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Ernst & Young Response to "Review of Business Taxation - A Platform for Consultation" Discussion paper 2 Volumes I and II Feb. 1999 (the 'Ralph Report')
This submission deals in general with national innovation policy in the context of the Business Tax Review and specifically with the R&D Tax Concession operating under section 73B of the Income Tax Assessment Act 1936.
For reasons of brevity, this submission sets out our summarised views without any detailed reference to the many public inquiries, academic reports and other studies made into national innovation and the benefits of the R&D Tax Concession. Ernst & Youngs credentials are based on our knowledge of the R&D Tax Concession and our working experience on behalf of a diverse client base since the R&D Tax Concession's inception.
These views are also informed by our past consulting engagements on behalf of the Department of Industry, Science and Resources (ISR) and the Industry Research and Development Board in respect of impediments to the uptake of R&D industry assistance programs in the life sciences and other similar industry reviews at a State level.
We summarise our views as follows:
The breadth and scope of the discussion papers are commendable. However, in their present form scant attention has been given to national business tax reform and its implications in respect of national R&D and innovation policy. Evidence at a global, national and firm level shows a direct and irrefutable correlation between R&D and longer term economic growth and employment. Business tax reform is thus inextricably linked to the destiny of Australian innovation capacity, skills and culture. Consideration must therefore be given to proposals that make the national economy more effective; for example, by promoting national innovation, as well as proposals that deliver greater business efficiency. Maintaining or increasing the R&D tax concession is a means of achieving these vital national objectives.
The R&D Tax Concession
We observe the recent press and public statements by members of the Ralph Committee on the R&D Tax Concession and note these have not unequivocally supported its retention. As the present discussion papers do not address this issue at all, we anticipate this will be remedied in subsequent reports.
The R&D Tax Concession has been a central plank of national R&D policy since 1985. While the legislation has been amended over time, its core objectives have been retained. These are to increase business investment in R&D, improve competitiveness of Australian companies and drive development of new products and process.
In making any assessment of the benefits of the R&D Tax Concession, the Committee should be mindful of the complete framework and fabric of all R&D industry incentives: the R&D Tax Concession, R&D Start grants, loans, rural R&D levies, industry-specific schemes eg the Pharmaceutical Industry Investment Program, as well as related issues such as capitals gains tax and access to venture capital.
It is accepted that all such programs have their place and that they may have significantly benefited individual companies at different times. However, the policy design and practical implementation of the R&D Tax Concession has the following specific and enduring advantages:
It is an 'open-access' form of assistance. Any Australian company regardless of size and industry sector may benefit, provided their R&D endeavours are eligible. The provision of a financial benefit of 9c in the dollar must increase the amount of socially-desirable R&D activity taking place by reducing its after-tax cost impost on companies.
The time-span needed for productive R&D investments and any subsequent product refinements requires long term planning horizons and consistent national policy. The R&D Tax Concession provides this certainty having been the core national R&D incentive program accessed by companies since 1985. Consistency and certainty of policy is repeatedly emphasised by R&D practitioners in both the public and private sectors.
The R&D Tax Concession remains critical to driving and sustaining R&D profile in corporations and a significant benefit when R&D professionals are promoting R&D programs to executives. There is anecdotal evidence that the lowering of the concessional rate from 150% to 125%, had a perceptual and psychological impact on the business community, underestimated by the Government. There are also examples of multi-national companies revising their R&D investment decisions in Australia, due to this change.
It is market driven, unlike a discretionary grants process. Industry makes its own decisions on business and R&D strategy in the knowledge of being able to obtain a definite level of benefit from the Government, dependent on the amount of eligible expenditure incurred.
As an open-access, self-assessment incentive, it also has lower compliance costs than discretionary grant programs. These costs can be further diminished by streamlined and efficient administrative practices. Very recent legislative amendments are directed to this end.
It is a driver of R&D in as much as it reduces the cost of dedicating resources to R&D work.
The tax concession's broad definition renders it accessible to companies undertaking all calibre of R&D work. This broad applicability enables it to reach the small to medium-sized companies that the Government purports to target with such assistance.
At its core, eligibility to the R&D Tax Concession is determined by:
Indeed, while R&D in both academic and corporate settings may ideally be "new to world discoveries", most R&D outcomes are less than this and won slowly by incremental advance. In a commercial setting, incremental improvements by R&D tend to be the norm rather than "new to world" discoveries. This however does not necessarily diminish the risk, nor inventiveness that may be needed to make what may superficially appear to be a simple incremental improvement. A classical example of this (seen in many industries) is the problems associated with scale-up of a bench level prototype to a commercial plant version. Clinical trials of new drugs are another example. Innovation and risk must therefore be examined on a case-by-case basis to see what passes the tests for eligibility.
The burden of the tax concession's compliance costs are somewhat overstated, particularly when offset against improvements in other operational efficiencies. Indeed, the rigours of the R&D Tax Concession have been used by many companies to sharpen their project and R&D portfolio management practices. It has had the unintended benefit of focusing their attention on R&D operational disciplines and the quality of their investments. The tighter tests of eligibility and the need for contemporaneous record keeping is also slowly improving R&D management practices.
The level of subsidy is subject to the corporate tax rate. This is a problem, as lower rates (eg 30%) begin to squeeze the margin between benefit and compliance costs to a point where making claims is of marginal value. This will change claim submission behaviours.
The R&D Tax Concession encourages development work that would not otherwise occur. Most of our clients assert that generally, they would either not undertake the work or the amount of work; nor sustain current rates of progress (thus failing to be "first to market"), without the tax incentive. They would also be less inclined to undertake work that was assessed to be of too high risk, or too long a return on investment.
However, as asserted in the Mortimer report, ultimately it is impossible to measure with any certainty the base level of R&D present in a company, as compared to that encouraged by the R&D tax concession.
The R&D Tax Concession does not provide immediate benefit to tax loss companies. This is a view with which we agree. Fledgling and small-to-medium sized high growth potential companies, on the whole, do not see the R&D Tax Concession of great benefit. A minority of these companies have benefited from R&D grant programs.
It is companies of this class (and their prospective entrepreneurs) who in our view are the most dissatisfied with current R&D industry incentives and other business tax settings eg. capital gains tax and hence access to venture capital. This problem needs to be addressed to help companies of this type grow. A number of policy changes are possible, an example being concessional input tax credits on R&D-related business expenses under the GST framework. This would have immediate cash flow benefits. Another example would be up-front payment of benefits for smaller projects, or the options favoured in the Mortimer Report.
We offer the following conclusions and recommendations:
The Ralph Committee make an analysis of all its business tax options and proposals (including capital gains tax and the R&D Tax Concession) as these may interact together, and specifically as they may impact on national R&D and innovation, and as they relate to different industry sectors and companies of varying size and growth.
The Ralph Committee directly address and consult with business on whether or not the savings from a 30% corporate tax rate would be directed back (in part) to drive company-level R&D. This cannot be left to assumption. The Committee would have to be satisfied that any removal of the R&D Tax Concession will not decelerate and further undermine the slow increase in business expenditure in R&D per GDP that has shown steady improvement against our international competitors over the past decade.
Should the new corporate tax rate be fixed at 30%, that the R&D Tax Concession be adjusted to a minimum of 130% to maintain current benefits, until such time as the Commonwealth holds a national innovation summit to consider these matters (scheduled we believe for late 1999 or 2000) or until such time as the issues under recommendation 1 and 2 are addressed.
That the costs of recommendation 3, if any, be either taken from simplification and/or rationalisation of the R&D Start Grant program and in particular a review of the need to maintain R&D Start Plus and R&D Start Premium schemes.
Thank you for the invitation to make this submission. We would be most pleased to expand on these summarised views if you seek further information. The Ernst& Young contact person is Mr Graham Wakeman ( 02-9248-5308 )