House of Representatives

Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Bill 2020

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 7 - Regulation impact analysis and statement for the R & D Tax Incentive

7.1 The enhancements to the R & D Tax Incentive contained in Schedules 4, 5 and 6 to the Bill make a number of refinements to what was proposed in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019. A supplementary regulation impact analysis of the 2020-21 Budget measure is provided below, and outlines the estimated impact of these changes.

7.2 Schedules 4, 5 and 6 to the Bill also implement aspects of the 2019-20 MYEFO measure outlined in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019. The regulation impact statement prepared for the former Bill is also set out below.

2020-21 Budget measure: Supplementary regulation impact analysis for R & D Tax Incentive

Background

7.3 Innovation is an important driver of productivity and economic growth, and R & D is an important input to innovation. The economic impact of business investment in R & D, however, goes beyond the benefits accruing to the firm undertaking the R & D and spills over to other firms and the economy as a whole.

7.4 Businesses may also have difficulty obtaining finance due to the uncertain returns from R & D activities. As a result, international research (including by the Organisation for Economic Co-operation and Development (OECD)) has found that firms typically underinvest in R & D relative to what is socially optimal. This represents a market failure and has been recognised internationally as justification for government intervention.

7.5 In Australia, the Government primarily supports business R & D through the R & D Tax Incentive (R & DTI). In the 2017-18 income year, over 11,000 R & D-performing companies claimed the R & DTI. According to the 2019-20 Science, Research and Innovation Budget tables, the estimated cost of the R & DTI program for 2017-18 was around $2.6 billion.

7.6 The R & DTI encourages companies to engage in R & D by providing a tax offset for eligible R & D activities. The currently legislated program has two core components:

·
a refundable tax offset (43.5 per cent) for companies whose aggregated turnover is less than $20 million. A company is entitled to a refund to any portion of the offset that exceeds their tax liability; and
·
a non-refundable tax offset (38.5 per cent) for all other companies. While the offset is not refundable, any tax losses can be carried forward to reduce future tax liabilities.

7.7 To be eligible for the program, a company must incur at least $20,000 eligible expenditure for the financial year. In addition, a company may only receive R & DTI benefits on the first $100m of R & D expenditure each financial year.

7.8 Eligibility for the R & DTI is self-assessed. Companies must first register their R & D activities with the Department of Industry, Science, Energy and Resources (DISER). Claims are then lodged by companies with the Australian Taxation Office (ATO) in their annual tax return.

7.9 In the 2018-19 Budget, the Government announced reforms to the R & DTI following the findings of reviews that the program was falling short of achieving its objectives of incentivising additional R & D activities and generating spillover benefits for the Australian economy. The reforms contained a number of measures to retarget support.

7.10 In December 2019, the Government introduced the 2019 Bill that made several refinements to these reforms. These refinements were made having regard to the findings of a Senate Economics Legislation Committee inquiry into the 2018-19 Budget reforms.

The problem

7.11 Drawing on work conducted by the Centre for International Economics (CIE), the 2016 review of the R & DTI, chaired by Australian Chief Scientist Alan Finkel AO, then Chairman of Innovation and Science Australia (ISA) Bill Ferris AC, and then Treasury Secretary John Fraser, found that the R & DTI program was not working as effectively as it could, particularly with regard to encouraging R & D activities that would not have occurred in the absence of Government support. The review identified a number of areas where improvements could be made in order to improve the effectiveness and integrity of the program, primarily by achieving a stronger focus on additionality.

7.12 On 30 January 2018, ISA released its report to the Government, Australia 2030: Prosperity through Innovation (the ISA 2030 Plan). The ISA 2030 Plan upheld the need for R & DTI reform and included some alternative recommendations aimed at improving the effectiveness of the program.

7.13 More recently, the Coronavirus pandemic has led to a period of domestic and global economic downturn and it is likely that it will take a number of years for the Australian economy to recover. In this environment, businesses are facing a range of pressures which are likely to constrain their ability to invest in R & D.

7.14 Smaller, innovative businesses typically rely on external investment to fund their operations, particularly when their products, processes and/or services are at a pre-commercial stage of development. It has been reported that many of these firms are experiencing difficulty in accessing finance due to the economic impacts of the Coronavirus, resulting in severe cash-flow difficulties.

7.15 For larger entities, the risky nature of investments in R & D means they are often amongst the first activities cut during times of economic weakness.

Case for government action/objective of reform

7.16 In light of the economic impacts of the Coronavirus, the Government has made significant outlays to support the economy in the immediate-term. Support measures have been designed to encourage business investment, preserve businesses through Coronavirus-related restrictions, and maintain the connection between employers and employees so that the economy is able to re-emerge when the crisis subsides.

7.17 The Government has also announced the JobMaker agenda, which will outline the reforms required to enable the Australian economy to emerge from the crisis and set up Australia for economic success over the next three to five years, supporting growth in jobs, investment and productivity in the medium-term. Announced areas of focus for the JobMaker agenda include reforms to Government support for research and science and Australia's taxation system.

7.18 The 2016 review of the R & DTI found a relatively low level of additionality under the program, as it provides the same level of support for all eligible R & D activities, and has no requirement to demonstrate that the R & D would not have occurred without government support. However, it should be noted that volume-based tax instruments tend to impose a lower regulatory burden on claimants, as eligibility is largely self-assessed. The review also found that the R & DTI provides effective support for small entities, reflecting the CIE's analysis that cash-constrained R & D start-ups and small entities are typically the most responsive to financial incentives. To address these findings, the review recommended improving additionality for larger businesses by redirecting government support to R & D-intensive companies - where intensity is defined as R & D expenditure as a proportion of total business expenditure. The CIE's analysis found that these claimants tend to make more efficient use of scarce R & D resources such as skilled labour and are more likely to be induced to increase their investment in R & D.

Policy options

7.19 The following three options were considered:

·
Option 1: Maintain the R & DTI as currently legislated;
·
Option 2: Proceed with the reforms currently before the Senate; or
·
Option 3: Refine the reforms to align with the Government's economic recovery measures.

Option 1: Maintain the R & DTI as currently legislated

7.20 Under this option, the R & DTI would continue in its currently legislated form. The program currently has two core components:

·
a 43.5 per cent refundable tax offset for eligible entities with a turnover of less than $20 million per annum; and
·
a 38.5 per cent non-refundable tax offset for all other eligible entities. Unused non-refundable offset amounts may be able to be carried forward to future income years.

7.21 The $100 million expenditure threshold would be maintained until the legislated sunset date of 1 July 2024.

Option 2: Proceed with the reforms currently before the Senate

7.22 This option would proceed with targeted reforms to the R & DTI as contained in the 2019 Bill. These reforms include:

·
an R & D premium that rewards companies that commit a greater proportion of expenses to R & D;
·
an increase in the R & D expenditure threshold from $100 million to $150 million;
·
a $4 million cap on cash refunds with an exemption for eligible expenditure on clinical trials;
·
linking the R & D tax offset rate to the claimant's company tax rate;
·
introducing a new power for the Board of ISA to make 'general determinations';
·
changes to anti-avoidance and clawback rules; and
·
requiring the publication of certain claimant details.

7.23 These changes would apply to the income years starting on or after 1 July 2019.

Table 7.1 : The R & DTI tax offsets as contained in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019

R & DTI tax offset Rates of offset
Refundable R & D tax offset (companies with turnover of less than $20 million) The claimant's tax rate for the year plus 13.5 percentage points.
Non-refundable R & D tax offset (companies with turnover of $20 million or more) The claimant's tax rate for the year, plus:

·
4.5 percentage points for R & D expenditure between 0 per cent and 4 per cent R & D intensity (inclusive)
·
8.5 percentage points for R & D expenditure above 4 per cent to 9 per cent R & D intensity (i.e. not including R & D expenditure falling within the first 4 per cent of the claimant's total expenses for the year); and
·
12.5 percentage points for R & D expenditure above 9 per cent intensity (i.e. not including R & D expenditure falling within the first 9 per cent of the claimant's total expenses for the year).

Option 3: Refine the reforms to align with the Government's economic recovery measures

7.24 Under this option, the 2019 Bill would be amended to increase support to R & DTI claimants and simplify the proposed changes, while retaining measures to improve the operation of the program.

7.25 The amendments would include:

·
streamlining the three-tiered intensity test into a two-tiered intensity test for calculation of the R & D premium for large companies;
·
increasing the R & D tax offset rates for both large and small companies;
·
not proceeding with the $4 million cap on annual refunds; and
·
delaying the start date of any changes to the current law to 1 July 2021.

7.26 See the table below for the new rates of offset under Option 3. Similar to Option 2, the rates of offset would be linked to each claimant's company tax rate, removing the need for ongoing legislative amendments to maintain the level of benefit provided by the R & DTI as company tax rates change.

Table 7.2 : The new R & D tax offsets under Option 3

R & DTI tax offset Rates of offset
Refundable R & D tax offset (companies with turnover of less than $20 million) The claimant's tax rate for the year plus 18.5 percentage points.
Non-refundable R & D tax offset (companies with turnover of $20 million or more) The claimant's tax rate for the year, plus:

·
8.5 percentage points for R & D expenditure between 0 per cent and 2 per cent R & D intensity (inclusive);
·
16.5 percentage points for R & D expenditure of above 2 per cent intensity (i.e. not including R & D expenditure falling within the first 2 per cent of the claimant's total expenses for the year).

Impact analysis of each option

Option 1: Maintain the R & DTI as currently legislated

7.27 Under this option, the current R & DTI continues unchanged. Therefore, there is no change to the regulatory costs of the program.

Benefits

7.28 The benefit of this option would be that there is no change to the regulatory burden for R & DTI claimants. Levels of support provided under the program would be maintained, providing entities undertaking R & D with some certainty while they manage the economic impacts of the Coronavirus.

Costs

7.29 None of the issues identified by the 2016 review of the program would be resolved. While retaining the current program settings would not alter the existing regulatory burden, the impacts of the Coronavirus mean that the ability to absorb that burden is likely to have been reduced for many businesses. All else remaining equal, the extent to which the program can be expected to incentivise businesses to spend more on R & D would remain sub-optimal.

Option 1 - Net benefit

7.30 While there would be no change to the regulatory burden on business, the identified issues in the program would continue. However, maintaining support under the program would be consistent with the Government's other measures to support economic recovery from the Coronavirus pandemic.

Option 2: Proceed with the reforms currently before the Senate

7.31 This option would implement the reforms in the 2019 Bill with no modification.

Benefits

7.32 The reforms would assist in improving the R & DTI's efficacy, administration and integrity by:

·
introducing an R & D premium for larger claimants would sharpen the focus on additionality by rewarding large companies for conducting a high intensity of R & D;

-
The review found that R & D-intensive companies are generally more responsive to fiscal incentives intended to support R & D. While this finding is contestable (a recent OECD study has reached a different conclusion), the review recommended targeting large R & D-intensive companies for a number of reasons. For example, the review found that targeting large R & D-intensive companies is likely to lead to more efficient use of scarce R & D resources and greater spillovers through the spread of additional knowledge.

·
an increase in the R & D expenditure threshold from $100 million to $150 million would encourage large companies to spend more on their R & D in Australia;
·
the exemption for clinical trials from the $4 million cap on cash refunds would ensure that support is maintained for critical drug and medical device development;
·
linking the R & D tax offset rate to the claimant's company tax rate would address the need for legislative amendments to account for future company tax rate reductions and ensure that the benefits of the non-refundable R & D tax offset are not determined by the claimant's turnover;
·
introducing a new power for the Board of ISA or other relevant authority to make 'general determinations' would assist in improving the clarity of advice provided to claimants, and would provide claimants with clearer guidance about eligibility and other requirements; and
·
changes to anti-avoidance and clawback rules would improve the integrity of the program.

Costs

7.33 It is expected that these changes would impose an additional regulatory burden on R & DTI claimants. This reflects the implementation costs related to the amount of learning and education required for the various changes to the incentive, particularly the complexities of the new intensity thresholds. Implementation costs will also arise from the need to adjust evaluation, planning and record-keeping systems in response to the changes.

7.34 The changes are estimated to reduce support for most claimants of the R & DTI. The 1 July 2019 start date of the R & DTI reforms contained in the current Bill also means that the measures would apply to the 2019-20 income year, which has just concluded. This has led to uncertainty among businesses around the tax framework under which they will be lodging their 2019-20 and future income tax returns, which may be causing some businesses to delay investment decisions, and may require some businesses to amend claims already made.

7.35 As noted for Option 1, the impacts of the Coronavirus mean that the ability of businesses to absorb any regulatory burden has been reduced.

Option 2 - Net benefit

7.36 The net result is that the R & DTI would be more focused towards supporting high intensity R & D expenditure and encouraging additionality and spillovers. However, this comes with a moderate additional regulatory burden and reduced support for some R & DTI claimants at a time where they are facing many other uncertainties and challenges resulting from the Coronavirus pandemic.

7.37 This option would result in an estimated additional total average annual regulatory cost for businesses of $26.3 million (OBPR 25318):

Table 7.3 : Regulatory burden estimate (RBE) table (Option 2) (OBPR 25318)

Average annual regulatory costs (from business as usual)
Change in costs ($ million) Business Community organisations Individuals Total change in costs
Total, by sector: $26.3 Nil Nil $26.3

* Average annual impact (calculated over 10 years).

Option 3: Refine the reforms to align with the Government's economic recovery measures

7.38 This option would amend the current Bill to increase support to R & DTI claimants, reduce complexity of the proposed changes and align the R & DTI with the Government's economic recovery measures. Some measures to improve the operation of the program would be retained.

Benefits

7.39 As outlined in the impact analysis of Option 2, the changes to be retained would future-proof the R & DTI program and improve its effectiveness, transparency, integrity and administration. In addition to this:

·
delaying the start date of any changes to the current law to 1 July 2021 would maintain the current program as the economy recovers from the impact of the Coronavirus, and give businesses additional time to prepare for the changes;
·
streamlining the three-tier intensity threshold system for the non-refundable component of the R & DTI and not proceeding with a $4 million cap on annual refunds would reduce complexity of the reforms to the R & DTI;
·
increasing the R & DTI tax offset rates would mean more generous support for all R & DTI claimants in comparison with Option 2, assisting R & D-active businesses as they recover from the recent economic shocks from the Coronavirus pandemic.

Costs

7.40 Not all claimants will benefit from the new R & DTI tax rates relative to currently legislated settings. Due to the reductions in the company tax rate in recent years, the proposed R & DTI tax offset rates may provide a lower dollar benefit than the currently legislated offset rates for some companies with turnover between $20 million and $50 million and a low R & D intensity. However, the proposed rates will maintain the benefit from the R & DTI at a fixed margin over the company tax rate at a similar level to what existed before the company tax rate reductions began, and delays to the start date will also ensure that any dollar benefit from the R & DTI will remain unchanged in the short term.

7.41 By continuing to provide generous support for initial investments in R & D, the incentives to conduct additional R & D activities may not be as strong as under other options. However, the proposal employs other measures to target additional investment in R & D, such as by providing more generous support to small entities relative to larger entities through a higher offset rate and refundability. The 2016 review, international reports from the OECD, and academic literature all support the view that small and medium companies are more responsive to fiscal incentives to undertake R & D.

Option 3 - Net benefit

7.42 The net result is that the R & DTI would be providing more generous support to most R & DTI claimants compared with the measures proposed in the current Bill (Option 2), and with a small reduction in regulatory costs. By increasing support for small entities relative to the Bill and by retaining the intensity measure, the modified changes target support at entities that the 2016 review found were typically the most responsive to fiscal incentives.

7.43 While this option may still reduce the dollar value of support for some companies currently with turnover between $20 million and $50 million and a low R & D intensity, it would ensure that the rate of support from the non-refundable tax offset is consistent for all entities regardless of their turnover. It also helps to future-proof the R & DTI in the event of further reductions to the company tax rate. Firms in this range will also have an incentive to increase their R & D intensity to receive more support.

7.44 This option would result in an estimated total average annual regulatory cost for businesses of $24.7 million, which would be fully offset by regulatory savings of other Treasury proposals.

Table 7.4 : Regulatory burden estimate (RBE) table (Option 3) (OBPR 25318)

Average annual regulatory costs (from business as usual)
Change in costs ($ million) Business Community organisations Individuals Total change in costs
Total, by sector: $24.7 Nil Nil $24.7

* Average annual impact (calculated over 10 years).

Consultation plan

7.45 There has been significant consultation on the reforms to the R & DTI.

7.46 The first round of public consultation occurred during the review of the R & DTI in early 2016, which included a program of targeted consultations with a variety of stakeholders from industry, the research sector, government and tax agents. The Government then undertook public consultations to inform its response to the review's recommendations, following the public release of the review report on 28 September 2016. Consultations included written submissions, roundtables with peak industry bodies, and multiple stakeholder forums in all states and territories.

7.47 Following the Government's announcement of reforms in the context of the 2018-19 Budget, draft legislation was released for public consultation from 29 June 2018 to 26 July 2018. Feedback from this process helped refine the reforms in the Bill. Following its introduction to Parliament, the legislation was referred to the Senate Economics Legislation Committee for review. The Committee released its report on 11 February 2019. A number of stakeholders made submissions to the Committee and appeared at its public hearing to voice their views. Further refinements to the legislation were made with the recommendations of the report in mind.

7.48 The resulting 2019 Bill was introduced on 5 December 2019 and was again referred to the Senate Economics Legislation Committee for inquiry. The Committee is currently scheduled to report on 12 October 2020.

7.49 In addition to the above formal consultations, the Minister for Industry, Science and Technology and DISER and the ATO have continued to engage with stakeholders (for example, through face to face meetings, roundtables and teleconferences), and will continue to do so throughout implementation of the reforms.

Option selection/conclusion

7.50 The preferred policy option is to implement the amendments to the R & DTI to align with the Government's economic recovery measures (Option 3). Option 3 would better support R & DTI claimants, helping them manage the economic impacts of the Coronavirus pandemic, while reducing the complexity of the proposed changes and proceeding with measures to improve the operation of the program. Business investment in R & D is central to the development of new products, processes and services that will help make Australia more competitive and create more jobs in the long-term.

Implementation and evaluation/review

7.51 Legislation is required to implement this proposal, and it will be delivered by the ATO and DISER in line with existing administrative arrangements.

7.52 To support R & DTI claimants in understanding their obligations under the reformed program, the ATO and AusIndustry will issue improved guidance products for claimants. This will be augmented by the proposed changes that permit the ISA to issue binding public guidance.

7.53 The ATO and ISA will continue to undertake their client feedback processes, which assist in identifying opportunities to improve the administration of the R & DTI. Treasury and DISER will also consider feedback from regulators and stakeholders as to how the reformed R & DTI is operating in practice.

7.54 Following the end of a financial year, there is a delay before complete registration and taxation data for that years' R & DTI registrants becomes available. This time lag means that analysing companies' behavioural responses will not be possible for some time, particularly given a number of years of data from the reformed program would be necessary.

7.55 Evaluations for the R & DTI are performed in consultation with DISER's internal evaluation unit, and the results are made public at Ministerial discretion.

7.56 General summaries of Government support provided for business R & D will continue to be published in the annual Science, Research and Innovation Budget Tables. In addition, the reforms to the R & DTI will ensure transparency of the program by publishing the names of companies, and their claim amounts, following a two year delay.

2019-20 MYEFO measure: Regulation impact statement

Background

7.57 Innovation is an important driver of productivity and economic growth, and Research and Development (R & D) is an important input to innovation. The economic impact of business investment in R & D, however, goes beyond the benefits accruing to the firm undertaking the R & D and spills over to other firms and the economy as a whole. Businesses may also have difficulty obtaining finance due to the uncertain returns from R & D activities. As a result, international research (including by the OECD) has found that firms typically underinvest in R & D relative to what is socially optimal.

7.58 The underinvestment by business in R & D represents a market failure and has been recognised internationally as justification for government intervention. In Australia, the Government primarily supports business R & D through the R & D Tax Incentive (R & DTI). While a socially optimal investment level is a theoretical construct and therefore unable to be quantified, providing support for business R & D is likely to represent a positive movement towards optimal investment.

7.59 The R & DTI program is the largest component of Australian Government support for business R & D. In the 2016-17 income year, over 12,000 R & D-performing companies claimed the R & DTI. According to the 2018-19 Science, Research and Innovation Budget tables, the estimated cost of the R & DTI program is around $2.0 billion in 2019-20.

7.60 In the 2018-19 Budget, the Government announced reforms to the R & DTI. The reforms sought to address the findings of the successive reviews of the R & DTI, while also taking into account the considerable stakeholder feedback received over a two year period between the release of the Review report in 2016 and the 2018-19 Budget.

7.61 The reforms were to commence on 1 July 2018 and contained a number of measures to better target the R & DTI towards additional R & D activities, and improve the fiscal sustainability, integrity and administration of the program. This included:

·
the introduction of a $4 million cap on cash refunds for the refundable component of the R & DTI with an exemption for clinical trials;
·
introducing a non-refundable R & D premium calculated with reference to the claimant's company tax rate and R & D intensity (R & D expenditure as a proportion of total business expenses). The premium increases with R & D intensity, rewarding companies for conducting a high intensity of R & D;
·
an increase in the R & D expenditure threshold from $100 million to $150 million;
·
linking the R & D tax offset rate to the prevailing company tax rate; and
·
changes to improve the integrity of the program.

7.62 A Bill to implement these reforms was introduced to the Parliament on 20 September 2018. The Bill was subsequently referred to the Senate Economics Legislation Committee, which released its report on 11 February 2019. In the report, the Committee acknowledged the need for reform of the R & DTI, but recommended that consideration of the Bill be deferred until further analysis of the impacts of the Bill could be undertaken.

7.63 The Bill lapsed when Parliament was prorogued on 11 April 2019. However, the Government considers that the case for reform remains, and is now reintroducing a Bill to implement the reforms with several amendments formulated following feedback from stakeholders and the findings of the Senate Inquiry.

The problem

Current government support for R & D does not fully meet its objectives

7.64 The National Innovation and Science Agenda (NISA) was launched on 7 December 2015. When launching the NISA, the Government committed to undertaking a review of the R & DTI (the Review).

7.65 The Review was conducted by a review panel comprising Mr Bill Ferris AC (then Chair of Innovation Australia), Dr Alan Finkel AO (Chief Scientist) and Mr John Fraser (then Secretary of the Department of the Treasury). The review panel was supported by an interdepartmental taskforce comprising officers from the Department of Industry, Innovation and Science (DIIS), the Treasury and the Australian Taxation Office (ATO).

7.66 The review panel, drawing on work conducted by the Centre for International Economics (CIE), found that the R & DTI falls short of meeting its stated objectives of additionality - encouraging R & D investment that would not occur in the absence of the program - and spillovers. The panel identified a number of areas where improvements could be made in order to improve the effectiveness and integrity of the program, primarily achieving a stronger focus on additionality.

7.67 On 30 January 2018, Innovation and Science Australia (ISA) released its report to the Government, Australia 2030: Prosperity through Innovation (the ISA 2030 Plan). The ISA 2030 Plan also found that reforms to the R & DTI were required to improve the program's effectiveness and integrity, and included alternative recommendations to reform the R & DTI.

Inherent difficulties in measuring program effectiveness

7.68 The intended outcomes of the R & DTI - additionality and spillovers - are very difficult to quantify and necessitate analysis that relies heavily on anecdotal and qualitative evidence.

7.69 In its program evaluation, the CIE stated that:


The two most crucial elements of the R & D TI (additionality and spillovers) turn out to be extremely difficult to empirically measure and evaluate.

Additionality cannot be directly measured and must be inferred through interviews, surveys, statistical analysis and modelling. Therefore, estimates of additionality will always be imprecise and subject to uncertainty.

Spillovers, while in principle evident from the techniques of growth accounting, have also proved to be extremely difficult to measure empirically.

7.70 Despite the difficulties noted above, the CIE attempted to measure additionality levels in Australia using a mix of survey data and statistical analysis. DIIS also commissioned the Centre for Transformative Innovation at Swinburne University to undertake an econometric analysis evaluating the level of program additionality.

7.71 The analyses found results broadly consistent with studies from other countries (0.3 to 1.5 additional dollars of R & D per dollar of tax forgone for CIE, and 0.8 to 1.9 for Swinburne). There is also common agreement that additionality is greater for small companies than large companies.

7.72 A key finding of the Review and the CIE is that, at a conceptual level, the program's volume based design (i.e. all R & D attracts the same benefit) is poorly targeted towards incentivising additional R & D.

7.73 The most recent estimate of spillovers in an Australian context was presented by the Productivity Commission (the PC) in 2007. The PC estimated that a 1 per cent increase in market R & D led to approximately 0.02 per cent increase in productivity or 65 cents of average spillover benefit from each dollar of R & D conducted. It should be noted that this estimate relates to market-induced business R & D (that is, R & D that would have occurred in the absence of government support).

7.74 There is limited data in relation to spillover benefits and it is not expected that the reformed program will assist in overcoming these measurement issues.

Case for government action/objective of reform

7.75 Businesses generally invest less in R & D than is socially optimal due to their inability to fully appropriate the returns; the inherently risky nature of R & D activities; and the related uncertainty around their outcomes. There is a widely agreed role for government intervention to address this market failure and encourage additional R & D.

7.76 The Review found that the current R & DTI falls short of meeting its objectives of encouraging additionality and spillovers. Reform of the R & DTI is required to ensure the efficacy and cost effectiveness of the program. The OECD has found that 'basic research' (i.e. experimental or theoretical work undertaken primarily to acquire new knowledge, without any particular application or use in view) results in larger spillovers than applied research (i.e. experimental or theoretical work directed primarily towards a specific practical aim or objective).

7.77 There is, however, no evidence that specific industries or types of R & D produce additionality and spillovers in greater amounts than other industries or types of R & D. Therefore it is important that the R & DTI is industry-neutral, aiming to incentivise novel R & D in all sectors of the economy. This is catered for under the R & DTI through the broad definition of what constitutes eligible R & D.

7.78 The Review found a relatively low level of additionality under the current R & DTI, stating that "volume-based tax instruments such as the Incentive not only subsidise this additional R & D but also support the activities a company would have done anyway." That is, the program provides the same level of support for all eligible R & D activities undertaken by a claimant, with no requirement to demonstrate that it is additional to 'business-as-usual' R & D that would have been progressed in the absence of government support. However, it should be noted that volume-based tax instruments tend to impose a lower regulatory burden on claimants, as eligibility is largely self-assessed.

7.79 The Review found that the program design could be improved by reducing support for business as usual activities and refocusing support towards additional R & D, particularly in the non refundable portion of the program (available to larger businesses with $20 million or more turnover per annum).

7.80 The Review recommended improving the R & DTI's additionality for larger businesses by redirecting government support to R & D intensive companies - R & D intensity was defined as R & D expenditure as a proportion of total business expenditure. Compared to companies with lower R & D intensity, these claimants make more efficient use of scarce R & D resources such as skilled labour and specific capital equipment and are more likely to be induced to increase their investment in R & D (i.e. generate increased additionality and thus produce greater spillover benefits). It is also acknowledged that most companies will undertake some R & D to keep up with competitive pressures and additional R & D will necessarily fall into higher intensity bands.

7.81 The Review found that although the R & DTI provides effective support for small and medium sized enterprises (SMEs) via its refundable component (available to companies with annual turnover below $20 million), the significant growth in the number of SMEs participating in the program since its introduction was placing upward pressure on program costs. To address this, the Review recommended keeping the rate of benefit unchanged, but capping cash refunds for refundable R & D tax offset claimants as a way of placing some restraint on the maximum level of payment that can be made (SMEs can currently 'cash out' their entire R & D tax offset if they are in a tax loss position).

7.82 New taxation data indicates that growth in the refundable component of the R & DTI has moderated since the release of the Review in April 2016. The main reasons for lower growth in refundable R & DTI claims include the post-mining-boom business investment environment and increased ATO and AusIndustry compliance activity. However, factors such as the current business investment environment may not persist over the longer-term and do not necessarily preclude the re-emergence of fiscal pressures in the future.

7.83 Further, companies would need to be spending very large amounts on R & D to exceed the cap on cash refunds for refundable R & D tax offset claimants. These companies that would be impacted by a cap are likely to have access to other sources of finance, in addition to the R & DTI, to support their R & D activities. As the Review put it, "Refundability is likely to provide fewer tangible benefits for SMEs with larger R & D expenditures, who will be able to find alternative sources of finance at relatively lower costs in comparison with firms with lower R & D expenditure."

7.84 The Review also noted that "...as the tax offsets under the program are at a fixed level, they are relatively more valuable when the company tax rate is lowered (in comparison to the deduction received for normally deductible expenses). Hence, the fixed level of the tax offset should always be calibrated to the level of the company tax."

7.85 The CIE's and other studies have shown that the companies most responsive to financial incentives are often cash constrained R & D start-ups, SMEs, and R & D-intensive companies (those companies whose core business is R & D-centric). These companies generally devote a greater proportion of their activities to R & D.

Policy options

7.86 This regulation impact statement compares the Government's proposed reforms to the R & DTI to two other potential policy responses: 1) no policy change; and 2) adopting the Review recommendations.

Option 1: No policy change

7.87 If the Government took no action the R & DTI would continue in its current form. The program currently has two core components:

·
a 43.5 per cent refundable tax offset for eligible entities with a turnover of less than $20 million per annum; and
·
a 38.5 per cent non-refundable tax offset for all other eligible entities. Unused non-refundable offset amounts may be able to be carried forward to future income years.

7.88 The $100 million expenditure threshold would be maintained until the legislated sunset date of 1 July 2024.

7.89 In the absence of the R & DTI, companies would deduct their expenses at the relevant standard company tax rate (currently 27.5 per cent for businesses with annual turnover less than $50 million and 30 per cent for all other businesses). If a company was in tax loss, however, they would not receive any immediate benefit.

7.90 The net benefit provided by the R & DTI is the difference between the R & D offset rate and what the company would otherwise receive in the absence of the program (i.e. the value of the standard tax deduction). These rates can be seen in Table 4.1 below. As the corporate tax rate for companies with a turnover of less than $50 million continues to decrease over the coming years, the net benefit for these companies will increase serendipitously if no change is made to the R & DTI.

Table 7.5 : R & DTI Net Benefit Rates, 2019-20

Annual Turnover Company Tax Rate (%) R & DTI Offset Rate (%) Net Benefit
0 - $20m (Unprofitable) 0 43.5 43.5 cents
0 - $20m (Profitable) 27.5 43.5 16 cents
$20m - $50m 27.5 38.5 11 cents
$50m and above 30 38.5 8.5 cents

7.91 Under the refundable tax offset, if a claimant's offset exceeds their tax liability then the claimant receives the excess as a cash refund, rather than carrying forward an amount to offset tax liabilities incurred in future income years.

Option 2: The Review's Recommendations

7.92 The Review found that the program does not fully meet its stated policy objectives and proposed a range of recommendations to improve its effectiveness and integrity. The recommendations included initiatives to encourage additional R & D. The Review's recommendations are summarised in Table 4.2 below.

Table 7.6 : Review's recommendations

Rec Detail
1. Retain the current scope of eligible activities and improve guidance to registrants.
2. Introduce a collaborative premium of up to 20 per cent for the non-refundable tax offset to provide additional support for the collaborative element of R & D expenditures undertaken with publicly-funded research organisations.

-
The premium would also apply to the cost of employing new STEM PhD or equivalent graduates in their first three years of employment.
-
Companies falling below the intensity threshold should still be able to access both elements of the collaboration premium.

3. Introduce a cap on the annual cash refund (in the order of $2m) with remaining offsets treated as non-refundable offset and carried forward.
4. Introduce a 1-2 per cent R & D intensity threshold for the non-refundable element, such that only R & D expenditure over the threshold attracts a benefit. Intensity is defined as the proportion of R & D expenditure over total expenditure.
5. If an R & D intensity threshold is introduced, increase the R & D expenditure threshold from $100m p.a. to $200m p.a.
6. Investigate options for improving the administration of the R & DTI (e.g. adopting a single application process; developing a single program database; reviewing the two-agency delivery model; and streamlining compliance review and findings processes, publishing annually the names of companies claiming the R & DTI and the amounts of R & D expenditure claimed) and additional resourcing that may be required to implement such enhancements. To improve transparency, the Government should also publish the names of companies claiming the R & DTI and the amounts of R & D expenditure claimed.

Option 3: Targeted reforms to the R & DTI (preferred option)

7.93 The Government's option is to proceed with targeted reforms to the R & DTI. These reforms comprise a number of targeted changes to the R & DTI including:

·
a $4 million cap on cash refunds with an exemption for clinical trials;
·
an R & D premium that rewards companies that commit a greater proportion of expenses to R & D;
·
an increase in the R & D expenditure threshold from $100 million to $150 million;
·
linking the R & D tax offset rate to the prevailing company tax rate;
·
introducing a new power for ISA to make 'general determinations'; and
·
changes to improve the integrity of the program.

7.94 The changes would apply to income years starting on or after 1 July 2019.

7.95 The reforms include a $4 million annual cap on cash refunds for R & D claimants with aggregated annual turnover less than $20 million. Amounts in excess of the cap would become a non-refundable tax offset to be carried forward into future income years. Expenditure on clinical trials would be excluded from the $4 million cap on cash refunds, recognising the critical role of clinical trials in developing life changing drugs and devices.

7.96 To help ensure support provided under the program is well targeted, the new R & D premium refocusses support for larger companies (with annual turnover of $20 million or more) towards those companies which devote a greater proportion of their expenses to R & D (i.e. with higher R & D intensity), while continuing to provide a baseline level of support for companies with lower R & D intensity. The R & D premium provides multiple rates of non-refundable R & D tax offsets, increasing with the intensity of companies' R & D expenditure. The increasing rate of support provides companies with a greater incentive to undertake additional R & D activities.

7.97 The current $100 million expenditure threshold would be increased to $150 million and made a permanent feature of the law. The higher expenditure threshold encourages large companies to spend more on R & D, as a greater proportion of their R & D expenditure will be eligible for the R & DTI.

7.98 See Table 4.3 for the rates of benefit provided by the R & D Premium. Box 1 provides an example of how the R & D Premium would operate in conjunction with the increased expenditure threshold.

7.99 The rates of the R & D tax offsets would be linked to each claimant's company tax rate, removing the need for ongoing legislative amendments to the R & DTI tax offset rates as company tax rates change (see Table 4.3). This ensures that companies receive a fixed premium (above the value of a standard tax deduction) for R & D expenditure as the Government's corporate tax cuts take effect. This also removes differences in support due to the disparity between the turnover thresholds that determine a company's corporate tax rate and its level of support under the R & DTI.

Table 7.7: The new R & DTI tax offsets

R & DTI tax offset Rate of offset
Refundable R & D tax offset (companies with turnover less than $20 million) The claimant's tax rate for the year plus 13.5 percentage points.
Non-refundable R & D tax offset (companies with turnover of $20 million or more) The claimant's tax rate for the year, plus:

·
4.5 percentage points for R & D expenditure between 0 per cent and 4 per cent R & D intensity (inclusive);
·
8.5 percentage points for R & D expenditure above 4 per cent to 9 per cent R & D intensity (i.e. not including R & D expenditure falling within the first 4 per cent of the claimant's total expenses for the year); and
·
12.5 percentage points for R & D expenditure above 9 per cent intensity (i.e. not including R & D expenditure falling within the first 9 per cent of the claimant's total expenses for the year).

Box 1 - How does the expenditure threshold work?

For a given income period, if Company A has total business expenses of $800 million and eligible R & D expenditure of $125 million, the company has a 15.6 per cent R & D intensity ($125 million / $800 million). Under existing policy settings, the company would receive the 38.5 per cent non-refundable R & D tax offset on the first $100 million of R & D expenditure. The excess amount above the threshold, $25 million, would receive an offset at the company's company tax rate (a 30 per cent offset assuming the company's turnover is above $50 million). This would result in a total non-refundable tax offset of $46 million.

Under the R & D Premium with an associated increase of the expenditure threshold to $150 million, the first $32 million (4% of $800 million) would attract an offset of $11 million (34.5 per cent x $32 million). The next $40 million would receive an offset of $15.4 million (38.5 per cent x $40 million). The remaining $53 million would receive an offset of $22.5 million (42.5 per cent x $53 million), resulting in a total non-refundable tax offset of around $49 million. As before, any R & D expenditure above the expenditure threshold (now $150 million), would receive an offset calculated at the company's tax rate (without any premium).

7.100 The ISA Board would have the power to publish 'general determinations', which would be binding on the ISA Board. The general determinations would provide guidance on the circumstances in which the Board can exercise its powers or perform its functions or duties in relation to the R & DTI.

7.101 Lastly, the targeted reforms would improve the integrity of the R & DTI by strengthening anti avoidance rules, publishing claimant details and amounts of R & D expenditure claimed and improving guidance to help ensure that taxpayers do not make incorrect claims. The reforms would also make the rate at which the offset is recouped (i.e. feedstock and clawback rules) more accurate in situations where receiving the R & D tax offset would result in a company accruing an additional benefit.

Impact analysis of each option

7.102 To receive a benefit under the R & DTI, companies must go through a two stage process: registering R & D activities with the DIIS; and then claiming the incentive for the related expenditure in their annual tax return (including an R & D Tax Schedule) with the ATO. The activities associated with the registration and claiming processes comprise the R & DTI's regulatory costs. As with the rest of the taxation system, over 80 per cent of companies that register for the R & DTI use consultants to assist with their applications. The fees paid to these consultants impose a regulatory burden on registrants, and are therefore considered when determining the regulatory costs of the different options.

Option 1: No policy change

7.103 Under this option, no action would be taken by the Government and the current R & DTI continues unchanged. There is therefore no change to the regulatory cost of the program.

Benefits

7.104 The benefit of this option would be that there is no increase in regulatory burden for claimants.

Costs

7.105 The cost of this option would be that the Government continues to provide support to 'business as usual' R & D which would likely have been conducted anyway (i.e. in absence of the program). The R & DTI would continue to fail to fully meet the program's objective of encouraging greater additionality in R & D activities.

7.106 There would also be a risk that future growth in the number of companies in the program or claim amounts could place upward pressure on program costs, without an attendant increase in additionality.

7.107 Program costs will also continue to rise as the Government's company tax cuts come into effect. Without changes to offset rates, the lower company tax rates increase the effective benefit of the R & DTI and the resulting cost to government.

Option 1 - Net outcome

7.108 While there would be no change to the regulatory burden on business, the identified deficiencies in the efficacy of the program would continue, limiting the economic benefits and cost effectiveness of the R & DTI.

Option 2: R & DTI Review Recommendations

7.109 This option would implement the recommendations of the Review without any alterations.

Benefits

7.110 Introducing a minimum R & D intensity requirement would target support towards companies that are the most significant participants in Australia's R & D landscape. As the benefit would not be provided for R & D expenditure under the threshold (the Review found that at least such a level of expenditure would be expected as business as usual in a truly innovative company), the intensity threshold is more likely to direct support to companies investing in additional R & D.

7.111 Companies below the threshold would no longer be eligible to receive a benefit under the program, which, in some cases, may reduce the overall administrative burden. This would be due to fewer companies needing to complete the registration process and separately account for related expenses, therefore removing the need for associated record keeping and compliance-ready measures.

7.112 The Review also recommended that the $100 million expenditure threshold should be increased to $200 million so that large R & D intensive companies retain an incentive to increase R & D in Australia. The higher expenditure threshold, when combined with the intensity threshold, would likely sharpen the additionality of larger companies. This is because the companies in a position to benefit from the higher expenditure threshold would be able to register more R & D activities in order to receive the greater benefit.

7.113 A $2 million cap on cash refunds would constrain the costs of the refundable R & D offsets under the program. At the time of the Review, the refundable R & D offset was the most costly element of the program and was growing at unsustainable rates. However, it should also be noted that these companies were found by the Review to be the most responsive to support being provided and the most likely to reinvest the support provided into additional R & D.

Costs

7.114 The introduction of an intensity threshold in isolation is estimated to deny an R & DTI benefit to those claimants with intensities less than 1 or 2 per cent. Conceptually, the companies falling below the threshold are more likely to be undertaking 'business as usual' R & D than 'additional' R & D. While business as usual R & D is expected to continue without Government support, there may be an overall decline in R & D that would have been conducted in Australia. For example, this measure would impact some businesses for which R & D is complementary rather than central to their core activity - such as manufacturing. In these businesses, while R & D intensity might not be high due to the relatively high level of expenditure on other costs, the introduction of the threshold could reduce their incentive to conduct additional R & D.

7.115 A $2 million refund cap may deter some start-ups from investing in additional R & D and could significantly impact the development of new innovative start-up companies in Australia. The biotech and medical industries would be particularly affected. These industries are generally very R & D intensive, with long term R & D projects that require large amounts of persistent capital and financing. The industry frequently incurs large expenses before any returns on investment are made. There is often a long time between the initial R & D and commercialisation due to the rigorous safety and efficacy testing requirements required for new medications and medical devices. Without a specific exemption, the $2 million cap could force clinical trial activities offshore as the cash refund cap would limit cash flow.

7.116 The collaboration premium may be limited in its ability to effectively increase the level of collaboration. While the collaboration premium would reward companies for collaborating with publicly funded research organisations, factors such as the differing objectives of industry and universities in conducting research and poor mobility between academia and businesses would remain significant inhibitors of collaboration. Further, as with the R & DTI generally, additional support would be offered for collaborative R & D activity already underway at no additional benefit to the taxpayer. A collaboration premium also creates the potential for distortionary impacts and rorting. For example, a company with the internal capability to undertake R & D may choose to outsource the activity simply to receive a higher benefit rate. This would not be an efficient allocation of resources.

Option 2 - Net benefit

7.117 The net result would be lower regulatory costs for the R & DTI, largely driven by changes that effectively exclude companies from accessing the program.

7.118 The intensity threshold precludes a significant number of non-refundable claimants from accessing the R & DTI. As these companies would no longer be required to register their R & D activities or complete the R & D schedule to their tax return, their regulatory burden is reduced.

7.119 The $2 million refund cap proposed by the Review is significantly more restrictive than the $4 million refund cap included in the targeted reforms to the R & DTI (Option 3) and has no exemptions. It would be expected to adversely impact smaller companies with significant, longer term investments in R & D (including biotech, medtech and life science companies). These companies might have to go to significant effort and incur higher costs to secure alternative sources of financial support should they choose to continue their R & D activities in Australia.

7.120 The design elements of the collaboration premium - such as the specific definition of 'collaboration', the eligibility criteria and the claiming process - were not elaborated upon by the Review. While the Review proposes a premium rate for collaborative R & D, those activities are already eligible under the current program arrangements. The regulatory impact would require separating out the related expenses. This is likely to occur already through contract agreements, given intellectual property is being created. As a result, the regulatory impact from the measure is believed to be negligible.

7.121 Regulatory costings for the Review recommendations are lower than the Option 3 reforms as a result of companies being excluded from the program, which reduces registration, record keeping and audit costs for these companies.

7.122 Overall, this option would result in an estimated total average annual regulatory saving for businesses of $12.3 million.

Table 7.8 : Regulatory burden estimate (RBE) table (Option 2)

Average annual regulatory costs (from business-as-usual)
Change in costs ($ million) Business Community organisations Individuals Total change in cost
Total, by sector $12.3 save Nil Nil $12.3 save

*Average annual impact (calculated over 10 years).

Option 3: Targeted reforms to the R & DTI (preferred option)

7.123 Under this option, the Government's targeted reforms to the R & DTI would be implemented.

Benefits

7.124 Introducing an R & D Premium for larger claimants would target support towards R & D intensive companies that are the most significant participants in Australia's R & D landscape. R & D intensive companies are considered to be more responsive to fiscal incentives intended to support R & D. Focussing on targeting these companies would therefore better target the program's focus on additionality and spillovers.

7.125 Under the R & D Premium, large companies with lower R & D intensities will have their R & D claims reduced, resulting from the reduction in the level of support for R & D expenditure that is more likely to be business as usual. The level of support will be increased for R & D that is more likely to be additional. The reduced support for business as usual R & D and increased support for additional R & D expenditure is expected to improve the additionality of the program.

7.126 Although companies with low R & D intensities are expected to have some behavioural response to the reduction in their overall support, their response may be quite small. This is because the reduction in support is for R & D expenditure that is more likely to be business as usual - that is, likely to be conducted even in the absence of the program.

7.127 There are a number of distinct benefits of targeting support for larger companies under the program towards those that are more R & D intensive. The Review found that large R & D intensive companies are more likely to:

·
use R & D inputs such as skilled labour and specialised equipment efficiently;
·
partner with other bodies, increasing prospects for spillover benefits; and
·
be undertaking basic research and novel R & D (found to generate greater spillovers).

7.128 The current $100 million expenditure threshold would be increased to $150 million and made a permanent feature of the law. The higher expenditure threshold would encourage large companies to spend more on their R & D in Australia.

7.129 The package of changes to the non-refundable R & DTI is estimated to provide a higher average level of support to approximately 25 companies compared to the existing program. This modelling is based on tax administration data reported for the 2016-17 income year.

7.130 A $4 million cap on cash refunds would sharpen the R & DTI's focus on additional R & D activity by ensuring that government resources are provided to those most in need. The $4 million cap would place a reasonable constraint on the amount of refund provided to a company in a given year. Companies would retain access to the full amount of their R & D offset but, refundable amounts exceeding $4 million would be carried forward as a non refundable tax offset for use in future years.

7.131 To be impacted by the cash refund cap of $4 million, a company needs to spend around $10 million on eligible R & D expenditure in an income year. R & D spending of this size cannot be sustained by tax refunds alone, resulting in the conclusion that these companies have access to alternative sources of finance. As one of the key rationales of the refundable component of the program is to support small, cash constrained SMEs, there is little policy rationale in providing unlimited Government funding to companies capable of obtaining finance through private means. As is the case with most other international jurisdictions offering cash refund for R & D activities (e.g. Denmark, Ireland and Spain), it is reasonable for an upper limit to be placed on the amount of cash benefit a company can receive in an income year.

7.132 The reforms to the refundable tax offset would also include a carve out for clinical trials. This carve out would mean that eligible expenditure incurred on clinical trials would be exempt from the $4 million cap. The carve-out would ensure that support is maintained for critical drug and medical device development.

7.133 Linking R & D offset rates to the company tax rate would address the expected program cost increases resulting from the proposed company tax rate reductions in a manner which avoids the need to amend the tax law in the future. In the absence of linking to company tax rates, the program would need to be amended every time the company tax rate was changed in order to maintain the level of benefit available under the R & DTI. The linking also removes the different levels of support that is caused by the disparity between the turnover thresholds that determine a company's corporate tax rate and its level of support under the R & DTI.

7.134 The ISA Board would have the ability to publish 'general determinations', which would be binding on the ISA Board and pertain to the circumstances in which the Board can exercise its powers or perform its functions or duties in relation to the R & DTI. The broad scope of general determinations would assist in improving the clarity of advice provided to industry claimants, and would provide program participants with clearer guidance about eligibility and other requirements. Practically, this is expected to result in reduced time and money devoted to program registration and dealing with compliance activities. Clearer guidance and eligibility will also result in a reduced need for companies to engage consultants and expert advice when engaging with the program.

7.135 Amending Part IVA of the Income Tax Assessment Act 1936, to include both the refundable and non-refundable R & D tax offsets in the definition of a 'tax benefit' would provide the ATO with the ability to challenge contrived tax arrangements that seek to utilise R & D tax offsets.

Costs

7.136 Around 1,030 (65 per cent) of companies claiming the non-refundable R & D tax offset currently have intensities of 4 per cent or lower, giving these firms access to the lowest R & D Premium. The remaining non-refundable offset recipients (approximately 550) have intensities greater than 4 per cent.

7.137 Some companies receiving the refundable R & D offset would see a reduction in their overall benefit amount as a result of linking to the company's tax rate.

7.138 It is estimated that a $4 million cap would impact the cash refund values of around 20 claimants receiving the refundable offset, taking into account other elements of the package. These registrants would no longer receive a cash refund for amounts in excess of the $4 million cap, however they would be able to carry forward the excess amounts to future financial years as a non-refundable tax offset.

7.139 For companies that are impacted by the cap on cash refunds, those conducting clinical trials would still be able to receive a cash refund above $4 million.

7.140 The linking measure will reduce the level of benefit available to profitable SMEs from 16 per cent to 13.5 per cent. However, this measure is required to reset the level of benefit to that which was available prior to the company tax cuts. Profitable SMEs have in the meantime been the beneficiaries of an unintended windfall arising from this anomaly.

7.141 Unprofitable SMEs will see a reduction in their refundable benefit of 2.5 per cent. This is an acknowledged policy consequence of the linking measure, and provides a consistent level of benefit for both profitable and unprofitable SMEs.

7.142 There are difficulties measuring the responsiveness of R & D expenditure incurred by smaller claimants that would allow an assessment of the likely impact of the measure on the aggregate level of R & D. While the level of benefit is being slightly reduced, the equivalent reduction in company tax rates will have more widespread positive cash flow consequences. Given the two policies will be implemented over a similar period, future analysis is also unlikely to be able to clearly disaggregate the effects of these two policies.

7.143 Given the changes being made to the program, the feedstock, clawback and balancing adjustment rules would need to be amended to ensure they correctly reverse the tax benefit of claiming R & D in situations such as where the R & D activities are funded by other forms of government support or the results of R & D activities are sold. This may result in some transitional costs for taxpayers already claiming under the program.

7.144 It is expected that the regulatory impact of the changes would be moderate. The intensity calculation for companies receiving the non-refundable offset would use information from existing tax return labels. As companies already collect the required information, making an additional calculation would impose limited additional costs. The introduction of the cap on cash refunds is not expected to change the way that companies would register or claim their R & D expenditure, except for those claiming a clinical trials exemption.

7.145 Increased regulatory burdens would largely lie with companies who would benefit under changes in the program. For example, the companies in a position to benefit from the higher expenditure threshold may choose to register additional R & D activities in order to maximise their benefits under the program.

Option 3 - Net benefit

7.146 The net result is that the R & DTI would be more focused towards supporting additional high intensity R & D expenditure, reducing support for activities likely to be business-as-usual and improving the returns to the economy and to taxpayers. The changes help reduce the cost of the program, delivering an estimated gain to the budget of $1.8 billion over the current forward estimates period in fiscal balance terms.

7.147 Under Option 3, the regulatory burden is higher than for Option 2, however this is due to retained access for all non-refundable claimants. These companies would still be able to access a baseline level of support even if their R & D intensity is less than one or two per cent. These lower intensity companies are excluded under Option 2, and so reduce the associated regulatory costs under that option.

7.148 The targeted reforms to the R & DTI would have minimal regulatory impact on program participants and the reforms do not exclude any companies from claiming under the R & DTI. Minor changes would be required to the registration and claims processes as a result of the changes. Record keeping requirements would remain largely unchanged, and information required to calculate a company's intensity (e.g. total expenses) is already available as part of the company tax return process. Accordingly, only a minor increase in compliance costs is expected.

7.149 The potential for companies to establish specific R & D entities for the purpose of accessing the higher R & D intensity benefits was considered during the legislation consultation process. Following stakeholder feedback, it was considered that the risk of this occurring is manageable and the ATO has advised that the anti-avoidance provisions in the tax law, which are being strengthened as part of this legislative package, may apply to such schemes.

7.150 This option would result in an estimated total average annual regulatory cost for businesses of $26.3 million:

Table 7.9 : Regulatory burden estimate (RBE) table (Option 3)

Average annual regulatory costs (from business-as-usual)
Change in costs ($ million) Business Community organisations Individuals Total change in cost
Total, by sector $26.3 Nil Nil $26.3

*Average annual impact (calculated over 10 years).

Consultation plan

7.151 There has been significant consultation on the reforms to the R & DTI.

7.152 The first round of public consultation occurred during the Review of the R & DTI in early 2016. To inform their deliberations, the Review Panel conducted a program of targeted consultations with a variety of stakeholders including those from industry, the research sector, and government and tax agents. The Review consultation period began on 13 January 2016 and ended on 18 March 2016.

7.153 The Review was released publicly on 28 September 2016. To inform its response to the Review's recommendations, the Government announced a four week public consultation period, which was undertaken following the public release of the Review report. In addition to written submissions, the then Minister for Industry, Innovation and Science convened a number of roundtables with peak industry bodies, and one-on-one meetings with targeted stakeholders and DIIS conducted multiple stakeholder forums in all states and territories to receive feedback. The written submissions are publicly available on the DIIS website at industry.gov.au.

7.154 Following the Government's announcement of reforms in the context of the 2018-19 Budget, draft legislation was released for public consultation from 29 June to 26 July 2018. In addition to written submissions, consultations included a series of face-to-face meetings with key stakeholders conducted by DIIS in consultation with the Treasury and the ATO. Consistent with the prior consultation processes, some stakeholders objected to the potential reduction of benefits under the proposed changes. However in general, feedback from this process helped refine the legislation with the following stakeholder suggestions being adopted:

·
amending the 'R & D premium' so that it is calculated as a portion of 'total expenses' and not 'total expenditure'. Stakeholders argued this would be easier to comply with as the information is more readily available in their accounting systems;
·
clarified the scope of the clinical trial exemption to remove ambiguity;
·
expanded the new mechanism for working out clawback and feedstock adjustments to include balancing adjustments for R & D assets, meaning a single mechanism is used for adjustments to the amounts of benefit received under the Incentive;
·
excluded clawback amounts from the income tests that apply to early stage investment companies (ESICs), to ensure the Incentive does not inadvertently impact eligibility for other Government programs; and
·
explicitly legislated a minimum 2 year delay for the ATO publishing R & DTI claimant details to help alleviate stakeholder concerns that data published soon after year end could be commercially sensitive in nature.

7.155 Following its introduction to Parliament, the legislation was referred to the Senate Economics Legislation Committee for review. The Committee received 75 written submissions and held three public hearings between 16 November 2018 and 31 January 2019. The Committee released its report on 11 February 2019. Further refinements to the legislation have been made with the recommendations of the report in mind, including a delay to the start date of the legislation to 1 July 2019 and the increased rate and changes to the calculation of the R & D Premium.

7.156 In addition to the above formal consultations, the Minister for Industry, Science and Technology and DIIS and the ATO have continued to engage with stakeholders (for example, through face to face meetings, roundtables and teleconferences), and will continue to do so throughout implementation of the reforms.

Option selection/conclusion

7.157 The preferred policy option is to implement the targeted reforms to the R & DTI (Option 3). Option 3 would better target the R & DTI by inducing greater additionality and spillovers, while improving the integrity of the program. Option 3 addresses the issues raised in the Review and provides a greater incentive to high R & D intensity companies than that recommended by the Review (Option 2). Option 3 implements a larger annual cap on cash refunds and provides a minimum base rate of support for claimants with low R & D intensity.

7.158 Although Option 3 is expected to result in higher regulatory costs, it continues to provide support to companies that would be completely excluded from the program under Option 2. It also addresses the policy concerns with the current program, which would have persisted under Option 1. It is therefore the preferred approach to reform the R & DTI.

Implementation and evaluation/review

7.159 Legislation is required to implement this proposal. The reforms to the R & DTI will apply for income years commencing on or after 1 July 2019. As such, legislation will need to be passed by 30 June 2020 as the measures apply to the 2019-20 year.

7.160 To support R & DTI claimants in understanding their obligations under the reformed program, the ATO and AusIndustry will issue improved guidance products for claimants. This will be augmented by the proposed changes that permit ISA to issue binding public guidance, increasing certainty for claimant's as to what is and is not eligible R & D activity under the R & DTI. Additional resourcing for the regulators is also being used to undertake greater enforcement activity, further improving the integrity of the R & DTI.

7.161 Following the passage of the legislation, the ATO and ISA will continue to undertake their client feedback processes, which assist in identifying opportunities to improve the administration of the R & DTI. Treasury and DIIS will also consider feedback from regulators and stakeholders as to how the reformed R & DTI is operating in practice.

7.162 Following the end of a financial year, there is a 16 month delay before complete registration and taxation data for that years' R & DTI registrants becomes available. This time lag means that analysing companies' behavioural responses to the proposed measures would not be possible for some time (late 2021 at the earliest). This is because a number of years of data from the reformed program would be necessary to perform a useful evaluation of the effects of any changes. Accordingly, any review performed before 2023/24 would be of limited value as the dataset would not cover a sufficient period.

7.163 Evaluations for the R & DTI are performed in consultation with DIIS's internal evaluation unit, and the results are made public at Ministerial discretion.

7.164 As discussed earlier in this document, there are longstanding challenges in evaluating program effectiveness against its objectives of additionality and spillovers. To again quote the CIE:


...there are significant difficulties in measuring additionality and spillovers arising from the R & D TI. This means that a sound quantitative estimate of the overall benefits of the scheme to the economy (or an estimate of the value that the taxpayer receives for their expenditure) will always be subject to considerable uncertainty.

7.165 It is not expected that the reformed program will assist in overcoming these data issues.

7.166 General summaries of Government support provided for business R & D will continue to be published publicly in the annual Science, Research and Innovation Budget Tables. In addition, the reforms to the R & DTI will ensure transparency of the program by publishing the names of companies, and their claim amounts, following a two year delay.


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