Does the R&D Tax Concession Create Additionality?

by Ian Ross-Gowan, Manager, Michael Johnson Associates

Within the National Innovation Review the need for additionality has been mentioned quite frequently. The objectives of the R&D tax concession are:

To provide a tax incentive, in the form of a deduction, to encourage research and development activities in Australia and make eligible companies more internationally competitive by:
(a) encouraging the development by eligible companies of innovative products, processes and services; and
(b) increasing investment by eligible companies in defined research and development activities; and
(c) promoting the technological advancement of eligible companies through a focus on innovation or high technical risk in defined research and development activities; and
(d) encouraging the use by eligible companies of strategic research and development planning; and
(e) creating an environment that is conducive to increased commercialisation of new processes and product technologies developed by eligible companies.
(Income Tax Assessment Act 1936 s73B(1AAA))

In other words, the concession’s objective is to encourage, increase and promote additional technological advancement in Australia. It is also intended to create an environment to aid additional commercialisation of that advancement.

The Layman's Argument
At the layman’s level it is argued that most of the R&D tax concession that is claimed by businesses would have occurred anyway. If this is so then most claims are not achieving the objectives sought from the concession. However, is it true that little additionality is occurring? Are companies doing more research and development and are they commercialising more of this as a result of the concession?

The answer from my experience is yes – additionality is occurring as a result of the R&D tax concession. Sure, many projects that are claimed would have been done. However, not all and those that would probably would not have been done in the same way.

R&D projects may have done on tighter budgets
This would reduce the scale as well as the impact or the level of innovation included in the project. This would result in outcomes that are less driven by innovation or high levels of technical risk. They also may have lower levels of commercial success and shorter lives, and fruitful areas of investigation may not have been pursued due to resource constraints.

R&D projects may not have been done as timely or as regularly
Every business has limited resources to apply to future developments and commercialise them. Many businesses will factor the potential high cost of innovation or technical risk into their decisions about when to go ahead with a project. The concession allows a partial offset of these costs and risks. This offset is generally delivered at a time when the returns from the development are not yet there. Many businesses will factor the R&D tax concession (but not the premium) into their decisions. This increases their resources allowing them to do more development quicker and influences resource allocation.

R&D projects may not be done in Australia
Australia competes on a world stage. Increasingly, businesses are choosing where in the world to do their R&D and where that should be commercialised. The Australian economy is competing with other economies that are aggressively seeking R&D and commercialisation within their economies. Whilst initial R&D can be done anywhere with appropriate research resources, it is the commercialisation of this that provides the benefits beyond the spillover effects of the R&D itself. If new Australian R&D is commercialised overseas then future R&D on that development will probably be done where it is commercialised. This is key.

The Federal Department of Industry, Tourism and Resources released OECD studies of Behavioural Additionality from the R&D Start program and the R&D tax concession in 2006 and 2007 respectively. In both cases they found that not only was there direct additionality identified by participants to the benefit of the Australia economy, but that the behavioural changes from both programs had flow on effects to the businesses as well. In the case of the R&D Start review 63% said that the projects would have occurred anyway – however all the projects would have taken longer to reach fruition. Most would have been done on a smaller budget, on a smaller scale, and/or with less ambitious outcomes. For the 37% that would not have done the project this was mostly because of lack of resources to fund the project. It is important to note that this survey was done after the end of the program. As the program had already ended there is less motivation to colour results to keep the program running.

Similar results were found in the subsequent survey on the R&D tax concession. More than 70% of respondents would have had a smaller budget to do R&D. Projects would have not been done or would have been done on smaller budgets and/or at a slower pace. This would have resulted in lower outcomes, less or smaller commercialisation and less collaboration with Universities.

In addition to these direct effects both studies also found that the R&D Start and R&D Tax Concession created other additionalities. These where from the behavioural changes within the businesses. Such behavioural additionalities included:

• Better management of technology,
• Increased commitment to R&D,
• Improved technology planning with flow ons to business strategy development,
• Better product commercialisation with higher returns and future taxable income,
• Improved collaborations and R&D networking.

In short, the R&D Tax Concession does encourage, increase and promote additionalities. Because it also focuses on commercialisation and benefits to Australia, it creates more additionalities than a focus on pure research which may not be commercialised or may be commercialised elsewhere.