Chapter 2
Views on the policy underpinning the bill
2.1
This chapter outlines the evidence that the committee received regarding
the overall policy intent behind the bill.
2.2
Swanson Reid, an R&D tax incentive advisory firm, advised that it
supports the proposed amendments. Swanson Reid argued that the R&D tax
incentive is over budget and that savings from the measure could allow
resources to be reallocated within the Department of Industry portfolio.[1]
However, submissions received by the committee from other professional services
firms, corporations and industry bodies did not support the proposed policy
change. For example, KPMG stated that it was 'disappointed' that the government
had decided to proceed with the previous government's proposal.[2]
Telstra wrote that it 'is regrettable that this taxation change appears to have
been taken as a savings measure in isolation of any broader policy package to
promote innovation, including R&D activities'.[3]
Some of the submissions which questioned the merits of the policy, however,
acknowledged the government's difficult budgetary circumstances.[4]
2.3
From the submissions that did not support the bill, the committee has
identified several common arguments and areas of concern. These matters were
examined further during the committee's public hearing. This evidence is
discussed in the following paragraphs. Some submissions also outlined
alternative options for amending the R&D tax incentive; these alternative
policies are outlined at the end of the chapter.
Would the changes 'better target' access to the incentive?
2.4
The explanatory memorandum states that the bill 'better targets the
R&D tax incentive to businesses that are more likely to increase their
R&D spending in response to government incentives, delivering a greater
return for taxpayers'.[5]
It adds that there 'is broad support internationally for the view that R&D
spending of small firms is more responsive than that of large firms to
government incentives'.[6]
2.5
KPMG and Michael Johnson Associates, a consultancy firm specialising in
R&D and other government innovation incentives, questioned these
statements. They noted that the explanatory memorandum does not provide
evidence in support of the contention that smaller firms are more responsive to
R&D tax incentives. According to Michael Johnson Associates:
A number of arguments can be put in counter to the assertions
that small companies are more innovative than large companies and that they are
more responsive to R&D incentives. These include the advantages afforded
large companies through scale, deep access to supply chains and connections to
research communities. The competitive environment regarding innovation outputs
is one where large companies are the preferred medium to establish and compete
in international markets of global dimension.[7]
2.6
KPMG countered the explanatory memorandum's claim by citing a paper
written by Sir James Dyson CBE, founder of Dyson Limited.[8]
Deloitte provided a specific example of where an R&D tax incentive has led
to a large company undertaking additional activities in that jurisdiction:
...the UK government, despite its ongoing recession, has
recently made strong efforts to increase its lack of representation on the Top
100 Global Innovators list...by introducing its self-styled Patent Box
legislation which cuts the tax rate for income derived from patented
technologies to 10%. This has also been supported by a general cut in the UK
corporate tax rate to 20% and other local initiatives to demonstrate its patent
box incentives to internationally mobile companies ... Subsequently
GlaxoSmithKline recently invested £500m into its UK manufacturing operations
based on the introduction of the UK patent box legislation. Recent UK filing
records in late 2013 also reflect a move of many Australian technology
companies (including Atlassian) to reincorporate in the UK; an early and
significant indication that the Patent Box model and generous R&D tax
breaks are indeed being successful in attracting its targeted internationally
mobile capital to take advantage of the 10% patent box tax rate.[9]
2.7
The University of New South Wales (UNSW) also pointed to a Department of
Industry report on innovation that stated:
[Small and medium enterprises] are lean innovators, accounting
for a very small share of total investment in innovation, and are much less
likely to generate new-to-world innovations. By contrast, large Australian
businesses made up the majority or total investment in innovation, are much
more likely to collaborate with the research sectors and generate
new-to-the-world innovations.[10]
2.8
The explanatory memorandum does not provide sources to support its
contention that the R&D spending of small firms is more responsive to
government incentives than that of large firms. The initial policy announcement
by the previous government, however, did refer to some research to support this
position: a study of Norway's R&D tax incentive and a transcript of
evidence given by the Organisation for Economic Co‑operation and Development
(OECD) to the US Senate Committee on Finance.[11]
A Department of Industry official also referred to these papers at the
committee's hearing.[12]
2.9
The OECD testimony considered that the aim of government incentives to
encourage business investment in R&D is often to correct or alleviate the
following two market failures:
- 'difficulties by firms to fully appropriate the returns to their
investment';[13]
and
- 'difficulties in finding external finance, in particular for
small start-up firms'.[14]
2.10
The OECD considered that the available evidence—studies in Québec, the
Netherlands and Norway—suggest that smaller firms appear to be more responsive
to R&D tax incentives.[15]
Additionally, at Senate Estimates in June 2013, the executive director of
Treasury's Revenue Group noted that during the Business Tax Working Group
process in 2012:
...there were certainly a lot of anecdotes to the effect that
for a range of very large firms the increased deduction did not drive a lot of
activity.[16]
2.11
Mr Ezra Hefter, a partner at Ernst & Young, acknowledged that there
'is some truth' to the assertion that the R&D spending of small firms is
more responsive to tax incentives than the spending of large firms. Even so, he
added that large firms are still affected by the R&D tax incentive. Mr
Hefter noted that differences between small and large firms are already reflected
in the R&D tax incentive through the differential feature of the incentive that
enables small firms to access a 45 per cent refundable tax offset while other
firms are restricted to a 40 per cent non-refundable offset.[17]
Impact on economic activity in Australia
2.12
Related to the above discussion, submissions also questioned the impact
that the proposed amendments may have on Australia's ability to attract or
retain R&D investment in the global economy. They suggested that any loss
of R&D could negatively impact economic growth, employment and tax revenue,
and a point repeated in submissions was that the proposed amendments would
encourage large companies to shift R&D activities to other countries with
more favourable and more stable R&D tax arrangements. KPMG in particular
clearly expressed how the two lines of argument are connected:
Whether or not the R&D incentive encourages large
companies to undertake R&D, it certainly encourages them to undertake the
R&D activities in Australia (either directly or through contracted R&D
with small and medium enterprises). Such activities create jobs in Australia
and result in employment income, profits and transactions which are taxable in Australia.[18]
2.13
Ernst & Young argued that large multinational corporations have the
greatest flexibility to choose where to undertake their R&D activities and
that the attractiveness of tax incentives is one factor taken into
consideration.[19]
The Corporate Tax Association noted that when a large corporation engages an
external party to undertake R&D activities of its behalf:
...the terms of engagement often include an express requirement
that the R&D activities (or at least the majority of the activities) be
conducted in Australia. Under the proposed changes, there is no incentive for
the affected companies to conduct R&D activities in Australia.[20]
2.14
BDO Australia observed that any move by companies affected by the
proposed amendments to conduct more R&D activities in other countries could
result in: the loss of Australian jobs and tax revenue associated with those
jobs; limited benefits and royalty streams to Australia associated with any
intellectual property developed as a result of the R&D activities; and a
loss of expertise.[21]
Deloitte expects an initial 'severe' impact on the large corporate groups directly
impacted by the proposed amendments followed by consequential effects on
entities in the supply chain, such as smaller 'speciality firms with niche
capability'.[22]
2.15
Submissions also considered the proposed changes in a global context. KPMG
claimed that, to the best of its knowledge, Australia 'will be the first
country in the world to exclude such a specific and targeted subset of large
companies from claiming an R&D tax incentive'.[23]
To bolster an argument that Australia's R&D tax policy is moving in a
different direction to those of other countries, submissions advised that:
- the United Kingdom has expanded its R&D assistance regime
despite difficult economic circumstances;[24]
- Singapore recently introduced an R&D regime with a 400 per
cent tax incentive and has since increased the level of benefit available to
all companies;[25]
- the French Minister for Innovation directly responded to the
announcement of the R&D changes made by the previous government and 'invited
large companies to undertake their R&D in France instead of Australia';[26]
and
- Japan, as of 2013, has a 40 per cent tax credit for R&D
activities.[27]
2.16
Ernst & Young summed up its concern about Australia's apparent divergence
in R&D tax policy, particularly compared to countries in Asia, as follows:
In short, as the Government prepares Australia and
Australians to thrive in the "Asian Century", it appears
counter-productive to be pulling back on incentivising R&D activities for
our largest companies, just when the Asian region appears to be heading in the
opposite direction when it comes to R&D tax policy.[28]
2.17
However, a Department of Industry official noted that there are factors
other than the R&D tax incentive which influence decisions about where
R&D is conducted, such as the existing R&D contacts and relationships
in Australia that the large corporations have:
Our expectation based on that is that large firms will
continue to conduct R&D in Australia, as they always have, using the
smaller research agencies, as they have; that they value the R&D contacts
and relationships that they have in Australia; and that there are factors other
than the R&D tax incentive which determine where they conduct their R&D
research.[29]
2.18
The OECD's testimony to the US Senate Committee on Finance also
suggested that government incentives were a secondary consideration for large
multinational companies when determining where to locate their R&D
activities:
In recent years, several governments have also started to use
innovation policies to attract R&D activities of multinational
corporations. The reason is that in a context of growing internationalization
of R&D activities, government support might make a country a relatively
more attractive location for R&D investments than its competitors. However,
the available evidence suggests that government support is often only of minor
importance for the decisions of multinationals to locate their R&D
facilities in a particular country; other factors such as access to markets and
to a country's knowledge base, or the availability of researchers tend to be
more important.[30]
2.19
Deloitte also acknowledged that if the R&D activities of companies
targeted by the bill were reconsidered because of internal competition for
funding within the company and the tax incentive no longer being available, it
would likely only affect more marginal projects:
There is bidding for internal projects and some projects are
cut. Some projects on the margin only get over because of the incentive. If you
took a step back and looked at what we are trying to do from an economic
perspective, a 10c in the dollar subsidy will only impact the marginal project.[31]
Impact on SMEs and collaborative R&D projects
2.20
Michael Johnson Associates questioned the impact that the changes would
have on R&D collaborations large companies may undertake with other
entities, such as small to medium enterprises (SMEs), co-operative research centres
(CRCs) and universities. It added that collaborative R&D projects could be
negatively affected if companies above the $20 billion threshold were no longer
attracted to a project because they could not access the R&D tax incentive,
a possible consequence being that the project is ultimately carried out with a
partner 'less suited for the work on a range of key criteria such as market
access, technical qualification and relevant research facilities'.[32]
2.21
Ernst & Young similarly considered that the proposed amendment could
negatively impact 'innovation ecosystems'. Mr Ezra Hefter, a partner at Ernst &
Young, explained:
There is a high degree of interdependence between researchers
from very large companies through to small companies through to universities. I
think it is fairly well understood that the large companies have the ability to
fund research that looks to the future, that steps out. They have deeper
pockets and a greater ability to do that, whereas smaller companies often do
not. And I think there is a real risk there for collaboration between large and
small companies but also for universities and CRCs.[33]
2.22
UNSW advised that companies affected by the proposed amendments support
about 30 per cent of UNSW's research effort, with $6 million contributed by
these companies per annum (on average over the past seven years).[34]
2.23
When asked about the likely impact of the proposed amendments on other
entities that support R&D, Department of Industry officials reiterated the
view—supported by international research—that large companies will continue to
undertake R&D in Australia. A Treasury officer observed that 'it is
difficult to draw a conclusion':
The structure of the concession is that it is relatively more
generous at smaller levels, so the question is how often the R&D activity
is structured. Sometimes I think that when we talk about R&D activity it is
quite a broad term. Some of it, as people probably imagine, is in a lab
somewhere and fairly mobile. But it is important to point out that a lot of
R&D activity is also carried out in the production process. So you can think
about some elements of R&D activity that are fairly mobile and can be
carried out in a range of different ways, and you can think about some elements
of R&D activity as forming parts, essentially, of the production process,
so then the decision is linked to the actual production of a product.[35]
Frequent changes create uncertainty
2.24
Submissions also stressed the need for stability and certainty in the
R&D tax incentive. The primary basis of this concern is that the current
R&D tax incentive was only introduced in 2011 (applied to the 2011–12 tax
year onwards); however, an additional consideration is that the R&D tax
incentive is scheduled to be reviewed in 2014 and may be reviewed again as part
of the taxation white paper.[36]
Ernst & Young pointed to a 2013 report by the OECD that stated:
OECD analysis...suggests that in countries that have
experienced a large number of R&D tax policy reversal, the impact of
R&D tax credits on private R&D expenditure is greatly diminished. It is
therefore important that governments do not repeatedly tinker with such
policies to minimise policy uncertainty for firms.[37]
2.25
Medicines Australia similarly expressed concern that changing what it
considers are 'globally competitive' R&D tax incentives could harm
Australia's reputation 'as a stable and predictable business environment' and
impact future R&D activities. Medicines Australia recommended that the
current arrangements operate unchanged at least until the entire system is
reviewed, although it did inform the committee that it understood the rationale
for the proposed amendments in the context of the government's budgetary
position.[38]
Revenue implications
2.26
Treasury estimates that the proposed amendments will increase revenue by
$1.05 billion over the forward estimates period.[39]
This figure is based on modelling of the direct revenue impact associated with
the measure, not any flow-on effects.[40]
2.27
KPMG asserted that this estimate is 'flawed'; it argued that the proposed
changes will provide 'at best a small increase in consolidated revenue now at
the price of longer term growth in Australia in future' given the medium to
long-term timescale of R&D investment decisions.[41]
Other stakeholders found it difficult to comment on the reliability of this
projection as they did not have access to Treasury's modelling.[42]
Retrospective application
2.28
The amendments are intended to commence on Royal Assent and apply to income
years commencing on or after 1 July 2013.[43]
As noted in chapter 1, the measure was first announced by the previous
government on 17 February 2013. The explanatory memorandum notes that the
commencement date is intended to be before the date of enactment. Nevertheless,
it states that the measure 'would not catch taxpayers unawares because the
measure was previously introduced in a bill that lapsed when the Parliament was
prorogued for the 2013 federal election'.[44]
However, the explanatory memorandum does warn that if 'there were a significant
delay in [the bill] receiving the Royal Assent, it is possible that the measure
could apply to an income year that has finished'.[45]
2.29
Several submissions disagreed with the explanatory memorandum's
assessment about taxpayers' awareness of the proposed amendments.[46]
Although they acknowledged that the proposal had been in the public domain
since it was announced by the previous government, they argued that taxpayers
could not be certain that the measures would proceed as a result of the federal
election and the change of government. That the bill was being reviewed by this
committee with a reporting date of mid-March 2014 was another factor cited.[47]
The Minerals Council of Australia articulated the nature of the concern as
follows:
Companies that undertook R&D spending in good faith on
existing law prior to announcement will be unfairly impacted. Large
multinationals that focus the majority of their R&D spend in Australia will
be particularly affected. Such an outcome hardly fosters confidence in
multinational companies to undertake their R&D in Australia.[48]
2.30
As noted in chapter 1, the Senate Standing Committee for the Scrutiny of
Bills considered the retrospective application of the bill. That committee encountered
the following difficulty:
Senate Resolution No. 40 relates to the introduction of a
bill to amend taxation law within 6 months after a government announcement of that
proposal. However, the resolution does not contemplate the current circumstance
in which a bill that lapsed upon Parliament being prorogued could be passed by
a newly constituted parliament (whether within, or outside, the 6 month
timeframe).[49]
2.31
Nevertheless, that committee accepted that a bill proposing to introduce
the measure was first introduced in June 2013. As the Scrutiny of Bills
Committee generally does not recommend particular action on a bill but instead
raises issues for the Senate's consideration,[50]
the 'question of whether the proposed approach is appropriate' was left to the
consideration of the Senate.[51]
Committee comment
2.32
Generally, retrospective tax legislation is not desirable and any such
legislation should ideally be limited to rare circumstances, such as to correct
unintended consequences or to address integrity issues. However, the proposed
amendments have been foreshadowed for some time—the previous government introduced
a bill in June 2013 which, if passed, would have enacted them.
2.33
The committee appreciates the difficulties that the uncertainty
associated with the passage of time and change of government may have caused
for the small number of affected taxpayers and those that advise them. However,
the committee is not necessarily convinced that there is any significant
detriment given the evidence received that suggests the R&D activities of
these very large companies would have been undertaken regardless. Further, the
proposed amendments could only reasonably pose uncertainty for decisions made
between when the previous bill lapsed and the new bill was introduced.
Alternative approaches
2.34
The explanatory memorandum advises that the government will use an
upcoming review of the R&D tax incentive, scheduled to take place in 2014, to
review access to R&D support. The taxation white paper will also consider
the effectiveness of existing innovation tax incentives.[52]
Several submissions suggested that the proposed amendments contained in the
bill should instead be considered as part of these processes.[53]
2.35
Submissions also put forward alternative proposals for consideration.
Ernst & Young argued that, if the aim of the measures 'is to only provide
an incentive where it is absolutely certain to sway the R&D investment
decision', then a pre-approval system for large companies considering
significant projects could be developed as part of AusIndustry's existing
R&D advance ruling system:
This would allow large companies to present their proposed
R&D Tax activities and seek approval from government prior to expenditure
being incurred, if approval is given. This would provide certainty for
claimants and allow them to employ relevant staff/resources. If not approved
then these companies can make an informed decision about whether it is
worthwhile to proceed without an incentive or not proceed at all.[54]
2.36
Deloitte argued that if changes to the R&D tax incentive need to be
made, one of the other options for changing the incentive outlined by the
Business Tax Working Group in 2012 should be consulted on instead. These
included:
- a reduction in the percentage rate of the R&D tax incentive
from 40 per cent to 37.5 per cent; and
- imposing a cap per taxpayer on the amount of R&D expenditure
eligible for the tax incentive.[55]
Committee comment
2.37
The committee considers that the upcoming review of the R&D tax
incentive and the taxation white paper will provide a useful opportunity for
wide consultation to be undertaken on a range of issues relating to R&D and
government incentives to encourage R&D. However, the future scheduled
reviews do not mean that the R&D tax incentive cannot be amended in the
meantime if necessary.
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