SMEs should find it easier to access revised R&D tax credit: experts

Tax experts say the Government’s revised R&D tax credit should be easier for SMEs to understand and access, thanks to Treasury’s decision to abandon its original narrow definition of core R&D activity.

The Government was heavily criticised after releasing its first draft of the R&D tax credit legislation in December 2009 due to a major change in the way R&D activity eligible for a tax break was defined.

Under the current tax break (which is in the form of a tax concession), eligible R&D can be either innovative or risky, but under the Government’s first draft of the legislation both criteria needed to be satisfied.

But the second exposure draft, released late on March 31, includes an entirely new – and much broader – definition.

Under the proposed changes, core R&D activities must be “experimental activities whose outcome cannot be known or determined in advance”, must use a “systematic progression of work that is based on principles of established science” and must be “conducted for the purpose of generating new knowledge (including knowledge about the creation of new or improved materials, products, devices, processes or services)”.

The “innovative” and “risky” criteria have disappeared altogether.

Yasser El-Ansary, tax counsel at the Institute of Chartered Accountants in Australia, has been working closely with the Government on the changes and believes the definition of “core R&D” is more improved.

“It’s much broader than it was before and not only that, it’s much easier to understand. That’s one of the objectives here – to make the R&D tax credit more user friendly,” he says.

“The package is a significant leap from where we were in December 2009. It’s clear the Government is focused on rebalancing and retargeting the R&D tax credit for the SME market, rather than the big end of the market.”

Other major changes relate to the definition of “supporting R&D” activities that will be eligible for the R&D tax credit.

Under the new definition, supporting R&D will need to be directly related to the core R&D being undertaken and will need to pass a “dominant purpose” test to meet this criteria.

However, accounting firm PricewaterhouseCoopers has warned that this new definition “may significantly impair R&D claims by companies which undertake R&D within a production or commercial environment” where R&D spending on products already in production will no longer be eligible as supporting R&D.

El-Ansary says this will be a concern for some businesses, but says the Government has been trying to tie supporting R&D spending more closely to the core R&D spending, partly in reaction to companies trying to “push the boundaries” on what constitutes supporting R&D spending.

“The reality is that there will be a narrowing of the eligible expenditure. I don’t think that’s an accident.”

The other major change was a reprieve for the software sector. Under the original draft of the legislation, R&D spending for software was no longer eligible for tax breaks, but this position has been reversed in the new draft.

El-Ansary says companies will need to get their heads around the new changes, which he describes as the biggest changes to R&D tax breaks in more than 10 years.

“The Government has been focused on developing a system that was more targeted and more controlled from a spending point of view.”

“It’s going to mean that a lot of businesses are going to need to look very closely at these new rules and determine what that means for their R&D expenditure.”