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Thursday, 17 June 2010
Page: 5713

Mr FLETCHER (10:16 AM) —When I gave my maiden speech to the House in February this year, I mentioned key policy areas in which I hoped over time to be a voice for change. One of the areas I spoke about was the process of commercialisation of innovation—that is, moving smart ideas from the laboratory to the market place. In my speech at that time I mentioned that I saw this as requiring:

… closer ties between research institutions and industry … choosing key areas of research where we can build real scale and leverage that into a national competitive advantage.

In addition, the emphasis on the commercialisation stage is very important to bear in mind and goes to perhaps one of the key differences between the coalition and the government on this legislation, which seems to embody a philosophy which fails to recognise the importance of the commercialisation phase and fails to recognise the relative importance of the development phase, as contrasted to the research phase.

I want to pay particular tribute to the Howard government Minister for Communications, Information Technology and the Arts, Senator Richard Alston, for whom I worked. Senator Alston had a deep interest in the issues of innovation and commercialisation. It was a privilege to work with him and others, including Neville Stevens, the then secretary of his department, David Quilty, his then chief of staff, and indeed Dr Terry Cutler, who was an important informal adviser on these issues. Dr Cutler’s name is prominent in this policy area as the author of one of the key reports which influences the policy changes put forward today. It is unfortunate perhaps that the connection between Dr Cutler’s recommendations and the specific policy changes appears to be less direct than it ought to be.

It is very disappointing that the legislation before the House is flawed in its approach to re-engineering the mechanism of concessions for Australian businesses for research and development. This legislation does not give effect to the theme which the Labor Party took to the 2007 campaign of promoting innovation. Its substantive effect is quite at odds with what is claimed and in fact winds back support for research and development in Australia.

It is certainly true that Australia’s research and development levels are running at below the OECD average and the objective of increasing research and development levels is one which all of us support. The key issue before the House is whether the mechanism proposed in this legislation is going to be effective in encouraging research and development. On this side of the House, we are clearly of the view that it will not be effective.

It is important to understand the context for the current research and development tax concession and the way it has worked in practice. It has been an important mechanism to support business expenditure on research and development. The Australian Industry Group, in one of its submissions during the process of developing these bills, had this to say:

The case for public support of business research and development arises because of the direct and indirect spillovers that arise when the full value that flows from the expenditure is not captured by the businesses making the expenditures but part of which flow to other parties … Without public support, the total quantity of business expenditure undertaken would be less than the socially optimum level.

It is clear that inherent in that is the notion of a public good and it is well accepted that an appropriate area of public policy activity by a government is to encourage public goods because, for the reasons the Australian Industry Group has articulated, private players may not sufficiently act to encourage those goods themselves.

The existing research and development incentive arrangements consist of four elements: 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 Rudd government’s stated aims are to make the R&D tax support arrangements simpler, more predictable and more generous. None of these aims, regrettably, has been achieved in this bill.

One of the things that are particularly striking is the profound internal contradictions between the two major reports that have been used by the government as the basis for these legislative changes. There was the Productivity Commission report, which was released in 2007, which concluded that the basic 125 per cent tax concession was failing in its purpose as it gave concessions in relation to R&D that would have happened anyway. I do not express a view as to the merits of that conclusion; I just note that there is a contradiction between the underlying philosophy of the 2007 Productivity Commission report and the review that was conducted in 2008 by Dr Terry Cutler, of whom I spoke earlier. He is a man who has been involved in policymaking in this area for many years.

Objective observers have described Dr Cutler’s recommendations as being the polar opposite of the Productivity Commission report. He recommended an increase in the base concession, a greater concession available for smaller entities and a closure of the incremental provisions. When the government first responded in May 2009, in its Powering ideas statement, it supported the move to a tax credit. But the story then got very murky as the Treasury got involved in the consultation process, issuing a paper in September 2009 and exposure drafts in December 2009 and March 2010. The Treasury’s paper seemed to revert to the Productivity Commission approach of substantially tightening up eligibility criteria for the tax concessions. It is important to note that the Productivity Commission conceded that its proposals for restricting the scope of the concession would increase administrative and compliance costs and that there would be unforeseen consequences.

One industry participant I have spoken to expressed the view that the September 2009 paper could have been written based wholly on the Productivity Commission report, as it makes so little reference in substantive terms to what was recommended by Dr Cutler. It is for this and other reasons that a number of industry observers have asked whether this is simply a revenue measure in substance, designed to reduce the amount of tax expenditure in this area, and that that is the overriding policy objective as opposed to stimulating research and development.

The key provisions in 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. But there is an important sting in the tail: this bill brings a new and more restrictive regime to determine eligible research and development activity. The bill creates two key categories for eligibility, being core research and development activity; and supporting research and development activity. There are very significant problems with both of these definitions. Many industry participants have made that point, including the Australian Industry Group.

It has been widely pointed out that the bill and the new provisions that it introduces are not consistent with the Frascati definition of research and development, which has been the basis for the approach used by the OECD in this area for decades. Under that approach, research and development is defined as ‘creative work undertaken on a systemic basis in order to increase the stock of knowledge, including knowledge of humanity, culture and society, and the use of this stock to devise new applications’.

Importantly, under the existing arrangements in Australia consistent with this definition, research and development includes both creating new knowledge and using existing knowledge to create new applications. The problem with the approach that the bill takes is that it limits, in both its objects and its specific provisions, the availability of the credit for activities that are undertaken for the purpose of ‘acquiring new knowledge or information’.

In other words, this bill involves a clear shift to put a greater emphasis on research and a reduced emphasis on development. We do not believe that that is a good policy approach. It removes from the application of the credit a key aspect of what research and development involves—what in the Frascati model is called ‘experimental development’ which is defined as, ‘Systemic work, drawing on existing knowledge gained from research and/or practical experience, which is directed to producing new materials, products or devices, to installing new processes, systems and services, or to improving substantially those already produced or installed.’ In other words, under the bill, novelty becomes a prerequisite, and the use of existing knowledge to develop new applications is rejected.

The bill seeks to address this concern with the notion of ‘supporting R&D activity’ but the definition of that term is so circumscribed that most observers believe it is going to be very difficult to take advantage of it. A whole range of activities are specifically excluded—for example, an activity that produces goods or services or an activity that is directly related to producing goods and services. In addition, there is an overarching test that the activity must be for the ‘dominant purpose’ of supporting core research and development activities.

This dominant purpose test effectively operates to kill off any application of the credit to experimental development. Some experts have pointed out that it is difficult to envisage a situation where a supporting activity would not fall within one of these exemptions and thus be barred from eligibility for the credit. There is, in addition, real uncertainty as to what this new term ‘dominant purpose’ means.

Heather Ridout, of the Australian Industry Group, has called the new approach deeply flawed and says that it will significantly reduce innovation. Indeed, the Australian Industry Group commented in its submission:

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 compete against imports.

Another party making submissions on this bill estimated that 60 per cent of their activities would no long be eligible under the new definition. It is also noteworthy that that 2007 Productivity Commission report to which I referred earlier found that 61 per cent of business research and development was experimental development—that is, drawing on existing knowledge. In other words, there is a huge area of ground which has now been excluded from being eligible for the tax credit. So we are at risk of moving from a regime which provides incentives for research and development to a regime which simply provides incentives for research. Therefore, one has to be very sceptical about the government’s real motives for this legislation, particularly given the strong involvement of the Treasury in the final form of the legislation. It is hard to avoid the conclusion that the primary motivation is to achieve cost savings.

An additional aspect of this legislation which is deeply troubling is that the consultation process has been wholly inadequate. It is interesting how often that is the theme of the Rudd government. The timetable for these proposals was completely absurd. The first draft exposure bill was released just before Christmas. There were very substantial rewrites and a second draft exposure bill was released with entire concepts having been altered. The new regime is supposed to take effect on 1 July—that is, in less than 15 days. The bills have not even been passed. A Senate committee inquiring into this matter reported only one or two days ago.

So we have flawed policy and policy which has been developed with inadequate consultation. We also have policy which has a substantive effect which is quite different to the government’s rhetoric—once again a clear theme in the way the Rudd government operates. What we have seen, regrettably, is an all too clear example of the atrocious process that characterises the way that the Rudd government operates. In substance, what we are seeing is a bill which introduces a complete change to a regime that has operated effectively for quite a number of years to provide tax incentives for research and development activity. The way in which the changes have been introduced has maximised confusion and uncertainty in the sectors that rely upon this research and development tax concession.

The underlying substantive policy impacts of this legislation do not conform to the government’s rhetoric and its stated objectives, so it is no wonder that amongst the comments which have been made by expert observers about this legislation is the following:

The R&D tax concession was broad-based and available to every company. With this nonsensical and complex piece of legislation, they are killing it.

That comment comes from a KPMG partner. A tax partner at PricewaterhouseCoopers described this legislation as ‘a kick in the guts for business’. The Dean of Business at the University of Technology Sydney, Roy Green, was quoted in the Australian Financial Review as saying the proposal ‘seems mainly designed to bring about cost savings on support for large corporate R&D budgets’. The CEO of the Australian Information Industry Association has stated:

… the whole success of the NBN rests on the value-added services to be delivered on the back of the network. This is a huge area of opportunity that will be stifled by the proposed changes to R&D that limit what software companies can claim.

Without expressing any additional views on the merits of the NBN—my views on that topic are well known—I would simply point out that that is yet another piece of evidence of the internal contradictions which are absolutely rife in this legislation. The fact is that its substantive effect will be at odds with its stated purpose. The fact is that the regime of consultation which has occurred has been wholly inadequate and has left most interested parties frustrated and disappointed that their expertise has been disregarded. The fact is that we have, in substance, a piece of legislation which not only is not going to achieve the stated objectives but in fact, on all of the evidence, appears designed to achieve a quite different set of objectives. Sadly, this is a story which is all too common under the Rudd government, where we hear one stated policy objective but the actual substance of what is done is quite the opposite. For these and many other reasons, the coalition is not supporting this legislation.

The SPEAKER —Order! The question is that this bill be now read a second time. Before calling the member for Canberra, I understand that it is the desire of the House that there be no points of order during the speech. I call the member for Canberra.