Chapter 7

RESEARCH AND DEVELOPMENT TAX INCENTIVES

Brief history

7.1 A Research and Development (R&D) tax concession was introduced in 1985, allowing companies to claim 150 per cent of the cost of R&D as an expense against taxable income. Companies registered with the Industry Research and Development Board to be eligible to claim; and eligible R&D was closely defined. Syndication, whereby two or more companies could jointly register for concessions for projects with R&D expenditure in excess of $500 000, was introduced in 1987.

7.2 In the 1996 - 97 Budget, the R&D tax concession was cut from 150 per cent to 125 per cent; syndication was terminated on 23 July 1996 on the grounds of its high costs and the fact that it was used to minimise tax by syndicate partners with little interest in R&D. However about 200 syndicates remain active to complete projects.

7.3 By way of compensation, the Strategic Assistance for Research and Development (R&D Start) program was introduced in November 1996 to support the development and commercialisation of high risk-high return projects by SMEs. It was expanded following the Investing for Growth report. It is a targeted and competitive program, under which firms compete for grants. Offers of between $170 million and $200 million are expected for 1999-2000.

7.4 In a related approach, the Innovation Investment Fund (IIF) was introduced in 1997 to encourage the growth of early-stage technology-based companies, and to create a self-sustaining early stage venture capital industry. Total Commonwealth funding was $230 million, provided on a 2:1 basis with private capital; funds were to be operated by private sector funds managers, investing in technology companies with an annual revenue of $4 million or less.

Current level of R&D in Australia

7.5 The most common measure of a country's R&D effort is its gross expenditure on R&D expressed as a proportion of its GDP. Australia's gross expenditure on R&D in 1996 - 97 was c. $8.7 billion, or 1.68 per cent of GDP. This placed us 13th of the OECD countries, and below the 1.97 average for OECD countries. [1]

7.6 Business expenditure on R&D (BERD) is also well below the OECD average. The following table shows gross expenditure before and after the reduction in tax concessions.

Year	1995 - 96	1996 - 97	1997 - 98	1998 - 99
R&D tax incentive	150%	125%	125%	125%
Business expenditure on R&D	$4.343 b (0.86%GDP)	$4.2 b (0.80%GDP)	$4.044 b (0.72%GDP)	NA

There have been sectoral differences in BERD: between 1996-97 and 1997-98, mining recorded falls in R&D spending of 24 per cent compared with 5 per cent in manufacturing. [2]

Ralph proposals, endorsed by Government

7.7 After considering R&D options, the Ralph Report recommended the maintenance of the R&D tax concession at 125 per cent. [3] Other changes were endorsed in the Ralph Report and, if enacted, will potentially impact on R&D. They include:

• exemption from tax for super funds when they receive income from a Pooled Development Fund representing gains on the disposal of eligible venture capital investment; [4]
• scrip-for-scrip rollover relief so new enterprises can undergo restructuring during development phase without triggering a CGT liability; [5] and
• scrapping of CGT for eligible venture capital investments in Australia by non-resident pension funds that don't pay CGT at home – US, UK, Japan, France and Canada. [6]

Recent studies of R&D funding

7.8 R&D funding has been studied extensively in recent years, with major reports being published by the Industry Commission, [7] the Mortimer review, [8] and the House of Representatives Standing Committee on Industry, Science and Resources. [9]

7.9 The Industry Commission found that removing the R&D tax deduction would have a negative effect on GDP, taking into account the offsetting benefit of not having to fund the concession. It found a rate of return from R&D in Australia of between 25-90 per cent. In 1995, approximately 2000 companies registered for the concession; the amount claimed was approximately 70 per cent of overall business expenditure on R&D. [10] Mortimer quoted Australian studies estimating the social return from R&D at between 50 and 100 per cent; he also found that innovation accounted for about 50 per cent of long-term economic growth in advanced industrial countries. The House of Representatives Industry, Science and Resources Committee noted the decline in business spending on R&D, in part attributable to the removal of syndication which, it was asserted, had become a mechanism for avoiding tax rather than an effective means of commercialising R&D. It also noted a perception that our current tax regime acts as a deterrent to investment in Australia and considered that reform of capital gains tax would be a welcome outcome of the Government's review of business taxation. It recommended, inter alia, that funding for the very successful Cooperative Research Centre Program be maintained at least at current levels; and that the National Innovation Summit in February 2000 evaluate the balance between the generally available tax concession and targeted grants such as R&D Start.

Views expressed to the committee

7.10 It was widely acknowledged that because of the proposed lower corporate tax rate, the value of the R&D incentives would be eroded. For every dollar spent on R&D, from 1 July 2001 business will get only a 7.5 cent subsidy instead of the present 9 cents and instead of the 18 cents in 1995 - 96. On the other hand, it was also acknowledged that the lower corporate tax rate and lower CGT would make Australia a more attractive investment climate in which venture capitalists might be encouraged to kick-start emerging high-technology companies.

Benefits to society of R&D

7.11 Geoff Lehmann pointed to literature which showed that the benefits to society of business enterprise R&D was roughly double the benefit obtained by the business enterprise itself from its own R&D, one reason for which is technology leakage. While such studies have potential methodological defects, it is intuitively correct that R&D is `a good thing' and hence needs to be encouraged. The most appropriate method of encouragement, and the extent of that encouragement, are the questions which need to be resolved.

Appropriate level of tax concession

7.12 The Taxation Institute of Australia (TIA) pointed out that an R&D tax concession `has been enshrined as a permanent fixture of the Australian taxation system for nearly 15 years' and that reports from Mortimer, Goldsworthy, and submissions to the Ralph Review urged the Goverment to reinstate the 150 per cent tax concession. The TIA believed an R&D tax concession of 7.5 cents in the dollar (125 per cent at a corporate tax rate of 30 per cent) was `wholly inadequate' and, taking into account compliance costs, many companies would view the concession as marginal. In addition, our competitors offer more generous incentives, the UK, for example, offering a 150 per cent tax credit scheme. The TIA's preference was for an R&D tax concession of 180 per cent. [11]

7.13 A separate submission from the Victorian Research and Development Group of the TIA reiterated the TIA's stance, supporting a permanently fixed 150 per cent R&D tax concession as a minimum, to ensure that the present level of R&D support of 45 cents in the dollar is maintained.

7.14 Mr Lehmann, who reviewed the R&D tax incentive for the then Department of Industry, Technology and Commerce in 1987, also considered that the 9 per cent incentive was already too low' [12] and the 150 per cent deduction should be restored. Mr Lehmann believes that it was the reduction in the deduction rate that led to a substantial reduction in business enterprise R&D in the last two years (7 per cent down in 1996-97, 4 per cent in 1997-98 in real terms).

Is a general tax concession or targeted assistance preferable?

7.15 Many witnesses supported a minimum 150 per cent general R&D tax concession, though conceded that if funds have to be found to reinstate it, they should come from the R&D Start program. [13] The TIA suggested that the gross cost of increasing the tax concession should be offset by reduced R&D claims by companies accessing other forms of assistance such as the $2 billion Automotive Competitiveness & Investment Scheme, the $700 million Strategic Investment Program for the Textile, Clothing and Footwear Industry, or the $1 billion R&D Start program. [14]

Attracting venture capital

7.16 There is some evidence that the lowering of the CGT rate and its removal for non-resident pension funds will actually attract venture capital. A 1999 Deloitte Touche Tohmatsu survey of 32 UK and US venture capital providers concluded that up to $1.9 billion would be invested in Australia if the CGT were internationally competitive. [15]

The need for `patient' capital

7.17 Dr Marcus Wigan was of the view that the Ralph 50 per cent abatement over short terms where inflation did not eat up the real gains was pitched at two-to-five year speculative business investments and penalised `patient' capital essential for R&D (many of which still depended largely on family and friends for seed capital). [16]

Impact on revenue neutrality

7.18 Because there is no change proposed in the level of tax concession for R&D, it has not figured in the business tax reform fiscal impact tables. It seems probable that some of the reforms are likely to have a favourable impact on both R&D and venture capital availability: the exemption from tax for super funds when they receive income from a Pooled Development Fund representing gains on the disposal of eligible venture capital investment; the scrip-for-scrip rollover relief so new enterprises can undergo restructuring during the development phase without triggering a CGT liability; and the scrapping of CGT for eligible venture capital investments in Australia by non-resident pension funds. In the event that the business tax reform package proves to be revenue positive, as Ralph and the Government maintain, the Business Coalition for Tax Reform believes the extra revenue generated should be earmarked for, amongst other things, improving tax incentives for R&D. [17] The committee notes that such an outcome will not be known for many years.

7.19 The committee notes the support for a reinstatement of the 150 per cent tax concession for R&D, if necessary at the expense of targeted programs. It expects these issues to be considered in detail at the National Innovation Summit in February 2000 jointly run by Business Council of Australia and the Department of Industry, Science and Resources.

Footnotes

[1] Science and Technology Budget statement 1999-2000, p. 4.3.

[2] Australian Bureau of Statistics, Research and Experimental Development, Businesses 1997-98 (Cat.8104.0) June 1999, p. 3.

[3] Review of Business Taxation, A Tax System Redesigned, July 1999, p. 330.

[4] ibid., p. 621.

[5] ibid., p. 615.

[6] ibid., p. 611.

[7] Industry Commission, Research and Development, Report no. 44, 1995.

[8] Mortimer Review of Business Programs, Going for Growth: Business Programs for Investment, Innovation and Export, 1997.

[9] House of Representatives Standing Committee on Industry, Science and Resources, The Effect of Certain Public Policy Changes on Australia's R&D, August 1999.

[10] Industry Commission, op.cit., pp. 510-11.

[11] Taxation Institute of Australia, in Submissions and Documents, p. 60.

[12] Submissions and Documents, p. 98.

[13] See, for example, Submissions and Documents, p. 60, p. 65, p. 99.

[14] Submissions and Documents, pp. 60-61.

[15] House of Representatives Standing Committee on Industry, Science and Resources, The Effect of Certain Public Policy Changes on Australia's R&D, August 1999, p. 118.

[16] Submissions and Documents, pp. 45-46.

[17] Submissions and Documents, p. 91.