Kim Carr’s announcement yesterday of cross-bench support for the government’s new research and development (R&D) tax concession is an important win — for Labor and for innovation in Australia. The Greens have also chosen the right rather than the easiest decision.

Former Minister for Industry and Commerce John Button was proud of the R&D tax concession he introduced in 1985. It led the world, but was also a masterpiece of perversity from which our many imitators managed to learn. It entitled firms to claim 150% of their R&D expenditure, thus lowering their tax liability.

But two huge problems went unaddressed for far too long.

First, many of the most innovative firms — particularly start-ups — are in tax loss and so have no immediate tax liability which the concession can offset. Pharmaceuticals start-ups paid the additional compliance costs to qualify for the concession for six or more years of losses. But some never made profits and quite a few of the successes found themselves unable to access their tax losses because corporate restructuring as they moved into expansion triggered the anti-tax loss trading provisions of the Tax Act.

Second, accountants found ways to write off very large proportions of production expenditure as “directly related” to R&D under the legislation. For instance, mining often involves relatively small R&D projects to deal with specific geological issues which are then firmed up in normal production. Following some judicial decisions in 2000 “whole of mine” claims burgeoned. Two years ago mining passed manufacturing as the highest claimant on the scheme. Compare this to Canada, where miners’ R&D comes in at less than a tenth of Canadian manufacturers’ R&D!

Meanwhile, the evidence suggested that Australian manufacturers were gearing up for some “whole of production” claims themselves.

How was all this affordable? The tax concession’s value had dropped with falling rates of company tax and with John Howard cutting the concessionality of the scheme in half — from 150% to 125%. These changes saw the value of the scheme fall by over two thirds — from 24.5 cents in the dollar to 7.5 cents.

The Cutler Review in 2008 proposed ending “whole of mine” claims and using the proceeds to increase assistance rates and allow tax loss firms with turnover under $20 million to access the concession as a cash grant.

Not surprisingly, smaller firms supported the changes while larger firms, their accountants and industry associations strongly opposed them. As is the way these days, it was all up to the Greens. They’d indicated their sympathy to the smaller end of town. But what quid pro quo could they extract from the government to mollify industry?

The Treasury had devised a clever way to prevent whole of mine claims by allowing only production activity with the “dominant purpose” of supporting R&D — where most production has the dominant purpose of generating output to sell (in comparision, the UK and Canada simply excised all production from eligibility for their comparable schemes). The early candidate was exempting small business from the “dominant purpose” test. Treasury guesstimated this would cost $95 million. Yet production that isn’t for the dominant purpose of supporting R&D will take place in any event.

I suggested a better option in a paper for the Australian Business Foundation. Recent research has demonstrated that big business has been relatively insensitive to changes in the level of assistance in the concession over time. But one small change made a big difference for small business: when the Howard government enabled tax loss firms with a turnover of less than $5 million to access the concession in cash in 2001, small firm R&D leapt — without any increases in the measly rate of assistance (less than 10 cents in the dollar). Clearly a subset of small R&D intensive firms wanted to expand R&D but couldn’t finance it. So giving them access the concession quarterly, rather than annually, would increase R&D at vastly lower cost than the $195 million alternative which would have negligible effect on R&D.

I recall putting this to Greens senator Christine Milne at a meeting of stakeholders who seemed to take note. But it usually takes more than that to turn a politician away from an easier option. But judging from Carr’s announcement, I can joyously report that I was wrong. The new, much more effective scheme will come in with small firms able to access payments quarterly. That’s a win for innovation.

Peter Fray

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