Last month’s Federal Budget included measures to revamp the Research & Development Tax Incentive. AMTIL corporate partner William Buck provides a round-up of the changes and their implications for Australian manufacturers.

Budget papers released on 8 May reveal that R&D Tax Incentive claimants including SMEs and the start-up sector may be faced with additional compliance burdens. Under the new measures, which come into effect on 1 July, there will be additional funding for enforcement activity allocated to the Tax Office and AusIndustry.

Jack Qi, Director of Tax Services and R&D specialist at William Buck, says that while at first glance SMEs and start-ups may have been spared the brunt of the tightening of the R&D Tax Incentive, compliance changes could have the biggest impact.

“Given that such activity has already ramped up in recent years, any further focus will mean it’s more important than ever to prepare robust R&D claims and quality, contemporaneous internal documentation that will withstand scrutiny,” says Qi. “From a cash flow perspective, we anticipate potential delays in companies receiving their R&D refunds until any review is finalised.”

Qi warns the Government against making any more changes to the R&D Tax Incentive: “Stability of the incentive is key to instilling the confidence of the business sector to make long-term decisions on investment in Australian R&D. Once these changes are legislated, we urge the Government to refrain from further tinkering of the R&D Tax Incentive.”

Dr Rita Choueiri, Principal and R&D Specialist at William Buck agrees, saying that since the introduction of the current R&D Tax Incentive Scheme in the last seven years, there has been a boom in organisations wanting to conduct R&D in Australia.

“News of the benefits of conducting R&D in Australia is only just starting to trickle across the world and specifically to North America and Asia,” says Choueiri. “I’ve personally seen an increased level of awareness and interested to conduct R&D Australia from both these regions over the past 18 months alone. There’s a real threat that many businesses will go offshore to undertake R&D if measures are tightened further.

“The manufacturing sector is slowly starting to recover after a massive wave of companies moved manufacturing operations to Asia to cut costs. After discovering their entitlements for the R&D Tax Incentive, they are slowly moving operations back or setting up new ones in Australia.”

Choueiri welcomes other integrity measures including more effective, binding guidance to be released outlining the scope of eligible R&D activities: “This will give more clarity to claimants who need better guidance in understanding what activities are eligible as well as pose less financial risk to their business.”

Key changes affecting SMEs and start-ups

For companies with a turnover of below $20m, the R&D offset will be a premium of 13.5 percentage points above its corporate tax rate. Currently, such companies receive a flat 43.5% incentive.

The new rules will link the R&D incentive rate with the company’s tax rate, which, if the proposed legislation is passed, could be 30% or 27.5% depending on its characteristics. It is expected the rate will progressively reduce to 25% by 2026. Accordingly, some companies could see a reduction in the R&D Tax Incentive from 43.5% to 41% of eligible expenditure.

Also, perversely, this could see some pre-revenue companies receive a lower R&D incentive than a similar company deriving ‘passive’ income. We anticipate there will be calls for this anomaly to be addressed before legislation is passed.

Cash refunds from the refundable R&D tax offset will be capped at $4m per annum (except clinical trials). Any unrefunded amount will be carried forward as a non-refundable tax offset. While this represents a tightening of the R&D Tax Incentive, this will not impact on the vast majority of SMEs and tech start-ups.

Enforcement & integrity measures will include:

  • Greater funding will be allocated to enforcement activity by the Tax Office and AusIndustry.
  • More effective, binding guidance will be released outlining the scope of what is “eligible R&D”.
  • R&D claimant details will be publicly disclosed, along with the amount of R&D expenditure claimed.
  • Anti-avoidance rules in the tax law will be strengthened.

Changes affecting large businesses

Currently, companies with an annual turnover of $20m or more are entitled to a non-refundable tax offset of 38.5% of eligible R&D expenditure. The proposed measures will introduce an ‘R&D intensity percentage’ to calculate the tax offset as a proportion of the company’s R&D expenditure to total expenditure.

Depending on the company’s corporate tax rate, the R&D tax offset is proposed to be:

  • 5% or 34% offset if R&D intensity percentage is between 0% and 2%.
  • 34% or 36.5% offset if R&D intensity percentage is between 2% and 5%.
  • 5% or 39% offset if R&D intensity percentage is between 5% and 10%.
  • 40% or 42.5% offset if more than 10% of total expenditure relates to R&D.

Companies with R&D activities making up a greater portion of their overall business are more likely to benefit from these measures – this will be good news for some. However, companies with greater capital spend (such as manufacturing) may suffer. Furthermore, the maximum amount of eligible R&D expenditure that can be claimed under the scheme is proposed to increase from $100m to $150m per annum – this will be welcomed by large claimants.