Proposed R&D changes will hit mid-sized firms hard

The Treasurer, Scott Morrison, had revealed the Australian Government was going to “relaunch” the research and development (R&D) tax incentive before the May Budget was announced.

This was an ominous signal that the R&D tax concession was going to be significantly changed to limit what could be claimed. It was his view that the government was had been “writing blank cheques to everyone that has a good idea”, and that the programme guidelines had to change so that it was no longer seen as “a tax incentive for business as usual”.

Fortunately, the changes he unveiled have not been as dramatic as had been mooted, but they are significant nonetheless.

All the announced changes take effect from 1 July 2018, so there is very little lead time until the new rules take effect or to vary commitments to existing research projects/programs.

For “small” SMEs with an annual aggregated turnover of less than $20m, the refundable R&D tax offset will be capped at $4m in cash refunds per year. Expenditure giving rise to in excess of $4m in a cash refund in one year is able to be carried forward to future years and claimed in those future years, assuming the business continues to remain under the annual turnover threshold of $20m.

Offsets that are carried forward to future years will be classified as non-refundable in nature. This is an important change for SMEs to factor into how they plan to allocate their future R&D expenditure. 

The minimum annual amount of eligible R&D expenditure sufficient to justify an R&D claim has been left at $20k.  R&D related to the undertaking of clinical trials will not count towards the R&D cap.

The R&D premium percentage will remain at 13.5%, but it will now be aligned to the corporate tax rate of the company. This means the offset rate able to be claimed will be either 41% (27.5% corporate rate + 13.5% or 43.5% (30% corporate rate + 13.5%) of the eligible R&D spend.

For larger entities that have an aggregated annual turnover of $20m or more, the changes are more significant and introduce a new “intensity” test to determine the R&D premium they are eligible to claim – i.e. the premium in addition to their corporate tax rate. The marginal R&D premium will be the claimant’s company tax rate plus:

• 4 % for R&D expenditure between 0% to 2% R&D intensity
• 6.5 % for R&D expenditure above 2% to 5% R&D intensity
• 9 % for R&D expenditure above 5% to 10% R&D intensity; and
• 12.5 % for R&D expenditure above 10% R&D intensity.

There will be additional funding allocated to the ATO and AusIndustry to undertake more reviews of claims for the R&D offset. The additional enforcement measures are also meant to be aligned to increased funding for education and the production of guidelines and explanatory materials to assist taxpayers in preparing their claims.

R&D intensity is an annual measure of the eligible R&D expenditure measured as a percentage of the total expenditure of the company in a given year. As before, the R&D offset is non-refundable for larger companies.

The maximum amount of eligible R&D expenditure able to be claimed by way of an offset has been increased, however, from $100m, as is the case now, to $150m, potentially in recognition of the tightening that the R&D intensity test will provide for larger companies eligible to claim an R&D offset.

Implications for CRC participation

The scaling back of the R&D incentive through the introduction of annual caps for small SMEs and an annual R&D intensity test for larger companies will reduce the attractiveness of the R&D offset, if that is a significant driver for spending on innovation and research.

However, by making stand-alone R&D projects less attractive from a tax perspective, such a change is likely to swing the pendulum back in favour of corporates, particularly SMEs, leveraging their investment via contributions from research institutions and federal funding dollars, as is achieved through a CRC.

Mid-sized SMEs are likely feel the impact the most given the way the R&D intensity test deliberately reduces the R&D premium for lower levels of R&D spending. And it is this part of the SME market where R&D is critical for the development of capacity to deliver on future innovation and research, as is acknowledged in the CRC Guidelines themselves.

As these changes will be effective from 1 July 2018, SMEs looking to participate in a CRC or a CRC-P, or currently engaged in one, may need to look through their financial projections to ensure their planned commitment remains viable beyond 1 July or whether their commitment needs to be scaled back in future years.

At present, there are no “sunset” or “grand fathering” arrangements to protect pre-existing R&D commitments, meaning the new rules apply to each R&D dollar spent as from 1 July this year.

The only remaining question then becomes whether the proposed changes can be passed into law before they commence operation given the full legislative agenda facing the current Government.