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Australasian Biotechnology, Vol. 12, No. 5, Oct-Nov, 2002, pp. 37-38 BIOTECH R&D Biotechnology Companies - Is the R&D Tax Offset a Genuine Option? Susanna Muttilainen & Alun Needham Innovation and Incentives, SER Tax & Law, Ernst & Young, 120 Collins Street, Melbourne, Victoria, 3000. Email: alun.needham@ernstyoung.com.au Code Number: au02031 Abstract This article is a follow up to our New Incentives for R&D - Recent Changes to R&D Tax Concession article published in the August/September 2002 edition of Australasian Biotechnology. In particular, this article focuses on the new R&D Tax Offset, which allows eligible companies to receive a cash rebate equivalent to the value of the R&D Tax Concession. This is an initiative welcomed by small companies across most industry sectors, encouraging higher levels of expenditure on R&D. However, there are concerns that some companies in the biotechnology sector will fail to qualify for the Offset because they are spending too much on eligible R&D activities or have an ownership structure that is in breach of the requirements. This article discusses these issues in detail as well as providing suggestions as to how the Offset might be made of value to more biotechnology companies. Introduction - R&D Tax Offset The Federal Government has acted to encourage small companies to invest in R&D by introducing the R&D Tax Offset ('the Offset') enabling eligible companies to receive a cash rebate equivalent to the value of the R&D Tax Concession. The Offset provides an attractive opportunity for many small companies in a tax loss position to recoup a portion of the expenditure they incur on eligible R&D activities. To access the Offset a company needs to have an annual group turnover of less than $5 million and annual group R&D expenditure of less than $1 million (for further information on the R&D activity and expenditure eligibility criteria please see (1)). A company that meets the Offset provisions is entitled to claim 30 per cent of its eligible R&D expenditure as a cash rebate. This means a rebate of 37.5 cents in the dollar for a company entitled to a 125 per cent deduction under the R&D Tax Concession. Therefore, a company that spends the maximum $1 million on eligible R&D will be entitled to receive a cash rebate of $375,000 (offset against any other tax liabilities), with even higher amounts available if the company incurs incremental R&D expenditure over its average of R&D spend in the previous three years (for more information also see (1)). To access the Offset a company needs to be registered with AusIndustry before lodging its annual income tax return with no option to obtain the Offset by amending the tax return after lodgement. Issues of Concern for Biotechnology Sector Whilst this initiative has been generally welcomed by the biotechnology sector and companies in other sectors that have previously struggled to access government support for R&D expenditure (and particularly so in the current situation with R&D Start grants suspended), there are three particular issues that severely limit the ability of many biotechnology companies to access the Offset. 1. Maximum expenditure on R&D capped at $1 million As discussed in our previous article, the R&D expenditure limit at $1 million per year on a company group basis severely restricts the availability of the cash rebate for many biotechnology companies with most spending significantly more than $1 million a year on eligible R&D activities. According to the Australian Biotechnology Report 2001 (2), in 2000/01 the average R&D spend was $3.3 million with an increase to $4.4 million anticipated for the year 2001/02. 2. Lack of transition between the Offset and R&D Tax Concession Another issue relating to the R&D expenditure cap is the lack of effective transition between the Offset and the R&D Tax Concession that is commercially realistic. Given that many biotechnology companies are spending more than $1 million on eligible R&D expenditure and hence are ineligible for the Offset, they must turn to the R&D Tax Concession. However, given that these companies invariably carry forward significant tax losses, there is little if any short-term financial benefit to be derived from claiming an additional tax deduction via the R&D Tax Concession. This is of particular concern where return on investment in R&D in the biotechnology sector is typically a decade or more. 3. Relationships with exempt entities Section 73J(2) of the Income Tax Assessment Act 1936 ('the Act') precludes a company from accessing the Offset where: "an exempt entity, the affiliates of an exempt entity, an exempt entity together with its affiliates, or 2 or more exempt entities, at any time during the tax offset year, legally or beneficially own, or have the right to acquire, the legal or beneficial ownership of: (a) interests in the company that carry between them the right to exercise, or control the exercise of, at least 25% of the voting power in the company; or (b) interests in the company that carry between them the right to receive at least 25% of any distribution of income or capital by the company." As stated in section 73M of the Act, a company may be considered to be an affiliate 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 or research and development expenditure". It is clear from a review of many biotechnology companies' situations that section 73J of the Act presents particular difficulties for some because: (i) as biotechnology start-up companies, they have been spun out from taxexempt entities such as universities where typically the founding members have equity at more than 25 per cent which is usually only slowly diluted by other investors (eg. venture capitalist or others) as the company matures; and (ii) the existence of more mature companies that have complex equity share holdings which includes private equity (eg. VC investment), but where a fraction of this equity might be traced back to Commonwealth funds in the form of equity via, for example, the Innovation Investment Fund (IIF) program. In the first case, these tax-exempt entities or their affiliates commonly retain equity in excess of 25 per cent in the newly formed companies at least during the first few years of the startup. For example, in a typical arrangement a commercialisation arm of a university, an affiliate of a taxexempt entity and itself an incorporated entity, will retain over 25 per cent of the ownership or voting rights in a biotechnology start-up. In most cases, the commercialisation arm has a hands-off approach to its investment in the start-up and therefore will not exert control in the company if it has less than 50 per cent equity or voting rights. However, with the current legislation, the start-up in question will not qualify for the Offset. In the case of investment via the likes of the IIF, the application of section 73J(2) of the Act is unclear when the relationship between the investor (the IIF licence-holder) and the Commonwealth is taken into account. However, if we assume the IIF licence-holder is considered to be an affiliate of the Commonwealth and thus subject to the exempt entity provisions, the company would be prevented from accessing the Offset if the 25 per cent interest level is deemed to have been breached. Whilst the Commonwealth is encouraging new start-ups (particularly with the commercialisation of public sector R&D) via programs such as BIF, COMET, the Pre-Seed Fund and others, the impact of the 25 per cent limit is that such investments are put at risk if the Offset in unavailable to such companies at the next step of their growth cycle. Alternatives for Amending the Offset Rules The following alternatives are discussed as a way of improving the accessibility of the Offset and, thus, increasing the level of Government support for R&D expenditure incurred by biotechnology and other companies currently adversely affected by the provisions identified above. 1. To ease transition from the Offset to the R&D Tax Concession and as an alternative to raising the cap, companies could be allowed to claim the cash rebate for eligible R&D expenditure up to the cap of $1 million. For example, a company that spends $2.3 million on eligible R&D in a year, would be able to claim the Offset in respect of the first $1 million. In doing so, it would not be eligible to claim the Concession in respect of the remaining $1.3 million. As such, the company would elect either a cash rebate capped at $375,000 or the additional tax deduction via the R&D Tax Concession. 2. A 50 per cent threshold in ownership by a tax-exempt entity or its affiliate(s) would seem more reasonable and commercially based for identifying where a party has a genuine ability to control a company and its activities and would not penalise companies that may have been spun out of a research or educational institution. 3. The Industry Research and Development Board needs to continue its monitoring of the suitability of the maximum spending cap on R&D for Offset purposes. If it eventuates that the R&D spend Offset cap is being exceeded by a significant percentage of applicants, there is a need to act promptly to increase the R&D spend Offset cap to a higher level. Conclusion The Offset is an important initiative that provides welcome support particularly for early stage start-up companies that are (i) unable to access any meaningful benefit from the R&D Tax Concession and (ii) unlikely to gain support from the R&D Start program. However, as it currently stands, the Offset seems to offer more support for SMEs in other sectors where the investment in R&D is often within the limit of $1 million annually and the incidence of start-ups with exemptentity 'connections' is less prevalent. Consequently, whilst the Offset remains a good opportunity for many companies to recoup some of their R&D expenditure, including those in the biotechnology sector, there are clearly areas of the program that could benefit from some further consideration and amendment. References
Copyright 2002 - AusBiotech |
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