Changes to RD tax incentives as Australia prepares to join the patent box club

What you need to know

• The Australian Government has announced a new patent box tax regime.  
• Income earned from Australian medical and biotechnology patents will be taxed at a concessional rate of 17%.
• The Government will consult on the detailed implementation of the scheme, which will apply to income years from 1 July 2022.
• A new R&D tax offset regime will be in place from 1 July 2021, which will change the rate of the R&D tax offset for eligible R&D entities.

What you need to do 

• Monitor the implementation of the patent box regime and consider how you can take advantage of it.  
• Review your R&D activities and consider how you may be affected by the new R&D tax offset rates applicable from 1 July 2021.

Patent box regime

In an effort to boost innovation in Australia, the Federal Government announced its new "patent box" tax regime in this year's Budget on 11 May 2021.  The regime will provide a concessional corporate tax rate of 17% on income derived from certain biotechnology and medical technology patents.  For comparison, the standard corporate tax rate is 30% and 25% for small and medium sized companies (or "base rate entities").  

The Federal Government hopes that this new incentive will encourage additional investment in Australia's biotechnology and medical technology sectors, and encourage companies to develop and apply their innovations in Australia.

The fine print

The concessional tax rate will only be available for income years from 1 July 2022.  In order to be eligible for the concessional tax rate, the patent in question must be granted, and must have been filed after the Budget announcement on 11 May 2021. 

Much of the fine print concerning the implementation of the patent box regime is yet to be worked out.  The Federal Government has indicated that it will consult with industry on the detailed implementation of the regime.  It has also indicated that the regime will follow the guidelines of the Organisation for Economic Co-operation and Development (OECD) on patent boxes.

At this stage, the concessional tax rate will only be available to income derived from patents in the biotechnology or medical technology fields.  The Federal Government has indicated that it will also consult on whether the patent box regime should be expanded to the clean energy sector.

Other key elements of the patent box set out in the Budget papers are that: 

• the research and development underpinning the patent must be done in Australia (ie, it is not sufficient for the patent merely to be owned by an Australian entity); 
• the patent must be owned, and the income received, by an Australian company (or permanent establishment of a foreign company); and 
• the income must be derived directly from the patent.

In relation to the last matter, manufacturing income is excluded from the scope of the regime.  It is unclear why this would be the case, as it would exclude income derived by an Australian company from manufacturing products itself, using a patent it has developed.  Similarly, income due to "branding" is excluded, which may create difficulties in determining the extent to which income is due "directly" to the patent itself, or due to branding and goodwill associated with products produced from the patent.

A number of other complexities and interaction issues are likely to arise as the regime is developed.  For example, it is unclear at this stage how the 17% concessional tax rate will interact with the Australian imputation/franking credit regime, and whether the benefit of the concession will be effectively unwound at the Australian shareholder level upon dividends being received (ie, due to "top up" shareholder tax on the dividends if they are only partially franked).  This may create differential outcomes for Australian-owned and foreign-owned Australian patent box companies.

Will it work? 

There are currently over 20 countries that have similar patent boxes in place and adhere to the OECD's guidelines, including the UK and France.  

The key outcome sought from a patent box regime is to encourage Australian businesses to retain innovation and manufacturing within Australia.  However, opinion is divided on whether patent box regimes do in fact encourage local investment in innovation.  In a 2015 report, Australia's Office of the Chief Economist concluded that "there are no solid theoretical or empirical grounds for claiming that patent box regimes induce more innovation".  

No doubt much will depend on the design of the patent box regime, but a patent box regime is a welcome development to increase the attractiveness of Australia as a location for research and development in the life sciences sector which, if successful, could potentially be expanded to other sectors.    

Existing R&D tax incentives

In addition to the new patent box regime, companies may continue to take advantage of the existing Research and Development Tax Incentive (R&DTI) regime.  As discussed below, important changes to the R&DTI will take effect from 1 July 2021.

The R&DTI is the Australian Government's principal measure to encourage industry investment in research and development.  Under the regime, companies may be eligible for a tax offset depending on whether their R&D activities meet the program criteria.  The offset is refundable for certain companies and non-refundable for other companies.  The eligible R&D expenditure must be at least $20,000 for the income year.  

To be eligible, R&D activities need to be registered with AusIndustry annually within 10 months following the end of the company's income year in which the activities were conducted.  The tax offset is claimed through the company's tax return with the ATO.

The rate of the offset depends on the company's aggregated annual turnover.  The rates are changing from 1 July 2021 following amendments made to implement reforms announced at the 2020-21 Budget, as part of government tax measures to assist economic recovery from the COVID-19 pandemic.

From 1 July 2021, for companies with an aggregated annual turnover of less than $20 million, a refundable tax offset set at 18.5% above the applicable company tax rate applies (ie, a 43.5% refundable tax offset rate will apply for these companies, which are "base rate entities" eligible for a 25% corporate tax rate).  

For companies with an aggregated annual turnover above $20 million, a non-refundable tax offset applies determined by reference to a new intensity measure, based on R&D expenditure as a proportion of total expenditure for the year.  Companies with an intensity measure of up to 2% will receive an offset of 8.5% above the applicable company tax rate.  Those with an intensity measure above 2% will receive a non-refundable tax offset at 8.5% above the company tax rate on R&D expenditure up to 2% R&D intensity, then an offset at 16.5% above the company tax rate on R&D expenditure that exceeds this 2% R&D intensity.  The applicable company tax rate is either 25% for a company that is a "base rate entity" (broadly, a company with aggregated annual turnover of up to $50m) and 30% otherwise (meaning that the tax offset ranges from 33.5% to 46.5%, depending on the applicable company tax rate and the company's R&D intensity).

Further, the R&D expenditure cap will increase from $100m to $150m, over which a company's eligible R&D expenditure is not eligible for the full rate of the relevant R&D tax offset.  Rather, expenditure above this cap will give rise to an offset at the R&D entity's applicable corporate tax rate.

Finally, on 11 May 2021, the government announced that the Board of Taxation will review the administration of the R&DTI regime, which is currently administered jointly by the Australian Taxation Office and Industry Innovation and Science Australia.  The scope of the review is confined to the administration of the regime and it will not examine broader policy issues. 

The patent box and R&DTI regimes reflect the government's focus on driving continued investment into innovation in Australia, and discouraging technology developed in Australia from being transferred offshore.  

Our further insights into the Federal Government's 2021-22 Budget are available here.

Authors:  Stuart D'Aloisio, Partner; Sanjay Wavde, Partner and Daele Tyler, Lawyer