Boosting Investment in R&D in Australia via the tax system Dept presentation 24 June 2011 Nance Frawley

 Our tax system contains many provisions that aim to stimulate certain behaviour or alternatively provide benefits/support for certain taxpayers  Tax expenditures – not for revenue raising; in fact reduce potential revenue (similarities to direct govt spending, but administered thru tax system)  2010/11 year estimates- $243 billion will be raised in taxes; approx. $49 billion will be forgone in tax expenditures (v. difficult to accurately measure) Using the tax system for purposes beyond revenue raising

 Income tax payable = taxable income x tax rate – tax offsets (ie assessable income- deductions) A tax expenditure connected to income tax* can be considered as any tax provision that reduces the amount of income tax payable. Ie 1.Income exemptions (ie making certain types of income non-assessable either because of category of income or category of tax payer) 2.Concessional deductions (ie allowing greater than 100% deductions for certain expenditures- limited benefit for t/ps in tax loss position) 3.Providing tax offsets/tax credits (apply directly to reduce tax liability - can be refundable or non-refundable; decoupled from the tax rate) 4.Applying a lower tax rate to certain tax payers types of tax expenditures

 Currently Australia provides R&D tax deductions ( either 125% or 175% ) for eligible R&D.  Effective from 1 July > R&D tax Credits NOT deductions -SMEs (grouped t/o less than $20m) -> 45% refundable tax credit (to be paid quarterly from 2014). - Larger companies -> 40% non-refundable tax credit.  Note: importance of grouping rules as integrity measure Tax expenditures for R&D

 current estimate of cost of R&D tax concession for 2010/11 financial year- $1.563 billion  Approx claimants  Most of the $ goes to large companies  Small number of very large claims- particularly from mining & construction industries Some stats

 budget Rudd govt announced the change to R&D tax credits in (to take effect from 1 July 2010) – consequence of several years of investigations & reports  The new R&D Bill has twice been passed by the House of Representatives BUT not yet passed by the Senate (Coalition opposed)  Last week (15/6/11) - joint media release by Treasury & DIISR- crossbench support achieved (ie a deal done with the Greens; some conditions imposed) ; change in Senate composition 1/7/11 R&D credit will become law by second half of year; retrospective to 1 July 2011 Parliamentary Process & the new R&D tax credit

 R&D stimulates generation of new knowledge, new technology & new processes spillover benefits to community  Market forces alone result in suboptimal levels of business R&D  Only one part of innovation theory  Tax incentives only one form of govt support for R&D Basis for govt support of business R&D

 BERD intensity- important measure of R&D performance  Latest available figures 08/09- Australia’s BERD was $16,858. BERD : GDP was 1.34% ( OECD average is 1.63%)  Australia currently 11 th out of 30 OECD countries (08/09- now 34 countries in OECD )  Large businesses accounted for 71% of BERD  Note: OECD Frascati Manual – internationally accepted definition of R&D- covers pure basic research, strategic basic research, applied research & experimental development- most of Australia’s BERD relates to experimental development and applied research. In 08/09 basic research only accounted for 5.7% How does Australia perform on the world stage?

BERD in 70s & 80s- very low & declining- upward trend in most OECD nations R&D tax concession introduced BERD = Strong upward trend from 1991 to – R&D tax concession rate dropped from 150% to 125% BERD= substantial decline between 1996 to 2000 (dropped to 0.64%) changes to R&D tax concession, particularly intro of R&D tax offset for small companies BERD- steadily rising since 2001 BUT BERD figures should not be viewed in isolation- in some instances Australia’s productivity growth was growing rapidly even though BERD intensity was low BERD & the R&D tax concession

4 elements: 1.Basic 125% tax deduction 2.175% incremental premium deduction- introduced in 2001; aimed at encouraging companies to increase their R&D expenditure above a rolling 3 year average; modelled on OS systems. Not very successful 3.175% international premium- introduced 2007; multinationals with Australian subsidiaries; to encourage choice of Australia as location for R&D. Not very successful. 4.Refundable tax offset for small coys (t/o < $5m, R&D spend limited to $2m)- introduced 2001; very successful but very restricted access. A bit more detail on our current R&D tax incentives

 Self assessment; but high use of specialised consultants  Jointly administered by ATO and Innovation Australia interesting issues re compliance, division of powers etc  ATO tends to deal with costs issues; Innovation Australia tends to deal with technical issues. Applicants can be audited by either or both  Registration of R&D activities with Innovation Australia, compulsory- must be registered within 10 months of end of financial year after R&D activities carried out. NOTE: New R&D Bill- gives significantly greater powers to Innovation Australia than currently exist Administration of the R&D tax concession

 The benefits are more generous, especially for SMES  More robust & stable incentive with greater certainty for business  Budget neutrality-  clearer definition of R&D activities & simpler for claimants  Will deliver more support to more businesses  Expanded access to foreign companies who undertake R&D in Australia & who hold IP offshore  Will align with international best practice WILL COME BACK TO THIS ……. What is the govt saying about the new R&D tax credit?

 Hawke Govt introduced 150% (deduction) R&D tax incentive in May 86 (initially temporary measure)- political economy at time- shift away from heavily protectionist policies to integration with global economy  First review lead to intro of syndication –> rorting ; abolished 1996 (also retrospective claims abolished in 1996)  Howard Govt cut rate to 125% in 1996, then made significant changes in 2001 (‘Backing Australia’s Ability’) including introduction of 175% incremental premium & refundable tax offset for small companies; plus requirement to prepare R&D plan (based on 3 significant Evaluation Reports)  Over the years other major changes to: feedstock rules, R&D building expenditure; R&D plant; interest payments; core technology; expenditure considered ‘not at risk’ Brief background

 Number of Evaluation Reports prepared most significant:  2007 Productivity Commission Report (‘Public Support for Science and Innovation’)  2008 Cutler Review (Review of the National Innovation System- Venturous Australia ‘Building Strength in Innovation’) Lead up to the new R&D tax Credit

Key Findings: -The R&D tax concession did not screen out R&D that would have occurred regardless -Net benefits to community would substantially increase if the base incentive (ie 125%) was accessible only by small companies & large companies could only claim 175% premium 2007 Productivity Commission Report (‘Public Support for Science and Innovation’)

Suggestions on R&D tax concession:  change to R&D tax credits with refundable 50% tax credit for companies with t/o less than $50m and non-refundable tax credit of 40% for larger companies  Allow access to benefits to multinationals who carry out R&D in Australia Note govt response ‘ Powering Ideas’ (2009) expressed support 2008 Cutler Review (Review of the National Innovation System- Venturous Australia ‘Building Strength in Innovation’)

 Public submissions invited for PC Report & Cutler Review  Public Consultation Paper on proposed new R&D Tax Credit released Sept 09; public forums  First Draft of Legislation released- 18 Dec ‘09 (just before Christmas)- harsh criticisms of proposed substantially reduced eligibility of many currently claimed R&D activities  Second Draft of Legislation released 31 March ’10 (just before Easter!)- feedstock rules removed- promise that new feedstock rules would be the same as existing rules; eligibility criteria softened slightly; significant change to language & terminology The Consultation Process

 Tax credit better than tax deductions  Greater access to refundable tax credit than currently exists (providing stricter eligibility criteria are satisfied)  Removal of incremental 175% premium has attracted very little negative comment  Greater access for multinationals & relaxing of IP rules  Biotechnology & Pharmaceutical sectors v. happy (basic research)  Removal of requirement to prepare an R&D Plan What elements of the new R&D tax Credit have attracted the most support?

 Substantially increased restrictions on eligibility of R&D activities  Introduction of new test ‘ dominant purpose test’ for R&D supporting activities- adds to complexity & compliance burden plus ignores commercial realities & prejudices small companies who cannot afford to carry out R&D in isolation from commercial activities  Favours basic research over research and development (or applied research)- prejudices mining & construction sectors & probably manufacturing sector  Generally increases compliance burden  Feedstock rules What elements of the new R&D tax Credit have attracted the most criticism?

1.The benefits are more generous, especially for SMES- Only at one level- need to consider impact of restricted eligibility 2.More robust & stable incentive with greater certainty for business – Maybe but time will tell; uncertainty re application of dominant purpose test; feedstock rules & increased powers of ‘Innovation Australia’ 1.Budget neutrality- Cost Cutting instead ?? Why no modelling?? Response to govt claims about the new R&D tax credit

4.clearer definition of R&D activities & simpler for claimants- But loss of 25 years of claimant understanding & jurisprudence 5.Will deliver more support to more businesses- Only if the business meets new stricter eligibility reqs; more support probably available from ‘Innovation Australia.’ Will this reduce use of consultants? 5.Expanded access to foreign companies who undertake R&D in Australia & who hold IP offshore -Yes, Agreed 7. Will align with international best practice – Not sure- further comparative research required. Response to govt claims about the new R&D tax credit cont.

 The government promises it will carry out a comprehensive review of the new R&D Tax credit in the next few years Time will tell