Opinion: Business hit by R&D Tax Credit uncertainty

By Tracey Murray, Partner, BDO

Twelve months after the release of the initial draft of the R&D Tax Credit, a series of false starts, contested claims and last minute legislative changes have seen the proposed 1 July 2010 start date come and go, with no resolution to the confusion in sight.

What started as a key incentive for small to medium businesses engaged in innovative activities has instead resulted in thousands of businesses being confused not only about whether the law will affect them, but also when any changes will take effect.

Read more about the R&D Tax Credit

A number of issues have affected the government’s support for this key legislative change. First and foremost has been Industry Minister Senator Kim Carr’s repeated assurances that once introduced, the legislation will apply retrospectively.

While not unprecedented, such a step would tarnish Australia’s reputation as a safe and predictable destination for investment, of the kind commonly seen in the biotechnology and life science industries.

Investing in innovation is risky enough in the life science industry, with often millions of dollars spent for no guaranteed outcome. Decisions on investments in these areas are often impacted by the availability of government grants and incentives.

If the proposed R&D Tax Credit is introduced in its present form, most current R&D Tax Concession claimants will be ineligible to claim this government ‘incentive’ or will have a significantly reduced claim.

As a result, introducing the current Tax Credit legislation with retrospective effect will make the investment decisions of hundreds of Australia’s most innovative companies uneconomical, forcing many to evaluate either the location of their R&D activities or their continued conduct.

There is little doubt that the potential for a retrospective start date is a significant impediment to the forward passage of the proposed legislation, with many industry groups and businesses lobbying furiously to have this changed.

Senator Carr has been vocal in his demands that the legislation be passed as is and with the start date of 1 July 2010. Yet each time the bill is discussed, its potential retrospective nature grabs the spotlight.

Some believe it may be Senator Carr’s strategy to include an unacceptable clause in the proposed legislation to detract attention from the actual technical contents of the bill, allowing him to offer it up as a last minute concession to gain passage.

Whilst this may be a good strategy to get a piece of bad legislation through Parliament, it will be interesting to see if the strategy works. The dynamics of the recently elected minority Parliament may work against him.

For the bill to pass, independents Rob Oakeshott and Tony Windsor must vote with the government, however both voted against the bill when it was first introduced into the House of Representatives.

As the bill remains largely unchanged from the one they previously rejected, it will be interesting to see if they see through Carr’s last minute concession for what it is and support the bill, if the threat of retrospectivity is removed.

However, perhaps the greatest impediment to the bill’s passage is that it is a retrograde piece of policy, in no way supportive of Australia’s innovators. Whilst the proposed feedstock provisions (which are very different from the current feedstock rules) will knock out or significantly reduce any claim that produces a good or product as a result of the R&D activities, it is the dominant purpose test that proves the folly of the proposed legislation.

Under the dominant purpose test, if a pharmaceutical company wants to conduct trials related to a new product and the trials produce a good or product, the company would need to demonstrate the dominant purpose of the trials was related to R&D.

As part of the trial, the company may need some equipment. Instead of buying equipment that lasts only six months, the company may choose to purchase a more expensive item capable of use in other operations.

Yet in its explanation of the dominant purpose test, Treasury has indicated such an expense would fail since one of the intentions for the use of the equipment was a commercial purpose. This absurd concept flies in the face of good business decisions and is at the heart of why many companies in the biotech and life science industry will have significantly reduced R&D claims under the proposed R&D Tax Credit.

To date, it is unclear whether the government intends to reintroduce, redraft or abandon the proposed legislation. One thing is clear, if the government wants to bring certainty to investing in innovation in Australia, the issue must be resolved one way or another as quickly as possible.

This opinion piece was contributed by Tracey Murray from BDO. You can contact Tracey on (07) 3237 5999 or via email at tracey.murray@bdo.com.au.