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Monday, 22 August 2011
Page: 5076

Senator BACK (Western Australia) (20:10): I rise this evening to also address the Tax Laws Amendment (Research and Development) Bill 2010. Regrettably, it is another example of legislation being drafted and presented by people with little or no understanding of the business environment in which we exist in Australia, particularly the challenges that confront us. These will be, regrettably, the outcomes of this particular bill once it passes this place. It will preclude the achievement of enabling small and medium-sized businesses undertaking R&D activities to more readily access and benefit from the proposed R&D tax credits, and a direct result of that will be inhibiting or radically reducing investment in the SME sector.

Secondly, it will result in a drain of expertise and investment by small and medium-sized businesses, which Senator Bilyk herself has addressed in the last few minutes, away from Australia, at the very time we need to be protecting and preserving this most. And of course it will discourage major companies who participate in R&D activities from participating in the R&D scheme. The end result of this, whether by accident or by intent, may be a radical reduction in the government's cash contribution to industry, at a time when this cash-starved government needs to grab back every dollar it can.

What in fact is the scope of what we are speaking about? The fact sheet presented by the government in October last year, under the Business Expenditure on Research and Development, known as BERD, indicates that in 08-09 there was $16.8 billion invested by companies that would apply under the R&D scheme. Of this, $1.6 billion would be what government says it forgoes in tax concessions. So this is the size and scale of the operation we are speaking about. For example, industry, manufacturing and mining contribute $8.5 billion of R&D, and that constitutes 51 per cent of that $16.8 billion; the professions, scientific and technical companies contribute $2.5 billion, constituting around 15 per cent; and the financial and insurance services sector about $2 billion, or 12 per cent. By company size, those with staff numbers exceeding 200 account for 71 per cent of that figure, being $12 billion; those with staff numbers of 20 to 199 contribute $3 billion, or 17 per cent; and those with fewer than 20 staff contribute, in R&D terms, about $2 billion, or 12 per cent.

So, what is the impact of all this, and what are we moving from and what are we moving to? Since 1985 the R&D tax concession has operated in such a way that companies have been able to register, claim and cost their R&D activities on a project-by-project basis. Of course, this makes perfect sense. Technical people think in terms of projects, accountants do their costing in terms of projects, and that is the way logically you would think we would continue to operate—but, no, we are moving to what are known as activity based credits with this particular R&D legislation change.

What, for example, is the impact of this? Let me give it to you in simple terms, in a company that I can relate to myself, having been chief executive of an IT services company in WA through much of the last decade. Under the concession, or the existing project based R&D situation, the company must describe all of its activities under a project heading. If, for example, eight people in a small or medium-sized enterprise are working on the project, they can capture their eligible time and submit a claim with the cost of the eight people involved and identified. We can all assume that we can identify with that.

We now move to what will be contemplated in this legislation. For example, under the credit program of activities, based on if the project has 10 activities, still with the same eight people involved, we may potentially have 80 pieces of cost information. This is eight people working on R&D and all of a sudden we have 80 pieces of information that we must track, record and report on, and upon which there must be audit. A quotation given to me by a practitioner in the field I think summed it up perfectly. She said, 'One should never design a system to better target the minority that misuse it at the expense of the responsible majority and the overall program objectives.' We heard Senator Milne address this question of abuse. We must always be conscious of those who would abuse a system. We do not want to see waste in this particular way. But when we throw the baby out with the bathwater, when we get to the stage where the responsible majority are significantly disadvantaged, we are in trouble. That is where I point us to.

Some of the points relevant to the legislation as it is presented are these. First there is administration and compliance, which I mentioned in the last few moments. Registration requirements which mandate that explicit written identification of core activities and those of other activities that support core activities are onerous. What is interesting is that to this moment it is my understanding that there are no business processes in place or software available for the SME sector that can actually configure, capture and store the sort of data about which we are speaking. This will be further exacerbated by the application of different standards to each supporting activity. You can see the web into which we are building ourselves here: a small business with up to eight people doing some work and all of a sudden there is no software and there are no supporting activities. So, unless a claimant can provide the information of the detail about which I speak, in a written format, they will be precluded from even registering and will therefore be unable to access the proposed tax credits.

What then defines these core activities as opposed to supporting activities? This is very interesting. It is referred to as the 'purpose test'. I will define it from the explanatory memorandum in the legislation:

The need to employ the scientific method also reflects the degree of novelty in the ideas being tested. That is, the knowledge being sought must go beyond validating a simple progression from what is already known and beyond merely implementing existing knowledge in a different context or location.

Let me give you an example of an agri­cultural nature. A specific question was asked of me by one of my constituents who was seeking to assist clients developing an agricultural machine capable of identifying one green plant from another at speeds up to 20 kilometres per hour. My colleague Senator Macdonald might be interested in this because the technology would be deployed in the sugar cane industry, amongst other places, in Queensland. What would it do? First of all, by being able to identify a specific plant upon which a chemical can be placed to kill it, you then improve weed control, you reduce herbicide use and you reduce the runoff of chemicals and other nasties into the Great Barrier Reef marine reserve. You would think how absolutely brilliant this is. The catch here in this constraint lies, according to the legislation, in the field of multiple technologies, because what we actually find is that this is the application of none other than ink jet printer spray technology, but with its adaptation to agricultural contexts, with all of the advantages about which I spoke. We then go to the legislation. Does this activity of developing this precision spray knowledge for agricultural application qualify or not qualify as original design, because indeed it is modifying an existing ink jet printer nozzle technology to a new context. You might ask if this is relevant; it is very much key to this whole activity.

I then go to the treatment of cash received under the proposed R&D incentive. We heard Senator Bilyk telling us what a wonderful benefit this is going to be for the small business sector. But, unfortunately, there is considerable confusion surrounding this whole question. And there is a wide discrepancy between the benefits for larger companies and those of smaller and medium-sized companies, despite the much heralded incentives and benefits as outlined in the second reading speech. In that second reading speech, as we heard from Senator Bilyk, it is claimed that a new incentive is there as a 45 per cent refundable tax offset on companies with a turnover of less than $20 million. Doesn't it sound fantastic. But we should read on. In his second reading speech the minister made the statement that this 45 per cent refundable tax offset doubles the current base rate available to SMEs and the tax offsets are calculated on the basis of expenditure on eligible R&D activities and the declining value of depreciating assets. He claimed that small innovative firms are big winners from the new R&D tax incentive, with great access to tax refunds for the R&D expenditure. However, the truth is somewhat different to the statement. Currently, for example, the R&D tax offset returns 37½ per cent on moneys expended on the activity by claimants whose turnover is less than $5 million. So you would say that this is wonderful: 45 per cent versus 37½ per cent; isn't that good. But this money is received as a refund of tax and creates in accounting terms a 'permanent difference'. It is received much as an individual receives their tax refund cheque, with no further strings attached other than the normal compliance costs and requirements that we would expect.

We now turn to the proposed legislation. This is the 45 per cent refundable tax credit. Here, the claimant receives 45 per cent of the moneys expended on R&D but, unfortunat­ely, the receipt of that tax credit will impact on their franking account and limit or prevent the claimant from paying a franked dividend to any shareholder until such time as the claimant has paid enough income tax to equal the tax benefit. In other words, all of the moneys received by way of the proposed refundable R&D tax credit must be returned to the government through future payment of income tax before a claimant can reward their shareholders by the payment of a franked dividend.

Putting it another way: the R&D tax offset currently creates an enduring financial benefit. However, under the proposal, we see that it is more akin to a loan. It has a short-term cash benefit, as Senator Bilyk has said, but it must be fully repaid in the longer term. Therefore, to a small business, it has very little benefit, particularly when trying to attract investment. We all know that the current climate, with the uncertainty in the world economy, with the uncertainty of a carbon tax and with all the problems associated with productivity—and we know that Australian productivity is falling way behind that of our competitors—is not a climate in which an SME, in particular, is going to invest in R&D.

So how can this change in policy be seen as a positive move? It proposes a change from a situation where companies receive cash with no strings attached to one where companies gets the cash today but must fully repay it before they can reward any of their shareholders—generally, in the case of many small businesses, including the financier as well.

Time does not permit me to go through the cash element of this, but I could show that it is a severe cash disincentive—worst of all inhibiting investment. Industry repre­sentatives have already put to me that clients in Western Australia see this as inhibiting their capacity to attract investment, particularly into companies which involve themselves in R&D activities. It is risky from a technological point of view because the investor knows full well that no reward will flow to them unless or until the company has fully repaid all moneys received from government. This is not a great new push into encouraging investment.

For me, the tragedy is that I know of three small companies in WA which have already moved offshore. Two have moved to Singapore with their R&D activities; the third has moved to Scandinavia. So what have we lost? We have lost the intellectual property from this country and we have lost the expertise of the people who have moved. Australia has lost the wealth benefit not only of the current activities of those companies but, in the event that their R&D activities yield fruit and become commercial, of the opportunity from another innovation—the sort of opportunity with which we could turn ourselves into the smart country.

I come to the question of retrospective application. This is a concern which has been amplified by this legislation—it has retrospective application, with the proposed starting date going back to July 2010. It is not yet obvious to me where we sit with this new legislation and a company with R&D activities going back to when this legislation was first proposed. As we all know, this will impose a significant burden on both small businesses and larger ones, but especially on those SMEs who will need greater time and investment to modify their internal processes and policies to capture the information required to be in a position to even attempt registration.

There will be an even greater, and as yet undefined, commitment to invest in software programs to capture the necessary data, with attendant capital costs associated with purchase and ongoing annual maintenance. For small and medium-sized enterprises, the software packages to capture the data required by the proposed legislation are simply not there as yet. The advice to me, and I would be very pleased to be corrected, is that practitioners have to date been unable to identify any off-the-shelf computer applications which will, without significant customisation, generate the necessary level of detail. The software needs to interlink those specific core and supporting activities, about which I spoke, whilst applying a dual standard to supporting activities, the applicable standard depending on which one of two areas those activities fall into—that is, the production or the non-production environment. This legislation seems to require that information from a company merely for it to obtain the registration number which is the key to the R&D tax initiative.

In my final few moments, I will go to this concept of core and supporting R&D activities. The legislation has specific criteria defining core and supporting R&D activities respectively. Each needs to be mapped at the registration phase—not at the application but the registration phase—and there is concern from companies, large and small, that business systems simply will not be able to do this.

I now turn to the burden of company directors and their fiduciary responsibilities, and indeed their legal responsibilities under corporations law. What responsible director, chairman or chief financial officer will sign registration forms and therefore find themselves possibly in default under corporations law or find themselves in a circumstance in which, at some time in the future, they may be subject to a retrospective tax audit? They would be exposed not only to withdrawal of funds that have been paid to them under the R&D scheme but to severe penalties. And, if they are loath to sign the registration forms, this will reduce registration numbers and the number of claimants for R&D support.

As we read the proposed legislation, core R&D activity must always precede any supporting R&D activity. But in the real commercial world that is not how it works. I know from my own experience that quite often you arrive, if you like, at a pre-creation research phase. This is required in order to determine the particular characteristics of a proposed new product before you define it as a core business. For example, does the market require the product as an oxide or as a carbonate? What level of purity is required for the product to be marketable? These are the sorts of things that you often do not know but which, under this legislation, you will be required to declare—under the pain of audit failure. Therefore it will not be eligible if the core R&D activity is the creation of the product to meet these requirements in the market. These points have been made to the department and its advisers, but unfortunately we have seen no satisfactory result to date.

So we come to the dominant purpose test. The dominant purpose test is a directly related test which will only increase confusion and only has the one outcome in mind.

Where does this leave us with this legislation? First of all, investment will dry up, particularly in the small and medium business sector. Secondly, businesses will find it too hard to operate in Australia, they will leave the shells of their companies here in Australia while they move overseas and, regrettably, many larger companies will find it too difficult to comply. The end result will be that the $1.6 billion will not be spent by government.