Changes to the research and development (R & D) tax incentive system are due to commence 1 July 2010. What expenditure will qualify for the new concessions and incentives?
The Government announced the changes to the R&D tax concession system in the 2009 Budget, and almost exactly one year later, on 13 May 2010, the Tax Laws Amendment (Research and Development) Bill 2010 and the Income Tax Rates Amendment (Research and Development) Bill 2010 were introduced into Parliament to implement the changes. The Bill will repeal the existing R & D provisions in the 1936 Tax Act and introduce a new Division 355 in the 1997 Tax Act. The administrative rules and the role of Innovation Australia will be set out in a new Part III of the Industry Research and Development Act 1986.
It’s been a bumpy ride for the government with heavy criticism of its first draft of the legislation forcing it to re-think and redefine what R & D will be eligible for the concessions.
What will the new system involve?
The new system will provide a refundable tax credit equal to 45 per cent of expenditure on R & D to companies with an annual turnover of less than $20 million. For companies which exceed the $20 million turnover threshold a tax credit equal to 40 per cent of expenditure on R & D will be available, but it will not be refundable.
At first glance it appears that the new system will cost the Government more money, as a greater level of concession will be available, and, for small companies, the tax credit is refundable and therefore available even if the company is in a loss position. However, the Government stated that the new system would achieve revenue neutrality, despite the increase in the concessions, by tightening the definition of eligible R & D.
What R & D will qualify?
The first exposure draft of the legislation required R & D to be both innovative and involve technical risk in order to qualify for the tax rebate. Software development was cut out of the definition of R & D. However, these measures were heavily criticised, with allegations that such a restrictive approach would place the Government in a revenue positive position.
The legislation introduced into Parliament on 13 May contains an entirely new definition of "Core R & D". Core R & D activities are experimental activities:
- "whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work that (i) is based on principles of established science; and (ii) proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions, and
- that are conducted for the purpose of generating new knowledge (including about the creation of new or improved materials, products, devices, processes or services)."
There is a list of items that are not Core R & D activities. Software development activities will not be eligible core R & D where the software is developed for the dominant purpose of internal business administration by the entity (or connected entities) for which it was developed, modified or customised. Otherwise, software development is able to qualify.
Supporting R & D is also eligible for the tax rebate provided the activities are directly related to core R & D activities or are undertaken for the dominant purpose of supporting core R & D activities.
What are the problems?
The "dominant purpose" test for supporting R & D has been criticised as, in a commercial context, the dominant purpose is rarely one of furthering knowledge – one eye is always kept on the bottom line.
Federal Innovation Minister Kim Carr stated that the lion’s share of the current benefits are enjoyed by only 100 companies and the aim of the new system is to broaden access to the concession. It remains to be seen whether the introduction of an entirely new definition of R & D will achieve this goal.