Discuss about the R&D Tax Incentives for Small Business.
Australian Taxation Office (ATO) the taxation controlling arm of the Revenue Department in Australia started offering R&D incentives from 1 July 2014. It set aside an A$100 million threshold for companies to spend on R&D and claim concessional tax offset under R&D Tax Incentive Scheme. Even for companies who spent above the threshold, the R&D Tax Incentive was available at the company tax rate, as per Bakker & Kloosterhof (ed.), (2010). This tax offset was categorised into two periods for all eligible small and large businesses.
- For income years ending before 1 July 2016, the companies could avail –
- 45% refundable tax offset for companies having annual turnover less than A$20million.
- 40% non-refundable tax offset to all other eligible companies. They were also eligible for cash refund in case of a tax loss.
- For income years starting from 1 July 2016, the companies could avail –
- 5% refundable tax offset for companies having annual turnover less than A$20million.
- A 38.5% non-refundable tax offset to all other eligible companies.
A PwC survey has shown that more than 13,000 companies, including above 10,000 SMEs, were part of this initiative by the government, although the survey also confirmed that the eligible number of companies for the offset is about 25,000 to 30,000. This study has also confirmed that 47% of the SMEs outsourced their R&D involving their products or services. 73% of the SMEs reported of environmental benefits and another 83% reported benefits in worker’s health conditions. The study has also proved that an Innovative Business is more productive, competitive and profitable, say Jorgenson & Landon (ed.), (1993). Businesses involving R&D as a driver of their innovation efforts have been found to be leading in the –
- Development of new products and services;
- Improving their business processes; and
- Solving their problems with an improved efficiency.
The awareness created by the ATO about the benefits associated with R&D Tax Concessions has shown that more than 90% of companies in the SME Segment are showing an ongoing commitment towards R&D. This is not only central to their business, it is also at the core of their competitiveness, as per Tooma (ed.), (2008). These companies have proved that a commitment towards R&D at the administrative level plays a key role in establishing new markets with the help of new products or processes or services being developed through sustained R&D. These companies have experienced an enhanced level in their market position through development of new and even improved products or processes or services, assert Cch, (2010). These companies are maintaining and in some cases even cutting down their expenses and have shown a growing trend in their revenue generation because of reduced costs concerning their production, operational and delivering systems, declare Nethercott, Devos & Richardson, (2010).
Companies are using at least one and in some cases all of the following three R&D investment strategies in their business operations –
The Proactive Approach
This approach makes the administration invest in R&D for generating new products or processes or services.
Approach Adopted
The Reactive Approach
Those following this approach invest in R&D for modifying or improving the existing range of their products or processes or services.
The Production Efficiency Approach
Those following this approach make investment in R&D for developing either a new or an improved version of their product or process or service in order to reduce the costs and enhance the productivity.
Whatever be the approach of the companies following the practice of R&D, 66% are focussing on development of next generation versions of their existing products or processes or services. 54% are concentrating on extending their existing products or processes or services and more than 32% are developing products or processes or services which are entirely new in their field or expertise, whereas another 21% is either adopting and/or adapting itself to an off-the-shelf technology, as per Coughlan, (2003).
Purpose of R&D
On the whole, the managements of 38% of these innovative companies are working towards benefits derived from their R&D investment by improving their competitiveness with increased productivity and even reduced production costs. About 28% are making efforts of staying ahead of the market or are trying to enter new markets through their R&D efforts and the remaining 34% are investing in R&D to meet the changing needs of their customers by developing innovative products or services, says McCouat, (2012). This study has observed that small businesses are investing in R&D mainly to develop new products or services for developing new markets. Hence the focus of most small businesses on undertaking R&D was to develop a next generation product or service so they could increase their market share, assert Reynolds, Williams & Savage, (2000).
This study also confirmed that above 90% of the companies preferred their R&D to be in-house. Reasons such as Intellectual Property, commercial interests, competitors advantage and retaining of knowledge were backed by lack of control in a third party environment and dependence on external workforce. It makes sense when protection of commercial values and outcomes of the research are at stake because of competitors taking advantage, as per Lindahl, (2008). Moreover, retaining the skilled technical and trade staff in an overzealous labour market is a big challenge in the current stimulating work opportunities and since many R&D projects involve changes to be affected in the manufacturing process, design or innovation, the emphasis on in-house R&D id favourable as the management can draw from the skills and knowledge of the in-house staff who understand the internal arrangements and requirements for innovation.
Protection of Intellectual Property (IP) was cited by more than 48% of the respondents to this study. The remaining 52% were concerned about the industrial secrecy and technical dead-ends leading to reverse engineering, says McCouat, (2012). Every innovator wants to protect their IP and work hard for a good return on their investment. This is more so among the SME companies who acknowledged that patent protection came at a high cost post the results of the R&D. It was also stated that such actions are time-intensive and may lead to disclosure of sensitive knowledge to competitors. The biggest drawback of external R&D companies is that they have limited control on effectively pursuing patent infringements. SMEs believe that retaining the in-house R&D gives them a competitive advantage, assert Jorgenson & Landon (ed.), (1993).
This study found that investment in R&D, apart from producing public benefits, also adds to the accrued benefits of the company. Investment in R&D leads indirectly to long-term benefits for the companies. Most of the SMEs were of the opinion that doing in-house R&D had resulted in an enhanced commitment to quality and positive changes in the way workers managed their work, according to Nethercott, Devos & Richardson, (2010). Overall, the SMEs were also aware of the fact that R&D Tax Concession provide a direct and timely return on the investment in R&D. It also raises awareness of considering R&D as an investment option among decision makers. It acts as a leverage for increasing equity for further investments in R&D and encourages the managements to broaden the scope of R&D projects. This is being done with additional expenditure being incurred on projects focussed on finding better solutions to existing problems and expanding the scope of meeting increasing market demands, says Tooma (ed.), (2008).
According to this study, SMEs acknowledged that R&D Tax Concession were an influencing factor in 51% cases for increasing the size of investments in individual R&D projects by companies. R&D Tax Concessions were also instrumental for 26% of managements bringing-in more R&D funds for projects, so as to enable faster completion and increase their commercial values. R&D Tax Concessions are positively influencing the R&D budgets and the timing of individual R&D projects, but one area seems to be lacking behind as companies are not encouraging those R&D projects to be undertaken which have a poor business case, as per Bakker & Kloosterhof (ed.), (2010).
More than 60% of the respondents to this study believed that the R&D Tax Concession has made their approach to R&D in a more structured way and has led them to an increased recognition of its long-term benefits. More and more SMEs are experiencing a surge in the performance of their human resources and this is improving the serviceability of their research equipment. SMEs also overwhelmingly reported that decisions on the location about the R&D activities were being made on the basis of the available expertise and facilities at an affordable cost, assert Bakker & Kloosterhof (ed.), (2010).
The R&D Tax Concession initiative by the ATO has influenced more than 20% of the respondents towards taking-up R&D projects in Australia instead of going overseas. Although it was not the most important factor which affected their decisions, it was a bold step in encouraging other local SMEs to take up R&D projects, says Cch, (2010).
This has also led to a number of factors which were henceforth limiting the impact of R&D Tax Concession initiative and the main reasons slowing the initiatives were –
- Lack of awareness among SMEs about the R&D Tax Concession when they decided to undertake R&D.
- An inability of claiming the R&D Tax Concession with regard to the software which could not be used for multiple sale-points. This issue has been raised with the IT companies and software developers for customising the operations of this sophisticated capital equipment.
- Understanding the cost in time and money for registering and claiming R&D Tax Concession and comparing the benefits. This has been an issue, especially with micro companies and small projects, which are not in a position of incurring more than $50,000 in expenditure per annum.
The R&D Tax Offset, although favoured for providing a cash benefit, also has a major impact on induction of additional R&D investment by SMEs because it –
- Enables the recipient SMEs, having intermittent cash flows, in performing R&D on a continuous basis by providing them with a regular and certain cash flow.
- Directly funds the increased investment in R&D.
- Provides a good return on investment, even though the project may not be a technical success.
- Enables the SMEs in employing more staff to work on the R&D Project.
The R&D Tax Offset has also been impacting the recipient SMEs by providing them with financial support so that they can innovate their products or services for better commercialisation of the newly developed technology from the R&D facility. This also helps the SMEs in contributing to the growth of their business and also acts as leverage for to raising additional equity for further supporting the R&D projects in future. The 175% Premium being offered by the ATO is resulting in an enhanced commitment apart from the additional, high-risk R&D facilities being promoted by the SMEs. This initiative has also surged an expansion program among the businesses and their research strategy. This is beneficial for the SMEs as very few of them have the capacity of significantly increasing their R&D budget in a short period and take advantage of the 175% Premium.
Application of section 73A of the Income Tax Assessment Act 1936 in Scientific Research.
Allowable deductions
Section 73A has four expenditure categories which allow deductions.
- Payments made to an approved research institute.
- Expenditure of capital nature on scientific research which is related to development of business.
- Plant expenditure provided the plant is to be used for scientific research.
- Capital expenditure on building.
Subsection 73A(1) states, and I quote:
“The following payments made, and expenditure incurred, during the year of income (other than any amount which is allowable as a deduction under any other section of this Act) by a person carrying on a business for the purpose of gaining or producing assessable income shall be allowable deductions –
- Payments to –
- an approved research institute for scientific research related to that business; or
- an approved research institute, the object of which is the undertaking of scientific research related to the class of business to which that business belongs; and
- Expenditure of a capital nature on scientific research related to that business (except to the extent that it is expenditure on plant, machinery, land or buildings or on alterations, additions or extensions to buildings or in the acquisition of rights in or arising out of scientific research).”
List Of References
Bakker, A. and Kloosterhof, S. (ed.). 2010. Tax risk management. IBFD, Amsterdam.
Cch. 2010. Australian Master Financial Planning Guide. CCH Australia Limited, Sydney.
Coughlan, L. 2003. The Law and You. Pascal Press, Glebe, NSW.
Jorgenson, W. D. and Landon, R. (ed.). 1993. Tax reform and the cost of capital: an international comparison. Brookings Institution Press, Washington, DC
Lindahl, D. 2008. How Small Investors Can Get Started and Make It Big. John Wiley & Sons, Hoboken, NJ.
McCouat, P. 2012. Australian Master GST Guide. (13th ed.). CCH Australia Limited, Sydney.
Nethercott, L., Devos, K. and Richardson, G. 2010. Master Tax Examples 2010/11. (9th ed.). CCH Australia Limited, Sydney.
Reynolds, W., Williams, A. J. and Savage, W. 2000. Your Own Business: A Practical Guide to Success. (3rd ed.). Cengage Learning Australia, Sydney.
Tooma, R. A. (ed.). 2008. Legislating against Tax Avoidance. IBFD, Amsterdam.
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