Australasian Biotechnology (backfiles) AusBiotech ISSN: 1036-7128 Vol. 12, Num. 4, 2002, pp. 49-51

Australasian Biotechnology, Vol. 12, No. 4, Aug-Sept, 2002, pp. 49-51

BIOTECH R&D

NEW INCENTIVES FOR R&D RECENT CHANGES TO R&D TAX CONCESSION: 115% TAX CONCESSION AND CASH REBATES FOR R&D

Susanna Muttilainen and Alun Needham

Innovation and Incentives, SER Tax and Law, Ernst & Young, 120 Collins Street, Melbourne, Vic 3000. Email: alun.needham@ernstyoung.com.au

Code Number: au02026

Abstract

'Backing Australia's Ability the Federal Government's Innovation Policy announcement released on 29 January 2001, introduced a number of changes and additions to the R&D Tax Concession with a view to encouraging increased R&D spending. This article provides an update on the tax-based incentives available for R&D, including discussion of some recent changes to the legislation and new program elements. Among the changes was the introduction of 175 % Premium Concession and an opportunity for companies in a tax loss situation to obtain a cash rebate for their expenditure on R&D via a new R&D Tax Offset.

Introduction

The R&D Tax Concession (the 'Concession'), introduced inJuly 1985, remains the principal support mechanism for encouraging greater levels of business expenditure on R&D (BERD) in Australia. For many years, the Concession has provided companies that are tax paying or able to carry forward losses with a concessional tax deduction for expenditure incurred on eligible R&D activities.

Since 1996, the rate of concession for companies incorporated in Australia has been 125% for expenditure incurred on eligible R&D activities. However, the Concession has proven to be of limited value to smaller companies that are in tax loss positions, particularly over a number of years, preventing the ability to realise the benefit of the concessional deduction in the year(s) that expenditure has been incurred. As part of the Federal Government's Innovation Policy, 'Backing Australia's Ability' released on 29 January 2001, a number of changes and additions to the Concession were proposed. Some of these changes to encourage increased R&D spending were legislated on 1 October 2001. The key changes introduced include two new initiatives:

• 175% Premium Concession
  An increased deduction for additional spending on R&D over a three-year rolling average spend. The Government estimates that this initiative could provide in the order of $550 million of additional funding over the next five years to support $4.3 billion of BERD (1).
• R& D Tax Offset ('the Offset')
  an opportunity to obtain a cash rebate for companies with an R&D spend of up to $1 million and annual turnover up to $5 million, both assessed on a group basis. Under this initiative, the Government expects to provide up to 1300 small companies with approximately $30 million in support over the next five years (1).
• Requirement for R&D Plans
  R & D activities commenced on or after 1 July 2002 need to be included in a company-approved R&D Plan in order to be eligible for the Concession or the Offset.

Eligibility - Overview of Requirements

1.    Applicant
To claim the Concession or Offset a company must be an eligible business entity incorporated in Australia and have spent at least $20,000 on eligible R&D, unless contracting the services of a Registered Research Agency (RRA) in which case there is no expenditure threshold. RRAs include government research organisations, universities and some private laboratories. The majority of the R&D activities must be conducted within Australia; however there is a possibility for some of the expenditure to be incurred overseas if registered with Industry Research and Development (IR&D) Board in advance.

For an eligible business entity to make an R&D claim, it need not carry out the R&D itself. However, any work that is subcontracted to another company must be carried out on behalf of the claimant. That is, the claimant must enjoy effective ownership of the results of the work, bear the financial and technical risk and control the R&D. Where a joint venture arrangement exists, each participant claims their contribution to the R&D work..

Many different arrangements arise between parties where there is a need to contract out some of the R&D work. Consideration of the specific arrangements must be made to determine whether the contractor or the contractee can satisfy the above mentioned 'on-own-behalf' requirements.

2. Activities
In general, R&D activities related to physical, chemical, biological, medical, engineering or computer sciences ate eligible and can be defined as:
(a) systematic, investigative and experimental activities that involve innovation or high levels of technical risk and are carried on for the purpose of:
(i)    acquiring new knowledge whether or not it 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).

Activities referred to in (a) are commonly known as 'core' activities while those referred to in (b) are known as 'supporting' activities. From the definition it is clear that without eligible core R&D activities there can be no claim for supporting activities.

There should be a commercial aim to the R&D activities. That is, the project should aim to increase the market competitiveness of the company; for example, by developing better products and services or improved productivity. These aims are generally achieved by:

manufacturing new or improved products;

• using a unit of plant or process within the company to manufacture a product more efficiently or effectively;
• assigning or licensing industrial property rights developed from R&D;
• entering a technical know-how agreement, say, for the production of a new product; or
• providing a new or improved service.

Note that an unsuccessful project is not precluded from eligibility. If a project fulfils eligibility requirements as specified in this section, but cannot be commercialised because it is unsuccessful, it may still contain eligible R&D activities. A project may be unsuccessful due to technical or commercial reasons.

3.    Expenditure
Eligible R&D expenditure includes salary, plant and contracted expenditure as well as other expenditure incurred directly in respect of R&D activities carried on by, or on behalf of, the company.

When conducting R&D projects, it may be necessary to utilise external R&D expertise and/or facilities. If the contracted activities are eligible activities and carried out on behalf of the applicant company, which bears the technical and financial risk, these costs are eligible for the Concession and Offset. As well as contracts with other companies, contract expenditure with institutions such as the CSIRO, tertiary education institutions, Cooperative Research Centres (CRCs) and specialised research laboratories is eligible.

There is a requirement to obtain approval from the IR&D Board prior to conducting limited R&D activities overseas (and incurring related costs) if expertise, technology, plant or know-how is not available in Australia. Expenditure incurred on certified overseas R&D activities that is able to be claimed is limited to 10 per cent of the total eligible R&D expenditure on a particular project. Expenditure that is ineligible includes: advertising costs, company establishment and other fees in relation to the administration of the company, factory overheads relating to production (ie. non-R&D activities), rent paid for premises which are not to any extent used in R&D activities and salaries associated costs and on-costs of support staff not linked with R&D activities. Notably, legal expenses incurred in taking out a patent, copyright or trademarks in marketing a new product or technology, or as a result of R&D activities are also generally ineligible.

Different Treatment of Eligible Expenditure

Expenditure deductible at either 125% or 175%: salaries and oncosts;

• contractor costs;
• overheads;
• direct project costs (materials and consumables);
• net feedstock costs (eg. raw materials).

Expenditure deductible at maximum of 100%:

• core technology (subject to costs of associated activities);
• interest costs incurred to finance R&D activities;
• mark-ups on goods and services acquired for R&D purposes within groups.

Expenditure deductible at only 125%:

• qualifying plant pre-l2pm 29/1/0 1 (based on one third of cost over three years and assuming exclusive R&D use);
• pilot plant acquired pre-l2pm 29/1/0 1 (amount determined by reference to useful life);
• plant (including pilot plant) post-12pm 29/1/0 1 (to extent of R&D use).

Application Process - Claiming the Concession or Offset

The Concession is administered jointly by the IR&D Board and the Australian Tax Office (ATO). The IR&D Board is primarily concerned with the eligibility of R&D activities while the ATO's primary responsibility lies in determining whether a company's expenditure is eligible for the Concession. In order to claim the Concession or Offset, applicants must on an annual basis:

• register their R&D activities within 10 months of the end of financial year with the IR&D Board by completing an 'Application for Registration of R&D Activities' (available from Auslndustry);
• include the relevant R&D information in their income tax return (ITR); and
• commencing for the 200 1/02 income year: submit a new R&D Schedule to the ATO's Innovation Segment in Adelaide as part of the annual ITR process. The R&D Schedule will document the amount of eligible R&D expenditure and R&D deductions in greater detail than has been provided to the ATO in the past.

175% Premium Concession -Additional Eligibility Requirements

The Premium Concession is designed to encourage Australian companies to spend more on R&D in the longer term. A company may qualify for the Premium Concession if:

• the company has a three-year history of registering for and claiming the Concession, or has received grants for R&D projects under the IR&D Board's R&D Start program;
• only expenditure above the three-year rolling average can be claimed at the 175% rate. Amounts below this three-year average amount are still claimable at the standard 125% rate.
• only non-plant expenditure is eligible for the 175% premium deduction. The main components of this eligible expenditure will be salaries and contractor expenses.

is particularly important to note that any company wishing to apply for the 175% deduction must have registered for the Concession for three years. It is thus important to continue to register even for those years when the R&D spend may be lower.

R&D Tax Offset - Additional Grouping Rules

The Offset will be available to companies with annual group turnover of less than $5 million and group annual R&D expenditure of up to $1 million. The Offset is payable after a company's lodgment of its ITR and will offset any Commonwealth taxes owed by the company. When the amount of the Offset exceeds the amount of tax payable, then the excess is refundable as a cash rebate.

The cash rebate will be the equivalent in value to the Concession, at either the 125% or 175% rate if a company qualifies for the Premium Concession. This means a cash rebate of either 37.5 cents or 52.5 cents for each dollar of eligible R&D expenditure, respectively (i.e. 125 percent x 30 percent being the current corporate tax rate, giving a rebate equivalent of 37.5 cents in the dollar).

Under the legislation, for the purpose of Offset, a company is grouped with another company if either controls the other, or both are directly or indirectly controlled by a third company. The legislation imposes a 50% rule in relation to control when assessing a company under the grouping provisions. In addition, a company may be considered to be grouped with an affiliate company, if it "acts, or could reasonably be expected to act, in accordance with the other company s directions or wishes, or in concert with the other company, in relation to the affairs of the company's business".

The legislation also precludes a company from accessing the Offset where tax exempt entities, such as scientific institutions, public educational institutions or public hospitals, have interests in the company exceeding 25 per cent. In addition to ownership of the company, these interests can include rights to exercise voting power or to receive any distribution of income or capital.

Other Changes to the R&D Legislation

R&D Plans

To encourage companies to recognize better the strategic value of their R&D and to support improved management of R&D projects, all companies seeking to claim the Concession or Offset in relation to R&D activities commenced on or after 1 July 2002, are required to prepare and have approved a R&D Plan before undertaking any of the R&D activities. A tax deduction or cash rebate will not be allowed for activities commenced on or after 1 July 2002 that are not included in a company-approved R&D Plan. Also importantly, a company must maintain R&D Plans even if a contractor performs some or all of the work.

The IR&D Board has released its Guidelines for Research and Development Plans 2001 ('the R&D Plan Guidelines') to assist companies to implement this new requirement. The R&D Plan Guidelines state that an R&D Plan needs to be separated into two parts: (A) the R&D Plan Authorisation and (B) individual R&D project plans for each project.

The IR&D Board is not imposing a particular format for the R&D Plans, which may be based on or adapted from existing documentation provided the required information is covered elsewhere. Also, it is not necessary for a company to submit its R&D Plan with its application for the Concession but to keep it as part of the records and make it available to the IR&D Board or AusIndustry on request.

If a project significantly changes in relation to budget, technical objectives, major activities or milestones, the R&D Plan must be amended and the changes approved by an authorised officer or the designated project manager.

Treatment of R&D Plant

A change in the legislation states that items of plant, such as laboratory equipment, acquired after 12 pm on 29 January 2001 are no longer required to be used exclusively for R&D in order to be eligible for the Concession. Instead, a concessional deduction can be claimed for the proportion of time the plant is used for R&D, based on its effective life. The changes to the treatment of plant means that an item of plant acquired, constructed or commenced to be constructed after 12pm 29 January 2001 that is used, or intended for use, in both R&D and non-R&D activities, will now be eligible to the extent of its R&D use.

Mark-Up Rules Within a Group of Companies

From 1 July 2001, components of a company's R&D expenditure that includes a mark-up applicable to goods or services sourced from entities that it was related to at the time are no longer eligible for the 125 per cent concessional deduction. However, these mark-up elements can still be deducted at a 100 per cent rate.

Tax Incentives and Biotechnology Companies

With the recent addition of the Premium Concession and the Offset, the various elements of the Concession are intended to provide ongoing support for local BERD. The Government's initiative in this regard is to be welcomed, with the availability of the Offset for 2001/02 expenditure countering at least to some degree the current unavailability of R&D Start funds.

However, when you consider the high cash burn, tax-loss status of many Australian biotechnology companies, particularly those in the early stages of their growth, it is debatable as to whether any of these measures will provide meaningful or ongoing support. Clearly, the Offset with its turnover and R&D expenditure caps severely restricts the ongoing availability of support with most biotech companies spending more than $1 million a year on eligible R&D (the Australian Biotechnology Report 2001 (2) reported an average R&D spend in 2000/0 1 of $3.3 million with an increase to $4.4 million anticipated for the following year.)

Furthermore, when the 'effectiveness' of the Concession is considered in light of recent ABS data showing Australia's BERD to GDP is well down against those OECD nations that we would like to compete with, it is seriously hoped that the Premium Concession will provide sufficient incentive to improve our current ranking. On this last point, the jury is still out.

More detailed discussion on these and other taxation issues facing biotechnology companies in particular, and recommendations for further taxation reform in support of the growing biotechnology industry in Australia, have appeared in two recent position papers by AusBiotech (3) and BioMelbourne Network, Committee for Melbourne and Ernst & Young (4).

References

1. http://backingaus.gov.au
2. Australian Biotechnology Report 2001. Ernst & Young, Freehills and ISR. 2001.
3. Growing Australian Biotechnology Through Improved Access to People and Capital. Recommendations for Changes to Taxation. AusBiotech, 2002.
4. Growing Our Knowledge Economy: Proposals for further reform. BioMelbourne Network, Committee for Melbourne and Ernst & Young. February 2002.

Copyright 2002 - AusBiotech