AusBiotech submission to the Review of the Research & Development Tax Incentive

To: R&D Tax Incentive Review Secretariat GPO Box 9839 CANBERRA ACT 2601 E-mail: R&DTaxIncentiveReview@industry.gov.au

29 February 2016

From: AusBiotech Ltd ABN 87 006 509 726 Level 4, 627 Chapel St South Yarra VIC 3141 Telephone: +61 3 9828 1400 Website: www.ausbiotech.org

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Introduction

As the Australian representative body for one of Australia’s most innovative industries - the biotechnology industry - AusBiotech is pleased to make this submission to the Review of the Research and Development (R&D) Tax Incentive, based on comments from AusBiotech members and from its work to grow Australia’s strength in biotechnology.

AusBiotech is a well-connected network of over 3,000 members in the life sciences industry, which includes bio-therapeutics, medical technology (devices and diagnostics), food technology industrial and agricultural biotechnology sectors. The industry consists of an estimated 900 biotechnology companies (400 therapeutics and diagnostics and 500 – 900 medical technology companies) and employs in excess of 45,000 Australians.

As the Australian representative body of one of the world’s most innovative and globally-mobile industries, AusBiotech is acutely aware of the difference that can be made to innovation stimulation with the right policy settings and conversely the damage to the growth of an industry from poor public policy and constantly changing provisions of programmes. The R&D tax refund is critical to the growth of innovation in Australia, and the introduction of the R&D Tax Incentive has been hailed as a game-changer for Australian innovation, especially biotechnology. In-tact preservation of incentive is top-of-mind in R&D-intensive industries. This submission makes the case for this tax incentive to remain in-tact to support Australia’s innovation ecosystem in order for innovative industries, including biotechnology, to underpin the economy and to increasingly provide jobs, exports, intellectual property assets and the resulting health and community benefits. Biotechnology has the capacity to address the big issues of our time, such as food security, alternative fuels, ageing populations, personalised gene-based medicines and diagnostics, climate change, access to clinical trials.

AusBiotech has welcomed the National Innovation and Sciences Agenda and the Federal Government’s recognition of the important role tax plays in supporting innovation. In particular, we applauded the tax offsets and capital gains tax break for investors in early stage companies. However, the proposed design does not work for the typical biotech start-up company or assist pre-revenue biotech start-ups that seek capital by listing on equity markets too early as the only viable option.

The key message from the biotechnology sector is that the R&D Tax Incentive programme is doing exactly what it was designed to do - encouraging increased R&D in Australia and the spillover benefits it provides – and the programme ought to be retained in its current format in relation to companies we are familiar with. Many Australian companies, and all biotechnology companies, need to function with a global view – regardless of their age and size. As other countries can offer comparable business environments with competitive tax regimes, it’s critical that Australia remain competitive on a global scale. Australia must consider its positioning and ability to compete as R&D incentives, patent boxes and other innovation-targeted incentives become commonplace around the world. AusBiotech has been leading the industry’s call for further tax reform in Australia to provide

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incentives for innovative companies and high-tech manufacturing to support Australia’s future and keep us internationally competitive by attracting, growing and retaining business, and the resulting jobs and exports. AusBiotech advocates making tax incentives an asset for innovation and business, with four pillars:

• Retain the R&D Tax Incentive in-tact, abandon the proposed 1.5% reduction and introduce quarterly payments;

• Introduce the Australian Innovation & Manufacturing (AIM) Incentive, to incentivise the monetisation of IP, and in turn innovation, and retain the associated benefits once it reaches commercialisation;

• Make further adjustments to the recently announced fiscal incentives for investors in start-up companies, to include all pre-revenue, R&D intensive companies to encourage ‘patient’ venture capital; and

• Retain Employee Share Scheme (ESS) eligibility conditions that assist ASX-listed biotechnology companies operating in loss.

Industry support

In public policy terms, the 2011 introduction of the R&D Tax Incentive was a momentous and pivotal inflection point for Australian innovation. The Incentive is actively attracting companies from around the world to bring their R&D to Australia, helping Australian companies fast track the development and commercialisation of medicines, cell therapies, medical devices diagnostics and vaccines, and attracting clinical trials to Australia, which is building our biomedical ecosystem.

The benefits of increased R&D in this sector has seen increased contract research within the local university sector and public hospital system, which provide spillover benefits to clinicians and clinical trial nurses and most importantly to patients, through clinical trial access and improved healthcare.

The R&D Tax Incentive was the result of many years of work, campaigning and planning that started as far back as its recommendation by Dr Terry Cutler in the Innovation Review (Venturous Australia) of 2008. The innovation industry worked with the Federal Government for almost three years after the Review recommended it, to see the R&D Tax Incentive delivered as a ‘landmark reform’.

Together we have worked long and hard and the policy represents an important ‘legacy’ to the economy and to future generations. From the perspective of the biotechnology and medical technology industries, the incentive has been game-changing with huge benefits and therefore any proposed measure that undermines the programme causes concern and angst in the biotechnology

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community and dissuades international companies from considering Australia for fear of change part way through a costly and complex clinical trial process.

The R&D Tax Incentive was very well received by the industry and its in-tact preservation remains the number one public policy issue within the industry. Since the R&D Tax Incentive’s implementation, the annual Biotechnology Industry Position Survey of CEOs (2013, 2014 and 2015) has ranked the Incentive amongst the industry’s most pressing public policy issues, with industry leaders repeatedly expressing their support of the programme and concern that it might be reduced or withdrawn.

The Survey in 2016, currently underway, already shows clear support for the Incentive. When asked “How important to your business and operation is stability in policy governing the R&D Tax Incentive?” almost all company CEOs said very important or important (80% said very important and 17% said important). A further 83% are concerned over the current review of the R&D Tax Incentive.

The surveys mapped over the past seven years show that employment in the biotechnology sector was significantly impacted by the announcement of the R&D Tax Incentive in the May Federal Budget 2009 and industry saw an immediate up-swing in confidence (See the table below).

Efficiency and effectiveness In regard to the effectiveness and efficiency of the programme, we agree with the Issues Paper that “To assess the economic welfare impact of the programme, any broader benefits from the additional R&D should be weighed against the costs of the programme, including administration, firm-level compliance and economic efficiency costs. If it is possible to reduce either one of these costs without impacting the cost to revenue or the overall benefits, this would improve the programme’s effectiveness.”

Programme Costs

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Recent media reports and the Review’s Issues Paper, have reported costs and forward estimates of the programme that are portrayed as having “risen strongly”. AusBiotech has sought to understand the reported budget costs and seeks verification of the calculations and assumptions of the modelling. We are keen to know if we understand the reports correctly as we find that the growth in the budget cost of the programme far exceeds the growth in the actual R&D expenditure claimed (according to ATO annual reports), particularly under the refundable R&D tax offsets. According to data presented in the Review’s Issues Paper total R&D expenditure claimed has moderated and stabilised. The rapidly rising budget cost of the programme therefore appears to be potentially overinflated.

In seeking clarification, AusBiotech members, RSM, have publicly released their workings on the program costs: https://lnkd.in/bZcX2_5 RSM finds that the $3 billion figure being reported as the programme costs may be overstated by more than $1 billion a year, which is their best estimate without taking into account franking credit impacts into account, which would further reduce the cost of the R&D Tax Incentive programme to government.

We are aware of a number of other companies, including those amongst Australia’s top accounting experts, who have expressed concern about the current and projected costs being overstated. These costs may be correctly put against the programme, but without taking into account other direct up-side/returns or amounts that ought to be added back to give a clearer picture, or indirect benefits. This gives the appearance of material overstatement and unfortunately frames public discourse about the programme in ‘cost containment’, instead of in regard to the benefits that are being delivered.

It has been implied by some that companies are gaming the system by conducting R&D for the purpose of claiming the incentive, which is clearly curious. Companies would not invest their own funds simply to claim a refund.

In the broader context, the R&D Tax incentive was introduced at a time when innovation was at a critical junction, caused by the combination of the GFC in 2009 following Commercial Ready being suddenly axed in 2008. Much has changed over the past decade in terms of programme support for innovation. The sector advocated long and hard for this programme as other programmes have been systematically removed, changed, tweaked and spoiled. In the past eight years alone the Federal Government has removed:

• COMET

• Commercial Ready

• Commercial Ready Plus

• P3

• Employee Share Schemes (now majority reinstated)

• Commercialisation Australia

• Innovation Investment Fund

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• Innovation Investment Follow-on Fund

Uncertainty damages technology development

AusBiotech contends that the constant reviews, threats and tweaks to the R&D Tax Incentive are unsettling for biotechnology developers, who have long development cycles - and undermine business confidence.

Pre-revenue companies in tax loss are reliant on investment (venture capital, issuing equity, etc.) and grants to complete their R&D programmes and reach commercialisation. Biotechnology development is a long-term activity that requires large investment. It can take 10 – 15 years and up to $2.5 billion to bring one biopharmaceutical product for early research to market. The Tax Incentive allow companies to progress much faster than they otherwise would, increases their probability of global success.

The negative impact that uncertainty of funding support has on product development/innovation companies is destabilising and the Government's programme changes cause one of the greatest costs, in practical terms. As well as making it more difficult to attract investment, uncertainty strikes companies in two ways: firstly, companies are not sure whether the measures they have put in place, the deals they have struck and the investments made are going to receive the benefit(s) the Government previously pledged; and secondly, those that have not made commitments yet are sure to hesitate and wait for a more stable environment.

AusBiotech has had feedback from overseas investors that they intended to invest in Australian innovation but saw the regular reviews and changes to this policy as a discouraging risk. Anecdotally, we have been told this has resulted in a few clinical trials destined for Australia relocated to other countries.

The OECD (2014, Review of Innovation Policy, Netherlands) contends that re-winding tax incentives can be damaging and a long-term approach is in this regard does increase R&D, particularly for small companies. The OECD said: “For countries that have experienced a large number of R&D tax policy reversals, the impact of R&D tax credits on private R&D expenditure is greatly diminished. It is therefore important that governments do not repeatedly tinker with such policies to minimise policy uncertainty for firms.”

Developing biotechnology is an especially long-term proposition and the threat to much-needed support is working against the industry fulfilling its potential. Australia has the same potential to be a nation driven by innovation as the world leader (the US). We have a strong education system, stable government, good regulatory, IP and legal environment and a proven track record in innovation. However, we have a recent history of unstable public policy supporting innovation and constantly changing programmes. A great example of programme stability is the Small Business Innovation Research (SBIR) programme in the US. If we as a nation are serious about innovation, we must address the gaps and maintain stability to create the right environment for innovation to thrive.

Not the right tool for collaboration

In the context of the above, AusBiotech notes the recent policy positions and comments of the Group of Eight Australia (Go8), Australian Academy of Technological Sciences and Engineering (ATSE)

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and others that propose the R&D Tax Incentive be used to solve the identified issue Australia faces with comparative low levels of collaboration between industry and researchers.

The Go8, which represents this country’s leading research-intensive universities, accounting for over two-thirds of Australian university research activity said in its submission to the ‘Re: think: Tax Discussion Paper‘ (2015) that Go8 universities attracted 67% of category three (industry and other) funds over the last five years. It would appear to be an effective vehicle to encourage industry/university collaboration events. Perhaps looking to improve this mechanism will provide a greater degree of collaboration.

The Go8 submission contends that “R&D tax incentives offer a powerful lever to encourage greater collaboration from industry, and provide an incentive for more firms to actively seek ways to engage in innovation activities,” and recommends: a more nuanced suite of tax incentives; differential rates of incentive depending on type of R&D activity, with higher rates for engagement with public research organisations; and leveraging activity generated through the Industry Growth Centres.

While we understand and applaud the intent of these proposals and comments, and agree that better industry/academic collaboration is required, we disagree that the R&D Tax Incentive is the right ‘tool’ to achieve better performance in this regard. We are also concerned that placing more restrictive rules on the programme may in fact reduce its benefit and create other issues – thereby making the programme less effective.

As the majority of biotechnology companies’ programmes are based on university research at their genesis or collaboration in research phases, the mechanics of what is being proposed is difficult to understand and would be complex - arguably impossible - to manage. For example, if industry is incentivised to work with a public sector partner and is motivated primarily by the incentive, phantom partnerships will eventuate. It will also make the R&D Tax Incentive more complex and increase compliance costs.

Funding already flows to the public sector from industry through contract R&D and this is a positive thing. However, the R&D tax Incentive exists to “help more businesses do R&D and innovate” as it is recognised that the many and varied spillover benefits are desirable to our community. It appears to be counterproductive to use the incentive to achieve other outcomes, such as motivating collaboration for its own sake.

It is important that companies maintain freedom to partner on research as the need arises and with the most appropriate partner.

The ARC Linkages programme and CRCs already exist for the purpose of motivating collaboration and provide effective mechanisms. These should be examined for greater effectiveness or a grant or voucher system would be a more sensible mechanism for encouraging collaboration and get results as it will ‘speak’ directly to what is to be achieved – and without compromising the R&D tax Incentive.

This would be the subject of a stand-alone consultation process if it is where the Government wants to direct efforts.

Efficiency

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When introducing the R&D Tax Incentive programme (2009 – 2011) the Federal Government deliberately engineered the definitions and requirements of the program to target it to legitimate R&D. This has resulted in a complex programme that incurs cost for the claimant and operational cost for government. Any move to reduce compliance or administrative costs would be welcomed by the biotechnology sector.

Additionality and spillovers While the Issues Paper noted that the additionality provided by the programme is implied to be in the order of 10 – 20 percent, AusBiotech contends that this is likely to be significantly higher if the biotechnology sector were sectioned off for analysis.

In part this is because the majority of the industry is SMEs and as noted in the paper, 54% of R&D decisions are shown to be influenced by the programme in SMEs compared to 34% in larger entities. It is also because this industry is highly R&D intensive and these companies typically have no revenue while their R&D costs are at their peak in the life cycle.

Effective in creating additionality in Australian companies

The program has been effective in assisting Australian biotechnology companies to remain in Australia to conduct their R&D programmes – which amounts to R&D activity that we otherwise may have moved to overseas jurisdictions with competitive tax incentives.

In a previous AusBiotech submission Scott Power, Senior Analyst - Morgans Financial Limited (formerly RBS Morgans) said: “There are numerous Australian ASX-listed companies that wouldn’t be in Australia if it wasn’t for the R&D Tax Incentive.” An example of the impact on a local company is Nexvet Biopharma’s story, showing the Incentive’s power to drive innovation in Australia. Nexvet is an animal health biotechnology start-up co-founded by Australian scientist-entrepreneurs and based on technology invented in Australia. The R&D Tax Incentive was crucial to its becoming a NASDAQ-listed global company.

The Australian R&D Tax Incentive was critical to Nexvet’s funding of early-stage trials in Australia to demonstrate proof-of-concept. Like many Australian start-up companies Nexvet eventually required the significant funds required to move into full product development. In February 2015 Nexvet listed on the NASDAQ and raised US$42 million. Largely due to the attractiveness of the Australian R&D Tax Incentive scheme, Nexvet has kept its R&D team in Melbourne and has in fact expanded this team, creating a globally competitive veterinary biologics research center. Australian incentive programmes provide a meaningful offset to on-going pressures to move R&D activities closer to international markets, major investors, and large specialist talent pools.

International competitiveness

In the context of the global market and the portability of IP, research that can be attracted to and retained in Australia ought to be considered additionality. Australia’s largest biotechnology companies, CSL, said in its submission to the same Review:

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And

A clear example of a company that would not otherwise be conducting economic activity in Australia is Innate Immunotherapeutics, which moved from New Zealand to Sydney and has since listed on the ASX, as a result of the R&D Tax Incentive.

The Company has designed and manufactured a unique immunomodulator microparticle technology, which can be used to induce the human immune system to fight certain cancers and infections, or modulate certain immune mechanisms implicated in autoimmune diseases such as multiple sclerosis. The same technology can be used in the design of better vaccines to potentially treat or prevent diseases such as influenza, cancer, malaria, or tuberculosis. The company said in a media statement that it made the move to initiate a clinical trial on the efficacy and safety of MIS416 in the treatment of people with Secondary Progressive Multiple Sclerosis, which will treat 90 patients in its clinical trial, because of the R&D Tax Incentive.

AusBiotech has reported in the media that there was evidence at BIO 2015 that the message on Australia as a location for investment is gaining traction.

Numerous companies have now commenced pre-clinical and clinical trial activity in Australia and several companies are looking to establish or further their activity in Australia. We have been saying for a number of years that the R&D Tax Incentive is a very attractive mechanism to attract investment, and for companies planning or considering collaborating or partnering with an Australian company or researcher, it certainly makes a big difference.

Canada and the UK have attractive R&D tax incentive schemes, but Australia’s offering is the most attractive, which also highlights the importance of maintaining international competitiveness.

It certainly highlights the value of a long-term commitment to engagement, and of maintaining policies that leverage Australia’s comparative strengths in biotechnology.

Southern Star Research said: “The R&D Tax Incentive offers not only a tangible gain to companies but it also provides the motivation to recognise all of the others positives that Australia can provide in terms of clinical research.”

“Although estimates indicate that approximately 10 – 20% of the R&D currently conducted in countries with similar volume-based tax instruments in place would not otherwise occur, the experience of Southern Star Research suggests this figure is actually much higher. Our forecast would indicate that around 40% of our revenue this financial year will be from clients who are new

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to clinical research in Australia. In each case, it was the R&D Tax Incentive that encouraged these organisations to consider and then commit to bringing their clinical trials here. “Although many factors are typically involved in this type of decision, without this incentive, these companies would have maintained their R&D activities off-shore. This incoming investment directly benefits more patients with access to new treatments, and also supports a large number of doctors and nurses at teaching hospitals and private medical facilities, as well as pathology laboratories, drug manufacturing and packing companies and an array of SMEs that provide ancillary services to the research sector. The Australian economy gains many follow-on benefits in turn.” Q-Pharm Pty Limited, an Australian-based contract research organisation, has compiled a list of companies that have been customers and that have taken advantage of the Federal Government’s R&D Tax Incentive to illustrate that any change in the R&D Tax Incentive would have noticeable negative consequences for research in Australia.

Over the period 2012-2014, Q-Pharm had 42 projects active in various stages in Australia and contingent on the R&D Tax Incentive. Of these 21 were from 13 foreign companies. This makes up about a quarter of the companies already attracted to Australia to conduct their clinical research, which is worth on average $1 million each. Numerous projects are also in the pipeline with European, US and Asian companies looking to open operations in Australia to take advantage of Australia’s technical expertise, pragmatic research regulatory regime and R&D Tax Incentive scheme.

These companies vary from virtual biotechnology companies based in the US that have created an entity here to small vaccine companies in Europe or Australia. Example case studies are:

• Company A is a biotechnology company that is developing a product for allergy. The total value of the project for Q-Pharm is just under $1 million. There is complementary bioanalytical work to be carried out in Australia ($200,000), manufacturing of the product in Brisbane ($700,000) and all the other work associated with this project (regulatory consultants, transports, laboratories, financial consultants, etc.) They have stated several times that the R&D Tax incentive has been a cornerstone for their choice of Australia as a location for their early clinical development

• Company B is a vaccine company, based in the US, with whom Q-Pharm is negotiating the fourth vaccine development programme. Their latest programme was worth $400,000 plus satellite activities worth about $700,000. This company uses the refund from the R&D Tax to partially re-invest in the following year’s study.

• Company C is a Chinese biotechnology company. They had a first in man study with 74 participants. The total value of the work for Australia was over $850,000 plus costs associated with the study in the region of 1.5 times that. Again the management indicated that the R&D Tax Incentive was a crucial element in the decision to bring the clinical study to Australia.

Dr Gregor Rozenberg, Biotech & Venture Consulting, is assisting a number of overseas companies that are conducting R&D activities in Australia. The R&D Tax Incentive is helping overseas companies become more aware of Australia’s offering and is one of the deciding factors in their assessment of where to conduct their clinical activities. The list below, which is not comprehensive,

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exemplifies companies that are currently conducting R&D in Australia, ranging from pre-clinical testing to multi-site Phase II trials. The total value of these companies’ R&D expenditure in 2015-16 is about $8 million and is likely to double every year. Dr Rozenberg also anticipates a steady increase of new companies setting up subsidiaries in Australia. He expects to see about 10 new companies moving some R&D operations to Australia from overseas in next financial year alone.

• Company A, with headquarters in San Francisco US, is developing drugs that target protein homeostasis with focus on autoimmune diseases.

• Company B, with headquarters in Austin US, is a pharmaceutical company targeting orphan drug indications for lung injury and disease.

• Company C, with headquarters in Crestwood US, is a clinical stage company developing immuno-inflammatory regulators.

• Company D, with headquarters in, Oxford UK, is a nanomedicine company.

• Company E, with headquarters in Washington DC, is commercialising a live cell-encapsulation technology for the treatments of cancer.

• Company F, with headquarters in San Francisco CA, is commercialising a portfolio of drugs delivered by inhalation.

• Company G, with headquarters in Honolulu US, technology increases the oral bioavailability of therapeutics.

• Company H, with headquarters in Crestwood US, is developing therapeutics to treat asthma and chronic obstructive pulmonary disease.

• Company I, with headquarters in Eagan US, is developing therapeutics against cancer cells.

• Company J, with headquarters in Atlanta US, is a private clinical stage drug development company.

The specialist R&D Tax Consulting team at the IP firm, FB Rice, said they have seen, across industry sectors, an increase in companies undertaking R&D under the new R&D Tax Incentive. “Previously, these companies may have not claimed under the previous R&D tax concession programme as the deductions through the concession may have only added to losses and not provided cash flow for further R&D activities. We have seen this access to the R&D offset enable companies to fund continuing R&D activities to move towards commercialisation of these ideas.”

“We have seen companies undertaking more R&D activities as a result of the R&D tax incentive programme in the small to medium sized companies (SMEs).

“The concepts of R&D ‘additionality’ and spill over of technologies were pivotal in the design of the current Tax Incentive. The higher level of the R&D Tax Incentive, and ability to cash out this benefit if in losses available to SMEs (less than $20 million turnover) was intended to encourage the performance of R&D in smaller businesses and has, statistically largely achieved that end with more

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companies claiming for their R&D activities. Any tightening of the provisions would put pressure on emerging technologies and the commercialisation of technologies by the SME sector.”

In a global industry, we have seen companies move away from the business-as-usual approach and invest in R&D activities in Australia under this programme. Attracting and retaining activity in and to Australia ought to be considered a form of spillover that is additional ‘business as usual’. Eliminating business-as-usual activities ought to be the key outcome of this review. This will alleviate any pressure on budget while retaining the benefit and support of genuine R&D.

Summary

This submission contends and recommends:

• Preservation of the integrity of the R&D Tax Incentive programme, which has been a highly-successful for Australia’s biotechnology community, particularly at SME stage.

• The programme is doing its intended job of providing additional R&D in Australia and spillover benefits. It is helping to build the industry and attract clinical trials for the benefit of Australian patients and the domestic healthcare system as well as generating clear economic activity in science-based jobs.

The R&D Tax Incentive is providing additionality by retaining R&D activity in Australia that may otherwise have migrated to other countries with competitive tax regimes and attracting R&D from other countries. This is especially evident in Australia with Phase I clinical trials and also with pre-clinical work. This ought to be considered an important form of spillover that is additional ‘business as usual’.

• AusBiotech encourages an end to on-going tweaks and reviews that are causing instability and uncertainty, which undermines the programme.

• The realistic cost of the programme is uncertain at this time and any analysis in this regard ought to take into account the broader context of accounting and macro-economic factors.

Australia has excellent potential to be a nation driven by bio-innovation and our tax policy settings provide us with an opportunity to encourage growth where we want it to happen. We need a business tax regime to support the innovation ecosystem, both at start-up phase and throughout the lifetime of a company to retain international competitiveness. Our competitors and major trading markets have acted and many have more attractive arrangements for innovative companies commercialising medical research and developing intellectual property. The R&D Tax Incentive has helped us ‘turn the corner’ in industry development terms. Now is the time for stability and looking to further enabling initiatives to ensure the “innovation freeway” is fully open – not the time to limit the major and successful programme facilitating innovation. AusBiotech congratulates the Government on its National Innovation and Sciences Agenda, in particular the Biomedical Translational Fund and the investor incentive that offers a tax offset and capital gains tax breaks to encourage investment in early stage companies. The package is a moveent in the right direction and it was welcomed by AusBiotech as a game-changing package that will transform Australia’s ability to commercialise and benefit from our world-class R&D.

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The biotechnology and medical technology sectors are particularly excited by the ability of the programme’s investment to be a multiplier and make available much-needed capital to translate our research from our universities and medical research into products and services, like medical therapies and cures, medical devices, digital heath solutions, diagnostics and vaccines.

AusBiotech urges the Government to analyse carefully any move to limit or reduce the R&D Tax Incentive programme, especially where it is making great gains, lest tinkering undermines the programme and undoes hard-won momentum in innovation in Australia.