Guest Contributor: Michael Ronai
“SMEs win in new R&D tax breaks plan.
Thus ran a headline in The Australian Financial Review on 10 April 2010 flagging the introduction of the new R&D tax incentive legislation into Parliament on 13 May 2010.
According to Minister Carr, this new simplified R&D Tax Credit that supersedes the complex and outdated R&D Tax Concession from 1 July 2010:
- will stimulate more of Australia’s 2 million businesses to undertake research and development rather than just the 8000 that benefit from the current concession
- doubles the incentive for small and medium business enterprises
- gives small innovative firms greater access to cash refunds for their R&D expenditure and more generous rates of assistance
Are you one of the 2 million + Australian businesses who will be a winner?
There are a whole raft of grant and incentive programs at both Federal and State Government levels to encourage innovative, competitive and export-oriented Australian industries.
However, the highly specific and detailed information requirements to meet minimum eligibility for any of these grants and incentives, let alone receive any monies, is usually so onerous that most small businesses have just put these opportunities for assistance in the “too hard” basket.
The R&D Tax Concession was an outstanding member of the “too hard” basket. Effective 1 July 2010, it is to be replaced by the R&D Tax Credit legislation which the Federal Government says will provide for a substantially simpler and more broad-based and market driven incentive package than the existing regime.
The New R&D Tax Incentives Package
The 2 core components under the new regime are:
- a 45% refundable tax off set (equivalent to a 150% concession) for companies with turnover of less than $20 million
- a non-refundable 40% tax offset (equivalent to a 133% deduction) for all others
The use of an entity’s turnover to determine the rates to be applied and how the incentive will be delivered is a major simplification compared to the complex array of deductions and tax offsets under the soon to be replaced R&D Tax Concessions regime all of which was intended to deliver the equivalent of125% deduction.
The 45% refundable R&D offset is a major win for SMEs. In other words, a business receives its tax offset back in cash, rather than a tax deduction which would only be of value when the business turned profitable. Under the old regime, this access to cash back is limited to companies who had a turnover of less than $5 million and had tax losses.
However, as with all things in tax, the devil is in the detail and whilst the proposed R&D Tax Credits legislation provides greater clarity as to how the tax incentives operate, there are still a complex web of rules that determine eligibility.
Here are some of high level guidelines about R&D tax incentives and the new definitions that will apply from 1 July 2010. It should be noted that at the time of writing, the Bill is still going through Parliament and there may be changes when it is enacted as legislation.
Who Qualifies For R&D Tax Credits?
Eligibility rules have been extended to include foreign companies which are Australian residents or have a permanent establishment in Australia through which they operate. Eligible entities under the new legislation include:
- a corporation incorporated under an Australian law;a corporation incorporated under foreign law that is an Australian resident for tax purposes; and,
- a corporation incorporated under foreign law that:
- is resident of a country with which Australia has a comprehensive double tax agreement; and
- carries on business in Australian through a permanent establishment (within the meaning of the term ‘permanent establishment’ in that agreement)
- A public trading trust that has a body corporate acting as trustee
Ordinary trusts are still not eligible.
Under the new rules, a company that undertakes R&D activity in Australia but doesn’t own the resultant IP can now claim tax incentives. However, there are tight rules around how this applies.
What activities qualify for R&D Tax Credits?
Under the new legislation, eligible R&D activities are explicitly classed in two distinct categories 'Core' or 'Supporting' under the new legislation. These are defined as follows:
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).
The key test under the new legislation is that new information is needed to solve a problem, develop a new product or improve a process; and that the business needs to undertake an experiment to discover the requisite knowledge to do so.
However, there has to be method in the madness: trial and error activities lacking rigour in methodology and problem solving techniques will not necessarily qualify as Core R&D.
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.
The term ‘dominant purpose’ is the key here. Under the old regime, the test used was whether these “activities were undertaken for a purpose directly related to the Core R&D”.
The dominant purpose test for Supporting R&D activities has attracted much criticism by industry groups and business advisers on the grounds that it would result in bona fide R&D activities undertaken in a commercial or production environment being denied eligibility for the tax incentives as well as significantly increasing the compliance burden for SMEs.
In general, R&D activities whether core or supporting have to be conducted in Australia in order to be eligible for tax incentives. The new rules include provision for R&D activities conducted overseas to be eligible BUT only under certain tightly prescribed circumstances.
The requirement for a minimum spend of $20,000 in order to qualify remains under this new legislation. Expenditures of less than $20,000 may be eligible BUT conditions apply.
In short, determining what constitutes eligible R&D activities under the new legislation still requires ploughing through reams of legal provisions coupled with an intimate understanding of how these will be applied to a particular set of facts.
How Do I Access The R&D Tax Incentives?
The Australian tax rules state these concessions are an entitlement, not a competitive grant. This is unlike some of the other Federal and State Government grants (apart from Export Market Development Grants) which are invariably competitive.
Businesses who are already registered for Concessions should note that the current Bill includes some transitional provisions where the income year straddles the repeal of the Concessions regime and commencement of the Tax Credits regime.
The proposed R&D tax incentives will continue to operate on a self-assessment basis. Innovation Australia, an AusIndustry body, will continue to play a central role in managing the process. Its responsibilities include:
- registration and assessment of R&D activities
- undertaking risk assessment and compliance work to confirm the integrity of an entity’s self-assessment of R&D activities as “core” or “supporting”. Findings of Innovation Australia are binding on the Commissioner of Taxation.
Accessing R&D entitlements is a complex exercise. Many managers and accountants without experience in this specialised area are not clear on what comprises R&D for existing Government concessions.
In our experience as R&D Tax Concession advisers, we have found that even companies already registered for assistance under the existing regime are not optimising the extent of their entitlements nor complying correctly with record keeping requirements.
The benefits for SMEs undertaking R&D under the proposed R&D Tax Credits legislation are even more significant than the existing Concessions regime. The provisions of the new legislation, supposedly simplified relative to the existing regime, are still complex to navigate.
Professional advice should be sought from registered tax practitioners who specialise in this area of tax law. This will ensure you maximise the benefits of the incentives for your R&D activities and remain complaint with the all legal requirements.
The R&D incentives fall under taxation laws and penalties for breaches can be severe.
Other Grants & Assistance Schemes To Consider
Export Market Development Grants
Businesses seeking to establish and/or grow export markets for their products and services can benefit from Export Market Development Grants. This Government assistance program is typically available only after the event and is based on 50% of eligible expenditure over $10,000. The grant amounts are significant, running to thousands of dollars for companies who are marketing their products or services overseas.
Where a company has a new product or service that it wishes to commercialise, there is a new organisation called Commercialisation Australia that can provide significant benefits. However, its requirements can be quite onerous and it is quite competitive.
In addition, there are a myriad of continuously changing Federal and State Government assistance schemes. Most companies would only be eligible for one or two of them at most. The application process for these can be quite onerous and they are usually highly competitive.
Most organisations applying for any of these Government entitlements retain an outside consultant to maximise their chances of success and to ensure they meet the compliance requirements.
About the Author: Michael Ronai is the principal of Ronai & Associates Pty Ltd, a consultancy practice that specialises in helping businesses in accessing government grants & assistance packages. Both Michael and his compnay are registered with the Tax Practitioners Board and are legally authorised to provide advice on the application of tax laws in respect of R&D activities.
Ronai & Associates Pty Ltd has assisted more than 25 companies in successfully obtaining R&D benefits in excess of $2 million over the last 19 months. Michael has also assisted companies in obtaining Export Market Development Grants, commercialisation and other grants and completion of tenders.
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