RSM Australia Response to the: Review of the R&D Tax Incentive

Transcription

1 RSM Australia Response to the: Review of the R&D Tax Incentive

2 RSM Australia (RSM) is one of the largest nationally owned accounting firms and forms part of RSM International, which is the sixth largest international accounting and consulting organisation worldwide. In Australia, RSM is one of the fastest growing mid-tier firms with over 115 Directors and Principals and over 950 employees operating from 28 locations throughout Australia. Our staff operate across a range of industries, public, private, Government and not-for-profit-sectors. We appreciate the opportunity to make a submission to Innovation Australia (subsequently to be known as Innovation Science Australia) in relation to the review of the R&D Tax Incentive. It should be noted that RSM has previously made submissions in response to Treasury s Re:Think, Tax Discussion Paper (Re:Think Paper), and the Chief Scientists STEM report (STEM Report). RSM provides specialist and extensive R&D Tax services for a broad array of industries and technologies, and assist entities ranging from start-ups to SMEs through to multinationals. RSM is also actively and strongly involved in the innovation community through: Co-working spaces; Award programmes; Associations; Industry peak bodies; Sponsorships; and Pitch events. Our staff have been involved in R&D Tax and Government support programs since the late 1990s and have had significant experience with the following programs: R&D Tax Incentive; R&D Tax Concession (125%/175%/R&D Tax Offset); Innovation grants (R&D Start grants through to the current Accelerating Commercialisation grants program); and Export Market Development Grants. RSM therefore believes it is has significant knowledge and experience from which to provide advice in response to the questions raised in the R&D Tax Incentive Review Issues Paper (Issues Paper). Introduction There has been substantial stakeholder and media interest in the R&D Tax Incentive review, and a large amount of misinformation put forward by various sectors and stakeholders that seek to reallocate Government business R&D support away from the R&D Tax Incentive. The majority of the arguments put forward by these stakeholders are based upon non-existent, or grossly inaccurate data, such as the budget cost of the R&D Tax Incentive. The Issues Paper states: The Government has asked the Review to identify opportunities to improve the effectiveness and integrity of the R&D Tax Incentive, including by sharpening its focus on encouraging additional R&D expenditure. The Issues Paper then uses Costs of R&D tax support to lead into discussions on all of the key aims of the Review. Unfortunately, using cost as the starting point of all follow on discussions is floored as the budgeted cost of the R&D Tax Incentive is overstated by at least 50%. We will demonstrate in our following response that instead of the cost of the program being $3 billion in it is closer to $2 billion. The methodology used for the Refundable R&D Tax incentive appears to be February 2016 RSM Australia 2 of 17

3 substantially incorrect. This incorrect budget data has then flowed into various analyses, other reports and data produced, resulting in grossly inaccurate interpretations and conclusions by Government and non-government stakeholders. As well as describe and resolve the magnitude of the error in the budget cost we have analysed effectiveness, integrity and additionality in detail. To do this we have looked beyond the myths and anecdotal comments and analysed existing data to support structured responses, for instance: The level of additionality was considered by the Centre for International Economics (CIE) and shows that the R&D Tax Incentive overall is achieving a world class standard of additionality benchmarked against various international studies. This is particularly the case for the Refundable R&D Tax Offset that is generating between 90% 150% of additional R&D expenditure for every tax dollar forgone. The Government body, AusIndustry, that regulates eligibility for the R&D Tax Incentive, has stated in the Issues Paper that approximately 15 percent of companies claiming the R&D Tax Incentive are reviewed annually as part of the compliance framework and of more than 12,000 entities lodging claims; fewer than 10 have proceeded to review by the Administrative Appeals Tribunal Therefore, based upon available AusIndustry data, the R&D Tax Incentive does not have an integrity problem. The CIE, the body selected by the Government to undertake the review commenced under the Tax Discussion Paper, concluded in 2003 that the R&D Tax Concession was appropriate and effective, the current data indicates the current R&D Tax Incentive has similar levels of economic results and therefore should also be considered as effective. As part of this submission we have taken the opportunity to assess the underlying core assumptions and propositions that have been based upon: anecdotal data; qualitative rather than quantitative surveys; and aggressive budget cost modelling and interpretations. If a true analysis of the R&D Tax Incentive program is to take place it would be appropriate to conduct accurate data analytics and economic analysis before making broad statements on the cost versus benefit of the program. Significant real world data is available at the ATO and AusIndustry that can be used to appropriately assess the R&D Tax Incentive. Executive Summary We have summarised our key recommendations regarding our response to the R&D Tax Incentive Review as follows: Recommendation 1: That the cost of the R&D Tax Incentive in the Federal Budget, particularly the Refundable R&D Tax Offset is corrected, based upon accurate modelling. The assumptions and methodology of its calculation must be made public to enable an open discussion to take place, from which a realistic budget cost can be determined. Recommendation 2: The ATO, AusIndustry and Treasury share data in relation to the cost of the Refundable and Non-Refundable R&D Tax Offsets, including franking accounts, so that accurate modelling of the budget cost can be undertaken. Recommendation 3: Without data to support the position, there is no integrity concern with the program. No changes should be made to the R&D Tax Incentive on the basis of integrity concerns as no data substantiates that position. Recommendation 4: Government better engage with R&D tax consultants to more fully understand the role they perform with their clients, and the education/advocacy role that they play. February 2016 RSM Australia 3 of 17

4 Recommendation 5: The existing data indicates that the R&D Tax Incentive is already providing appropriate additional benefits to the economy. The Government should model the loss of R&D activities, from Australia to overseas that would occur if the R&D Tax Incentive was degraded, as additional R&D that is currently being undertaken. Recommendation 6: The R&D Tax Incentive is super-efficient, therefore providing a very large effectiveness rate for Government. We have detailed and referenced external evidence regarding how the interaction of the R&D Tax Incentive and dividend imputation creates this super efficiency. Government should ensure the impact of this super-efficiency is included in its budget cost modelling. Recommendation 7: Due to the approximately $1 billion a year budget saving we have identified, there is fiscal opportunity to implement improvements that would increase effectiveness and encourage additional R&D, such as: Removing the pending 1.5% reduction to the R&D Rate; Providing an increased R&D rate for university collaboration; and Loosening the ownership rules for University spin-off companies and projects. Recommendation 8: Do not change to a pre-registration system, particularly for SMEs who will be disadvantaged through the denial of R&D tax benefits, reducing the level of additionality and making the program less effective. Recommendation 9: Maintain the current two-stage administration system. February 2016 RSM Australia 4 of 17

5 Review Question: What is the Historical and Projected Cost of the R&D Tax Incentive? What Drives the Cost? There are a number of myths that exist in relation to the cost of the R&D Tax Incentive, most of which are borne out of inaccurate budget modelling. This budget cost issue has been previously raised in RSM s Re:Think submission in response to Treasury s Tax Discussion Paper, stating that there was a significant risk that the cost of the R&D Tax Incentive in the Science, Research and Innovation (SRI) Budget is being over estimated. This critical issue has not been properly investigated and it was not included as part of the Summary of Stakeholder Feedback Collected During the 2015 program Review of the R&D Tax Incentive, (Stakeholder Feedback), with the current cost still cited as $3 billion for in the Issues Paper. Given the lack of proper attention and review of this key issue, RSM has conducted further analysis since making the Re:Think and STEM submissions. The over-inflation of the budget cost of the R&D Tax Incentive is a critical issue, as it has driven Government innovation policy since the inception of the R&D Tax Incentive, resulting in the $100 million R&D expenditure cap that has been put in place, and the 1.5% cuts to the Refundable and Non-Refundable R&D Tax Offsets currently before Parliament. Both of these cuts and caps were unnecessary and are retrograde steps that will cost Australian jobs and the Government the associated tax revenues. Over time these measure will result in a lower level of GDP growth than would have otherwise been achieved. The aggressively modelled budget figures have also been used by various stakeholders to put pressure on the program at a time where the Government is fiscally constrained. Finally, the overinflated budget figures have contributed to incorrect analysis, for example the level of indirect vs direct, Government BERD support and indirect support vs GDP, which has also been used by stakeholders to make arguments for reducing the level of indirect Government BERD support, in preference to greater use of direct grant funding. The cost of the R&D Tax Incentive in is stated as approximately $3 billion, which, according to our calculations, grossly overstates the cost of the scheme. The Issues Paper has increased this to $3.5 billion by The budgeted figures were increased recently, with the MYEFO increasing the cost of the Refundable R&D Tax Incentive by $1.8 billion over 4 years ($206 million in , with $1.5 billion over the remaining 3 years). Our calculations indicate that the $3 billion budget cost is calculated as follows: Non-Refundable R&D Tax Offset = $1,070 million (Tax Expenditure Statement 2014) Refundable R&D Tax Offset = $1,881 million (SRI for that apply to ) Total cost of R&D Tax Offset = $2,951 million In order to estimate how these budget costs are calculated we have utilised available data regarding the actual R&D expenditure claimed in (the following data is from the ATO Annual Report from , as the R&D expenditure claimed is only available in the year after ). Non-Refundable R&D Tax Offset = $14,200 million Refundable R&D Tax Offset = $5,200 million The cost of the Non-Refundable R&D Tax Offset is a factor related to the R&D expenditure claimed: February 2016 RSM Australia 5 of 17

6 Cost (in millions) = $14,200 x Factor = $1,070 Factor = 7.5% Therefore, the cost is 7.5% of each dollar of R&D expenditure a company claims. This would appear reasonable as the after tax benefit a company has under this program is 10% (which is the difference between the R&D rate of 40% and the corporate tax rate of 30%) and budget modelling of the cost may take into account other issues that reduce the cost to Treasury such as franking account impacts, and possibly that companies in tax losses will not become tax payable and never have a cost related to the R&D claim. Carried forward tax offsets can also be lost due to companies failing continuity of ownership/same business tests. Using the above methodology, the cost of the Refundable R&D Tax Offset is more confusing: Cost (in millions) = $5,200 x 36.2% = $1,881 Following the Non-Refundable R&D Tax offset methodology, the after tax benefit of the Refundable R&D Tax offset is 15% and therefore is not the underlying basis of the budget cost. If we consider that companies in tax losses under this program are eligible to cash out their R&D tax losses and receive a full gross rebate of 45% of their R&D expenditure we can model the cost budget differently: Refundable R&D Tax Offset Cost = (Total Claimed R&D Expenditure x 45% x Y percentage of companies that are in losses and will never make a profit) + (Total Claimed R&D Expenditure x 15% x (1-Y) percentage of companies that are tax profitable and tax loss companies that will become profitable) Refundable R&D Tax Offset Cost = $5,200 x 45% x Y + $5,200 x 15% x (1-Y) = $1,881 Y = 70.6% = the percentage of companies that are in tax losses, receive the full 45% Rebate and will never make a profit Note, that this does not include any factors that have been used in the Non-Refundable cost model that reduced the cost from 10% to 7.5%. Therefore, it appears that the budget cost is substantially based upon the full gross 45% rate of the Refundable R&D tax offset, not the additional, cost of the scheme above the cost to Government of normal business tax deductions for the R&D expenditure (i.e. 15%, as per the 10% used in the Non-Refundable methodology). For companies that are in a tax loss situation, it is true that they receive the full 45% benefit, but they have foregone the future tax benefit of 30%. This occurs because the tax losses that would have been otherwise carried forward and available to be utilised once a profit is made, have already been converted to the 45% Refundable R&D tax offset. Therefore, they will in fact pay more tax in the future and effectively the Government recoups 30% from the 45% benefit. Thus the only situation where the cost is actually 45% is where a tax loss company never becomes tax payable (fails). As we have shown above, for the year, which is the most recent year with actual R&D expenditure claimed data available, our calculations indicate 70.6% of the expenditure claimed under the Refundable R&D Tax Offset has been modelled by the Government at the full gross 45% rate. This means that the budgeted cost is based on the assumption that 70.6% of the total actual R&D expenditure, claimed under the Refundable R&D tax offset, is to tax loss companies that will never make a profit (will fail). February 2016 RSM Australia 6 of 17

7 Based upon RSM s large and diverse client population, we have determined that 18.2% of our clients are eligible to access the Refundable R&D Tax Incentive are in a tax loss position. While these may be in tax losses at the moment many will go onto tax profits. We have found a report Australian Small Business, Key Statistics and Analysis, December 2012, from the Department of Industry, Innovation, Science, Research and Tertiary Education, that states It is frequently claimed that a very large share of all start-ups fail within the first few years. These claims are usually exaggerated. and they have determined a rate of 12% of young firms that terminate. This report also states that Around 76 per cent of young firms reported no financial loss upon termination. For the purposes of our cost estimation for the Refundable R&D Tax offset we will set the following assumptions: Percentage of companies in tax losses = 20% (rounded up from RSM s 18.2% above) Percentage of companies that will fail (not become tax profitable) = 12% Therefore, the percentage of companies that access the full 45% rebate that will never become tax profitable = 20% x 12% = 2.4% Thus, Refundable R&D Tax Offset Cost = $5,200 x 45% x 2.4% + $5,200 x 15% x 97.6% = $ million Note: this does not take into account that companies making tax losses tend to spend less than an average company and franking account impacts on reducing the cost to Treasury. Therefore, the difference between the budget cost and our estimate of the cost of the Refundable R&D Tax offset = $1,881 - $ = $1,063 million The Government s budget cost modelling assumption is therefore highly inaccurate, and grossly over-inflates the cost of the entire R&D Tax Incentive program. Below we have compared the cost of the R&D Tax Incentive in , using our Refundable cost estimate, against the R&D Tax Concession cost, it shows that the cost of the program has only grown 13%. Year Program Cost ($millions) R&D Tax Concession 1 1,671 Refundable R&D Tax Offset % (as per our estimate) Non-Refundable R&D Tax Offset 1,070 40% (as per budget) Total Program Cost 1,671 1,887 There are a number of reasons for the low level of cost increase between the R&D Tax Concession in its final full year in and the R&D Tax Incentive in Some factors increase the cost such as the increase in base rates under the R&D Tax Incentive whilst others decrease it. The reasons are: The R&D Tax Incentive has a higher base rate (133%/150% equivalent deduction vs 125% under the R&D Tax Concession); 1 Based upon most recent updated 2015/16 Budget Data. A downwards adjustment was made to the prior programs R&D tax offset, for consistency with the R&D Tax Incentive. February 2016 RSM Australia 7 of 17

8 The 175% Australian and Foreign Owned R&D deduction has been abolished, which is a significant cost saving under the R&D Tax Incentive; The previous R&D Tax Offset under the R&D Tax Concession has been abolished; and The quantum of total R&D expenditure is similar under the R&D Tax Concession and R&D Tax Incentive. Given the above factors it should therefore not be surprising that the cost of the R&D Tax Incentive for (the most recent year that actual R&D expenditure claimed information is available), does not significantly exceed the cost of the R&D Tax Concession in There has been no real cost blowout, in moving from the R&D Tax Concession to the R&D Tax Incentive, and in applying the same assumptions to budget forward estimates there will be no cost blowout, in the future. The following table estimates the size of the impact of the cost over-inflation of the Refundable R&D Tax Incentive upon the Federal Budget over forward estimates: Year Program Cost ($ millions) Total Budget Cost R&D Tax Incentive (budget) 3,025 3,360 3,500 3,500 Calculated Total Cost R&D Tax Incentive (RSM est.) 1,931 2,103 2,280 2,624 Difference 1,093 1,257 1, Total Program Cost Over Inflation The table above shows a $4.4 billion over inflation of the cost over forward estimates for the R&D Tax Incentive. The RSM cost assumptions for the forward estimates in the table above remain the same for the Refundable and Non-Refundable R&D Tax Offsets as for , however, the amount of R&D expenditure claimed under the Refundable R&D Tax Offset is grown at 15% annually. 4,445 This Refundable R&D Tax Offset expenditure claimed growth rate is a reasonable assumption as R&D expenditure under the Refundable R&D Tax Offset has moderated substantially since inception from to (33% growth), and to (17% growth) as detailed in ATO annual reports. This moderation in growth of R&D expenditure claimed under the Refundable R&D Tax Offset is expected to continue as the program matures, which should be reflected in the budget cost estimates. Instead, the budget cost of the program is being rapidly increased and attributed to the Refundable R&D Tax Offset, resulting in a distorted reality of the cost of the program to Government. It should also be noted that Australia is one of a few OECD countries to have both an R&D tax scheme and a classic dividend imputation scheme. This further reduces the cost of both the Refundable and Non-Refundable R&D Tax Incentives below the additional, 15% and 10% rates, as at least some of the additional, benefit is returned by shareholders, due to franking credit impacts. This impact renders some of the additional, benefit a temporary timing, rather than permanent difference. As an example CSL Limited (CSL) claimed a significant R&D benefit in , however, it issued an unfranked dividend. A significant amount of the additional, benefit provided to CSL would be recouped by the Government from shareholders. February 2016 RSM Australia 8 of 17

9 The most recent study in relation to R&D benefit washout, was undertaken by the Bureau of Industry Economics in 1993 and indicated that 29% of companies claiming the then R&D Tax Concession, were in a tax position of either being impacted by R&D benefit washout, at the shareholder level or modifying dividend behaviour to avoid R&D benefit washout. The impact of franking credits is a competitive advantage that the Australian Government has over almost all other OECD countries, as it is able to utilise its tax system to incentivise R&D, whilst recouping at least some of the additional, cost. No research has been undertaken by Government or other bodies investigating this issue since 1993, therefore, there is no current robust data is available to utilise in modelling. There is a need for detailed research to be undertaken, investigating this issue. This should be undertaken by the Department of Industry, Innovation and Science, possibly by the Office of the Chief Economist. Recommendation 1: That the cost of the R&D Tax Incentive in the Federal Budget, particularly the Refundable R&D Tax Offset is corrected, based upon accurate modelling. The assumptions and methodology of its calculation must be made public to enable an open discussion to take place, from which a realistic budget cost can be determined. Recommendation 2: The ATO, AusIndustry and Treasury share data in relation to the cost of the Refundable and Non-Refundable R&D Tax Offsets, including franking accounts, so that accurate modelling of the budget cost can be undertaken. February 2016 RSM Australia 9 of 17

10 Review Question: How could the R&D Tax Incentive programme be improved? - For greater integrity (minimising leakage outside beneficiaries) A significant question should be considered as to why the Review believes there is an integrity risk when there is no data to justify the position, in fact the data available states the opposite. The most significant data that discredits the statement that there are integrity issues is the AusIndustry submission to the Tax Discussion Paper, approximately 15 percent of companies claiming the R&D Tax Incentive are reviewed annually as part of the compliance framework and of more than 12,000 entities lodging claims; fewer than 10 have proceeded to review by the Administrative Appeals Tribunal. In the absence of any other data there are no grounds to make statements of integrity concerns. In addition to the above the Issues Paper brings up a concern with integrity leakages that is not supported by stakeholder feedback: The Issues Paper states the estimated total compliance cost to firms in the programme is around $437 million per annum, including fees paid to consultants and tax agents of $199 million. For large firms approximately half of their compliance costs are attributed to consultant fees, with slightly less for smaller firms. While these estimates include the cost of tax returns, they are high relative to the budgeted cost of the programme and the benefit to participants. This may reflect the complexity of the programme design. Whereas, the Stakeholder Feedback states that companies claiming the R&D Tax Incentive felt that compliance costs were not excessive (except in some audit/review cases), with estimates that the cost of compliance was likely to be less than 20 per cent, in the order of 10-15% of the benefit received. If the Review wishes to place an integrity spotlight on R&D Tax consultants as a leakage to the program, even though this is not considered as an issue by claimants, there needs to be significant rigour and analysis placed on how the $199 million cost estimate was established. We have no data with which to consider how accurate the cost estimate is and what assumptions were made. For instance, this could include R&D management, tax return integration, R&D cost book-keeping, etc? What is also not factored into the consideration of integrity leakage is to what extent AusIndustry would be achieving the high levels of compliance it currently does, as shown above, if companies were not utilising the services of consultants specialising in providing R&D tax services. Most consultants performing R&D tax services not only undertake the compliance role in assisting companies complete their claim, but also provide an education service in upgrading record keeping and strengthening an innovation culture within companies. An attempt to reduce the role of consultants in servicing their clients would likely result in substantially less compliance by companies claiming, with a resultant cost increase to Government. RSM believes that this interaction between clients and tax consultants is not understood by the Review and the education and advocacy service provided by consultants in relation to innovation raises the profile, of innovation in companies, strengthens formal innovation planning/documentation and results in more additionality, being generated by the program. It should also be noted that the provision of R&D tax services by consultants has become increasingly commoditised with a larger number of providers. This has, and will continue to put February 2016 RSM Australia 10 of 17

11 downwards market pressure on the price for the provision of R&D tax services by consultants, as has occurred for all other tax services. In addition, the Issues Paper states that there may be changes to online administration processes and additional explanatory material that could assist businesses to understand and comply with the programme, reducing the need for external advice. Whilst the provision of additional explanatory material would be of benefit, Government needs to understand that companies utilise consultants primarily because they do not want to undertake this work themselves, and because they see value in utilising the services of an experienced consultant. It is a rational business value judgement made by companies, they have limited time to conduct all of their business needs and if they choose to outsource tasks such as R&D Tax Incentive preparation and lodgement why is that any concern of the Government? The Issues Paper discusses that an absence of case law could result in boundary pushing. Since the introduction of the R&D Tax Incentive a number of cases have been conducted by AusIndustry and the ATO generating case law and providing clarity in specific areas. This case law and the guidance provided by it, combined with the AusIndustry risk review process, has substantially increased the integrity of the R&D Tax Incentive. Case law and guidance material has grown since the inception of the R&D Tax Incentive and is a strong reason to not make substantial changes to the definition of R&D. As more case law and certainty is generated, companies have less uncertainty and reduced need to engage with R&D tax consultants. Each time a change is implemented companies need more advice and assistance from R&D tax consultants. In summary, RSM believes there is no data supporting the accretion of existing integrity problems with the R&D Tax Incentive and it does not have an administrative cost problem, and in terms of fees charged by consultants, stakeholder feedback shows that business do not believe current consultant fees or other compliance costs are excessive. From a leakage perspective there is considerable added protection provided by consultants that assist with ensuring the compliance and application of the R&D tax program is appropriate. Recommendation 3: Without data to support the position, there is no integrity concern with the program. No changes should be made to the R&D Tax Incentive on the basis of integrity concerns as no data substantiates that position. Recommendation 4: Government better engage with R&D tax consultants to more fully understand the role they perform with their clients, and the education/advocacy role that they play. February 2016 RSM Australia 11 of 17

12 Review Question: How Could the R&D Tax Incentive Programme Be Improved: - For greater effectiveness (that is, prompting business to undertake further R&D that is likely to benefit the wider economy) - To better prompt additional R&D activity beyond what would have happened anyway In responding to this question it is assumed that the Government not only wants to improve the additionality and effectiveness from the R&D Tax Incentive, but also wants to further develop a world class system of Government support of business innovation. The objectives should be to increase the level of BERD, increase BERD as a percentage of Gross Domestic Product (GDP), improve collaboration between the private sector and universities, and improve Australia s ranking for commercialisation of BERD within the OECD. There are a number of improvements that could be made to the R&D Tax Incentive that we have recommended in both the Re:Think Paper and STEM Paper previously submitted. It is understood that the Government is currently experiencing significant fiscal constraint and that any expansionary recommendations are likely to require offsetting savings, from within the portfolio or program. As detailed above, the R&D Tax Incentive, particularly the Refundable R&D tax offset, has a cost substantially lower than is detailed in the Federal Budget. If the Government is serious about increasing the level of business innovation in Australia then it should consider recommendations previously provided (by us and many other stakeholders), the Review has substantial information already available that it could be using, why is it necessary to provide the information again? These expansionary program recommendations can be paid for by the approximately $4.4 billion budget saving that the Government will achieve, by correctly modelling both the Refundable and Non-Refundable R&D tax offsets. A recent OECD study found that Australia ranks 18 th within the OECD in terms of Government support for business R&D expenditure. It should therefore not be surprising that overall Australia ranks 15 th out of 34 OECD countries in business R&D expenditure. Australian business is therefore responding better than would be expected, based upon the level of Government support provided. Australian SMEs ranked 5 th out of 29 countries on the proportion of businesses innovating. The SME success in innovation can be at least partially attributed to the Refundable R&D tax offset. The issue causing Australia s current average innovation performance within the OECD is not the level of additionality or effectiveness of the R&D Tax Incentive, but the general lack of Government funding for BERD in Australia, relative to other OECD countries. If improved levels of BERD are desired, more Government support is needed, which will not be achievable by degrading or restricting the R&D Tax Incentive, or redirecting funding to grant programs. A stable policy setting over the long term is also of critical policy importance. This is supported by OECD data that shows that Australia is neither unique nor unusual in providing substantial R&D support through R&D Tax Incentives. Indeed, based upon the most recent 2013 OECD data Australia only ranks 7 th for the amount of Government support provided through tax incentives as a proportion of GDP. This does not support a switch from indirect to direct Government support. The Issues Paper and the Review seek input on additionality and effectiveness. We again reiterate that recognising that the cost of the R&D Tax Incentive is at least 1/3 less than is currently being estimated, with this correction, there would be a refocusing of any concerns around these two February 2016 RSM Australia 12 of 17

13 issues. Further, with the cost versus benefits readdressed the data would more accurately show how successful the R&D Tax Incentive program currently is. Government is correct to seek the best level of additionality and therefore value for money from programs such as the R&D Tax Incentive. However, the argument should not only be about the level of additionality, of a program, but also about its efficiency in doing so, and the ability of a program to generate sufficient economy-wide additionality that will raise Australia s overall BERD. As discussed in the RSM STEM Paper, only market-based mechanisms have the ability to generate sufficient economy-wide additionality in an efficient manner. Due to franking account impacts, as cited in RSM s Re:Think Paper, the prior R&D Tax Concession was described by the Business Council of Australia as super-efficient. These comments apply equally today for the R&D Tax Incentive, as they did then for the R&D Tax Concession. It is important to moderate expectations of what is achievable from the R&D Tax Incentive and remember that the Refundable R&D Tax Offset provides a net 15% after tax benefit for companies and the Non-Refundable tax offset provides a net 10% after tax benefit on expenditure. With this level of incentive it is not possible and unreasonable to expect to leverage a large multiple of additional expenditure. A study of the R&D Tax Concession in Australia by the Centre for International Economics (CIE), the body selected by the Government to undertake the review commenced under the Tax Discussion Paper, concluded in 2003 that the R&D Tax Concession was appropriate and effective as it had an inducement rate (level of additionality) of between 50% and 90%. The Issues Paper has stated that the Refundable tax offset is generating additionality of between 90% 150%, and the Non-Refundable R&D tax offset 30% - 100%, for every tax dollar forgone. Comparison to the prior R&D Tax Concession with a review under by the CIE with the same methodologies of evaluating programs, shows a significantly improved level of additionality, generated by the R&D Tax Incentive, particularly the Refundable R&D Tax Offset, which is broadly similar to studies of R&D tax schemes used in other countries. Given the CIE s comments in 2003 in relation to the R&D Tax Concession and level of additionality achieved by the R&D Tax Incentive, it must be considered that the R&D Tax Incentive is also appropriate and effective. To come to a different conclusion would be to apply a different, erroneous and unfair standard to the current program. The Issues Paper states that around 10 to 20 percent of the total R&D registered would not be undertaken in the absence of the programme. In total R&D expenditure was $19.4 billion. Therefore, according to this analysis $1.9 $3.9 billion of R&D expenditure in would not have been undertaken without the R&D Tax Incentive. As we have shown above, the total cost of the R&D Tax Incentive, without taking franking credit impacts into account was only $1.9 billion in A significant level of additionality is therefore being generated. More important than additionality or inducement able to be derived from a dollar of investment, is the ability of the primary business R&D mechanism to induce a large scale response across the economy. We discussed in our STEM Paper that only a market-based tax self-assessment mechanism such as the R&D Tax Incentive will be able to induce such a large scale response. This is of critical importance as a move toward directly funded programs could never produce the required large scale response needed, and would over time reduce Australia s innovation performance within the OECD. February 2016 RSM Australia 13 of 17

14 Grant based or other business direct investment programs, whilst theoretically achieving similar levels of additionality will never have the scale to leverage $20 billion in annual R&D expenditure, as the R&D Tax Incentive does. In regards to spillovers, the recent Australian Industry Report 2015, prepared by the Office of the Chief Economist as part of the Department of Industry, Innovation and Science stated that R&D is not persistent enough to be sustained over the long term without strong turnover or external stimulants such as spillovers and tax incentives, and it would rapidly fall to zero if not supported by other means such as strong sales or Government assistance. This clearly demonstrates the need for Government assistance through tax incentives for R&D to persist in a firm. Direct funding grant programs where a company only has a chance of receiving Government assistance, are unlikely to be sufficient for R&D to persist in a company. What is generally not considered when evaluating concepts such as additionality is what would happen if a program such as the R&D Tax Incentive were degraded or removed. Mobile knowledgeintensive industries such as Information Technology and Biotechnology are very likely to relocate to competitor countries. Much of the R&D activity undertaken in mobile industries should be considered additional because of the likelihood that it will relocate should restrictive changes be made to the R&D Tax Incentive. RSM has had companies state to it that if the Government ever degrades or removes the R&D Tax Incentive, they are on the first plane to Singapore. Although anecdotal, we believe this represents the sentiment of many high technology companies, and the removal or significant degradation of the R&D Tax Incentive has the potential to destroy jobs in Australia. This is a critical point that needs to be understood by Government. It would be an outcome that is entirely at odds with the Government s rationale for the Innovation Science Agenda that Australia should be strengthening its STEM capacity. In RSM s Re:Think Paper, it considered the revenue implications for Government if companies began offshoring R&D operations as a result of the degradation or removal of the R&D Tax Incentive. Very few substantial decisions need to be made by companies before the cost of this activity moving offshore in terms of jobs, economic activity and forgone Government tax revenue, exceeds the cost saving that the Government would achieve by degrading or removing the R&D Tax Incentive. In addition, Australia is in a much worse position to be the beneficiary of commercialisation new of technology in this country if the R&D activity is not conducted here. Given the generally higher costs of commercialising in Australia, if the R&D operations of a company have moved offshore, then there is much less chance of commercialisation occurring here. Finally, it should be noted that the current tax system incentivises companies to undertake R&D here, but foreign patent box regimes then encourage the commercialisation to be conducted off shore. There are many examples of this such as the acquisition of Spinifex Pharma by Novartis, with the commercialisation of the drug now likely to be undertaken offshore, and CSL Limited opening new manufacturing facilities in Switzerland to take advantage of a successful Australian based R&D program. Similarly, Fintech being developed in Australia is being lured by tax incentives, particularly in the UK. The economic cost to Australia of allowing the woeful level of commercialisation to continue cannot be over-estimated. As discussed in our previous Re:Think Paper, the R&D Tax Incentive is super-efficient, therefore providing a very large effectiveness rate for Government. We have detailed above, how the February 2016 RSM Australia 14 of 17

15 interaction of the R&D Tax Incentive and dividend imputation create this super efficiency. This is not a feature of other countries R&D Tax schemes within the OECD and gives the Australian Government a natural competitive advantage in how it can use its R&D tax system to generate additionality. Therefore, tax incentives are a strong natural fit for the Australian tax system, and exploiting this competitive advantage is a reason that the R&D Tax Incentive should remain the primary mechanism for incentivising business R&D in Australia. As a way to improve the effectiveness of the R&D Tax Incentive it has been suggested that Start-up organisation should receive a greater level of assistance through the R&D Tax Incentive and that there should be a re-distribution away from larger companies. Whilst RSM agrees that start-ups and the wider economy would significantly and positively benefit from this additional funding, it should not be at the expense of other companies, as the R&D investment decisions of SMEs and larger companies are also impacted by the availability of the R&D Tax Incentive. Government needs to consider that: SMEs and larger companies, in addition to start-ups, would benefit from an increase in the value of the R&D Tax Incentive; Providing additional benefits to start-ups does have an some increased risk; and Companies, small or large, are likely to move operations off shore in the absence of incentives to remain in Australia (jobs). There are many suggestions of how to modify the R&D Tax Incentive to increase collaboration with Universities and the economic benefits that would flow on from that. We also encourage the Government to assess how the R&D Tax Incentive grouping and ownership rules apply to University spinoffs to encourage the commercialisation of research via business pathways as early as possible. Recommendation 5: The existing data indicates that the R&D Tax Incentive is already providing appropriate additional benefits to the economy. The Government should model the loss of R&D activities, from Australia to overseas that would occur if the R&D Tax Incentive was degraded, as additional R&D that is currently being undertaken. Recommendation 6: The R&D Tax Incentive is super-efficient, therefore providing a very large effectiveness rate for Government. We have detailed and referenced external evidence regarding how the interaction of the R&D Tax Incentive and dividend imputation creates this super efficiency. Government should ensure the impact of this super-efficiency is included in its budget cost modelling. Recommendation 7: Due to the approximately $1 billion a year budget saving we have identified, there is fiscal opportunity to implement improvements that would increase effectiveness and encourage additional R&D, such as: Removing the pending 1.5% reduction to the R&D Rate; Providing an increased R&D rate for university collaboration; and Loosening the ownership rules for University spin-off companies and projects. February 2016 RSM Australia 15 of 17

16 We believe that the above content is critical and must be considered in detail for the Review. Following are some brief responses to other questions raised in the Review and the Issues Paper. Definitional Changes RSM supports the current definition of core, and supporting, R&D activities and believe that there is little need for change. Administrative Issues The Issues Paper states that CIE argue that a pre-registration process is likely to increase the consideration of the Tax Incentive in firms decision making, increasing the likelihood of claims generating additional R&D. This type of approach has been adopted in Norway, whose programme has reported high additionality rates. The Issues Paper also state that in some cases, R&D investments are made within a company before decision makers are aware of the programme. In this scenario, the R&D Tax Incentive represents a windfall gain from the firm s first use of the programme (mitigated if the windfall gain is subsequently reinvested in R&D). These statements appear at odds with CIEs report that has demonstrated that strong level of additionality that exists for the Refundable tax offset, of between 90% - 150% of additional expenditure for each tax dollar forgone. The Non-Refundable R&D tax offset is also generating acceptable levels of additionality, based upon a previous report produced by the CIE. At the upper end of this range, the Refundable R&D Tax Incentive is achieving a similar level of additionality as would be achieved with a matching funding grant program, except with a system that involves no picking of winners, and has a much lower administrative and consultant cost. As the program has been highly effective in creating additionality changing to a system that removes funding from businesses on the basis that they are treating the benefit they receive as a windfall gain, will naturally reduce the benefit available for reinvestment in R&D activity. Government needs to understand that in terms of creating additional R&D expenditure, it is irrelevant at what point a company became aware of the R&D Tax Incentive, but is important what happens with the benefit the company receives. Taking the R&D benefit away from SMEs based on the proposition that preventing companies to register R&D activities retrospectively, will raise the profile of the program creating additionality is short sighted and irrational. It also ignores all of the data stating the success of the current program, places a significant uncertainty risk on the impact and at most it will only result in pushing new companies back 1 year in their claims process. The Review is ignorant or ignores the R&D Plan process that was in place for the R&D Tax Concession that required companies to have an active R&D Plan in place before undertaking activities that it wished to claim R&D Tax benefits for. This R&D Plan requirement was scrapped when the new R&D Tax Incentive was commenced. In respect of comments that Norway has a pre-registration scheme and high level of additionality, it should be considered that the Scandinavian schemes are structured quite differently to the Australian scheme and that the business culture in Norway is very different to Australia. Attributing high levels of additionality to the pre-registration requirement in Norway without consideration of many other factors is a very superficial analysis, with similar comparisons able to be made to any other country that has a different scheme structure and achieve acceptable levels of additionality. February 2016 RSM Australia 16 of 17

17 Implementing a pre-registration process would require companies to predict, activities up until the end of the financial year. This lacks practicality and will cause review/audit issues when claimants have not accurately predicted all R&D activities. Furthermore, it should be noted that no other parts of the self-assessment tax system in Australia require companies to undertake tax return compliance activity during the income year. This is always undertaken subsequent to the income period, and requiring pre-registration will create an undesirable disconnect between the identification of R&D activities, and calculation of R&D expenditure. RSM believes it is likely to result in higher compliance costs for claimants, which is also undesirable. Recommendation 8: Do not change to a pre-registration system, particularly for SMEs who will be disadvantaged through the denial of R&D tax benefits, reducing the level of additionality and making the program less effective. Two-Stage Administration: It is understood that a single agency model is being considered. RSM believes that the current twostage model does offer advantages, particularly with AusIndustry evaluating the eligibility of activities. Given the tight Federal fiscal constraints and additional compliance challenges implementing an entirely new R&D Tax administration process, we can see no significant reason to make such a dramatic change. It should also be noted that from RSM s perspective the administration of the R&D Tax Incentive has improved significantly since its inception, with better risk based approaches such as the compliance continuum from AusIndustry. Recommendation 9: Maintain the current two-stage administration system. February 2016 RSM Australia 17 of 17