How a controversial R&D tax change could impact ASX small caps
Small cap biotechs, innovators and explorers could be the big losers if a crack-down on research and development tax refunds goes ahead as expected under the federal government’s pre-election agenda.
In April, Australian biotechs led a loud campaign against proposed changes to R&D tax incentives — under which former Treasurer — now PM — Scott Morrison proposed capping annual refunds at $4 million and lifetime claims at $40 million for companies with less than $20 million turnover.
At the time, Mr Morrison said the changes would preventing rorting and save $2 billion a year.
When the Budget was handed down, Mr Morrison allowed an exemption for clinical trials. But that hasn’t eased the concerns of other small companies who have been making bigger R&D claims for years.
A spokesperson for Minister for Industry, Science and Technology Karen Andrews told Stockhead the government was considering feedback given in June and July, before finalising the legislation.
But Melanie Reen, managing partner and R&D tax expert at Michael Johnson Associates, believes the government is committed to the reforms and thinks it’s possible they’ll be introduced to Parliament soon.
Small caps explorers, biotechs and tech companies are regular users of R&D tax refunds and in many cases it makes up the majority of their “revenue”.
For example, it represented 74 per cent of full year income at cannabis drug maker Zelda Therapeutics (ASX:ZLD) and 85 per cent of full year income at ClearVue (ASX:CPV), which is commercialising electricity-generating glass.
Miners and biotechs have been outspoken in how irate they are about the changes, with the former saying no one understands how much research goes into a successful mine and the latter that medical research dollars, already in short supply, will have to stretch even further.
Doing what it said on the box
The government says the existing R&D tax refund program has not been meeting its objectives but many disagree.
Ms Reen says the current system does incentivise R&D spending.
She says changes will especially hurt manufacturers with fixed input costs unconnected with R&D spending.
“These changes are only about reducing the cost of the program. It certainly has been said to us via the larger companies, particularly in manufacturing, that the reduced tax incentive rate, coupled with cost of compliance means won’t make financial sense to continue claiming the rebate.”
She says some of those companies are moving their R&D to New Zealand, which is bringing in a tax incentive system on April 1, 2019.
“A better way to reduce program costs is to introduce a small across-the-board rate cut.”
It’s unclear whether they will have an ally in the federal Labor party, as they seek to earn political points in the run up to the election.
Senator Kim Carr says the party has heard there are concerns particularly with the impact of the intensity threshold proposed for the non-refundable component, and will consider the proposed legislation when the detail is released.
But: “It is critical that R&D support from government is sustainable from a budget perspective. Labor also understands that there is a need for government policy stability in supporting businesses investing in R&D,” he said in comments sent to Stockhead.
Rare earths and lithium dreams in danger
While mining and tech have been called out as two sectors where claims have been made on razor thin evidence of actual R&D, mining executive Adrian Griffin gave a concrete example of what has been achieved under the existing regime.
Northern Minerals (ASX:NTU) where he is a director, has spent about $180 million developing a heavy rare earths project including a processing facility on the Northern Territory-West Australia border — the “middle of nowhere”.
He says they’ve received about $20 million in R&D tax refunds for the pilot plant, which he says will be the only one of its kind outside China.
“Had it not been for that rebate we would not have been able to finance that plant and it never would have been built,” he told Stockhead.
He says Australia’s plans to create a ‘Lithium Valley’ — a battery manufacturing sector enabling Australia to value-add its raw materials in-house rather than sending them overseas, could be in jeopardy if companies stop spending on R&D because of the changes.
Batteries could double Australia’s GDP, he says “but you people who have the balls to do the research”.
On the other side, Moreton Resources (ASX:MRV) has had its $9 million tax claim rejected and is planning to fight the decision in court.
Battery metals are basically biotechs
Mr Griffin complains that Lithium Australia, where he is managing director, is purifying waste materials to use in lithium ion batteries, and some of the lithium they’re cleaning up is medical: lithium carbonate is used to treat bipolar disorder.
His gripe is the nascent battery metals sector doesn’t get the same treatment as the nascent biotech sector did when it was starting out.
“R&D is the cement that holds all of that [the potential for Australia to build a battery industry] together and it is very shortsighted… I would like to see the government give us a carve out for energy metals as they have done for biotech and clinical trials.”
The tax rebate has been instrumental in turning Australia into a global clinical trial hub, attracting investments which have allowed an industry of expert doctors and clinics to grow up around that.