With the impending election and the release of the 2019-20 Budget by the current government on 2nd of April, it is worth taking a brief look at the past to understand how the national conversation has changed with regards to the R&D Tax Incentive- the primary government assistance for companies undertaking research in Australia.
To provide context to this, it is important to remember that at one stage the Australian government was bringing innovation to the forefront of the national conversation with the ‘National Innovation and Science Agenda’ in 2015 (ironically the great website it once had has been turned off but if you want to see more detail it is here). At the time, this initiative was described as so important ‘that it should not be permitted to become a victim of political point scoring. A long term, bipartisan approach is required.’
Fast forward to 2019. Australia is now on its 6th Minister in charge of the ‘Industry, Innovation and Science’ portfolio. The portfolio itself has had 4 name changes, including 12 months nested in the ‘Jobs and Industrial Relations’ portfolio under Michaelia Cash as ‘Minister for Jobs and Innovation’.
What has occurred in the last 12 months and why should you care?
In February 2018, discussion starts around corporate tax avoidance by multinationals. Cochlear and CSL continue calls for certainty on the R&D Tax Incentive as the US delivers tax cuts to business and Australia considers its own.
In April 2018 the national conversation around the R&D Tax took quite a different turn. Four Corners put the administration of the R&D Tax Incentive program under the spotlight highlighting the ATO’s role in its administration. This story centred around a 7-year audit of Blackwater Treatment Systems, a company that was set up to develop technology that would turn waste into reusable water. Where, according to the Sydney Morning Herald, the company “won research and development grants” until “the ATO decided the company wasn’t eligible for the grants and tax offsets and hit Freeman with a $250,000 tax bill”. For those of you familiar with the R&D Tax Incentive, you will know it isn’t won, it is self- assessed. The point though is this journalism highlighted current issues in the administration of the program adversely affecting businesses in Australia. At the same time as the details of this reporting was echoing through industry, Treasurer Scott Morrison confirmed an impending overhaul of the R&D Tax Incentive as part of the 2018-19 Budget announcement (see here).
In May 2018, more detail surfaced about proposed changes to the R&D Tax Incentive in the 2018-19 Budget, including the addition of an ‘R&D Intensity test’ as an integrity measure to focus the incentive on funding ‘additionality’ – things that would not have happened anyway – and rewarding the intensity of that effort. (See here and here). The May 2018 Budget further clarified the governments changes (summarised here) to ensure the changes made the scheme “fiscally affordable” and to crack down on claims that “push the boundaries” (see here).
I attended an event hosted by Innovation Australia on Budget night 2018. The mood was grim. People saw the changes as a way to save money. In stark contrast to the optimism that permeated the end of 2015.
In July 2018 the consensus was that the draft legislation lacked clarity and certainty (shocking! see here). Treasury received submissions but has not released the complete list of submissions The Ferris review in 2016 generated over 100 submissions (see here).
In August 2018 the Science portfolio got new leadership with Karen Andrews (number 6) now in charge (see here).
In September 2018, the ‘Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018’ is introduced to Parliament (see here).
In October 2018, the Senate referred provisions of the Bill to the “Economics Legislation Committee for inquiry and report” (see here). Further rounds of submissions were invited to inform this process. Whilst the various aspects of the Bill were being assessed by legislators, Big-4 accounting firms were forced to respond to promoter penalties which formed part of the changes to the R&D Tax Incentive. Part IVA was strengthened to prevent “R&D entities from being able to obtain tax benefits by entering into artificial or contrived arrangements to access the R&D tax offset” (see here). The Opposition demurred stating that “Labor will use Senate Estimates to ask the ATO to elaborate on their recent comments on professional legal privilege, including what reforms, if any, including legislative changes, the ATO believes are necessary,” (see here). “Three of the firms, Deloitte, EY and KPMG, said no further action was taken after the ATO made the formal requests for information about tax schemes they had designed and were promoting, and that they do not have any undertakings with the agency over tax exploitation” (See here).
In November 2018 submissions to the Economics Legislation Committee closed as they extended the deadline to report on the proposed R&D Tax Incentive changes to February 2019. Submissions suggested that the proposed changes would encourage business to relocate overseas (see here). This must be weighed against program cost given statements by the Department of Industry, Innovation and Science that recent program reviews have concluded that “around 80 to 90 percent of this [spending] would have occurred [anyway] in the absence of the program.”
The former Chair of Innovation and Science Australia (whose 3-year term had just ended), Bill Ferris, pointed out that R&D investment in Australia had fallen to its lowest levels since the GFC “to just below 1 per cent of GDP while top nations, including the US, Israel, Korea, Sweden, Japan, Germany and Singapore, had increased theirs to 2 to 3 per cent, and Israel to more than 4 per cent.” He also recognised the opportunity the Government had to reallocate the cost savings from changes to the R&D Tax Incentive to other parts of the science and innovation portfolio. “The unfinished business for government and ISA and for all stakeholders is to reverse this BERD [business expenditure on research and development] decline. There is an urgent opportunity to reallocate these savings.” He also noted the lack of consistent vision at a Government level as “it clearly isn’t helpful to have a revolving door from the minister down” (see here). Another company came forward, Digivizer, noting challenges associated with an audit on the eligibility of their R&D Tax claim which centred around software development of its digital content tracking tools (see here).
In December 2018, the AFR began a series of articles on the R&D Tax Incentive. The first article highlighted Airtasker’s failed audit and the challenges they faced with R&D Tax auditors. The “failed R&D claims involved working out how to combine two previously separate software languages, which it had demonstrated via web searches had not been done elsewhere before. It also developed machine learning and artificial intelligence algorithms to apply to online content moderation and detect undesirable behaviour on its platforms” (see here). Daniel Petre (from Air Tree Ventures) described the current interpretations as a “clusterfuck” and the Minister continued to assert that “legislative definitions remained unchanged” despite multiple references to the Frascati Manual both from audits and the Innovation Australia review. This manual is an OECD document that is not referenced in the legislation but is apparently used to define R&D in Australia by the Department of Industry, Science and Technology.
StartupAus recognises that R&D Tax claims filed under guidance applicable in 2014 are now being assessed under narrower interpretations being applied in 2018 and is positive about the impacts of the new ‘R&D Intensity test’ (see here, here and here). The Big4 have since resized their R&D Tax Incentive practices (see here). Daniel Petre (from Air Tree Ventures) suggested that the large companies were creating the issues with regulators where “the problem was mainly large corporates like financial institutions having a lend of the situation, claiming for things that they would have been doing every day anyway as R&D” (see here). Commonwealth Bank was then forced into the spotlight with news they were claiming $100M from the R&D Tax Incentive incorrectly. Deloitte responded saying “the regulators provide additional guidance but with retrospective application. It’s obviously created uncertainty for certain sectors because claimants are now having to consider the impact of the guidance for prior claims as well as future ones” (see here). And calls for the damaging effects of the new legislation and current regulation continue from another VC (see here). 2018 closed out with Labor committing to “preserve the Research and Development Tax Incentive” as part of their goal to devote 3 percent of GDP to research and development by the end of the next decade (see here).
In January 2019, CSL and Cochlear again asked for certainty as the Senate Committee hearings on the new legislation continued. “It is really important that we are able to understand and predict what the investment environment will look like. In CSL’s field of medical research, it takes at least 10 years of research to get a commercial product, so we need to think in this time frame when we are making research investment decisions” (see here and here).
In February 2019, new guidance on software was expected from the government and the Senate Economics Legislation Committee report was due on the legislation that was announced 9 months previously. What was not expected though was the government putting out an Expression of Interest to R&D Tax advisors to help asses the eligibility of claims, 2 months after publicly going after Big-4 accounting firms (see here and here).
The Senate Committee submitted their report and found that the proposed R&D Intensity test would “disadvantage Australian companies facing high costs of goods sold and low margins, or with both R&D and manufacturing onshore, rather than just domestic R&D and offshore manufacturing” as well as finding issues with the retrospective nature of the legislation (see here). Until this is addressed the legislation would not pass and as such is unlikely to come into effect before the election (see here, here, here and here). With this delay further uncertainty remains (see here and here) and naturally CSL is disappointed in the government (see here). As a result more companies consider opportunities overseas in places like the UK in spite of the Brexit uncertainty presented there (see here). In response, the Minister scheduled a round table discussion the following month to seek wider views (see here). Industry organisations also provided feedback to the government. The Information Industry Association called on the government to establish an advisory and oversight body to drive a consistent national innovation agenda through “good governance, established objectives and clear performance indicators” as part of their pre-Budget submission (see here and here).
The end of February saw the release of the much anticipated software guidance to provide “more clarity to companies around what are considered eligible software research and development activities under the program” (see here, here, here and here). The new guidance (see here) was released with a ‘Guide to Common Errors’ (see here). This guidance was not received as intended. According to James Cameron (from Air Tree Ventures) “The guidance will result in less startups and tech companies being able to access the RDTI scheme and is a cash grab made at the expense of Australian startups. It’s the government’s prerogative to do this, of course, but they should at least call it what it is. To try to dress it up as an innovation policy is completely disingenuous. This is a time where we need to be doubling down on our tech sector to ensure our economy stays competitive” (see here).
The Economics Legislation Committee met again and questions were raised over the lack of activity in the National Reference Group for the R&D Tax Incentive as well as the need to engage an external supplier to assist with eligibility assessments (see here and here). Kim Carr acknowledged that “there was quite clearly very widespread concern about the legislation” and queried the need for external assistance. The Department confirmed they are just “implementing the budget measure from the May budget last year. That budget measure was about increasing our capacity for compliance work in this program. Part of that capacity increase is additional staff, and we have taken on additional staff to do that and are investing in the capability of those staff. But we’re also looking at a range of other ways to increase the capacity to where we think it needs to be. So this expression of interest process is part of exploring whether there are other ways to boost the capacity we have to do compliance within the program.” Naturally the issue of conflict was raised:
In terms of compliance activity, the Department stated they had initiated “885 compliance activities, which make up preregistration reviews, registration reviews and statutory assessments which includes the advanced and overseas findings” and was asked “how many audits have actually been disputed?”. The Department stated that “we had 83 internal reviews initiated in the 2017-18 financial year.” The conversation then shifted to the compliance process which is very insightful:
In March 2019, the Commonwealth Bank announced the withdrawal of its AAT (Administrative Appeals Tribunal) case in defence of R&D Tax claims from 2012 and 2013. These claims related to “the CBA core banking modernisation project that involved digital transformation and software development” with the tax rebate said to be worth up to $100M. The project was “a six-year program involved around 1,500 full-time staff and a migration of 12 million customers” (see here, here, here, here, here and here). The ATO issued a statement saying that although they are “committed to supporting Australian businesses undertaking innovation,” “activities must meet strict legal criteria to qualify for the R&D tax incentive. Just because a project is large, expensive or risky does not mean it necessarily qualifies as R&D for the purposes of the tax incentive” (see here).
The first Roundtable session was held in March 2019 with industry associations attending and providing feedback on the R&D Tax Incentive (see here). Kim Carr also continued to promote the Oppositions research agenda which includes: a goal of devoting 3 per cent of GDP to research and development by 2030; more considered changes (if any) to the R&D Tax Incentive and a $1 billion Advanced Manufacturing Future Fund that will provide loans to companies who find it difficult to find finance and an Australian Investment guarantee that allows accelerated depreciation of new investments (up to 20%) in the first year (see here).
Data on ISA Legal matters (see here)
Whilst not every matter that ISA is involved in with the AAT involves disputed R&D Tax claims, a lot of them are and the trend shown here reflects increasing vigilance to ensure ‘integrity’ of the R&D Tax Incentive program. As a result more claims are withdrawn.
Key Insights so far:
- Interpretation from regulators on what constitutes eligible R&D activities is narrowing over time as shown in the numerous public examples
- Regulators will be increasingly vigilant in identifying and challenging R&D Tax claims that do not meet their interpretations of the legislation
- Regulators will continue with strict interpretations of the legislation to enforce the concepts presented in the guidance and the OECD Frascati Manual (‘Frascati’ is the second word in the new software guidance and is referenced 15 times in toal across both guidance documents)
- Regulators have an increased pool of resources to enforce their ‘integrity’ mandate and are currently looking to third party providers for potential assistance in the future
- There is an increased focus on both software activities and the standard of evidence they require, to satisfy current interpretations which align to the guidance and by proxy the OECD Frascati Manual
- Regardless of the election outcome these trends are unlikely to change in the short to medium term
So what does this mean for your business?
The R&D Tax Incentive is a self-assessment regime. The responsibility is therefore placed on the applicant to only claim eligible R&D expenditure. The guidance and numerous public announcements clearly shows that the regulators want applicants to prove what they are doing is not only new to business but not accessible on a ‘world-wide basis’. The reality is, this is a narrower interpretation. At some stage a decision from the AAT may change this, but until that time, businesses need to come to terms with the fact that in the mind of regulators: Innovation does not necessarily equal eligible R&D expenditure. Rightly or wrongly.
So how do you prove this?
Change. Companies that want to continue to claim the R&D Tax Incentive must enhance the way they undertake their R&D activities to survive audit activity. This is more a step change in how they think about R&D rather than a tax driven compliance process.
Triple Innovation works with clients using a number of tools to develop R&D Pathways that reduce the friction in this change process.
Contact us if you need support.
For those of you that want more detail, here is the chronological list of references:
- Four Corners- Mongrel bunch of bastards (09-Apr-18) here
- $3 billion tax refund scheme faces ‘intensity’ test (01-May-18) here
- Crackdowns on tax avoidance, tax concessions to help fund budget spending (06-May-18) here
- Budget 2018: It’s a carrot and stick budget for business (08-May-18) here
- Budget 2018: R&D tax break overhaul saves $2 billion (08-May-18) here
- 2018 Federal Budget: Budget reins in R&D to crack down on tax break rorts (08-May-18) here
- Federal budget 2018: R&D tax breaks tightened in $2b saving (08-May-18) here
- Uncertainty remains: R&D Tax changes (May-18) here
- Budget 2018: ‘Free kick’ for importers sparks manufacturer warning (09-May-18) Here
- Federal budget 2018: R&D slug for start-ups, small business (10-May-18) here
- Stop getting in the way of innovation CSL chief warns Canberra (03-Jun-18) here
- R&D tax incentive changes lack clarity and certainty, experts warn (04-Jul-18) here
- Bill introduced to Parliament (20-Sept-19) here
- Uncertainty over research tax incentives reigns as scheme tightened (04-Oct-18) here
- Labor flags bigger tax promoter penalties, as ATO faces court battle over Paradise Papers leaks (11-Oct-18) Here
- Deloitte, EY, KPMG and PwC reject privilege changes to tax promoter laws (24-Oct-18) here
- Bill Ferris laments weak business R&D, feds’ innovation cold shoulder (04-Nov-18) here
- ‘This will hurt’: Innovation stifled by tough R&D scheme, say founders (05-Nov-18) here
- ‘Very concerned’: Startups threaten to go offshore over R&D changes (16-Nov-18) here
- Airtasker hit by R&D incentive tax crackdown that threatens tech firms (03-Dec-18) here
- Innovation has lost its meaning: StartupAus (06-Dec-18) here
- The 10 things Australia needs to do to become the best place in the world for startups (06-Dec-18) here
- PwC slashes R&D staff after being targeted by ATO (09-Dec-18) here
- Give software start-ups exemption on repaying R&D grants: industry group (10-Dec-18) here
- Nightmare for tech start-ups with R&D audit and encryption bill (10-Dec-18) here
- How CBA, Deloitte triggered the R&D incentive crackdown (12-Dec-18) here
- Tax Office targets advisers over R&D claims in secret tax promoter list (12-Dec-18) Here
- Retreat & Destroy: what R&D reforms are doing to start-ups (12-Dec-18) Here
- Taking manufacturing through the tax debate (17-Dec-18) Here
- Labor to ‘preserve’ R&D tax scheme (17-Dec-18) Here
- Uncertain about R&D in Australia? Here’s all your questions answered (23-Jan-19) Here
- Long term certainty needed for R&D tax incentives: CSL, Cochlear (30-Jan-19) Here
- End R&D tax ‘tinkering’: Cochlear (01-Feb-19) Here
- Outsourcing the R&D crackdown (06-Feb-19) Here
- Delay R&D tax changes government told (11-Feb-19) Here
- Senate: R&D tax changes on hold (11-Feb-19) Here
- Government should delay plan to restrict R&D incentives, inquiry finds (12-Feb-19) Here
- Senate committee asks R&D tax incentive Bill be refined before it’s passed (12-Feb-19) Here
- Economics Legislation Committee- Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 (Feb-19) Here
- Startups face more unknowns as brakes put on R&D changes (12-Feb-19) Here
- Delayed reaction to R&D changes (12-Feb-19) Here
- CSL chief Paul Perreault: Government flip-flopping is bad for business (13-Feb-19) Here
- Australian start-ups fear tech has fallen out of favour with Government (15-Feb-19) Here
- UK targets Aussie tech firms for post-Brexit economy (18-Feb-19) Here
- Push to rethink ‘frustrating’ innovation debate ahead of budget (20-Feb-19) Here
- Government releases new R&D guidelines for confused tech firms (20-Feb-19) Here
- Push for budget innovation revamp (21-Feb-19) Here
- Feds reveal new guidelines for R&D tax incentive (21-Feb-19) Here
- Innovation department grilled over R&D incentive program (21-Feb-19) Here
- New government guidance available (21-Feb-19) here
- Economics Legislation Committee Transcript (21-02-2019) See transcript here
- Software guidance for businesses claiming tax incentive (22-Feb-19) Here
- New RDTI guidance a ‘kick in the teeth’ (22-Feb-19) Here
- RDTI concerns raised in Estimates (22-Feb-19) here
- New guidance for R&D tax incentives revealed: Here’s what it all means (25-Feb-19) here
- Some big four partners are ‘disrupting’ the tax system, the ATO tells estimates (26-Feb-19) here
- CBA’s backdown on $100m R&D claim ‘a positive’ for innovation: Fintech Australia (18-Mar-19) here
- CBA and ATO reach agreement over core banking R&D tax claims (18-Mar-19) here
- CBA settles in $100m R&D tax fight (18-Mar-19) Here
- CBA settles core banking R&D stoush with tax office (18-Mar-19) Here
- ATO confirms approach to research and development tax incentive (18-Mar-19) Here
- Work on fixing RDTI begins (20-Mar-19) Here
- The Manufacturing Sector Is Vital To Australia’s Future Prosperity (21-Mar-19) Here
- Innovation and Science Australia Annual Reports here