Sussan Ley (Farrer, Liberal Party, Shadow Assistant Treasurer) Share this | Hansard source

I am pleased to speak today on Tax Laws Amendment (Research and Development) Bill 2010 and Income Tax Rates Amendment (Research and Development) Bill 2010. At the time the Rudd government was elected there were four tax incentives for business research and development: the 125 per cent R&D tax concession, the 175 per cent incremental premium concession, the 175 per cent international premium concession and the R&D tax offset. What we are seeing here with the introduction of this legislation by the government is clearly a revenue-raising exercise. The government’s publicly stated intent was to offer enhanced incentives for companies to invest in R&D. It claimed that the new R&D tax credit would offer more predictable, less complex and more generous support.

Labor has made various concessions since its original announcement. They have included: changes to definitions, the reversal of its decision to largely treat software development differently from other forms of R&D activity, the elimination of certain forms of R&D that had originally been placed on an exclusions list, and changes to feedstock rules. However, throughout the process the government has continued to signal its intention to substantially alter the definitions of core and supporting R&D, restrict the eligibility criteria so that supporting R&D will only be funded if it is undertaken for the dominant purpose of supporting core R&D, confer sufficiently vague meaning on the term ‘dominant purpose’ so as to render it confusing and subjective, and revise the objects clause to reduce support for spillover and additionality benefits.

The government’s changes to the eligibility requirements are sweeping and threaten to significantly erode support for R&D investment in Australia. They are also fundamentally inconsistent with Labor’s stated intent of making R&D tax support arrangements simpler, more predictable and more generous. Instead, they impose a series of barriers upon firms rather than offering encouragement for innovation. In narrowing the definition of what constitutes genuine R&D the legislation will disqualify from assistance many forms of R&D undertaken by Australian businesses. In turn, the overwhelming expectation of those groups who have launched submissions on the exposure drafts is that Labor’s changes will reduce the number of firms qualifying for concession.

The proposed definitions of R&D will also foster significant uncertainty and complexity and will impose unnecessary administrative and compliance costs on many firms, especially small and medium enterprises. Indeed, Business Strategies International has advised that it is likely that protracted and expensive legal challenges to the interpretation of the new definitions will even be initiated in some cases.

So, in short, the legislation radically alters a regime that has been operating effectively since the 1980s and does so in a way that disadvantages a large number of Australian businesses. Where companies must currently demonstrate that their R&D activities are novel or have high technical risk, Labor proposes to fund firms only in cases where they can show that they have introduced a wholly new technique, process or solution. Its effect is punitive on a large number of companies whose best innovations are often based upon making refinements to existing practices, as well as the small business sector given that approximately 60 per cent of current applicants are small or medium enterprises. The changes have attracted substantial criticism from a variety of stakeholders. Increased innovation and productivity are both key factors in Australia’s future economic success, but this legislation seeks to gut an incentive that is integral to assisting and encouraging a diversity of companies to improve their business operations.

Within the last couple of days the Senate committee that inquired into this legislation handed down its report, and there was a comprehensive dissenting report by the coalition senators. I would like to draw on some of the comments made in that report to underline the opposition’s feeling and disappointment with this legislation and obviously to underscore the fact that we will be voting against the legislation in the House.

The coalition does support increased business investment in research and development and appropriate reforms to legislation to help achieve this outcome. Clearly, we do. We also accept the general principle that changes to the current law may potentially help to achieve a higher R&D rate for a greater number of Australian businesses, but we will not be supporting this bill because of its several significant shortcomings. The first problem area that the coalition senators have drawn people’s attention to is the consultation process. Throughout the inquiry, there have been considerable complaints made about the failure of appropriate consultation associated with the legislation. The government has given itself an absurdly short timetable for community consultation and examination by the parliament of what is a fundamentally new approach to the definition of ‘eligible expenditure’. The new approach would apply to all business R&D expenditure undertaken from 1 July 2010. Under the timetable presented, business will have two weeks to examine the new act before R&D spending will come under the new regime. Even putting aside the particular features of the proposed changes, this timetable for introducing a fundamentally new approach will increase the range of grey areas surrounding the tax incentive and the resulting uncertainty will see businesses scale back their expenditure. This outcome sits in stark contrast to the purpose of the R&D tax incentive, which is to encourage additional R&D expenditure by business.

A consistent theme of the submissions to the committee’s hearings was the inadequate time to digest the key documents associated with the introduction of the bills. Proper consultation with all relevant industry stakeholders over an extended period of time would have, we believe, prevented the numerous problems identified in the coalition senators’ report. There is no evidence of any supporting documentation, rulings, regulations, guidelines or forms for the new legislation, and this is really concerning, particularly if the bills are to take effect from 1 July 2010. How can we expect business to pick up on such a complex new regime, with no supporting documentation, in little under a month?

It was stated at the hearings that the educational material was still being developed by AusIndustry. The fact is that this legislation is being unnecessarily rushed through the parliament, leaving the Department of Innovation, Industry, Science and Research to prepare education campaigns, regulations and guidelines which have not been adequately tested with industry and stakeholders. This is a totally inappropriate state of affairs when industry is recovering from the global financial crisis and possibly facing further rough times ahead.

The first recommendation from the coalition senators’ dissenting report is that the start date for these bills be amended to 1 July 2011. Let us at least give it 12 months. An additional result of the hasty development of the bills was numerous drafting errors, as well as inconsistencies between the explanatory memorandum and the bills as identified in several submissions. We continue to be alarmed at the regular drafting errors that keep coming up in the Rudd government’s legislation. This is hardly surprising, given that there is such limited time between drafting and introduction. In no way do I blame the parliamentary draftspeople, who do an excellent job, but time is necessary and time is clearly not being made available to them. The second recommendation the coalition senators made is that the passage of the bills be delayed in order to rectify those drafting errors.

I would now like to move to the substantive problems with the legislation itself, centring on the definitions of ‘core’ and ‘supporting R&D’. This bill substantially alters the definitions of core and supporting R&D. In narrowing the definition of what constitutes genuine R&D, the bill will disqualify from assistance many forms of R&D undertaken by Australian businesses. In turn, the overwhelming expectation of the groups who have lodged submissions on the exposure drafts is that the government’s changes will reduce the number of firms who will qualify for the concession. There will be particularly grave consequences for firms focused on industrial R&D and other non-white lab coat activities, including those involved in manufacturing, prototyping and process development.

This was well explained in a submission to the Senate committee by Michael Johnson Associates. They explained that the problem with the new definition was that it is not better aligned with the Frascati Manual definition as had previously been contended by Treasury. In fact, the eligibility of the third limb of the Frascati definition, ‘experimental development,’ is in real doubt. R&D expenditure and concessions have been built on this definition for as long as I can remember. There is a very narrow definition of a ‘core activity’, ‘experimental work’, ‘unknown outcomes’, ‘new knowledge’ and then there are a range of choices as to what ‘supporting activity’ might be, with a strong flavour that anything in a production environment is in danger of not being eligible. It is those trials that could be unable to be claimed. Certain companies, when they look at this definition, believe that the majority of what they do is core and that their claims might be able to be sustained in this environment, but other companies look at this definition and say that a lot of what they do is in a production context—hence, the considerable confusion.

The second and central basis for the coalition senators’ strong opposition to this new approach to defining eligible business R&D is that it is highly restrictive. As I said, for approximately 25 years our R&D tax incentive has been based on what is known as the Frascati model, which has been developed under the auspices of the OECD over a number of decades. Under this model R&D is defined as:

… creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society and the use of this stock of knowledge to devise new applications.

The second part of the definition—‘the use of this stock of knowledge to devise new applications’—is central to the objections that many people have made about this new approach proposed by the government. The objects clause of the bill states that it is to encourage industry to conduct research and development activities:

… by providing a tax incentive for industry to conduct in a scientific way experimental activities for the purpose of generating new knowledge or information in either a general or applied form.

So, critically, this clause omits the second critical element in the Frascati approach: ‘the use of this stock of knowledge to devise new applications’.

Similarly problematic is the ‘supporting R&D activities’ definition in the bill. This was raised with considerable concern in several submissions and I understand it was followed up quite substantially during the hearings. The Australian Industry Group pointed out two major concerns with the definition of supporting R&D:

Firstly, supporting R&D expenditure is only eligible if it is ether “directly related to” core R&D activities or if it is “undertaken for the dominant purpose of supporting” core R&D activities. This means that businesses would have to be undertaking core R&D before any of its R&D expenditure could qualify as supporting R&D expenditure. If a business has no expenditure that qualifies as core R&D, it will have no eligible R&D expenditure.

Secondly, in any case much experimental development is neglected by the dominant purpose test in the definition of supporting R&D activities. In the Bill (s355-30), a supporting R&D activity is defined as an activity directly related to core R&D activities except if it is an activity that is: explicitly excluded, or if it is an activity that “produces goods or services”, or if it is an activity “is directly related to producing goods or services”. In any of these cases the expenditure needs to be undertaken for “the dominant purpose of” supporting core R&D activities.

So the third recommendation of the dissenting report of the committee is:

The Coalition recommends that the definitions of core and supporting R&D be reconsidered to be more closely aligned to the Frascati model of R&D.

Another area of concern is the eligibility criteria. The government’s changes to the eligibility requirements are sweeping and they threaten to significantly erode support for R&D investment in Australia. They are also fundamentally inconsistent with the government’s stated intent of making R&D tax support arrangements simpler, more predictable and more generous. Instead, they impose a series of barriers upon firms rather than offering encouragement for innovation. The major concern was the use of the term ‘dominant purpose’. Several witnesses at these hearings expressed concern about what the term actually meant. In submissions and during the hearings, there was evidence of continual and considerable confusion about what was meant by ‘dominant purpose’. The introduction of the dominant purpose test appears to be a large impost on businesses. As KPMG said in their submission:

The overwhelming feedback from our diverse client base indicates that a “dominant purpose” test will exclude a large proportion of production trial activity that is a necessary and legitimate part of the research and development cycle. If the aim is to contain the cost to revenue associated with large and open-ended production trials, the introduction of a cap on the total value of the group’s R&D claim would better achieve this objective, whilst also providing clarity and simplicity for claimants.

The dominant purpose test should be removed as it imposes an unnecessarily high threshold as evidenced in the EM, and does not target the minority of excessive claims which the Government purports are occurring.

Several alternative models were suggested, such as ‘a purpose directly related to’ test; a ‘substantial purpose’ test; apportionment of expenditure; dollar-capping the extent of production trials on the total value of the R&D claim, or on eligible R&D expenditure, for companies with group annual revenue exceeding a billion dollars; using more sympathetic language; specific provisions for specific excesses; time limits for trials; and pre-approvals for projects above certain values. All of those are options, either individually or in combination. So recommendation 4 was:

The Coalition recommends that the dominant purpose test be removed and be reconsidered.

The last area of technical objection concerns the object clause. The object clause needs to be revised in respect of spillover and additionality benefits. The object clause currently reads:

(1) The object of this Division is to encourage industry to conduct research and development activities that might otherwise not be conducted because of an uncertain return from the activities, in cases where the knowledge gained is likely to benefit the wider Australian economy.

(2) This object is to be achieved by providing a tax incentive for industry to conduct, in a scientific way, experimental activities for the purpose of generating new knowledge or information in either a general or applied form.

It was pointed out that this definition is much more restrictive and could impact on Australian industry. The Corporate Tax Association said:

While those concepts may be well and good, they are impossible to prove and therefore should not be part of the statutory framework—even as part of an objects clause. Such language might well be appropriate for a second reading speech but, in our view, does not belong in the law itself. We would much prefer the objects clause to make reference to increasing the efficiency and international competitiveness of Australian business, which reflects what we regard as the proper rationale for the incentive.

The fifth recommendation of the coalition senators is:

The Coalition recommends that the Object clause be amended to ensure that both research and development are given equal tax benefits.

In short, this bill radically alters a regime that has been operating effectively since the 1980s and alters it in a way that disadvantages a large number of Australian businesses. While companies must currently demonstrate that their R&D activities are novel or have high technical risk, this government essentially proposes to fund firms only in cases in which they can show they have introduced a wholly new technique, process or solution. Its effect is punitive on a large number of companies whose best innovations are often based upon making refinements to existing practices, as well as on the small-business sector, given that approximately 60 per cent of current applicants are small or medium enterprises.

Together, the proposed changes to elements of the legislation, such as the definition of R&D activities, the dominant purpose test for supporting activities, the registration processes and the feedstock rules, will have an effect opposite to the government’s stated intentions of providing greater generosity, predictability and simplicity. They will disadvantage rather than benefit most Australian companies intending to undertake R&D. The changes have attracted substantial criticism from a wide diversity of stakeholders, including major organisations. This is notwithstanding that during the development process of this legislation there were changes made that did meet with the approval of those stakeholders. Those changes did not, however, answer all the stakeholder concerns.

The government itself implicitly acknowledges a large number of potential problems with the legislation, including drafting errors and definitional concerns. It is not appropriate that bills be rushed through when they contain such errors and therefore give rise to considerable uncertainty. Reviewing elements of bills after three years is not an appropriate means of addressing problems of the kind that are evident in this legislation. A more practical step would be to make sure they are more appropriately drafted in the first place. I am not reflecting on wasting the parliament’s time when we have to fix up poorly drafted legislation but on wasting the efforts and the energy of small businesses, who will often back away if they do not understand and cannot conclude that they fit into a published set of criteria and cannot be confident that, if they make an investment, they will get the R&D tax benefit they seek.

Increased innovation and productivity are both key factors in Australia’s future economic success, but as I said earlier these bills do damage to an incentive that is important in assisting and encouraging a great array of our wonderful small and medium enterprises to improve their business operations. The coalition will not be supporting these bills.

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