R&D – a concession or incentive for SMEs?

While the replacement of the existing research and development (R&D) tax concession with the new R&D tax incentive has many commentators in a flap, the scheme introduced into Parliament last week aims to provide higher rates of assistance for more targeted activities.

Critics of the new legislation say it’s still too complex and restrictive. However for SMEs, the benefits under the new scheme warrant considering your eligibility to access the incentives if introduced as proposed on July 1, 2010.

The scheme provides a 45% refundable R&D tax credit and a 40% standard R&D tax credit.

The refundable tax credit at a rate of 45% of expenditure on eligible R&D activities is available to companies with an aggregated turnover of less than $20 million (equal to a tax deduction of 150%).

If the credit reduces a taxpayer’s income tax liability to zero, any unused refundable tax offset amount can be applied to reduce other tax liabilities, and any residual unused amount can be refunded as cash to the company.

For example, if a company spends $1 million on eligible R&D expenditure, they will be entitled to a refundable tax credit of $450,000, which for most SMEs is a critical source of funds.

The 40% standard tax credit or offset (replacing the tax deduction) will be available to companies with an aggregated annual turnover of more than $20 million.

It is designed to reduce the amount of tax payable, and can be carried forward where a company’s income tax liability for a particular year is zero.

So who is eligible and what can be claimed?

On the surface the new scheme provides a better outcome for most SMEs, as the 45% refundable tax credit is equivalent to a tax deduction of 150%, whereas the existing scheme only provides a 125% deduction.

Also, according to the Government under the new scheme more than two million businesses will gain access to the R&D tax incentive, as opposed to the 8,000 currently eligible for the R&D tax concession.

Any Australian-incorporated company, including both Australian-owned and foreign-owned, undertaking eligible R&D activities will be able to access the new scheme.

So too will companies with up to a 50% ownership by exempt entities (such as universities) as opposed to the current 25% cap.

However, companies will need to clearly distinguish between core and supporting activities, with the R&D activity being conducted in Australia.

Core R&D activities are defined as experimental activities whose outcome cannot be known and are conducted for the purpose of acquiring new knowledge, using systematic scientific principals.

Eligible supporting activities must be undertaken for the dominant purpose of supporting core R&D activities, which may limit claims for commercially focused R&D.

The second exposure draft also takes a new approach to software R&D and applies the same rules as for all other kinds of R&D but subject to a more targeted exclusion for certain in-house software.

For innovative companies currently undertaking R&D activities or those that are considering it, seek advice from a good accountant who can inform you when the changes do happen and how you can best benefit from them.

Marc Peskett is a partner of MPR Group, a Melbourne based firm providing accounting, tax, business advisory and financial services to fast growing small to medium enterprises.