Also in this series…
The proposed Australian R&D tax reforms…
Do they walk the talk?
I find it simultaneously flattering and saddening that so many innovative Australians and concerned industry observers felt the need to contact our offices over the past seven days to talk about the proposed reforms to Australia’s R&D tax incentive.
Not one caller had thought to contact his/her elected official or, indeed, our Federal Innovation Minister, Senator Kim Carr.
At the heart of the matter is a collective belief that their views have been ignored (or simply trampled upon) and that the range of opportunities to seek feedback over the past 26 months, from the outcry that accompanied the closure of Commercial Ready to the public forums staged to inform the creation of Venturous Australia, were cynically exploited to create the ‘perception’ of community involvement, rather than any genuine desire to gather real views from real people.
And, in politics, perception is reality.
Indeed, I wouldn’t be surprised if the folks responsible for assembling the Venturous Australia report, led by Dr Terry Cutler, feel a similar way.
After all, many of the recommendations (arguably most) featured in the report have not received any practical follow-through. (Correct me if I am mistaken.)
So, it was with initial enthusiasm that I greeted the proposed reforms to the Australian R&D tax concession.
Talking the talk
Earlier this week, I posted the second article in this Australia Day series, within which I quoted comments made by Senator Carr at the launch of the Venturous Australia report, whereby he echoed international opinion about the importance of this vital form of support for public and private sector innovation.
In case you missed it, this is what the Minister for Innovation had to say:
“Between 1995 and 2004, Australia was one of only three OECD countries to reduce its tax benefits for business R&D – and of those three, our cuts were the deepest. During the same period, sixteen OECD countries increased their level of support… In the nine months since Labor came to office, New Zealand, the United Kingdom, France, Belgium, the Netherlands and Spain have all introduced or extended tax incentives for business R&D. Japan and the United States have flagged their intention to do likewise.”
These words echoed the recommendations of Cutler’s report, which endorsed the importance of R&D tax concession, focusing on three key points: greater access for SMEs, higher benefit rate and ‘above the line’ government assistance for R&D (in terms of how it would appear as part of company budgets). The report also recommended that the government simplify the eligibility criteria.
However, if this endorsement of tax benefits for R&D is not encouraging enough, the Government’s white paper response to Venturous Australia, called Power Ideas – An Innovation Agenda for the 21st Century, should have left no doubt in the casual observer’s mind that the Federal Government clearly considers tax benefits for business R&D to be a good indicator of a country’s commitment to innovation.
Rousing sentiments from the report include:
“Business innovation translates creativity into jobs. The Australian Government’s ambition is to increase the proportion of businesses innovating by 25 percent, and lift the number doing R&D.”
“Social and economic disadvantage persists in Australia despite our relatively high standard of living…. Innovation — and especially advances in information and communication technology — can help to deliver these things.”
“The Commonwealth will also increase the use of ICT, including Web 2.0 technologies, to improve policy development and service delivery…. The government is mindful that advances in ICT accounted for a quarter of Australia’s output growth and a third of our labour productivity growth in the 1990s.”
“By 2020, the Australian Government wants a national innovation system in which…. businesses of all sizes and in all sectors embrace innovation as the pathway to greater competitiveness, supported by government policies that minimise barriers and maximise opportunities for the commercialisation of new ideas and new technologies”
“…many small firms lack the technical capacity to exploit these possibilities. They are also often starved of capital — and the global financial crisis has made matters worse. These constraints make it hard for smaller Australian firms to develop and commercialise new ideas. Too often, this means ideas are forced offshore, where the value they create is captured by our competitors.”
Wow! Rousing stuff, indeed.
So, let me summarise:
- The Federal Government acknowledges that R&D expenditure is a strong indicator of a government’s commitment to innovation.
- Its ambition is to increase the proportion of businesses innovating by 25 percent, and lift the number doing R&D.
- It recognises that ICT is fundamental to most aspects of innovation.
- It wants an innovation system that is accessible to businesses of all shapes and sizes, that will support funding-starved small businesses in particular.
I’m feeling really optimistic! So, let’s have a look at this in action.
The proposed R&D tax incentive
Shortly before the holiday break, the Australian R&D community was offered the chance to review the Draft Bill and Explanatory Materials for the design and operation of the new R&D Tax Credit. The Treasury has given interested parties until 5 February 2010 to submit a response. (That’s today!)
Here’s the good news.
The proposed amendments to the current R&D Tax Concession legislation will deliver a 45 percent refundable tax credit to small firms (group turnover less than $20 million per annum) and a 40 percent credit to companies with a group turnover more than $20 million per annum.
The new program will be extended to support R&D activities undertaken in Australia by foreign-owned firms and the complex 175 percent premium and international premium concessions will be abolished.
Sounds great! So why the dissent from the bleachers?
Too much ‘R’ and not enough ‘D’
The proposed reforms came about because apparently the program was being abused. It was being used by organisations that would have conducted the R&D anyway. That’s right. In the words of the Draft Bill:
“…an effective R&D tax incentive needs to result in firms conducting R&D that they would otherwise not perform because they cannot capture sufficient benefits from the activity to justify an investment.”
This makes sense, doesn’t it? Companies shouldn’t get a free ride for innovation projects that would be undertaken with or without the tax concession, right?
Just in case the intentions of the proposed reforms weren’t clear, the revised “Objects” clause states:
The object of this Division is to encourage industry to conduct R&D activities that might otherwise not be conducted because of technical uncertainty, in cases where the knowledge gained is likely to spillover to the benefit of wider Australian economy.
This eligibility clause is further narrowed by the proposed introduction of a dominant purpose test:
The tax offset is also available for directly related activities that are conducted for the dominant purpose of supporting such core experimental activities (rather than for a broader commercial or other purpose).
What the?! Now I’m confused.
As fairly pointed out by Kris Gale from MJA, in a blog post under the humorous headline Has Treasury Given Us What We Always Wanted or Just Another Pair Of Socks?, these statements do not reflect how real R&D decisions are made in the real world.
Essentially what this test does is place the emphasis of R&D eligible for support on the research side and not the development side of R&D. In the words of Gale:
“This equates to a meaningless incentive for companies (large and small) engaged in process technologies where downstream development costs and risks vastly outweigh the initial research effort involved, especially in manufacturing and mining.”
The problem with this approach is that it radically conflicts with global opinions about innovation and the purpose of R&D. To quote myself from the second piece in this series:
“Innovation is not the R&D you do, but what you do with the R&D.”
Novelty and Risk
There is a another, related element to this narrowed definition of eligibility that has innovators equally floored.
Claimants will need to qualify activities as either core or supporting. Core activities will need to display considerable novelty and high levels of technical risk. Supporting activities will need to demonstrate that their dominant purpose was to support the core R&D.
What this means is that, in the future, when the Treasury calls upon a concession recipient to demonstrate the validity of the R&D claim, companies will be required to show that their R&D activities are both novel and risky. In the past, innovators had to prove one or the other. There can be no doubt that this change is intended to significantly narrow the scope of eligible R&D.
Once again, this approach favours more academic activities designed to acquire new knowledge rather than the application of that knowledge. According to the Exposure Draft, new knowledge will generate greater spillover benefits to the wider Australian economy than the application of that knowledge.
Once again, it’s hard to reconcile this approach with what the rest of the world thinks.
How this will affect ICT projects
A final area of contention relates to a broadened list of excluded activities and, in particular, some provisions likely to hit the ICT industry particularly hard.
This aspect of the draft reforms is worthy of a post in its own right (my next post, in fact). But to summarise:
- The integration of ‘off the shelf’ commercial software or open source software is excluded regardless of the novelty or technical risk involved. (I personally can’t think of a software project that wouldn’t employ off-the-shelf or open software.)
- ‘Computer software services’ are also excluded, regardless of the novelty of technical risk involved. (This category, ‘computer software services’, is neither defined or explained.)
- The 20 year old statutory multiple sale prerequisite, unique to Australia and widely acknowledged as having outlived its relevance, is not only maintained but significantly strengthened and extended. (I’ll save the problems associated with this development for my next post.)
It doesn’t take a propeller head to realise that this ‘catch all’ has the practical effect of prohibiting all software services from being eligible for the R&D tax offset. But, more importantly, it stands to jeopardise almost any R&D project dependant on ICT, which sounds to me like… well… every R&D project.
Walking the walk
As above, it seems that the Federal Government acknowledges that R&D expenditure is a strong indicator of a government’s commitment to innovation. However, the overriding impact of the proposed reforms is seemingly to narrow the eligibility of applications and, therefore, limit access to the concession.
As above, the Federal Government’s stated ambition is to increase the proportion of businesses innovating by 25 percent, and lift the number doing R&D. However, the proposed reforms, in their current state, are likely to have the opposite practical effect. One arm has set a goal that can be measured, while the other has proposed reforms likely to render the achievement of this goal impossible.
As above, the Federal Government recognises that ICT is fundamental to most aspects of innovation. Yet, it has effectively prohibited computer software services and the use of ‘off the shelf’ commercial software or open source software in ICT R&D. Once again, it is hard to imagine any form of R&D, from mining to biotechnology, that does not require the inclusion of such ICT innovation.
As above, the Federal Government wants an innovation system that is accessible to businesses of all shapes and sizes, that will support funding-starved small businesses in particular. Yet, the reforms conflict with standard commercial R&D decision-making practices, which acknowledge that the true cost of R&D occur ‘downstream’.
But the greatest flaw of these reforms is in the ambiguity.
Consistency is king in R&D reform
From the perspective of the private sector, innovation is necessary for survival but can be unprofitable for a long-time. R&D tax concessions are among the most common ways to lower innovation costs.
We all know this.
As part of the Global Competitive Index for 2009 (which ranked Australia 22nd), the authors observed that a strong positive relationship exists between R&D tax programs, GPD and the performance of countries on its index.
“…the size of the credit seems to have little impact — primarily because innovation is such a business necessity that companies rarely change their innovation activities on the basis of the availability of tax credits.”
More important than size is their dependability.
According to respondents involved in the development of this Index, inconsistency is what most influences an organisation’s decision to invest in R&D and the extent of its R&D investment. This is because a company cannot budget and minimise risk if it does now know the extent to which it is likely to be eligible for a tax concession.
The proposed reforms to the R&D tax concession not only conflict with their stated purpose but offer no consistency to organisations already engaged in the complex task of commercialising innovation.
Ironic as this may seem, ambiguity is the enemy of innovation… whether novel or risky.
Did you prepare a submission? If so, please feel free to link your submission as a comment below.