19 Nov 2020 This week in tax
This week, one of the speakers at The Tax Summit, Mariana von Lucken, CTA, Partner at HLB Mann Hudd, Sydney, explains how businesses innovating and undertaking R&D should be supported either through the tax system or a grants system to take Australia forward.
Supporting businesses through innovation incentives
There was some welcome news for the innovation community on 6 October 2020 after the Federal Budget 2020–21 was handed down. The overall research and development (R&D) tax incentive rate was not reduced as anticipated. Going forward, the Government should stop fiddling with the R&D tax incentive, as the indecisiveness of the Government has created instability for claimants and made the innovation community cautious.
I ask myself why there has been so much uncertainty, as we know that stability is one of the factors that give confidence for entities to innovate in certain countries. When you compare Australia to the rest of the world, Australia sits above the OECD median in terms of total government support to business carrying out R&D as a percentage of GDP.
Interestingly, Australia, as well as Canada and Netherlands, use tax measures as the principal form of support for R&D businesses. In contrast, countries like Finland, Germany and Sweden use only grants to support their R&D businesses.
The world is becoming more competitive and Australia must stay ahead of the game and keep improving. The number of OECD countries providing R&D tax incentives has increased from 19 countries in 2000 to 30 countries in 2020, making it a competitive playing field. Still, Australia sits above the median.
Due to the uncertainty since 2018, we can see from reports available from Innovation and Science Australia that R&D applications and spending have decreased in Australia.
In the past, Australia had a tax concession which used a combination of incremental and volume-based principals for R&D, meaning the government objective was to maintain the level of R&D and reward high growth of R&D. In 2011, Australia changed to an R&D tax incentive system, being a volume-based system, meaning the objective of the incentive was to increase the overall R&D in Australia.
Until 2015–16, that objective seems to have been achieved in Australia, as registrations had grown to over 11,000 and R&D spending was $17.32 billion.
Reviews of the R&D tax incentive
The Government decided to review the R&D tax incentive to see if it was achieving the policy objectives. The Review of the R&D Tax Incentive report was released on 4 April 2016. It reported that Australia could do better and made six recommendations. To this day, only one of these recommendations has been implemented.
Shortly after, in 2017, the R&D tax incentive rate was reduced from 45% to 43.5% for entities with an aggregated turnover of less than $20 million, and from 40% to 38.5% for entities with an aggregated turnover of $20 million or more.
Innovation and Science Australia brought out the Australia 2030: Prosperity through Innovation plan (Australia 2030 plan) to ensure that Australia would thrive in the global innovation race. This plan outlines how Australia can make innovation greater via a well-designed R&D tax incentive. It mentions, among other things, introducing a collaboration premium and growing the momentum of Australian Venture Capital as the way forward. Again, there has been nothing legislated in response to these recommendations.
Instead, what we have seen is the Australian Taxation Office (ATO) issuing many rulings and AusIndustry issuing many guidelines. They are trying to provide guidance, but instead have confused the innovation community. A lot of taxpayers are saying: ‘This is just too hard, the requirements make it difficult to comply.’
Once you read Kate Carnell’s report, carried out by the Australian Small Business and Family Enterprise Ombudsman’s office in December 2019, you would be forgiven for thinking that the ATO and AusIndustry were not trying to assist, but instead make life harder for those entities innovating.
This can be seen by the drop in AusIndustry applications and spending by businesses on the R&D tax incentive in the period between 2015–16 and 2018–19.
Changes to the R&D tax incentive
The Government wanted to reduce the incentive by:
- For businesses with an aggregated turnover of less than $20 million:
- Further reducing the R&D incentive rate to 41%; and
- Capping the R&D tax incentive refund;
- For businesses with an aggregated turnover of $20 million or more:
- Introducing a tiered system based on R&D spending.
They made two attempts at introducing this legislation but failed. Instead, due to the COVID-19 pandemic, the R&D tax incentive has been made more generous in order to ensure that Australia thrives in the future.
From 1 July 2021, the R&D incentive rate for smaller entities with an aggregated turnover of less than $20 million will be fixed at 18.5% plus the corporate tax rate (generally 25%, as few companies that are not base rate entities undertake R&D). Larger businesses that have R&D spending of greater than 16.5% of their total business expenditure will benefit from either a 41.5% or a 46.5% rate (depending on their corporate tax rate). This is much better than we have now.
The future of R&D
Some of the observations and questions raised about the R&D tax incentive are as follows:
- Should the R&D tax incentive be narrowed in focus? Professor Bob Deutsch, Senior Tax Counsel at The Tax Institute, mentioned in the preamble in TaxVine on 22 November 2019 that Australia should focus on our strength being medical research and unproven renewable energy.
- Should we continue to have an R&D tax incentive, or change it to grants like some other OECD countries?
- Should we implement some of the recommendations made by the Australia 2030 plan and the Review of the R&D tax incentive?
- Should we leave the current settings as is for the time being and focus on how we keep the intellectual property (IP) in Australia, maybe consider a mandatory patent box, like the regime in Switzerland that meets the OECD standards?
Considering the history and what the OECD reports, Australia does the front end well, being the R&D tax incentive compared with other OECD countries. In my view, the question we should be focusing on is: How do we keep the IP in Australia?
Bill Ferries AC, mentioned in his ‘Forward’ to the Australia 2030 plan that:
‘Australia has also failed to capture the full value of our many inventions; the black box flight recorder, heart pacemaker … and many others were all based on Australian research breakthroughs, but commercialised overseas.’
Why has this been the case? It is likely due to funding. The availability of funds overseas is made up of bigger pools of money, for example in the United States. US investors understand that they will invest but will not necessarily get control or a seat at the board. Whereas in Australia, venture capital or private equity will, in many instances, want control or a seat at the boardroom table.
In my opinion, the Government should stop fiddling with the R&D tax incentive, which is hopefully the outcome of the Federal Budget 2020–21. This will allow the innovation community to regain confidence and start increasing their R&D work.
Instead, we should be more focused on keeping IP in Australia and commercialising it in Australia. But how can we achieve this?
Some suggestions have been made in the Australian Investment Council’s Roadmap to recovery issued in June 2020 and the Productivity Commission’spublic inquiry into Intellectual Property Arrangements, the report which was provided to the Government in December 2016.
Finally, a word on the upcoming Virtual Summit event of The Tax Summit: Project Reform. The lead-in series of Focus sessions and Keynotes, which wrapped up this week, has built our understanding of the need for, and possible avenues of, tax reform in different areas of our system. At the Virtual Summit event, all these ideas will be brought to the table to settle on the priorities for reform, as defined by the profession.
Relevant to this preamble will be Session 4.1, Designing incentives to advance innovation, which considers how well-designed tax incentives can support valuable R&D.
I am sure that many will be interested in Session 9, Running the Gauntlet… How to effect change?, in which powerhouse panellists, including NSW Treasurer, The Hon. Dominic Perrottet MP and Rt Hon Sir Bill English, former Prime Minister of New Zealand, will outline how reform can be achieved and implemented in a way that sticks.
I encourage you to join the conversation The Tax Summit: Project Reform virtual summit on 24–25 November and help build a case for meaningful tax reform.
As always, we welcome your views and thoughts, which you can provide here.
Mariana von Lucken, CTA