R & D Tax Concession Reforms

The R & D concessionary tax system has long been in need of reform.

In the 2009-10 Federal Budget, the Government announced it would replace the existing research and development (R&D) tax concession with a new, more streamlined R & D tax incentive from 1 July 2010. The changes to the R & D tax incentive are intended to ensure that tax benefits are only available for genuine research and development projects and to replace the old tax deductions system with a new tax credit system. On 18 September 2009, Treasury released a consultation paper to provide information about the new R & D tax incentive and to seek feedback and comments from interested parties. Submissions on this paper closed on 26 October 2009. The main elements of the new system are summarised as follows:

The New R & D Tax Credits

Unlike the present system, which grants deductions to R & D expenses, the proposed system will operate by conferring tax credits.

Standard 40% tax credit

The proposed standard R & D tax credit will be 40% of eligible expenditure and will be granted to companies carrying on eligible R & D activities, where group turnover is equal to or exceeds $20 million p.a. This equates to a tax effect of 10% which is higher than the current base rate of 7.5%.

The credit will be non-refundable. Therefore, once the company has reduced its taxable income to zero, the remaining offset amount cannot be applied to other tax liabilities, cannot be cashed out, but can be carried forward to be applied against future income tax payable.

Refundable 45% tax credit.

The proposed refundable R & D tax credit will be granted to companies carrying on eligible R & D activities where group turnover is less than $20 million p.a. The refundable tax credit will be 45% of the R & D expenditure. This equates to a tax benefit of 15% which is twice the current base rate of 7.5%.

It appears that the refundable R & D tax credit will operate in the same manner as the current “R&D Tax Offset”. The R & D Tax Offset allows companies to offset the refundable credit against other tax liabilities (other than income tax) and any unused offsets are refunded to the company in cash.

Access to the New Incentive

Who can claim?

The new R & D system will be available for any R & D activities undertaken in Australia by companies that are incorporated in Australia. A positive outcome from these proposed changes seems to be that companies that are foreign owned can be eligible for the new incentive, as long as incorporation is in Australia.

It would appear that foreign companies as well as entities such as individuals, trust and partnerships will continue to be excluded from the new incentives.

Grouping

It appears that the current grouping provisions will also continue to apply to the new regime.

The grouping rules under R & D are extremely stringent and are predominantly used as an integrity and anti-avoidance measure to ensure that company groups do not artificially manipulate funding arrangements to maximise the entitlements.

Australian R & D Activities

The new incentive is restricted to R & D activities conducted in Australia. At this stage, the Government has not decided whether to permit some overseas R & D projects to be entitled to the benefits, as under the present system.

Unlike the present system, the new incentive does not require the resulting Intellectual Property (“IP”) from the R & D to be owned in Australia.

Eligible R & D Activities

The new incentive scheme will further tighten the definition of R & D activities to ensure that only genuine R & D qualifies for support.

Core Activities

The definition for core R & D is an activity defined as “Systematic, investigative and experimental that involves innovations or high levels of technical risk to acquire new knowledge or create new products or services.”

Mere innovation is not enough in itself. Innovation without risk is commercially sensible and therefore should not require incentives.

Supporting R & D

Under the present system, supporting activities may be entitled to accelerated tax deductions. Supporting activities is defined as “activities carried on for a purpose directly related to core activities”.

Supporting R & D will continue to be recognised under the new R & D tax incentive but claims will be subject to new limitations.

The intent behind the proposed limitation has been triggered by a concern that claims are excessive, especially where the supporting activities are part of the company’s commercial activities anyway and ought not to be subsidised.

The Government has not decided how to limit R & D incentives for supporting activities but have suggested a number of possible methods: namely

• Capping as a proportion of core R & D;
• Sole purpose test;
• Exclusion method;
• Net expenditure method; and
• Low rate of assistance method.

Non – R & D Activities

The present R & D rules contain a list of activities excluded from core R & D. The Government intends to retain the present list and may even add to it.

The current list of activities excluded for Core R & D is:

• Market research;
• Quality control;
• Cosmetic or stylistic changes to products & production;
• Management studies;
• Research in social sciences or the humanities;
• Pre-production activities such as researching commercial viability;
• Preparation for teaching; or
• Routine specialised medical care.

Conclusion

The proposed new R & D tax incentive system still has some way to go before it gets to its final destination. There are many issues that remain unresolved and it will be interesting to see how the final legislation will look.

A further round of public consultation on exposure draft legislation and associated exploratory materials will occur later this year. Legislation to implement the new scheme will be introduced into Parliament in early 2010.