Chapter 5
Eligible Expenditure
Introduction
5.1
In their 2007 report, the Productivity Commission identified three types
of R&D when they reviewed the role of public support for innovation:
- basic research – basic research is the experimental or
theoretical work undertaken primarily to acquire new knowledge of the
underlying foundation of phenomena and observable facts, without any particular
application or use in view although it is this type of research that is likely
to have large spillover benefits;
- applied research – applied research is original investigation
undertaken in order to acquire new knowledge, it is however directed primarily
towards a specific practical aim or objective; and
- experimental development – experimental development is systematic
work, drawing on existing knowledge gained from research and/or practical
experience, which is directed to producing new materials, products or devices,
to installing new processes, systems and services, or to improving
substantially those already produced or installed.[1]
5.2
Under the new R&D tax incentive, eligible entities will be entitled
to a tax offset for expenditure on eligible R&D activities and for the
decline in the value of depreciating assets used for eligible R&D
activities.[2]
The rules governing the tax incentive will be set out in new Division 355 of
the ITAA 1997.
5.3
The operation of the new provisions relies on the concepts of 'R&D
entities' and 'R&D activities' – it being R&D entities that qualify for
a tax offset in respect of their R&D activities.[3]
What are 'R&D entities'?
5.4
'R&D entities' continue to be defined as being:
- a body corporate (ie a company) incorporated under an Australian
law;
- a body corporate incorporated under a foreign law that is an
Australian resident; and
- a body corporate incorporated under a foreign law that is a
resident of a foreign country[4]
but carries on business in Australia through a permanent establishment.
5.5
Companies that meet the definition of an R&D entity will, in principle,
be eligible to claim the new tax offset. They will however need to have notional
deductions[5]
for R&D expenditure of at least $20,000.[6]
This requirement of a minimum threshold is also a feature of the existing R&D
tax concession. It does not apply however in circumstances involving R&D
expenditure of a Research Service Provider or contributions to a Cooperative
Research Centre.[7]
5.6
The definition of 'R&D entity' did not attract attention or comment
throughout the course of the Committee's inquiry.
What are 'R&D activities'?
5.7
R&D activities are defined in section 355-20 of the bill as being 'core'
R&D activities or 'supporting' R&D activities. These concepts are further
clarified in sections 355-25 and 355-30, yet, according to the explanatory
memorandum are not new:
The new R&D tax incentive retains some elements of the
framework for R&D activities that currently applies... (For example, the
distinction between core and supporting R&D activities continues.) However,
these elements have been refined so that the new scheme better aligns with the
rationale for providing a general subsidy for business R&D...[8]
5.8
Although the explanatory memorandum suggests that the concepts of 'core'
and 'supporting' R&D activities are not new, the redrafting of the
definitions received the majority of attention in submissions received and at
the public hearings held. The general consensus was that the re-written definitions
will reduce the number of firms eligible for the tax incentive as they amount
to a 'wholesale re-write' of the provisions.
When the Cutler report came out, we were very receptive to
what was in it. Basically it said that there are some areas where there was a
case of misuse and that the definition of R&D should be refined to address
those areas of misuse. We think that is a sensible thing to do as ongoing
maintenance of the tax act. But they did not recommend a wholesale rewrite of
the definition of expenditure eligible for R&D, nor was there an indication
in the government’s media release and announcements in the budget last year,
when it indicated that it was proceeding with some changes, that it was going
to redefine eligible R&D.[9]
The changes to the definitions of R&D are genuinely
problematic in terms of various industries—for example, in manufacturing, the
importance of the development side versus the research side in manufacturing.
You end up with unintended consequences, such as the consequences of complexity
and the like from the dominant purpose test, and I am not sure why.[10]
The proposals stem from the Cutler Report which seemed to
recommend the support of the iconic R&D Tax Concession with increased
support levels for SMEs. It also proposed to change from a tax deduction to a
tax credit and cut out the 175% premium...nevertheless, those aims could surely
be achieved in a much simpler manner than by a wholesale change to the R&D
Tax Concession and without the major increase in complexity currently proposed.[11]
5.9
As indicated, those who commented on the changes, mostly beneficiaries
of the existing scheme, were generally critical of the redrafted definitions contending
that the existing definitions did not require amendment.[12]
5.10
There was general consensus around some aspects of the bill. For
example, there was broad support for abolishing the complex 175 per cent
premium concession, which perversely rewards volatile R&D and is of no
assistance to new firms:
The removal of the 175 per cent concession, which was complex
to model, and almost impossible to model in advance for large corporate groups,
is also welcome; I think it is good policy.[13]
The 175 per cent incremental did not make sense to them and,
beyond the simple case, it was a complicated after-the-fact tax calculation
where windfalls occurred because of corporate merger and acquisition activity.
We think it was underpowered at 7½ cents under the 125 and overcomplicated
because of the premium. We have got a high base rate regime and that is great.
We have got rid of the premium and we think that is excellent as well... We have
consulted every day in their 175 per cent incremental premium. We generate fees
help for companies every day, and we have advocated for its closure since
before it began.[14]
5.11
Some concerns were raised, however, in relation to the operation of the
objects clause together with the redrafted definitions of core and supporting
activities.
The objects clause
5.12
The object of Division 355 will be set out in section 355-5 and will
state:
(1) the object of this
Division is to encourage industry to conduct research and development
activities that might otherwise not be conducted because of an uncertain return
from the activities, in cases where the knowledge gained is likely to benefit
the wider Australian economy.
(2) This object is to be
achieved by providing a tax incentive for industry to conduct, in a scientific
way, experimental activities for the purpose of generating new knowledge or
information in either a general or applied form.[15]
5.13
Numerous submitters to the inquiry raised concern with the new objects
clause on the basis that its reference to activities that 'might not otherwise
be conducted' and the requirement to 'generate new knowledge or information' limit
the definitions of core and supporting R&D and will therefore affect their
ability to access tax incentives for R&D expenditure.
The objects clause of the bill...omits the second critical
element in the Frascati approach—‘the use of this knowledge to devise new
applications’. The narrow coverage of the objects clause suggests to us that
the government intends to pare back the role of the R&D tax incentive to
fund, almost exclusively, research. It does not intend to include much of what
business R&D is about—namely the development of existing knowledge to
‘devise new applications’. Instead the government intends that the R&D tax
incentive will apply to activities conducted for the purpose of producing new
knowledge.[16]
The objects clause in the draft legislation definitely
narrows the definition and has a much greater emphasis on the R rather than the
D, compared to the existing situation.[17]
A number of tests need to be satisfied by all claimants and
they are cumulative in nature. Let us start, firstly, with my opening comments
around the definition of core R&D...I think there is a conflict between
this definition and the objects clause.[18]
5.14
Treasury, however, disagreed with the criticisms raised and suggested to
the Committee that:
An issue raised in some submissions is the wording of the
objects clause. The objects clause in the current law provides a general
statement of the intent of the law to provide a tax incentive in the form of a
deduction to encourage R&D activities in Australia that increase commercial
competitiveness. The bill’s objects clause describes the essence of R&D,
namely to encourage industry to conduct research and development that might
otherwise not be conducted because of an uncertain return from the activities
in cases where the knowledge gain is likely to benefit the wider Australian
economy. This object is stated to be achieved by providing a tax incentive for
industry to conduct in a scientific way experimental activities for the purpose
of generating new knowledge or information in either a general or applied form.
In this way, the object and the operating provisions are aligned and entirely
consistent.[19]
Committee view
5.15
The Committee acknowledges the concern of some submitters that by its
express reference to the scientific process and new knowledge the objects
clause tends to focus on research rather than development. The Committee does,
however, note that the objects clause clearly identifies that those research
and development activities can be carried out in an experimental way for the
purpose of 'generating new knowledge or information' in an applied form.
5.16
Based on the evidence provided to the Committee explaining that the 'D'
of R&D refers to the application of existing knowledge in new ways, which
is referred to by the Frascati model[20]
as 'experimental development',[21]
the Committee considers that the objects clause should not operate to restrict unduly
development activities.
5.17
The Committee does, however, take the view that the opportunity should
be taken to clarify the law prior to its enactment and therefore where the
words in the bill can be made clear, that approach should be preferred above
reliance on extrinsic material.
Recommendation 1
5.18
The Committee recommends that subsection 355-5(2) of the objects clause
be amended to clarify the reference to 'new knowledge or information in either
a general or applied form' by adding 'new knowledge in an applied form includes
new or improved materials, products, devices, processes or services'.
Core activities
5.19
The existing definition of R&D activities in section 73B(1) provides
that research and development activities are:
(a)
systematic, investigative and
experimental activities that involve innovation or high levels of technical
risk and are carried on for the purposes of:
(i)
acquiring new knowledge (whether
or not that knowledge will have a specific practical application); or
(ii)
creating new or improved
materials, products, devices, processes or services; or
(b)
other activities that are carried on for
a purpose directly related to the carrying on of activities of the kind
referred to in paragraph (a).[22]
5.20
Section 73B(2B) provides further guidance explaining that, for the
purposes of the definition of research and development activities:
activities are not taken to involve innovation unless they
involve an appreciable element of novelty; and
activities are not taken to involve high levels of technical
risk unless the probability of obtaining the technical or scientific outcome of
the activities cannot be known or determined in advance on the basis of current
knowledge or experience; and the uncertainty of obtaining the outcome can be
removed only through a program of systematic, investigative and experimental
activities in which scientific method has been applied, in a systematic
progression of work...from hypothesis to experiment, observation and evaluation,
followed by logical conclusions.[23]
5.21
This is contrast with the proposed definition of core R&D activities
that will be set out in section 355-25. It will provide that:
(1)
355-25 Core R&D activities are
experimental activities:
(a)
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:
(i)
is based on principles of
established science; and
(ii)
proceeds from hypothesis to
experiment, observation and evaluation, and leads to logical conclusions; and
(b)
that are conducted for the purpose
of generating new knowledge (including about the creation of new or improved
materials, products, devices, processes or services).
(2)... [excluded activities]
5.22
Treasury submit that the definition in the bill improves certainty by
removing contradictions, focusing clearly on underlying experimental activities
and using plainer language.[24]
They are of the view that the current definition of core R&D activities[25]
is 'problematic' as it involves 'multiple overlapping tests and qualifications
applied to the basic concept...'[26]
5.23
The Australian Industry Group however takes a different view and contends
that the proposed definition will reduce support for development.
What we are concerned about is the experimental
development—that is, the application of existing knowledge in new ways. Clearly
it does not fall into the definition of core R&D and, because one way or
another it is excluded under the supporting R&D tests, it will not be
eligible to be claimed as supporting R&D either. That is our concern and
that is not really research related; that is more experimental development—this
process of developing things on the run, if you like, in the production
process, which is, as the Productivity Commission notes, where 61.6 per cent of
2004-05 R&D expenditure undertaken by business actually occurred.[27]
5.24
Cochlear, also raised some concerns with the proposed new definition of
core activities, explaining that:
It is the importance of the D as well as the R, and a company
like Cochlear is doing more D than R. It is capital D and little r. We call it
R&D. It is the recognition that it is an ongoing step-by-step-by step
building on what has gone on before. To give you an example, 30 years after the
first implant of our cochlear implant, we are still spending 13 per cent of our
revenues on technological innovation...We are doing that because it is a
step-by-step journey, and it is development. I guess that is the difference
between, say, devices and drugs. A drug either works or it does not, but with a
device you hit it with a hammer or paint it green or make it blue and add a
little widget or whatever, and you develop it. It is a development process. It
is the successful development of that over the long term that creates
substantial competitive advantage and keeps you in business, and that is why
the development side is really important. Even if you come up with an emphasis
on the R that might help the SME when it starts up, unless it gets in its head
that ongoing development it will not be there. It is a really important point.[28]
5.25
It is this process of demonstration, leading and following that results
in spillover benefits that provide the rationale for public sector support for
R&D activities.[29]
Indeed, Professor Roy Green highlighted the importance of both elements of
R&D when he told the committee that:
[I]n experimentation prototyping the D element of R&D is
an important aspect of the definition. I would be surprised and concerned if
that were not to be part of a final scheme...I am looking at it from the broader
issue of public policy and the application of principles...if it does narrow
R&D in an illegitimate way— and that excludes legitimate R&D, including
the D part of experimentation and other forms of development—I would be
concerned... The point is that, if they are doing R&D that is risky and
innovative, it should be covered by the terms of the new scheme...provided that
companies are undertaking R&D within what I hope will be a broad
definition, they ought to be eligible for such return, but it may not be simply
return for business as usual...[30]
5.26
Mr Serge Duchini of Deloitte also highlighted the importance of ensuring
development is supported.
The definition of core R&D...does not explicitly and
sufficiently cover application R&D in my opinion, and this was referred to
in earlier submissions. This stems from the policy belief that greater benefits
flow to the broader community from generating knowledge rather than from the
application of the knowledge that is the product of the R&D. No evidence
has been presented throughout this entire policy debate that the public subsidy
for new knowledge creation will yield greater economic benefit than the subsidy
of the application of that new knowledge to the creation of new products,
processes, services and devices...There is significant public benefit and wealth
creation occurring, with the focus of the R&D as its practical application.
This is where the rubber really does hit the road, where tangible commercial
outcomes are achieved...It is where corporates take on a significant risk and
where technical failures are also common.[31]
5.27
Treasury advised the Committee that they disagree with claims of
stakeholders that the proposed definition will 'skew public financial support
towards theoretical research and away from the development of new products and
services'.
This is not the case [and] [a]lthough the rewording
highlights the purpose of new knowledge, it is clear that the knowledge can be
in the practical form of developing new or improved products, processes or
services. It has also been put that, if an Australian company could not access
knowledge about a product owned by another company and it sought to bridge that
knowledge gap through its own R&D, it may be denied the tax incentive since
it might be argued that its own R&D is not generating new knowledge... Such an
interpretation is not warranted. It ignores the fact that knowledge that is not
accessible cannot logically form the benchmark from which the generation of new
knowledge can be measured...In any case, under the current law, the concept of
new knowledge already exists and, moreover, the particular activities may need
to involve appreciable novelty, a concept that overlays a further element of
degree and subjectivity. The effect of the knowledge test is to avoid
subsidising activities that merely amount to reinventing the wheel or that
merely address routine uncertainty.[32]
5.28
The Department of Innovation, Industry, Science and Research (DIISR) has
also sought to allay the concerns that have been raised advising that:
The development aspect of R&D is captured by the
application of knowledge recognised in the object clause and also in the definition
of core R&D. Core R&D activities are experimental
activities conducted for the purpose of generating new knowledge (including
about the creation of new or improved materials, products, devices or
processes). The expression 'improved' within 'new' or 'improved' means
experimental development activities. These experimental development activities
can occur in any environment, including a production or commercial environment.[33]
5.29
As Professor Green put it:
The point is that, if they are doing R&D that is risky
and innovative, it should be covered by the terms of the new scheme...provided
that companies are undertaking R&D within what I hope will be a broad
definition, they ought to be eligible for such return, but it may not be simply
return for business as usual...[34]
Committee view
5.30
While the Committee recognises the apprehension of stakeholders and their
concern that application of the new rules will favour research over
development, it notes the evidence provided by the Treasury and DIISR.
5.31
The advice provided to the Committee confirms that it is not the
intention of the amendments to curtail D but rather to ensure that 'business as
usual' activities are not subsidised by taxpayers.
5.32
It is the Committee's preference that the definition of core activities
should be sufficiently clear that it does capture both R and substantial D where
it is clear that the D is not business as usual activity and will result in
spillover benefits. In forming this view the Committee refers to the
Productivity Commission's 2007 research report – Public Support for Science
and Innovation, which identified that:
R&D should not just be judged on its immediate promise of
improvements in products, services or processes, but also on its ability to
provide the capacity for better decision making in the future...[35]
A large part of economic growth reflects the steady
application and adaptation by firms of knowledge and innovations that are quite
dated from an international perspective but are new to their own productive
processes.[36]
5.33
Bearing these observations of the Productivity Commission in mind and
having regard to the rationale for public support of R&D, the Committee
regards the passage of this bill as the ideal opportunity to remove doubt and
ambiguity from operation of the law to provide certainty for those affected by
the changes.
Recommendation 2
5.34
The Committee notes that many of the concerns were raised by
organisations who want to maintain the status quo. Nevertheless, given the
concerns raised, but acknowledging the need to ensure that public support is
targeted appropriately, the committee recommends that the definition of 'core
R&D activities' in section 355-25 be amended to remove the word 'about'
from paragraph 355-25(1)(b) so that the paragraph reads as:
[talking about experimental activities] that are conducted
for the purpose of generating new knowledge (including about the
creation of new or improved materials, products, devices, processes or
services).
5.35
Removing 'about' from the parentheses after the word 'including' would
clarify that the creation of new knowledge includes the creation of new or
improved materials, products, devices, processes or services. It was suggested
to the Committee that as the paragraph currently reads the placement of the
word 'about' may be interpreted as a qualifier limiting what the generation of
new knowledge includes:
...the test now focuses on new knowledge, which can be
construed as emphasising research but largely ignoring the development side of
the equation. In practical terms, there is a question as to whether a building
development that involves on-site R&D can even be considered as an R&D
cost under the incentive. For instance, in order to test a green retrofit for
insulation or structural reinforcing for a new and innovative type of building,
it is necessary to conduct part of the R&D within the building itself to
take account of all variables. However, the costs associated with that test may
not strictly fit the definition of core R&D, as it is currently defined.
That would be a very unusual outcome, I would have thought. It really depends
on how you interpret ‘new knowledge’ regarding improving materials, products,
et cetera. That is fairly easily fixed, in fact, by ensuring that the R&D
definition indicates that the actual creation of new and improved materials,
products, devices et cetera is a part of core R&D. That is actually a very
simple change because it involves removing two words from section 355-25, being
‘about’ and ‘the’ in parentheses.[37]
I have always advocated that we should just get rid of the
word ‘about’. To me it connotes that it is the development of knowledge around
the process of creation rather than the hard, fast creation activity that
includes eligible R&D activities. I think that should be amended and I
think it is a quick fix. Overall, when I as a professional read the definition
I believe that it is easier to read, and I think an engineer reading it would
get it, as it talks about ‘experimental’ and ‘experimentation’. Where is the
knowledge gap? On the surface, it is a simpler definition than the clunky one
that we now have. I accept that, and it is good.[38]
Supporting R&D
5.36
The proposed definition of supporting R&D also attracted criticism
throughout the inquiry.
5.37
The definition, that will be set out in section 355–30, will specify
that:
355–30 Supporting R&D activities
(1) Supporting R&D activities are activities directly
related to core R&D activities.
(2) However, if an activity:
(a) is an activity referred to in subsection 355–25(2) [ie an
excluded activity]; or
(b) produces goods or services; or
(c) is directly related to producing goods or services;
the [excluded] activity is a supporting R&D activity only
if it is undertaken for the dominant purpose of supporting core R&D
activities.[39]
5.38
Concerns have arisen predominantly in relation to the introduction of
the 'dominant purpose' test that must be met where a claimant is seeking to
access the R&D incentive in respect of an otherwise excluded activity.
5.39
Excluded activities are identified in subsection 355-25(2) and include:
(a) market research, market testing or market
development, or sales promotion (including consumer surveys);
(b) prospecting, exploring or drilling for minerals or
petroleum for the purposes of one or more of the following:
(i) discovering deposits;
(ii) determining more precisely the location
of deposits;
(iii) determining the size or quality of
deposits;
(c) management studies or efficiency surveys;
(d) research in social sciences, arts or humanities;
(e) commercial, legal and administrative aspects of
patenting, licensing or other activities;
(f) activities associated with complying with statutory
requirements or standards, including one or more of the following:
(i) maintaining national standards;
(ii) calibrating secondary standards;
(iii) routine testing and analysis of
materials, components, products, processes, soils, atmospheres and other
things;
(g) any activity related to the reproduction of a
commercial product or process:
(i) by a physical examination of an
existing system; or
(ii) from plans, blueprints, detailed
specifications or publicly available information;
(h) developing, modifying or customising computer
software for the dominant purpose of use by any of the following entities for
their internal administration (including the internal administration of their
business functions):
(i) the entity (the developer) for which
the software is developed, modified or customised;
(ii) an entity connected with the developer;
(iii) an affiliate of the developer, or an
entity of which the developer is an affiliate.[40]
5.40
Although the redrafted definition has caused considerable concern,
Treasury explain that the tightening of the provisions application is
intentional:
An important policy change in this bill is that supporting
R&D is connected more tightly to core R&D... The key task of the dominant
purpose test for any supporting and excluded activities is to prevent
activities that would be conducted regardless of core activities being
leveraged off them so as to qualify for the tax incentive—that is, the R&D
tax incentive should not cross-subsidise production activities that the
experiment is merely piggybacking on.[41]
5.41
The potential application and operation of the dominant purpose test is
causing particular concern to those companies that undertake R&D in a
production environment given that it will require claimants to show that the
activities in the production environment are for the dominant purpose of
supporting their core R&D activities.
...the dominant purpose test will severely restrict genuine
manufacturing R&D carried out in a production environment...[42]
5.42
Throughout the inquiry, the introduction of the dominant purpose test
was related to the matter of 'whole of project' claims; situations where companies
are claiming as R&D normal business activity or claiming the whole of a
large project when only part of it is innovative (such as claiming the whole of
a building as an expense when only the air conditioning was experimental). The
Department identified the need to address this issue noting that in some cases
directly related supporting activities amount to 90 per cent of tax concession
claims.[43]
5.43
Witnesses before the Committee also acknowledged the need to address
excessive claims.
There was a need to do something about...‘whole-of-mine claims’...
Cutler noted that, while these large claims in areas such as mining, civil
engineering and the like are currently eligible under the program and are
R&D, they are a big cost impost on the system.[44]
There is whole of project. This is an example whereby people
are claiming as R&D stuff that is clearly not R&D; it is normal
business activity. The case of a road has been used in examples of that type of
major project. There have been cases in the financial system of people claiming
their normal IT expenditure as R&D. There are a whole series of activities
and some of them have involved hundreds of millions of dollars. But it is not
true to say that this involves just one or two isolated cases.[45]
Senator XENOPHON—Following on from Senator Cameron’s line of
questioning, you do agree that under the current system it is open to abuse and
rorting, in some instances?
Mr Parsons—Yes, excessive claims are a possibility using the
support activity provision in the sense that they become disproportionate. I
would express it as ‘excessive claims providing a disproportionate outcome
which allows for poor outcomes in terms of policy’.
Senator XENOPHON—Sure. Others might call that rorting,
though.[46]
5.44
Although submitters recognise the need to address these excessive claims
they contend that the problem could be addressed without the need to re-write
the eligibility criteria.
From my understanding, some of the excessive claims are where
the supporting R&D is very, very large relative to the core R&D. You
deal with it by a multiple like that. There are other ways of dealing with it,
perhaps by pre-approval for the program.[47]
...We would question whether a blanket application of a more
complicated and restrictive set of eligibility criteria is the best way to
address this issue.[48]
Dr Roberts—Those two examples that you mention could very,
very easily be addressed by setting some ratio of supporting versus core
R&D or a cap.
Mr Oliver—Or even a cap on the overall size of the project
that then drives the need to have an internal review or advance approval.
Mr Chia—Or when trials are run over a period of time, such as
when a trial is run over more six months, you get approval for that to become
eligible expenditure under the new incentive.[49]
There has to be a better way than having dominant purpose.
When you understand that businesses undertake activities, they try to undertake
activities in the most efficient way by piggybacking them together and
achieving multiple outcomes that will achieve an R&D end and maybe a
commercial objective, which is what you want organisations to do. Maybe the
word ‘dominant’ should be softened to ‘substantial’, which is not an
insignificant or a de minimis purpose; it is still a substantial purpose
connected to R&D.[50]
5.45
The main alternative canvassed by some submitters was the suggestion
that the 'dominant' purpose test be replaced with a 'substantial' purpose test
on the basis that this would address the problem of excessive claims yet ensure
that the R&D tax incentive is still available to those companies who rely
on their existing production processes to commercialise their R&D.
5.46
Consideration of the use of 'substantial' rather than dominant has
however raised the concern that this term is in itself ambiguous and its use
would not be consistent with the policy objectives that are sought to be
achieved.
5.47
Indeed, use of the term 'substantial' has proven problematic in the Trade
Practice Act 1974 context where the word has been interpreted differently
in different contexts: section 46, relating to predatory pricing, refers to a
corporation that has a substantial degree of power in a market'. Here, the word
'substantial' has been interpreted to mean 'real or of substance, rather than
minimal or trivial'. Another judgement found 'substantial' in the context of
section 46 to mean a degree of market power which is considerable or large.
Section 50 of the TPA prohibits acquisitions which have the effect or likely
effect of substantially lessening competition in a market. Here, the word
'substantial' requires that the acquisition be meaningful or relevant to the
competitive process.
5.48
DIISR are also of the view that replacing the word 'dominant' with
'substantial' will not achieve the policy intent and would result in an outcome
'fundamentally inconsistent' with the object of the new incentive.
5.49
They have also raised concerns that the use of the word 'substantial'
will result in ambiguity and perpetuate the current problem of excessive
claims.
The dominant purpose test ensures that taxpayers do not claim
their ‘business as usual’ activities. The R&D tax incentive is not intended
to support these activities, as normal business deductions are available for
such activities... The word ‘substantial’ should be avoided because in other
contexts the courts have found the word to be imprecise and potentially
ambiguous. For example, in the 1979 Federal Court case of Tillmanns
Butcheries Pty Ltd v Australasian Meat Industry Employees’ Union Justice
Deane said:
The word “substantial” is not only
susceptible to ambiguity: it is a word calculated to conceal a lack of
precision. In the phrase “substantial loss or damage”, it can, in an
appropriate context, mean real or of substance as distinct from ephemeral or
nominal. It can also mean large, weighty or big. It can be used in a relative
sense or can indicate an absolute significance, quantity or size.
If ‘substantial’ were used to mean ‘not insignificant or de
minimis’, the existing low bar for supporting R&D activities would be
retained. This will be inconsistent with the meaning of the term ‘dominant’ and
will not solve the problem of claims related to ‘business as usual activities’.[51]
Committee view
5.50
The Committee acknowledges industry concerns about the unknown impact of
the 'dominant purpose' test on R&D activity in Australia. In recognising
this concern however, the Committee supports the need for government to target
public spending in this industry and in so doing ensure that public funds are
not misappropriated. Replacing the 'dominant purpose' test with a 'substantial
purpose' test could frustrate the intention of the bill that 'business as
usual' activities not attract support.
Recommendation 3
5.51
Given the scope of the changes proposed, the Committee is of the view that
the amended provisions, including the effect of the 'dominant purpose' test, be
reviewed after two years to ensure that the legislation is operating
consistently with the Government's intent.
Intellectual Property and Software
5.52
Two changes that will be introduced by the bill and which are seen as
positive amendments are:
(a)
the proposal to remove the requirement for intellectual property to be
owned in Australia; and
(b)
the changes to the treatment of software.
Intellectual property
5.53
When discussed during the inquiry, submitters were supportive of
removing the requirement that intellectual property be owned in Australia.
This makes sense and ensures that Australia’s R&D
incentives are appropriate for a modern, globally integrated economy.[52]
...it is a fact that globalisation has created a dynamic where
intellectual property is very transportable and is protected in jurisdictions
outside of Australia. It is an unfortunate reality that we need to work with
that reality and recognise that where R&D activity is within Australia, that
delivers many good outcomes for the Australian economy and that we need
probably to be sympathetic with our legislation to understand that IP can be
held anywhere in the world.[53]
EGGLESTON—So you do not see any issues about the fact that,
under this legislation, intellectual property rights for the outcome of any
research will be held by foreign nationals in the United States, the UK,
Germany and Switzerland? That will not affect you in any way?
Mr Hick—It would not directly affect us...[54]
Software
5.54
Similarly, the proposal to remove the existing exclusion that requires
'in‑house' software to include 'multiple sales' and replace it with an
exclusion that clarifies that 'activities related to the development,
modification or customisation of software are not eligible core R&D where
the software is developed for the dominant (sole) purpose of internal business
administration by the entity...for which it was developed, modified or
customised'[55]
has been applauded.
The general approach of not treating software R&D activity
any differently from other R&D activity is welcomed.[56]
The removal of the attack on software related R&D is
welcome.[57]
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