House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 3 - Research and development tax incentive: reducing the tax offset rates

Outline of chapter

3.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to reduce the rates of the tax offset available under the research and development tax incentive by 1.5 percentage points. The higher (refundable) rate of the tax offset will be reduced from 45 per cent to 43.5 per cent and the lower (non-refundable) rates of the tax offset will be reduced from 40 per cent to 38.5 per cent.

3.2 The reduction in the tax offset rates is consistent with the Government's commitment to cut the company tax rate from 1 July 2015 by maintaining the relative value of the offsets. The gain to revenue and savings from this measure will be redirected to repairing the Budget.

Context of amendments

Research and development tax incentive

3.3 The research and development tax incentive is the primary mechanism by which the Commonwealth seeks to encourage companies to undertake research and development activities in Australia.

3.4 Broadly, the incentive provides:

•

a 45 per cent refundable tax offset to eligible entities with a turnover of less than $20 million, and which are not controlled by income tax-exempt entities, for their expenditure on eligible research and development activities in Australia; and

•

a 40 per cent non-refundable tax offset to all other eligible entities for their expenditure on eligible research and development activities in Australia.

(See subsection 355-100(1) of the ITAA 1997)

3.5 In determining what rate applies, an entity will be considered to be controlled by an exempt entity or entities if, broadly, the exempt entity or exempt entities hold an interest in the entity of at least 50 per cent at any time in the income year (see section 355-100 of the ITAA 1997).

3.6 The tax offset rates of 40 per cent or 45 per cent of the eligible research and development expenditure replace any income tax deduction or other offset that would otherwise be available in respect of the expenditure. As a result, research and development expenditure generally results in a greater net benefit than an income tax deduction for research and development expenditure at the corporate tax rate.

3.7 Eligible research and development activities include both core activities, being experimental activities undertaken for the purpose of acquiring new knowledge, and supporting activities, which are activities either directly related to core activities or are undertaken for the dominant purpose of supporting core activities (sections 355-20 to 355-30 of the ITAA 1997).

3.8 Eligible entities are Australian resident corporations, Australian permanent establishments of foreign corporations and certain public trading trusts (section 355-35 of the ITAA 1997) who have registered under Part III of the Industry Research and Development Act 1986.

3.9 Provisions exist to claw back the additional tax benefit provided by the research and development tax incentive for eligible expenditure where an entity obtains a recoupment from government for the expenditure or where the expenditure relates to feedstock that has been or is sold (see Subdivisions 355-G and 355-H of the ITAA 1997).

Company tax rate cut and the research and development tax incentive

3.10 In its 2013 election campaign, the Coalition committed to lowering the company tax rate from 30 per cent to 28.5 per cent for the income year beginning on or after 1 July 2015, and for all subsequent income years. This is intended to make Australia a more competitive destination for investment.

3.11 As a result of this change, the benefit provided by the research and development tax incentive would increase relative to the standard treatment of normal business expenses.

3.12 To preserve the relative value of the research and development tax incentive and assist in repairing the Budget, the tax offset rates will be reduced by 1.5 percentage points, consistent with the proposed reduction in the company tax rate.

Tax Laws Amendment (Research and Development) Bill 2013

3.13 The Tax Laws Amendment (Research and Development) Bill 2013 is currently before the Parliament. It would amend the ITAA 1997 to deny access to the research and development tax incentive for companies with aggregated assessable income of $20 billion or more for an income year.

3.14 The amendment is intended to better target the research and development tax incentive to businesses that are more likely to increase their research and development spending in response to government incentives, delivering a greater return for taxpayers.

Consultation

3.15 Targeted confidential consultation was undertaken on exposure draft legislation with affected stakeholder bodies. No concerns were raised during consultation.

Summary of new law

3.16 Schedule 3 to this Bill amends the ITAA 1997 to reduce the refundable and non-refundable rates of the tax offset available under the research and development tax incentive from 45 per cent to 43.5 per cent and from 40 per cent to 38.5 per cent (respectively).

3.17 The changes do not affect the eligibility of entities to claim the research and development tax incentive or the administration of the research and development tax incentive more generally.

Comparison of key features of new law and current law

Detailed explanation of new law

3.18 Schedule 3 to this Bill amends the three rates of the tax offset available as part of the research and development tax incentive detailed in the table in section 355-100 of the ITAA 1997.

3.19 The first rate in the table in section 355-100 applies to entities with a turnover of less than $20 million (and to which the second rate does not specifically apply). These entities previously received a tax offset equal to 45 per cent of their eligible research and development expenditure. They will now receive an offset equal to 43.5 per cent of their eligible expenditure. [Schedule 3, item 1, item 1 in the table in subsection 355-100(1) of the ITAA 1997]

3.20 The second rate in the table applies to entities which, at any time during the income year, are controlled by an entity that is exempt from income tax (an 'exempt entity'), including entities which would otherwise meet the criteria for the first rate to apply. These entities previously received a tax offset equal to 40 per cent of their eligible research and development expenditure. They will now receive an offset equal to 38.5 per cent of their eligible expenditure. [Schedule 3, item 2, item 2 in the table in subsection 355-100(1) of the ITAA 1997]

3.21 The third rate in the table applies to all other eligible entities. These entities previously received a tax offset equal to 40 per cent of their eligible research and development expenditure. They will now receive an offset equal to 38.5 per cent of their eligible expenditure. [Schedule 3, item 3, item 3 in the table in subsection 355-100(1) of the ITAA 1997]

3.22 There is also a note to the table which previously referred to the 45 per cent rate. The note now refers to the 43.5 per cent rate. [Schedule 3, item 4, note to subsection 355-100(1) of the ITAA 1997]

3.23 For simplicity, no change has been made to the provisions providing for the adjustment of tax benefits in respect of eligible research and development expenditure, where the entity obtains a recoupment for the expenditure or sells feedstock to which the expenditure relates. Following the proposed reduction in the company tax rate, the tax outcomes for entities to which these provisions apply will be largely the same as before these amendments.

Application and transitional provisions

3.24 These amendments apply in respect of assessment for income years commencing on or after 1 July 2014. [Schedule 3, item 5]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Research and development tax incentive: reducing the tax offset rates

3.25 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

3.26 The research and development tax incentive is the primary tax mechanism by which the Commonwealth seeks to encourage companies to undertake research and development activities in Australia.

3.27 Broadly, under the research and development tax incentive, eligible entities (Australian resident corporations, Australian permanent establishments of foreign corporations and certain public trading trusts (section 355-35 of the ITAA 1997) who have registered under Part III of the Industry Research and Development Act 1986) are entitled to receive a tax offset for a certain percentage of their eligible expenditure on research and development.

3.28 As a result of the amendments, the refundable tax offset rate will be reduced from 45 per cent to 43.5 per cent for taxpayers with annual turnover under $20 million that were not controlled by entities that are exempt from income tax at any point during the income year, and the non-refundable tax offset rate will be reduced from 40 per cent to 38.5 per cent for all other taxpayers.

3.29 The reduction in the tax offset rates is consistent with the Government's commitment to cut the company tax rate from 1 July 2015, with the gain to revenue and savings from this measure to be redirected to repairing the budget.

Human rights implications

3.30 This Schedule does not engage any of the applicable rights or freedoms.

3.31 The change only affects the amount of tax offset that can be claimed by corporate taxpayers which engage in eligible research and development activities.

Conclusion

3.32 This Schedule is compatible with human rights as it does not raise any human rights issues.