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Economics Legislation Committee—Standing Committee—Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 [Provisions]—Report, dated October 2020


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October 2020

The Senate

Economics Legislation Committee

Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 [Provisions]

© Commonwealth of Australia

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iii

Members

Chair Senator Slade Brockman LP, WA

Deputy Chair Senator Alex Gallacher ALP, SA

(Member from 2 July 2019 to 5 February 2020. Deputy Chair from 4 July 2019 to 5 February 2020. Member from 16 June 2020. Deputy Chair from 17 June 2020)

Senator Kimberley Kitching ALP, VIC

(Member from 5 February 2020 until 16 June 2020. Deputy Chair from 6 February 2020 until 16 June 2020)

Members Senator Andrew Bragg LP, NSW

Senator Jenny McAllister ALP, NSW

Senator Susan McDonald NATS, QLD

Senator Rex Patrick IND, SA

Participating members Senator the Hon. Kim Carr ALP, VIC

Senator Sarah Hanson-Young GREENS, SA

Senator Louise Pratt ALP, WA

Senator Whish-Wilson GREENS, TAS

Senator Janet Rice GREENS, VIC

Senator Stirling Griff CA, SA

Secretariat Mr Mark Fitt, Committee Secretary Mr James Strickland, Principal Research Officer Mrs Taryn Morton, Administrative Officer

PO Box 6100 Phone: 02 6277 3540

Parliament House Fax: 02 6277 5719

Canberra ACT 2600 Email: economics.sen@aph.gov.au

v

Contents

Members ............................................................................................................................................. iii

Chapter 1—Introduction .................................................................................................................... 1

Referral of the inquiry ......................................................................................................................... 1

Purpose of the bill ................................................................................................................................ 1

Background ........................................................................................................................................... 2

The 2011 commencement of the RDTI ................................................................................... 2

The 2015-16 Three Fs review of the RDTI ............................................................................. 3

The 2018-19 Budget proposal to reform the RDTI ............................................................... 4

The current proposal to reform the RDTI.............................................................................. 6

Provisions of the bill ............................................................................................................................ 7

Schedule 1—Better targeting the R&D Tax Incentive .......................................................... 8

Schedule 2—Enhancing the integrity of the R&D Tax Incentive ..................................... 11

Schedule 3—Improving the administration of the R&D Tax Incentive .......................... 14

Government consultation ................................................................................................................. 16

Commencement of the bill ................................................................................................................ 17

Financial impact ................................................................................................................................. 17

Regulatory impact .............................................................................................................................. 17

Legislative scrutiny ............................................................................................................................ 17

Retrospective application ...................................................................................................... 17

Broad delegation of administrative powers ........................................................................ 18

Conduct of the inquiry ...................................................................................................................... 19

Budget 2020-21—JobMaker Plan—Research and Development Tax Incentive—supporting Australia’s economic recovery measure .............................................................................. 19

Acknowledgements ........................................................................................................................... 19

Chapter 2—Views on the bill.......................................................................................................... 21

Senate Economics Legislation Committee's 2018 bill inquiry ...................................................... 21

General views on R&D policy within Australia ............................................................................ 22

Better targeting the RDTI .................................................................................................................. 24

Increasing the expenditure threshold .................................................................................. 26

Extending eligibility to unincorporated businesses ........................................................... 27

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RDTI for small entities ........................................................................................................... 28

RDTI for large entities ............................................................................................................ 29

Budget 2020-21—JobMaker Plan—Research and Development Tax Incentive— supporting Australia’s economic recovery measure .............................................. 30

Committee view ................................................................................................................................. 31

Labor Senators Additional Comments ......................................................................................... 33

Appendix 1—Submissions and additional information ........................................................... 45

Appendix 2—Public hearing and witnesses ................................................................................ 51

1

Chapter 1 Introduction

Referral of the inquiry 1.1 The Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 (the bill) was introduced into the House of Representatives and read a first time on 5 December 2019.1

1.2 On 6 February 2020, the Senate referred the provisions of the bill to the Senate Economics Legislation Committee (the committee) for inquiry and report by 30 April 2020.2 This date was later extended to the 12 October 2020.

Purpose of the bill 1.3 The bill's Explanatory Memorandum (EM), has three core objectives:

 better target the Research and Development Tax Incentive (the RDTI);  enhance the integrity of the RDTI; and  improve the administration of the RDTI.3

1.4 The bill comprises three schedules, with each focusing on a specific objective:

 Schedule 1 reforms the RDTI to better target the incentive and improve its effectiveness and integrity.4  Schedule 2 aims to enhance the integrity of the RDTI by ensuring that R&D entities cannot obtain inappropriate tax benefits and by clawing back the

benefit of the RDTI to the extent an entity has received another benefit in connection with an R&D activity.5  Schedule 3 aims to improve the administrative framework supporting the RDTI by making information about R&D expenditure claims transparent,

enhancing the guidance framework to provide certainty to applicants and streamlining administrative processes.6

1.5 In his second reading speech, the Hon. Josh Frydenberg MP, Treasurer of the Commonwealth of Australia, stated:

Today the government is reintroducing legislation to reform the research and development tax incentive—reforms that will ensure that the tax

1 Votes and Proceedings, No. 35, 5 December 2019, p. 587.

2 Journals of the Senate, No. 38, 6 February 2020, pp. 1247-1250.

3 Explanatory Memorandum, p. 3.

4 Explanatory Memorandum, p. 3.

5 Explanatory Memorandum, p. 3.

6 Explanatory Memorandum, p. 3.

2

incentive remains an effective and sustainable part of Australia's overall support for R&D.

…the existing flat premium available to companies with an annual turnover above $20 million is being changed to one that increases as a company's R&D intensity increases. This will provide an incentive for companies to increase their R&D expenditure.

Relative to the bill introduced in the previous parliament, the intensity test has also been simplified, with a three-tier test replacing the previous four-tier system.

…the maximum amount of R&D expenditure eligible for concessional R&D tax offsets will increase from $100 million to $150 million per annum. This gives the largest investors in R&D an incentive to keep their R&D activities in Australia.

In better targeting and improving the integrity and sustainability of the research and development tax incentive, the reforms in this bill will ensure that the incentive remains an important part of the government's overall support for research and development in Australia.7

Background

The 2011 commencement of the RDTI 1.6 In the 2009-10 Budget, the Rudd government announced it would replace the existing Research and Development Tax Concession with the RDTI.8

1.7 Treasury's 2009 consultation paper provided the following description of the proposed measure:

The new R&D tax incentive will be more effective in delivering support for business R&D and in targeting that support to where it is most likely to produce net-benefits for the Australian community.9

As recommended by the Review of the National Innovation System (the NIS Review), the existing scheme of enhanced deductions will be replaced with less complex and more predictable tax credits. Companies will no longer need to distinguish between their base and incremental expenditure on R&D in working out their claim. It is the location of R&D activity in Australia that will count under the new scheme rather than where the resulting intellectual property (IP) rights reside.10

1.8 The RDTI commenced on 1 July 2011 and, as per the EM, its original purpose was to encourage R&D activities that might not otherwise occur and which

7 The Hon. Josh Frydenberg MP, Treasurer of the Commonwealth of Australia, House of

Representatives Hansard, 5 December 2019, p. 7061.

8 Department of the Treasury, 2009-10 Budget—Budget Paper No. 2: Budget Measures, p. 361.

9 Department of the Treasury, The new research and development tax incentive—consultation paper,

September 2009, p. 2.

10 Department of the Treasury, The new research and development tax incentive—consultation paper,

September 2009, p. 2.

3

would likely have wider benefits, such as positive externalities, for the Australian economy.11

1.9 The RDTI currently consists of two core components. They are the:

 43.5 per cent refundable tax offset available to most small R&D entities—i.e. those with aggregated turnovers of less than $20 million; and the  38.5 per cent non-refundable tax offset available to larger R&D entities and R&D entities controlled by one or more exempt entities.12

1.10 The RDTI is subject to a $100 million expenditure threshold.13 Expenditure on R&D activities in-excess of $100 million is not eligible for the full rate of the relevant R&D tax offset. Instead, these notional deductions give rise to an offset at the R&D entity's corporate tax rate.14

The 2015-16 Three Fs review of the RDTI 1.11 In December 2015, the Turnbull Government commissioned a review of the RDTI as part of its National Innovation and Science Agenda.15 The review panel was chaired by the then Chair of Innovation and Science Australia (ISA),

Mr Bill Ferris AC; Australia's Chief Scientist, Dr Alan Finkel AO; and the then Secretary to the Treasury, Mr John Fraser.

1.12 The review is often referred to by stakeholders as the 'Three Fs Review'. The purpose of the review was to 'identify opportunities to improve the effectiveness and integrity of the RDTI, including by sharpening its focus on encouraging additional R&D spending'.16

1.13 The review panel and supporting taskforce conducted stakeholder consultations with companies, peak industry entities, research institutions, reference groups, and policy makers. The review received 92 submissions.17

1.14 The review panel found that the 'programme falls short of meeting its stated objectives of additionality and spill-overs', and made six recommendations to

11 Explanatory Memorandum, p. 5.

12 Explanatory Memorandum, p. 5.

13 Explanatory Memorandum, p. 6.

14 Explanatory Memorandum, p. 6.

15 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, p. 1.

16 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, p. 1.

17 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, p. 1.

4

be considered as a package of measures to improve the overall effectiveness and integrity of the programme while encouraging additional R&D.18

1.15 A short summary of the review's recommendations is set out below:

 Recommendation 1—Retain the current definition of eligible activities and expenses under the law, but develop new guidance, including plain English summaries, case studies and public rulings, to give greater clarity to the scope of eligible activities and expenses.

 Recommendation 2—Introduce a collaboration premium of up to 20 per cent for the non-refundable tax offset to provide additional support for the collaborative element of R&D expenditures undertaken with publicly-funded research organisations.

 Recommendation 3—Introduce a cap in the order of $2 million on the annual cash refund payable under the R&D tax incentive, with remaining offsets to be treated as a non-refundable tax offset carried forward for use against future taxable income.

 Recommendation 4—Introduce an intensity threshold in the order of 1 to 2 per cent for recipients of the non-refundable component of the R&D tax incentive, such that only R&D expenditure in excess of the threshold attracts a benefit.  Recommendation 5—If an R&D intensity threshold is introduced, increase

the expenditure threshold to $200 million so that large R&D-intensive companies retain an incentive to increase R&D in Australia.  Recommendation 6—That the government investigate options for improving the administration of the R&D tax incentive (e.g. adopting a

single application process; developing a single programme database; reviewing the two-agency delivery model; and streamlining compliance review and findings processes) and additional resourcing that may be required to implement such enhancements. To improve transparency, the government should also publish the names of companies claiming the R&D tax incentive and the amounts of R&D expenditure claimed. 19

1.16 The bill's EM notes that the current reforms to the RDTI are made in response to the above recommendations made by the Three Fs Review in 2015.

The 2018-19 Budget proposal to reform the RDTI 1.17 Following the review, the Turnbull Government announced in the 2018-19 Budget that 'the Government will amend the research and development (R&D) tax incentive to better target the program and improve its integrity and fiscal

18 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, p. 1.

19 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, pp. 2-4.

5

affordability in response to the recommendations of the 2016 Review of the R&D Tax Incentive'.20

1.18 The key reforms announced during the budget were:

 For companies with aggregated annual turnover of $20 million or more, the government will introduce an R&D premium that ties the rates of the non-refundable R&D tax offset to the incremental intensity of R&D expenditure as a proportion of total expenditure for the year.

 The R&D expenditure threshold—the maximum amount of R&D expenditure eligible for concessional R&D tax offsets, will be increased from $100 million to $150 million per annum.

 For companies with aggregated annual turnover below $20 million, the refundable R&D offset will be a premium of 13.5 percentage points above a claimant’s company tax rate. Cash refunds from the refundable R&D tax offset will be capped at $4 million per annum. R&D tax offsets that cannot be refunded will be carried forward as non-refundable tax offsets to future income years.  Implementing stronger compliance and administrative improvements, such

as increasing resourcing for the Australian Taxation Office and Department of Industry, Innovation and Science, which will be used to undertake greater enforcement activity and provide improved program guidance to participants. 21

1.19 The Treasury subsequently undertook a consultation process on the draft legislation from 28 June 2018 to 26 July 2018 which implemented the government's reforms and received 76 submissions during this process.22

1.20 On 20 September 2018, the Assistant Treasurer, the Hon. Stuart Robert MP, introduced the Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 (the prior bill) into the House of Representatives.

1.21 The prior bill was an omnibus bill and, amongst other reforms, contained the Turnbull government's proposed reforms to the RDTI.

Senate Economics Legislation Committee's inquiry into the prior bill 1.22 On 18 October 2018, the Senate referred the provisions of the prior bill to the committee for inquiry and report.23 The committee held three public hearings and received 75 submissions. The committee held the following view:

20 Department of the Treasury, 2018-19 Budget—Budget Paper No. 2: Budget Measures, p. 21.

21 Department of the Treasury, 2018-19 Budget—Budget Paper No. 2: Budget Measures, pp. 21-22.

22 Department of the Treasury, Research & Development Tax Incentive Amendments,

https://treasury.gov.au/consultation/c2018-t289033 (accessed 25 April 2020).

23 Journals of the Senate, No. 125, 18 October, p. 3994.

6

The committee notes the findings of the 2016 Review of the R&D tax incentive [the Three Fs Review], in particular that the R&D tax incentive program falls short of meeting its stated objectives of additionality and spill-overs. On balance the committee supports this bill in its intent to address this issue.

The committee was pleased to hear that the R&D tax incentive program had had a positive impact on many Australian businesses and researchers.

On examination of the proposed $4 million cap on the refundable tax offset, the committee believes that it would benefit from some finessing to ensure that R&D entities that have already made investment commitments are not impeded unintentionally.

The committee also notes the concerns raised by participants in relation to the calculation of the proposed intensity premium. The committee shares participants' concerns that this intensity measure may have unintended consequences for larger R&D entities undertaking eligible R&D activities.

The committee considers that, as currently drafted, the proposed intensity measure has possible unintended consequences that may disadvantage a range of Australian R&D entities.24

1.23 In its final report to the Senate on 11 February 2019, the committee made the following recommendations in relation to the RDTI:

The committee recommends that the Senate defer consideration of the bill until further examination and analysis of the impact of schedules 1-3 [the schedules related to the RDTI] is undertaken. In particular, the committee recommends that:

 the approach to the cap on the refundable portion of the Research and Development (R&D) tax incentive is refined, noting investment decisions already taken; and  the formula for R&D intensity is refined, noting inherent differences in

R&D intensity across industries and impacts on businesses with large operating costs.25

1.24 On 11 April 2019, the earlier iteration of the bill lapsed when the 45th Parliament was prorogued by the Governor-General.26

The current proposal to reform the RDTI 1.25 On 5 December 2019, the bill was introduced into the House of Representatives and read a first time.

24 Senate Economics Legislation Committee, Treasury Laws Amendment (Making Sure Multinationals

Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 [Provisions], February 2019, p. 32.

25 Senate Economics Legislation Committee, Treasury Laws Amendment (Making Sure Multinationals

Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 [Provisions], February 2019, p. 34.

26 See https://www.aph.gov.au/senators_and_members/senators/senate_composition, (Accessed

11 March 2020).

7

1.26 The bill contains very similar clauses to the prior bill, which lapsed at the end of the 45th Parliament, with the key difference being made to the intensity thresholds.

1.27 Specifically, the number of intensity thresholds [Tiers] and their associated rates were amended as shown in Tables 1.1 and 1.2 below.

Figure 1.1 Prior bill's intensity thresholds

Tier

R&D intensity range

Intensity premium

1 National deductions representing up to

and including 2 per cent of total expenses 4 percentage points

2 Notional deductions representing greater than 2 per cent and up to and including 5 per cent of total expenses

6.5 percentage points

3 Notional deductions representing greater than 5 per cent and up to and including 10 per cent of total expenses

9 percentage points

4 Notional deductions representing greater than 10 per cent of total expenses 12.5 percentage points

Source: Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018, Explanatory Memorandum, p. 17.

Figure 1.2 Current bill's intensity threshold

Tier R&D intensity range Intensity premium

1 Notional deductions representing up to and including 4 per cent of total expenses 4.5 percentage points

2 Notional deductions representing greater than 4 per cent and up to and including 9 per cent of total expenses

8.5 percentage points

3 Notional deductions representing greater than 9 per cent of total expenses 12.5 percentage points

Source: Explanatory Memorandum, p. 13.

8

Provisions of the bill

Schedule 1—Better targeting the R&D Tax Incentive

Summary of the new law 1.28 Schedule 1 to the bill aims to better target the RTDI and improve its effectiveness and integrity. It does this through:

 increasing the R&D expenditure threshold from $100 million to $150 million, and making the threshold a permanent feature of the law;  linking the R&D tax offset for refundable R&D tax offset claimants to claimants' corporate tax rates plus a 13.5 per cent point premium;  capping the refundability of the R&D tax offset at $4 million per annum27;

and

 increasing the targeting of the Incentive to larger R&D entities with high levels of R&D intensity, reducing the benefits provided to certain entities undertaking R&D activities and increasing the benefit to others.28

1.29 Table 1.3, below shows a comparison of the current law with the new law, as proposed by the bill.

Figure 1.3 Comparison of key features of new law and current law

New law Current law

The expenditure threshold

The R&D expenditure threshold is increased to $150 million The R&D expenditure threshold applies to eliminate the incentive

component of the R&D tax offset in relation to notional deductions in excess of $100 million

The R&D expenditure threshold is a permanent feature of the law The R&D expenditure threshold is legislated to cease on 1 July 2024.

The R&D Tax Offset for small R&D entities

R&D entities with aggregated turnover of less than $20 million are generally entitled to an R&D tax offset rate equal to their corporate tax rate plus a 13.5 per cent premium

R&D entities with aggregated turnover of less than $20 million are generally entitled to an R&D tax offset rate of 43.5 per cent.

27 Note that, per the EM, the offset amounts that relate to expenditure on clinical trials do not count

towards the cap.

28 Explanatory Memorandum, p. 7.

9

The amount of a refund that an R&D entity can receive is capped at $4 million per annum

Offset amounts that relate to expenditure on clinical trials do not count towards the cap and remain refundable.

R&D entities with aggregated turnover of less than $20 million are entitled to a tax refund for any R&D tax offset they receive in excess of their income tax liabilities

The R&D Tax Offset for large R&D entities

R&D entities with aggregated turnover of $20 million or more are entitled to an R&D tax offset equal to their corporate tax rate plus a premium based on the level of their incremental R&D intensity for their R&D expenditure

R&D entities with aggregated turnover of $20 million or more are entitled to a non-refundable R&D tax offset at a rate of 38.5 per cent.

Source: Explanatory Memorandum, p. 9.

Detailed explanation of the new law

Increasing the expenditure threshold 1.30 As per the EM, the $50 million increase will allow entities to claim additional amounts of concessional tax offsets on R&D activities, and promote large R&D entities to continue to engage in these activities when their expenditure

exceeds $100 million.29

1.31 The current law provides that the expenditure threshold will cease on 1 July 2024 and requires the government to conduct a review of the threshold after 5 March 2020. The bill repeals this requirement and makes the threshold a permanent feature of the law.30

The refundable R&D tax offset for small R&D entities 1.32 An R&D entity with aggregated turnover of less than $20 million for an income year is generally entitled to a refundable tax offset equal to their corporate tax rate plus 13.5 per cent.31

1.33 This refundable offset does not apply to an R&D entity controlled by one or more exempt entities. These R&D entities are instead entitled to the

29 Explanatory Memorandum, p. 10.

30 Explanatory Memorandum, p. 10.

31 Explanatory Memorandum, p. 10.

10

non-refundable R&D tax offset available to R&D entities with aggregated turnover of $20 million or more.32

1.34 Only the first $4 million of any R&D tax offset is a refundable tax offset, and any excess amount must be carried forward as a non-refundable tax offset.33 Notwithstanding this, amounts of the R&D tax offset arising from R&D activities that form part of a clinical trial do not count towards the cap and, hence, may be included in a refundable tax offset.

1.35 The government's objective with this exemption is to incentivise clinical trials that have the potential to demonstrate net improvements to health outcomes.34

Intensity-based R&D tax offset for large R&D entities 1.36 R&D entities with aggregated turnover of $20 million or more for an income year are entitled to an R&D tax offset equal to their corporate tax rate plus marginal intensity premiums determined with reference to the R&D intensity

of their R&D expenditure on an incremental basis.35

1.37 The intensity premiums apply to notional deductions with a range of R&D intensity for R&D expenditure where notional deductions are expressed as a proportion of the R&D entity's total expenses.

1.38 To calculate the R&D tax offset, a large R&D entity must determine its R&D intensity. The R&D intensity is the proportion of the R&D entity's total expenses spent on R&D expenditure for the income year. This formula is shown in Figure 1.1 below.

Figure 1.4

Explanatory Memorandum, p. 14.

1.39 This formula intends to provide a higher rate of support for incremental R&D expenditure to entities that devote a significant portion of their overall operations to eligible support under the RDTI.36 Notional deductions in excess of the $150 million expenditure threshold do not attract an intensity premium

32 Explanatory Memorandum, p. 10.

33 Explanatory Memorandum, p. 10.

34 Explanatory Memorandum, p. 10.

35 Explanatory Memorandum, p. 13.

36 Explanatory Memorandum, p. 14.

11

and are not counted for the purposes of calculating an R&D entity's R&D intensity.37

1.40 Once an entity's R&D intensity is determined, the following intensity thresholds, shown in Table 1.4, are applied.

Figure 1.5

Tier R&D intensity range Intensity premium

1 Notional deductions representing up to and including 4 per cent of total expenses 4.5 percentage points

2 Notional deductions representing greater than 4 per cent and up to and including 9 per cent of total expenses

8.5 percentage points

3 Notional deductions representing greater than 9 per cent of total expenses 12.5 percentage points

Source: Explanatory Memorandum, p. 13.

Schedule 2—Enhancing the integrity of the R&D Tax Incentive

Summary of the new law 1.41 Per the EM, Schedule 2 of the bill aims to enhance the integrity of the RDTI by ensuring that R&D entities cannot obtain inappropriate tax benefits and by clawing back the benefit of the RDTI to the extent an entity has received

another benefit in connection with an R&D activity.38 It does this through:

 extending the general anti-avoidance rules in the tax law to R&D tax offsets directly;  making the rate at which the offset is recouped more accurate in situations where the offset would otherwise result in an additional or double benefit;

and

 making that rate at which deductible balancing adjustment amounts incorporate the RDTI more accurate.39

Figure 1.6

New Law Current Law

Schemes to obtain an R&D tax benefit

The Commissioner may also deny a tax benefit in the form of an amount The Commissioner may deny a tax benefit in the form of a deduction or

37 Explanatory Memorandum, p. 14.

38 Explanatory Memorandum, p. 19.

39 Explanatory Memorandum, p. 23.

12

of a refundable or non-refundable R&D tax offset that an R&D entity seeks to obtain from a tax avoidance scheme.

notional deduction that an R&D entity seeks to obtain from a tax avoidance scheme.

The uniform clawback rule

Recoupment amounts and feedstock adjustments give rise to an amount of assessable income equal to the grossed-up value of the incentive component of associated amounts of R&D tax offset.

Recoupment amounts are subject to a standalone tax of 10 per cent

One third of feedstock adjustments are included in an R&D entity's assessable income.

An amount is included in the assessable income of the R&D entity that received or is entitled to the R&D tax offset in relation to a recoupment amount or feedstock revenue received by a related entity.

In cases involving related entities, the entity receiving a recoupment is subject to recoupment tax.

In cases involving related entities, the R&D entity entitled to the R&D tax offset is subject to a feedstock adjustment if the related entity receives feedstock revenue.

Balancing adjustments for R&D assets

The R&D entity's assessable income is increased by an amount equal to the grossed-up value of the incentive component of the associated amounts of R&D tax offset.

For an R&D asset held only for R&D purposes where the balancing adjustment amount is included in the R&D entity's assessable income - the amount is generally increased by one third.

For an R&D asset held partially for

R&D purposes where the balancing adjustment amount is included in the R&D entity's assessable income - the R&D component of the amount is generally increased by one third.

Source: Explanatory Memorandum, p. 23.

Detailed explanation of the new law

Schemes to obtain an R&D tax benefit 1.42 Part 1 of Schedule 2 explicitly extends the concept of tax benefits in the general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to include the R&D tax offset. These amendments allow the

Commissioner of Taxation (the Commissioner) to apply Part IVA to prevent

13

R&D entities from being able to obtain tax benefits by entering into artificial or contrived arrangements to access a non-refundable or refundable R&D tax offset.40

1.43 Part IVA of the ITAA 1936 applies in situations where a scheme or arrangement is entered into in order to obtain a tax benefit. This allows the Commissioner to cancel the relevant tax benefit where the conditions under Part IVA are satisfied.41

The uniform clawback rule 1.44 Part 2 of Schedule 2 to the bill remakes and consolidates subdivisions 355-G and 355-H of the ITAA 1997 (about the clawback of R&D recoupments and feedstock adjustments respectively) into a new subdivision 355-G. This

subdivision also introduces a new uniform clawback rule that applies for recoupments, feedstock adjustments and balancing adjustment amounts that are included in an R&D entity’s assessable income. The amendments ensure that an R&D entity must disgorge the entire benefit of an R&D tax offset to the extent it (or a connected entity or an affiliate entity where appropriate) receives a recoupment amount, feedstock adjustment or assessable balancing adjustment because of the offset.42

Catch-up rule for R&D balancing adjustments 1.45 The amendments introduce a new catch-up rule for R&D assets. This rule provides an additional deduction to R&D entities when a deductible balancing adjustment amount arises for an R&D asset.43

1.46 The catch-up rule mirrors the uniform clawback rule but operates in reverse, providing a deduction in lieu of an amount of R&D tax offset forgone rather than including an amount in assessable income.44

1.47 As with the clawback amounts for balancing adjustments, there are four different catch-up amounts to cover R&D assets either wholly or partially used for R&D, assets held by R&D entities and those held by R&D partnerships. The catch-up amounts reflect the amount an R&D entity can ordinarily deduct for the balancing adjustment event.45

40 Explanatory Memorandum, p. 24.

41 Explanatory Memorandum, p. 25.

42 Explanatory Memorandum, p. 25.

43 Explanatory Memorandum, p. 32.

44 Explanatory Memorandum, p. 32.

45 Explanatory Memorandum, p. 32.

14

1.48 The catch-up amount rules replace provisions of the current law that sought to estimate the value of the R&D tax offset forgone or replace it with a new R&D tax offset entitlement, neither option giving rise to an accurate catch-up.46

Schedule 3—Improving the administration of the R&D Tax Incentive

Summary of the new law 1.49 Schedule 3 seeks to improve the administrative framework supporting the RDTI by making information about R&D expenditure claims transparent, enhancing the guidance framework and streamlining administrative processes.

A comparison of the current law and new law are shown in Table 1.6 below.

Figure 1.7

New Law Current Law

Transparency of R&D claimants and activities

As soon as practicable after the period of two years following the end of the financial year, the Commissioner must publish information about the R&D entities that have claimed national deductions for R&D activities, including the amount claimed.

No equivalent.

ISA determinations

The Board of ISA may also make determinations about the circumstances and ways in which it will exercise its powers, or perform its functions or duties in relation to the Incentive. These determinations are binding on the Board of ISA.

The Board or ISA may make findings specific to an R&D entity's circumstances, including whether certain activities of the entity are R&D activities.

Findings are binding on the Commissioner.

ISA delegations

The Board of ISA and its committees may delegate their powers to any member of the Australian Public Service staff assisting them.

The Board of ISA and its committees may delegate their powers to SES employees assisting them.

46 Explanatory Memorandum, p. 33.

15

Extensions of time

The Board's ability to grant an extension of time is subject to a cap of three months on the total extension available, unless the extension is granted to allow an applicant to wait for the outcome of a separate pending decision.

The Board of ISA must grant extensions of time for registrations and the provision of information of up to 14 days if it is necessary and may grant a longer period if an applicant's ability to meet the deadline is impaired by events outside the applicant's control.

Source: Explanatory Memorandum, p. 43.

Detailed explanation of the new law

Transparency of R&D claimants and expenditure 1.50 Two years after the relevant income year, the Commissioner is required to publish information about the R&D activities of R&D entities claiming the R&D tax offset. The government states this will improve public accountability

for R&D claimants and encourage voluntary compliance with the program, while balancing these objectives against the potentially commercially sensitive nature of the information being published.47

Innovation and Science Australia determinations 1.51 The Board of ISA may, by notifiable instrument, make a determination about how it will exercise its powers, and perform its functions and duties. However, a determination cannot relate to the exercise of powers, or the performance of

functions or duties, in a particular case or in relation to a particular R&D entity.48

1.52 The EM states that determinations seek to augment the existing program guidance by allowing the Board of ISA to publicly state its position on the application of its functions and its interpretation of the legislation, including the definition of R&D activities, the definition of clinical trials or any other administrative matters where specific guidance would reduce the compliance burden for R&D entities.49

1.53 The EM states this is intended to make compliance easier for R&D entities, as they will be able to better understand what is required to demonstrate eligibility for the R&D Tax Incentive.50

47 Explanatory Memorandum, p. 44.

48 Explanatory Memorandum, p. 45.

49 Explanatory Memorandum, p. 45.

50 Explanatory Memorandum, p. 46.

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Innovation and Science Australia delegations 1.54 The Board of ISA and its committees may delegate some or all of their functions to members of the Australian Public Service staff assisting the Board. The expansion of the delegations powers allows additional staff to be

delegated responsibility for a number of administrative program tasks.51

1.55 The EM states the current limit on the delegation power has proved to be impractical and a significant barrier to the Board of ISA carrying out its functions necessary to the operation of the RDTI.52

Extensions of time 1.56 Extensions of time granted under the Industry Research and Development Act 1986 (the IR&D Act) may relate to an application to register R&D activities, provide further information requested by the Board of ISA, a form to continue

registration as a research service provider or an application for review of a reviewable decision. An extension will apply on top of the time limits in the IR&D Act.53

1.57 The Board of ISA must not grant extensions of time under the IR&D Act in excess of three months. Restricting extensions to three months mitigates the risk that long extensions granted by the Board of ISA result in applications being accepted a number of years after the relevant R&D activities are undertaken.54

Government consultation 1.58 As part of the Turnbull Government's National Science and Innovation Agenda, the government undertook a review of the RDTI in 2016 (the 'Three Fs' Review). The panel and supporting taskforce conducted consultations with

companies, peak industry groups, research organisations, reference groups, and policymakers and sought submissions.55 Following the Three Fs Review, the Department of the Treasury undertook public consultation on its draft bill which was developed in response to the recommendations to the Three Fs Review.56

51 Explanatory Memorandum, p. 48.

52 Explanatory Memorandum, p. 48.

53 Explanatory Memorandum, p. 48.

54 Explanatory Memorandum, p. 48.

55 Mr Bill Ferris AC, Dr Alan Finkel AO, Mr John Fraser, Review of the R&D Tax Incentive,

4 April 2016, p. 1.

56 Department of the Treasury, Research & Development Tax Incentive Amendments

https://treasury.gov.au/consultation/c2018-t289033 (Accessed 6 March 2020)

17

1.59 It is not apparent that the government undertook further consultation to inform the changes to the 2018 bill,57 which appear in the current bill.

Commencement of the bill 1.60 All of the amendments made by the bill commence on the first

1 January, 1 April, 1 July, 1 July, or 1 October to occur after the day the Act receives Royal Assent.58

Financial impact 1.61 Per the EM, the amendments are estimated to have a gain to the budget of $1.8 billion over the forward estimates period; i.e. 2019-20 to 2022-23, included. Table 1.7 below shows this breakdown by fiscal year.

2019-20 2020-21 2021-22 2022-23

$175m $435m $585m $570m

Source: Explanatory Memorandum, p. 3.

Regulatory impact 1.62 The EM states that the bill is expected to result in an overall compliance cost increase, arising from minor changes to the registration and claims processes, as well as the initial adjustment to the new program.59 It estimates the total

average annual regulatory costs for businesses to be $26.3 million. 60

Legislative scrutiny 1.63 The Senate Standing Committee for the Scrutiny of Bills (Scrutiny Committee) drew Senators' attention to the comments it made in relation to the prior bill; i.e. Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair

Share of Tax in Australia and Other Measures) Bill 2018. These comments are discussed below.

Retrospective application

Committee's commentary 1.64 The Scrutiny Committee requested the Treasurer's advice as to why it is necessary to retrospectively apply proposed amendments under Schedules 1 and 2 to income years commencing on or after 1 July 2018, or to tax benefits

57 See Treasury Laws Amendment (Making Sure Multinationals Pay Their Fair Share of Tax in

Australia and Other Measures) Bill 2018. This bill lapsed upon prorogation of the 45th Parliament.

58 Explanatory Memorandum, p. 3.

59 Explanatory Memorandum, p. 4.

60 Explanatory Memorandum, p. 4.

18

derived on or after 1 July 2018, and whether any persons would be detrimentally affected by the retrospective application.61

Ministerial response 1.65 The reforms were announced on 8 May 2018 as part of the 2018-19 Budget in response to the 2016 Review of the R&D Tax Incentive. The reforms generally apply to income years commencing on or after 1 July 2018. Affected taxpayers

were aware of the reforms and the potential impact the reforms would have on the scope of the program from the date of the Budget announcement. An Exposure Draft of the legislation implementing the reforms was also released for public consultation prior to the 1 July 2018 application date.62

1.66 While the reforms may be important considerations for some taxpayers from 1 July 2018, taxpayers will only be expected to register for the program and lodge income tax returns under the reforms following the end of the income year, from 1 July 2019.63

Broad delegation of administrative powers

Committee's commentary 1.67 The Scrutiny Committee considered that it may be appropriate to amend the bill to require that the Innovation and Science Australia Board, or a committee appointed to advise the board, be satisfied that persons performing delegated

functions and exercising delegated powers have the expertise appropriate to the function or power delegated, and requests the Treasurer's advice in relation to this matter.64

Ministerial response 1.68 ISA is authorised to approve delegations under existing legislation and satisfy itself that persons performing delegated functions have the expertise appropriate to the function delegated as part of its approval processes.65

1.69 The proposed functions delegated under the amended powers include high-volume, low-risk functions, such as granting extensions of time to submit applications and requesting information on an application.66

61 Senate Standing Committee for the Scrutiny of Bills, Scrutiny Digest 12 of 2018, October 2018, p. 57.

62 The Hon. Stuart Robert MP, Assistant Treasurer, ministerial response to the Senate Standing

Committee for the Scrutiny of Bills, October 2018, p. 4.

63 The Hon. Stuart Robert MP, Assistant Treasurer, ministerial response to the Senate Standing

Committee for the Scrutiny of Bills, October 2018, p. 4.

64 Senate Standing Committee for the Scrutiny of Bills, Scrutiny Digest 12 of 2018, October 2018, p. 58.

65 The Hon. Stuart Robert MP, Assistant Treasurer, ministerial response to the Senate Standing

Committee for the Scrutiny of Bills, October 2018, p. 4.

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1.70 The Assistant Treasurer concluded that he did not consider an amendment to be necessary, or that it would contribute to the effective administration of the program in light of ISA's existing and proposed processes that support delegations.67

Conduct of the inquiry 1.71 The committee advertised the inquiry on its website and wrote to relevant stakeholders and other interested parties inviting submissions by close of business 6 March 2020. The committee received 93 submissions, which are

listed at Appendix 1.

1.72 The committee held a public hearing in Canberra at Parliament House on 29 July 2020.

1.73 A list of witnesses who appeared at each hearing can be found at Appendix 2.

Budget 2020-21—JobMaker Plan—Research and Development Tax Incentive—supporting Australia’s economic recovery measure 1.74 On 8 October 2020, the government announced, as part of the 2020-21 Budget further enhancements to its 2019-20 MYEFO measure Better targeting the

research and development tax incentive—refinements to support business R&D investment in Australia and help businesses manage the economic impacts of the COVID-19 pandemic and assist in the economy's recovery.

1.75 The new measure, JobMaker Plan—Research and Development Tax Incentive— supporting Australia’s economic recovery, supersedes this bill's provisions significantly modifying the proposals it contains.68 The committee has completed its report based on the consultations and input from stakeholders related to the 2019 bill though it acknowledges the impact of the Budget's measure on this bill inquiry as part of its committee view in chapter two.

Acknowledgements 1.76 The committee thanks all individuals and organisations who assisted with the inquiry, especially those who made written submissions and attended public hearings to provide evidence.

66 The Hon. Stuart Robert MP, Assistant Treasurer, ministerial response to the Senate Standing

Committee for the Scrutiny of Bills, October 2018, p. 4.

67 The Hon. Stuart Robert MP, Assistant Treasurer, ministerial response to the Senate Standing

Committee for the Scrutiny of Bills, October 2018, p. 5.

68 Budget 2020-21, Budget Measures, Budget Paper No. 2, JobMaker Plan—Research and Development

Tax Incentive—supporting Australia’s economic recovery, p. 19.

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Chapter 2 Views on the bill

2.1 This chapter summarises the views held by stakeholders on the provisions of the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 (the bill). The chapter is intended to provide an indicative, though not exhaustive, account of the key issues examined during the committee's inquiry.

2.2 Following a call for submissions, the committee received 93 submissions from interested parties. The majority of these submissions raised concerns with the provisions of the bill, especially regarding Schedule 1—Better targeting the RDTI.

2.3 The following discussion is separated into the following sections:

 views and recommendations resulting from the Senate Economics Legislation Committee's prior inquiry into a related bill;  general views of R&D policy within Australia; and  views on better targeting the RDTI.

Senate Economics Legislation Committee's 2018 bill inquiry 2.4 As discussed in chapter 1, on 18 October 2018, the Senate referred the provisions of the prior bill to the Senate Economics Legislation Committee (the committee) for inquiry and report. The committee held three public

hearings and received 75 submissions. At the conclusion of its inquiry, the committee held the following view:

The committee notes the findings of the 2016 Review of the R&D tax incentive [the Three Fs Review], in particular that the R&D tax incentive program falls short of meeting its stated objectives of additionality and spill-overs. On balance the committee supports this bill in its intent to address this issue.

The committee was pleased to hear that the R&D tax incentive program had had a positive impact on many Australian businesses and researchers.

On examination of the proposed $4 million cap on the refundable tax offset, the committee believes that it would benefit from some finessing to ensure that R&D entities that have already made investment commitments are not impeded unintentionally.

The committee also notes the concerns raised by participants in relation to the calculation of the proposed intensity premium. The committee shares participants' concerns that this intensity measure may have unintended consequences for larger R&D entities undertaking eligible R&D activities.

The committee considers that, as currently drafted, the proposed intensity measure has possible unintended consequences that may disadvantage a range of Australian R&D entities.

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2.5 In its final report to the Senate on 11 February 2019, the committee made the following recommendations in relation to the prior bill:

The committee recommends that the Senate defer consideration of the bill until further examination and analysis of the impact of schedules 1-3 [the schedules related to the RDTI] is undertaken. In particular, the committee recommends that:

 the approach to the cap on the refundable portion of the Research and Development (R&D) tax incentive is refined, noting investment decisions already taken; and  the formula for R&D intensity is refined, noting inherent differences in

R&D intensity across industries and impacts on businesses with large operating costs.1

General views on R&D policy within Australia 2.6 A number of inquiry participants were concerned with the decline in Australia's R&D effort and the government's general approach to supporting it in Australia. A number of submitters and witnesses drew attention to the

decrease over the last ten years in R&D investment in Australia. For example, Universities Australia, in its submission, noted that:

Australia’s investment has been in decline for over a decade, from 2.25 per cent of GDP in 2008 [to 1.79 per cent in 2017], and there is no sign of stabilisation. This contrasts with a small but steady increase in the OECD average over the same period, from 2.28 per cent to 2.37 per cent. At 1.79 per cent of GDP, Australia lags behind our competitors and is now well below the OECD average.2

Business expenditure on R&D as a share of GDP declined by 31 per cent from a peak of 1.37 per cent in 2008 to 0.94 per cent in 2017-18. Government expenditure has declined by a similar percentage.3

2.7 KPMG noted the importance of R&D expenditure to Australia's wellbeing, stating:

Australia's global competitiveness and future prosperity depends on our ability to translate our inventiveness into successful commercial outcomes. Business investment in R&D, supported by the RDTI, is fundamental to that success. However, reductions to tax incentives and instability in the program can have the opposite effect.4

2.8 The AMWU believes the reforms made by the bill send the wrong message, and will discourage investment and lead companies to transfer highly-skilled

1 Senate Economics Legislation Committee, Treasury Laws Amendment (Making Sure Multinationals

Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2018 [Provisions], February 2019, p. 34.

2 Universities Australia, Submission 53, p. 2.

3 Universities Australia, Submission 53, p. 2.

4 KPMG, Submission 69, [p. 3].

23

jobs overseas. It believes this will result in lower productivity growth, a less competitive manufacturing industry, less investment in capital and, in the long run, few jobs and lower wages.5

2.9 GlaxoSmithKline (GSK), an international healthcare company, is concerned with the government's failure to adequately consult with industry, and notes that the proposed reforms may have unintended consequences, such as jobs losses and reductions in export revenues generated by local manufacturing, and reductions in investments in scientific research across the Australian medical and research communities.6

2.10 CPA Australia states that 'the government should be cautious not to restrict or impede R&D in Australia simply because of the direct short-term impact on the budget, especially when it is seeking to develop an innovative, high-tech economy with a deep pool of science, technology, engineering and maths labour.'7

2.11 Charles Sturt University is concerned that the government's policy framework for publicly-funded research is focused on larger firms and metropolitan universities, and that this approach does not always meet the needs of Australian industry or result in significant positive impacts for regional economies. 8

2.12 Although supportive of the reforms to the RDTI which improve its targeting, Cochlear does not support an overall reduction in government incentives for research, development, and innovation.9 In its submission, Cochlear also recommends the government take a broader approach to supporting R&D than solely providing tax incentives. Specifically, it states:

Australia is unique in having such a heavy focus on a tax incentive as the main government funded initiative to drive BERD [business expenditure on R&D] and innovation. Ideally the Australian Government would be increasing its overall funding support for business related innovation underpinned by a comprehensive and coordinated Australia wide strategy.10

2.13 Australia's peak industry group for the medicines industry, Medicines Australia, opposes the proposed reforms and notes the impact it may have on ongoing R&D investment within Australia. Specifically it notes that:

5 Australian Manufacturers Workers' Union, Submission 47, [p. 1].

6 GlaxoSmithKline, Submission 63, p. 1.

7 CPA Australia, Submission 21, [p. 1].

8 Charles Sturt University, Submission 67, p. 3.

9 Cochlear, Submission 78, p. 2.

10 Cochlear, Submission 78, p. 7.

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…medicines investment is high-risk with approximately only 12 per cent of medicines that enter clinical trials reaching approval for use by patients at an estimated investment of $2.55bn. Therefore, our industry is highly reliant on a stable policy environment that strongly supports innovation, research and development, and commercial translation to the same levels as competitor nations. Without these policies, there will be limited incentive for ongoing investment into Australia.

2.14 StartupAUS, in its submission, drew attention to the importance of the RDTI for start-up businesses operating in Australia, stating that:

Research conducted by StartupAUS indicates unambiguously that the RDTI is a critical part of the success of startups in Australia. In a survey of 74 startups conducted by StartupAUS, 89 per cent of national respondents reported that the RDTI was either critical (68.9 per cent) or very important (20.3 per cent) to their business.11

2.15 Australian Information Industry Association (AIIA) also noted the present potential impact of the bill will be compounded by the current Covid 19 crisis stating:

Due to COVID, I have been informed that some SMEs, especially technology start-ups, have taken out loans against the R&D cash refund they were hoping to receive in a few months. Any changes that reduce the FY20 or even FY21 benefit will have an immediate and significant impact on those companies and their ability to bring innovative products and services to market.12

2.16 Atlassian stated that while there is heavy reliance by many nascent start-up tech companies on the incentive in their early stage development, the RDTI was more important than ever in the current COVID situation.

Even before the COVID-19 pandemic, many technology companies were reliant on the RDTI to support them at the critical early stages of their businesses. In this continually evolving COVID crisis, the incentive is more important than ever to the economic recovery and revival of the tech sector.13

Better targeting the RDTI

Targeting the intensity measure 2.17 Mr Calder explained the rationale for the adoption of the changes to better target the intensity measure of the bill:

[the government] in 2018 picked an intensity measure that would not exclude any businesses or any companies from receiving some level of support for their eligible R&D activities but would try to target that

11 StartupAUS, Submission 19, p. 2.

12 Mr Simon Bush, General Manager, Policy and Advocacy Australian Information Industry

Association, Committee Hansard, 29 June 2020, p. 32.

13 Atlassian, Submission 93, [p. 1.]

25

support to companies with higher levels of R&D intensity. The [three Fs] review report itself found that companies with a high level of R&D intensity were more likely to create spill-over benefits for the rest of the economy. Benefits that a company can't internalise itself spill over to other stakeholders within the industry so that they can utilise that knowledge. That was based on a four-tier method. Again, the metric remains the same—R&D expenses over total expenses—and then subsequently moves to a three-tier intensity model, again using exactly the same methodology that had been proposed by the review when it released its report in 2016.14

2.18 As such, Mr Calder described the present bill as 'a recalibration of the intensity test' which moved from the previous 2019 bill's four-tier intensity model to increase the generosity of the intensity test compared with the previous bill to a three-tier intensity model.

2.19 Furthermore, Mr Calder noted the possible constraining variables in regard to settling on the intensity measures and metrics that should be adopted.

All of them would have some degree of distortional impact. You might change the conditions for one company and then change them in the opposite direction for another company. It was decided to go with the simplest measure, the one indicated by the recommendations of the

[three Fs] review. The R&D tax incentive will only give companies a relatively modest reward for eligible R&D activities in Australia. The issue around companies offshoring or moving their operations overseas would be based on a range of factors, and the R&D tax incentive, in our view, would only be a small component of that decision.15

2.20 In response to claims of possible offshoring of operations and loss of jobs based on changes to the intensity measure, Mr Calder stated that:

Decisions about where companies locate their operations would be based on a range of factors that they need to consider, part of which will be access to a skilled workforce. Australia has a highly skilled R&D and university sector to contribute to that R&D activity. There's the extent to which Australia is a relatively stable economy; it has long periods of economic growth, providing opportunities for companies to grow their operations domestically.

2.21 Treasury officials also noted that the emphasis on the bill's measures were primarily to refocus tax payer funded R&D support to provide the necessary additionality in the economy not just reward businesses for business as usual.

That review [the three Fs] did identify that the R&DTI wasn't meeting its stated objectives. It wasn't providing additionality. It was rewarding businesses' usual activity.16

14 Mr Calder, Committee Hansard, p. 44.

15 Mr Calder, Committee Hansard, p. 44.

16 Mr Bede Fraser, Principal Adviser, Individuals and Indirect Tax Division, Revenue Group,

Department of the Treasury, Committee Hansard, p. 59.

26

2.22 Mr Richard Mulcahy CEO of Lighting Council Australia stated that:

To remain competitive, the member companies of the Lighting Council make substantial investments in R&D in Australia. The changes proposed in this bill will only further disadvantage these Australian manufacturers and are in sharp contrast to policy development internationally, including by our close neighbour New Zealand and by the UK, which have both recently moved to increase R&D investment—by £22 billion, in the instance of the UK.17

Clarity around eligible expenditure 2.23 A number of inquiry participants raised their concerns around the ambiguity of the types of expenditure which are considered eligible and the technical language used. For example, StartupAUS stated that:

Thanks to shifts in interpretation, the RDTI is currently failing to adequately support software development activities. Any amendments to the scheme (such as those proposed by this Bill) should address this shift away from support for software development activities by adding clarifying language to the scheme reinforcing the eligibility of software development activities.18

2.24 In agreement with the above, CPA Australia recommended that the issues around software R&D be addressed through amending definitions in line with a review undertaken by the ASBFEO and the 2015 update to the OECD's Frascati Manual.19

2.25 Startup Victoria raised the technical and legal nature of the language used when determining an entities eligibility for the RDTI, and recommended the government:

…[m]ake the language and accessibility simpler. Many smaller technology companies that are eligible for the R&D Tax Incentive do not understand the legal and Government language used to describe what the incentive is, how it works and what is required in managing a claim. Many eligible startups do not take up the incentive for fear they are ineligible or will make a mistake in their claim and put their business at risk. The R&D scheme should be accessible enough to empower startups to submit claims without having to rely on experts.20

Increasing the expenditure threshold 2.26 A number of inquiry participants raised the proposed increase in the R&D expenditure threshold, from $100 million to $150 million, in their submissions.

17 Mr Richard Mulcahy, CEO, Lighting Council Australia, Committee Hansard, p. 21.

18 StartupAUS, Submission 19, p. 1.

19 CPA Australia, Submission 21, p. 2.

20 Startup Victoria, Submission 71, [pp. 2-3].

27

2.27 Although Cochlear supported the increase in the threshold to $150 million, it recommended the threshold be abolished. Specifically, it stated:

Cochlear strongly supports increasing and ultimately removing the expenditure cap. Ideally, the cap should be abolished or the increased cap of $150 million should be subject to a sunset clause and review in 2030 rather than made permanent as proposed. This is because a cap or maximum threshold at any level is arbitrary and effectively acts as a disincentive for any company investing large amounts into R&D to invest in Australia over that cap.21

2.28 Similarly, Ai Group also did not see the rationale for the government to maintain the threshold on R&D expenditure, stating:

While Ai Groups is supporting the proposal to raise the cap on R&D spending from $100 million to $150 million, this is more because the higher cap would be better than the lower cap rather than because we see merit in the cap proposal in itself.

The rationale for the R&DTI is that it generates positive spill-overs. There is no reason to suggest that these would be lower once the amount of R&D spending exceeded a certain level. Indeed, under the logic implicit in the intensity approach proposed in the Bill, the external benefits flowing from a business undertaking more R&D spending are higher (other things being equal) than for a business with a lower R&D intensity.

This same logic would appear to be an argument against a cap on the level of R&D spending that can receive backing from the R&DTI. Yet the Bill proposes both the intensity measure and retaining the cap…22

2.29 In its submission to the inquiry, Telstra highlighted the adverse interplay between the new marginal intensity premium structure and the increased threshold. Specifically, it observed:

The proposed intensity measure introduces a three-tiered incentive designed to encourage R&D expenditure, with the top tier having a generous “headline” rate of 12.5 percent. However, the imposition of a $150M cap ensures that businesses with expenses greater than $3.75 billion can never get beyond the first tier (4.5 percent net benefit) regardless of how much we actually spend on eligible R&D activities.23

Extending eligibility to unincorporated businesses 2.30 The National Farmers' Federation (the Federation) noted in its submission that, although agricultural R&D has significant spill over benefits for the community, the majority of Australia's farming businesses are ineligible for the

21 Cochlear, Submission 76, p. 6.

22 Ai Group, Submission 81, p. 7.

23 Telstra, Submission 22, p. 2.

28

RDTI. This is because the majority of these businesses are sole traders and partnerships, which are ineligible under the scheme.24

2.31 Given this, the Federation recommended that the RDTI be extended to unincorporated businesses to allow for these small and medium-sized farming businesses to be eligible for the RDTI.25

RDTI for small entities

Linking the refundable RDTI to a claimant's corporate tax rate 2.32 Currently R&D entities with an aggregated turnover of less than $20 million are generally entitled to an R&D tax offset rate of 43.5 per cent.26 The bill amends this by making the R&D tax offset equal to the entities corporate tax

rate plus a 13.5 per cent premium.27

2.33 The Ai Group supports this proposed linking of the tax offset to an entity's corporate tax rate, as it believes it would better accommodate Australia's dual tax structure.28 CPA Australia, however, recommends that the $20 million threshold be increased to $50 million to align it with the company tax base rate entity threshold, instant-asset write off threshold, and the definition of small proprietary company per the Corporations Act 2001.29

Capping the refundability of the RDTI 2.34 A number of witnesses supported the capping of the tax offset. Mr Reed from the Ai Group stated that:

We think that establishing the basis of the refundable tax offset at the corporate tax rate plus a 13.5 percentage point premium is a good clarification, along with capping the refundability of the tax offset at $4 million per annum.

We also support it [the cap] as an appropriate way to limit what appear to have been some abuses or excessive uses of the offset to date.

…there does seem to be a consensus and reasonably strong evidence presented in the course of the three F inquiry…that a cap would be appropriate.30

24 National Farmers Federation, Submission 93, p. 5.

25 National Farmers Federation, Submission 93, p. 5.

26 Explanatory Memorandum, p. 9.

27 Explanatory Memorandum, p. 9.

28 Ai Group, Submission 81, p. 5.

29 CPA Australia, Submission 21, p. 2.

30 Mr Tennant Reed, Principal National Adviser, Public Policy, Ai Group, Committee Hansard, p. 38.

29

Clinical trial exemptions 2.35 The development of medicines and vaccines rely on clinical trials to test and prove new pharmaceuticals for use. Some argued that the legislation should be amended to either exclude the life sciences sector or the intensity threshold

requirements and manufacturing measurements should be removed from the bill as they create a disincentive to undertake R&D in Australia. Mrs de Somer, from Medicines Australia stated that the tax incentive is one important factor about where companies will commit to place clinical research.

…companies compete with their own affiliates in other countries to place clinical trials, and they have to demonstrate patient population, critical infrastructure, clinicians and expertise, which Australia does well in.

In Australia the positives in the commercialisation activities occurring here are our First World health infrastructure, our university and research infrastructure and critical skills. The quality of the work that is done in Australia is of very high quality. The things that also encourage research and development and commercialisation here are such things as the R&D tax incentive. I do think it is in fact the only legislative incentive from that perspective. The disincentives for doing it here are high energy costs, high labour costs, a reasonably small population and the speed of getting things done.31

RDTI for large entities

Marginal intensity premiums 2.36 Large R&D companies with aggregate turnover of $20 million or more are entitled to an offset equal to their corporate tax rate plus one or more marginal intensity premiums. The government's introduction of this new structure was

the central concern for a large number of submitters who stated they would be adversely affected. Although the vast majority of submitters were opposed to the measure, Cochlear, in its submission, believed that the new model would be an improvement on the current policy settings, stating in its submission:

Compared to the current policy settings, increasing the cap on expenditure in combination with the new intensity based premium tiers, would make the R&D environment in Australia more attractive to Cochlear.32

2.37 Two professional accounting organisations, CPA Australia and Chartered Accountants Australia and New Zealand (CAANZ), opposed the proposal, with CPA stating that:

…the Bill constrains and complicates the R&D investment landscape and innovation ecosystems by further limiting access to funds through …

31 Mrs de Somer, Committee Hansard, p. 8.

32 Cochlear, Submission 78, p. 2.

30

either reducing or removing access to the R&DTI for key large Australian businesses and industries via the proposed intensity test.33

2.38 A number of large international professional advisory firms also opposed the intensity model, with EY, KPMG, PwC, Deloitte and BDO all criticising it. BDO and Deloitte, in their respective submissions to the inquiry, stated the following:

We note that at 8.5 per cent, Australia already provides one of the lowest R&D tax subsidies for large entities across all OECD countries offering a volume-based R&D tax credit, while the mean subsidy for large profit-making companies across the OECD is 13 per cent. Under the proposed intensity test this subsidy will drop to just 4-5 per cent for a majority of large taxpayers, making Australia the least attractive jurisdiction in the OECD for entities.34

Departmental questions on notice 2.39 Questions were put on notice by the committee to the Treasury, Australian Taxation Office (ATO) and the Department of Industry, Science and Energy (DISE) regarding the RDTI. Both Treasury and ATO failed to provide answers

to QoNs by the requested date. The DISE provided answers to the QoNs in the required timeframe and these are can be found in Appendix xx.

Budget 2020-21—JobMaker Plan—Research and Development Tax Incentive— supporting Australia’s economic recovery measure 2.40 The committee notes that on 8 October 2020, the government, as part of the 2020-21 Budget, announced further enhancements to its 2019-20 MYEFO

measure Better targeting the research and development tax incentive—refinements.

2.41 The new Budget measure, JobMaker Plan—Research and Development Tax Incentive—supporting Australia’s economic recovery, significantly modifies the proposals considered as part of this bill inquiry.35

2.42 The government states that the Budget measure's enhancements are designed to support business R&D investment in Australia and help businesses manage the economic impacts of the COVID-19 pandemic and assist in the economy's recovery.

2.43 The measure will have no $4 million cap on annual cash refunds as outlined in the bill though it will continue to increase the R&D expenditure threshold from $100 million to $150 million, unchanged from the present bill's proposal.

33 CPA Australia, Submission 21, p. 2.

34 BDO, Submission 74, p. 9.

35 Budget 2020-21, Budget Measures, Budget Paper No. 2, JobMaker Plan—Research and Development

Tax Incentive—supporting Australia’s economic recovery, p. 19.

31

2.44 Importantly, for small companies, with aggregated annual turnover of less than $20 million, the refundable R&D tax offset will increase by five percentage points from the current proposal of 13.5 percentage points to a generous 18.5 percentage points above the claimant’s company tax rate.

2.45 Significantly, for larger companies, those with aggregated annual turnover of $20 million or more, the government will reduce the number of R&D intensity tiers from the current proposed three tiers to two tiers. The government states that this will provide greater certainty for R&D investment while still rewarding those companies that commit a greater proportion of their business expenditure to R&D.

2.46 The R&D premium ties the rates of the non-refundable R&D tax offset to a company’s incremental R&D intensity, which is R&D expenditure as a proportion of total expenses for the year. The two new marginal R&D premium tiers will be the claimant’s company tax rate plus:

 8.5 percentage points above the claimant’s company tax rate for R&D expenditure between 0 per cent and 2 per cent R&D intensity for larger companies; and

 16.5 percentage points above the claimant’s company tax rate for R&D expenditure above 2 per cent R&D intensity for larger companies.  This represents a significant reduction in the level of R&D intensity required to receive a much large tax offset than originally proposed in the bill for large companies.

2.47 The government has also indicated that it will defer the commencement date so that all changes to the program apply to income years starting to 1 July 2021, to provide businesses with greater certainty as they navigate the economic impacts of the COVID-19 pandemic.

2.48 All other aspects of the 2019-20 MYEFO measure will remain unchanged. The new measure is estimated to decrease the underlying cash balance by $2.0 billion over the forward estimates period.

Committee view 2.49 The committee is supportive of well targeted tax payer funded assistance of research and development where it encourages activities with broad economic benefit. In particular the committee is very concerned about the impact that the

COVID 19 pandemic is causing to the Australian economy and businesses and welcomes the certainty the new Budget measure provides business in a post COVID recovery.

2.50 The committee notes that, the new two-tier structure proposed in the Budget should encourage greater R&D expenditure than those measures proposed in the 2019 bill.

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2.51 The committee also notes that the existing flat premium available to companies with an annual turnover above $20 million will be changed to one that increases generously as a company's R&D intensity increases. This will create further incentives to undertake R&D activities. Likewise, the committee sees the increase to the maximum amount of R&D expenditure eligible for concessional R&D tax offsets from $100 million to $150 million per annum as per the bill, as another incentive for greater R&D efforts. The committee considers that both these measures will assist the largest investors in R&D keeping their R&D activities in Australia.

2.52 The committee further notes that while the tax offset for smaller companies was 43.5 per cent (30 per cent corporate tax rate) with the proposed 13.5 per cent refundable R&D tax offset which was destine to fall with the implementation of new corporate tax rate of 27.5 per cent, under the government's generous Budget measure, this will now increase back up to by five percentage points to 46 per cent with the 18.5 per cent refundable R&D tax offset.

2.53 While many across the research and industry sector have found that the bill potentially did not hit the mark they were looking for, the committee considers that the new measure announced in the 2020-21 Budget should provide significant clarity and motivation for all sectors undertaking R&D.

Senator Slade Brockman Chair

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Labor Senators Additional Comments

Labor Senators' remarks on the consequences of the 2020-21 Federal Budget for the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 1.1 In his Budget speech on 6 October 2020, the Treasurer announced that the

Government would introduce changes to the Research and Development Tax Incentive (RDTI) that negate many of the measures included in the bill considered by this committee.

1.2 Instead of a $1.8 billion cut to the value of the Incentive, it will now be increased by $2 billion. The Government will no longer proceed with the proposed $4 million cap on refunds for firms with an annual turnover of less than $20 million, and the number of tiers in the intensity scale for calculating the tax offsets of firms with a turnover of more than $20 million will be reduced from three to two.

1.3 These changes essentially mean that the bill considered by the committee has been superseded, and the fact that the committee chair's report contains no recommendation implicitly acknowledges this. The new measures announced by the Treasurer are contained in schedules 4, 5 and 6 of the Treasury Laws Amendment (A Tax Plan for Covid-19 Economic Recovery) Bill 2020, which was introduced into the Parliament on the day after the Treasurer's speech and passed two days later

1.4 Labor Senators are profoundly concerned, however, that the Government has retained the most damaging element of its 2018 and 2019 bills to restructure the RDTI: an intensity scale for calculating the non-refundable tax offset for larger firms. The reduction in the number of intensity tiers eliminates the 2019 bill's 4.5 per cent tier, which would have halved the rate for most businesses claiming the RDTI. That is an improvement, but it does not change the fact that intensity scales are a fundamentally flawed means of assessing the value of R&D activities.

1.5 Intensity scales measure a firm's commitment to R&D by expressing its R&D expenditure as a proportion of its total operating costs. For manufacturers, the bulk of operating costs comprise wages, purchase of raw materials and equipment, and investments in the supply chain. Specific R&D activities will always be a small proportion of the total operating costs for these manufacturers, but that is no indication of the inherent value of the R&D they undertake.

1.6 The manufacturing sector is the most innovation-intensive in the economy, and manufacturers spend four times the national average on R&D. In submissions and evidence to the committee many of them warned that the

34

introduction of an intensity scale would force them to move either their R&D or their manufacturing offshore. The elimination of the 4.5 per cent tier might make it less likely that they will face such a choice, but the intensity scale continues to discriminate against Australian companies that conduct both R&D and manufacturing in Australia. Multinationals that can manufacture offshore and conduct R&D here will be better placed to claim the premium rate.

1.7 The costs typically incurred by large manufacturers mean that they will also be unfairly disadvantaged by the $150 million cap on what can be claimed under the RDTI. The Government had an opportunity to lift this cap in the new measures announced this week but did not take it.

1.8 Under the impact of the severe recession brought about by the COVID-19 pandemic, putting R&D activities and manufacturing jobs at risk is hardly a prescription for recovery. Labor Senators urge the removal of the intensity scale from the RDTI. A far better approach to improving the RDTI would be to introduce a premium rate for collaboration between industry and research institutions, as recommended in the following report.

Labor Senators' remarks on the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019

Overview 1.9 The Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 reintroduces, with only minor changes, measures relating to the RDTI that were included in the Treasury Laws Amendment (Making Sure

Multinationals Pay Their Fair Share of Tax and other Measures) Bill 2018. The earlier bill was with withdrawn after a bipartisan recommendation of the Senate Economics Legislation Committee that further consultation be undertaken with industry stakeholders, who had overwhelmingly opposed the changes to the RDTI. The stakeholders' opposition remains unchanged to the present bill, which would severely disadvantage businesses that manufacture and conduct R&D in Australia, creating a strong incentive for them to send either their R&D or their manufacturing operations offshore.

1.10 Under either outcome, Australian jobs would be lost, the skills base of the workforce would be eroded and the prospect of building a more diverse and complex economy would fade. Further, none of the stakeholders were consulted by the Treasury and/or the Department of Industry, Science, Energy and Resources (DISER), as the committee inquiry into the 2018 bill had recommended. The Government appears to have persisted in seeking changes to the RDTI solely to create budget savings, despite the overwhelming evidence that the changes would undermine the most important measure in

35

the nation's innovation toolkit—a measure of vital importance as Australia seeks to rebuild its economy in the wake of the COVID-19 pandemic.

1.11 What is more, there is strong evidence that the projected saving could be achieved without the changes introduced in the bill. The $1.8 billion the Government is seeking to cut from the RDTI over the forward estimates is being saved through improved integrity measures and a decline in the estimated cost of the RDTI. The 2016 Review of the R&D Tax Incentive estimated the cost of the RDTI for 2017-18 to be $3.48 billion, but Department of Industry figures (cited in Research Australia's submission to this inquiry) show that the actual cost for 2017-18 was $800 million less, at $2.57 billion. The Department's estimate of the cost for 2018-19 is $2.05 billion.1

1.12 The official cost estimates are also questioned by industry, which argues that Treasury's modelling of the cost does not take account of the 'timing' benefit, in which the cost is recouped through taxes paid when businesses are profitable, or of flow-on reductions to franking credits, taxes paid later as a result of R&D spending, amounts recovered through tax paid by smaller companies in tax-payable position, and amounts 'clawed back' under the feedstock and grant-clawback provisions. On this basis, KPMG estimates that the net cost of the RDTI program is $1 billion a year less than the Government's official figures.2

1.13 For all these reasons, Labor Senators believe the bill should be withdrawn. If enacted, it would undermine Australia's innovation system and profoundly hamper long-term economic recovery.

Intensity measures 1.14 The strongest criticism of this bill, shared almost unanimously by industry stakeholders who made submissions to the committee and gave evidence at the hearing, is that the proposed intensity scale for calculating the non-

refundable R&D tax offset will be a disincentive for businesses and especially manufacturers to conduct R&D in Australia. At present, the 38.5 per cent non-refundable offset for companies with a turnover of more than $20 million, which do the bulk of private-sector R&D in Australia, provides either an 8.5 per cent or 11 per cent benefit depending on the corporate tax rate. It is understood that a large percentage of these companies are actually small to medium sized businesses (SMEs).

1.15 The bill changes the offset for these businesses to their corporate tax rate plus a premium based on their incremental R&D intensity, calculated as a proportion of overall annual expenditure. The bill provides for a three-tiered intensity scale and most businesses claiming the non-refundable offset will fall within the lowest tier—4.5 per cent—effectively halving the rate for many businesses

1 Research Australia, Submission 28, pp. 5-6.

2 KPMG, Submission 69, p. 2.

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and reducing the rate by almost 60 per cent for SMEs with a turnover between $20 million and $50 million. As numerous industry submissions point out, since R&D intensity is calculated as the company's spend over its total expenses for the year, and this cannot be determined until the end of the income year, the measure does not create an incentive for companies to undertake more R&D. The intensity measure is fundamentally flawed and would create a disincentive to Australian companies trying to innovate in the wake of COVID-19.

1.16 The consequence of introducing the intensity premium will be to force many companies to choose between sending either their R&D or their manufacturing operations offshore. The urgency of that choice will be heightened by the fact that other R&D regimes in the region are becoming increasingly competitive (e.g. New Zealand has introduced a 15 per cent R&D tax offset). As Mr Benjamin Eade, CEO of Manufacturing Australia, told the committee hearing:

Fundamentally, intensity measures are bad for local manufacturing. The reasons for that is they measure your commitment to R&D as your percentage of total expenditure on R&D as a proportion of your overall operating cost base. If you're an Australian-based manufacturer, the vast majority of your cost base is made up of employing Australians, using Australian raw materials and investments in an Australian supply chain.

For a large-enterprise Australian manufacturer it is almost impossible to clear those intensity hurdles, and indeed, the way they've been designed in this bill does make it impossible for most companies to clear those intensity hurdles.

What you're going to see is that the combined impact of those intensity measures will drive R&D investment offshore or drive manufacturing production offshore—I think the former is more likely than the latter but the net outcome is that you will have less R&D expenditure being undertaken by companies that actually manufacture here, because they will be severely punished for making a decision to allocate their production to this country.3

1.17 Other industry witnesses made similar criticisms. Ms Sandra Boswell, a partner at Grant Thornton who gave evidence for the Lighting Council of Australia, said:

You'll see projects go offshore or projects close. All projects have elements of R&D and have elements of process and operations…in that manufacturing environment, it's required for experimentation to test the hypothesis of the R&D, so it's not all done in commercial R&D; it's very much done in that operational environment. I think we will either see

3 Mr Benjamin Eade, Chief Executive Officer, Manufacturing Australia, Committee Hansard,

29 June 2020, p. 11.

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projects move offshore, or now with COVID, projects close—they won't go anywhere. Either way, jobs will be lost in Australia.4

1.18 Ms Boswell also emphasised that changing the present offset would deter foreign companies from investing in Australia:

I would often get calls once or twice a week from offshore entities looking to understand the program here—so it brings investment into Australia— and also making decisions about where to locate projects. I think the other thing about this program is that it makes Australia competitive on a world stage, so it does drive investment in the economy here.5

Retrospectivity 1.19 The measures in the bill would be retrospective: they are intended to operate from 1 July 2019. As noted by almost all 93 written submissions, this means the measures would have an immediate impact on R&D activities already

commenced by companies on a legislative expectation. The stakeholders do not report having received any advice or assistance from the Australian Tax Office or DISER on the problem created by this retrospectivity.

1.20 Labor Senators note that, in a return to a question on notice, DISER claims that e-bulletins have been used to inform businesses and agents of the retrospective nature of the bill.6 But on analysis of the bulletins the advice to the sector is confusing and understated. Companies are effectively being asked to operate with two sets of books—it is not only a calculation that companies are being asked to do.

1.21 Note: If the bill is enacted with retrospective effect, decisions made since 1 July 2019 would essentially be invalidated. And since labour costs are the primary cost of R&D, a company's labour cost for employees engaged in R&D would retrospectively increase by 4 per cent—the rate reduction from 8.5 per cent to 4.5 per cent under the intensity measure.

1.22 That is a real cost of doing business and it is likely that companies would have taken different decisions, such as hiring fewer people, if they had known that the rate was halved. This is not just a tax calculation. The effect is that decisions made on whether to employ staff, their hours of work and their salary levels would be retrospectively invalidated.

1.23 Labor Senators remain highly concerned that the retrospective nature of the bill will see businesses burdened with a tax liability they weren't expecting at the time they invested in the R&D.

4 Ms Sandra Boswell, Partner, Grant Thornton, Committee Hansard, 29 June 2020, p. 22.

5 Ms Sandra Boswell, Partner, Grant Thornton, Committee Hansard, 29 June 2020, p. 23.

6 Department of Industry, Science, Energy and Resources, answer to questions on notice no. 8,

29 June 2020 (received 10 July 2020).

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COVID-19 and economic recovery 1.24 As many stakeholders have noted, the Morrison Government's declared aim of reviving Australia's manufacturing sector as a key to post-pandemic economic recovery is not consistent with the bill's almost certain consequence of

discouraging R&D investment in this country. As Ms Elizabeth De Somer, CEO of Medicines Australia, said:

The Prime Minister said recently that in emerging from the COVID-19 crisis he wants Australia to build its economic sovereignty to ensure we have a prosperous and healthy community…A healthy research and development sector will be critical to meet the Prime Minister's aspirations. Growing investment in R&D will be one of the keys to providing the essential jobs for this new cohort of highly skilled researchers and scientists.

It will also attract much-needed foreign investment, strengthen Australia's expertise and international connections in the development of medical treatments, and open up opportunities for advanced manufacturing for homegrown discoveries.

To achieve this, the Government must reverse the tide of recent history. Investment in R&D in Australia has been falling for decades, and implementing this bill would only accelerate the downward trajectory…the proposed changes in this bill would be detrimental to Australia's health and productivity at the best of times, but especially so when we are faced with the unprecedented challenge of COVID-19.7

1.25 Research Australia (RA) argued in its submission that the lack of diversity in Australia's economy places our long-term future at risk, and that COVID-19 has highlighted the dangers in Australia's over-reliance on one major export partner, China, a reliance without parallel in the developed world. Overcoming this will require:

…supporting the companies in Australia, both small and large, that engage in research and development, creating new jobs and opportunities and diversifying our economy. These are the companies that utilise the RDTI and which will be disadvantaged by the proposed changes.8

1.26 Research Australia points out that the complexity of a country's economy, measured in terms of the diversity of its international trade, is a good measure of the economy's strength and resilience, and its capacity for continued innovation and growth.9 The RA submission cites Harvard University's Atlas of Economic Complexity as evidence of the lack of complexity in the Australian economy.10 According to the Atlas, Australia has only the 93rd most complex

7 Ms Elizabeth De Somer, Chief Executive Officer, Medicines Australia, Committee Hansard,

29 June 2020, p. 6.

8 Research Australia, Submission 28, pp. 6-7.

9 Research Australia, Submission 28, p. 7.

10 Research Australia, Submission 28, p. 7.

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economy, placing it behind Morocco, Uganda and Senegal. RA cites this comment from the Atlas:

Compared to a decade prior, Australia's economy has become less complex, worsening by 22 positions…Australia is less complex than expected for its income level. As a result, its economy is projected to grow slowly. The Growth Lab's 2027 Growth Projections foresee growth in Australia of 2.2 per cent annually over the coming decade, ranking in the bottom half of countries globally.11

1.27 The dismal picture of Australia's economic future set out in the Atlas was drawn before the COVID-19 pandemic wreaked its havoc on the Australian and global economy. The future now is even more bleak. If greater economic complexity is to be achieved, and if excessive dependence on fragile global supply chains—especially those emanating from China—is to be reduced, changes to the RDTI that create incentives to send R&D or manufacturing offshore would be counter-productive.

Collaboration premium 1.28 As well as their unanimous rejection of the bill's intensity measures, most stakeholders urged the adoption of a recommendation in the 2016 Review of the R&D Tax Incentive that was not included in either the 2018 bill or the present

bill. This was a proposal for a premium rate of the RDTI to be available to businesses that conduct R&D activities in collaboration with universities or public research agencies. The ALP's 2019 election platform included the introduction of 10 per cent collaboration premium, but several stakeholders, including Science and Technology Australia, called for a 20 per cent collaboration premium in their evidence or submissions.

1.29 Mr Eades, of Manufacturing Australia (MA), urged the adoption of a collaboration premium when asked during the hearing about the consequences of COVID-19 for the changes set out in the bill and MA's submission:

If I were preparing this submission in a post-COVID environment, I think I would lean further into the concept just discussed around a premium rate for R&D that drives local production. I am increasingly asked, in discussions more broad than today's, about ways that governments can incentivise manufacturing. I think we are all on a unity ticket around the idea that manufacturing is more than just production, but we need to incentivise the production…

I'd be allocating a premium rate for R&D tax incentives where it was demonstrably linked to domestic manufacture, where you can demonstrate as a company that your manufacturing R&D is directly fuelling innovation that allows you to make more in Australia, to hire more and to invest more

11 Research Australia, Submission 28, p. 7.

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in production. I'd be applying a premium rate such as we've discussed in the university partnership area.12

1.30 Mr Eades agreed with the Parliamentary Budget Office's observation in 2019 that the premium rate announced in Labor's election platform would not necessarily add to the cost of the RDTI program, but would promote a shift from non-collaborative to collaborative expenditure. And he added:

Collaboration is how we get more manufacturers that are currently in a small-to-medium enterprise to scale up in Australia…I'd like to see more Duluxes and Blue Scopes, and to see more SME manufacturers have the capability and the opportunity to scale up their production here in Australia, rather than prove a technology and then be forced, for a range of other reasons, to offshore the production component of that. So the opportunity to collaborate, to form alliances with university partnerships, is primary to that.13

Smaller businesses, start-ups and integrity problems 1.31 Most businesses registered for the RDTI—generating 80 per cent of the cost of the program—have turnovers of less than $20 million and are therefore eligible for the refundable component. They include many start-up enterprises,

especially in the bio-tech sector, and support for these businesses is one of the reasons for the existence of the program. It is a myth propagated by critics of the RDTI that the program exists to benefit large businesses only: its reach is economy-wide and that is one of its key strengths

1.32 Unfortunately, many of the integrity issues connected with the operation of the program have arisen in connection with unscrupulous agents and advisers who have sought to take advantage of both the businesses and the program. The rorts have been surveyed in a December 2019 report by the Small Business Ombudsman, Ms Kate Carnell, who also proposed various measures to counter shonky practices, thereby saving money for the RDTI program. Anecdotal reports of these practices include claims for website and app development that do not comply with the definition of R&D, gym equipment and even hair dressing salons.

1.33 These problems have been brought to the Government's attention on numerous occasions but it has done nothing to address them. It has not even commissioned an independent review—for instance the Australian National Audit Office has only recently listed the RDTI as a potential area for audit in FY21, possibly in response to Ms Kate Carnell's scathing review of its administration. If the Government really wanted to save money for the program—money that could be reinvested in genuine R&D activities—tackling

12 Mr Benjamin Eade, Chief Executive Officer, Manufacturing Australia, Committee Hansard,

29 June 2020, p. 14.

13 Mr Benjamin Eade, Chief Executive Officer, Manufacturing Australia, Committee Hansard,

29 June 2020, p. 14.

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these integrity and administrative problems should be a priority, and it would not require damaging changes to the structure of the program through intensity measures for larger SMEs and 'big' business.

The R&D Tax Incentive and Australia's declining global competitiveness 1.34 Taxation is one of the most powerful levers available to governments to influence investor behaviour, and the RDTI has accordingly become the chief measure integrating Australia's taxation and innovation systems. The

Morrison Government, citing assertions in the 2016 Three Fs Review of the RDTI, claims that the present structure of the RDTI does not sufficiently encourage additionality—investment that would not occur in the absence of the program—or spillover investment that benefits the wider economy.

1.35 The Government maintains that this is why the changes set out in the bill are needed, but it has not been able to demonstrate how measures such as the intensity premium would create greater additionality and spillovers. Stakeholders, on the contrary, overwhelmingly expect that the changes would do the opposite. Research Australia's submission to the committee warns that:

The currently proposed amendments to the RDTI risk destroying the additionality and spillover benefits the program is designed to create, simply because there is not a sufficient understanding of where and how the additionality and spillover benefits are being created and where this is not being achieved.14

1.36 Research Australia's warning is especially important because of the decline in Business Expenditure on Research and Development (BERD) in Australia in recent years. The most recent Science, Research and Innovation Tables reveal that BERD has fallen by 32 per cent since 2015, and DISER annual reports show a comparable decline of 30 per cent.

Table 1. Science Research Innovation Budget Tables on Research and Development

Refundable Non-refundable Total

2015/16 $2.18 billion $824 million $3.00 billion

2018/19 $1.69 billion $358 million $2.05 billion

32% reduction

14 Research Australia, Submission 28, p. 12.

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Table 2. Department of Industry, Science, Energy and Resources Annual Reports - Actual Business R&D expenditure

Total

2015/16 $17.32 billion

2018/19 $11.92 billion

30% reduction

1.37 This decline has taken place during a period of decline in Government support for innovation programs since 2013, including the axeing or defunding of programs set in place under the previous Labor government. A net $2 billion has been cut from innovation support, and the changes introduced by this bill would only accelerate the decline further by creating disincentives to invest in R&D in Australia.

1.38 A 2019 International Monetary Fund report, cited in KPMG's submission to the committee, found that R&D tax incentives have a strong positive effect on stimulating investment in R&D by business—in the UK, R&D investment has increased by an average of 33 per cent as the UK's R&D tax credit has become more generous.15 The contrast between countries such as the UK and New Zealand, which have increased the value of tax offsets for business investment in R&D, and Australia is stark. Australia's RDTI is already globally less competitive than it was at the time of its inception in 2011, and the changes introduced in schedule 1 of this bill—that is, the intensity measures—will make Australia even less attractive to business considering whether to conduct their R&D here.

1.39 As Emeritus Professor Roy Green, of the University of Technology Sydney, noted in an interview with Geoff Chambers, Australia has been lagging in terms of the manufacturing proportion of our economy for some time.16 We are down to 6 per cent. Other economies are around 15-20 per cent.17 Professor Green is quoted in the article saying that the weaknesses in domestic manufacturing should be used as an opportunity to:

…identify niches in the world economy where we can be globally competitive…

There's a big opportunity there. It's going to require big investments both by the public and private sectors in lifting our R&D performance, which is lamentable…

15 KPMG, Submission 69, p. 6.

16 Geoff Chambers, 'Get smart and get cracking on R&D', The Australian, 29 July 2020, p. 6.

17 Geoff Chambers, 'Get smart and get cracking on R&D', The Australian, 29 July 2020, p. 6.

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We're down to 1.79 per cent of GDP. The rest of the world average [for OECD nations] is 2.4 [per cent]. Korea, Japan, Switzerland, Germany are all over 3 per cent now.

…Germany has just invested $80 billion in digital manufacturing, digital transformation. Britain has just committed $40 billion to lift their R&D performance. Even Singapore has committed $20 billion. Joe Biden…in his new program is committing to more than $400 billion.18

1.40 The declining international competitiveness noted by Professor Green reveals the hollowness of Morrison Government rhetoric about reviving Australia's manufacturing sector in the wake of the COVID-19 pandemic. The Government has rightly commended the achievements of manufacturers that have adapted to the immediate needs created by the pandemic, such as the production of personal protective equipment or hand sanitizer. The Government's rhetoric does not, however, recognise that reviving a manufacturing sector requires more than short-term support for end-stage producers.

1.41 Building a strategic reserve of personal protective equipment, for example, relies on the existence of chemicals and plastics industries, and for these materials Australia is still over-dependent on fragile global supply chains. Reducing that dependence and increasing the size of the manufacturing sector will require substantial public and private investments of the kind proposed by Professor Green. Maintaining an effective and globally competitive RDTI will be crucial to that, but the Morrison Government is intent on cutting the value of the RDTI at this time when it is crucial to economic recovery and to ensuring prosperity in the longer term.

1.42 The overwhelming evidence is that this bill would create significant disincentives for business investment in R&D in Australia, at a time when the Australian Government should be taking every opportunity to increase incentives for business both to conduct R&D and to manufacture here. Labor Senators therefore make the following recommendations.

Recommendation 1

1.43 Labor Senators recommend that this bill be withdrawn.

Recommendation 2

1.44 Labor Senators recommend that the Australian Tax Office and the Department of Industry, Science, Energy and Resources conduct proper consultations with industry stakeholders, as recommended by the committee's inquiry into the 2018 bill.

18 Geoff Chambers, 'Get smart and get cracking on R&D', The Australian, 29 July 2020, p. 6.

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Recommendation 3

1.45 Labor Senators recommend that any future bill to reform the RDTI should not operate retrospectively.

Recommendation 4

1.46 Labor Senators recommend that any future bill intended to make the RDTI work more effectively in encouraging innovation in Australia should include a premium rate for collaboration between industry and universities or public research agencies.

Senator Alex Gallacher Deputy Chair

Senator Jenny McAllister Senator for New South Wales

Senator the Hon Kim Carr Senator for Victoria

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Appendix 1

Submissions and additional information

Submissions 1 Clean TeQ Holdings Limited 2 Montague

3 Opica Group 4 MYOB

5 The Manna From Heaven Group 6 NostraData 7 Bodycare Workplace Solutions 8 SOLPOD

9 Eclipse CS Pty Ltd 10 Intercorp Technology Pty Limited 11 Sentek

12 Australian Small Business and Family Enterprise Ombudsman 13 Name Withheld 14 Martogg Group 15 Mackay's Banana Marketing 16 PwC

17 Brickworks Limited 18 Boundary Bend Group 19 StartupAUS 20 The University of Melbourne 21 CPA Australia 22 Telstra

23 ResMed 24 Corporate Tax Association 25 Lighting Council Australia 26 Cement Industry Federation 27 RnD360 Advisory Group Pty Ltd 28 Research Australia 29 Medicines Australia 30 Michael Johnson Associates 31 RMS

32 Nissan Motor Co (Australia) Pty Ltd 33 Deloitte 34 Siemens 35 Confidential 36 FBR Limited 37 Australian Information Industry Association (AIIA) 38 Bosch Australia Pty Ltd

46

39 AusBiotech 40 Roche Products 41 Costa Group 42 Confidential 43 Geelong Manufacturing Council 44 Hardcat 45 Health Innovation Collective 46 Pact Group 47 Australian Manufacturing Workers' Union 48 Confidential 49 Reliance Worldwide Corporation 50 Channel Bio. 51 Manufacturing Australia 52 REA Group 53 Universities Australia 54 Treasury Wine Estates 55 Ernst & Young 56 Cement Australia 57 RSM Australia 58 Dulux Group 59 Australian Fresh Produce Alliance 60 Per Capita Australia 61 Business Council of Australia 62 Legrand Australia 63 GSK

64 Science & Technology Australia 65 Stryker 66 The Australia Institute 67 Charles Sturt University 68 Stone and Chalk 69 KPMG

70 SANOFI 71 Simplot Australia Pty Ltd 72 Glasshouse Advisory 73 Startup Victoria 74 BDO Services Pty Ltd 75 Boeing Australia Holdings Pty Ltd 76 FinTech Australia 77 MSM Milling Pty Ltd 78 Cochlear

 78.1 Confidential

79 Mondelez Australia Group 80 Committee for Sydney

47

81 AiGroup 82 Successful Endeavours Pty Ltd 83 Red Meat Advisory Council 84 Australian Prawn Farmers Association 85 Australian Forest Products Association 86 Toyota Motor Corporation Australia 87 South East Melbourne Manufacturers Alliance Inc. 88 Close the Loop 89 Australian Investment Council 90 Chemistry Australia 91 Chartered Accountants Australia and New Zealand 92 Victorian Minister for Jobs, Innovation and Trade 93 National Farmers Federation 94 Atlassian 95 Canva Pty Ltd

Additional Information 1 Clarification from the Australian Tax Office (ATO) relating to the public hearing in Canberra on Monday, 29 June 2020

Answer to Question on Notice 1 Answers to questions on notice from AI Group asked by Senator Carr at the public hearing in Canberra on Monday, 29 June 2020 2 Answers to questions on notice from AIIA asked by Senator Carr, Senator

Patrick and Senator Pratt at the public hearing in Canberra on Monday, 29 June 2020 3 Answers to questions on notice from Manufacturing Australia at the public hearing in Canberra on Monday, 29 June 2020 4 Answers to questions on notice from the Department of Industry at the public

hearing in Canberra on Monday, 29 June 2020 - Question No.1 5 Answers to questions on notice from the Department of Industry at the public hearing in Canberra on Monday, 29 June 2020 - Question No.2 6 Answers to questions on notice from the Department of Industry at the public

hearing in Canberra on Monday, 29 June 2020 - Question No.5 7 Answers to questions on notice from the Department of Industry asked by Senator Carr at the public hearing in Canberra on Monday, 29 June 2020 -

Question No.7 8 Answers to questions on notice from the Department of Industry asked by Senator Carr at the public hearing in Canberra on Monday, 29 June 2020 -

Question No.8

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9 Answers to questions on notice from the Department of Industry asked by Senator Carr at the public hearing in Canberra on Monday, 29 June 2020 - Question No.6 10 Answers to questions on notice from Medicines Australia at the public hearing

in Canberra on Monday, 29 June 2020 11 Answers to questions on notice from the Australian Investment Council (AIC) at the public hearing in Canberra on Monday, 29 June 2020 12 Answers to questions on notice from Science & Technology Australia at the

public hearing in Canberra on Monday, 29 June 2020 13 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000149 Drop-off in business activity 14 Answers to questions on notice from the Treasury at the public hearing in

Canberra on Monday, 29 June 2020 - Reference IQ20-000150 Re-evaluation of bill 15 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000151 Refundables 16 Answers to questions on notice from the Treasury at the public hearing in

Canberra on Monday, 29 June 2020 - Reference IQ20-000152 Estimated eligible R-D expenditure 17 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000153 Decline in R-D

expenditure from 2015-16 through to 2018-19 18 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000154 Public consultation 19 Answers to questions on notice from the Treasury at the public hearing in

Canberra on Monday, 29 June 2020 - Reference IQ20-000155 Modelling on how many enterprises will move from that higher rate to the lower rate 20 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000156 Modelling 21 Answers to questions on notice from the Treasury at the public hearing in

Canberra on Monday, 29 June 2020 - Reference IQ20-000157 Compliance activities 22 Answers to questions on notice from the Treasury at the public hearing in Canberra on Monday, 29 June 2020 - Reference IQ20-000158 Modelling

undertaken in regard to the premium rate for collaboration between research agencies and industry claimants 23 Answers to written questions on notice from the Treasury, received 28 July 2020 - Reference IQ20-000148 RDTI Refundables 24 Answers to questions on notice from the Australian Taxation Office (ATO) at

the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 01.SMEs accessing non-refundable component of the tax incentive

49

25 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 02.Cash refund component

26 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 03.Claims within different tiers

27 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 04.ASBFEO consultations

28 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 05.Cost-benefit analysis of the proposed bill changes

29 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 06.Data supplied to Treasury and DISER

30 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 07.RDTI returns in the July to September quarter

31 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 08.Administrative treatment

32 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 09.Number of registrations and average spend

33 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 10.Total cost of the program

34 Answers to questions on notice from the Australian Taxation Office (ATO) at the public hearing in Canberra on Monday, 29 June 2020 received 28 July 2020 - 11.Estimated cost of the program

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Appendix 2

Public hearing and witnesses

Monday, 29 June 2020 Canberra

ResMed

Medicines Australia

Manufacturing Australia

Australian Investment Council

Lighting Council Australia

Science & Technology Australia

Australian Information Industry Association (AIIA)

AiGroup

Department of Industry, Science, Energy and Resources

Australian Tax Office

Department of the Treasury