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Oct. 24 — Tax incentive changes under consideration by the Australian government would discourage many multinationals from undertaking research and development in the country, tax practitioners warn.
The government is seeking comment by Oct. 28 on recommendations by an independent review of its research and development (R&D) tax incentive scheme, which includes a proposal for a new large company screening process.
The screening amounts to an R&D “intensity threshold,” which would only permit tax incentives for R&D expenditure above 1 percent to 2 percent of total business expenses.
The proposal is designed to ensure the incentive only supports R&D beyond business-as-usual levels, delivering what the review terms a greater level of “additionality"—the amount of additional R&D investment companies undertake for every dollar of tax revenue forgone—and raising the economic benefits of the scheme relative to its cost.
KPMG’s Melbourne-based global head of R&D, David Gelb, told Bloomberg BNA that if the proposals became law, they would affect every multinational investing in R&D in Australia.
“It would have a severe impact on Australia’s attractiveness as an R&D destination,” Gelb said.
He noted that the change would be on top of a recently legislated reduction in the refundable tax offset—the impact of which means that companies with turnover above A$20 million would receive 8.5 cents of benefit for every A$1 invested, compared to the previous level of 10 cents.
“A further significant reduction in their entitlements could actually spell the death knell for R&D in Australia,” he told Bloomberg BNA Oct. 20.
As a trade-off for the proposed new intensity test, the review recommended the limit for eligible R&D expenditure be raised from the current level of A$100 million to A$200 million ($76 million to $152 million).
But the increased limit would only benefit “a very small number of companies,” Gelb said.
“The number of companies that would have eligible R&D expenditure in Australia over 100 million is very, very small indeed,” he said. “I suspect it would be less than 50 perhaps, even less than 30.”
Furthermore, these companies could still find themselves worse off in net terms because of the intensity test, he said, adding that estimating R&D intensity levels would be extremely difficult.
Kris Gale, Sydney-based partner at R&D tax incentive consultancy Michael Johnson Associates (MJA), said the intensity test “has not found much support in the innovation community.”
“Simply put, the intensity requirement means that the incentive would only pay a benefit on R&D expenditure above the threshold rate,” he said in an Oct. 21 blog post. “For example, if the rate was set at two percent and the group’s intensity was three percent, only a third of the R&D expenditure would attract the incentive—three percent minus two percent equals one percent.”
The criticisms of the proposal “are becoming legion” according to Gale, who attended a recent meeting of the R&D Tax Incentive National Reference Group convened by Innovation Minister Greg Hunt to address the recommendations.
They include concerns that it will create “an innovation underclass” that can’t meet the threshold test for reasons related to their sector, life cycle and expenditure conditions, he said.
Although companies would only get the incentive on the 1 percent spending above the 2 percent threshold, they would need to document all the expenditure to demonstrate they have met the threshold test, Gale said.
“Interestingly, the review did not offer any international precedents displaying examples of such a model working successfully,” he said.
“MJA understands that only two regimes—Belgium and Japan—operate an intensity regime but these are opt-in programs that offer a higher level of support than the standard regime available. Intensity does not restrict access in these regimes. Rather, it incentivizes exceptional performance.”
Gale described the proposal as a potential “wrecking ball in the history of government support for Australian innovation” and expects the government will ultimately disregard it.
“The discussion will move quickly on from the intensity proposal to the investigation of other ways of maintaining a viable and vibrant incentive,” he said. “We urge you to consider the intensity proposal as a highly provocative conversation-starter and to take it in that spirit,” he said.
David Mumford, Sydney-based R&D tax specialist with IP consultancy Watermark, also has concerns about the R&D intensity test.
R&D investment “by its nature is cyclical,” which means companies could find themselves below the intensity threshold in some years and above in others, he told Bloomberg BNA in e-mailed comments.
The prospect of having to manage funding of eligible R&D projects in such a way as to remain above the threshold in any given year could be “the deciding commercial factor” that prompts some companies to opt-out of R&D in Australia, he said.
Mumford said many start-ups are also unimpressed by the prospect of the limit on eligible expenditure being doubled to 200 million Australian dollars.
They see the more generous limit as “specifically benefiting larger multinational corporates rather than refining our R&D regime to better support early-stage businesses,” he said.
Mumford said another review recommendation, the provision of a premium-rate incentive for R&D carried out in collaboration with publicly funded organizations, could be a boon for companies in sectors such as pharmaceuticals, biotech and food technology.
Companies would have to collaborate with researchers at universities and other public organisations who are within three years of graduating to receive the premium-rate incentive, which would likely result in stiff competition to partner with the “cream of the crop” from the limited pool of eligible researchers, he said.
David Pearce, executive director of Canberra-based consultancy the Center for Independent Economics, said it was far from certain that an R&D intensity test would boost additionality.
For example, it could in fact be the case that companies that would meet a threshold test are already R&D-focused and would be unlikely to be prompted by a tax incentive to make additional investments, he said.
Similarly, companies with very low levels of existing R&D investment could be jolted into undertaking additional R&D investment by a tax incentive, he told Bloomberg BNA.
“It’s hard to predict in advance what impact it may have,” said Pearce, who led a statutory review of the R&D tax incentive scheme carried out, in addition to the high-profile independent panel’s review.
“This is a space where it is quite hard to come to definitive evaluations,” he said.
Consequently, governments have to be somewhat “innovative and experimental” in developing policy, and then monitor closely the effect of the changes, he said.
Pearce added that given that additionality is a primary goal, ensuring small firms can benefit from R&D tax incentives is extremely important, as “on average, it’s more likely that smaller firms will have higher additionality than larger firms.”
A spokesman for innovation minister Greg Hunt Oct. 21 told Bloomberg BNA that the independent panel’s report was “to government, not from government.”
“There’s significant consultation underway at the moment and the government’s position will be finalized next year,” he said in e-mailed comments.
The independent panel’s report made no mention of patent boxes, which provide a tax break for IP either developed or registered in a country, and which have been implemented in China and 11 European countries.
A November 2015 report by Australia’s Office of the Chief Economist concluded that the overall return on a patent box regime in Australia was likely to be negative.
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The recommendations and related documents are at https://www.business.gov.au/assistance/research-and-development-tax-incentive/review-of-the-randd-tax-incentive.
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