The Risk to Future Dividends When Receiving R&D Tax Incentives
Research and development tax incentives provided by the government are an attractive incentive for Australian startups, especially those that are burning cash with large R&D budgets. But, accepting them has some ramifications on your future dividends that owners and investors may not be aware of.
The basics of R&D Tax Incentives in Australia
The Australian government created a programme that provides incentives for companies that have significant R&D expenditures. Earlier this year, an amended package of the Research and Development Tax Incentive was announced by the government with reforms commencing on 1 July 2021. The changes included:
For companies with an aggregated turnover of $20 million or more, the Government will introduce a two-tiered premium that ties the rates of the non-refundable R&D tax offset to the incremental intensity of the R&D expenditure as a proportion of total expenditure for the year. The new rates will be the claimant's company tax rate plus:
8.5 percentage points for R&D expenditure up to 2 per cent R&D intensity
16.5 percentage points for R&D expenditure above 2 per cent R&D intensity
For companies with an aggregated turnover below $20 million, the refundable R&D tax offset will be a premium of 18.5 percentage points above the claimant's company tax rate.
They increased the R&D expenditure threshold from $100 million to $150 million per annum.
Additionally:
Improving the transparency of the program by publicly disclosing R&D claims
greater enforcement activity and improved program guidance to participants
amendments to technical provisions.
Source: Australian Tax Office
The purpose of this grant is to encourage R&D expenditure for businesses, especially startups, that are spending considerable cash attempting to commercialise their products in Australia, without the ability to offset those expenditures through product sales.
This often seems like an incredible incentive when your startup is burning through cash at a quick pace early in its development, however, the situation can take a turn once your business becomes profitable, and you start to pay out dividends to shareholders and try to utilise your franking credits.
How claiming R&D grants affects franking credits
Franking credits are earned tax credits that enable a company to filter their paid corporate taxes down to shareholders. The shareholders receive credit for the tax already paid by the company, thereby reducing or eliminating their liability.
The rebates taken as a part of the R&D tax incentive are calculated as debits in a company’s franking account - or a negative balance in your available franking credits. Therefore, your company may NOT be able to pass through the tax it has paid once it become profitable, creating a possible double taxation environment for both the company and its shareholders.
Tax liabilities when utilising R&D refund money
Essentially, shareholders of a company may be taxed twice in the absence of franking credits. Company income is taxed at the applicable rate, reducing net profit. Dividends are then paid to shareholders out of after-tax profit, and shareholders must again pay tax on these dividends.
Making the right decisions for a startup
This is another example of where businesses don't know what they don't know. It’s vital for entrepreneurs and investors to be aware of the impact that applying for R&D tax incentives can have once the company becomes profitable. There are no ways to skirt the issue, so company stakeholders need to have as much information as possible in order to make the right decision for their business.
The R&D incentives can still be incredibly beneficial to many startups, even when taking the loss of franking credits down the line into account. Many small businesses wouldn’t be able to shoulder continual large R&D expenditures without the tax credits. It’s up to you to understand how they will affect your future profits and use this information to maintain effective investor relations.
If you are looking for a Sydney business advisor that can help you navigate situation like these, contact us here. Our SME experts can provide you with a wealth of resources and provide guidance that empower you to get the most out of your business.
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