R&D Tax Incentives and the SME Turnover Dilemma
The R&D Tax Incentive program (R&DTI) provides valuable support to Australian businesses investing in R&D. With an annual outlay of more than $3 billion, the program accounts for one third of the Australian Government’s support for innovation and is accessed by more than 14,000 Australian companies [1].
The program utilises a $20 million annual turnover threshold to distinguish SMEs from larger companies to determine what tax benefit can be accessed. This turnover threshold has been unchanged since the last major change to the program in 2011. The result is a potential R&D tax rebate cliff for SMEs. A $19.9mill turnover business is currently entitled to R&DTI benefits that are more than double the benefit a $20mill turnover business can access.
Inflationary pressure and the inconsistent definition of SMEs for other government measures necessitate a review of the R&DTI thresholds. There are also growing concerns around Australia’s R&D investment, our global innovation standing and the need to ensure government support for businesses investing in R&D is delivering results and encouraging R&D activities that might otherwise not be pursued.
Overview of the R&DTI
The R&DTI was established in 2011, replacing the prior R&D Tax Concession which had operated since 1986. The program operates as part of the Income Tax Assessment Act 1997 and is administered jointly by the ATO and Department of Industry, Science and Resources. By navigating the various requirements for registering eligible R&D activities and expenditure, Australian businesses can avail themselves of annual tax benefits (in the form of tax offsets) to recoup costs of undertaking certain types of R&D.
As part of establishing the R&DTI, the Federal Government adopted $20 million aggregated turnover as the preferred method to distinguish SMEs from large corporates. SMEs were entitled to a refundable, more generous R&D tax offset (initially 45%), whilst larger corporates were entitled to a non-refundable and lower R&D tax offset amount (initially 40%). The stated purpose of this change was to “significantly improve the incentive for smaller firms to undertake R&D” [2].
Following more recent changes to adjust the R&D tax offset amounts, the current R&DTI tax benefits are as follows:
Eligible entities with an aggregated turnover of less than $20 million are entitled to a refundable R&D tax offset equal to their corporate tax rate plus an added 18.5% [3].
Eligible entities with an aggregated turnover of $20 million or more are entitled to a non-refundable R&D tax offset equal to their corporate tax rate plus an additional 8.5%, unless their R&D intensity is above 2% in which case the additional offset becomes 16.5% [3].
SME involvement with the R&DTI
In the 2021-2022 income year, assessment of the R&DTI’s performance found that of the 12,762 registrations representing 14,740 R&D performing entities, 11,198 of the registrations were for SMEs, representing 88% of program participation [4].
The R&DTI provides significant benefits to Australian businesses. For example, recent biotech sector analysis indicates the R&DTI generated a return of $3.14 for each forgone tax dollar in 2021, an increase of 138% from $1.32 in 2013 [5]. It’s also estimated that, for the biotech sector alone, the program has increased Australian GDP by approximately $9.1 billion since inception [5]. The benefit of the R&DTI would be if the social benefits of R&D outputs were also quantified and included [5]. This demonstrates the compounding productivity gains and value of sustained investment, particularly a sector where over 80% of companies are SMEs.
Definition of an SME
The definition of a small and medium business in Australia and globally is inconsistent and continues to evolve, with varying thresholds depending on the policy or program. For example:
Australia’s company tax rates currently apply a $50mill turnover threshold to distinguish between SMEs and large corporate taxpayers [6].
Immediate tax deductions for prepaid expenses are available for Australian business with less than $50mill turnover [7].
Australia operates multiple small business concessions or tax policies, all with different thresholds. For example, CGT concessions ($2mill), income tax offset ($5mill), restructure roll-over ($10mill), simplified GST reporting ($10mill) [8, 9].
Several Australian government support programs for SMEs utilise $50mill as the turnover threshold, or alternatively a headcount of 199 employees. For example, SME Energy Efficiency grants, Small Business Technology Investment Boost, Small Business Energy Incentive [10, 11, 12].
The EU and UK define SMEs as those with a turnover less than €50 million (approx. $80 million AUD). Significantly, the SME turnover threshold for the UK’s R&D tax relief system is £100 million (approx. $165 million AUD) [13, 14].
Additionally, some countries use employee counts as the key determining factor for a SME threshold (e.g. New Zealand <49, Canada <499) [15, 16].
Many countries vary the SME definition threshold by turnover, employee count or other measures, depending on the industry (e.g. Japan, USA, South Africa, India) [17, 18, 19, 20].
The ATO’s definition of an SME encompasses “small businesses” with a turnover under $10 million and “medium businesses” with annual turnover between $10 million-$250 million [7, 21]. Latest ATO estimates calculated that approximately 80% of medium businesses had a turnover of less than $50 million [21].
As indicated, the R&DTI SME definition has remained unchanged since 2011 despite an average annual inflation rate of 2.6% over this period (2011-2023) [23]. The inflationary impact alone supports an increase in this R&D tax SME turnover threshold to approx. $27 million.
The challenge
The current R&DTI program results in SMEs facing a R&D rebate cliff as they grow. A company on the precipice of the $20 million threshold can access a refundable R&D tax offset with a minimum 18.5% tax benefit (perhaps a much larger refund if in tax losses), or alternatively face a more complex and unpredictable two-tiered non-refundable tax offset with a return as little as 8.5% for its R&D investment.
Coupled with this sudden arbitrary reduction in R&DTI entitlement, SMEs are also challenged by increasing program complexity and more-demanding compliance requirements. Software SMEs in particular have experienced a higher level of uncertainty with a high degree of compliance activity compared to other sectors.
The question is whether the current R&DTI program design and administration is encouraging businesses throughout their life cycle to undertake R&D that may otherwise not occur.
Beyond R&DTI, other options for supporting industry-led R&D are lacking. State and Federal government to tending to ‘pick winners’ and direct grant funding to specific industry advancements over others. Thus, a small number of SMEs in a handful of ‘sexy industries’ attract the majority of government support at the expense of others.
As the only non-competitive program catering to a broad range of STEM activity, it’s vital the R&DTI is effective to support SMEs as they grow into more significant economic contributors. Together with the lack of progress in other initiatives (e.g. patent box), the drop-off in support for growing businesses extending their R&D and IP development is potentially a key contributor to Australia’s continued poor standing in the global R&D and innovation stakes (ranked 24th in the Global Innovation Index) [24].
What can be done?
Thirteen years after the R&DTI program’s inception and unchanged $20 million turnover threshold, it is time to review this arbitrary line in the sand. The goal should be alignment of the R&DTI with other SME measures to ensure innovative businesses are incentivised to continue their R&D investment as they grow.
Without reviewing this program companies will be disincentivised from continuing R&D investment as they grow; this investment becomes less valuable in net terms.
A simple solution would be to increase the SME threshold for the refundable R&D tax offset to $50 million. This would align the R&D Tax Incentive definition of SMEs with other government policies including recently updated company tax rates. This would better target R&D tax measures to medium-sized businesses and improve financial R&D support for SMEs as they grow.
While simple, a valid concern is the potential cost blowout of the program which is currently estimated to cost $3.2 billion pa, with approx. 80% of this directed to companies claiming the refundable offset [25].
Given the need to derive program value and maximise the impact of allocated funding, an alternative is to adopt three R&DTI tiers that better recognises the need of varying support for small, medium and large businesses. For example:
Tier 1, Small Businesses (<$10 million turnover): Refundable R&D tax offset of 43.5% (25% tax rate + 18.5% incentive)
Tier 2, Medium Businesses ($10 million -$50 million turnover): Non-refundable R&D tax offset of 41.5% (25% tax rate + 16.5% incentive)
Tier 3, Large Businesses ($50+ million turnover): Non-refundable R&D tax offset using the current R&D Intensity rates:
38.5% (30% tax rate + 8.5%) for 0-2% R&D intensity
46.5% (30% tax rate + 16.5%) for 2%+ R&D intensity
These proposed changes would:
Preserve the current refundable R&D tax offsets for small businesses with less than $10mill turnover that require access to cash and higher incentives for R&D.
Generate program cost savings by better targeting access to the refundable R&D tax offset to start-ups and small businesses with less than $10mill turnover rather than the current $20mill turnover threshold.
Increase R&D tax benefits and provide greater certainty of the R&D investment returns for true medium-sized businesses ($20-50 million turnover). Under the current program they are treated as large businesses.
Retain the R&D tax offset rates driven by R&D intensity for larger enterprises only recently implemented.
Achieve improved alignment of the R&DTI turnover thresholds with the corporate tax rate, other tax policies and business support programs.
Other R&DTI program changes could also be considered such as addressing Australia’s ongoing failure to facilitate industry and research collaboration by offering R&D tax incentive premiums for companies undertaking collaborative R&D with research institutions. However, a review of the R&DTI thresholds should be prioritised to address the evolving definition of SMEs and to better encourage Australian businesses to continue their pursuit of R&D as they scale.
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[1] B. Ferris (et al.), "Review of the R&D Tax Incentive," Department of Industry, Innovation and Science, 2016.
[2] T. P. o. t. C. o. Australia, "Explanatory Memorandum: "Tax Laws Amendment (Research & Development) Bill," 2010.
[3] Australian Government, "Offset your R&D costs to help innovate and grow your business," 18 January 2024. [Online]. Available: https://business.gov.au/grants-and-programs/research-and-development-tax-incentive/overview-of-rd-tax-incentive.
[4] Industry Innovation and Science Australia, "Industry Innovation and Science Australia annual report 2022–23," Department of Industry, Science and Resources, Canberra, 2023.
[5] AusBiotech, "New report quantifies the impact of R&D Tax Incentive (RDTI) in Australia’s life sciences sector," 1 November 2023. [Online]. Available: This demonstrates the compounding productivity gains and the value of sustained investment over time. .
[6] Australian Taxation Office, "Changes to company tax rates," 20 June 2024. [Online]. Available: https://www.ato.gov.au/tax-rates-and-codes/company-tax-rate-changes.
[7] Australian Taxation Office, "Small business entities," 25 May 2023. [Online]. Available: https://www.ato.gov.au/forms-and-instructions/deductions-for-prepaid-expenses-2023/small-business-entities.
[8] Australian Taxation Office, "Concessions for eligible businesses," 25 May 2023. [Online]. Available: https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/income-and-deductions-for-business/concessions-offsets-and-rebates/concessions.
[9] Australian Tax Office, "GST reporting methods," 15 April 2021. [Online]. Available: https://www.ato.gov.au/businesses-and-organisations/preparing-lodging-and-paying/business-activity-statements-bas/goods-and-services-tax-gst/gst-reporting-methods.
[10] Department of Climate Change, Energy, the Environment and Water, "Energy Efficiency Grants for Small and Medium Sized Enterprises," 16 April 2024. [Online]. Available: https://www.dcceew.gov.au/energy/programs/energy-efficiency-grants-small-medium-sized-enterprises.
[11] Australian Taxation Office, "Small business technology investment boost," 20 June 2024. [Online]. Available: https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/income-and-deductions-for-business/deductions/small-business-technology-investment-boost.
[12] Australian Taxation Office, "Small business energy incentive," 1 July 2024. [Online]. Available: https://www.ato.gov.au/about-ato/new-legislation/in-detail/businesses/small-business-energy-incentive.
[13] European Commission, "SME definition," [Online]. Available: https://single-market-economy.ec.europa.eu/smes/sme-definition_en.
[14] HM Revenue & Customs, "Claiming Research and Development (R&D) tax reliefs," 5 January 2024. [Online]. Available: https://www.gov.uk/guidance/corporation-tax-research-and-development-rd-relief.
[15] Small Business Council, "Defining Small Business Recommendations of the New Zealand Small Business Council for the Minister of Small Business," Small Business Council NZ, 2019.
[16] Innovation, Science and Economic Development Canada, "Key Small Business Statistics 2022," 11 January 2024. [Online]. Available: https://ised-isde.canada.ca/site/sme-research-statistics/en/key-small-business-statistics/key-small-business-statistics-2022.
[17] EU-Japan Centre for Industrial Cooperation, "Taxation outline," 2024. [Online]. Available: https://www.eu-japan.eu/taxes-accounting/taxation-outline.
[18] A. W. Hait, "The Majority of U.S. Businesses Have Fewer Than Five Employees," United States Census Bureau, 19 January 2021. [Online]. Available: https://www.census.gov/library/stories/2021/01/what-is-a-small-business.html.
[19] Department: Small Business Development, "SMMEs and Co-Operatives Funding Policy for South Africa," Department: Small Business Development, 2023.
[20] Asian Development Bank, "Asia Small and Medium-Sized Enterprise Monitor 2021," Asian Development Bank, Mandaluyong, 2021.
[21] Australian Taxation Office, "Latest estimate and trends Compare the 2020–21 medium business income tax gap to trends from previous years.," 30 October 2023. [Online]. Available: https://www.ato.gov.au/about-ato/research-and-statistics/in-detail/tax-gap/medium-business-income-tax-gap/latest-estimate-and-trends.
[22] Australian Taxation Office, "Transition from the R&D tax concession to the R&D tax incentive," 28 February 2017. [Online]. Available: https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/incentives-and-concessions/research-and-development-tax-incentive-and-concessions/research-and-development-tax-concession/in-detail/transition-a-r-d-tax-concession-to-in.
[23] Reserve Bank of Australia, "Inflation Calculator," 2023. [Online]. Available: https://www.rba.gov.au/calculator/annualDecimal.html.
[24] Department of Industry, Science & Resources, "Business Innovation Data," [Online]. Available: https://www.industry.gov.au/publications/science-research-and-innovation-sri-budget-tables-2023-24/business-innovation-data#:~:text=Australia%20ranks%207th%20out%20of,of%20132%20(WIPO%202023)..
[25] Department of Industry, Science and Resources, "Science, research and innovation (SRI) budget tables 2022–23," 28 April 2023. [Online]. Available: https://www.industry.gov.au/publications/science-research-and-innovation-sri-budget-tables-2022-23.