Ombudsman calls for reforms to R&D tax incentive processes

Small business ombudsman Kate Carnell said audits by the Australian Taxation Office and the Department of Industry, Innovation, and Science are leaving some companies in 'financial ruin'.

The Australian Small Business and Family Enterprise Ombudsman Kate Carnell has expressed "grave concerns" about how the Department of Industry, Innovation, and Science (AusIndustry) and the Australian Taxation Office (ATO) go about administering the R&D tax incentive (R&DTI), criticising the current approach as "untimely, inconsistent, and in many cases targeted".

"We identified an overall 'shift' in the way the R&DTI legislation has been interpreted over the last three to four years; a narrowing of focus leading to a rejection of claims, which in previous years had been regarded as low risk," Carnell said.

"The way the program has been administered has created uncertainty amongst companies and their advisors and has undermined the policy intent of the R&DTI legislation."

In a review of the R&D tax incentive [PDF] the ombudsman has put forward 24 recommendations, including the need for compliance examinations or audits that would be carried out by AusIndustry and the ATO. These would take place as close as possible to the first year of registration of the project.

"In all cases, this compliance activity was retrospective and commenced several years after the relevant research and development activity was undertaken and the R&DTI refund received," Carnell said.

"In almost all of these cases, the R&DTI claims were rejected in total. This has had a devastating impact on the companies, with some saying they face financial ruin. Others have scaled down their R&D efforts in Australia and reduced their R&D staff."

The ombudsman also recommended for guidance material to be made clearer and updated, pointing out for instance, that software guidance material should be rewritten so that it focuses on what is eligible, instead of what is ineligible.

The ombudsman said it also wants to see guidance materials provide examples about how using "agile" can allow a company to demonstrate that software development falls within the category of R&D activities.

See also: Software development, non-business skills sought in 2020 (TechRepublic)

The review also recommended for record keeping by the agencies to be simplified; to consider the commercial operation of small businesses; and for more assistance to be provided to small businesses to help identify and retain professional R&D consultants.

The release of the review comes a week after Treasurer Josh Frydenberg reintroduced legislation into Parliament to reform the R&DTI.

He said the reforms would "ensure that the tax incentive remains an effective and sustainable part of Australia's overall support for R&D". 

"In better targeting and improving the integrity and sustainability of the research and development tax incentive, the reforms in this bill will ensure that the incentive remains an important part of the government's overall support for research and development in Australia," he said. 

Frydenberg outlined some of the specific reforms, which include changing the existing flat premium available to companies with an annual turnover above AU$20 million to one that increases as a company's R&D expenditure increases; increasing the maximum amount of R&D expenditure eligibility for tax offsets from AU$100 million to AU$150 million per annum; and giving the board of Innovation and Science Australia the ability to make binding decisions about R&D eligibility.

The reforms were initially announced by the federal government during the 2018-19 Budget.

At the time, then Treasurer Scott Morrison said the purpose would be to crack down on taxpayers to ensure that the R&DTI "are used for their proper purpose, with enhanced integrity, enforcement, and transparency arrangements, saving taxpayers AU$2 billion over the next four years". 

"To support companies genuinely investing in R&D, we are refocusing the R&D tax incentive to give more support to companies that invest a higher proportion of what they spend in R&D, over and above what others would just do anyway."

The R&DTI was stranded earlier in the year when the Senate Economics Legislation Committee asked federal government to go back to the drawing board on a range of measures.

The committee said while it recognised the need for government to maintain public confidence in the integrity and financial sustainability of the R&DTI, it was not confident the introduced measures would provide exactly that.

"This confidence promotes business innovation across the economy and allows the scheme to meet its stated objectives of additionality and spillovers," the committee wrote. "Further, the committee recognises that, while the R&D tax incentive in its current form is falling short of these aims and objectives, there is a need to reform the R&D tax incentive.

"On the weight of evidence presented, the committee considers that the bill should not proceed until there is further consideration of the R&D tax incentive measures." 

The R&D tax incentive was introduced in 2011 in its current form. It is the principle mechanism used by the Australian government to stimulate industry investment in R&D, and does this by providing a tax offset for eligible R&D activities.   

Approximately 13,000 companies are registered under the R&D tax incentive scheme.   

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