3.1
Evidence to the committee emphasised the importance of an overall favourable tax framework for FinTech business success. This chapter provides a short overview of the tax system for businesses in Australia, then discusses a number of taxation issues raised in evidence to the committee, including: the Research & Development Tax Incentive (R&DTI); payroll tax; employee share schemes; and initial coin offerings.
Overview of business taxation in Australia
3.2
Businesses operating in Australia are subject to a range of taxes, including:
Company tax, collected by the Commonwealth Government at a full rate of 30% per annum, or 27.5% for companies with aggregated turnover less than $50 million from 2018–2019;
Goods and Services Tax, a national, broad-based consumer tax on most goods and services sold or consumed in Australia;
Capital Gains Tax, collected by the Commonwealth and applicable to any capital gain made through the disposal of assets;
Payroll tax, collected by state and territory governments on the basis of wages paid to employees; and
other Commonwealth and state and territory taxes applicable to certain business activities, such as land tax and fringe benefits tax.
3.3
The Australian Government's 2015 Tax discussion paper, noted that Australia relies heavily on income taxes, particularly company income tax compared to other developed countries. It observed that Australia's tax system was designed when the economy was very different and the tax system needs to adapt to support the modern economy. Key factors include 'technological change (particularly the rise of the digital economy), highly mobile investment and greater labour mobility'. The Tax discussion paper noted that:
Technological change is particularly significant for the taxation of income, especially corporate income. Multinational firms operate across many jurisdictions, much of their value is intangible and the location where value is added can be difficult to determine. The digital economy also facilitates greater personal importation of goods and services, placing pressure on the indirect tax bases.
3.4
It was pointed out that:
Tax is becoming increasingly important as competition for foreign investment intensifies and businesses become more mobile. Australia’s corporate tax rate is high compared to many countries we compete with for investment, especially those in the Asia-Pacific region.
While company tax is paid by companies, the burden is passed on to shareholders, consumers and employees. A more competitive business tax environment would encourage higher levels of investment in Australia and benefit all Australians through increased employment and wages in the long run.
3.5
The Tax discussion paper also noted the increased complexity of the corporate tax system as well as compliance costs which were estimated for all taxpayers to be in the order of $40 billion per year. In relation to business innovation, the Tax discussion paper further noted:
Business innovation encompasses improvements to goods and services, processes and marketing. Benefits can include productivity enhancements, firm growth, job creation and higher living standards. The research and development tax incentive and employee share schemes are two ways that the tax system supports business innovation.
3.6
A more recent report by PwC in June 2020 again noted similar issues, observing that Australia's tax system is ill-equipped to support a growing economy due to:
an over-reliance on personal and corporate taxes
inequities (particularly intergenerational)
a reliance on unsustainable tax bases
a misalignment between revenues and responsibilities
a reliance on distortionary and inefficient taxes
an inability to keep up with global business
tax avoidance throughout the cash economy.
3.7
The PwC report noted 'significant tax reform to grow economies in other jurisdictions' arguing that tax reform in post-COVID-19 Australia will become even more important because of the need to:
generate revenue to support ongoing government expenditure;
improve equity, particularly intergenerational equity given that the costs of The Great Lockdown will be borne disproportionately by the young; and
3.8
State and territory governments collect around 15 per cent of tax revenue largely through payroll and property taxes. The 2015 tax discussion paper noted that in practice payroll tax is less efficient and more complex than it could be because of tax free thresholds and other exemptions such as size of payroll, business type and wage type. It observed:
…there is significant criticism of payroll tax, including of its short-run impact on business costs. While the states and territories have substantially harmonised legislation and the administration of payroll tax in recent years, some business groups, particularly those operating across state borders, remain concerned about the complexity associated with differing thresholds and rates across states…
3.9
The lack of efficiency of state and territory taxes such as payroll tax, due to exemptions provided, was also noted by PwC in its 2020 report.
3.10
A number of submitters and witnesses to the inquiry commented that Australia is uncompetitive in its company tax settings, particularly as they relate to entrepreneurs and startups. FinTech Australia argued that Australia’s current corporate tax rate is too high, particularly when compared with other relevant jurisdictions such a Singapore, and stated:
In relation to taxation more broadly, setting an overall favourable tax framework is key to business success. If government were to align Australia’s legal and tax framework with international best practice it would attract increased international private capital investment and simplify the structures that make it difficult to attract foreign investment.
R&D tax incentive
3.11
The committee received a great deal of evidence in relation to the R&DTI. The R&DTI provides targeted tax offsets designed to encourage more companies to engage in research and development activities. The stated aim of the R&DTI is to boost competitiveness and improve productivity across the economy by:
encouraging industry to conduct R&D that may not otherwise have been conducted;
improving the incentive for smaller firms to undertake R&D; and
providing business with more predictable, less complex support.
3.12
The R&DTI has two core components:
a 43.5% refundable tax offset of for eligible entities whose aggregated turnover is less than $20 million; and
a 38.5% non-refundable tax offset for eligible entities whose aggregated turnover is greater than $20 million.
3.13
A $100 million threshold applies to the R&D expenditure for which companies can claim a concessional tax offset under the R&D Tax Incentive. For any R&D expenditure amounts above $100 million, companies are able to claim a tax offset at the company tax rate.
3.14
The Australian Government pays out R&DTI offsets worth over $2 billion annually.
3.15
Companies wishing to access the R&DTI must register their R&D activities with the Department of Industry, Science, Energy and Resources within 10 months of the end of the company's income year. Companies then lodge their claims for the R&DTI as part of their corporate tax return. The committee heard payments of the offset are generally made to companies between September and December for the preceding financial year, via the ATO portal.
3.16
R&DTI claims may be audited by the department, with clawbacks of amounts already paid out to companies possible in the event that the department determines the initial claim was ineligible.
3.17
The committee heard conflicting views about the operation of the incentive, with some saying it is working well and can be accessed, but many others saying the definitions make it incredibly difficult to access and that the process is long, difficult and resource intensive. However, the one thing witnesses agreed upon was the importance of the incentive.
Importance
3.18
Evidence to the committee highlighted the importance of this tax incentive for startups including FinTechs.
3.19
StartupAUS acknowledged that the R&DTI 'is the single biggest government program supporting startups in Australia', with the program accounting for around $3 billion, of which about two-thirds is spent on companies with less than $20 million in annual turnover. StartupAUS reported on data that suggests for almost 9 in 10 startups (89.2 per cent) the incentive is either 'very important' or 'critical' to the success of their business. Mr Peter Bradd, Chair StartupAUS also highlighted that from their Crossroads report they found '82 per cent of the respondents said they used the money to hire more staff for product-related research and development'.
3.20
The importance of this program was also emphasised by other witnesses including the Australian Investment Council:
The Research and Development Tax Incentive is a critically important policy that drives large parts of Australia's innovation ecosystem. The R&D Tax Incentive encourages considerable investment into the development of new products and services across countless sectors of the economy, which is essential for the economic transition that we need to make towards a more knowledge-based high value-add market. The R&D Tax Incentive regime is a strong and compelling commercial driver for attracting offshore R&D programs to relocate to Australia and undertake their activities here. This has the effect of helping to transfer knowledge and skills into the local market.
3.21
FinTech Australia highlighted that the R&DTI 'has been identified as the number one regulatory issue for FinTechs in the Fintech Census for the past three years'. It further explained:
The importance of the R&D tax incentive to the industry cannot be underestimated, as evidenced by the large number of fintechs who have successfully applied or are in the process of doing so (64%). Further to this, 76% of fintechs indicate that the R&D incentive helps keep aspects of their business onshore. An absence of an effective R&D scheme would significantly hamper innovation and monetisation of Australian fintech offerings.
3.22
Mr Michael Bacina, Partner, FinTech Group, Blockchain Group, Piper Alderman argued that the R&DTI is 'certainly viewed as an essential aspect of the Australian startup culture, whether that's because startups have just come to rely upon it or because it provides that critical early boost of funds when a project may be bootstrapping and getting towards a point where it could seek investment'. Mr Bacina provided more context around the investment culture in Australia:
Australia does have a shortage of that very early stage angel investment, and Australia, culturally, is much more comfortable from the investor perspective of investing in something that's a little bit more proven, which does contrast otherwise to our habits of betting on two flies crawling up a wall. But that boost there is very targeted and very useful, and I think that's essential to our start-up space. That covers all fintechs.
3.23
Mr Yasser El-Ansary, Chief Executive Officer, Australian Investment Council also supported this view and stated:
…we believe fundamentally that the R&D program is Australia's best and most important innovation policy bar none, by a country mile. It is the centrepiece of our investment policy framework. Any changes that we make to the R&D program have to be viewed from that lens.
3.24
It was highlighted to the committee that being able to access the R&DTI would assist in attracting venture capital. Mr Alan Tsen, Chairman FinTech Australia explained:
In many ways, it has a multiplicative effect. If you are an investor and you see other forms of cash capital come in, that also gives more safety in terms of the company being around. For example, in this instance, that is R&D.
3.25
While supporting targeted tax concessions such as the R&DTI, CPA Australia recommended 'consideration of more targeted grants to reduce the current heavy reliance on the tax incentive to encourage innovation'.
Issues raised with the committee
3.26
The committee heard two primary concerns in relation to the R&DTI:
there is uncertainty about the types of software development activities that are eligible under the scheme; and
the ability for rebates paid to companies to be clawed back retrospectively creates significant ambiguity and uncertainty among startups as well as larger innovative firms.
3.27
Several other issues were also noted by submitters and witnesses.
Uncertainty around eligibility of software
3.28
Witnesses emphasised the lack of clarity and uncertainty around the tax incentive, particularly in relation to software development. StartupAUS explained that when the current iteration of the RDTI was introduced in 2010, it was with the intention that most software R&D would be treated consistently with R&D occurring in other sectors; however, the bulk of software development is now not currently eligible due to an increasingly narrow interpretation of the ‘new knowledge’ requirement in the R&DTI legislation:
Under s355-25(1)(b) of the Act, ‘Core R&D Activities’ are required to be conducted for the purpose of generating new knowledge. Importantly, s355-25(1)(b) identifies that ‘new knowledge’ includes ‘new knowledge in the form of new or improved materials, products, devices, processes or services’.
If this language in s355-25(b) is given full effect, software development which is done with the effect of producing ‘new products’, ‘new devices’, ‘new processes’, or ‘new services’ would be included as a Core R&D Activity, provided companies can meet the stringent legislative evidence and process requirements. This would include most software development, in line with the original intention of the scheme[.]
3.29
StartupAUS commented that the R&DTI ‘is set up in such a way that, despite its importance to startups, it has always been awkward for software firms to meet the requirements’:
Under the scheme, eligible R&D must follow a strict and extensively‑documented scientific model (called the ‘Frascati model’) of hypothesis, experimentation, observation and evaluation, and logical conclusions. The results of the experiment must not be able to be predetermined[.]
3.30
StartupAUS further explained that '[t]his process is highly suitable for lab experiments and scientific research [but] is not so suitable for software development or other kinds of technology commercialisation'. It provided several example of software development activities it considered should be eligible in line with the original intent of the scheme:
experimental development of new software to meet an identified or hypothesised commercial market gap;
software development processes designed to iteratively add innovative features to an existing software product; and
testing, improving, and refining software or software features identified above using innovative software development methods.
3.31
StartupAUS stated that the current narrow focus of the interpretation of the ‘new knowledge’ component of the R&DTI requirements ‘incorrectly limits the definition in favour of research and invention focused R&D, ignoring development and innovation focused activities (which are often more directly commercially applicable’. It recommended that the R&DTI legislation be amended to specifically make clear that software development qualifies as core R&D activities in the examples described above.
3.32
Mr Anthony Baum, Founder and Chief Executive Officer, Tic:Toc suggested that 'Australia should do more to support R&D, to update the legislation for the way technologies are evolving and to effectively support the sharing of risk with respect to development of software as we see the businesses in the technology sector grow as a percentage of the overall economy'. He suggested that 'I think the framework around revenue and the hurdles you need to jump can be set as your revenue base grows'.
3.33
Airwallex also emphasised to the committee a lack of clarity with the program in relation to software:
The R&D Tax Incentive is one of the largest programs supporting the growth of startups in Australia, but can be difficult to correctly interpret, even with external consultation. It is often unclear what claims are considered appropriate under the scheme, particularly in the case of software R&D claims.
3.34
Mr Robert Bell, Chief Executive Officer 86 400 emphasised the need for clarity, particularly for small FinTechs saying 'any clarity at the front, or any extra things at the front to help understand what the outcome would be, will help fintechs, even ones smaller than us. We were very well funded in the first instance, so we're a little bit more privileged relative to some of the two- or three-man shops that are starting'.
3.35
This view was supported by Afterpay:
There are particular challenges for startups that are creating software R&D, and we experienced some of these challenges ourselves in the early days. Getting the paperwork right can require expert assistance, and many startups will struggle to access and/or afford specialist assistance. There is no doubt that we would have benefited from greater expert support during our early days.
3.36
Mr McKay also offered the view that: 'I think getting very clear guidelines, particularly for software companies around what is eligible and what isn't, would be very useful'.
3.37
FinTech Australia was concerned that 'the current definition of 'experiments' prevents software companies from claiming this incentive which has the result of hampering innovation'. It recommended that 'experiments in the R&D tax incentive should be interpreted broadly by the ATO to include companies which contribute to building new and innovative services for the fintech sector, even where these are built on top of existing rails'. The Australian Banking Association (ABA) noted this recommendation, commenting:
The ABA view is that RegTech's natural market is solving distinct problems within a large, mature and heavily regulated Australian financial services system. The ABA sees value in ensuring that technological improvements to existing infrastructure are not negatively impacted under the R&D eligibility. Our view is aligned with FinTech Australia in that this would drive research, innovation and efficiencies in the sector.
3.38
Mr Stuart Stoyan, Member FinTech Australia and Founder/CEO MoneyPlace, saw the issues as the design of the scheme but also a need for improved guidance around 'at what point it is software innovation and what point it is not'.
3.39
Zip suggested that '[g]uidance materials for the software/technology industry need to be improved and made much more practical'.
3.40
The RegTech Association also called for more clarity:
The goal of the current R&D grant is innovation and providing an economic advantage to Australia. We would encourage the Government to consider how RegTech fits within the R&D programme, and issue guidance to that effect. Since the regime tightened, there is confusion about where RegTech fits.
The challenge is that RegTech companies are often conducting process innovation – they do not work in laboratories and their research is often in ascertaining whether the design is acceptable to the industry, the regulators and the regulated entities. This is why we would argue the focus needs to be more on ‘D’ than R&D.
3.41
Mr Bacina also suggested greater clarity of the interpretation of the existing scheme for software development in the form of 'clarification from the [tax] commissioner'. He usefully summarised:
Anything that we can have that's a bright line from a regulator, in my view, is very useful when you have reports of these issues coming up. They'll obviously need to be adjusted over time.
3.42
Mr Bacina also suggested a different design:
…you could look at a separately funded bucket of an amount that is available for specifically this kind of software-driven [X]-tech development—whether it's focusing on fintech, depending on the government's priorities—to provide a specific path to that. That may be something you could tie into a more self-assessed approach to reduce those costs of businesses accessing it.
3.43
FinTech Australia recommended creating tax incentives to encourage businesses to use fintech start-ups. Expanding on that idea, Mr Alex Scandurra, Chief Executive Officer, Stone and Chalk suggested an alternative process to encourage large companies to direct some of their R&D expenditure towards startups:
We could quite easily update the legislation regarding the R&D tax credit regime by assigning a proportion of R&D tax credit spend with Australian startups and scaleups which can apply to companies with an annual revenue of greater than $100 million…In doing so, this provides a financial incentive to larger firms to conduct research and development with Australian startups and scaleups at no additional cost to the budget. Additional benefits may result in an improvement in the time it takes to commercially negotiate with large firms thereby improving cash flow and having the secondary benefit of obviously increasing the success rate at early stage.
3.44
In contrast to the views expressed above Mr Andrew Johnson, Chief Executive Officer, Australian Computer Society, was of the view that the scheme is working well:
…at a high level I think it's very easy to say that any software development is innovation and that you're building something new and that with that come some risks. The program incentivised that risk taking. On the flip side, it's very hard to see how you'd start a new business providing digital products and services without having some technology to base it on. Was it the intention of the scheme when it was first designed to build business as usual? We would think not. So there needs to be that happy medium, and so far our anecdotal evidence would say that that has been achieved.
3.45
Ms Leica Ison, Founder and Chief Executive Officer, SkyJed, said that in her personal experience 'the R&D tax incentive has been a very strong support mechanism for that early phase of experimentation and developing your product construct'.
Concern about retrospective action leading to further uncertainty
3.46
The other aspect of uncertainty highlighted to the committee was in relation to audits of previously awarded incentives by the then Department of Industry, Innovation and Science which resulted in some companies being ordered to repay rebates. In December 2018, media reported that high profile startups including Airtasker were sent notices to pay back millions of dollars in R&D incentives with the issue 'looming as a potentially disastrous problem for the development of a vibrant Australian software industry, which many view as a key employer of the future'. Some companies indicated that they had paid for professional advice to ensure their claims complied with the R&D rules.
3.47
The Australian Investment Council indicated that '[t]his about-turn on eligibility has had a material effect on many early stage businesses, who have relied on their access to R&D tax incentive refundable offsets in order to fund ongoing cashflow investment into R&D activities'.
3.48
Mrs Katherine McConnell, Chief Executive Officer and Founder, Brighte capital spoke from first-hand experience about an audit:
We put in two applications. Hundreds of thousands of dollars: for an early stage company that was a substantial amount that we were able to receive. And then we got the letter from AusIndustry that we were under review. I think you can imagine that to potentially be at risk for hundreds of thousands of dollars for an early stage company when you haven't broken even is a huge concern to yourself, your staff and your shareholders. That period of uncertainty lasted for many months. We were working with AusIndustry, providing information. We thought we'd done the right thing because we'd engaged a top tier accounting firm to help us develop our hypotheses and our approach. We thought we'd done the right thing. In the end, we were one of the first lucky ones to get a positive outcome, but I know many peers who haven't received a positive outcome, and I know how difficult that has been for them given the capital constraints that startups operate under. The timing that it takes to resolve that is very stressful. Also, what we felt was that uncertainty. I was there when Malcolm Turnbull made that announcement at Stone & Chalk—'innovation nation'. We engaged top tier support and we paid for that. We thought we'd done the right thing, and then we were just left. It felt as though the rug was pulled out. We felt as though we'd potentially done the wrong thing. So I think that is an area where I can see other startups experiencing trouble.
3.49
Witnesses described the effect of this uncertainty on their business. StartupAUS reported that '[a] common experience right across the sector is that R&D claims are being pared back substantially to try to reduce the risk of facing a potentially catastrophic clawback'.
3.50
Ms Simone Joyce, Director FinTech Australia and Founder/CEO Paypa Plane told the committee that despite being successful two years ago 'I chose not to even attempt last year, because I felt like it was too risky for a call-back to happen…'.
3.51
StartupAUS suggested the R&D tax incentive is 'slipping away from startups':
Startups - particularly software startups - find themselves in a particularly difficult position here. They’re engaging in a form of development that doesn’t always neatly fit the process outlined in the legislation. They’re also generally small and short on cash runway, which means even the threat of an ATO clawback can have very serious (often existential) business ramifications. Few are likely to hire armies of lawyers to fight any adverse ruling (something larger claimants would do as a matter of course). As a result, if they perceive that software is no longer welcome in the R&D Tax Incentive program, it’s reasonable to expect that lots of these businesses will drop out of the scheme entirely, or substantially reduce their claims regardless of their merits.
3.52
Airwallex also expressed concern about the retroactive actions and recommended:
…an increase in scope and clarification on what software claims are eligible under the scheme, that review and audit is conducted at the time of claim to prevent rejection of claims years after submission, and that the threshold for refundable tax offsets be raised to cater for high growth, pre-profit startups that invest heavily in their tech and software R&D.
3.53
Mr Price agreed that 'the risk of audit for what I could imagine a smaller fintech would be, I think, would be very real' and supported a 'tiered approach where true fintechs, depending on where that dollar figure scale is, are exposed to slightly less risk with regard to audit but, the higher up that scale you go, the higher the burden you would expect to manage that process'.
3.54
StartupAUS suggested a way forward:
In the immediate term, there needs to be some assurance for vulnerable software companies. Companies with turnover of less than $20m that have been claiming the incentive, in good faith and on credible professional advice, need an assurance that they are not going to be subject to audit processes unless their claims are manifestly unreasonable or have had sharp unfounded increases. Such a moratorium should remain in place until the introduction of a clear legislative fix to the way the R&D Tax Incentive operates or a new scheme that directly supports software development is implemented. This would help address uncertainty and reduce existential risk for good-faith claimants.
3.55
Zip suggested ensuring that ‘risk and compliance activities are conducted as close as possible to when companies register their R&D activities and before they claim the benefit with the ATO’:
Retrospective compliance activity, especially after refunds are received and then claims amended to reduce or reject them, has a devastating impact on the companies, with many facing financial ruin.
Other sector concerns
Process of applying for and claiming the R&DTI
3.56
Evidence to the committee, even from some successful applicants, was that the process of claiming the R&DTI is long, difficult and resource intensive and this is particularly challenging for early stage FinTechs which are resource and time poor.
3.57
Raiz Invest, a FinTech which successfully claimed the R&DTI, described the process as 'difficult' and 'long', taking a 'solid three months' worth of work'. Mr Brendan Malone, Chief Operating Officer, Raiz Invest Limited, stated that in his view the process wasn't built to accommodate technology:
I remember a couple of years ago when we did our first one; it wasn't built for technology. The applications, and even the registration process, weren't built. It was: 'What are you building? What's your widget? What's your agriculture? What's your medicine or buyer?' It was really centred on the old R&D sides. So that matter has increased. It's a process. We do it. We've done it for three years now. Our submissions would be 40 or 50 pages long. We've built processes around our R&D that we do in-house to make sure that it's easier to complete the application forms. We have steps. We have processes. We have changed management processes in place to make it easier to complete the actual administration process.
3.58
Mr Michael Morris, Head of Technology, Ferocia, discussed the challenge of knowing what is new research in a definitional sense, describing the current process as 'cumbersome' saying the ATO are 'trying to map the quite prescriptive R&D process'. While Ferocia were ultimately successful the process involved 'a lot of pain'.
3.59
Mr Guy Sanderson, Partner, Baker McKenzie commented that it is 'complicated' and further explained:
I think the issue is that some of our clients don't find it reliable. They might be undertaking the expenditure up front without having the certainty that what the outcome will be in terms of getting the incentive.
3.60
Mr Daniel Price, Chief Enterprise Officer, Tic:Toc reported that the process 'is very onerous, depending on the scale of the business'. Mr Bob McKay, Co-Founder, AgriDigital, indicated that they have 'heavily relied on that rebate coming through every year' but '[w]e've utilised one of the big four to help us prepare that. So it does come at a cost, but I just don't think we could do it ourselves'.
3.61
Zip reported that it has 'previously received an R&D incentive but as the process has been more complex, and the cost of lodging the last return equalled the value [of] the incentive, it is unlikely Zip will lodge further claims under the R&D scheme'. However, Zip was of the view that it provides important benefits for FinTech companies and should be retained.
3.62
FinTech Australia highlighted the need to '[s]implify the application requirements for the R&D Tax Incentive' and confirmed that from the 2019 FinTech Census, 88 per cent of FinTechs considered making the R&DTI more accessible would be a way of promoting and growing the Australian FinTech industry.
3.63
Afterpay encouraged the government to 'consider allocating resources, especially for start-ups, so that they can better understand and navigate the processes for applying for the incentive'.
$20 million turnover limit for refundable R&D tax offset
3.64
Mr Bob Mckay, Co-Founder AgriDigital, 'a fintech operating in an ag commodity space' told the committee that they 'very quickly breached the $20 million turnover limit for the refundable R&D tax offset' because:
…unlike most fintechs, who just take loans on to their balance sheet, we have to buy and sell the actual commodity that we're financing. So that very quickly means that we breach the $20 million limit. It would be very welcome if there were some sort of carve-out for people financing ag commodities, because it does severely impact on our ability to get the refundable component of the R&D program.
3.65
Zip also drew the committee's attention to the $20 million in turnover explaining:
The refundable tax incentive is particularly attractive. But given the compliance costs, the program is not attractive for a fintech company once it reaches over $20 million in turnover. To explain - under $20 million turnover companies get a cash rebate back based on their R&D spend. Over $20 million and they get an additional tax deduction. But it is the cash refund every year that is very attractive for fast-growth technology companies. Additional losses that might be used years down the track is far less attractive as it does not help with cashflow in the short term.
3.66
Zip suggested that 'consideration should be given to raising the $20 million turnover cap to $50 million'.
3.67
Dr Adrienne Ryan, General Manager, Rural Affairs, National Farmers Federation added:
…the vast majority of farm businesses aren't able to access their R&D tax incentive due to not being incorporated entities. They are sole traders or partnerships, by and large, so they are not eligible currently for the R&D tax incentive, despite the fact that a number of them probably would engage in activities that would meet the requirements of that measure. So that's an issue that we are exploring at the moment given the legislation that's currently before the parliament.
Suggestions on the R&DTI to assist industry in light of the COVID-19 pandemic
3.68
Following the COVID-19 pandemic, the committee reopened submissions and received additional evidence on suggestions in relation to the R&DTI. Several key sector stakeholders emphasised the importance of the R&DTI to the ongoing viability and recovery of the FinTech and broader innovation ecosystem in Australia.
3.69
FinTech Australia suggested increasing the tax incentive available under the R&DTI from 43 per cent to 65 per cent for the 2020 financial year to provide a boost to firms. The Australian Innovation Collective recommended immediate enhanced funding for the R&DTI program of $500 million, focused specifically on software and deep technology hardware development.
3.70
Several submitters recommended bringing forward R&DTI payments to help businesses with immediate cashflow issues. FinTech Australia commented that waiting for businesses to submit new claims for the 2020 financial year would not provide benefits quickly enough, and that the government should make immediate payments based on claims submitted for the 2019 financial year. It recommended further that a ‘two times multiplier could be established for R&D with a focus on SMEs’ (applying, for example, to those with a turnover up to $50 million per financial year). This ‘would provide immediate financial benefit to SMEs in innovation intensive sectors, which in turn would support jobs and research’.
3.71
The Australian Innovation Collective also recommended a ‘bring forward payment’ of the R&DTI, targeted at startups with revenue of less than $20 million in the current financial year, and based on R&DTI payments for the 2019 financial year.
3.72
In addition to bringing forward payments for the 2019-20 financial year, some submitters suggested that eligible companies be authorised to make a forward claim on their future R&DTI payment for the 2020-21 financial year, based on a fair and reasonable forecast of that year’s R&D activity (for example, enabling companies to claim 50-100 per cent of their 2019-20 claim amount).
3.73
Submitters also suggested that, rather than R&DTI payments being made annually, these payments could be made to businesses half-yearly or quarterly. Early-stage FinTech firm Identitii Limited commented that this measure would mean it could access the rebate it has already accrued in the first half of this fiscal year and deploy the cash in the business immediately.
Eligibility and R&DTI criteria
3.74
The Australian Innovation Collective submitted that to assist startups and scaleups focused on the development of software and deep technology hardware, streamlined eligibility criteria should be implemented, namely: making ‘software development costs eligible for the refundable RDTI component’; and a two year guarantee that claims for software development of any kind will not be rejected.
3.75
The Australian Investment Council submitted that the government needs to ‘address recent uncertainty around the future settings of the R&D program’, and recommended that steps should be taken to ‘broaden the definition of “experiments” to encompass businesses that innovate on top of existing infrastructure and to provide clarity on which R&D claims are eligible’ to avoid potential disputes with the Australian Taxation Office (ATO).
Government work and proposed legislative changes
3.76
In announcing the National Innovation and Science Agenda on 7 December 2015 a review panel was formed to 'identify opportunities to improve the effectiveness and integrity of the R&D Tax Incentive, including by sharpening its focus on encouraging additional R&D spending'. The review found that the incentive is 'falling short of meeting its objectives of supporting additional R&D activities that generate broader benefits for the Australian economy'.
3.77
The government announced its response to the review as part of the 2018-19 Budget described as 'sharpening its focus on additional eligible business R&D while ensuring ongoing fiscal affordability'. Media at the time reported that the changes would save $2.9 billion over 2018-19 to 2020-2021 by reducing grant levels for many claimants and increasing compliance and enforcement measures.
Proposed Legislation
3.78
Legislation to support the 2018-19 Budget announcement was first introduced in September 2018 and considered by the Senate Economics Legislation Committee. A number of concerns were raised through the inquiry which reported in February 2019 and recommended amendments to address industry concerns. This bill lapsed with the dissolution of the parliament.
3.79
Revised legislation was introduced into parliament on 5 December 2019 and referred to the Senate Economics Legislation Committee on 6 February 2020, with the inquiry due to report by 12 October 2020.
3.80
The key reforms announced include:
an R&D intensity premium for larger companies, which replaces the existing 38.5 per cent non-refundable R&D tax offset with a tiered series of thresholds, and provides progressively higher rates of support as a claimant’s R&D intensity increases;
increasing the maximum threshold amount of R&D expenditure eligible for concessional R&D tax offsets from $100 million to $150 million;
for smaller companies (with an annual turnover below $20 million), the available offset is equal to their corporate tax rate plus a 13.5 per cent premium; and
introducing a cap on the total refundable amount available to smaller companies of $4 million per annum with clinical trials exempted.
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The Explanatory Memorandum to the revised legislation indicates that the amendments will result in a gain to the Commonwealth budget of $1.8 billion over the forward estimates.
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The Department of Industry, Innovation and Science reported that the revised legislation takes account of the Senate Economics Legislation Committee's recommendations and the refinements include:
deferring of the start date for the reforms by 12 months, now applying to income years commencing on or after 1 July 2019 –
this helps minimise the impact on investment decisions made by businesses before the reforms were announced, including SMEs impacted by the cap on cash refunds; and
simplifying the new R&D intensity premium by reducing the tiers from four to three –
this improves the benefit for initial R&D investment in keeping with the Senate recommendation, but continues to reward those with higher R&D intensity with a higher premium, consistent with the aims of the reforms.
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In relation to the legislation, the Australian Investment Council (AIC) noted that:
…while the bill marked an important step forward in providing certainty to businesses about the future direction of Australia's R&D tax incentive, certain definitions used in the legislation are likely to continue to create uncertainty on the eligibility criteria for R&D tax incentives.
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Mr El-Ansary from the AIC further explained:
…we were not supportive of changes that would seek to restrict the eligibility of certain businesses to access the R&D refundable credit program in particular, which is the program… we are most interested in from a stakeholder perspective. As you would all know, at the moment the program does not have a cap for refundable credits, subject to meeting all of the relevant criteria tests that exist. In our view, the thinking about an introduction of a cap was flawed but…we have convinced ourselves—at least as an industry—that, in the context in which changes are to be made, introducing caps at a range of $4 million per year would be appropriate and reasonable and much better than the proposed caps of $2 million a year that were originally mooted.
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Mr Alf Capito, Tax Policy EY provided the EY view on the current legislation:
Our view is the same as it was when the bill was first introduced, which is that the notion of an intensity test is an adverse move. That intensity test effectively halves the benefit companies can claim for R&D incentives. It takes it from the existing 8½ per cent to basically 4½ per cent for most companies. In order to get the same 8½ per cent benefit as you do now under the intensity test, which only applies admittedly to companies that have a turnover of more than $20 million—you heard from the last witness that even farmers have trouble staying under that limit—in order to retain the same benefit, you need to have an R&D intensity of 13½ per cent. That means that your R&D costs as a numerator above the denominator, being all of your operating costs, have to be 13½ per cent. Hardly anyone has that unless you go to a Cochlear or a CSL or something.
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The Australian Innovation Collective also recommended revising the criteria for the longer-term by amending the proposed R&DTI legislation in the following ways:
the qualifying expenditure threshold should remain at $100 million to ensure the longevity of the program;
the R&D expenditure threshold should be a permanent feature of the law;
R&D entities with an aggregated turnover of less than $50 million should be generally entitled to an R&D tax offset equal to their corporate tax rate plus a 13.5 per cent premium;
there should be no caps placed on those accessing the refundable R&D tax offset;
instead of the proposed intensity premium, the government should retain a flat percentage rate above the corporate tax rate for expenditure on R&D activities and introduce a 20 per cent non-refundable startup and scaleup collaboration premium in its place.
Software guidance published
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On 21 February 2019, the Minister for Industry, Science and Technology published new software guidance which:
…does not change the eligibility of software under the R&DTI, but provides more clarity to companies around what are considered eligible software research and development activities under the program and what are not, helping them to self-assess their claims more effectively'.
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The guidance was part of a 'broader program of user-focussed education products being rolled out by the Department of industry, Innovation and Science to improve clarity and support to businesses seeking to claim the R&DTI'.
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In relation to software development, the then Department of Industry, Innovation and Science submitted to the committee:
While often innovative, not all ICT and software development and other digital innovation activities are eligible R&D, as defined in R&D Tax Incentive legislation. Since 2011, consistent with the program’s objectives, this definition has centred on the extent to which outcomes are uncertain without undertaking specific R&D processes, and whether activities are being undertaken with the purpose of generating new knowledge.
However, digital innovation activities frequently utilise approaches that do not rely on a traditional R&D cycle. These approaches can include agile methodologies, incremental improvements to existing products or services, or business model optimisation.
Consequently, a range of digital innovation activities are not eligible for the R&D Tax Incentive, or may have met the definition at one time, but no longer do so due to the pace of technological advancement in this sector. For example, over a relatively short period of time, the outcomes of particular ICT and software development activities become more certain, the knowledge generated no longer new, the risks lower and the benefits easier to capture. As businesses are more likely to invest in these sorts of activities without government support, they are not the intended target of the R&D Tax Incentive.
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The department noted further that ‘the limitations of the program’s scope, including with regard to digital innovation, has been raised on a number of occasions’:
For example, it was considered by the 2016 Review, the Government’s response to the Review and the Senate inquiry. In all cases, it was agreed that current scope was fit for purpose and should be retained.
To ensure the Government achieves best value for Australian tax payers and is not simply funding businesses to do what they would have done anyway, its support for digital innovation activities needs to be deliberate and targeted. The Government has a range of more direct measures to support and drive broader R&D and innovation of this kind. These include Cooperative Research Centres, Venture Capital incentives…and elements of the Entrepreneurs’ Programme, like Accelerating Commercialisation.
Innovation and Science Australia 2020 report
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In February 2020, a report by Innovation and Science Australia (ISA) to the Minister for Industry Science and Technology, titled Stimulating business investment in innovation, was released. It makes a distinction between R&D innovation and non-R&D innovation, concluding that:
Consequently, the traditional focus of business innovation policy on stimulating the supply of R&D should be complemented by measures that stimulate the supply of non-R&D innovation, especially where spillovers are important or systemic impediments exist. Government should also look at demand-side measures (examples include government procurement and missions) to spur greater innovation investment by businesses.
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The report recommended that:
…Government rebalance its policy mix to support business investment in both non-R&D innovation and R&D, specifically with significant additional support for non-R&D innovation for a defined period, say, 5–10 years.
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In relation to greater investment in technology the report recommended:
ISA recommends that Government reduce reliance on the R&D Tax Incentive (R&DTI) as the primary support to businesses and complement support with direct measures (such as grants) to encourage non-R&D innovation investment.
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In response to this report, Mr Stoyan of FinTech Australia provided the following view:
The position that Andrew Stevens in ISA took earlier this week in the report is now a delineation between R&D innovation and non-R&D innovation, where ISA categorises non-R&D innovation to be software. The assertion that innovation cannot happen outside of a petri dish is ludicrous. You see a bias and a very strong opinion from ISA. Following a scientific method is one thing, but it is possible to follow a scientific method in a software environment for a software product or software innovation. But the view that has been taken by ISA has typically been that unless it's in a laboratory, unless there is true chemistry happening in that situation, it's not innovation.
Payroll tax
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Although a state imposed tax, the 2019 FinTech Census reported on other tax related initiatives that would assist Australian fintechs and a 'reduction in taxes associated with hiring employees, such as payroll taxes' was considered to be effective by 83 per cent of FinTechs.
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Airwallex emphasised the effect payroll tax has on early to mid-stage startups:
…state imposed payroll tax can represent a significant financial burden when looking to rapidly grow local teams. Payroll tax can act to de-incentivise employee growth, leading to small local teams and driving high value technology employment opportunities offshore.
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Xinja also recommended a 'decrease in payroll taxes for startups in their initial years'.
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When asked to elaborate on the points made in the Airwallex submission at a public hearing, Mr Adam Stevenson, Senior Legal Counsel, Airwallex responded:
I think Airwallex is happy—we're growing rapidly, we employ people all over the world and we want to employ people all over Australia. One of the barriers is obviously this state based regulation which makes it hard for us to learn what payroll tax in South Australia is compared to New South Wales and Victoria. What we want to do is simplify that in terms of how easy it is for us. We have one employee in Sydney and we have a whole additional regime to comply with. That takes up time for our finance staff to figure out what the pay is for just one staff member. We're less likely to grow around Australia with these types of taxes in place.
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When providing suggestions to support the FinTech ecosystem, Mr Simon Bligh, Chief Executive Officer, illion, noted 'it would be good to support some small businesses via increased R&D tax concessions and, perhaps, payroll tax concessions'.
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A.T. Kearney also mentioned the 'proliferation of jurisdictional payroll tax platforms' and suggested '[a] single payroll tax platform could provide all Australian businesses with a simple, common interface':
This would allow each jurisdiction to still have their own unique payroll tax laws in place, and simplify the compliance process for businesses, who would be required to simply answer basic questions related to number of employees, salaries and other basic variables needed to understand the employer’s payroll tax obligation.
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The Government of South Australia told the committee of its work in this area:
In South Australia, we are creating an environment to make it easier to do business. In January 2019 we reduced the payroll tax burden for small businesses by lifting the annual taxable wages threshold from $600,000 to $1.5 million. This provides a saving of up to $44,550 a year and will benefit more than 3,500 South Australian businesses.
Employee Share Schemes
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Xinja detailed recruitment challenges for startups:
To enable startups to better attract talent, there needs to be sufficient compensation for the risk of working in a startup, such as salaries, options, learning and development, or other benefits. Startups in their early years can be limited in their ability to pay the above market rates required to attract tech talent – and are therefore more reliant on non-salary based incentives.
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Digital Industry Group provided the report Australia's Digital Opportunity which noted the use of employee share schemes in the US:
Successful technology companies and startups often rely on equity in their business as a way to incentivise high quality talent and compete with larger businesses. This particularly prevalent in the US which offers accessible and attractive employee share schemes which incentivise talent to work in startups.
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According to the ATO, employee share schemes 'give employees a benefit such as: shares in the company they work for at a discounted price; and the opportunity to buy shares in the company in the future (a right or option)'. The ATO indicates that in most cases, 'employees will be eligible for special tax treatment known as tax concessions'.
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FinTech Australia noted that '[a]lthough improvements have been made for employee share schemes, there has been significant confusion'. It explained:
As the prospect of owning a stake in the business is a major incentive for talent to join uncertain fintechs, taxing shares as income is detrimental. Effectively it equates unlisted shares in an early company with uncertain valuation, with cash. This is a significant disincentive.
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Xinja made a number of recommendations 'to not only enable fintech startups to attract the talent they need, but also to raise the profile of the fintech industry as an attractive career and employment alternative'. It included the recommendation to 'provide a CGT [Capital Gains Tax] exemption for startup equity, including employee share schemes, to enable fintech startups to better compete for hard to find talent'.
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Airwallex also highlighted the CGT implications for Australian employees receiving equity, providing more detail:
Employee share schemes (ESS) have come to represent a significant component of many remuneration policies designed to both attract and retain talent. Current Capital Gains Tax (CGT) implications for Australian employees receiving equity and exercising options are complex and prohibitive, decreasing the effectiveness of ESS as an acquisition and retention tool, especially in maturing and high growth startups. Changes to the tax treatment of employee share schemes has improved for startups since 2015, however these improvements fail to extend to more mature startups that fall out of the startup exemption.
Under current legislation, organisations are required to disclose details of the ESS offered to more than 20 employees and/or non-senior managers per year (the 20/12 rule). Disclosure of this nature contains sensitive data, is time consuming, and is quickly made redundant given the rate of startup growth and the propensity for equity to form part of remuneration.
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Airwallex suggested legislative amendments 'to allow for a broader range of growing tech companies to be covered under the start-up concession, including significantly raising the current $50m annual turnover threshold'. In addition 'employees granted equity should not be considered ‘investors’ under the 20/12 rule to reduce the burden of disclosure on startups and reflect the common nature of equity forming a part of remuneration'.
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The Australian Securities and Investments Commission (ASIC) informed the committee that it has:
issued class waivers for employee incentive schemes (LI 14/1000 and LI 14/1001) that enable companies to incentivise employees with equity based remuneration. This is popular among tech companies that require highly skilled staff but are unable to offer competitive salaries.
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ASIC also noted the review process on employee share schemes underway by Treasury. A consultation paper was released on 3 April 2019 and submissions closed at the end of April 2019. Submissions have been published on the relevant Treasury website and it states that the consultation process has been completed. However, a final report does not appear to be available.
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On 6 February 2020, the House of Representatives Standing Committee on Tax and Revenue commenced an inquiry into the Tax Treatment of Employee Share Schemes which invited submissions by 28 May 2020. Hearings have been held in June and July 2020.
Tax treatment of Initial Coin Offerings
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Witnesses highlighted the potential of blockchain and welcomed the National Blockchain Roadmap from the Department of Industry, Science, Energy and Resources.
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The importance of access to capital for blockchain firms was emphasised to the committee. Power Ledger highlighted that 'for blockchain enabled startups, an important means of achieving this can be through an Initial Coin Offering (ICO) whereby tokens that perform a certain utility can be sold to the market, as an alternative to traditional forms of capital raising'. Power Ledger suggested that Australia's tax laws have not contemplated this new way of capital raising with the issuance of an ICO currently taxed as income. Blockchain Australia and RMIT Blockchain Innovation Hub have released a report titled Australia's Blockchain Future: Recommendations for the Taxation of Initial Coin Offerings which highlighted that 'other countries have remedied or are in the process of changing their tax laws to encourage their blockchain sector'. Dr Jemma Green, Executive Chairman and Co-Founder, Power Ledger, explained what is occurring in some other countries:
Many countries—for example, Switzerland—are changing that to put them on capital accounts, which is moving the taxing point to when proceeds build a platform which generates income. In Australia, the proceeds are presently being taxed as income. As a result of this regulation, Australia is not an attractive proposition to undertake one of these initial coin offerings or indeed set up a business here.
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Dr Green highlighted that '[t]o date, globally, more than US$26 billion of capital has been raised through these ICO markets and Australia has only captured less than one per cent of this value'. She argued:
I think that the opportunity here, if we take it, is for the Googles and Facebooks in the blockchain sector of tomorrow to be based in Australia and to capture a bigger piece of that $26 billion pie that I mentioned. In doing so, there will be many companies, like Power Ledger, which will indeed employ tens of thousands of people. So from an employment perspective it's a really exciting story. And then the taxation revenue from those companies that come in profitable will be the bounty for the Treasury. And so I think there's a bigger play around capturing the value for those markets in the Australian economy, as opposed to them being based outside Australia. It's stimulating the fintech sector, providing employment opportunities and delivering better quality services to the Australian people.
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The Treasury is currently conducting a review into ICOs which includes tax treatment. An issues paper was released in January 2019 calling for submissions by 28 February 2019. Submissions have been published on the relevant Treasury website and it states that the consultation process has been completed.
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In response to a question on notice the Treasury confirmed that Treasury staff met with industry participants and government agencies and hosted roundtable discussions before and after the issues paper was released. The Treasury confirmed the issue raised with the committee is part of the review and that decisions related to the timing of any announcement of the review's outcomes are a matter for government.