Budget Review 2007-08 Contents

Industry Statement – Re-commitment to current policy settings

Michael Priestley
Economics Section

Background

On 1 May 2007, the Prime Minister and the Minister for Industry, Tourism and Resources released the Government’s Industry Statement – Global Integration: Changing Markets, New Opportunities. The 2007-08 Budget gives effect to the new initiatives and enhancements to existing industry support and export promotion programs announced in the Statement.

The Industry Statement follows the Minister’s call for public submissions and roundtable discussions with industry representatives to help set the future policy direction of Australian industry. In July 2006, the Minister invited public submissions to the Industry Statement, stating:

The Government's new Industry Statement, to be finalised by early next year, will set the policy directions to maintain the country's present economic momentum over the next 20 to 30 years.

Australia’s recent economic performance is the envy of the world – low interest rates, low unemployment and strong growth – and current industry policy settings have served the country well.

However we are now entering an era of true globalisation, of communications advances that mean business without borders and the need for industry sectors to become regular contributors to global supply chains.

There are many new challenges facing our industries, including the rise of low-cost competitors like China and India. The Statement will be a considered plan to tackle the challenges while also highlighting opportunity.

The Minister received over forty submissions to the Industry Statement and, in the lead-up to the release of the Industry Statement, a Background Paper was produced to focus discussion on the Statement at a series of business roundtables across Australia.

Innovation and global integration

The Industry Statement marks a re-commitment to the current policy settings which were fashioned by the policy statements, Backing Australia’s Ability Mark I and II. But in recognition of the potential for export growth and gains from greater integration into the global economy, the Statement provides increased support to Australian industry to compete internationally. The funding measures are predominantly geared to assist small and medium enterprises (SMEs) in developing new market opportunities and in undertaking innovation and R&D. The Industry Statement also recognises that economic performance and innovation are influenced by a spectrum of industry policies. In some cases, policies have been specifically designed to increase innovation and to achieve better export outcomes. In other cases, existing policies have been enhanced to improve individual business capacities.

The Industry Statement includes new initiatives and enhancements to current programs worth $1.4 billion over 10 years. The key industry initiatives are:

• $254.1 million for the Global Opportunities program to help SMEs identify opportunities to bid for work on international projects and integrate into global supply chains.
• $351.8 million to establish Australian Industry Productivity Centres to assist SMEs improve their performance and international competitiveness.
• More than $500 million to extend eligibility of the 175 per cent premium R&D tax concession to foreign-owned SMEs undertaking additional R&D in Australia.
• $90.3 million to support the Commercial Ready Plus progam for emerging companies and spin offs from public research organisations.
• $21.5 million for the development of a National Nanotechnology Strategy for expanding Australia’s manufacturing base and $36.2 million to develop manufacturing industries based on nanotechnology.
• $54.2 million to support R&D in the food processing industry and $20.1 million to encourage technology transfer through the Intermediary Access Program.

Manufacturing exports

Australia’s exports

Resources (energy and minerals, principally coal and iron ore) have long been the mainstay of Australia’s exports. In 2005-06, mining exports were worth $73.3 billion - around 38 per cent of the total value of Australia’s goods and services exports and 8 per cent of GDP. This included $24.3 billion worth of coal, $12.8 billion of iron ore and $7.3 billion of gold exports. Energy and minerals make up nine of the top 12 individual export commodities. Bovine meat (beef and veal) was the seventh largest export commodity ($4.5 billion), wheat was the tenth largest ($3.2 billion), followed by passenger motor vehicles ($3.2 billion). [1] But as the following two charts show the current resources boom is more price (demand) driven and has less to do with export volumes (supply).

Source: Australian Bureau of Statistics.

Source: Australian Bureau of Statistics.

Higher world prices for energy and mineral products have sustained an historically high Australian dollar. World trade volumes have grown faster than world GDP at the same time. As a consequence, the strong Australian dollar has adversely affected all other export categories and contributed to the marked slowdown in exports of Australian manufactures. As Treasury has noted, “The significant appreciation of the Australian dollar between August 2002 and March 2004 eroded the competitiveness of Australian manufactures; those producing goods with close substitutes made overseas were forced either to cut prices or accept lower sales. More recently, the currency has stabilised and manufacturers have been able to adjust to the higher level. This is likely to have contributed to the recovery in growth in exports of manufactures in 2005.” [2]

Manufacturing exports since 2001

Manufacturing exports totalled $39.5 billion in 2005-06, or 4.3 per cent of Australia’s GDP. They accounted for 20 per cent of the total value of Australia’s exports of goods and services. Treasury estimates that more than 9,000 manufacturing companies are exporters, with the largest 1,300 of these companies producing 90 per cent of manufacturing exports. [3] The main manufacturing states, New South Wales and Victoria, are the major source of manufacturing exports.

Manufacturing exports grew steadily for most of the 1990s but slowed after 2001 despite the increase in world exports and global economic activity. As Treasury noted, the slowdown reflects international competition in key manufacturing sectors and, since August 2002, a sharp appreciation of the Australian dollar. The chart below shows the overall slowdown in manufacturing exports since 2001. For the first six years of the new millennium, growth in the volume of manufacturing exports averaged less than 3 per cent per annum (2.7 per cent). The most recent five-year trend growth in the value of Australian manufacturing exports was 0.1 per cent. [4]

Although there was a recovery in manufacturing exports in 2005-06, the growth in exports varied across manufacturing categories and this uneven growth is forecast to continue.

'Road motor vehicles', which includes new passenger motor vehicles and motor vehicle parts, is one of the larger categories of manufacturing exports. The fluctuating performance of Australian automotive and component manufacturing in recent times and a strong Australian dollar has meant that the value of road motor vehicle exports has increased by an average of less than one half of one per cent per annum since 2001. Exports of motor vehicle parts fell the most, by an average of 10.0 per cent per annum. [5]

Chart 3: Australia’s manufacturing exports
(annual percentage change; chain volume measure)

Source: Australian Bureau of Statistics.

'Other machinery and transport equipment' is the largest and most diverse category of manufactured products. It includes electrical and power-generating machinery, hand tools, aircraft equipment and parts. This category has managed an annual average growth rate in the value of exports of 2.4 per cent since 2001-02. However, export growth rates vary within the category. While exports of storage containers, aircraft and transport equipment have steadily declined, high annual average growth rates for power-generating machinery (15.2 per cent), car engines (24.7 per cent) and scientific instruments (5.1 per cent) contributed to net export growth for the group.

The second largest category of manufactured products is 'Chemical and other semi-manufactures'. This includes diverse manufactured products ranging from paints, plastics, rubber tyres, papers, cosmetics, medicines and pharmaceuticals. The value of these exports has grown by an annual average of 4.6 per cent since 2001-02. Average annual growth rates have ranged from -13.3 per cent and -5.1 per cent for wood and paper products respectively to 6.7 per cent for plastics and 9.3 per cent for medicines. As in the case of manufactured products in the 'Other machinery and transport equipment' category which had high annual average growth rates at a time when the Australian dollar has risen sharply, manufacturing sectors which increased their exports relied on innovation and product specialisation.

Global Opportunities program and Australian industry productivity centres

Around half of the projected funding of the Industry Statement will be directed to the Global Opportunities program and to the establishment of Australian industry productivity centres. These initiatives seek to build, as the Minister stated, “the capacity of Australian firms to become truly global businesses” and translate proposals advocated by the Australian Industry Group (AIG). The AIG response to the Industry Statement noted that:

Many of the measures adopted by the Government have been advocated by Ai Group over the past year in the wake of our ground-breaking report Manufacturing Futures: Achieving Global Fitness. Ai Group's report pointed to the considerable efforts by businesses in response to the twin pressures of intensifying competition from emerging economies such as China and India and the sharply higher Australian currency.

Ai Group particularly welcomes the proposal to create Productivity Centres around the country to evaluate business needs and opportunities and to assist them to make productivity-enhancing investments. The initiative draws on Ai Group's Industry Statement submission which contained proposals to improve Australia's business capabilities - especially for small and medium sized businesses. The Global Opportunities program to foster greater export activity and other forms of international engagement also picks up on proposals put forward by Ai Group in the context of the expanding opportunities for Australian participation in global supply chains and networks. [6]

The policy measures are also a response to a shift in manufacturing export volumes which appears to be broad-based, with many parts of Australian manufacturing experiencing growth in their exports despite the fall in exports from 2000 to late 2004 and a rising dollar. Although still small relative to the large manufacturing exporters, these exporters contributed to the recovery in manufacturing exports and have strong prospects for further export growth.

R&D performed by subsidiaries of multinational enterprises

Currently, the R&D tax concession is available to Australian companies only. The beneficial ownership requirement prevents subsidiaries of foreign-owned companies from access to the 125 per cent R&D tax concession and the 175 per cent premium concession. In its submission to the Productivity Commission’s inquiry into Public Support for Science and Innovation, GlaxoSmithKline Australia Pty Ltd outlined the nature of the restriction as follows:

… the tax environment within Australia may not be the most favourable for stimulating science and innovation. Indeed, this is particularly the case in the context of health and medical research due to the “beneficial owner” requirements in place for accessing the tax concession. Under the Income Tax Assessment Act and the IR&D Act the concession is limited to those entities that hold the intellectual property associated with R&D domestically. This effectively prevents subsidiaries of multi-national entities, for which head office requires intellectual property to be held centrally, from accessing the benefit and means that a significant proportion of the R&D carried out by members of the pharmaceutical industry is without any significant public support by way of tax incentives. For this reason, overall the tax concession appears to facilitate the mining industry and provide significant support to the information technology sector, but has “strikingly low impact upon the fields of research associated with the medical and bio-science areas”.

The rationale for restricting access to the concession was “a desire by Government to avoid transferring revenue to foreigners without delivering a corresponding benefit to Australia”. However, the Commission concluded that the net social benefits to the Australian community of additional R&D conducted by foreign firms in Australia outweighed the associated revenue loss. But the Commission also noted that there was not a strong case for relaxing the beneficial ownership requirements applying to the 125 per cent concession and on balance recommended that “The beneficial ownership requirement for subsidiaries of foreign-owned firms should be relaxed for the incremental scheme alone.” [7]

175 per cent premium R&D tax concession

The largest funding component of the Industry Statement is the Government’s decision to extend eligibility of the 175 per cent premium R&D tax concession to foreign-owned SMEs undertaking additional R&D in Australia ($200 million over 4 years).

Relaxing the beneficial ownership provisions is expected to lead to an additional $1 billion in R&D expenditure over next five years, with more than 300 eligible companies registering for the 175 per cent concession. [8]

Eligibility for 175 per cent concession

The 175 per cent premium R&D tax concession was announced in January 2001 and has been in operation since 30 June 2001.

The 175 per cent concession is available to Australian companies for additional expenditure on R&D. To be eligible for the 175 per cent concession, companies must increase their R&D expenditure on labour during the year above a base level determined by their average R&D expenditure over the previous three years. Companies require a three year history of registering for and claiming the 125 per cent R&D tax concession. [9]

As more companies put in place R&D plans and make additional investment in R&D, the number of companies claiming the 175 per cent concession has increased. The Table below shows that the number of companies intending to claim the 175 per cent concession has increased by 24 per cent in 2004-05. This is also reflected in a 43 per cent increase in R&D expenditure by companies claiming the 175 per cent concession in 2004-05. R&D expenditure by these companies was $3.7 billion in 2004-5 (or 48 per cent of the total business expenditure on R&D in 2004-05).

Table 1: Registrants as at 30 June 2006

Source: Industry Research & Development Board, Annual Report 2005-06.

Cost of 175 per cent premium R&D tax concession

The following table gives actual and projected tax expenditures related to the 175 per cent concession.

Table 2: 175 per cent tax concession for additional R&D expenditure ($m)

Source: Treasury, 2006 Tax Expenditures Statement.

According to estimates in Budget Paper No. 2, Budget Measures 2007-08, the change to the beneficial ownership test for the 175 per cent concession will cost an additional $200 million over four years.

Table 3: Extension of the 175 per cent concession to subsidiaries of multinational enterprises

Source: Budget Paper No. 2, Budget Measures 2007-08.

Innovation

Innovation activity as measured by business expenditure on research and development (BERD) as a share of GDP has increased in Australia over the last six years. BERD as a proportion of GDP now stands at 0.95 per cent and is the highest recorded BERD to GDP ratio since the R&D tax concession was introduced in 1985. The continued growth in BERD dates back to 1999-2000 when the ratio fell to 0.64 per cent. Nonetheless, business investment in R&D remains below the OECD average of 1.53 per cent. [10]

In a 2006 report Economic Policy Reforms – Going for Growth, the OECD identified areas for reform to improve Australia’s innovation performance. The report recognised that R&D spending is not an end in itself and that innovation performance encompassed framework conditions which can influence the uptake of innovation and the diffusion of technologies within a country’s economy. The OECD report recommended the following indictor-based and broad policy measures to improve innovation in Australia:

The Industry Statement includes new policies to improve business innovation, recognising its importance as one of the main drivers of long-term economic growth. The initiatives address the framework conditions required to increase innovation through collaborative research and the commercialisation of R&D, and go some way in addressing the recommendations in the OECD report. The Commercial Ready Plus program announced in the Statement will provide start-up assistance to public research spin-off companies, while the National Nanotechnology Strategy and National Research Flagship for Niche Manufacturing establish a framework for expanding Australia’s manufacturing base. The development of manufacturing platforms such as nanotechnology, microelectronics and bioengineering illustrates the potential in adding value to established manufacturing activities and for creating new niche industries.

Venture capital

Venture capital is a subset of private equity and refers to equity investments in businesses at various stages of development. It includes pre-seed and start-up capital, expansion-stage capital, later-stage development capital, and finance for management buy-outs and buy-ins (MBO/MBIs). In Australia, the majority of venture capital investments are MBO/MBI type of investments, around 40 per cent of the total value of venture capital invested. [11]

Australian venture capital market

Australia’s venture capital market totalled $10.9 billion as at the end of June 2006, an increase of 9 per cent on the $10.0 billion the previous year. [12] Since 2001 the venture capital market in Australia has more than doubled. The largest source of venture capital is Australian superannuation funds, representing 50 per cent of venture capital investment. 

According to the Australian Bureau of Statistics Venture Capital and Later Stage Private Equity survey, $4.1 billion or 38 per cent of total venture capital is uncommitted (or unused). Of this, $3.4 billion was in direct investment vehicles and $700 million in funds of funds. [13]   

When analysed by activity, manufacturing and transport related activities attracted the largest share of venture capital investment, $1.5 billion (or 37 per cent). Retail, services and real estate attracted $1.2 billion (or 29 per cent) and information technology, communications and electronics, $681 million (or 16 per cent). [14]

Changes to the venture capital regime

The Tax Laws Amendment (2007 Measures No. 2) Bill 2007 before Parliament makes changes to the venture capital regime following the Review of the Venture Capital Industry by an expert group headed by Mr Brian Watson.

Currently, subsection 118-425(2) of the Income Tax Assessment Act 1997 requires that the company must at the time the investment is made be an Australian resident for the purposes of the capital gains tax (CGT) exemption. The Taxation Laws Amendment (Venture Capital) Act 2002 extends the CGT exemption to foreign residents investing in eligible Australian venture capital investments.

The current Bill extends the CGT exemption to foreign resident investors by allowing up to 20 per cent of committed capital in venture capital limited partnerships and Australian venture capital funds of funds to be invested in companies and units trusts that are not located in Australia. As stated in the Explanatory Memorandum:

8.9 The venture capital regime was introduced in 2002 to provide an incentive for foreign investors from certain countries to invest in the Australian venture capital industry, to develop the Australian industry and to provide a source of equity capital for relatively high risk and expanding businesses which found it difficult to attract investment through normal commercial mechanisms.

8.10 This measure relaxes the eligibility requirements for the venture capital regime, without changing its intrinsic nature, by allowing eligible venture capital investments to be acquisitions of units in unit trusts and convertible notes, that are equity interests, in companies and unit trusts; allowing some investments (up to 20 per cent of committed capital) to be in companies and unit trusts that are not located in Australia; allowing limited partners to be residents of any foreign country and general partners and VCLPs to be resident of, or established in, any country with which Australia has a double tax agreement in force;

According to estimates in Budget Paper No. 2, Budget Measures 2007-08, extending the CGT exemption for foreign residents investing in companies and unit trusts not located in Australia will cost $25 million over three years.

Table 4: Venture capital

Source: Budget Paper No. 2, Budget Measures 2007-08.

The report of the Review of the Venture Capital Industry was not published despite calls from the venture capital industry for its release. [15] Relaxing the requirement that investee companies must be located in Australia would appear to be a response to the report, although this is not clear from the Explanatory Memorandum. While the improved taxation treatment of venture capital investments will offer a better mix of investment options and higher capital returns for foreign resident investors, it is difficult to see how the intrinsic nature of the venture capital regime, which is to attract venture capital for new and innovative Australian companies, will not change. 

Endnotes

[1] .     Department of Foreign Affairs and Trade, Composition of Trade Australia 2005-06, November 2006.

[2] .     Treasury, Australia’s manufactures exports, Treasury submission to the House of Representatives Economics, Finance and Public Administration Committee public inquiry, August 2006, pp. 7-8.

[3] .     Ibid, p. 2.

[4] .     Department of Foreign Affairs and Trade, Composition of Trade Australia 2005-06, November 2006.

[5] .     Department of Foreign Affairs and Trade, Exports of Primary and Manufactured Products Australia 2005-06, February 2007.

[6] .     “Government’s proactive industry statement good for business”, Press Statement by Australian Industry Group Chief Executive, 4 May 2007.

[7] .     Productivity Commission, Public Support for Science and Innovation, Canberra, 9 March 2007, p. 395.

[8] .     Minister for Industry, Tourism and Resources, Press Release, “Tax changes to boost R&D by $1 billion”, 8 May 2007.

[9] .     Industry Research and Development Board, Annual Report 2005-06, Canberra, 2006, p. 27.

[10] .    See Australian Bureau of Statistics, Research and Experimental Development, Businesses, Australia 2004-05, Catalogue No. 8104.0, 28 August 2006.

[11] .    Australian Bureau of Statistics, Venture Capital and Later Stage Private Equity 2005-06, Catalogue No. 5678.0, 16 February 2007.

[12] .    Ibid.

[13] .    These are funds which offer multiple managers and multiple strategies to achieve above market investment returns.

[14] .    See Australian Venture Capital Journal, No. 162, March 2007, p. 10.

[15] .    Ibid, pp. 3-5.

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