CHAIRMAN —Welcome. We have received your submission. Do you wish to make a short opening statement to complement the submission?

Mrs Ridout —I would like to make a short one. We are very pleased to be here. We want to acknowledge the fact that the government has shown a willingness to consult on the issues, and we have noted the important changes that have been made. The bill contains some important amendments to the R&D tax concession, and a number of these are supportable and very worth while, and we are very supportive of them. In our submission we set out a number of principles to ensure that the maximum value is derived from the tax incentive. It needs to be simple, and easy to administer and to understand. It needs to provide a sufficient commercial incentive, and the incentive needs to be broadly based, supporting a wide range of R&D functions, and broadly accessible for Australian industry, because we believe the tax incentive does provide the most important mechanism to support business R&D in Australia.

Against these criteria we have identified three issues that we believe should be amended in terms of the bill: the definition of eligible R&D to incorporate an innovation and high technical risk test; the requirement to offset feed stock profit against any deduction for plant and equipment for R&D purposes; and the simplicity of the incremental tax incentive, the 175 per cent—most importantly, the issue of adjustments. We have put three recommendations in relation to these issues: firstly, we believe the bill ought to be amended to retain the existing R&D definition; secondly, we would remove the requirement that the company offset any feed stock profit against deduction for plant for R&D purposes; and thirdly, we support the abolition of the adjustment amounts and adjustment balances in terms of the 175 per cent premium R&D incentive.

I would say again that we do believe the bill has a lot of important issues in it for industry but we feel that unless these issues are addressed the maximum impact and value out of the changed arrangements will not be derived for industry. I would reaffirm how very strongly we believe that a broadly based commercially valuable R&D tax incentive which is available to a broad range of Australian companies across a broad range of sectors is absolutely vital. I think our organisation has been on the record on that issue for many years—probably ad nauseam— but it certainly is our view. Thank you. We are happy to take questions.

CHAIRMAN —Thank you very much for your submission and for your statement. I guess I should start off by saying that some of the discussion this morning has been about requesting some changes to the bill or widening the effect of the bill, but also giving recognition to the fact that the R&D concession was part of the overall tax package for business out of the Ralph report whereby corporate tax rates went down and there were other significant changes to business tax. So, the tightening up of the definition and the concession for R&D, as well as the changes to depreciation, were part of the trade-offs for the achieving of a 30 per cent corporate tax rate as well as capital gains tax changes. Would you care to comment?

Mrs Ridout —Yes, I would indeed like to comment on that issue. Business never saw the R&D tax concession as part of the Ralph changes. We strongly submitted that it should not be. We put that in writing and said we would not support any changes to the corporate tax rate that did incorporate a dilution of, or negative changes to, the R&D tax concession. In fact, it was the strong and ongoing submission of our organisation that the R&D tax concession had to be increased to offset the fact that the reduction in the corporate tax rate reduced the value of the concession. That has been a very strong view of our organisation.

Also, it needs to be put on the record that the changes to the corporate tax rate for the manufacturing sector, which I represent, had a lot of risks attached to them. Even on the modelling done by Econtech, there was an absolutely lineball benefit to industry once you gave up the changes to capital allowances. In an industry like ours, which is capital intensive and whose future lies in being capital intensive, that was a very difficult choice. We were strongly of the view that if you were going to trade off R&D we would never support the changes to the corporate tax rate on that basis.

CHAIRMAN —Finally, again from this morning, we had a witness from Deloittes a little while ago who, in answer to a question from Senator Cherry about whether he wanted to see this bill actually get through the parliament or not, made the comment that he would sooner see it defeated. Would you care to comment?

Mrs Ridout —I think there are many worthwhile aspects to the bill: the small business offset, for example. There are a number of issues in it that are valuable but we would like to see it go through with these amendments and, as I said in the opening of my comments, we have been quite pleased and very appreciative of the fact that the government and the department did open up dialogue on a lot of these issues—for example, the 175 per cent premium incentive rate. The attachment to turnover was severed, in great part due to the value of those consultations. So we are anxious to get an incentive, even on the basis of what is proposed. We do not see it actually turning around quickly, this parlous R&D performance— investment by business—but it can make a modest and important contribution. But it will not make it unless you take on board some of the comments we submit in relation to these three key areas.

CHAIRMAN —Mr Frank Drenth, from the Corporate Tax Association, an earlier witness today, also made the point that, in his view, a lot of their members do what they believe is R&D but, because the projects are relatively small, they do not bother going through the administrative process of claiming the tax concession. As a consequence, the recording of what Australian commerce and industry is actually doing in R&D is understated.

Mrs Ridout —I think there is some sort of idea that industry is out there waiting for the government to give them a handout to do R&D. That is not the case. We have studies of our members, which we have made available to the government, that indicate that 90 per cent of R&D is done really without any allusion to tax concessions. But we would also say that the fact that only around 3,000 companies are now applying for the R&D tax incentive does reflect (a) the weak value of the concession and (b) the administrative compliance arrangements that attach to it.

One of the concerns about these changes that we have had all along is that, if you have to have a three-year claims record with the R&D board, you are not going to get a lot of companies, other than those 3,000 that are eligible applicants, in the short term. So, really, the value of these changes applies to small businesses that can get a rebate under the offsets program, are in a non-profit situation and are already registered R&D providers. You put all that together and think, `How many out of the 868,000 enterprises in Australia'—which we need to be innovative if we are going to be a competitive country going forward—`are going to be eligible to get any assistance out of this programs?' That is a point we have made to the government and to the department. But that does not in any way dilute the fact that we think this is significant.

I would say in defence of the R&D tax concession that it has proven to be the one thing that changed R&D behaviour in Australia. When it was 150 per cent and meant 150 per cent, you had an increased investment in R&D, an increased engagement by companies and, I think, the opportunity for the incentive to actually mould behaviour. We have no real problem with the concept of plans that have to be submitted as part of your R&D submission, other than that they be simple and easy to do, because it means that innovation is not just an R&D project; it is a way of doing business. So there are lot of positive aspects to engaging more companies formally in the process.

Senator GEORGE CAMPBELL —I would like to clarify something that was said this morning in relation to the issue of the tax concessions being part of the business review trade-off. I happened to chair the committee that inquired into that and I do not recall any discussion about trade-offs in respect of the business tax review or the reduction in the corporate tax rate. But there were matters such as the taxation of trusts and the alienation of personal income that were part of those trade-offs that have never seen the light of day in legislation. I do not think we ought to place too much weight on those types of arguments.

Mrs Ridout, I do not know whether you have seen the Ford Australia submission to this inquiry. They make a number of points in their executive summary that I want run through quickly with you. They say:

The R&D tax concession was introduced to encourage business investment in innovation and technology. The change in definition further erodes the encouragement to companies.

Would you agree with that statement?

Mrs Ridout —I think the tax concession, having been eroded from 150 per cent down to 125 per cent, has certainly eroded the value of the incentive. In a market as small as Australia, where the risks are higher than in most economies to invest in these kinds of arrangements, I would agree with that. The changes that are proposed now, the amendments that we are seeking, for the problems that we perceive are in this legislation would improve it. But, if the legislation goes through without those amendments, I think you would certainly, as stated in the Ford submission, reduce the value of the incentive. It will not have a big impact.

Senator GEORGE CAMPBELL —They also say:

The proposed change to the definition will result in increased dispute between Government and industry and increased compliance costs for industry.

We heard this morning, I think from Deloittes, that the increased compliance costs are set against the 7[half ] cents in the dollar benefit and that in many instances the compliance costs are going to outweigh the benefit and it just will not be worth while for companies to even make a claim. Is that a statement you would agree with?

Mrs Ridout —We have said that one of the essential principles guiding the tax concession is that it be simple and easy to administer—that compliance does not fail the simplicity test, which is a problem we have had with a number of other pieces of legislation. If you want to get more companies engaged in this process you have to make it easy for them. At 7[half ] cents in the dollar, the return is minimal in terms of the commercial incentive that is there, but whatever is there should be maximised rather than be made administratively difficult by a turgid framework of compliance being created. That is also our concern with the 175 per cent. If you are small company already spending an extra eight or nine hours a week on GST compliance and tax compliance and you have to look at that formula for working out the eligibility, that will kill off your enthusiasm. We want the thing to be open, broad based and accessible to as many companies as put their foot in the pond, frankly.

Senator GEORGE CAMPBELL —Ford says that very few companies will actually access the 175 per cent premium rate. At a Senate estimates hearing, the department estimated—and this was under the old definition, I concede—that around 600 countries would qualify for access to the 175 per cent premium. Have you done any assessment amongst the companies you represent of those likely to be able to access that premium rate?

Mrs Ridout —With our members, 60 per cent of business R&D is done in the manufacturing sector, so we have quite a strong interest. Sixty per cent of the ideas out of industry in Australia come from manufacturing, which people ought to recognise more, I suspect. Our members are interested in the 175 per cent. There is a bit of confusion: they think it is going to be on their whole R&D spend and it is just on the difference between last year's or the last three years spend and next year's spend. So it is more limited than you might think, but it is still a valuable move forward. But if you then add this whole ATO process of adjustments and obfuscation you will certainly deter companies from getting into it. We think that can be addressed through the audit process. We do not know why companies have to be confronted with such a big hurdle to have to climb over. It will undoubtedly deter companies from getting involved in the process. Also, on the basis of the example we put to the committee in our submission, it creates anomalous outcomes and it will really deter good companies from being able to access the incentive.

Senator GEORGE CAMPBELL —Ford's submission also says that these changes will have a greater impact on manufacturing than on other sectors of the economy. Is that also your assessment?

Mrs Ridout —I think it will because (a) we are an R&D intensive sector, relatively, in Australia and (b) we are capital intensive, so some of the issues relating to plant and equipment use are very important to manufacturing. So, yes, I suspect our sector would be quite disproportionately affected.

Senator GEORGE CAMPBELL —On the tax offset of the $1 million, isn't the way in which that will operate almost a disincentive in itself to small companies to go beyond the $1 million?

Mrs Ridout —I think any of those cut-offs are arbitrary, whether they are on the simplified tax system or on the turnover arrangements that might apply here, and they can be quickly out of date. If companies are around that level, they all of a sudden get into another level and are out of the system. I find quite surprising the percentage of Australian businesses that fall under the $1 million limit. So, yes, they can be a disincentive; they can creative incentives to stop growing your business. But I come back to the point that I made to Senator Gibson: companies are not out there looking for government handouts to do R&D; they are about growing their businesses and surviving against ferocious competition. What this ought to be about is making them more innovative and about actually creating different behaviours and a different response from companies—`Let's get a good idea, let's take the risk and, gosh, this helps us take it'—and getting over that hurdle rate of return in the psychology and the commercial operation of companies.

Senator GEORGE CAMPBELL —Thank you.

Senator CHERRY —You have mentioned a couple of times the need for a broad based incentive. What do you mean by `broad based', in particular in terms of the treatment of labour component? Are you talking about broad based in terms of access to it or of what it covers?

Mrs Ridout —We are talking about a broadly accessible incentive as one of our principles. There is a lot of fashionable stuff: we should get into IT, we should get into biotech. A lot of them are our members and we support having some targeted industry sector approaches. But, at the same time, we have always believed winners pick themselves. If you have an environment in which everyone can succeed, all sorts of flowers will emerge.

We strongly support a very commercially valuable, broadly based tax concession. You can then build up sectoral policies on top of that, as exist in the motor vehicle industry and others. In terms of the broadly based nature of it, we know that the 175 per cent excludes plant and focuses on the labour component. That is a second-best solution as far as the Australian Industry Group is concerned. We have not expressed a strong view in this submission about that aspect of it, but we certainly would have if the 125 per cent had had that kind of provision in it. I suppose that is partly behind some of this concern we have with the trading stock, feed stock issue. The last thing you want is to make it harder for companies to take risks—to reward failure rather than success. I guess they are the two issues behind our broadly based—

Senator CHERRY —You have talked a little bit about the change to the double test of innovation and high risk. You have not mentioned the exclusion of the other supporting activities. Does the AIG have any view on the exclusion of all the other various activities from the concession?

Mrs Ridout —It has been raised with us by a number of members but it was not a major issue that we thought required us to submit on. I do not know whether Andrew has a view about that.

Mr McKellar —In terms of the feedback that we got, as Heather has pointed out, those areas that have been identified, on which we have made recommendations in the submissions, were the ones about which concern was expressed to us by industry. We have not had a lot of feedback on that particular area of the bill at this stage.

Senator CHERRY —Company plans was another issue that was not addressed in your submission, in terms of whether the requirement for a company plan for supporting an R&D activity was something which might restrict access to the concessions. We have heard about this quite a bit this morning. Do you have any views on the requirement for a company plan?

Mrs Ridout —We have no in-principle opposition to companies having to put an R&D strategy in the context of a broader business strategy. In fact, we support it, because innovation should be part of going forward. It should not be just saying, `We want to put research into a new meter.' You have to really say why that has to form part of the further strategy of the company, that there are skills issues attached to it, et cetera. We do not have any in-principle problem with that. Again, it is how hard it is, how simple it is and the extent of the detail that is required. I know there have been a number of submissions made and concerns expressed about that. I just want to reinforce that you should not make this too hard for companies, because they just will not do it. That is exactly what is happening in Australia at the present time. They are just not doing enough of it and, as an economy, we cannot afford that.

Senator CHERRY —Do you think the compliance costs are getting to the stage where companies will not bother going through the process to get R&D concessions? What will that mean in terms of whether they do R&D?

Mrs Ridout —Certainly, companies are falling out of the R&D loop. The number of companies applying for the concession has fallen quite substantially since 1996 because, at 125 per cent, with changes to the company tax rate during that period, there is just not enough incentive there in the system to go through all those compliance issues. They say, `We will not bother.' But that has undoubtedly led to less R&D being done in Australia, and less good R&D being done in Australia. I think we are concerned with the balance between compliance costs and the value of the incentive.

Senator CHERRY —Is the relationship that direct between the tax concession and the amount of R&D being done?

Mrs Ridout —I think it is. At the margin, companies look at this and they say, `We have got 10 projects. Five satisfy the rate of return internally that we can justify.' With the other five, they start to add up all the various issues, and the tax concession comes into play and none of them might get up. That is exactly what has been happening since 1996. That sixth, seventh, eighth, ninth or 10th project might be just the one that is important to the future of the company. So the tax concession is important, but it is no more important than Australia reducing the rate of company tax to 30 per cent and saying, `We are going to get all the international companies in the world opening up here.' That is not going to bring investment to Australia of itself but it will certainly be part of the contributing environment. That is how we see the concession—both at the industry level and in terms of the whole investment environment in Australia.

Senator CHERRY —Your report highlights that the change from the `or' to the `and' was highlighted in 1988 by AusIndustry and was not proceeded with then. What do you think has changed in terms of government attitude to see that thing back on the table at this stage?

Mrs Ridout —This has been mooted for a long time. In the 1995 election campaign there was a promise by the current government not to change the definition, so it is an old acorn. It is a bit like lots of the changes to the tax system: they are in someone's drawer for a long time, they get pulled out and all of a sudden you are confronted with them. So this is not a new idea. I know there have been AAT rulings and Federal Court decisions and there has been some discussion that you need to clarify the definition, but why overturn 16 years of practice for an issue that I do not think will yield the benefit or the reward that the government is seeking from the change?

CHAIRMAN —That completes the questions. Thank you very much for your submission to the committee and for appearing before us this morning.

Mrs Ridout —Thank you very much for the opportunity.

[11.26 a.m.]