Government support for R&D is at the crossroads
After nearly 12 months of uncertainty, industry has been presented with a proposal to significantly cut R&D Incentives.
The key issue of concern to 13,000 companies is the proposed elimination of R&D tax Incentives which have existed for over 30 years.
The current review of the R&D Tax Incentive follows in the footsteps of several other reviews and consultations in recent years – it has the supposed objective of future-proofing Australia through innovation but providing government support for that objective as efficiently as possible.
The current review puts forward six recommendations aimed at reducing the cost of the Incentive and increasing its ‘additionality’ (i.e. using it to support ‘additional’ spend on R&D).
A focus on additionality detracts from the fundamental issues of the debate – and assertions from certain quarters that a sizeable level of the R&D activity would occur anyway, without the need for the R&D Incentive, simply ignores commercial reality.
While we agree with many of the latest recommendations, there are two which must be called out – we believe that if they are implemented, tens of millions of R&D dollars and many Australian innovators will head offshore.
The proposed intensity threshold
Recommendation 4 proposes a new “intensity” threshold whereby only R&D expenditure in excess of the first 1-2 percent of the company’s total expenditure will attract an R&D tax offset.
For instance, using the example given in the report (at page 40), if a company able to claim the non-refundable tax offset has total expenses of $10 million and its R&D expenditure is $180,000 in the same year, then its R&D intensity would be 1.8 percent (180,000/10,000,000 = 1.8 percent). Or if it the threshold was set at 1 percent or 2 percent the effects would be:
- 1 percent, then the company would receive the non-refundable tax offset on the ‘additional’ $80,000 (over the $100,000 threshold). The net benefit to the company will be $6,800 (80,000×8.5% = 6,800).
- 2 percent, then the company would not receive a R&D tax offset (as its R&D expenditure was below the $200,000 threshold).
In the above example, the best case scenario is that the company receives a $6,800 tax offset to help offset the cost of spending $180,000 on R&D in Australia. This is not enough.
Many companies will seriously consider relocating their R&D to cheaper labour markets and better tax incentives overseas.
The intensity threshold is supposed to improve ‘additionality’. Additionality is great in theory, but flawed in practice.
If a company spends $10 on R&D, then additionality says the Incentive should be used to support an additional amount (say $5) on R&D. However in practice R&D budgets and spending vary; using the Incentive to support the first $10 may be what allows the company to spend an additional $5 or even $10 on R&D.
Without the initial support, companies may not get to $10 and so would never receive support from the Incentive. Further, how does one actually work out what the additional amount is? A 1-2 percent threshold is both arbitrary and a disservice to all those companies currently relying on the Incentive to help offset the cost of innovation. And if a principles based argument doesn’t appeal, there are also likely to be mechanical issues with calculating the 1-2 percent threshold (e.g. interaction with capitalised expenditure, feedstock, clawback, etc.).
If Government is serious about improving ‘additionality’, it needs to increase the net benefit related to the ‘additional’ expense, not introduce a threshold.
The proposed unilateral $2 million cap on cash refunds
Recommendation 3 proposes that the cash refund be capped at $2 million per annum and that any excess R&D tax offset amount become a non-refundable tax offset. While limiting the cash refund a company can receive in a given year makes sense, there should be provision for exceptions – especially where it is in the national interest.
For instance, Australia has many early stage biomedical companies that are sinking millions into R&D for the treatment and/or cure of disease. Many of those companies rely on the Incentive with every dollar received sunk straight back into paying for Australian researchers and equipment. Imposing a $2 million cap without exception may well bankrupt some of those companies.
Australia has an excellent health sciences industry with many leading researchers based here. Many of the recommendations are about helping that industry develop – the collaboration premium is a good example of this. However capping the cash refund for companies that are sinking tens of millions into medical research (including the refund they receive under the Incentive) means these companies will also look offshore.
Ultimately Australia needs to be spending more, not less on R&D and that includes Government support. A recent study by the International Monetary Fund (IMF) indicated that an extra $1 billion on increased tax breaks for R&D in Australia would add $80 billion to our economy.
Any measures to reward ‘additional’ R&D should not compromise the ability of the majority of the current cohort of 13,000 companies to claim the R&D Incentive.
A higher rate of incentive for incremental R&D would be a significantly better way to induce additional R&D.
From an SME and ‘start up’ perspective, the proposed annual cap of $2m p.a. also requires a robust review and consultation.
Tags R&D Tax