Proposed changes to R&D tax incentives regime in Australia will reward R&D intensity. Companies operating in Australia can benefit significantly if they know how to tap into this opportunity.
An overhaul of the R&D tax incentive legislation in Australia has been proposed which will have the effect of rewarding businesses with greater R&D intensity i.e. higher R&D spend as a proportion of total spend. The changes, once implemented, will apply to financial years commencing on or after 1 July 2018.
The changes were proposed by the federal government in the 2018-19 budget announcement on 8 May 2018 and draft legislation was released on 29 June 2018. The following is a snapshot of the changes.
Tax offset for R&D expenditures
Under the existing rules, a tax offset is calculated as a percentage of total R&D expenditure of the entity in a financial year. The tax offset can be applied against the entity’s income tax liability and may be refundable in certain circumstances if the tax offset exceeds the tax liability.
A refundable tax offset of 43.5% is available for entities with an annual aggregated group turnover of less than AU$20m. Entities with an aggregated group annual turnover of AU$20m or more are entitled to a 38.5% non-refundable tax offset. Unused non-refundable offset amounts can be carried forward to the next financial year.
A minimum R&D spend of AU$20,000 per annum is generally required to apply for the tax incentive while the maximum R&D spend for tax offset is currently AU$100m.
Targeted tax incentive for R&D proposed in the new 2018-19 Budget
As announced in the latest budget, the government aims to provide a refundable R&D tax offset equal to the entity’s tax rate plus 13.5%, capped at AU$4m R&D spend, for entities with annual aggregated group turnover of less than AU$20m.
This would result in an offset rate of 43.5% for entities with the standard tax rate of 30%. Entities with a tax rate of 27.5%, which applies in the 2017-18 year if aggregated turnover is below the threshold of AU$25 mn, would enjoy an offset rate of 41% after the changes.
For larger entities with an annual aggregated group turnover greater than AU$20mn, the proposed new tax incentive policy would be more targeted and would link the extent of the incentive to the R&D intensity of the business. R&D intensity is the ratio of the business’s R&D expenditure to its total expenditure. The greater the R&D intensity, the higher the tax offset rate the entity can enjoy.
The tax offset rates available for different slabs of R&D intensity are as follows:
- 0-2% intensity slab: tax rate +4%
- 2-5% intensity slab: tax rate +6.5%
- 5-10% intensity slab: tax rate +9%
- 10% (or more) intensity slab: tax rate +12.5%
The proposal also includes an increase in the R&D spending cap for larger entities from AU$100m to AU$150m.
What are the requirements to enjoy the new tax incentives?
Type of activities
Eligible R&D expenditures can relate to Core R&D Activities as well as Supporting R&D Activities. But how do you define these precisely?
In general, core R&D activities are defined as experimental activities, the outcome of which cannot be determined in advance based on current knowledge or experience, but can only be determined through systematic work based on scientific principles and conducted for the purpose of generating new knowledge, new or improved materials, products, devices, processes or services.
Supporting R&D activities must have a direct, close and relatively immediate relationship to the core R&D activities. Costs eligible to be claimed under this category would typically include costs of producing prototypes, conducting tests and trials. This could include salaries, wages for the research team (including contractors), costs of fuel and materials used in R&D and reasonably apportioned overheads of the business.
Type of entities
The types of entities that are eligible to apply for the R&D tax incentive include entities incorporated under Australian or foreign laws, and include companies and trustees of public trading trusts. R&D activities conducted by a permanent establishment of a foreign entity can only be claimed:
- when the PE belongs to a resident in a jurisdiction with a double tax agreement with Australia that includes a definition of ‘permanent establishment’; and
- when the R&D activity is conducted for the body corporate but not for the purposes of that permanent establishment.
Entities are required to register the eligible R&D projects with Innovation and Science Australia. Registration is required:
- for every income year of the claim;
- within 10 months of the end of the entity’s income year; and
- prior to claiming the R&D tax offset in the income tax return.
Impact on businesses in Australia
The new targeted R&D tax incentive scheme can be more attractive today, especially to those who wish to invest in or expand in Australia. The scheme applies to businesses operating in any service or manufacturing business.
Businesses in the medical industry should take note that the new proposed measures exempt clinical trials from the AU$4mn cash refund limit, recognising the critical role of R&D involved in clinical trials in developing life-changing drugs and devices.
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