In the government and business landscape, innovation is the driving force behind efficiency gains and economic progress. However, recent statistics raise concerns about the state of research and development (R&D) expenditure in Australia.

National spending on R&D fell to a 17-year low of 1.68 per cent of GDP in 2021-22, a 0.12 per cent fall from 2019-20, according to the Australian Bureau of Statistics (ABS). While a 0.12 per cent decline may seem small, it reflects the challenges Australia faces to boost R&D spending – which is needs to do to remain competitive with other OECD nations. This statistic falls significantly below the OECD average of 2.71 per cent but it also lags behind global leaders. For instance, South Korea has an impressive 4.93 per cent R&D-to-GDP ratio.

Robust R&D investment is of paramount importance to a nation as it fuels innovation, enhances competitiveness and secures a nation’s foothold in the global marketplace. The current trajectory for Australia paints a concerning story, with Australia potentially slipping further down the list of OECD countries investing in innovation in the next five years.

The consequences of this decline in R&D spending as a proportion of GDP extend across industries reliant on innovation, potentially compromising Australia’s global standing in technology, healthcare and other critical sectors.

The Federal Government’s most recent budget earmarked a review into Australia’s R&D system. The review will aim to reverse this trend of R&D investment in Australia and seek to understand the continuing decline in R&D business intensity.

The ATO has also issued additional clarification and guidance regarding some R&D integrity rules, directed towards addressing recurrent issues that regulatory bodies have identified in claims, which should provide valuable assistance in claiming the R&D tax incentive (RDTI). This guidance release marks its first commentary on R&D issues in quite some time. These include concerns related to:

Associate expenditure

Claiming R&D expenditure with associates involves specific considerations. Generally, such expenditure can only be claimed in the year of payment, unless the R&D entity opts for an irrevocable election. Notably, certain arrangements are viewed as not constituting payment to associates, including converting the amount owed into a loan or offsetting a licensing fee against R&D service fees in non-arm’s length transactions.

Aggregated turnover

Aggregated turnover is a crucial factor in R&D tax offset eligibility. Entities with an aggregated turnover below $20 million are entitled to a refundable offset, while those at $20 million or above receive a non-refundable offset. Exemptions apply to R&D entities 50 per cent controlled by exempt entities, ensuring eligibility for the non-refundable offset, regardless of turnover.

Overseas expenditure

Overseas expenditure claims require an overseas finding from the Department of Industry, Science and Resources (DISR). Without this, the work must be conducted in Australia, not subcontracted overseas. Physical location helps determines overseas expenditure validity.

This article was first published in Financial Times – Winter 2024.