will deliver more support to more businesses Expanded access to foreign companies who undertake R&D in

Australia & who hold IP offshore Will align with international best practice

WILL COME BACK TO THIS…….

What is the govt saying about the new R&D tax credit?

Hawke Govt introduced 150% (deduction) R&D tax incentive in May 86 (initially temporary measure)- political economy at time- shift away from heavily protectionist policies to integration with global economy

First review 1987- lead to intro of syndication –> rorting ; abolished 1996 (also retrospective claims abolished in 1996)

Howard Govt cut rate to 125% in 1996, then made significant changes in 2001 (‘Backing Australia’s Ability’) including introduction of 175% incremental premium & refundable tax offset for small companies; plus requirement to prepare R&D plan (based on 3 significant Evaluation Reports)

Over the years other major changes to: feedstock rules, R&D building expenditure; R&D plant; interest payments; core technology; expenditure considered ‘not at risk’

Brief background

Number of Evaluation Reports prepared

most significant:

2007 Productivity Commission Report (‘Public Support for Science and Innovation’)

2008 Cutler Review (Review of the National Innovation System- Venturous Australia ‘Building Strength in Innovation’)

Lead up to the new R&D tax Credit

Key Findings:- The R&D tax concession did not screen out R&D

that would have occurred regardless

- Net benefits to community would substantially increase if the base incentive (ie 125%) was accessible only by small companies & large companies could only claim 175% premium

2007 Productivity Commission Report (‘Public Support for Science and Innovation’)

Suggestions on R&D tax concession:

change to R&D tax credits with refundable 50% tax credit for companies with t/o less than $50m and non-refundable tax credit of 40% for larger companies

Allow access to benefits to multinationals who carry out R&D in Australia

Note govt response ‘ Powering Ideas’ (2009) expressed support

2008 Cutler Review (Review of the National Innovation System-

Venturous Australia ‘Building Strength in Innovation’)

Public submissions invited for PC Report & Cutler Review

Public Consultation Paper on proposed new R&D Tax Credit released Sept 09; public forums

First Draft of Legislation released- 18 Dec ‘09(just before Christmas)- harsh criticisms of proposed substantially reduced eligibility of many currently claimed R&D activities

Second Draft of Legislation released 31 March ’10 (just before Easter!)- feedstock rules removed- promise that new feedstock rules would be the same as existing rules; eligibility criteria softened slightly; significant change to language & terminology

The Consultation Process

Tax credit better than tax deductions Greater access to refundable tax credit than currently

exists (providing stricter eligibility criteria are satisfied)

Removal of incremental 175% premium has attracted very little negative comment

Greater access for multinationals & relaxing of IP rules Biotechnology & Pharmaceutical sectors v. happy

(basic research) Removal of requirement to prepare an R&D Plan

What elements of the new R&D tax Credit have attracted the most support?

Substantially increased restrictions on eligibility of R&D activities

Introduction of new test ‘ dominant purpose test’ for R&D supporting activities- adds to complexity & compliance burden plus ignores commercial realities & prejudices small companies who cannot afford to carry out R&D in isolation from commercial activities

Favours basic research over research and development (or applied research)- prejudices mining & construction sectors & probably manufacturing sector

Generally increases compliance burden Feedstock rules

What elements of the new R&D tax Credit have attracted the most criticism?

1. The benefits are more generous, especially for SMES- Only at one level- need to consider impact of restricted eligibility

2. More robust & stable incentive with greater certainty for business –Maybe but time will tell; uncertainty re application of dominant purpose test; feedstock rules & increased powers of ‘Innovation Australia’

3. Budget neutrality- Cost Cutting instead ?? Why no modelling??

Response to govt claims about the new R&D tax credit

4. clearer definition of R&D activities & simpler for claimants- But loss of 25 years of claimant understanding & jurisprudence

5. Will deliver more support to more businesses- Only if the business meets new stricter eligibility reqs; more support probably available from ‘Innovation Australia.’ Will this reduce use of consultants?

6. Expanded access to foreign companies who undertake R&D in Australia & who hold IP offshore -Yes, Agreed

7. Will align with international best practice – Not sure- further comparative research required.

Response to govt claims about the new R&D tax credit cont.

The government promises it will carry out a comprehensive review of the new R&D Tax credit in the next few

years

Time will tell