Research and development tax incentives a dangerous hazard to small enterprises

The Australian, June 29, 2017

Through no fault of AusIndustry, the government’s successful research and development tax incentive scheme has become a dangerous hazard to small enterprises.

Unfortunately the scheme has got caught up in the drive by Australian Taxation Office officials to set the law in small enterprise tax matters as I revealed was happening in mum and dad partnerships and in the distributions from those partnerships.

At the moment all small enterprise tax appeal avenues are controlled by the Australian Taxation Office because the court system is too costly. AusIndustry therefore needs to warn small enterprises to be very careful in accepting and using research tax concessions because, as I will explain below, their participation in the scheme could bankrupt them.

I first became aware that research and development was the subject of tax office lawmaking by looking at a truly horrible case that destroyed a small enterprise with an incredible opportunity. The details of that case are not ready for publication.

But after my commentary revealing the attack by the ATO on vulnerable small enterprises, I was contacted by a truly fearful food processor.

He can feel the ATO axe approaching his neck so in desperation he gave me permission to use his name and that of his business but I will not publish them because, as I have seen in past situations, once the bank and suppliers get wind that the ATO is on the warpath all credit is removed and business is quickly destroyed.

I have spent the past two days looking at this case and I must warn that I discovered that unlike the first example this is not a one-way anti-ATO street. The particular business made mistakes which entitled the ATO to look closely — mistakes that AusIndustry must alert users of the incentive to avoid to minimise the danger of ATO attack.

However my food processor is the perfect example of how the system is meant to work. The entrepreneur bought the food processing business and, after checking with AusIndustry that what he was planning was eligible for tax concessions, he then carried out research to improve recipes to enable greater automation and to design packaging that was unique. The research took three years — the financial years ending in 2012, 2013 and 2014.

In all, he received in cash tax benefits in the vicinity of $500,000 as part of the self-assessment system where the accountant submits the returns. And it worked because now he is exporting to Korea and Japan and China is showing interest. Amazingly, Australian supermarkets are buying the product. It could never have happened without the research grants.

But our food entrepreneur used an accounting group that also represented a whole series of people who abused the system. The accounting firm is no longer in business and the documents he sent to them are not available. In addition he did not keep a lot of the documentation. But he later funded an extensive study of what happened and to prove where the money was spent. And there is no question the research was carried out — look at the results.

For the final year he brought in one of the world’s largest accounting firms to make sure the 2014 claims were absolutely right, in accordance with the law.

The ATO has raided all the clients of the failed accountancy firm — as they should. But in the case of our food entrepreneur they rejected all of the 2012 and 2013 research grants that he had received and slashed out a big chunk of the global firm’s approved claims. The entrepreneur has to find some $500,000 and probably a vast amount more.

The large accounting firm told him that the taxation appeal system was a waste of time because the ATO controlled every stage (I have been saying this for a long time) and the court system was too expensive.

All he can do is throw himself at the mercy of the ATO. If the ATO follows the earlier case it will charge a hefty interest rate (probably 9 per cent) and impose a penalty of at least 25 per cent.

My food entrepreneur then goes bankrupt and Australia loses an export industry.

In the days of former tax commissioner Michael Carmody the ATO might have rejected some of the claims given the documentation problem in 2012 and 2013 but would have accepted the big accounting firm’s 2014 audited accounts. (I have a copy of their audit statement). There would be no penalty because this was a genuine case in which Australia had a win in the way the parliament planned.

AusIndustry has not realised that the culture of the ATO has completely changed since the Carmody days. I believe the Minister for Industry, Innovation and Science since January 2017 Arthur Sinodinos should instruct AusIndustry on how to warn small businesses.

Then one day either this parliament or the next a government will realise that when any group of people — in this case the ATO — has the power of investigation, prosecution, judge, appeal judge and sentencer it leads to power corruption and sometimes situations like the Cranston affair.

Large enterprises can afford the court system. Small enterprises cannot. In my view the best way to handle the problem is to widen the powers of the Inspector General of taxation to be an independent appeal body. My legal friends say that the lower courts system can be used at very low cost. In the meantime, warnings need to go out to those using R&D grants. Once an independent appeal system is in place the warnings can be removed although entrepreneurs must keep their documentation.