The Role of Innovation and the Evolution of the R&D Tax Incentive

Presentation Overview• Innovation and Growth • Research and Development Tax Incentive • The R&D Tax Environment• Legislative Changes • Recent Case Law • Current Compliance Focuses• Best Practice R&D • Bentleys R&D

Innovation and Growth

Innovation is a key driver of company growth and resilienceCompared to businesses that do not innovate, innovative businesses report that they are: • 60 per cent more likely to report increases in income from sales and

increased profitability • Four times more likely to increase the number of export markets targeted • Twice as likely to increase productivity and employment • Three times more likely to report increases in investment in training and

IT expenditure • Five times more likely to increase the range of goods and services offered.

Source: Australian Innovation System Report 2015

Innovation and Growth

Source: Australian Innovation System Report 2015

The R&D Tax Incentive

It is a rules based, self assessment program providing accelerated tax deductions and potential tax refunds for companies that conduct R&D.• Administered jointly by AusIndustry & the ATO• Australia’s premier business incentive mechanism - $2.97 billion• Claimed by 13,600 companies per annum - $18.5 billion – under

subscribed– growing at 15% per annum• 45% Refundable & 40% Non Refundable components• Advisory dominated by Big 4, but seeing a move to smaller

providers and online service offerings

R&D Tax Environment

The R&D Tax Incentive Review of the R&D Tax Incentive

The Australian Government announced its intention to examine support for research and development (R&D), including the R&D Tax Incentive programme, in the context of the Tax White Paper. The Review will evaluate the programme’s effectiveness and efficiency, as well as assessing the extent to which it is meeting its intended policy objectives.

The Government’s National Innovation and Science Agenda, launched on 7 December 2015, initiated a review of the R&D Tax Incentive, jointly chaired by Mr Bill Ferris AC (Innovation Australia), Dr Alan Finkel AO (Chief Scientist) and Mr John Fraser (Secretary of the Treasury) under the auspices of Innovation and Science Australia.

The Government has asked the Review to identify opportunities to improve the effectiveness and integrity of the R&D Tax Incentive, including by sharpening its focus on encouraging additional R&D expenditure.

The R&D Tax Incentive Proposed Change in Rates

In the 2015-16 Budget released on 12 May 2015, the Australian Government reiterated its intention to change the rates of assistance under the R&D Tax Incentive to 43.5 per cent for eligible entities with a turnover under $20 million per annum and 38.5 per cent for all other eligible entities, to apply from 1 July 2014.

The Government indicated in March 2015 that it remains committed to re-introducing legislation to change the rates of assistance. The rates of assistance currently legislated are 45 and 40 per cent respectively. This legislation has lapsed and will need to be re-tabled if it is to come into effect.

Case Law Mount Owen Pty Limited and Innovation Australia [2013] AATA 573 (16

August 2013)

The AAT found that none of the activities claimed by the applicant in relation to its open-cut coal mine at Mount Owen were R&D activities for the purposes of former s73B of the Income Tax Assessment Act 1936.

Background

1. The Applicant claimed activities relating to a large open-cut mining operation at Mount Owen in the Hunter Valley.

2. The deposit at Mount Owen was affected by major regional geological faults which gave rise to geotechnical difficulties and challenges in the mining process.

3. In order to mine at a required depth of 270m, the Applicant claimed that it faced a number of ‘geological complexities’ requiring R&D to overcome.

Case Law Mount Owen Pty Limited and Innovation Australia: Decision

The Tribunal found that all activities were ineligible on the basis of inadequate substantiation of hypothesis and evidence of ‘purpose’ for generating new knowledge.

Although it was not disputed that activity occurred, the Applicant could not demonstrate through documentation that it was conducted to test a hypothesis and failed to detail the ‘experimental’ nature of each of the ‘core’ R&D activities.

Where companies are carrying out (especially operational) activities there is a need to demonstrate that those activities are R&D activities – and for this you need a number of things. Some of the important elements are:

1. Purpose of generating new knowledge – this does require evidence. It is –not sufficient to just assert this, particularly where production purposes exist.

2. Specifics regarding what technical outcomes can’t be known without conducting experiments – the project being “complex” is not sufficient.

3. Specific experiments that address those technical outcomes – it is not sufficient just to say the whole activity is an experiment. On risk –whether the outcome can be determined in advance. It can’t be environmental or commercial risks around the project, it must be the outcome of specific technical experiments.

Case Law

JLSP v Innovation Australia [2016] AATA 23 The Administrative Appeals Tribunal (AAT) considered whether particular activities conducted by the applicant are “core R&D activities” within s 355-25(1).

Specifically, the matter sought to assess whether a clinical trial carried out in accordance with a contractual agreement was conducted for the purpose of generating new knowledge.

BackgroundThe applicant company is an Australian-based entity in an international corporate group that provides biopharmaceutical development services to clients conducting clinical trials under contract for a foreign related entity's.

Innovation Australia found that the activity in question was experimental, and that it met all elements of the first paragraph (a) defining “core R&D activities”. However, that the activity did not suffice paragraph (b) since it was conducted for the purpose of fulfilling contractual obligations rather than generating new knowledge.

The two central propositions put before the AAT were in relation to “purpose” in s 355–25(1)(b):

1. Whether the purpose for generating new knowledge must be held by the applicant R&D entity;

2. Whether the purpose of generating new knowledge must be at least the dominant purpose;

Case Law JLSP v Innovation Australia [2016] AATA 23: Decision

The AAT found that the activity in question was a “core R&D activity” within the meaning of s355 of the Income Tax Assessment Act 1997 (ITAA 1997).

The AAT agreed with Innovation Australia that to fulfil  s355-25(1)(b) the relevant purpose must be held by the applicant R&D entity. In this case, the AAT concluded that regardless of the activity being conducted under a contract, the clinical trials were undertaken with an intention to generate new knowledge about the drug’s efficacy.

The AAT concluded that the use of the phrase ‘the purpose’ rather than ‘a purpose’ in s355-25 meant the claimant’s purpose must be more than an insubstantial purpose, but need not be the dominant or sole purpose for undertaking the activity.

The Tribunal determined that the Board was “overreaching” its responsibility by assessing whether the expenditure would be eligible for the offset. The Deputy President noted that Board is responsible for administering the integrity of findings and not assessing the eligibility of expenditure. The Commissioner is responsible for the integrity of the taxpayer’s assessment of eligible expenditure against these activities.

Current areas of Compliance focus

Software Development• Software Development vs Software R&D Mining and Exploration• History of whole of mine • Flow Sheet models/Existing Processes Construction • Complex engineering but no experiment• Complying with RegulationBroad-acre Farming• Purpose and Scale of Activities • Inflated Claims

Best Practice R&D

• Plan projects, establish technical goals and identify knowledge gaps• Identify activities and classify as core or supporting.• Clearly state hypothesis • Record and communicate knowledge transactions and events

contemporaneously.• Record time and costs at an activity level identifying the nexus with

the activity.• Maintain substantiation materials.

MUST HAVE CONTEMPORANEOUS EVIDENCE

Bentleys R&D Tax Services

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