House debates

Monday, 22 November 2010

Tax Laws Amendment (Research and Development) Bill 2010; Income Tax Rates Amendment (Research and Development) Bill 2010

Second Reading

12:43 pm

Photo of Paul FletcherPaul Fletcher (Bradfield, Liberal Party) Share this | Hansard source

The Tax Laws Amendment (Research and Development) Bill 2010 is a bill which fundamentally changes the existing system of supporting research and development expenditure through tax expenditure and tax deductions. It seeks to identify some research and development as better than other research and development, and particularly seems to prefer research to development. Yet we have been given no clear explanation as to why this is. It seeks to suggest that research and development conducted by small companies is somehow better than that conducted by big companies. And again, we have been given no clear explanation as to why this is.

This bill claims to offer greater support for research and development but in fact narrows the circumstances in which companies can obtain tax benefits for research and development expenditure. We have heard the claim from the member who has just spoken that this bill will allow small companies to achieve greater success in securing support for their research and development activities. It is quite unclear from this bill how that will actually happen, because the very same mechanisms in this bill which will constrain the capacity of large companies to secure tax support for their research and development activities will similarly constrain the capacity of small companies. The provisions in the bill are the same. There is not one set of provisions which applies to large companies and another which applies to small companies. As a matter of basic logic, if the provisions in this bill tighten up the circumstances in which companies can secure tax deductions or tax credits for their research and development expenditure, that tightening up will apply to small companies just as much as it does to large companies.

This bill has been imposed on Australian industry in the face of overwhelming concerns expressed by many sectors of industry through a poorly managed consultation process and in a way which raises real suspicion that the true rationale for this bill is to reduce the aggregate amount of tax expenditure on research and development. Let me quote from a letter I received from Tracey Murray, a partner specialising in this area at the leading accounting firm BDO:

The proposed R&D Tax Credit program appears, in the first instance, very attractive, in that it offers companies with a turnover of under $20 million a 45% refundable tax credit. This is a huge advantage over the current program, however, scrutiny of the details as to who can access this increased funding and the expenditure eligible for this credit confirms that very few innovative Australian businesses will be able to access this elevated level of support unless their R&D fails or they have failed to commercialise the results of their R&D activities, the result of which penalises successful R&D activities.

It is clear that there are many matters which should concern us about the Tax Laws Amendment (Research and Development) Bill 2010, and I want to address three things in my remarks: firstly, the background and history for the bill being brought forward and the claimed basis on which the changes in this bill are being made; secondly, the key provisions in the bill and some of the problems with them; and, thirdly, the question in summing it all up—what is the Labor government really up to with this piece of legislation?

Today the existing R&D arrangements consist of four components: the basic 125 per cent tax concession, the 175 per cent premium concession, the 175 per cent international premium concession and the refundable R&D offset for small companies. The stated intent of the Gillard government with this bill is to make R&D tax support arrangements simpler, more predictable and more generous. Nobody could quibble with that as a set of aims. Unfortunately, it is very hard to see how these aims have been achieved in this bill.

One of the fundamental problems bedevilling this legislation is that it draws on two separate reports which approach this issue from fundamentally different philosophical premises. In 2007, the Productivity Commission released a report on this issue which recommended a narrowing of the criteria for eligibility for R&D tax concessions. Then, in 2008, a panel headed by Dr Terry Cutler recommended what some have described as the polar opposite of the Productivity Commission report—an increase in the base concession and, with a greater concession available for smaller entities, a closure of the incremental provisions. It also, importantly, recommended a change from a tax deduction to a tax credit. The government’s 2009 statement Powering ideas: an innovation agenda for the 21st century, on the face of it, gave support to the recommendations in Dr Cutler’s review. Subsequently we have seen a Treasury consultation paper and two exposure drafts of the legislation. The legislation as it has emerged, while adopting the recommendation of moving to tax credits, seems to have reverted to the Productivity Commission approach of substantially tightening eligibility criteria. It does raise the question: to what extent is this exercise a revenue-raising measure more than anything else? Certainly there appears to be a fundamental tension between the approach recommended by the Productivity Commission and the approach recommended by the Cutler review, and that tension appears in many ways unreconciled in the legislation as it has finally emerged.

Let me turn to the second area I want to address: the key provisions in this legislation and some of the problems of them. The key provisions of this bill create a 45 per cent refundable tax credit for entities with a turnover of less than $20 million and a 40 per cent non-refundable tax credit for all other eligible entities. At the same time and very concerningly, this bill establishes a new and more restrictive regime which determines eligible research and development activity by creating two key categories: core research and development activity and supporting research and development activity. The response of industry to this new framework has been overwhelmingly negative.

It is important to understand that for many decades research and development has been understood in terms of the so-called ‘Frascati definition’: creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of humanity, culture and society, and the use of this stock of knowledge to devise new applications. Very importantly, for many decades research and development has been understood to encompass both creating new knowledge and using existing knowledge to create new applications. The problem with the approach in this bill is that it limits, in both its objects and its specific provisions, the availability of the credit to activities that are undertaken for the purpose of acquiring new knowledge or information. In other words, a key aspect of what has traditionally been understood to be encompassed within research and development, so-called ‘experimental development’, has been removed. Under the bill, novelty becomes a prerequisite.

It might be argued that the second category of so-called supporting research and development activity addresses this problem, but the definitions required to qualify as ‘supporting R&D activity’ are so limited that it makes it very difficult indeed to meet these requirements. The activity must have a direct, close and relatively immediate relationship with the core research and development activity. In addition, we have a dominant purpose test which is an overarching requirement in the legislation and this effectively operates to kill off any application of the credit to experimental development. Many in industry argue that it is difficult to envisage a situation where a supporting activity would not fall within one of the range of exemptions that are set out in the act and therefore make those activities ineligible to receive the credit.

One member of the Australian Industry Group had this to say:

In a manufacturing environment research and development is necessarily heavily biased towards development in a live production environment, whether that be to commercialise research into new marketable products, to improve existing products, or to improve the efficiency of manufacturing processes. All of these activities are essential in order to remain competitive in a mature global industry, continue to export and to compete against imports.

Another member of the Australian Industry Group estimated that 60 per cent of their activities would not be eligible under the proposed definition. We face in this bill the prospect of Australia moving from having a regime designed to induce research and development to a regime which is designed solely to induce research. In the view of a great many people who have commented on this bill, that does not make sense.

It provokes the third question that I want to turn to: what is the Labor Party really up to? One has to be very sceptical about this government’s motivations and whether in particular, given the very heavy involvement of Treasury in the convoluted process through which this bill emerged, the overriding motivation is that the bill is designed to reduce tax expenditure in this area. For example, KPMG has estimated that the current approach will slash the current $1.4 billion tax expenditure on R&D by 50 per cent.

Our very reasonable concerns on this issue might be ameliorated if this government were to release modelling to support its claim that this measure is revenue neutral, but in a response which is sadly all too typical of the approach of this government to pressing public policy issues there has been a complete refusal to release modelling. There has been a complete refusal to allow parliament the information that it needs to carry out appropriately and properly the scrutiny which is part of the duty of parliamentarians and part of the proper function of a parliament. We can merely return to our suspicion, with that suspicion only increased by the persistent failure of this government and this minister to release modelling substantiating its claim that this measure is revenue neutral. Until we see that modelling we are forced to rely upon the very persuasive evidence put forward by a number of the large accounting firms, which suggests that in substance this measure will not be revenue neutral but will lead to a material reduction in the tax expenditure on supporting research and development, a very curious outcome indeed for a measure which is supposedly designed to support research and development.

This bill will also materially increase compliance costs for Australian businesses, which will be required to separate their activities into core R&D, directly related supporting R&D, and supporting R&D activities subject to the new dominant purpose test. A further objection to this wholly unsatisfactory, cobbled together collection of measures is the proposed retrospectivity—the proposed start date of 1 July 2010, which is obviously several months in the past. This is a highly unsatisfactory way for the government to treat industry. It is a highly unsatisfactory way to treat taxpayers, to treat businesses, which are seeking to make a decision about the extent to which they engage in research and development expenditure and face enormous uncertainty about the rules that are going to apply. It is sadly a consequence of the frankly atrocious consultation process which has been conducted by this government in the course of bringing forward this legislation. There were two rounds of consultation: one over the Christmas holidays and one over the Easter break. It is not the finest work of the Australian Public Service and of this government when they release exposure drafts and expect industry to comment in a very short time that extends over a period when many people are on holiday.

This bill purports to achieve sensible and desirable objectives, and certainly some aspects of it are worth supporting. The fundamental notion of moving to a tax credit approach is quite widely supported. But sadly the substance of this bill is deeply problematic. At base, the problem with this bill is that it does not deliver on the claims that have been made for it. It will, in fact, make it harder for many Australian businesses to seek and obtain support for research and development activity and therefore, in policy terms, this is a bill which is going in the wrong direction. Rather than supporting research and development it will, sadly, make it more difficult. (Time expired)


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