The state of play as the strategic R&D review commences

As the new business year starts in earnest, it is timely to revisit the terms of reference for the Strategic Examination of Research and Development published in December 2024. 

The year-long review was originally announced in the Federal Budget 2024-25 and ambitiously seeks to uplift Australia’s R&D intensity by:

• Maximising the value of investments made to date in Australian R&D
• Strengthening existing linkages and collaboration between research and industry sectors
• Improving national priority funding efficiencies and industry adoption of innovations

The review has been overall been welcomed by university and research bodies, with a public document expected to be issued for consultation. 

Although the R&D Tax Incentive (RDTI) is only a part of the wider Australian R&D ecosystem, albeit substantial, unless significant new funding becomes available under a re-elected Labor government or a new Coalition Dutton government, the RDTI regime is likely to continue to play a central role in any future reform mechanisms. 

Potential RDTI amendments 

Given its central nature, the expert panel could consider the following features of the RDTI regime which currently either hamper the intended global attractiveness of the regime or cause practical issues for clients and advisers.

R&D expenditure cap 

The publication of the first RDTI transparency publication in October 2024 illustrated the extremely limited number of current claimants breaching the current $150 million cap. Although data on multinationals with December substituted accounting periods will only be included in the next tranche, the interpretation is already that multinational groups are embracing more attractive programs that may also have a modified-nexus BEPS patent box regime. 

Historically, it is worth bearing in mind that the original $100 million cap, introduced in 2014 for a limited ten-year period, was merely the product of a Palmer United Movement (PUP) parliamentary movement to replace the then-proposed exclusion of companies with an aggregated turnover of greater than $20 billion. The resulting legislation was drafted in Parliament with no explanatory materials available (and notably by now, the original cap would have expired). 

The permanent $150 million cap then later emerged from the protracted process of change between 2018 and 2021 instigated by the 2016 review of the R&D Tax Incentive (colloquially known as the Triple F report), with belated pivots on proposed R&D rate cuts caused by the mid-pandemic focus on science and innovation.

Such reactive legislative responses on the run have served only to contradict the original intent and policy objectives of attracting global R&D onshore, and the now permanent introduction of an expenditure cap strongly hampers the global attractiveness of the RDTI regime. 
We believe that the panel should consider the implications of retaining the current cap, based on robust analysis and a reflection on the original policy objectives of the RDTI regime.  

Increasing the refundable threshold 

Any proposals to amend the RDTI regime should certainly include an increase in the $20 million threshold to access the refundable R&D tax offset, especially given recent high inflationary periods. Simple indexation since its inception would increase the threshold to closer to $30 million. 
Indeed, tax simplification principles would advocate for a refundable threshold to legislatively match the Base Rate Entity (BRE) threshold, currently standing at $50 million. Such a move would reduce the complexities of BRE companies falling into both the refundable and non-refundable RDTI categories. Legislated indexation of the resulting threshold(s) would also prevent these issues continuing to arise at regular intervals in the future, although pragmatically future governments may favour potential bracket creep to reduce the future costs of the regime. 

Intensity threshold complexity

Ongoing compliance for RDTI claims now also requires potential consideration of intensity threshold calculations, the complexity of which has been understated. Inter-year adjustments where capitalised expenditures have previously been claimed, as well as the calculation of clawbacks and catch-up deductions are difficult to calculate in practice, exacerbated by the already complex AASB 16 lease adjustments required. Notably, errors in the online ATO instructions of how to calculate the intensity threshold factors have not been corrected. 

The expert panel could review whether the intensity threshold feature is in practice achieving the aims of the highly academic concept of additionally, as articulated in the Triple F report, or whether the non-refundable R&D tax offset should revert to a single tier rate.  

Collaboration premium 

Given the terms of reference, the independent expert panel should also revisit some of the deliberations and recommendations made the Triple F report that have not yet been fully examined. 
Recommendation 2 included a non-refundable collaboration premium of up to 20% for the collaborative element of R&D expenditures undertaken with publicly funded research organisations. These issues were well canvassed at the time, with subsequent election-based discussion of introducing a similar 10% premium that did not eventuate.  

Quarterly credits 

In a similar revisit to the past, the introduction of quarterly refunds for RDTI refundable taxpayers would be welcomed by industry, a need accentuated by long-standing high interest rates, likely to be higher for longer in an era of high employment and Trump 2. 
The increasing importance of the R&D financing arena, and recent entrants, illustrates a key need for such early financing assistance to assist start-ups cross the well-known “valley of death”. Critically, at the time this was previously announced in 2012, appropriate draft legislation was already robustly consulted on and ‘shovel-ready’.

Interaction of RDTI with tax loss and tax consolidation regimes 

Generally, the evolution of legislating for the R&D tax offset several years after the tax consolidation regime was introduced in 2004 has paved the way for the R&D tax offset to become the inferior cousin of tax losses. The R&D regime moved from a super deduction mechanism to a position of representing the only substantive carry forward non-refundable tax offset. 

Unlike tax and capital losses, there is no legislative mechanism to transfer non-refundable R&D tax offsets to a head company at a joining time or their future utilisation under modified loss utilisation tests. Rather, tax offsets must rely on the entry history rule and unmodified loss utilisation tests. 

Moreover, some fourteen years after the RDTI regime was enacted, there is no clarity around whether on leaving, the exit history rule also applies or whether, like tax losses and franking credits, tax offsets remain with the head company.Legislative reform could see tax offsets either folded into 

Div 707 and the available fraction rules, mirrored treatment under similar parallel rules, or converted into tax losses at the joining time, akin to the treatment of excess current year franking credits.  

The design of such provisions should also seek to ensure that non-refundable tax offsets should also be encompassed in any tax loss carry back treatment, as occurred temporarily due to the pandemic. 

Specific industry considerations 

The RDTI regime has long been considered industry agnostic with some recent public commentary to the same. That said, the move from the former R&D Tax Concession to the RDTI did serve to discriminate against the construction industry with a revised interpretation of the building expenditure exclusion embraced by the regulatory bodies. 

That aside, the publication of the first data in the RDTI transparency publication swiftly resulted in a 2024-25 Mid-Year Economic and Fiscal Outlook (MYEFO) announcement that legislation will be introduced to deny the RDTI incentive for activities relating to tobacco and gambling activities. Indeed, there is legislative precedent for the gambling exclusion in the relatively recent introduction of the Digital Tax Gaming Offset (DGTO).  

From an industry perspective, we consider it would be detrimental if the review made further recommendations aligned to specific industries, with a possible exception for revisiting the issue of separate core R&D activity definition for the software industry which now makes up a substantive proportion of all RDTI claims.

RDTI case law considerations 

To date, there are unfortunately few substantive RDTI judicial authorities, except for the long-running Moreton Resources saga, which pleasingly rebutted early assumptions made by the regulatory bodies based on limited statements made in the original explanatory materials. Generally, the experience of RDTI decisions that have not simply failed at the first substantiation hurdle do affirm the critical need to proceed from first principles based on the law itself. 

Overall, key RDTI topics remain judicially unexplored, including the issue of feedstock – the GQHC and Commissioner of Taxation [2024] AATA 409 discussion of feedstock was naïve in it interpretation, with no examination of the nature of the composite provisions. The decision also failed to consider the GHP 104 160 689 Pty Ltd and Commissioner of Taxation [2014] AATA 869 case despite being assimilated into formal ATO guidance in TR 2013/3. 

It can be expected that higher courts will examine the nuances of the provisions in further detail, especially in the agribusiness and poultry sectors. 
Similarly nuances surrounding the foreign-owned R&D requirements require consideration, given that these provisions were specific RDTI policy aims to attract R&D activities onshore to benefits from the additionality and spillover benefits. 

In the absence of more substantive technical cases, test cases in some areas would be welcomed, especially given the poor quality of the RDTI claims that have been considered to date by the Courts, illustrated by the recent ‘slam dunk’ decision in Active Sports Management Pty Ltd v Industry Innovation and Science Australia [2024] FCA 1346.

More generally, all tax advisers must appreciate that substantiation requirements for R&D claims go well beyond the mere need to evidence that income has been derived, or deductions incurred. Existing and potential RDTI claimants should seek to develop and maintain a robust R&D tax governance framework. 

Notably, genuine RDTI claimants who fail at the documentation hurdle or decide against the efforts of defending a forceful regulatory review, often do not appreciate that the withdrawal of an RDTI claim at a later stage will not nullify the penalties imposed, with a 50% penalty in practice often being the starting point of the ATO as a failure to take reasonable care.  

Global influences 

Finally, it is to be expected that the Panel will explore the positive and negative experiences of other global regulatory bodies as part of their considerations.

From the perspective of the UK, there is a less complex approach to the quantum and types of eligible expenditures that can be claimed. On the negative side, 2024 saw the unravelling of a public scandal resulting from the HMRC “process and pay first, check later” approach – unfortunately further tainting an industry that has worked hard to shake off such perceptions. However, unlike the UK, the toughened Australian promoter penalty regime has the ability to address such governance concerns, with two decisions to date focused on the R&D regime. 

RSM comments 

RSM looks forward to contributing to the forthcoming public consultation aspects of the review, as well as evaluating the impact of future R&D transparency publications encompassing new data featuring the details of multinational groups undertaking R&D in Australia.

With an upcoming Federal election, and a new administration in the US, there continues to be both a local and global focus on the economy and sovereign manufacturing. The RDTI regime is a long-standing valued support for Australian business, and we look forward to reporting on the impact of the 2025 review on support for Australia’s R&D ecosystem, and other future measures.