Introduction
In the 2009-2010 Budget, the Australian Government announced that the existing research and development (“R&D”) tax concession will be replaced with a new R&D tax incentive. A consultation paper on the new tax incentive was released by the Treasurer and the Minister for Innovation, Industry, Science and Research on 18 September 2009. Interested parties have until 26 October 2009 to make a submission to the Government in respect of the consultation paper.
It is anticipated that legislation to implement the new R&D tax incentive will be introduced into the Parliament in early 2010. Note that draft legislation has not yet been released, although it is intended that it will be inserted into the Income Tax Assessment Act 1997 (the current regime is governed by extensive provisions in the Income Tax Assessment Act 1936) and would apply to income years commencing after 30 June 2010 and both new and existing R&D activity.
Overview of the current regime
As with the proposed regime, the aim of the current regime is to encourage innovative, competitive and export-oriented Australian industries through the promotion of R&D activity in Australia.
The concession is available to all Australian companies and (broadly) offers the following:
- a tax deduction of up to 125% of expenditure incurred on R&D activities;
- an R&D incremental (175% Premium) tax concession for those companies increasing their R&D expenditure and which have a three-year history of registering and claiming the 125% tax concession.
A refundable R&D “Tax Offset” is also available in certain circumstances.
Note that the current regime is complex, and that one of the aims of the proposed regime is to simplify and streamline the relevant process. In addition, the proposed regime will also seek to enhance the integrity of the process by ensuring that it will be more difficult for claims to be made for R&D activity where there is no strong rationale for public support.
Overview of the proposed regime
As noted above, draft legislation has not yet been released in respect of the new R&D tax incentive. At this point in time, a consultation paper has been released for comment. The consultation paper details seven fundamental design principles, which will guide and underpin the draft legislation intended to be released in early 2010. No further substantive materials are available at the present time.
In essence, the new scheme proposes the replacement of the 125% and 175% “uplift” deductions with a non-refundable 40% R&D tax credit, as well as a 45% refundable R&D tax credit for companies with a turnover of less than $20M.
What follows is a recitation of each principle detailed in the consultation paper, along with some additional expansive commentary.
Principle 1 - the new R&D tax incentive will be available to companies incorporated in Australia for R&D conducted in Australia. Location of ownership of the resulting IP will not be relevant.
The new R&D tax incentive will be available to both Australian-owned companies incorporated in Australia and foreign owned companies incorporated in Australia. Only companies will be eligible for the incentive.
Grouping rules will determine the application of the relevant thresholds to related companies.
The general rule is that eligible R&D activity must be conducted in Australia. There are some exceptions to this under the current regime, such as where the (Australian owned) R&D activity cannot be conducted in Australia and does not exceed 10 percent of the total expenditure claimed. The Government is open to the retention of these exceptions.
Under the current regime, a company can only claim the R&D concession if it conducts the relevant R&D activity itself, or if another company has conducted the activity on its behalf. This will be retained under the proposed regime.
Principle 2 - the Standard R&D Tax Credit will be available at a rate of 40 per cent for eligible R&D expenditure and can be carried forward where a company’s income tax liability is zero.
Where a company’s income tax liability is zero, any unused R&D tax credit can be carried forward to future income years, provided that the integrity measures detailed in Division 165 of the Income Tax Assessment Act 1997 (which sets out the requirements for carrying forward unused tax losses) have been satisfied. The credit cannot be applied against other tax liabilities, such as GST.
Principle 3 - the Refundable R&D Tax Credit will be available to companies with a turnover of less than $20 million at a rate of 45 per cent for eligible R&D expenditure.
Where a company’s income tax liability is zero, any unused refundable tax offset can be applied to reduce other tax liabilities, such as GST. Any remaining amount can then be refunded as cash to the company.
Several alternatives are being considered by the Government in terms of the treatment of R&D expenditure that is not eligible for the “uplift” deduction under the current regime, but is deductible nonetheless. One alternative is to provide access to a non-refundable tax credit on such expenditure at the company tax rate of 30%. Another alternative is to exclude such expenditure from the ambit of the proposed regime, leaving it to be deductible under the normal tax rules.
Principle 4 - legislation for the new R&D tax incentive will provide support for the scheme’s efficient and effective administration.
In administering the proposed regime, Innovation Australia and AusIndustry will be empowered (and expected) to adopt a more active role in supporting taxpayers in their efforts to self-assess their eligibility for the new R&D tax incentive.
Principle 5 - The new R&D tax incentive should target R&D that is in addition to what otherwise would have occurred, and provides “spillovers” — benefits that are shared by other firms and the community — that are large relative to the associated subsidy.
The new R&D tax incentive will only be available under the proposed regime in respect of R&D expenditure that results in benefits that “spillover” to other firms and the rest of the community. It will not be available for R&D activity that would not have occurred in the absence of the subsidy.
Principle 6 - Eligible R&D activity will be defined as systematic, investigative and experimental activity that involves both innovation and high levels of technical risk, and is for the purpose of producing new knowledge or improvements.
This relates to the distinction between core and supporting R&D activity which is recognised under the current regime. The “eligible activity” referred to under this principle represents core R&D activity.
Under the current regime, core R&D activity represents activity that is systematic, investigative and experimental. This has been retained in the proposed regime. In order to be eligible for the new R&D tax incentive, however, such activity must also be both innovative and technically risky. The absence of one of these factors reduces the likelihood of “spillover” benefits arising, and hence makes it more difficult to establish eligibility for the R&D activity in question.
Principle 7 - Supporting R&D will continue to be recognised under the new R&D tax incentive but claims will be subject to new limitations.
Companies will be able to continue to claim the new R&D tax incentive under the proposed regime for supporting R&D activity, as is the case under the current regime. Under the proposed regime, however, the ability to access the incentive will be more stringent. There are a number of avenues through which this may be achieved, including capping eligible supporting R&D activity at a percentage of core R&D expenditure, and a “sole purpose” test, under which supporting R&D activity is defined as activity carried on for the sole purpose of supporting core R&D activity (as opposed to being carried on for a purpose directly relating to the carrying on of core R&D activity, as required under the current regime).
Conclusion
The proposed changes are a welcome addition to a complex regime, as simplification and greater certainty will go a long way towards ensuring that the aims of the regime are consistent with the manner in which it operates. The principles detailed in the consultation paper are sound in this respect, and it will be interesting to see how effectively these principles will be enshrined in the draft legislation soon to be released.
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