R&D tax incentive changes to come.


27th January, 2020

Less favourable conditions for startups under proposed R&D tax incentive tweaks

Late last year, the Morrison Government put discussions on the R&D tax incentive back on the table, announcing that it intended to move ahead with changes that lessen the value of the incentive for startups and innovative businesses.

The R&D tax incentive has arguably been the most lucrative and consistent government incentive available to the innovation sector since its inception in 1985.

The scheme has undergone a number of significant changes over the years, with its most recent major overhaul taking place in the 2012 financial year, when a new component that added value to the SME sector was introduced into the incentive.

But the incentive has also been the source of much contention of late. It was a hot topic of discussion in the 2018 Federal Budget, where the Turnbull government proposed a series of new changes to the incentive, and it attracted much debate during the 2019 Federal Election as well.

But, after a series of breaks, distractions and long stretches of radio silence, the Coalition decided to revisit the R&D discussion right before the start of the holiday period late last year.

On 5 December 2019, Treasurer Frydenberg introduced a new Bill into government called the Treasury Laws Amendment (Research and Development Tax incentive) Bill 2019, which aims to implement the changes that the Government proposed to make in the 2018 Budget.

According to Frydenberg, the proposed changes will “better target” the incentive and encourage innovative business owners to invest a “higher-proportion of business expenditure on R&D”.

Proposed changes mean less returns for SMEs

While a number of the proposed changes were only relevant to larger businesses (meaning, business with more than $20 million in aggregated turnover), there were also a couple of changes that targeted SMEs, threatening to decrease the value of the incentive for smaller businesses across the board.

In the 2017 financial year, the value of the incentive for SMEs dropped from 45 percent to 43.5 percent. If the proposed changes are followed through, the value of the incentive for small businesses will drop to 41 percent – which would mean a four percent decrease in a three-year period.

READ: Top government grants for startups in Australia

Additionally, the Government has proposed to place a cap of $4 million in cash payouts (excluding payouts for costs associated with clinical trials).

Heavy increase of R&D tax incentive reviews

The proposed changes to the incentive have surfaced in a time where the amount of R&D compliance reviews and audits have surged.

Just like a personal or business tax return, the R&D tax incentive process is a self-assessment regime, placing the onus of knowing the tax law on the taxpayer and/or their tax agent, and relying on them to responsibly apply the law to their specific circumstances.

While the incentive does indeed follow a self-assessment process, the government bodies that administer the incentive (AusIndustry and the ATO) both reserve the right to review and audit claims for several years following submission – and in recent times, those reviews are becoming increasingly frequent and difficult to endure.

And the statistics speak for themselves.

Of the 12,123 claims submitted in the 2016 financial year, only 0.6 percent were subject to some level of review. Fast forward to the 2018 financial year, review numbers increased to 2.5 percent, which is a 250 percent increase in review rates across the board.

Challenging times for Australian startups

The proposed changes to the R&D incentive are another blow to the Australian startup sector, as the struggle to find early-stage funding continues to grow.

Last October, Techboard’s annual report into Australian Startup trends showed that local investors were beginning to mature and were gravitating towards larger ‘scale-up businesses’ – showing some worrying signs for local early stage ventures.

READ: Australia’s VCs reach the big leagues as appetite for tech investment grows

Some of Australia’s longstanding accelerator programs also announced that they’d be closing their doors, including Telstra’s MURU-D and Queensland University of Technology’s BlueBox program.

Silver linings

Sure, all of the above might make the future look pretty bleak for Australian founders and entrepreneurs – but fear not, for we are yet to reach the apocalypse.

As for the proposed R&D tax incentive, while the drop in value certainly isn’t ideal, the ability to claim a 41 percent tax offset on all eligible R&D activities is still quite lucrative.

Additionally, the proposed $4 million cap isn’t something that most startups need to worry too much about. In order to be eligible for such a large cash payout, the startup would need to be spending in excess of $10 million on eligible expenditure – an amount that excludes the vast majority of early stage tech startups.

Keeping in line with the better news, the ScoMo government has also promised to move forward with its Business Growth Fund this year, which will offer select Australian SMEs access to equity investments between $5 and $15 million – which in today’s terms can be equated to a Series A capital raise.