On 23 August 2011, the new Research and Development (R&D) Tax Credit law passed the Senate. This simplified tax credit scheme applies to activities and expenditure in income years commencing on or after 1 July 2011. The former R&D tax concession continues to apply to activities and expenditure conducted in prior income years.
The overhaul, foreshadowed in the 2009-10 Budget, provides a targeted tax credit (also referred to as a tax offset) that the Government claims is aimed at strengthening Australian companies, particularly small and medium size businesses, boosting investment and supporting R&D activities to build a more innovative economy.
The R&D Tax Credit has two core components for eligible entities that undertake eligible research and development activities:
- a 45 per cent refundable tax credit (equivalent to a 150 per cent deduction) for eligible entities with an aggregated turnover of less than A$20 million per annum. Eligible entities will receive a refund if the amount of the tax credit exceeds their tax liability; and
- a 40 per cent non-refundable tax credit (equivalent to a 133 per cent deduction) for all other eligible entities. These entities will not receive a refund if the tax credit exceeds their tax liability, but may recover the excess tax credit against future taxable income.
Eligible research and development activities
The new scheme has changed the criteria that must be satisfied for an activity to qualify as a research and development activity that is eligible for the tax credit. The Government has explained that the change is designed to make it easier for entities to determine whether their activities are eligible for the 45 per cent or 40 per cent tax credit. However, the new definition will also make it more difficult for some activities to qualify for this concessional tax treatment.
Similar to the former R&D concession regime, research and development activities are defined to encompass two types of activity – core R&D activities and supporting R&D activities. However, the new definition of core R&D activities includes activities that carry both innovation and technical risk (instead of one or the other, as was the case under the former regime). This narrower approach more closely resembles the approach adopted in the United Kingdom and the United States.
Subject to certain exceptions, core R&D activities are experimental activities:
- whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work that:
- is based on principles of established science; and
- proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
- that are conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services).
Supporting R&D activities will continue to be recognised under the new scheme, subject to added limitations. Entities will no longer be able to combine a small proportion of core R&D activities with a relatively large proportion of supporting R&D activities to subsidise the overall cost. Activities that produce, or are directly related to producing, goods or services will need to be undertaken for the dominant purpose of supporting core R&D activities to be classified as supporting R&D activities.
Research and development activities conducted offshore as part of a larger Australian project may qualify for the tax credit in certain circumstances. One accepted example is where those activities cannot be conducted in Australia due to a lack of facilities, expertise or equipment.
Australian companies and public trading trusts will continue to qualify as entities eligible to participate under the new scheme.
The range of eligible entities has been extended to include certain foreign companies that conduct research and development activities through an Australian branch. Foreign companies that are Australian tax residents are also eligible. Importantly, foreign-owned R&D can only qualify for the 40 per cent non-refundable credit regardless of the entity's turnover.
Further, eligible entities will be able to claim the credit regardless of whether the resulting intellectual property is held in Australia or offshore.
Quarterly payments of the R&D Tax Credit
From 1 January 2014, businesses that qualify for the 45 per cent refundable credit (that is, businesses with an aggregated turnover of less than A$20 million) will have the option to access quarterly payments of the tax credit. This will assist with cash flow and financing for R&D activities undertaken by small and medium sized businesses and may therefore be an attractive option.
The mechanism to facilitate this quarterly payment option will be set out in the tax regulations, which will be drafted before 2014. Because of this, the exact requirements to qualify for this option are yet to be finalised.
In addition to the changes outlined above, other key changes introduced by the scheme include:
- the ability for entities to seek an advance finding from Innovation Australia where they are not certain about the eligibility of a particular activity; and
- increased regulatory powers for Innovation Australia, including the ability to revoke or amend registration.
All businesses that engage in R&D activities should consider how the new scheme impacts on their R&D activities and the records they keep of such activities.