RSM Australia

A review of the Innovation Plan – the hits and misses

The release of the Federal Government’s Innovation Statement through the National Innovation and Science Agenda came on a day that iron ore and oil prices continued to drop.  The Australian economy desperately needs strong leadership to help it transform and Primer Minister Malcolm Turnbull’s first major policy release was critical to demonstrating that the Federal Government recognises this.

Across Australia in recent years there has been a relative boom in the start-up ecosystem, driven by passionate individuals with the drive needed to make a difference.  However, in the background, funding to research has been diminishing and understanding of the role of innovation in corporate Australia has been spasmodic at best.  There is a need for the Federal Government to help pull the levers that will result in not only more research but also the skills and funding needed to connect the dots between all the relevant parties to make innovation successful.

Many peak bodies and industry groups have put their suggestions forward in recent months on what they think is needed to improve innovation in Australia, but not surprisingly they predominantly tended to be self-centred, one-eyed views on what to do. What the Innovation Agenda has attempted to do, and successfully in our opinion, is provide a framework of that cover a number of the different drivers that are required. Given that it covers 11 different portfolios with a budget of over $1billion, it’s a very good starting point.

In November, the Office of the Chief Economist released the 2015 “Australian Innovation System Report” recognising a number of factors including: more diversity in models for equity funding; lack of skills in SMEs; more collaboration and need for Australian corporate culture to be more outward looking and engaging in innovation eco-system.  The Agenda predominantly aligns with this report and provides a comprehensive framework covering four pillars of Collaboration, Capital, Skills and Government.  Within each of these pillars are a number of diverse new programmes and changes to existing programmes and legislation are laid out.  It is a comprehensive Innovation Strategy and the Government deserves credit for releasing it.
However, the funding it proposes is modest in that it is distributed over a number of programmes and four years, but most disappointingly the Treasurer has announced that the spending will be matched by savings offsets in next week’s Mid-Year Economic and Fiscal Outlook.  The question therefore is, what will be the sting in the tail and will we expect bad news for other existing innovation support mechanisms next week?

The Agenda has highlighted a review of the R&D Tax Incentive to improve its effectiveness and integrity, including by sharpening its focus on encouraging additional R&D spend.  There are many concerns in this short statement.  It follows other recent negative commentary regarding the R&D Tax Incentive being restricted by an additionality test and targeting high growth and R&D intensive businesses.

A broad based R&D Tax Incentive is the centre piece of innovation support, not just in Australia but in almost all countries. In simple terms, R&D Tax is a low cost program, that is relatively simple to manage that supports a large number of projects across all sectors of the economy and does not discriminate against company or project. 

Government must acknowledge that almost all of Australia’s OECD competitors do not have strict “additionality” measures in place, or other proposed restrictive eligibility requirements, such as being in a “higher growth,” or “R&D intensive business.” These negative measures will be gladly welcomed by regional and global competitors, driving R&D projects offshore.  Indeed, competitor countries such as Singapore and the UK already aggressively approach Australia’s technology businesses, with the intention of having them relocate and capitalising on the R&D undertaken in Australia. These countries will enjoy an increased level of success with a degraded Australian R&D tax incentive.

It is highly likely that these negative changes to the R&D tax incentive, if implemented, would result in Australian R&D being offshored in a similar manner to the movement of intellectual property by multinationals.

In recent years it has become very simple for Australian companies to offshore almost any function of their business, including R&D needs. In many cases the decision of retaining R&D in Australia or having portions of it done cheaper overseas involve an R&D tax consideration. This decision to keep R&D in Australia by companies should be considered “additional,” and global competition for this work makes it a significant reason by itself, to retain a fully competitive R&D tax program in its current form.
Indeed, the recently released Australian Industry Report 2015, finds that “…R&D is not persistent enough to be sustained over the long term without strong turnover or external stimulants such as spillovers and tax incentives, and it would rapidly fall to zero if not supported by other means such as strong sales or Government assistance.”  The offshoring of R&D would be a strong component of the rapid fall to zero with a degraded R&D tax incentive.

Even highly innovative businesses such as pharmaceutical, or medical device development companies, could be ineligible for the R&D tax incentive, if it was considered that activities are not “additional,” to that undertaken in the absence of the R&D tax incentive. In fact any start-up company having raised some development capital, but in an exclusively R&D phase of its development, may be deemed ineligible with this restrictive approach. Companies deemed to be not in a high growth sector, or be sufficiently R&D intensive are likely ineligible. 

The R&D tax system in Australia is agnostic as are almost all G20 countries.  It is critical that readily accessible market driven, broad based R&D tax support remains for industry. It is not unreasonable for the Government to desire the best value for money achievable from programs such as the R&D tax incentive. However, detailed quantitative research of what is currently being achieved, including all costs and benefits of the R&D tax program, and current “additionality” levels should be carried out rather than making broad based assumptions. All the required data necessary for this analysis should be available from the ATO, however, the Government is currently pursuing a qualitative survey approach in evaluating the program.  

The cost of the R&D tax incentive as reflected in Government budgets should be primarily based on the “additional” cost of providing an R&D tax benefit.  This is the cost to the Government of providing an R&D tax benefit above the standard business tax deductions available on the expenditure. This does not appear to be the case currently, with the 2013/14 refundable R&D tax offset having $5.2 billion of expenditure claimed, and a budgeted cost of $1.9 billion. The 15% “additional,” cost of providing an R&D benefit for the refundable program, would only be approximately $780 million.  The current budget modelling approach of utilising the gross 45% R&D tax offset figure, substantially overstates the cost of the critical refundable R&D tax offset by approximately $1.1 billion in 2013/14, inhibits appropriate cost-benefit evaluations, and distorts stakeholder discussions of the program.

Degrading the R&D Tax program will undoubtedly lead to more R&D being conducted overseas and the good work done in the Innovation Agenda lost. If the Treasurer wants to find budget savings to pay for the Agenda, a good place to start will be correctly modelling the cost of the R&D Tax Incentive.

A closing comment on the Agenda is to remind the Federal Government that developing a successful Australian Innovation ecosystem requires all businesses in Australia to participate.  The Agenda has some good targeted initiatives predominantly for research and start-ups but applies very limited levers to incentivise corporate Australia to be engaged in the Innovation ecosystem. Suggestions have previously been put forward that tax levers for corporates are relatively easy to apply and can achieve highly effective results at low cost. We look forward to further innovation agenda policies that will fill this final gap in an otherwise positive Agenda.

If you would like assistance in better understanding how changes announced in the innovation plan can impact your business, please contact your local RSM adviser.

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