The Federal Government recently released the draft legislation for the new R&D Tax Credit.  The draft legislation significantly increases the benefit of the R&D concession, particularly for companies with group turnover below $20 million.  However, the draft legislation also makes it considerably more difficult to access the concession.

The legislation is intended to replace the existing R&D Tax Concession from 1 July 2010. The existing R&D Tax Concession is still available for the 2009/10 year.

The benefits of the changes

Companies with a group turnover less than $20 million

Companies will be eligible for a 45% refundable credit (a cash rebate that is paid even if the company is in a tax loss and cannot benefit from tax deductions).  There is no limit on the amount of expenditure that can be claimed.

Currently companies with tax losses can only obtain a cash refund if they have a group turnover of $5 million or less and aggregate R&D expenditure of $2 million or less.  If they exceed either of these limits they can only benefit by additional income tax deductions which only provide a cash benefit if the company has taxable income.

For example, a group with a turnover of less than $20 million with $1 million of R&D will receive a cash rebate of $450,000 whereas under the current rules the rebate would usually be $375,000.

Companies with a group turnover greater than $20 million

Companies will be eligible for a 40% non-refundable credit against their tax liability. This is equivalent to a 133% tax concession (currently the concession is usually 125%).

In some circumstances, Australian branches of foreign companies operating in Australia can claim the R&D Concession.  Under the current rules branches cannot claim the concession.

The cost of these incentives is intended to be funded by a tighter definition of eligible R&D activities which will restrict its availability.

Measures to tighten the definition of R&D

R&D continues to be divided into two categories, Core R&D and Supporting R&D.

The Bill proposes to change the definition of Core R&D to an activity that involves both innovation and high levels of technical risk.  Under the current rules, R&D activities only have to involve innovation or high levels of technical risk.

Four new tests are proposed to be added to the definition of Core R&D to:
•    narrow the type of activity that is eligible to be an R&D activity;
•    increase the degree of innovation required for an activity to be R&D;
•    increase the level of technical risk required; and
•    narrow the definition of the required purpose of the R&D activity.

The definition of Supporting R&D has been narrowed by requiring the activities to have a dominant purpose of supporting the Core R&D activity.

Computer Software

In house software is excluded from being an R&D activity unless the software development is for the purpose of making a profit from the supply of software to at least two unrelated persons.  For example, if the software allows the company to sell music to customers, the R&D concession could not be claimed unless the company earned a commercial return on the sale of the software rather than the sale of the music.

Software services, other than software development, and integrating off the shelf software/open source software are excluded from the definition of R&D.

Feedstock rule

Where the R&D activity directly produces output a feedstock adjustment operates to reduce the R&D by the value of the output.  For example, if a coal miner used a new process to mine coal the market value of coal extracted by that process is deducted from the cost of the R&D activity.  To do this the value of coal from that part of the mining process (as opposed to the other mining processes) needs to be determined; this will create significant compliance costs.

The above is a summary of some of the more significant proposed changes.  There are many other amendments which could affect your business.  If you have any questions regarding the R&D incentive please contact Howard Badger on (02) 8238 7718 or your Moore Stephens relationship partner.

Author: Howard Badger, Moore Stephens Sydney