Budget Review 2020–21 Index

Economic Policy

Budget Measures: Budget Paper No. 2: 2020–21 includes a measure to amend Australia’s research and development (R&D) tax incentive (pp.19-20). The announcement is significant and reflects a shift in the Government’s R&D tax incentive policy, particularly when compared with the controversial Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 (the 2019 R&D Bill), which was a response to a Government-initiated Review of the R&D Tax Incentive (2016). The 2019 R&D Bill sought to make the R&D tax incentive more targeted and efficient (see, Bills Digest, pp. 14-19), however the Bill was not well-supported by industry and was described by some as a budget savings measure.

This measure is one of several in the Budget making up the JobMaker plan that aims to support a business-led economic recovery. Others include the Modern Manufacturing Strategy, investments in energy, and a general business tax package (including immediate expensing of asset purchases and loss carry-back rules). The measure was included in the Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Bill 2020, which received Royal Assent on 14 October 2020. The changes to the R&D tax incentive come into force for income years start on or after 1 July 2021.

What is the R&D tax incentive?

The R&D tax incentive provides a tax offset to companies that invest in eligible research and development activities (see Bills Digest to the 2019 R&D Bill (the ‘Bills Digest’), pp. 11–13). Prior to the budget announcement, the tax offset applied to the first $100 million of eligible R&D expenditure at the following rates:

• 43.5 per cent for small R&D entities (legislatively defined as having annual turnover of less than $20 million) and
• 38.5 per cent for large R&D entities (legislatively defined as having annual turnover of $20 million or more).

Further, the R&D tax incentive was fully refundable for small R&D entities, while large R&D entities could carry forward unused tax offsets to future income years. For example, if a small R&D entity had eligible R&D expenditure of $1 million in 2019–20, it would receive a tax offset of $435,000 (this is higher than the value of the standard deduction amount of $275,000 at the company tax rate of 27.5 per cent). If the entity had a tax liability of $300,000, the R&D tax incentive would reduce tax payable to $0, and the entity would receive a refund of the remaining $135,000.

What is the rationale for R&D tax incentives?

There is a well-established body of literature that demonstrates that successful R&D and innovation policies can improve productivity, maintain high wage jobs, and drive greater economic prosperity and living standards. However, these policies are only likely to have a beneficial effect where they modify business behaviours to generate additional R&D activity that would not have occurred without the incentive, and lead to spill-overs for other businesses and society more generally (see, Bills Digest, pp. 6–7).

Although there has been a trend amongst OECD countries to increase the availability, simplicity and generosity of R&D tax incentives, there is a lack of clear empirical evidence about their effectiveness in promoting new R&D activity.

Budget announcement

In the Budget speech, the Treasurer announced that the Government would provide ‘$2 billion in additional Research and Development incentives—removing the cap on refunds, lifting the rate and rewarding those businesses that invest the most’.

As can be seen in Tables 1, 2 and 3 below, this is not an entirely accurate representation because:

• prior to the announcement, there was no cap on the refundability of the R&D tax incentive for small R&D entities—although it should be noted that the 2019 R&D Bill did propose a cap (meaning the Budget announcement reversed the Government’s position on this issue) and
• businesses with between $20 million and $50 million annual turnover and a tier one R&D intensity premium (see Table 2) will have a lower R&D tax incentive rate in 2021 compared to 2022.

Table 1: comparison of proposed changes to the R&D tax incentive

Table 2: R&D intensity premium

Table 3: effect of R&D intensity premium

Conclusion

It is likely that as Australia continues to grapple with COVID-19 and its longer term economic effects, R&D policy will continue to be a key pillar of Australia’s economic policy.

As such, it is important to note three key issues that have not been fully addressed by the budget measure, despite being raised by the Review of the R&D Tax Incentive and by stakeholders in submissions to the Senate Economics Legislation Committee in 2018 and 2019.

Firstly, the intensity premium has previously been criticised for potentially encouraging the outsourcing of non-R&D activities such as sales, administrative and marketing functions. In particular, stakeholders commented that there may be an incentive for businesses to outsource non-R&D activities to increase their R&D intensity level and access a far more generous R&D tax incentive rate. If this were to occur on a large scale, it could undermine the effectiveness of the R&D tax incentive as a job creation measure due to a net negative level of jobs created through outsourcing.

Secondly, the budget announcement only partially adopts the recommendation of the Review of the R&D Tax Incentive to increase the upper limit of the R&D expenditure threshold. While most stakeholders have welcomed this amount increasing from $100 million to $150 million, others, such as Cochlear, have previously stated that the $150 million limit is the bare minimum required. In its 2018 submission to the Senate inquiry, Cochlear also drew attention to the fact that many multinationals will make R&D location decisions based on available incentives:

Thirdly, the absence of a collaboration premium (which is also absent from the 2019 R&D Bill) is likely to be a point of ongoing contention and debate, especially in the higher education sector, given that it was recommended by the Review of the R&D Tax Incentive. For a more detailed discussion of this issue, see the Bills Digest (p. 28).

Notwithstanding these issues, the budget announcement has generally been well-received (see for example Manufacturing Australia and Startup Australia) even though it falls short of what industry and stakeholders have been calling for since the Review of the R&D Tax Incentive was first announced.

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