The announced changes, which coincided with the release of the government’s long-awaited White Paper, Powering Ideas: An Innovation Agenda for the 21st Century, are geared towards providing Australian businesses with a simpler, more predictable and more equitable scheme to reward innovation, when compared to the current R&D program.

By introducing the new R&D tax credit program, the government is clearly seeking to motivate Australian businesses with an additional incentive to dedicate increasingly scarce resources to R&D activities.

At the same time, the government’s reforms also appear to be aimed at providing Australian businesses with clarity and certainty as to the financial benefits they can expect from their investment in innovation, something that is widely acknowledged as a weakness in the current R&D tax concession program.

Faced with the challenges associated with keeping a burgeoning deficit under control, the government’s decision to commit $A1.4 billion in spending on the R&D tax credit program over the next four years is a strong reaffirmation of the integral nature and pivotal role R&D plays in assisting businesses to develop innovative ideas and products.

The government hopes these ideas and products will enable Australian businesses from all industries and regions to prosper and develop a competitive advantage on a global scale.

Key highlights

Commencing on July 1, 2010, the current 125% and 175% R&D tax concession scheme will be replaced with an R&D tax credit scheme. Key points in relation to the changes include:

• A 45% refundable tax credit (the equivalent to a 150% deduction) will be provided to small businesses with a turnover of less than $20 million per annum;
• A 40% non-refundable tax credit (the equivalent of a 133% deduction) will be provided to businesses with a turnover of more than $20 million per annum and to businesses that undertake R&D on behalf of foreign parents; and
• The increased benefits to businesses are balanced by removal of the overly complex R&D tax concession premium provisions and a tightening of a number of key definitions in order to support only genuine R&D activities.

The detail

Groups with turnover less than $20 million

A 45% refundable tax credit will be available to businesses with a group turnover of less than $20 million per annum. This change not only represents a doubling of the rate of support currently available under the tax concession, it also opens up the ability to access immediate funding, by way of a refundable tax credit, to a much wider range of businesses, when compared to the current tax concession program.

Under the current tax offset provisions, only businesses with a group turnover of less than $5 million and R&D expenditure of less than $1 million are eligible to “cash out” losses associated with their expenditure on R&D activities.

Under the new R&D tax credit scheme, the $5 million turnover limit has been increased to $20 million and the upper R&D expenditure limit of $1 million has been completely removed. This fundamental change should provide a significant economic advantage for small to medium-sized Australian enterprises, rewarding their investment in innovation by freeing up cash reserves in the form of the refundable tax credit.

As a transitional measure for the 2009-10 income year, the R&D expenditure cap associated with the R&D tax offset program will be increased to $2 million. This measure should provide a significant number of additional businesses with access to the cash benefits under this program.

Groups with turnover greater than $20 million

A 40% non-refundable tax credit will be available to businesses with a group turnover of more than $20 million per annum. The 40% non-refundable tax credit equates to a saving of 10c for every dollar incurred on eligible R&D expenditure – an increase from the 7.5c in the dollar available under the current scheme.

In addition, the 40% non-refundable tax credit scheme will be extended to circumstances where Australian businesses are conducting R&D in Australia on behalf of a related overseas company, even though the overseas company may hold the results of the R&D activities.

Additional proposed changes

The replacement of the R&D tax concession scheme with the new R&D tax credit scheme also brings to an end the 175% premium tax concession. This means that the 2009-10 income year will be the last opportunity for companies to access the 175% concession. As highlighted in the Cutler Review of Australia’s innovation policy, the 175% concession was viewed as particularly complex and, as such, it was difficult for businesses to predict the benefit they could be entitled to.

The Cutler Review came to the conclusion that the additional 175% concession did not materially influence business attitudes to the conduct of R&D activities and, as such, provided little or no incentive for companies to undertake additional R&D activities. In recognition of Cutler’s findings, the 175% premium concession no longer forms part of the government’s innovation policy.

The other major change alluded to in the budget is that the eligibility criteria for the R&D tax credit will be “tightened up” to ensure that only genuine R&D receives support and that the government’s support for innovation is better targeted.

When the Cutler Review was released in late 2008, it specifically singled out the ability to make “whole of mine” and “whole of project” R&D claims as an area the government should seek to address. In Dr Cutler’s view, the scale of such claims was not in the spirit of the R&D legislation.

Any proposed changes that seek to reduce the ability of a company to claim large R&D projects will obviously have a significant impact on Australia’s resource industry, potentially reducing the industry’s access to this generous government incentive.

The budget papers indicate the government will release a consultation paper on this issue in mid-2009, to seek industry input into any proposed legislative changes and the potential impact such changes will have in particular circumstances.

Need for clarification

One of the government’s motivations for introducing an R&D tax credit system was to bring clarity and transparency to what is currently a very complex program of R&D concessions. However, as some basic details as to how the government intends to administer the program have been omitted, many companies will be confused as to whether they are eligible to make a claim under the new program.

Of particular concern is the issue of how non-refundable tax credits are to be treated in the hands of loss-making businesses. If, for example, there is no facility to carry unused non-refundable tax credits forward (to be credited against future tax liabilities), a significant number of Australian businesses will have no ability to access the government’s key innovation incentive.

The current difficult economic conditions are likely to put some successful Australian businesses into temporary loss positions and, unless non-refundable R&D tax credits can be carried forward, many businesses will be denied the benefits of this initiative when they most need it.

As such, we believe the most pressing issue arising from the announced changes is the need for the government to provide further clarification on the ability for companies in tax-loss situations to carry forward the R&D tax credits.

What next?

Given that the changes to the current R&D incentive program will not take effect until July 1, 2010, companies have an excellent opportunity to start thinking strategically about maximising the benefits associated with their R&D spend. For example, companies with increasing levels of R&D expenditure may wish to bring R&D spending forward, in order to take advantage of the 175% premium concession while it is still available.

Companies that would benefit from the increased incentives offered under the new changes may investigate their ability to hold off incurring R&D expenditure until the new scheme takes effect. Also, companies would be prudent to consider whether there may be scope to legitimately maximise their R&D claims prior to the tightening of the definition of R&D activities.

It is encouraging that the government is seeking industry consultation with respect to the redefinition of R&D from a taxation perspective. But it is essential the R&D tax credit scheme remains focused on incentivising businesses to achieve commercially focused outcomes.

* Tracey Murray is a partner in the R&D team within the Corporate & International Tax division at BDO Kendalls.