Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)
Chapter 1 - Introduction to the new research and development tax incentive
Outline of chapter
1.1 The Tax Laws Amendment (Research and Development) Bill 2010 (Bill), together with the supporting Bill, the Income Tax Rates Amendment (Research and Development) Bill 2010 amend the law to provide a new tax incentive for research and development (R & D). This chapter provides an overview of the new R & D tax incentive.
1.2 The new R & D tax incentive provides eligible entities with a tax offset for expenditure on eligible R & D activities and for the decline in value of depreciating assets used for eligible R & D activities. The new R & D tax incentive replaces the existing R & D Tax Concession for income years commencing on or after 1 July 2010.
1.3 The operative rules for the new R & D tax incentive are primarily contained in a new Division 355 of the Income Tax Assessment Act 1997 (ITAA 1997). The extensive and complex provisions in the Income Tax Assessment Act 1936 (ITAA 1936) that govern the existing R & D Tax Concession will be repealed.
1.4 The administrative rules for the new R & D tax incentive are contained in a new Part III of the Industry Research and Development Act 1986 (IR & D Act). It sets out the role of Innovation Australia in relation to the administration of the new R & D tax incentive.
Context of amendments
1.5 In the 2009-10 Budget, the Government announced that it would replace the R & D Tax Concession with a new, streamlined tax incentive. The Government issued a consultation paper titled The new research and development tax incentive in September 2009. A first exposure draft of the legislation for the new scheme was released in December 2009. Following consultations with stakeholders, a second exposure draft was released in March 2010. The second exposure draft included changes to make the legislation clearer and to remove unintended consequences. This Bill reflects additional refinements following comments from and consultations with stakeholders on the second exposure draft.
1.6 The new R & D tax incentive is the biggest reform to business innovation support for more than a decade. It cuts red tape and provides a more targeted incentive for companies to invest in R & D. The new R & D tax incentive is also an opportunity to ensure that public support for business R & D is consistent with the underlying rationale for government intervention and delivers value for money for taxpayers.
The case for public support for R & D
1.7 Innovation is recognised internationally as an important driver of productivity and economic growth. It encompasses a wide range of activities in the economy including workforce skills, venture capital, knowledge transfer, technology uptake, management practices and R & D.
1.8 In a global economy, companies invest in R & D to improve their competitiveness and ongoing profitability. Broader economic factors such as macroeconomic stability, competitive markets, efficient credit markets and access to skilled labour are important influences on a firm's decision to invest in R & D.
1.9 Knowledge produced by a firm's R & D often has benefits for other firms or the economy as a whole. That is, the R & D can have a net positive economic impact beyond the benefits accruing to the firm doing the R & D. However, from an individual firm's point of view, uncertain returns for them from R & D activities may mean that a firm chooses not to undertake them. Where this happens, less R & D may take place than would be desirable from a whole-of-economy perspective.
1.10 A carefully designed incentive lowers the cost of doing R & D and helps boost productivity and economic growth. To this end, the new R & D tax incentive focuses assistance on activities that are likely to deliver economy-wide benefits that would not be enjoyed in the absence of public support. It also significantly improves the incentive for smaller firms to undertake R & D.
Summary of new law
1.11 The new R & D tax incentive provides eligible entities with a tax offset for expenditure on eligible R & D activities and for the decline in value of depreciating assets used for eligible R & D activities. The rate of the tax offset and whether it is refundable depend primarily on the aggregated turnover of the R & D entity.
R & D activities
1.12 Eligible R & D activities are categorised as either 'core' or 'supporting' R & D activities. Generally, only R & D activities undertaken in Australia qualify for the new R & D tax incentive. However, R & D activities conducted overseas also qualify in limited circumstances where the activities cannot be undertaken in Australia.
Core R & D
1.13 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:
- is based on principles of established science; and
- proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
- that are conducted for the purpose of acquiring new knowledge (including knowledge or information concerning the creation of new or improved materials, products, devices, processes or services).
1.14 Under the R & D Tax Concession, core R & D activities had to involve 'innovation' (defined as involving an appreciable level of novelty) or high levels of 'technical risk' (defined in terms of applying the scientific method to close a knowledge gap). Four overlapping tests were used to give meaning to these concepts.
1.15 The definition of 'core R & D activities' in this Bill uses clearer language instead of relying on terms such as 'considerable (or appreciable) novelty' and 'high levels of technical risk' and the overlapping tests that were associated with these terms. In essence, this new definition recognises that the taxpayer needs new information (to solve a problem, develop a new product or improve a process) and needs to do an experiment to discover that knowledge.
1.16 Further to this general principle, some activities are specifically excluded from qualifying as core R & D activities. In this Bill the list of specific exclusions is significantly shorter than the list in the former law.
1.17 Chapter 2 provides further information about the definition of core R & D activities and the exclusions list.
Supporting R & D
1.18 Supporting R & D activities are activities directly related to core R & D activities or, in the case of production activities (or any activities excluded from being core R & D activities), undertaken for the dominant purpose of supporting core R & D activities.
1.19 Under the R & D Tax Concession, supporting R & D activities were undertaken for a purpose directly related to conducting core R & D activities.
1.20 The new definition of 'supporting R & D activities' imposes a stricter test on activities that an entity is more likely to be undertaking for normal operational reasons. However, such activities remain eligible where the dominant purpose for conducting them is to support core R & D activities.
1.21 Chapter 2 provides further information about the definition of supporting R & D activities.
R & D conducted overseas
1.22 Generally, only R & D activities conducted in Australia qualify for the incentive. Innovation Australia can approve an R & D activity to be conducted overseas, but only where:
- there are physical limitations on an R & D activity being conducted in Australia;
- the activity to be conducted overseas has a significant scientific link to core R & D activities conducted in Australia; and
- the expenditure on the activity to be conducted overseas is less than that incurred on R & D activities conducted in Australia.
1.23 Chapter 5 provides further information about the approvals that Innovation Australia will be able to issue in relation to overseas activities.
R & D entities
1.24 The following entities (known in this Bill as R & D entities) can claim the new R & D tax incentive (provided they are not exempt entities):
- corporations that are Australian residents for tax purposes;
- foreign corporations that carry on R & D activities through a permanent establishment in Australia; and
- public trading trusts with a corporate trustee.
1.25 R & D entities will be able to claim the new R & D tax incentive for their expenditure on eligible R & D activities regardless of where the resulting intellectual property is held. This will strengthen the case for companies to conduct R & D activities in Australia.
1.26 Chapter 3 contains further information about the types of entities eligible for the new R & D tax incentive.
R & D expenditure
1.27 The new R & D tax incentive provides R & D entities with a tax offset for expenditure on eligible R & D activities and for the decline in value of depreciating assets used for eligible R & D activities. The tax offset is not subject to an expenditure cap.
1.28 The minimum expenditure threshold of $20,000 continues to apply under the new R & D tax incentive, except in relation to expenditure on R & D activities performed for an R & D entity by an entity registered as a Research Service Provider and contributions to a Cooperative Research Centre.
1.29 As an integrity measure, R & D entities are only able to obtain the tax incentive for expenditure incurred for an associate entity when they actually pay the amounts incurred.
1.30 The new R & D tax incentive also retains a feedstock rule consistent with the existing R & D Tax Concession. However, under this Bill, the feedstock adjustment takes the form of an increase in assessable income, rather than a reduced deduction (or offset).
1.31 Where an R & D entity benefits from a government recoupment (such as a grant or reimbursement) in relation to expenditures that are also eligible for the R & D tax incentive, clawback applies to avoid a double benefit. The clawback takes the form of extra income tax on the recoupment, rather than a reduction in the deduction as under the former law.
1.32 Chapter 3 explains in more detail when an R & D entity can claim a tax offset for their expenditure on R & D activities.
R & D tax offsets
1.33 The rate of tax offset, and whether it is refundable, depends primarily on the aggregated turnover of the R & D entity.
- A 45 per cent refundable tax offset is available to R & D entities with an aggregated turnover of less than $20 million (unless they are a tax exempt entity or majority owned or controlled by tax exempt entities).
- A 40 per cent non-refundable tax offset is available for all other R & D entities. R & D entities accessing the non-refundable tax offset can carry forward any unused offset amounts, under the tax offset carry forward rules.
1.34 Providing tax offsets rather than enhanced deductions for R & D provides entities with greater certainty about the after-tax benefit of the incentive.
1.35 Chapter 3 contains further information on the operative rules for the two tax offsets.
1.36 The following examples demonstrate the assistance available to small innovative companies under the new R & D tax incentive, compared to the R & D Tax Concession. More detailed examples are contained in Chapters 2 and 3.
Green Light manufactures solar powered outdoor lighting. The company has an annual turnover of $4 million. During 2010-11 the company incurs $1 million of expenditure on eligible R
D activities.Based on its turnover (which is less than $5 million) and R
D expenditure (less than $2 million), Green Light could, under the existing law, have claimed a refundable tax offset of $375,000 under the R
D tax offset.
- ($1,000,000 x 45% = $450,000)
Big Ideas Inc has an annual turnover of $4 million. During 2010-11 the company incurs $2.5 million of expenditure on eligible R
D activities.Based on its turnover and R
D expenditure, Big Ideas would, under the existing law, have missed out on the R
D tax offset. While the company meets the turnover test, it has exceeded the expenditure cap. Big Ideas would nevertheless have been able to claim the 125 per cent R
D Tax Concession.Under the new R
D tax incentive, Big Ideas will be able to claim a refundable tax offset of $1,125,000 when it lodges its tax return for the income year.
NuStart Enterprises produces organic fertilisers. The company has an annual turnover of $10 million but is currently in a tax loss situation. The company incurs $1 million of expenditure on eligible R
D activities in 2010-11.Under the existing law, NuStart would only have been able to claim the 125 per cent R
D Tax Concession on its expenditure, allowing it to add $1,250,000 to its tax loss.
- ($1,250,000 x 30% = $375,000)
- ($1,000,000 x 45% = $450,000)
1.37 The new R & D tax incentive applies to income years commencing on or after 1 July 2010. Special transitional arrangements apply where R & D activities straddle income years where the existing law and the new law apply.
1.38 Chapter 4 provides further detail on the application, savings and transitional provisions.
1.39 The new R & D tax incentive will operate largely on a self-assessment basis.
1.40 Innovation Australia (the Board) has an enhanced role in registering and assessing eligible R & D activities to increase certainty for taxpayers. In particular, it will significantly increase its advisory services, including through public guidance and findings and private advance findings. These advisory services will ensure that taxpayers are better informed about their entitlements and obligations under the new incentive.
1.41 The Australian Taxation Office will continue to determine whether an amount of expenditure is validly incurred for eligible R & D activities, as registered with the Board.
1.42 Chapter 5 provides further information on the role of the Innovation Australia in relation to the new R & D tax incentive.