Research and Development

R&D Tax Credit Bill fails to be passed by Parliament before proposed start date

As Australia's new Prime Minister grabbed the headlines on 24 June 2010, Tax Laws Amendment Bill (Research and Development) Bill 2010, containing the new R&D Tax Incentive was sidelined.

The Bill was initially scheduled for debate in the Senate on Tuesday 22 June 2010, but was delayed. Late on 24 June 2010 (the last day of Parliament's Winter sitting) the Bill was removed from the Order of Business, meaning that it will not be tabled until the Senate's next sitting, commencing 24 August 2010 at the earliest.

Given the comments made in the recent Senate Economics Committee Inquiry regarding perceived problems with the operation of the proposed measures, the other remaining question is the extent to which the Bill is likely to be amended in the Senate. There have been some proposed Government amendments in relation to the objects clause and the definition of core R&D. Senator Fielding has proposed additional amendments, including changes to some definitions and a delayed start date of 1 July 2011.

What does it mean for your business?

Businesses will now have to wait to hear how the Government intends to proceed with the R&D measures and to deal with the proposed amendments outlined above. There is a strong possibility that the commencement of the new R&D Tax Credit will be delayed until 1 July 2011. This may be good news, given that further changes to the Bill may help to deal with the complexities and problems which have been identified. These include the problematic "dominant purpose" test which will be difficult to apply in a commercial environment.

Watch this space

We are hopeful that the Government will continue to seek consultation on the R&D reform, as we believe more change is needed to ensure the new program is workable for businesses. We will keep you informed about any developments in the coming months.

New R&D Tax Credit

Tax Laws Amendment Bill (Research and Development) Bill 2010 (the Bill) concerning the new R&D Tax Incentive program was introduced into Parliament on 13 May 2010 to replace the existing R&D tax concession from 1 July 2010. The Bill is an amended version of the second Exposure Draft that was released for comment on 31 March 2010.

Changes from the Second Exposure Draft

The Bill has some changes from the second Exposure Draft released on 31 March 2010. The main changes are as follows:

• The addition of the feedstock provisions (which were not previously released). The new rules are intended to act similarly to the existing program, however rather than limiting the amount of the R&D offset, the provisions act to instead increase a company's tax liability when a company sells a feedstock output (or applies it for use), aimed to negate the tax benefit the company claimed under the R&D offset.
• A number of activities were removed from the 'exclusions list' including quality control, pre-production activities including demonstrating commercial viability, tooling-up and trial runs as well as routine collection of information, which provides more clarity for claimants regarding eligible activities.

Main aspects of the new Program

Broadly, the Bill confirms that the new R&D Offset will be two-tiered as follows:

• 45 per cent R&D Offset (refundable) for companies with group turnover less than $20 million, and
• 40 per cent R&D Offset (non-refundable) for companies with group turnover of greater than $20 million.

A new definition of 'core R&D activities' has been included, which does not refer to existing terms such as 'innovation', 'novelty' or 'technical risk'. Under the new definition, 'core R&D activities' in broad terms as defined in the Bill:

• must be 'experimental activities whose outcome cannot be known or determined in advance'
• are to be determined by 'applying a systematic progression of work that is based on principles of established science', and
• are conducted for the purpose of generating new knowledge.

The new program includes a 'dominant purpose' test for supporting R&D activities in some circumstances. Generally, supporting R&D activities will be eligible for the notional deduction where they are 'activities directly related to core activities', however they must also be undertaken for the 'dominant purpose' of supporting core R&D activities if the activity:

• appears on the 'exclusions list' (e.g. market research, prospecting, management studies etc), or
• is (or directly related to) the production of goods or services.

The treatment of software R&D has remained the same as the second exposure draft, whereby it will only be excluded from the program only if developed for 'internal administration' use. However it may still qualify as supporting R&D is directly related to core activities, if satisfying the 'dominant purpose' test.

Registration under the new program will require companies to split projects up between core and supporting R&D activities. Innovation Australia will have greater powers in relation to registration of activities and increased claim review processes and will have the ability to provide private binding rulings, which is a major change and will provide an increased level of certainty to claimants.

Other main aspects that have been affirmed in the Bill include:

• Foreign owned R&D will be able to access the program (regardless of cost reimbursement).
• The 'expenditure not at risk' provisions are contained in the Bill but do not apply to activities undertaken in Australia for foreign related companies.
• Overseas activities will be allowed at higher expenditure levels as costs will now be able to be included as long as the overseas costs are less than the Australian R&D costs. However companies will still require approval and other eligibility requirements to be met.
• The receipt of R&D related grants do not affect the availability of the R&D offset, however similar to the new feedstock provisions, an extra tax liability applies to negate the tax benefit received from the grant related R&D offset.
• Core technology expenditure will no longer be eligible for support and the normal tax treatment will apply.

Implications for your business

The new program generally increases the tax benefits available to many companies, especially those who can access the 45 per cent refundable credit (i.e. smaller companies in tax loss) and those undertaking R&D services in Australia for foreign parent companies.

However, the definition of R&D has been tightened, and there are limitations on the inclusion of costs which relate to commercial or production processes or services. This would appear to limit claims of companies and will mean that you will need to consider what you are currently claiming and determine whether it will continue to be eligible under the new program.

Particular consideration will be needed around the type of documentation that will be needed for commercially based R&D to ensure that companies are correctly documenting their processes and outcomes of the R&D being undertaken.

Companies should also assess the impact of the new program upon their business, especially in the following circumstances:

• Group turnover is less than $20 million per annum.
• Significant spending on R&D, especially where R&D claims involve work under contract or costs of production.
• R&D services undertaken for a foreign parent company.
• Expectation of significant overseas R&D costs.

For further information please contact your usual PricewaterhouseCoopers advisor.