Australia: R&D Tax Policy hits a new low

Last Updated: 27 July 2018
Article by Tracey Murray

Glasshouse Advisory reports on proposed changes to R&D Tax program to benefit foreign multinationals over Australian based multinationals.

When Treasurer Scott Morrison announced his intention to overhaul the current R&D Tax Incentive program in the recent Federal Budget, he cited a need to restore integrity to the current program and to reward those companies that invest heavily in R&D activities. Given the scant detail within the budget papers as to how this objective was going to be achieved, it was initially difficult to assess its impact on a company's R&D program, despite the Treasurer indicating the changes to the program will come into effect from 1 July 2018.

On Friday, the 29th June, Treasury released its draft R&D legislation, along with a 28-day public comment and consultation period. While the draft legislation has taken the opportunity to address a number of inconsistencies in the current R&D legislation, (primarily around the mismatch in the treatment of feedstock and clawback as a result recent changes in the corporate tax rate), it also became apparent that the proposed changes to the R&D program will primarily benefit subsidiaries of overseas multinationals conducting R&D in Australia, compared to subsidiaries of Australian based multinationals conducting R&D in Australia.

Given how the proposed R&D legislation will deliver an R&D benefit to overseas multinationals that are not available to locally headquartered multinationals, it is difficult to reconcile why, on the one hand, the Federal Government is implementing a suite of legislation to ensure multinationals are paying their 'fair share' of tax in Australia (via stringent transfer pricing and related integrity provisions), but at the same time, it is preferentially providing multinationals with a higher R&D Tax benefit that is simply not available to Australian based multinationals conducting R&D in Australia in the same set of circumstances.

The reason for this inequity (and why the proposed changes to the current R&D Tax program will preferentially benefit overseas based multinational groups conducting R&D in Australia, compared to Australian based multinationals) comes down to how the new legislation requires a company to calculate its 'R&D intensity'.

When Treasurer Morrison announced that he intended to change the current R&D program in order to reward companies who invest a higher proportion of their expenditure on R&D activities, his idea was based on increasing the percentage of R&D benefit as a company's R&D intensity increased.

For businesses with an aggregate turnover of more than $20 million, the new program proposes 4 tiers of benefit, as outlined in the following table.

R&D Tax Incentive Rate Level of intensity (eligible R&D expenditure as a percentage of total expenditure)
4% 0% – 2%
6.5% >2% – 5%
9% >5% – 10%
12.5% >10%

While limited detail was provided in the initial Budget papers as to how a company's 'R&D intensity' percentage would be calculated, the recently released draft legislation provides this detail, detail that creates further confusion and uncertainty regarding the application of the new program. For example, in the draft legislation, a company's 'R&D intensity' will be assessed by comparing the 'R&D entity's' (a defined term in the legislation) eligible R&D expenditure over the R&D entity's total expenditure (according to accounting principles). Whilst this seems a straightforward concept, this methodology will significantly disadvantage Australian multinational companies conducting R&D in Australia.

Financial advantage provided to Overseas Based Multinationals

In understanding the inequity within the proposed R&D legislation, consider a scenario whereby a German multinational has $4billion in global expenditure and has an Australian subsidiary engaged in R&D activities. The local Australian subsidiary (i.e. the 'R&D entity' which is the entity that lodges its R&D application with AusIndustry) has a turnover of $50 million, total expenditure of $40million and spends $3million on R&D activities. In calculating this company's R&D intensity percentage, the proposed legislation requires only the expenditure of the Australian based entity to form the denominator in the calculation (i.e. is not required to include the nearly $4 billion of expenditure incurred worldwide by the rest of the German multinational Group). This is because the 'R&D entity' only encompasses the Australian based subsidiary. In this example, the Australian subsidiary of the German multinational will have an R&D intensity level of 7.5% (despite having global expenditure of $4 billion), which will provide it with an R&D Tax benefit of $200,000.

German Multinational R&D Tax Benefit Calculation
Percentage R&D Tax Benefit Rate R&D Tax Benefit Amount
0% – 2% $ 800,000 @ 4% $ 32,000
>2% – 5% $1,200,000 @ 6.5% $ 78,000
>5% – 10% $1,000,000 @ 9% $ 90,000
Total Tax Benefit $200,000

Why are Australian Based Multinationals disadvantaged?

Now consider the same scenario, but with an Australian multinational with an Australian subsidiary engaged in R&D activities. Same turnover, same expenditure, same level of R&D spend as in the previous example and same global expenditure for the Australian multinational Group of $4 billion.

In this scenario, it would be reasonable to expect that the Australian subsidiary of an Australian based multinational would receive the same R&D benefit (i.e. $200,000) as previously calculated for the subsidiary of the German multinational conducting R&D in Australia.

However, due to the fact that the head entity of the Australian multinational tax consolidated group would be deemed to be the 'R&D entity' in any R&D claim (i.e. the entity that lodges its R&D application with AusIndustry), the proposed new legislation requires the 'R&D entity' to include all expenditure to be taken into account when calculating its R&D intensity which, in the case of the Australian subsidiary of an Australian based multinational, would include global expenditure of $4 billion. This inconsistency is due to the operation of Section 355-115 of the Income Tax Assessment Act 1997 ('ITAA 1997'), which defines an R&D entity's expenditure as: –

355 – 115 – Working out an R&D entity's expenditure
  1. An R&D entity's expenditure for an income year is the sum of the amounts covered by subsection
  2. The following amounts are covered by this subsection: –
    1. the expenditure incurred by the R&D entity for the income year worked at in accordance with the accountancy principle;
    2. any amount the R&D entity can deduct for the income year as mentioned in sub paragraph 355-100(1) to the extent the amount is not covered by paragraph (a).

This definition and its impact on calculating a company's R&D intensity has generated a significant level of uncertainty in how to apply the proposed new R&D legislation, specifically around how broad the net is cast when it comes to calculating total expenditure for the R&D entity. However, given section 355-35 of the ITAA 1997, defines an 'R&D entity' to include, "a body corporate incorporated under Australian law.", it is reasonable to interpret that a body corporate incorporated under Australian law (that lodges an R&D claim under the proposed new provisions) will need to include total global expenditure in calculating its R&D intensity percentage.

If we interpret the proposed legislation to include the global expenditure of the Australian multinational (given the head entity of this Australian based group would be considered the 'R&D entity') and we assume the same figures from the previous example (i.e. global expenditure of $4 billion), the R&D intensity for the Australian subsidiary of the Australian based multinational would be 0.00075% (i.e. $3 million in R&D expenditure over $4 billion of the R&D entity's expenditure). In this example, as the R&D entity's R&D intensity falls between 0% – 2%, the Australian subsidiary of an Australian based multinational would only have access to a total R&D benefit of $120,000 under the proposed new R&D tax legislation. This is despite undertaking the same level of R&D activities in Australia and despite investing the same level of R&D expenditure in Australia as the Australian subsidiary of a German multinational. Given the Australian subsidiary of the Australian based multinational has an R&D intensity level of 0.00075%, the disparity in R&D benefit is demonstrated in the table below.

Australian Multinational R&D Tax Benefit Calculation
Percentage R&D Tax Benefit Rate R&D Tax Benefit Amount
4% uplift (0-2% intensity) $ 3,000,000 @ 4% $ 120,000
6.5% uplift (>2-5% intensity) $ – $ –
9% uplift (>5-10% intensity) $ – $ –
12.5% uplift (>10% intensity) $ – $ –
Total Tax Benefit $ 120,000

This appears to be an unacceptably unfair outcome that provides multinationals based in other countries with a higher benefit than is available to the Australian multinationals investing the same level of expenditure on R&D in Australia. In effect, the proposed legislation will penalise Australian based multinationals conducting R&D in Australia, including some of our most innovative and iconic companies, including CSL, Ramsey Health Group, Brambles, and Bradken.

Inequity of R&D benefits between Consolidated and Unconsolidated Groups

The inequity in the proposed legislation (i.e. Australian and overseas based multinationals) also extends to consolidated tax groups, when compared to non-consolidated tax groups. Under the proposed new legislation, if R&D is conducted by a company within a tax consolidated group, given that the head entity is deemed to be the 'R&D entity', the R&D intensity (and therefore its available R&D Tax benefit) of that R&D entity will be reduced, compared to R&D conducted in an unconsolidated group.

The source of the inconsistent treatment and the reason for the reduced benefit available for R&D conducted within tax consolidated groups compared to unconsolidated groups is due to the requirement to include the expenditure of the entire consolidated group as the denominator in the calculation of R&D intensity, whereas an unconsolidated entity only has to take its own expenditure into account when calculating their R&D intensity.

As drafted, the proposed legislation provides unconsolidated entities with the potential to access a materially higher R&D tax benefit than the benefit available to entities within a tax consolidated group. This outcome therefore provides an incentive to structure a Group's tax affairs in a way that enables the R&D entity to sit outside the tax consolidated group where possible. This obviously creates an integrity issue, in a regime where the Treasurer indicated he was seeking to restore integrity to the program.

One of Treasurer Morrison's stated objectives for introducing a '4-tiered' R&D premium was to provide an increased benefit for those companies that invest more of their expenditure on R&D activities. From the examples provided (which primarily relate to companies with an aggregate turnover of more than $20 million), it is clear that the proposed legislation will never be able to deliver on this primary stated objective, due to the introduction of complex concepts that will disadvantage genuine R&D Innovators and encourage creative tax planning structuring to circumvent specific limitations associated with the legislation. What the proposed new R&D program does however deliver is access to an increased R&D tax benefit to multinational groups conducting R&D within Australia, compared to Australian based multinationals conducting R&D in Australia. The proposed new R&D legislation will also deliver increased R&D benefits to entities outside the consolidated tax regime, compared to entities within, in comparable circumstances.

As drafted, the proposed new R&D legislation has significant flaws in that it;

  • does not achieve its primary stated objective of rewarding businesses who engage in increased levels of R&D activity
  • provides access to increased R&D benefits to multinational groups compared to Australian based multinationals investing in R&D activities in Australia
  • provides increased access to higher tax benefits for companies engaged in R&D activities outside tax consolidated group, compared to entities that are within a consolidated group, and
  • is poor tax policy that creates more integrity related issues than it was designed to resolve.

What can we do to ensure this flawed legislation is never enacted in its current form?

  • Take advantage of the 28-day public consultation program (https://treasury.gov.au/consultation/c2018-t289033/ ) to explain to the Federal Government the impact the proposed legislation will have on your business.
  • Write to the local member of Parliament where your company has facilities located, to explain the impact of the proposed R&D changes on your ability to continue to fund R&D activities, its impact on profitability and the potential knock on effect in employment (often linked to reduced profits).
  • Alternatively, contact any of Glasshouse Advisory's Innovation and Incentives team, who will be happy to assist formulate and implement the strategy that is relevant to your company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Shelston IP ranked one of Australia's leading Intellectual Property firms in 2015.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions