R&D Tax Credit

Subject to successful passage of legislation currently before the Senate, from 1 July 2011 a new R&D Tax Credit will replace the R&D Tax Concession and will feature:

• a refundable tax credit (offset) of 45% of eligible R&D expenditure, for companies with an annual group turnover of less than $20 million;

OR

• a non-refundable tax credit of 40% of eligible R&D expenditure.

The Tax Laws Amendment (Research & Development) Bill 2010 will introduce a new R&D Tax Credit for Australian companies (and some foreign companies) and repeal the existing 125% R&D Tax Concession (the Concession) which has formed the principal private-sector R&D incentive in Australia for the past 25 years.

The program offers a headline increase in the level of available benefits relative to the Concession, albeit with a narrower, more restrictive definition of eligible R&D activity.  At current company tax rates, the 45% refundable tax credit benefit is equivalent to a 150% tax concession, and the 40% credit is equal to a 133% tax concession.  

Compound definition of Core R&D

The new program contains a definition of ‘Core R&D activities’ which sets a significantly higher threshold for eligibility.

Terminology such as ‘innovation’ or ‘high levels of technical risk’ has been removed, which means the long history of case law, legal precedent and collective knowledge regarding these concepts, and their operation under the Concession will have limited relevance for the new program.

The new definition of Core R&D is as follows:

1. 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:
     1. is based on principles of established science; and
     2. proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
   • that are conducted for the purpose of generating new knowledge (including about the creation of new or improved materials, products, devices, processes or services).

As is the case under the Concession, a range of activities – such as prospecting, market research, and reverse engineering – are excluded from being eligible core activities.  Where such activities are a necessary component of an R&D program, they may be eligible as supporting activities (see below).

Computer Software R&D

Included in this list of excluded core R&D activities is the development of computer software for internal business administration purposes. This exclusion replaces the ‘multiple-sale’ requirements for computer software R&D under the Concession, and in essence, prevents an applicant claiming benefits for R&D aimed at the development of computer software which will not be commercialised in some way by that company.

Supporting R&D Activities

A ‘supporting R&D activity’ is defined in the Bill as an activity directly related to a core activity.  

While this is similar to ‘directly related’ activities under the Concession, the Bill goes on to exclude any supporting R&D activity which is:

1. an excluded core activity; or
2. which “produces goods or services";
3. or is "directly related to the production of goods or services";

unless the dominant purpose of that activity is to support core R&D activities.

The nature of private-sector R&D is such that under the new R&D Tax Credit many supporting activities (and their costs) will be excluded from eligibility unless they can also be shown to have the dominant purpose of supporting one or more core R&D activities.  No such requirement exists under the Concession, which requires only that an activity be ‘directly related’ to a core R&D activity.

BSI Innovation believes that this aspect of the new program will be a significant constraint on the scope and value of many otherwise eligible R&D claims.  Please contact us today for a review of your project(s) in relation to dominant purposes issues and the likely impact of this measure on future claims.

Other changes

Areas of the new program which represent a departure from the existing Concession and R&D Tax Offset are as follows:

• a new exclusion which denies any entitlement to R&D tax credits for expenditure incurred in the purchase of "core technology" (being items of intellectual property that form the basis for further R&D);
• no R&D Tax Credit entitlement for interest payments made in relation to the cost of funding R&D activities - a major blow to start-up and early-stage claimants who currently benefit from a refundable R&D Tax Offset on these expenses under the Concession;
• No 175% Incremental R&D benefits for increased average expenditure on R&D;
• Expenditure incurred to associate entities eligible for R&D Tax Credit only once paid;
• No R&D expenditure limit for refundable benefits to firms with grouped turnover of less than A$20m (the current refundable R&D Tax Offset contained in the Concession program is limited to A$2m of R&D expenditure in any one income year);
• Program benefits available to some non-resident foreign companies carrying on business in Australia via a permanent establishment.
• Four year time limit for amendment of R&D claims by the Commissioner (in certain circumstances);
• Expanded feedstock provisions which claw back R&D offsets through additional income tax payments;
• Requirement for formal R&D plans in a prescribed format removed.

"What should our company be doing?"

Because the definition of R&D activities under the new R&D Tax Credit is structured differently to that in operation under the Concession, it is most important to:

• model the effects of the new legislation on your company's entitlements and benefits;
• review your R&D planning, scoping and documentation procedures to ensure that they capture the type of information that will be required to prepare future R&D Tax Credit claims; and
• explore whether internal accounting systems can be configured to capture important information as R&D expenditure is incurred.

Completing these tasks, and discussing any specific issues with your BSI Innovation consultant as soon as possible, will ensure your business is best placed to access and maximise the benefits available under the new R&D Tax Credit program for the 2011/12 financial year.

In addition, if you were previously ineligible to claim the Concession because R&D activities were being conducted on behalf of an overseas parent company, or the resulting intellectual property was held overseas, there may now be scope to claim the R&D Tax Credit.  Again, we would strongly recommend you contact BSI for advice as to the benefits you may now be entitled to where these factors are relevant to your R&D program.