Government pledges new equity funding for innovative start-ups

The Australian government’s recently released Industry and Innovation Statement contains a number of measures aimed at securing and increasing the number of Australian jobs. It also contains legislative measures that directly affect existing small and medium-sized enterprises (SMEs) and large companies, as well as start-up businesses, engaged in developing new and innovative products and processes.

One cornerstone of the policy is the establishment of up to 10 industry innovation precincts, informed by similar programmes overseas, such as the United Kingdom's Catapult Centres and the United States' National Network for Manufacturing Innovation. The first such precinct will be a manufacturing precinct, headquartered in southeast Melbourne where strong industry resources in advanced manufacturing already exist, with a second base in Adelaide (covering primarily defence-related technologies). The aim is to bring together industry (ie, start-ups, SMEs and large companies), research organisations (eg, the Commonwealth Scientific and Industrial Research Organisation (CSIRO) and the Cooperative Research Centres), tertiary education institutions and government initiatives such as Austrade, AusIndustry, Commercialisation Australia and Enterprise Connect to “create environments where businesses can collaborate in areas such as technology and process innovation, management, education, etc, to achieve business growth [and jobs]".

The second will be a food precinct which will cover the entire food supply chain, again headquartered in Melbourne in order to take advantage of the critical mass of industry and research located there. Other industry innovation precincts will be selected in 2013 and established by 2014, with up to three built around existing competitive advantage areas, while up to five smaller precincts will focus on emerging opportunities and technologies. All will build on existing programmes (eg, the programme underway at CSIRO in the area of manufacturing and material sciences). The National Broadband Network will play an important role in allowing geographically remote participants to interact effectively with those entities located in the new precincts.

It will be interesting to follow the development of these innovation precincts, in particular to see whether they achieve the intended outcome of creating clusters of technology excellence and give innovative Australian businesses the edge in competing with their products and services on the world stage.

Another cornerstone is the stated intention to "improve" access to finance for SMEs through Venture Australia, through a A$378 million financial package, and thus to:

• Facilitate the growth of new knowledge-based and innovation-driven businesses in Australia.
• Increase industry competitiveness.
• Attract new investment to Australia in its areas of strength.

In addition, a new A$350 million round of the Innovation Investments Fund (IFF) programme will be available to stimulate private investment in Australian start-ups, largely in tech-related sectors.

Because the funding is made available through the IFF, it has been reported in the press (Financial Review, 19th February 2013) that the new innovation fund has failed to excite the fledgling Australian venture capital and "angel" investor sector. Leading figures in the increasingly vocal tech start-up community are quoted as suggesting that the programme is a rehash of previously unsuccessful efforts by the Australian government to copy Silicon Valley and other success stories elsewhere in the world. Under the IFF, the government licenses fund managers and provides capital for investment in a start-up or SME up to a specified maximum, which must be matched by an equal contribution from private sector funding sources. Based on past performance of the IFF, reserving another A$350 million in taxpayer funds is unlikely to attract the same funding amount from the private sector in Australia, in particular early-stage angel investment. This is partly a result of there being few (publicised) high-tech start-up financial success stories in Australia, compared to the returns achievable on investment in speculative natural resource opportunities. However, it appears that Australian technology start-ups are gaining better traction with US-based venture capital vehicles.

To provide partial funding for the A$1 billion innovation strategy, the government has slated the elimination of access to the research and development (R&D) tax incentive to large companies with a turnover of greater than A$20 billion. This is expected to affect the top 20 companies in Australia, which will no longer be able to claim the additional tax incentive associated with R&D expenditure in Australia. While this will affect only a small number of companies in itself if it is passed through Parliament, it is a change to a scheme that has not yet seen one year of claims. It also indicates a worrying trend of making modifications and changes to thresholds.

Such regular and short-term tinkering with R&D tax schemes is unlikely to instil in relevant industry sectors the confidence necessary for planning long-term R&D projects in Australia, given the apparent absence of stable taxation rules applicable throughout the life of such projects.

However, if the changes are implemented as planned, a positive change will take effect from 1st January 2014 to allow companies with an aggregated turnover of less than A$20 million to claim and receive R&D refundable tax offsets in quarterly instalments throughout the year, rather than annually. This is likely to have a positive impact on cash flow, and thus is welcome news, in particular for start-ups and SME technology companies with heavy R&D budgets.

The government figures which were used to cost the R&D aspects of the scheme cannot be said to be accurate, given that many of the large companies to which they refer have not yet put their 2012 R&D tax lodgement under the new scheme. The new R&D scheme provides stricter rules around activities and eligible costs and many large companies will see a reduction in claims.

The concern remains that if the government proposes new thresholds for claiming R&D tax, this may result in more uncertainty in a scheme aimed at increasing research and development in Australia.

Based on a number of studies which suggest that small firms are more responsive than larger corporations in increasing their R&D spending as a result of R&D tax incentives, a less positive aspect of the government’s initiatives is the introduction of a third tier to the eligibility criteria for the R&D tax incentive. Very large companies with an annual Australian turnover of A$20 billion or more will no longer be able to claim R&D expenditure under the non-refundable 40% R&D tax offset. The saving grace, if there is one, is that based on the government’s own figures, the new tier is estimated to apply to fewer than 20 corporate groups. According to the Financial Review article, these companies represent less than 0.1% of all R&D tax incentive claimants, who receive around 18% of the value of all R&D tax claims. However, some of these companies are heavily engaged in R&D in Australia, such as Shell Corporation, and in the services sector, such as the top four banking institutions. On the other hand, the 85% of R&D tax concession claimants earning less than A$20 million annually take less than 42% of the benefit.

R&D costs can still be deducted as an income tax expense through other channels, so that the loss of benefits for the "upper end of town" may not be as dramatic and might not have a direct or negative impact on R&D activity going forward. The tax scheme savings realised by excluding the A$20 billion-plus company club from accessing the R&D tax incentive are intended to flow through to SMEs through other measures in the Industry and Innovation Statement. However, having regard to the widening budget deficit of the current Australian government, a real question remains as to whether the savings will be used to plug other revenue holes by yet another change of mind.

Further details can be found at http://aussiejobs.innovation.gov.au/Pages/default.aspx.