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Tax Laws Amendment (Research and Development) Bill 2010

CHAIR —I now welcome Professor Green. Professor, would you like to make an opening statement?

Prof. Green —Yes, I could make an opening statement in general terms. Good morning and thank you for inviting me to the committee. I think the main general point is the importance of innovation to public policy. R&D support is part of that, but only part, and innovation policy is crucial at this stage of our development, largely because of its impact on productivity. There are wider elements as well, as were highlighted in the Cutler review, Venturous Australia: building strength in innovation, on environmental issues and climate change and also on social inclusion.

The productivity agenda is really central to the R&D element and has been covered also to some degree in the House of Representatives Standing Committee on Economics, which reported earlier this year. But that was in large part in relation to the structural deterioration of productivity growth that has occurred in Australia over the last few years—since about 2000 and 2001—what the causes for that were and how we would address that in public policy. It made a number of recommendations. One aspect is undoubtedly the case—that is, behind the windfall gains of the resources boom mark 1 we did experience a structural deterioration in our productivity performance as a country. That potentially undermines our longer term recovery agenda, especially as we move into boom mark 2 and another terms of trade shift which will threaten the creation of the so-called two-speed economy and, in that context, with a lot of pressure on our export firms and our import competing firms, both in manufacturing and in services, but particularly in manufacturing.

Productivity through innovation will be the key to our future competitiveness. In that context, R&D support has been shown, I think, in the literature to have an impact on productivity and growth. There is a recent report to which I might refer you—in fact, it is so recent that it came out only in the last few days in the United Kingdom. It is a document that was delivered to the new Prime Minister, Cameron, that resulted from an inquiry led by James Dyson, the famous entrepreneur, called Ingenious Britain. It contains quite a lot of evidence in relation to R&D support and, in particular, the experience of tax credits in the UK with reference to a number of studies of the impact of that on growth and productivity. But it also refers again to the wider context.

There is a lot of other literature which puts competing claims for other aspects of innovation and public research. A new report was announced or introduced only a matter of weeks ago by Jonathan Haskel of Imperial College in London called Public support for innovation, intangible investment and productivity growth in the UK market sector, which highlighted the importance of public research. It needs to be taken into account in making assessments of the cost-effectiveness of various forms of innovation support. Finally, another aspect of innovation which is often overlooked is the non-R&D, non-public research element of innovation and that is organisational innovation—what needs to happen to improve the management of our organisations to achieve productivity growth. The London School of Economics and a team with which I was involved—sorry, was someone wanting to say something?

CHAIR —No, Professor Green, we were listening carefully.

Prof. Green —I heard something in the background. Just to complete that: the importance of organisational innovation should also be stressed in this context and the role of management. There was a study recently by the London School of Economics, and we participated in that from the Australian end with Australian data showing the enormous impact of improving management of our organisations and its impact on productivity. I know that this committee’s inquiry is about R&D, in particular, in relation to the tax credit. I am happy to talk about that, even though I must stress that I am not a tax expert—I am coming to it as an economist. I am happy to talk about the tax credit but in the context of this broader approach to innovation which has to be underpinning the government’s agenda.

CHAIR —Thank you, Professor Green. I think we have had a good deal of support from submissions regarding the tax thresholds and the changes to the tax law. I think it is fair to say that a lot of the criticism about the bill in specific instances is around this idea of the development and the processing of research and the dominant purpose clause that has been introduced. Do you have any comment about that? Are you aware of these criticisms?

Prof. Green —I am aware of the criticisms. I was concerned initially when the changes were announced that this was not an exercise to cut the resources aimed at the scheme in the guise of shifting resources from one group to another. Having looked closely at the changes, I think that they are positive ones. Even though they will disadvantage some areas that are currently gaining from the existing scheme, they will favour others. I would like to quote briefly from this new document Ingenious Britain which goes right to this issue. They have had that debate in Britain recently. Let me read this out. You will find this on the web and I am happy to send you the link:

The current system is well intentioned but not well targeted. It needs to be reinforced if we are to secure the future of the UK as a high tech hub. Too much money currently goes to the wrong companies and too little to the right companies. It needs to be refocused to those companies where the barriers to a sustained R&D programme are greatest and the potential spill overs to the rest of the economy are greatest. That means high tech companies, small businesses and start-ups.

We are not the only country having this debate. I think the current amended draft exposure bill, or whatever the title currently is, alleviates concerns about the tightening up of some of those criteria. There is still some definitional way to go in relation to what is in fact R&D and the Ingenious Britain report—and I would agree with this as well—advocates a broad view of what is meant by R&D. In fact, Singapore is taking its R&D tax credit and turning it into an innovation and productivity tax credit. Some countries are including design training and intellectual property protection.

It is important for us not to constrain what is meant by R&D, but I do support the move to something like dominant purpose and also that ventures should be innovative and risky. I think that is essential to getting those smaller companies out on the cutting edge that wish to participate. I might add that another recommendation of this Dyson report, which I think will be very important if we are shifting the focus to smaller companies and to ones that are taking risks, is that those are precisely the companies that cannot spend a lot of time filling in forms. The kind of system that finally emerges from these inquiries and from the government’s deliberations has to be one that is accessible and user friendly for those companies.

CHAIR —Part of the criticism has been that this will affect particular sectors, among them manufacturing, but also mining and construction. Do you see that as being a consequence of this bill?

Prof. Green —Not necessarily. It depends almost entirely on what the companies are doing. The point is that, if they are doing R&D that is risky and innovative, it should be covered by the terms of the new scheme. As I said, I am not a tax expert and I am not an expert on the application of the R&D measures. But provided that companies are undertaking R&D within what I hope will be a broad definition, they ought to be eligible for such return, but it may not be simply return for business as usual. Continuing return by the government scheme to companies that are simply replicating what they do from one year to the next at the expense in the end—we have to bear in mind in a limited resources environment—of companies that are trying to do something new but that do have not got access to the scheme, I think is probably against what most people would consider to be good public policy and good use of public resources.

CHAIR —I think you have been very strong in the past on development and improvement of processes, particularly in manufacturing but also in other areas. There was some criticism from Dr Chris Roberts of Cochlear that the emphasis on this bill was on the research side and not on development. Would you concur? Do you think there is any query about this bill on that?

Prof. Green —If that is what Chris Roberts is saying I would be concerned because obviously he is one of our leading entrepreneurs and a leading R&D participant in a very successful company. I think any committee would be well advised to heed his comments. I do not know whether that necessarily is the impact. I think he is probably firing a warning shot to say, ‘Make sure the definition of R&D includes the D.’ It has to be innovative and risky and development can be—in Cochlear’s case it could well be. He is making that point hoping no doubt that those definitions will be such that his R&D efforts can be included.

But he has to make sure that, even if the definition of R&D is sufficiently broad, the nature of the activity in which he is engaged is genuinely risky and innovative activity and is not just turning over an R&D budget from one year to the next, which companies can do. It is undoubtedly useful if we had more generous resources to do so. I think that, if more resources were available, we could include everyone in this scheme who is currently receiving it plus an additional element. Unfortunately, if the scheme is limited and we want to include companies that currently are not getting access, there has to be some tightening up of the criteria for those who are currently receiving it. I hope that Cochlear is not one of those that misses out.

CHAIR —Thank you. I will go now to Senator Eggleston.

Senator EGGLESTON —Thank you very much. I was very interested in your remarks supporting this proposal. Earlier this morning we heard from the Australian Industry Group and they were quite critical of this proposal. They suggested that business will scale back expenditure rather than increase expenditure on research. They said that the government apparently intends to restrict research and development to research and that this legislation should be renamed the ‘research tax credit’, and that it does not deal with experimental development, which is what the business of research and development is all about. What do you say to those remarks, in view of your own comments?

Prof. Green —I do not see that that should necessarily be the case. The development aspects and experimentation will I guess be the result of the formal definition of R&D when it emerges from the government. I have not seen that yet so I really cannot comment. I am not sure whether anyone else can comment either except to say that is what they want to see included in the definition, and that undoubtedly puts pressure on the government to do so. But in relation to the resources allocated to the scheme, looking at the budget papers an increase is budgeted for to about $1.5 billion. From my point of view I am satisfied that this is not a scheme that is attempting to cut costs in this area; it is continuing to budget for increases with some changed definitions, criteria and targets. It is premature, for me anyway, to comment on the definition of R&D and I am not sure that anyone can until they see it.

Senator EGGLESTON —Would you suggest that the British definition to which you referred might be something that this government in Australia could consider?

Prof. Green —I am sorry, I missed that, Senator.

Senator EGGLESTON —In your opening remarks you referred to the new UK government report on tax concessions entitled Ingenious Britain. Does that contain a definition of research and development?

Prof. Green —It contains a proposition about what it would like to see covered in research and development, and it is extremely broad. It also refers to schemes that are moving the tax credit to something like 200 per cent, and it advocates a huge increase to that level. I cannot imagine that the UK government would entirely accept those recommendations, but there is no harm in a document like that being very ambitious. But it certainly advocates—and you would expect this from James Dyson—that R&D includes areas like design. If we are looking at the link that we are trying to make in public policy now increasingly between manufacturing and design, does this count as R&D? I would hope that it does. That is the nature of the broad definition, including experimentation and prototyping.

Senator EGGLESTON —I have one last question. This bill changes the requirement that intellectual property should remain in Australia. Do you have any comment on that?

Prof. Green —I think essentially this is recognising that we are part of international markets and international supply chains and that IP is something that is now much more fluid. I think, with care, that proposition could be accepted with the government reviewing it maybe after two or three years of activity to see exactly to what extent it has resulted in benefits domestically. It is a bit of a risk for us in public policy but I think, given the globalisation of R&D, it is something we should try out to see what the impact might be.

Senator EGGLESTON —But you said it is a bit of a risk and it should be reviewed after a period of time.

Prof. Green —I think it should be reviewed to see exactly to what extent it has stimulated the R&D effort in Australia and has not necessarily resulted in R&D being eroded or being located abroad.

Senator EGGLESTON —Thank you.

CHAIR —Senator Cameron?

Senator CAMERON —Professor Green, I have just been having a quick look at the Ingenious Britain report. I must say that I am not an expert; I am just scanning it after you advised me about it. One of the arguments that is put by the report is that 25 per cent of government research and development should go to early-stage high-tech small to medium enterprises. One of the problems that has been identified is that there is an industry hanging off the research and development funding in Australia. That industry of consultants actually skews the amount of public funding heavily towards the big end of town. Big companies and big businesses are accessing the bulk of the R&D. This legislation is attempting to change that. I would like your comment on whether you think the legislation goes far enough in changing it back to what the Dyson report is saying.

Prof. Green —I agree with those comments. In introducing any change, those who are receiving resources are bound to make the most noise, and those who are about to receive benefits do not know it yet and therefore are not necessarily part of the constituency for change. That is the problem of all change and transition in any scheme, and this is no exception. Whether we go far enough with this scheme I cannot really say, but it think it is a move in the right direction. I take your point that there is an industry of consultants who have an interest in the current arrangements and who will make their point of view very well known.

But I think the problem in introducing the scheme is that all of those struggling and vibrant entrepreneurial businesses that will gain from it are not aware of it yet. In order to make them aware of it there will have to be—and this is the point in Dyson’s report as well—a lot of public awareness raising for those companies that these are the companies that we want to focus on for the future of the country to develop those companies and to ensure that they succeed. As I said at the beginning, an R&D tax credit is only part of that story; there has to be a whole ecosystem of support for companies that want to get to the next stage.

In my position at a business school I see so many great ideas out there—we are an ingenious country too—but we do not follow through the implications of that and we do not support early stage companies to the extent that other countries do. We see so many bright ideas and, in particular, so many young individual entrepreneurs failing after a year or two of activity, not necessarily through their own failure. Sometimes it is, of course, and sometimes it is simply a lack of skills, which is another aspect of all this, but there is also a lack of nurturing of companies at early stages. The R&D tax credit ought to be part of this broader ecosystem.

Senator CAMERON —I think the other report to which you referred was the Haskel report from Imperial College. Is that correct?

Prof. Green —That is correct, yes.

Senator CAMERON —I had a quick look at that and one of the key recommendations there is that, even though some of the R&D in the UK is well-intentioned, it is not well targeted, and that the spillovers are greatest in high-tech, small start-up companies. That seems to link with the Dyson report which states that 25 per cent of government R&D should go to early stage, high-tech SMEs. Examples that have been discussed with the committee are, for instance, in the resource sector, core R&D worth $20 million has been turned into a $500 million claim when it is linked to mining operations. Do you think the legislation does enough to make sure that we focus on where the spillover to the community and industry are the strongest? Do we do enough in this legislation and are we doing enough to stop some of the rorting that has been reported?

Prof. Green —I am not sure whether we are doing enough. I think that is why I refer to the broader ecosystem which encourages both the early stage ventures and the spillover impact of R&D tax credits in the broader knowledge community. I certainly take the point that is made in the Haskel report that in the way the R&D tax concessions were structured in Britain, and this is a retrospective look at the experience in Britain over 20 years, the money going into public research through the research councils was having far greater impact—more bang for its buck, as Haskel pointed out when the research was being launched—than the R&D tax arrangements as they were previously structured. So Britain has spent some time trying to target its R&D tax arrangements and there is still some way to go for them as well.

All I can say is that ours suffer from the same defects and they are moving in the right direction now with this legislation. I think there were some anomalies in the original draft, and I think the government has tried to address those, and there may still be more that we could do. At a minimum—it is hard to get everything through the House of Representatives and the Senate, as we know, in one bite—if we just focus on tightening the criteria, reorganising the access to resources, encouraging awareness, and placing this tax credit in the broader innovation public policy environment so that it is linked to other measures that encourage new ventures, start-ups and SMEs without detracting from legitimate claims from larger organisations, I think this policy will have made an important contribution.

CHAIR —Senator Bushby?

Senator BUSHBY —Professor Green, I am a little confused by your opening statements and some of the comments that you made about not seeing a definition of R&D. Have you seen the final bill as introduced to the House of Representatives?

Prof. Green —I have not seen the definition of R&D in that, if that is what you are referring to.

Senator BUSHBY —From what I understand from the evidence that we have received, the definition, including the dominant purpose test et cetera, was finally put forward sometime in late April as part of that bill. From my assessment, that is where it appears that most of the current concerns arise in respect of this legislation. This morning we heard from Cochlear and the Australian Industry Group, and yesterday we heard from a number of tax specialists and specialist advisers in R&D tax who have raised this point as a concern. Coming back to the comment you made earlier, you said that it appears on paper to preclude a lot of the D—the ability to attract tax credits out of R&D. Given those concerns are based largely around the definition and the terms in which it is finally being presented, which came out only a few weeks ago, there has been little opportunity for consultation. That is where most of the concerns have arisen.

Prof. Green —I see. I was under the impression that the government had yet to define more clearly what the scope of R&D was, but perhaps I have missed something.

Senator BUSHBY —Maybe I am missing something, but I am just giving you an opportunity to comment. That definition of R&D seems to be where most of the concerns raised by those involved in R&D activities are arising. I acknowledge that the way in which it is defined in the legislation is quite different from the intent as outlined to us by Treasury officials. But the words that are written down in the legislation raise serious concerns in relation to what impact that may have on the ability of companies to claim for their experimental development as they take their research from an academic level and try to put it into production.

Prof. Green —Yes. I can only really comment in principle as I do not have the words in front of me. I would certainly advocate, as I have just done in the context of the Dyson report, that in experimentation prototyping the D element of R&D is an important aspect of the definition. I would be surprised and concerned if that were not to be part of a final scheme.

Senator BUSHBY —Yesterday Treasury officials basically said that to pay for the higher rates of the tax credits we needed to narrow the base. Quite clearly, there is a policy intention to narrow the base and the activities for which you can claim these credits in order to pay for the higher rates and the greater focus on small and medium enterprises. We have also heard evidence that there are a number of ways this could have been done to keep the overall range of measures revenue neutral, including potentially capping the amount that is payable or, alternatively, introducing a ratio between direct R&D and supporting R&D to ensure that you do not have the big blowouts in supporting R&D, and other potential options that could have done that. But they appear to have gone down the path of narrowing the definition or taking a more narrow approach to R&D rather than the broad approach to R&D that, as you mentioned, Ingenious Britain thinks you should take. If that is the case, is that a concern?

Prof. Green —I think an inevitable part of the transition is that there will be some narrowing and tightening of criteria in relation to aspects of R&D criteria, not necessarily in the definition of R&D itself but in relation to what is risky, what is innovative and what is the purpose of the exercise. That tightening, if there are to be resources for companies that have not accessed it before, is an inevitable part of what we are doing. In an ideal world, of course, and without Treasury looking over our shoulders, I guess one would say, ‘Let us take what we have at present and add to it.’ In a resource constrained environment that is not possible, so governing is about choice. If a choice is to be made I would certainly be one of those who would advocate that some of those larger companies that have accessed resources on a habitual basis in the past may have to lose some of that in order that newer companies with newer ideas can access it. I think that is just a point of principle. We can argue about the means by which that comes about, and you mentioned several options. I guess tightening the criteria is one of them. As long as that is done cleverly and accurately, it will achieve a purpose.

Senator BUSHBY —I guess that is the question: will it be done cleverly and accurately? None of the evidence we have received suggests that there is any opposition to addressing abuse of the system. That is an appropriate thing to be doing and it is a good time to have a look and freshen up the way we approach these things to make sure that does not happen. Most of the objection comes from the fact that the way it appears to be written in the bill will narrow the definition of R&D and remove the ability for companies that are undertaking legitimate R&D activities, in particular, the development side of the R&D, to access the tax credits, and that the choice has been made to do that rather than some of the alternative ways that we might have limited the expenditure to pay for the shift to the smaller companies.

Prof. Green —As I said, I cannot comment on the detail, as I am not part of the tax expert group that you have been calling in to give other evidence. I am looking at it from the broader issue of public policy and the application of principles. But I certainly take your point that, if it does narrow R&D in an illegitimate way—and that excludes legitimate R&D, including the D part of experimentation and other forms of development—I would be concerned. I cannot say it would be the case precisely without seeing what the final definition of the bill will look like. But I can certainly see that companies might have some concern if they saw that that area of their activity was going to be eliminated from consideration for these tax credits.

CHAIR —Thank you, Professor Green, for participating this morning. Thank you for your evidence.

Prof. Green —Thank you for having me.

[11.07 am]