Proposed changes to R&D tax offset rates – what is the potential impact?

Earlier this week the Federal Government tabled the Tax and Superannuation Laws Amendment (2015 Measures No.3) Bill 2015 proposing to reduce the current rates of the R&D tax offset, effective for income years commencing on or after 1 July 2014.

This “re-jigs” an earlier attempt by Government to reduce the effective rate of support to entities undertaking eligible R&D activities and expenditure. The first attempt to do this was blocked in the Senate last year.

2015-05-29

The impact of the proposed amendments

The Government currently offers support ranging from 40-45% dependent on the aggregated group turnover of claimants. Simplistically, entities with turnover equal to or less than $20 million would receive the 45% rate and all other entities would be eligible for the 40% rate. The proposed reductions would reduce the rates to 43.5% and 38.5% respectively.

On the surface this does not appear a significant reduction, however, when you consider the mechanics of claiming R&D, both reductions are material.

A reduction in the net benefit

With respect to those entities eligible for the non-refundable 40% R&D tax credit, the net benefit of claiming R&D is actually 10%; the difference between the 40% R&D tax credit and the 30% company income tax deduction foregone. Similarly, those entities eligible for the 45% R&D tax credit, which is also refundable, are entitled to a net benefit of 15%.

A 1.5% reduction to each of the tax credit rates actually equates to a 15% reduction in net benefit for entities with turnover greater than $20 million, and 10% for entities with turnover equal to or less than $20 million. It is the net benefit amount that is the real rate of the R&D tax incentive.

At a time where growth in business investment has stagnated, and this trend is forecast to continue, reducing the level of support for R&D and innovation in Australia suggests a short term vision.

This week, the Federal Government also released the Tax Laws Amendment (Small Business Measures No.1) Bill 2015. This Bill provides for the reduction in company income tax, but only for small to medium enterprises, from 30% to 28.5% and only for income years commencing on or after 1 July 2015. A small to medium enterprise is defined as having turnover less than $2 million.

What is the potential impact?

Overlaying the two Bills, and assuming both become law, those entities with turnover less than $2 million that claim the refundable tax offset will be adversely affected, despite the drop in corporate tax rate, as the cash refund amount will be reduced from 45% of the eligible expenditure to 43.5%.

Furthermore, if you also factor in other adjustments made for feedstock and clawback, the net benefit is further reduced. The Government is not proposing consequential amendments to these integrity provisions, arguing simplicity, yet this will have negative impacts. The 10% and 15% reductions to net benefit will in fact be higher.

We believe that it is imperative that Australia has a broad-based R&D incentive program that will foster an environment of encouraging R&D investment, increasing business expenditure on R&D and assisting to make Australian companies more competitive both domestically and internationally. Reducing the rate of incentive will have Australian businesses asking whether there is sufficient margin to continue to invest in R&D or, perhaps, whether they should look to off-shore their R&D efforts to countries where the R&D incentives are significantly more lucrative.

It will be interesting to see what happens now in the Senate. Australian businesses will be hoping that the Senate recognises the impact of the proposed changes and does the right thing by Australian business.