New R&D Tax Incentives deliver value to innovators

Small to medium sized enterprises (SMEs), which for the purposes of the new Incentive are companies with an aggregated turnover of less than $20 million per annum, are eligible under the new incentive for a refundable tax credit which operates at a flat rate of 45 per cent. This leads to a permanent tax saving of 15 cents in the dollar. For companies in tax loss, up to 45 cents in the dollar will be available as a cash refund. Importantly, there is no upper limit on the amount of R&D expenditure in a given year - meaning early stage high-tech businesses who are investing heavily in R&D stand to gain significantly.

The ATO has also foreshadowed that from January 2014, the refundable offset will be available on a quarterly basis in arrears. This source of cash-flow will likely prove invaluable to small innovators in Australia.

While the scrapping of the incremental premium concession will be seen as a loss by some large companies, the new flat base incentive, equivalent to a permanent tax saving of 10 cents in the dollar, will increase certainty and predictability with respect to large companies' R&D investments. While the 40 per cent tax credit is non-refundable, companies in tax loss will generally be able to carry forward unused credits against future tax liabilities.

While many businesses may be familiar with the notions of 'innovation' or 'high levels of technical risk' which were at the heart of the previous R&D Tax Concession, the new Incentive focuses on 'Core' and 'Supporting' activities.

Claimants will be required to demonstrate - and document - how their Core R&D activities involve, amongst other things, experimental activities which follow the 'scientific method', in an effort to generate new knowledge, including knowledge in the form of new products and processes.

Supporting activities may also be claimed, however they must be directly related to Core R&D activities. In cases where supporting activities are also directly related to the production of goods or services (or are featured in a list of 'excluded' activities, such as market research and efficiency surveys), an additional purposive test has been legislated. For these activities claimants must be able to prove that these activities were carried on for the dominant purpose of supporting R&D, rather than a commercial or other purpose.

These new definitions are likely to be an area of contention as claimants and regulators seek to lay down a marker as to what now constitutes R&D for tax purposes. With much of the substantial body of case law associated with the previous R&D Tax Concession now rendered obsolete, it is expected that during the first years of operation of the new scheme we will see a number of 'test cases' work through the system.

While the short lived International Premium Concession has been repealed, the new program no longer discriminates against companies carrying out R&D on behalf of an overseas related entity.

Companies which are carrying out R&D in Australia, even when reimbursed by a foreign related party who retains the resulting intellectual property, are eligible for the R&D Tax Incentive.

This is of particular benefit to local subsidiaries of multinational corporations in the pharmaceutical, software and other industries. It will also better enable Australian subsidiaries to compete for limited funding within their corporate families.

In a boon for Australian software developers, the outdated and seemingly arbitrary software development provisions of the previous R&D Tax Concession have been dropped. In their place is a simple requirement that software development cannot be a "Core" R&D activity if it is seeking to develop software for the dominant purpose of internal business administration of the claimant, its group members or affiliates.

Where a claimant can demonstrate that some aspects of their R&D activities cannot be carried on in Australia, up to 50 per cent of an eligible project may be carried out overseas. While subject to strict criteria and an advance finding by AusIndustry, this further broadens the potential scope of claims for many innovators carrying on Australian-based R&D.

While the R&D Tax Incentive is an entitlement program for eligible companies and remains in line with the rest of Australia's federal tax regime as a self assessment program, both the ATO and AusIndustry have indicated that a significant compliance program will be undertaken, from the outset of the new incentive and carrying on throughout its operation.

With the potential for many large, refundable claims in the first years of the program, we expect that the ATO and AusIndustry will be eager to limit what they see as inappropriate or excessive claims.

In order to reduce uncertainty for companies and their investors, prospective claimants can now request an 'Advance Finding' from AusIndustry on the eligibility of their R&D Activities. Unlike the advance finding delivered under the old R&D Tax Concession, the Advance Finding will now be binding on the Innovation Australia Board and the ATO. This certainty could prove vital for companies seeking investment on competing funding.

PwC's National R&D Leader, Sandra Mason, said: "SMEs should be the real winners out of the new incentive if they identify areas of innovation in their business. We are advising clients to spend time now 'front-ending' the R&D process to maximise the support they can garner from the new regime.

"Innovation in product and process development is critical for the future growth of a business, and this new incentive is a great platform of support available."