An update on the finance and expenditure select committee responses to the R&D Tax Bill.
As the R&D tax incentive applies from the beginning of the 2019/2020 income tax year, most taxpayers are now within the regime.
Although the Bill has yet to be enacted, it is now going through the final stages in Parliament, and when passed it will have retrospective effect from the beginning of the 2019/2020 income tax year.
The Finance and Expenditure Select Committee have completed their review of the R&D Tax Incentive Bill and the submissions that were made.
In this update we outline the Committee’s responses to the submissions made by KPMG and others.
Issue: Adopting the “on behalf of” test from 2008 tax credit regime
Although officials acknowledged that it is important the legislation is not confusing, and that many taxpayers are familiar with the “on behalf of” tests used in the 2008 tax credit regime, they considered that the tests for control and ownership are best clarified in guidance, rather than in legislation. Further, the control requirement has, in effect, been removed from the legislation and been replaced with an anti-avoidance measure to ensure that there is only one claimant for an R&D project.
Issue: Core R&D activity – day-to-day management
We recommended that the day-to-day management requirement should be moved and reconciled with the controlling rights requirement. Officials agreed that the day-to-day management requirement did not add anything additional to the core R&D activity definition and should be deleted all together.
Issue: Internal software development expenditure and the $3 million cap
In response to our submission to be able to apply to extend the cap, officials recommend two key amendments:
i. increasing the internal software development cap from $3m to $25 million in recognition that there is an imprecise distinction between some types of internal and external software development.
ii. broadening the outright exclusion for internal software development undertaken for the purpose of internal administration, so that it does not have an exhaustive list of excluded activities.
Issue: Commercial production rule
We submitted that eligible overheads should be allowed where R&D is performed in the course of commercial production.
Officials declined this submission on the basis that the commercial production rule is designed so that the extra costs associated with R&D are eligible but that the costs that would have been incurred anyway as a result of the commercial operations are not eligible, which they consider the appropriate approach.
Issue: Contracted R&D expenditure – profit margin
Officials agreed with our submission that a contractor’s profit margin is a true cost to the principal in getting the R&D performed. They recommended that one hundred percent of the principal’s R&D tax credit claim, when engaging a contractor to perform R&D on their behalf, should be eligible (and not be reduced by twenty percent to account for the contractor’s profit margin as was originally proposed).
Issue: Contracted R&D expenditure – ineligible expenditure
The submission that ineligible expenditure should not be removed from the contract amount when determining the amount eligible for the R&D tax credit was declined.
Officials responded that if ineligible expenditure is not taken out of the contract amount for R&D tax credit purposes, then the integrity of the scheme would be undermined. There would effectively be no list of ineligible expenditure where a contractor was engaged, resulting in claimants receiving a credit on expenditure that was not intended.
A de minimis rule as allowing ineligible expenditure for a large number of small claims was also dismissed for the same reasons.
Issue: Cost of in-year approval applications
Officials advised that although cost is not referred to in the legislation, the guidance will clarify that no fees will be charged for in-year approval applications.
Issue: General approval of supporting activities
We recommended that general approval should be available for core and supporting activities, so that businesses have certainty regarding whether their activities are eligible.
Officials agreed with extending the general approval process to supporting activities on the basis that the distinction between core and supporting activities is not always overtly clear so the extension will provide businesses with more certainty
Issue: General approval application form
Officials noted our submission that businesses should be required to provide a brief explanation of how their R&D activities satisfy the relevant definitions, and that there should be a fast track procedure should a business have to vary an existing approval. This will be taken into consideration by the Commissioner when designing the general approval application process and deciding on the appropriate timeframes for processing variation requests
Issue: “business-as-usual activities” is too restrictive
Officials agreed that “business-as-usual activities” is too restrictive and recommend that section LY 1(1)(b) is amended to better reflect the policy intent of the regime to provide a tax credit for activities that generate new knowledge, and to ensure that activities that are not R&D do not inappropriately qualify.
Issue: Guidance should provide more information on when records need to be created.
Officials responded that information around when records need to be created will be clarified in guidance to the extent it remains relevant.
Issue: Eligibility for the tax credit and Callaghan project grants differ
KPMG submitted that it is relevant to the overall policy goal of supporting R&D that there is a misalignment of eligibility requirements between the R&D tax credit and the R&D Project Grant administered by Callaghan Innovation.
Officials stated that the submission would be noted and that some differences may be resolved when Project Grants are reviewed.
Following the consideration of the Bill by the Finance and Expenditure Committee, there have been some other notable improvements: