The Greens and the ALP come good in R&D win

Below is my column today from Crikey.

This gives me as much of a sense of satisfaction as my involvement in the Button Plan with the recipe for success following much the same formula. Get a small possie as an ‘insider’, get some bearings on where policy should be heading and then persuade as many other insiders as you can.  Persevere (in both cases for well over a year) through all the strange twists and turns of the political machinations – which is to say not just through Parliament, but through departments, individual offices and so on. And always remember, you may not have much power, but if you have a good, simple grasp of what’s wrong and how it can be made better, if you understand how the pieces fit together, your ideas may be able to be more useful to the various players at pretty much every stage of the process from crafting the basic lines of the policy to finalising the details.

Kim Carr’s announcement yesterday of cross bench support for the Government’s new R&D tax concession is an important win – for the Government and for innovation in Australia. The Greens have also chosen the right, rather than the easiest decision.

John Button was proud of the research and development (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 per cent 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. Pharmaceutical 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 proven 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. (Canada’s miners’ R&D comes in at less than a tenth of its manufacturers’ R&D!) Meanwhile there was evidence that Australian manufacturers were gearing up for some ‘whole of production’ claims themselves.

How was all this affordable? The tax concession’s value had fallen with falling rates of company tax and with Howard’s cutting the concessionality of the scheme in half – from 150 to 125 per cent. These changes saw the value of the scheme fall by over two thirds – from 24.5 cents in the dollar to 7.5 meaning that under any reasonable assumptions over 90 percent of the R&D assisted by the concession would have taken place anyway.

The 2008 Cutler Review proposed ending ‘whole of mine’ claims and using the proceeds to increase assistance rates and allow tax loss firms with turnover under $50 million to access the concession as a cash grant.  The Government pursued this option though in more straightened times cut the rates of assistance back a little and the threshold for small firms back to $20 million turnover.

Not surprisingly smaller firms supported the changes whilst 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 that production activity with the “dominant purpose” of supporting R&D – where most production has the dominant purpose of generating output to sell! (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 (pdf). Research since the Cutler Review (pdf) had 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 had 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. 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 $95 million alternative which would have negligible effect on R&D. The other problem was that the Tax Office was wary of quarterly payments as explained in the paper to the Business Foundation:

The  Review  of  the  Australian  Innovation  System considered options for bringing R&D Tax Offset payments forward. The Tax Office indicated  that  paying  offset  payments  in  advance  or  even  quarterly as of right would introduce administrative difficulties into the current administration of the tax offset if integrity were to be maintained. However, the prospective benefits are of sufficient effectiveness in maximising the efficiency of the scheme that some regime should be developed where the refundable credit can be claimed at least quarterly in arrears for firms with a profile which enables them to be judged agood risk.

I recall putting this to Greens Senator Christine Milne at a meeting of stakeholders. She seemed to take note. But it usually takes more than that to turn a politician away from an easier option. But judging from Kim Carr’s announcement, I can joyously report that I was wrong. The new, much more effective scheme will be effective from 1 July this year.  Small firms will be able to access payments quarterly!

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derrida derider
derrida derider
10 years ago

Nice work, Nicholas. Though I suppose that if I was in the ATO I’d also be a tad nervous about quarterly payments, especially in some industries where small phoenix firms are common. Make sure your compliance mechanisms here are good, fellas.

But –
“accountants found ways to write off very large proportions of production expenditure as ‘directly related’ to R&D under the legislation”

Now you could never have predicted that. <>

Revenue and spending proposals should always assume that if people can find a way to qualify for a freebie, they will. Instead Finance excludes almost all behavioural effects from budget costings in order to prevent vague “second round” benefits – “multipliers”, “incentivisation”, “tax clawbacks due to higher wages or profits”, etc – being used by Departments to make their favourite options look good. As I’ve said elsewhere, I think this blanket ban actually skews decision making as badly as wishful thinking about beneficial knock-on effects would.

Patrick
Patrick
10 years ago

If it cheers you two up, the government has only as recently as the last Federal Budget announced reinforcement of the ATO’s (already strong) powers with respect of phoenix companies.

And if your concern is the difficulty of dealing with the ATO, well, such is life!

Duncan Riley
Duncan Riley
10 years ago

Decent enough article, but sad to see you writing for the left wing socialist bastion that is Crikey.

Duncan Riley
Duncan Riley
10 years ago

@nicholas I can live with Mayne: I’ve met the guy a couple of times and he’s not a bad bloke, least not hard core left wing; he has his libertarian moments, but on some issues he’s left.

The current owners on the other hand… Sophie Black is a decent enough editor, but it slanted hard core left before she took over under the now “editor” of ABC’s “Drum” Jonathan Green (who’s as hard left and anti-new media as they come.)

I’ll give you a +1 for spreading the word with those against it (I subscribe for many years…but gave up when it became political vs apolitical mostly with Mayne.)

derrida derider
derrida derider
10 years ago

I think I’m in violent agreement with you that that individual agencies often have a kneejerk reaction to proposals – they see the pros or cons solely from their own quarter and base their support or opposition on that – and that can create needless obstacles to good ideas.

But then I suppose they’d argue that that is their job – to present a perspective to be weighed with other perspectives in decison-making. In IDC processes they often see themselves as being like barristers presenting a case, with Cabinet being the role of judge.

Kris Gale
Kris Gale
10 years ago

The quarterly payements system doesn’t commence until 1 January 2014.
What do you think is the reasoning behind the two and a half year delay?

Kris Gale
Kris Gale
10 years ago

Make that “payments”

derrida derider
derrida derider
10 years ago

Pretty obviously, Kris, the delay is to get that compliance system developed and bedded down.

It is reasonable to want to be thorough in covering off a known risk (note allowing scams is a POLITICAL as well as revenue risk – this government has suffered enough from “couldn’t run a Sunday school picnic” portrayals). Thoroughness really does take time, especially if an entirely new payment system has to be built for it.

OTOH, maybe they’re sulking at being overriden and want to starve the thing of resources. Starving it of resources will also chew up time. Who knows?

Patrick
Patrick
10 years ago