TCF Services response to R&D Tax Incentive Review
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SUBMISSION IN RESPONSE TO THE REVIEW OF THE R&D TAX INCENTIVE (RDTI), SUBSEQUENT TO DECLARATION OF THE NATIONAL INNOVATION AND SCIENCE AGENDA
1 – Respondents & Summary Recommendations
1.1 This submission is prepared by TCF Services Pty Ltd of Level 2, Suite C, Level 2, 55 Mentmore Avenue, Rosebery, NSW 2018. The primary contact for feedback in relation to the contents of this submission is Mr Gerry Frittmann (gerry@tcf.net.au). Telephone 02 82194900 or 0413 647664.
1.2 TCF Services provides a full-spectrum advisory service to individuals and firms undertaking innovative activities in Australia, who in turn seek to leverage the Research & Development Tax Incentive and other Government-provided incentives to industry, predominantly via the Automotive Transformation scheme (ATS), Clothing and Household textiles (Building Innovative Capability) scheme (BIC) and the Export Market Development Grants scheme (EMDG). Please view www.tcf.net.au for further information.
1.3 TCF Services directly employs 19 people, with over 63% of our staff holding innovation-specific or tax and legal related qualifications, as follows: 10 x Registered R&D Tax Agents with the Tax Practitioners Board with the following degrees – 3 x Certified Practicing Accountants with CPA Australia, 1x Bachelor of Science PhD in Chemistry, 1 x Bachelor of Law/Bachelor of Business & Commerce (Accounting), 1x Bachelor of Science (Hons) PhD in Physics, 1 x Bachelor of Mechanical Engineering PhD in Process Engineering
1.4 This submission has been developed following a roundtable workshop to consider the R&D Tax Incentive Review Issues Paper which drew on the collective experience of 12 TCF Services consulting staff associated with the delivery of R&D support to industry totalling 96 years, and associated with the current provision of research & development tax incentive advice to over 250 active clients per annum.
1.5 TCF Services has previously lodged a submission to the Senate Economics Reference Committee inquiry into Australia’s Innovation System. [Refer Appendix B].
1.6 In terms of the current review of the R&D Tax Incentive by Mr Bill Ferris, Dr Alan Finkel and Mr John Fraser (the Review Panel), TCF Services submits the following:
1.6.1 Whilst the imposition of the $100m cap is well understood given Federal Government budget pressures and wider taxation issues relative to a very limited number of large companies affected by the cap, the further proposed 1.5% reduction in benefit for the next tier of companies with aggregated turnover of $20m or more is certainly a disincentive to further innovative activity, and thus counter-productive to the policy objectives of the programme outlined in the Review Issues Paper;
1.6.2 The main issue for many firms with turnover of $20m or more is the fact that they receive no benefit from the programme if they don’t pay tax (i.e. if they have a current tax year loss OR accumulated tax losses from prior years). Many of these are medium sized firms/employers potentially under threat in their marketplace and in most need to undertake R&D activities to survive, and in some instances in tax loss only due to R&D expenditure being incurred. This anomaly should be addressed as companies under $20m in annual turnover cash out their tax losses and receive a 45% cash benefit.
1.6.3 We believe that companies of $20m or over with tax losses are disadvantaged under the current rules and should accordingly benefit by having the ability to receive a net refundable 10% cash reimbursement benefit, as this would have a profound effect on producing evidence based “additionality” to this very important employment sector. We submit that this idea for programme reform is worthy of modelling and determining costs/benefits, especially for regional firms.
1.6.4 In the main, other than the prior point, TCF Services fully supports the R&D Tax Incentive for firms with annual turnover of $20m or more.
1.6.5 In relation to the innovative disruptive start up sector and firms under $20m, we argue that policy objectives would more appropriately be addressed through restructuring the current RDTI by way of converting the tax incentive to a grant program from 1st July 2017. Changing to a grant-based incentive would substantially lessen administrative costs as a result of de-linking the benefit with the Tax system, while enabling a more accurate view of the associated costs in supporting innovation within smaller enterprises and enterprises that are growing. A grant-based incentive would also require claimants to specify more substantive expectations of additionality, such as economy-wide benefits, impacts/improvements to the environment, employment growth, the provision of better services and the generation of more active consumer choice.
1.6.6 To help focus activities on the achievement of policy objectives in relation to additionality, an R&D Incentive for smaller enterprises based on the payment of a grant would require up-front: the preparation of an R&D plan, demonstrated linkages of the R&D plan to a complementary enterprise plan or strategic business plan, and the definitive sketching of anticipated costs and a pathway to commercialisation. Such measures will strengthen the commitment of firms to undertaking research and development activities in a more formal and planned manner, as potential R&D grant applicants would be encouraged to outline a specific ‘Technology Roadmap’ to substantiate their claims, and thus focus their efforts on those activities likely to yield the most benefit when cross-referenced to government initiatives in regard to technology growth centres and the opportunities emerging from recent Free Trade Agreements.
1.6.7 These latter requirements would ensure the restructured R&D Incentive would truly reward innovation, and hence lessen the likelihood that scarce government resources were not being used to underpin R&D undertaken in the normal course of business, as the Review Issues Paper intimates, whereby current arrangements have ten months from the close of the financial year to submit their claims.
1.6.8 Several deficiencies also remain in the determination of eligibility under the existing RDTI for activities in the disruptive software space. At issue is the innovative merit associated with the redesign of historical business models. For example, not all cases of innovation necessarily involve high levels of technical or scientific risk/ advancement. However, the developmental risk and manner in which these process based services are brought to market are entirely the same. Start ups testing new ideas and undertaking innovative developmental concepts should be recognised as eligible to claim benefits under a new grant program, as opposed to trying to claim benefits under the RDTI and “flying under the radar”. We recommend broader and more reflective eligibility criteria be developed to address the needs of this sector, which clearly support Innovation.
1.6.9 Accordingly, technical advancement (or in other words – process ‘innovation’) needs to be recognised and determined eligible under a future less than $20m turnover grant program, in order that local enterprises advancing disruptive business model innovation would also be eligible for benefits, as they would have under the prior R&D Tax Concession whereby high levels of technical risk AND innovation were eligible.
1.6.10 The integrity of any government self-assessment assistance scheme is heavily dependent upon the robustness of the claim review and audit regime that is applied to applications. As the RDTI applies industry wide, the large number of entities (over 13,500) seeking the <$20m benefit make up over 75% of claimants. Such entities are burdened with having to deal with two administering bodies, which themselves generally suffer from a lack of resources (as well as inconsistencies in the application of RDTI administrative principles) to really effect sufficient audit activity. Whilst AusIndustry educates, encourages and supports delivery of the RDTI programme, the ATO supports a different engagement culture and in the main are uncontactable within the applications process. The ATO administers the eligibility of expenditures through the tax return system and delivers benefits via either cash payments or a reduction of tax payable. R&D Tax benefit are treated as “non assessable income” for tax purposes, as opposed to a grant which is regarded as “taxable” income.
1.6.11 One alternative to encouraging firms to undertake more innovative activities is to require that RDTI claimants prepare a statement in the form of an innovation route to substantiating eligibility. Requiring that costs claimed should be externally audited as part of the benefit application process will also help reduce administration costs for the Commonwealth, as will a decision to nominate one lead government agency as being responsible for adjudicating on the merit of R&D claims.
2 – R&D Tax Incentive Review Issues Paper
2.1 TCF Services welcomes the more specific focus of the R&D Tax Incentive Review Issues Paper, including its acknowledgement of the principal objective for Government intervention in research and development being to address market failure in the allocation of risks and rewards between firms undertaking R&D activities, and the wider Australian society.
2.2 TCF Services also notes that the role of the RDTI in the total mix of Australian Government innovation programmes has necessarily changed subsequent to the Government’s delivery in December 2015 of its new National Innovation and Science Agenda (NISA).
2.3 TCF Services accordingly welcomes the new Review’s focus on identifying opportunities to improve the effectiveness and integrity of the RDTI, including its emphasis on specifically encouraging ‘additional’ R&D expenditure over-and-above that which would be undertaken in the normal course of business.
2.4 Accordingly, it is important that the Review Panel looks to assess the effectiveness of the RDTI in the context of the broader suite of innovation measures being put into place under NISA (i.e. not consider the RDTI from a ‘disconnected/isolated’ or ‘cost only’ point of view), as well as international best practice in the delivery of similar R&D incentives overseas. Moving forward, the definition of eligible R&D needs to place more emphasis on the actual achievement of innovation.
2.5 We also note that the Review Panel’s deliberations are benefiting from work undertaken by the Centre for International Economics (CIE) in analysing the RDTI from the perspective of its policy rationale, programme design, impact and cost. At the time of the preparation of this submission, we note the CIE’s work had not been publicly released.
3 – Economic Outlook Governing Innovation Activities in Australia:
3.1 TCF Services has reviewed the Government’s Mid-Year Economic and Financial Outlook (MYEFO) published in December 2015, and notes the downwards revision of economic growth forecasts contained in that document, and in turn, the outlook for a continuing deterioration of the Budget deficit in the years through to 2017/18.
3.2 Notwithstanding the opportunities for growth contained in MYEFO – in particular, its mention of the prospects for growth in exports to East Asian destinations benefiting from recent Free Trade Agreements – TCF Services maintains the outlook for Australian innovators remains challenging. It is therefore not the time to be reducing incentives for greater R&D efforts in Australia.
3.3 MYEFO’s confirmation of the outlook for subdued economic growth thus increases the importance and need for government incentives to support the successful commercialisation of Australian innovations, as well as the need for such incentives to remain relevant to the business circumstances encountered by Australian entrepreneurs in the contemporary marketplace.
3.4 TCF Services also notes MYEFOs projections (p43) that payments related to the RDTI are expected to increase by $206 million in 2015/16 ($1.8 billion over the four years to 2018/19), on the basis of a higher than expected number and size of claims for the R&D refundable tax offset. Such provisions should be considered positively as reflective of the success of the tax incentive as a measure to boost local innovation activity.
3.5 We also note the Review Issues Paper’s notation that, outlays to support the RDTI are projected to grow further, to around $3.5 billion in 2017/18, and said to be largely due to growth in the cost of the refundable component for businesses with a turnover of less than $20 million. Again, this should be viewed positively as an indicator of the success of the programme, with due credit to AusIndustry in promoting the programme, including via a self-help website and potential claimants workshops targeted to a vibrant start-up community which readily shares knowledge beyond the scope of advice provided by the accounting fraternity. Without growth in innovative ideas and their associated increase in research and development activities, Australia will fall even further behind other progressive countries.
3.6 TCF Services acknowledges the difficulties unforeseen programme expenditure growth creates for Government in achieving stable Budget forecasting, especially at a time when the Federal Government’s budgetary deficit is also forecast to continue to deteriorate.
3.7 Nevertheless, it is important that any proposals to improve the effectiveness and integrity of the R&D Tax Incentive arising out of the ISA Review remains focused on achieving the RDTI’s principal objective (refer para 2.1), and are not simply driven by selective measures to achieve blanket reductions in the amount of funding required to support the programme.
4 – Current Initiatives to limit the Growth in Budgetary Costs from R&D Tax Incentives:
4.1 TCF Services notes that 2014 Budget measures to reduce RDTI costs to revenue by way of reduced benefit thresholds are yet to pass into law.
4.2 The uncertainty over reduced benefit thresholds coupled with the imposition of the $100m cap to eligible R&D expenditures have acted as disincentives to additional R&D activity in some sectors, and thus are counter-productive to the policy objectives of the programme.
4.3 The value of the RDTI to industry has nevertheless been confirmed with the participation of small-to-medium sized enterprises (SMEs) continuing to grow which indicates investment and economic dividends are being generated.
4.4 At the same time, the growth in R&D activity benefiting from the RDTI has not been accompanied by a parallel increase in the level of collaboration between industry and universities/research organisations. This could be due to a perception of high participation costs and a lack of understanding within small and mid-sized firms about the research capabilities available to them, plus the fact that most Research Institutes expect ownership of the resultant intellectual property (IP). This is despite the commercial partner who conceived the idea having taken the financial risk, and therefore needing to commercialise the idea in order to receive a return.
4.5 As such, we strongly recommend that the R&D benefit should continue to be provided to the entity undertaking the financial and commercial risk. Nevertheless, differing grant rates targeting desired outcomes should be used to determine the quantum of benefits paid under a new National Innovation, Science and Technology (NIST) grant program for companies under $20m.
4.6 TCF Services also acknowledges it is a priority of the NISA to improve R&D collaboration in Australia. The RDTI in its current form does not wholly encourage this. For example, if an entity is 50% or more owned by a university, it can only claim limited benefits, being a non-refundable tax offset which is of little use to a start up trying to commercialise a new product. Such entities should be able to claim in the same manner as any other business with annual revenue under $20m, but as its stands, University spin-offs with 50% or more ownership cannot currently access any real benefit. At a minimum, they should be able to receive a refundable tax offset equal to 10%. A new grant program would address this anomaly, as the RDTI in this instance has resulted in a negative net benefit to new innovative entity borne out of a collaboration with a University.
4.7 TCF Services suggests that the workings of the RDTI should be revised to eliminate those areas of eligibility and administration that discourage the achievement of the Government’s collaboration objective.
5 – Administration and Compliance Costs:
5.1 TCF Services notes that the current (2011/12) RDTI rests on a legislative base of concessions for industry that date back many years. The Australian economy is currently challenged with transitioning from predominantly mining investment boom-led growth, to one that in parallel features a shrinking low differentiation/volume-based manufacturing sector alongside a rapidly expanding ‘Services’ sector.
5.2 TCF Services accordingly believes that the definition of R&D activities eligible under the current incentive is not fully reflective of the needs of a modern ‘Services’ economy, which is increasingly being driven by disruptive software/firmware applied to traditional business models. The imagination of alternative business models is as innovative as related activities in technical or scientific advancement.
5.3 The current RDTI legislation and administrative structures presents to potential participants as being overly complex in design. Most innovators are not thinking about tax when they are seeking assistance for innovative activity, and therefore, the need for such considerations generally confuses the discussion of how firms can best access assistance to bolster cash flow to span their innovative activities through to earlier commercialisation. These challenges are only made more difficult for participants by having to deal with two administering agencies – Innovation Australia (via AusIndustry) and the Australian Taxation Office.
5.4 Accordingly, it is not surprising that growth in RDTI participation has been accompanied by heavy reliance on the use of advisors and consultants. TCF Services itself employs a range of consultants with technical qualifications that facilitate a better understanding of programme requirements. The application of such high-level expertise must be paid for and, as a result (as noted in the Review Issues Paper), such costs appear “high relative to the budgeted costs of the programme and the benefit to participants”. TCF Services submits that consultants fees of $200m cited in the report account for 7% of the total benefit delivered, and are not necessarily high given the support required to deliver any legislated program that features added complexities associated with tax, thus compounding the claims process. Perhaps it is better to look at the positives consultants bring to the process by way of delivering auditable claims, marketing the programs and taking the financial risk involved with their successful delivery. Consultants therefore act as both a multiplier and filter, with their fees alternatively needing to be seen as a fair price to pay for the work performed, as compared with Government trying to play this role. Also, generally not recognised is the role Consultants play in providing wider support to the Innovation community (networking, capital raising, structuring, accounting, business planning, IP protection etc).
5.5 It is inevitable that Government assistance programmes based on taxation concessions present RDTI claimants and their advisors with a time/cost trade-off between full compliance and less-than-full compliance, with the associated risk of substantially additional costs (and penalties) should claims be subsequently found through audit/verification measures to be unjustified. On many occasions when reviewing claims prepared by third parties, TCF Services has had to remind claimants of the requirements of R&D tax incentives legislation and, in turn, adjust draft claims to ensure they are compliant with the requirements of the relevant legislation. The lack of robust contemporaneous records has often been an issue as to whether certain activities are eligible for RDTI benefits. Such issues could also be eliminated from a scheme that requires pre-registration.
5.6 TCF Services understands that overseas R&D incentive programmes are generally more comprehensive than Australia, are better defined in terms of eligibility criteria and are more effectively audited in terms of ensuring that claims do not proceed when they do not meet each programme’s respective requirements. As such, the processes of the US Internal Revenue Service (IRS) are worthy of study.
5.7 TCF Services further understands that claimants are more likely to be regularly audited in Canada and Singapore than in Australia. This is because, due to a lack of resources or a lack of skilled staff with programme compliance skills, AusIndustry does not generally enforce a very high level of compliance, and this in turn is likely to affect the mindset of participants in not committing to maintaining adequate records to back up their claims. Robust internal controls and accurate record keeping as to what goes into substantiating a claim are therefore a must in seeking to have any assistance focused on those activities that will yield the most additionality, in terms of whole-of-economy benefits from R&D activities supported by the Commonwealth.
5.8 TCF Services maintains that as a result of the current self-assessment approach, the dual agency administration of the RDTI – along with a perceived lack of resources or enthusiasm by administering agencies to support an active claim review and audit regime – the ‘additionality’ objective underpinning Government support for the RDTI has frequently been compromised.
5.9 TCF Services especially notes the Review Issues Paper’s observation that it is unusual in OECD countries that R&D incentive schemes are delivered by tax-based concessions, rather than through more traditional direct measures such as grants.
5.10 We accordingly submit that, in future, research and development assistance for firms with annual turnovers of less than $20 million should be delivered via a grant mechanism which is similarly accompanied by more robust application requirements, information guidelines that are more definitive on eligible expenditure and perhaps an interim client application review step where the programme administrative body checks that R&D activities underway are consistent with programme objectives.
5.11 Reflective of the Government’s recent announcements in regard to the NISA, TCF Services believes that OECD arguments that R&D tax incentives should be designed primarily to meet the needs of young innovative firms and stand-alone firms without cross-border tax planning opportunities is even more reason to move away from the tax incentive for companies under $20m.
5.12 If any innovation program or the RDTI is really to make an impact on driving Australian innovation internationally, we would recommend that early stage Australian-based patenting costs be made eligible for assistance under a NIST programme, in recognition that the achievement of a successful transition of the Australian economy from a resources and manufacturing dominance will require differences to some assistance schemes if Australia is to really provide an incentive to expand the Services economy.
6 – Policy Design Issues – Administration/Firm-Level Compliance/Economic Efficiency Costs:
6.1 TCF Services welcomes acknowledgement in the Review Issues Paper of the need for continued Government intervention to overcome the risks of market failure in the generation of R&D activities in Australia.
6.2 We further note the challenge facing government in designing an effective mechanism that both supports R&D activities most likely to generate spillover benefits, whilst also being additional to business-as-usual activities – all within an administrative construct that facilitates business up-take.
6.3 TCF Services accordingly supports changing the focus of current R&D assistance away from the taxation mechanism, and the reorientation of benefits for SMEs within a simplified administrative structure encompassing a switch to grant-based assistance for claimants with annual turnovers of less than $20 million.
6.4 We see this re-orientation of R&D assistance as being justified through reference to the current composition of Australian industry (ie: a majority of SMEs which, by and large, are responsible for the majority of employment generation). We also note the Review Issues Paper’s observation of international studies citing ‘additionality’ as likely to be greater for SMEs than for larger firms.
6.5 TCF Services nevertheless submits that current arrangements relating to the timing of registrations and the claiming of benefits supports a higher risk that benefits subsequently claimed have the potential to encompass ‘business-as-usual’ activities. The adoption of more traditional approaches to claimants substantiating their claim with adequate records may go some way towards government programmed objectives being more fully acquitted.
6.6 As a means to ensuring research and development incentives are skewed towards additionality, TCF Services supports the notion of closing the gap between registration and the submission of claims to address this issue.
6.7 For the current RDTI or any new grant-based arrangement, TCF Services proposes that eligibility to access benefits would require up-front: the preparation of an R&D plan, demonstrated linkages of the R&D plan to a complementary enterprise plan or strategic business plan, and the definitive sketching of an anticipated pathway to commercialisation. Proper record keeping and the alignment of activities with government objectives in relation to growth centres and free trade agreements would go a long way in focusing priority R&D activities to be undertaken in Australia.
6.8 These could be summed up in a Technology Roadmap that would include a technology gap analysis, development route, means of creating collaboration and a pathway to commercialisation. The technology roadmap could futher include a set of milestones/stages of predefined break-throughs such as overcoming a known obstacle or the stages of prototype development. Such information could be used to establish the boundaries where all costs that fall within those boundaries are eligible (no hidden surprise for AusIndustry or the applicant), thus improving programme administration outcomes.
6.9 In developing a grant-based R&D assistance programme for firms with less than $20m in turnover, Government has many prior and current grant programs to draw upon for ‘best practice’ design principles which AusIndustry fully understands, such as the current BIC and EMDG schemes which could be re-purposed for a new NIST program.
7 – Definition of R&D Activities:
7.1 TCF Services notes that the current R&D Tax Incentive relies on a legislative base that dates back over 30 years, and accordingly has been revised and amended on numerous occasions resulting in a complex programme design that is only made more difficult for participants by having to deal with two administering agencies – Innovation Australia (via AusIndustry) and the Australian Taxation Office. A shift to a single agency having responsibility for programme administration should be accompanied by an increased emphasis on the achievement of real innovation in order to access government assistance.
7.2 TCF Services believes that the current time delay between the submission of claims and registration and AusIndustry’s integrity reviews, increases the likelihood that a certain proportion of claims do not meet the real innovation test, and hence, present more as business-as-usual activities.
7.3 Such risks could be more effectively addressed by a combination of improved guidance in relation to eligibility that is more reflective of Australia’s contemporary (and evolving) industrial structure, the nomination of a single agency to lead programme administration, and the conversion of the current RDTI for companies under $20m into a grant-based programme.
7.4 Additional improvements could be made by requiring participants to claim projects and project costs, instead of separate definitive activities. For example, many SME’s are completing multiple project activities at the same time, not one after the other. The expectation of recording the conduct of each R&D activity to determine its eligibility via a “directly related” and/ or “dominant purpose” test, along with the need to form a “hypothesis”, is an added burden and not consistent with the manner in which a company will would normally operate.
7.5 Alternatively, an R&D project might be required to meet different eligibility criteria addressing directly related expenses that are defined and eligible – in the main over 80% of directly related expenses are labour and materials. To eliminate the need to calculate indirect costs a new scheme should simply prescribe a claimable “salary on costs uplift factor” (like the current BIC scheme) of say 30% and the ability to claim depreciation on R&D assets. In such a case, the eligibility of expenditure is clearly defined and simple to calculate, which would subsequently be verified by an external auditor and audit certificate provided as part of the grant submission.
7.6 TCF Services notes that in mustering government resources to support the current review, the Review Panel is being ably assisted by a Taskforce formed within the Department of Industry, Innovation and Science, and which includes representatives from the Department of the Treasury and the Australian Taxation Office.
7.7 TCF Services has regularly experienced difficulties in progressing RDTI claims due to differences of opinion between AusIndustry and the Australian Taxation Office (including conflicting advice on their respective websites e.g. early stage patenting activities/ osts), which have involved additional and unnecessary costs in working through two agencies to resolve issues of contention.
7.8 We accordingly recommend that having now raised the Taskforce, Government should maintain the concept by carrying it through into future administration of the RDTI, with a single agency being appointed as programme lead, and therefore being responsible for coordination and the sourcing of advice and programme data in the hands of other agencies. Savings in administration from such reforms could then be channelled back into achieving more visibility of programme performance data, perhaps in the form of a quarterly innovation report to the Parliament.
7.9 TCF Services further notes administration and participation costs would be all the more simpler if the RDTI was regenerated as a grant-based programme for companies with less than $20 million in annual turnover.
8 – Rates & Thresholds:
8.1 TCF Services supports retention of the current RDTI for companies over $20m with minor changes, as mentioned in Paras 1.6.1 and 4.4. Nevertheless, we believe that grant rates established under a new grant program for less than $20m companies should be tiered in a manner whereby the greatest benefits are paid to activities identified by government by way of its nomination of new industry growth sectors. Although all firms need to continually innovate, the level of risk is generally greater in newer firms than in older/more established industry sectors characterised by less future growth and employment opportunities. Such a change of emphasis would direct the greatest benefits to emergent/future economic sectors, but still recognise the needs of the industrial age sectors whereby the ability to innovate is far less.
8.2 Adoption of this programme reform would require the grant mechanism also instituted a secondary “level of inventiveness test”, in order to enable determination of the grant rate to be paid in a manner which directed the greatest benefits to applicants overcoming the most challenging innovation tasks. By setting grant rates starting at 15% – and rising incrementally to 25%, 35% and 45% – programme expenses could be much better (and more fairly) managed to enable outlays to fall within annual funding limits – which we estimate would need to be in the order of $1.2b – $1.5b a year.
8.3 Such programme reform would eliminate government fears of continual and unplanned growth in outlays, even though such growth should be looked on positively as a measure of success – not a uncapped budgetary burden. As such, any capped grant program would also carry with it a modulation factor to be applied if the scheme was over – prescribed (as is the case today with other programs), as well as a three year cycle of funding cap review. Under the programme, entities from any sector who engage Research institutes and undertake to address an inventive step for commercial purposes would be provided with the highest 45% grant rate.
8.4 More robust requirements to achieve registration for R&D incentives would also serve requirements for greater additionality and spillovers. For example, this might be achieved by adding an ‘Additionality and Commercialisation’ section in the RDTI application form outlining expected outcomes in this area. This would generate data on paybacks to the economy to substantiate taxpayer support for R&D activities, in particular, by putting real numbers on employment growth, increases in firm turnover, tax payments received from incremental activities and exports. The current Australian Bureau of Statistics R&D businesses survey covering a subset of claimants does not quantify the impact of support for R&D endeavours. Instead, its focus is on activities, not outcomes.
8.5 The ability to determine “eligible expenditure” can also be prescribed in a grant type program, expenses incurred like the local, early stage search and provisional patenting or other forms of IP registration fees should be eligible as it forms part of the process in determining project direction, requires the rigour of recording and proving the advancement of knowledge and is measurable statistically.
9 – Administration & Compliance:
9.1 TCF Services endorses the CIE’s observation that a pre-registration process is likely to increase the consideration of the RDTI in the decision making processes of firms, and thus increase the likelihood of claims generating additional R&D.
9.2 In implementing any pre-registration process, TCF Services further believes that best practices from related industry assistance programmes should be adopted, such as the requirement for a Statement of Intent for future R&D activities that are clearly linked to the company’s Strategic Business Plan.
9.3 TCF Services has previously submitted that dual-agency administration of the current RDTI involves unnecessary uncertainty (in relation to eligibility and benefits) and additional costs to claimants. In its place, we recommend the nomination of a single lead administration agency built around the ‘Task Force’ concept now being employed by government in the current review to co-ordinate inputs from other related agencies.
9.4 We strongly submit that it is unfair that the costs of ‘cultural’ differences between two government organisations raised to provide industry benefits and administration of the taxation system should be borne by RDTI claimants. It is the government’s responsibility to structure industry assistance programmes so that they can be delivered and administered as efficiently as possible.
APPENDIX A:
DESIGN RULES FOR GRANT-BASED R&D ASSISTANCE TO SMALL FIRMS under a $20m and start ups National Innovation Science and Technology (NIST) programme
- New grant-based programme to commence 1/7/2017 with a legislated budget of $1.5 billion per year – with a provision for modulation of payments if scheme ends up repeatedly over-scribed and a funding budget review every 3 years.
- Would be a self-assessment entitlement program with a requirement to pre-register annually and furnish an audit certificate with the final application attesting to the expenditure claimed.
- New programme would encompass a wider interpretation of eligibility to include “innovation” and “novelty” for the disruptive start-up community.
- Pre-registration requirements to provide integrity to the scheme in terms of measurable “additionality” and “spillovers”, as a claimant would need to plan their projects before they register, and provide written information about the activities and costs they will undertake in the next year and how this will impact the business.
- Pre-registrations to occur by the 30th June each year in order to achieve registration for the following year BUT with an ability to register at any time throughout the year for new firms entering the innovation cycle or existing firms commencing a new project. Any activities and costs incurred before registration would not be eligible.
- Tiered grant rate benefits based upon nominated government industry growth sectors and associated level of risk (inventiveness). Grants rates tiered at 15%, 25%, 35% and 45% with the highest rates provided to the 6 identified growth sectors ( Food, mining, advanced manufacturing, disruptive technologies, Biotech and renewables)
- Grants to be deemed alienable – so as to allow start ups to use them as security to receive earlier cash flow support and accelerate their R&D pathway, which is often hampered by early stage unavailability of funds.
- AusIndustry to solely administer the new scheme in association with other related agencies.
- Simpler and prescribed “eligible expenditure” to assist program participation and reduce the cost of external auditors. This measure should also be tailored to better meet the costs incurred like early stage local IP costs/ investigations.
- Taxable grants paid to profitable companies will return a benefit, conversely subsidised R&D projects which result in commercial success will also pay an eventual dividend, so the determinant for receiving a benefit under this programme will better offset the costs and share the cost with firms who are prepared to invest and innovate.
- The former TCF Strategic Investment Programme which was condensed into the current BIC scheme provides a perfect model under which to structure a new innovation scheme for firms with turnovers of less than $20m.
Given costs are to be externally audited, AusIndustry (as they do currently) would continue to assess eligibility, albeit in a much more open manner given the added inclusion of innovation/ novelty, means that programme administrators only need to be comfortable that innovation has occurred and based upon its industry sector will determine the grant rate allocated with the added provision that the degree of inventiveness can be used as a second determinant, thus rewarding any sector with an appropriate quantum of support whilst keeping a cap on budgeted funding.
APPENDIX B:
TCF SERVICES PTY LTD
Submission to Senate Economics References Committee on Australia’s Innovation System
- Recommendations
1) That the R&D Tax Incentive Program be urgently reviewed to reduce compliance cost and to make it more accessible to innovative SMEs.
2) That the benefit not be reduced for the 2014/15 period. One reason is the ever increasing compliance cost and the impact of this on the net benefit.
3) That the eligibility of patent costs be clarified and the cost of preparing provisional patent specifications be allowable
4) That compliance be performed by one agency only
5) That quarterly payments be introduced as previously proposed
The reasons for making these recommendations are:
- Difficulties in assessing and determining what are eligible activities and expenditure
The complexity and difficulty in interpreting the current R&D Tax Incentive legislation is a significant barrier that SMEs face in claiming the R&D Tax Incentive benefit. This complexity and difficulty is illustrated by the fact that the Commonwealth is providing contradictory advice in guidelines or otherwise on a number of issues, specifically:
2.1 Supporting Activities – is it “and” or “or”?
Current AusIndustry guidelines contain different interpretation of the meaning of supporting activity definition (this definition is one of the most important parts of the legislation).
The “A Guide to Interpretation” a current guideline interprets the definition of supporting activities at page 18 in the following way:
– all supporting R&D activities must be directly related to a core R&D activity; and
– in addition, if the activity is an excluded activity or produces goods or services, or is directly related to producing goods or services, the activity must be undertaken for the dominant purpose of supporting a core R&D activity.
In effect, this guideline is stating that an excluded activity or a supporting activity that produces goods and services must satisfy both of the above requirements/dot points.
However, another current guideline also produced by AusIndustry contains the completely opposite interpretation. Specifically the Overview of the R&D Tax Incentive at page 6 states:
An activity is eligible as a supporting R&D activity where:
– it is directly related to a core R&D activity; or
– for certain activities, it has been undertaken for the dominant purpose of supporting core R&D activities.
This guideline is stating that a supporting activity that produces goods and services need only satisfy the second dot point, ie the second branch of the definition of supporting activities. An observation is that, if Ausindustry has difficulty in interpreting the legislation that it administers, how can it reasonably be expected that SMEs are able to correctly self assess.
2.2 Supporting Activities – when is an activity “directly related”?
The difficulty in applying the directly related test is illustrated by AusIndustry providing conflicting advice in its Industry Guides.
The ICT Guide at page at page 5 outlines the case why a GUI is an eligible supporting activity. However, Energy Guidance at page 31 argues a case why a GUI is not eligible although it is unlikely that the nature of the “underlying” facts and issues were significantly different. This guideline states that the GUI in this case was not eligible for the reasons that:
“The development of the GUI was not directly related to the conducting of the experimental activities in a core R&D activity.”
It is noted that the current definition of supporting activity does not contain any reference to “conducting” and therefore the AusIndustry person(s) who produced/vetted this guideline may be providing incorrect advice. This is not the only instance where AusIndustry or other government persons involved in administering innovation programs are providing “incorrect advice” or conflicting advice. This supports the case that the current R&D Tax Incentive legislation is difficult for SMEs to interpret and apply and therefore self assess.
2.3 Supporting Activities – dominant purpose test – eligibility of patent activities.
Recent feedback from AusIndustry staff is that applying for patents (eg preparing provisional patent specification) is driven by “by the commercial imperative to protect the company’s post-R&D” and is therefore not eligible since it does not satisfy the dominant purpose test. This test being used by AusIndustry staff seems to ignore the fact that all business R&D has a “commercial imperative”. If this test is applied generally, no supporting activity where a dominant purpose test applies may be eligible which is clearly not the intention of the legislation.
It is noted that even the most recent guideline – “A Guide to Interpretation” at page 32 discusses this matter in some detail without ever considering whether a very important patent activity, ie preparing a provisional patent specification is eligible.
It is further noted that the current AusIndustry position may be in conflict with a current ATO guideline accessible at:
https://www.ato.gov.au/Business/Research-and-development-tax-incentive/In-detail/Guides–ATO/Research-and-development-tax-incentive—amounts-you-can-claim/?page=10
and specifically at the following paragraph which infers that, say, applying for a provisional patent during a project is not excluded if it satisfies a timing requirement:
“legal expenses not associated with any approved research project, for example, legal expenses for a patent search before undertaking a research project or in taking out a patent after a successful project”
This is an example which illustrates the difficulty in dominant purpose test in relation to patent activities. This difficulty applies more generally, for example, in relation to activities that involve the production of goods and services.
It is recommended that preparing a provisional patent application early in a R&D project be allowable for the following reasons:
– Lodgement of a provisional patent application does not provide any IP protection – it only sets a priority date and lodging a provisional application is usually followed by experimentation, ie core activities, to develop the product or process or in patent jargon, provides the opportunity to find the best method of performing the invention.
– The immediate purpose of preparing and lodging a provisional is frequently to enable core experimental activities to be undertaken, eg to raise funds from an investor for financing the experimental activities, to work with a collaborator such as a university in undertaking joint experiments or to enable public testing and trialling of the innovation.
2.4 Application of Clawback – Commercialisation Australia (CA) recipients and the R&D Tax Incentive benefit
We have found that CA case managers may have been advising some CA grant recipients that they are not eligible also to claim a R&D Tax Incentive benefit for R&D activities that are being funded by the CA grant. This is clearly incorrect – Subsection 355-G of the ITAA 1997 allows this by applying what could be termed a 10% Clawback Tax to an “amount” of expenditure to partially or wholly offset the value of claiming the R&D Tax Incentive benefit.
This may be another example of Commonwealth Government officials who are directly involved in facilitating business innovation finding it difficult to interpret their own legislation and many SMEs subsequently not receiving a benefit that they are legally entitled to. Where the CA grant recipient is an SME and is in a loss situation, this lost benefit is significant.
We have also found confusing advice in ATO guidelines on how much expenditure is subject to the 10% “Clawback tax”. There are many other areas where it is difficult to determine whether specific types of expenditure and activities are eligible or not or how much is eligible. This includes the application of the core activities definition, how to treat design expenditure and the feedstock provisions.
- High Compliance Cost
There is a high and ever increasing compliance cost for the following reasons:
– the ever increasing compliance requirements. For example, the volume of information required in the registration form is now probably double that required for the R&D Tax concession and increases every time a new version of the registration form template is released.
– the difficulty for SMEs in determining what is eligible due to the difficulties in applying the R&D definition, the lack of clear guidelines on many issues and conflicting guidelines and advice as described above. – this difficulty is compounded by problems in obtaining objective and timely advice on specific eligibility and expenditure issues from either AusIndustry or the ATO. Any query is escalated through a number of levels and it may take several days to get “expert” advice on a single issue. Having a single agency involved in compliance, who can provide prompt advice and be focussed on providing a specialist quality service to innovative SMEs would be a significant benefit.
– having to deal with both the ATO and AusIndustry on compliance – this means that SMEs need to maintain two sets of records and deal with two bodies on compliance. Any follow up compliance action by either body substantially adds to the burden of compliance and can quickly erode any benefit.
One impact is that many companies use the services of consultants, many of whom charge amounts that represent a significant amount of the benefit. Please note that TCF Services charges are at the low end of the fee spectrum while providing a quality service and ensuring the companies limit their claims to what is justified.
Even when a SME prepares its own registration and has the appropriate resources to prepare the registration form etc and maintain adequate records, it is unlikely that compliance cost will be less than between 2% and 3% of eligible R&D expenditure. If there are any compliance actions by either the ATO or AI, then compliance costs will be significantly increased.
With the benefit being reduced to 8.5 cents in the dollar for larger companies from July 2014, this means that compliance, even in ideal conditions is high and represents a significantly higher portion of the benefit compared to prior to July 2104 period. Where companies use high charging consultants, the cost of compliance erodes an even higher portion of the benefit.
Loss of franking credits and carry forward losses that can be offset against future profits also means that the net benefit is much less than the advertised benefit of, for example, 40% or 45% or 10 or 15 cents in the dollar. In some cases, for example where franking credits are lost and when compliance costs are fully accounted for, the net benefit may be negative.
For these reasons, it is strongly recommended that action be undertaken to reduce the compliance burden, maintaining the benefit at least at the pre July 2014 level and have only one government agency being responsible for compliance. An observation is that having one agency involved in compliance and doing it well may very well result in cost savings for the Commonwealth Government as well as being able to tweak the program to make it more effective. An example of how two Government agencies being involved in delivering a similar program resulting in “inefficiencies” is when I worked for AusIndustry at the time of R&D Tax Syndication, I observed that neither AusIndustry nor the ATO took timely responsibility for core technology valuations. This may have cost the Commonwealth many millions of dollars if not a billion or more at that time.
- Improving the Effectiveness of Government Innovation Support
Does the Commonwealth Government have a role in improving the economic effectiveness of the R&D Tax Incentive and should the single delivery agency have a role in this?
One obvious mechanism to improve effectiveness is to reduce the cost of compliance thus freeing financial resources available to SMEs to fund their experimentation.
The quarterly payment mechanism proposed, but not introduced would also help facilitate cash flow and therefore enabling SMEs to be more responsive to market opportunities and rapidly changing markets which is occurring in the IT sector. It is strongly recommended that quarterly payments be reconsidered. Having a single delivery agency may make this more feasible to introduce from a Government perspective.
Another area is whether the Government has a role in ensuring that SMEs are applying best practice in managing their R&D and innovation therefore improving the prospects of successful commercialisation.
An observation is that software and service SMEs are increasingly using agile development methodologies and tools to manage their R&D and a second observation is that 47.2% of 2014 registrants are in this sector. The Australian product JIRA is an example and Atlassian (the company who developed this product) claim that using their products result in better software. Such products track issues and project manage and some have associated time sheets and report generating tools. Thus there may be the potential for encouraging companies to use such tools and to obtain, at marginal cost, the added benefit that using such tools enable them to comply with the record keeping requirements. The single delivery agency could have a role in determining whether such products (if properly used) satisfy many if not all of the record keeping requirements or what may be additionally needed to satisfy their record keeping requirements. This may be another potential avenue to reduce compliance cost.
– TCF Services Submission for R&D Tax Incentive Review –
Services
Ryan can assist with services such as:
- Scope your potential to claim various grant programs
- Assist with the preparation and lodgement of grant applications
- Review or provide a health check on your internally prepared grant applications
- Establish record-keeping practices as required under various grant programs
- Provide prepayment loans against future cash refunds under the R&D Tax Incentive
- Keeping industry informed on all new Government policy and grant initiatives
Don’t hesitate to give us a call.
