Budget 2018 puts government to the innovation test

The federal government faces a litmus test of its commitment to startups and innovation with the release of tomorrow’s budget.

StartupAUS and others in the sector are concerned the government will impose caps on its R&D tax concessions.

“This is the single biggest program that government delivers for startups anywhere in Australia,” according to StartupAUS chief executive Alex McCauley.

There has been concern from within the bureaucracy about the burgeoning cost of the scheme for several years. The scheme’s annual cost now exceeds $3 billion. Australia is one of the few countries in the OECD that uses tax concessions as the principal means of supporting R&D, with most countries opting for a mix of tax and competitive grants.

A high powered review of the incentive delivered to government two years ago recommended several significant changes including a cap of $2 million on the cash refundable portion of the concession (only available to companies with turnover of less than $20 million).

The concession means that companies not yet in profits can receive a cash refund on the eligible R&D portion of their expenditure. For companies with more than $20 million in turnover the concession is only available as a tax offset.

The review also recommended intensity thresholds for larger companies, which would require them to expend a larger part of their business expenses (at least 1%) on R&D in order to qualify for the incentive. If this recommendation was accepted, the review wanted the expenditure threshold for these large companies to be doubled to $200 million.

The review sparked an intense debate, with the sector arguing that a $2 million cap would kill many innovative, heavily R&D dependent startups. Alternatives proposed include a $4 million cap on cash refunds and lifetime caps of $40 million.

Treasurer Scott Morrison has flagged changes to the R&D grants and the sector is anxious the concessions for smaller companies are maintained by targeting any cuts at larger companies, which it claims treat R&D as an adjunct activity.

“It is a very risky thing to change the incentive substantially because it will force a lot of companies to rethink whether they are keeping their R&D bases in Australia and could jeopardise the model that lots of our most successful companies use, which is build local and sell global,” McCauley says.

“If it is more like a $4million than $2 million cap it won’t effect too many digital startups, but the companies in the biotech sector will be more affected by that given you get a lot of pre-revenue, high R&D spend companies that rely heavily on the incentive.”

“We did a survey of 100 startups and scale-ups and the results were staggering. It was something like 90 percent of those companies were claiming the R&D tax incentive and of those companies 85 percent said it was either a four or five out of five importance to their business — that is very important or critical to their business.”

The money spent at the startup end of the concession has to be prioritised, McCauley argues.

“We know that at the startup end, the money goes straight back into employing more people doing R&D — in other words incentivising companies,” he says. McCauley claims this is far less likely for larger companies that frequently have a set R&D budget that rolls on year-to-year, with the concession operating primarily as a subsidy rather than an incentive.

StartupAUS also wants to see the language of the scheme changed to reduce the focus on research and make it more accessible to commercialisers. Currently, the incentive requires that commercialisers prove new knowledge and demonstrate a scientific method.

“It’s not really how development works and is a square peg in a round hole for companies doing high quality development work,” he says, adding that the government is looking very closely at all software claims made on the scheme.

“The irony is that while Australia excels at research, it ranks close to last in the OECD for commercialisation of its research. It is one of our biggest weaknesses.”

FinTech Australia says while the government has been highly supportive of innovation and fintech in recent years, it is also concerned by possible changes to the R&D incentives.

“I would hate to see an arbitrary (R&D tax refund) cap introduced that prevents innovative companies from developing great new products and services. The reality for a financial services business is that it is complex and is that there is a lot of investment that goes into developing, refining and then bringing a fintech to market,” says Fintech Australia chair Stuart Stoyan.

He admits it is a challenge for many fintechs to access the scheme and hopes there will be greater opportunity for software developers and startups generally to take advantage of the incentives.

“The concessions are overwhelmingly viewed through a scientific lens and I would argue that AusIndustry (which jointly runs the scheme with the ATO) has the view that innovation can only happen in a petri dish,” Stoyen says.

“Innovation is being impeded by the blinkered view of AusIndustry. The government has articulated that it wants to back founders and makers, and we want to see the R&D tax incentives reflect this priority.”

Stoyen also wants restrictions on access of large ASX companies to the scheme. “It is all about where the greatest benefit and innovation will be derived from this expenditure,” he says. 

Startup budget priorities:

• Limit changes to R&D tax refunds for companies with turnover of less than $20 million;
• Increase focus on startups in targeting of R&D Export Market Development Grants;
• Release of further details on the Global Talent Scheme;
• Greater funding for regulatory agencies, particularly ASIC and its administration of the regulatory sandbox in the fintech sector;
• Announcement of funding of standards development around open banking, designed to increase transparency, portability and innovation in the financial sector; and
• A continuation of existing capital write-offs for small business.

NOW READ: Skills and share schemes: What startup founders want from this year’s budget