Decision time on R&D for parliament

The politics of compromise can work to solve problems by taking everyone's needs into account. But sometimes we just get caught up in pacifying those reluctant to part with existing entitlements. As Parliament debates the Government's proposed changes to the tax concession for Business Expenditure in Research and Development (BERD), it should be wary of buying off those seeking to hang onto their BERD in the hand.

As I concluded in a recent study for the Australian Business Foundation, The BERD in the hand: Supporting Business Investment in Research and Development, if forced to choose, I'd abolish the current tax concession for R&D rather than maintain it. Why? When it was introduced in the mid 1980s it provided 24.5 cents assistance for every dollar of BERD. Today, with large reductions in company tax rate and the headline rate of assistance – from 150 to 125 per cent – it's worth just 7.5 cents in the dollar.

So it has very little effect on business decision making – that the concession is simply a windfall on over nine tenths of R&D because it would have been done anyway. So the existing scheme probably generates more administrative, compliance and revenue costs than it does R&D benefits.

The scheme is also complex with multiple sub-schemes. And though the rate of assistance is low, some businesses have claimed a large share of their total production activities as R&D related. This sounds fair enough, but the only way it's been affordable is via the atrophy of the rate of assistance. Both Canada and the UK can afford much more generous rates of R&D assistance, but only by ruling out production activities altogether.

And as the Cutler Report highlighted in 2008, one of the main beneficiaries of our laxity on production related R&D is mining. Some mines involving novel technical challenges have claimed the majority of their expenses as R&D related!

Fortunately there's a better option than abolishing the scheme – improving the current scheme. The changes the Government proposes are consistent with the Cutler Review recommendations. They ramp up the rate of assistance to R&D – from 7.5 to 10 and 15 per cent for large and small firms respectively – and this is funded by abolishing several complex sub-schemes within the existing concession and by making production activity ineligible for assistance unless it was undertaken for the "dominant purpose" of supporting R&D.

Not surprisingly some firms will lose from the new definition. And they're not all responsible for the so called 'whole of mine' claims we were concerned about on the Cutler panel. For instance Cochlear, the Sydney based bionic ear supplier thinks it will lose from the new arrangements.

So I explored the issue with an open mind, but ended up impressed with the way the Treasury proposed dealing with the problem of excessive claims on production. The new scheme distinguishes production undertaken with the dominant purpose of supporting R&D (which remains eligible) from other production which may nevertheless have some direct relation with R&D (which becomes ineligible).

Because the more stringent tests on production create losers, political debate and possible compromise has focused on softening this feature of the new arrangements for instance by capping claims on production or allowing incidental production for small firms but not large ones. But if those seeking amendments really want to maximise their policy impact on R&D they shouldn't hunt their quarry here. Pretty obviously, production that isn't for the dominant purpose of supporting R&D would take place for its own (production based) reasons, with or without R&D assistance.

But there's one proven way policy can increase R&D. When first introduced, the tax concession operated solely by reducing company tax – which meant that companies tax loss, as many R&D intensive firms are – could not benefit from the accumulated tax losses, often for many years.

In 2001, though the rate of assistance remained measly, smaller firms in tax loss were given access to their concession as a cash grant. Their R&D responded strongly showing that cash flow was constraining an otherwise healthy desire to increase R&D. So if we want to make a difference getting small firms their money sooner could have a substantial impact. And it would be cheap for governments because it has very low capital costs.

But whatever we do, we should avoid further delay. If the new scheme is generous enough to encourage more when it's legislated, it's enough to have at least some firms biding their time until our hung parliament decides what it will do.