Here’s how Australia’s Research and Development Tax Incentive Works

Australia’s Research and Development Tax Incentive (R&D Tax Incentive) regime can be useful for pre-commercialisation companies serving as a non-dilutive source of funding.

Progressing new medical treatments or technologies to market is not a cheap exercise and it can be difficult to secure funding from investors (either debt or equity). Even if a company can secure such external funding, debt repayments can hinder a company’s cash flows and progress, whilst equity dilutes existing shareholders. The R&D Tax Incentive can serve as an alternative.

What is the Research and Development Tax Incentive?

It is a Federal Government Program that provides companies with a refundable offset on eligible expenditure incurred on designated R&D projects.

In the cases of smaller companies (those with annual aggregated turnover of less than $20m), the Australian government’s R&D program is sometimes called the ‘43.5%’ R&D Tax Incentive – calculated from the 18.5% percentage point figure above, as well as the 25% corporate tax rate for small companies. In essence, 43.5% of a company’s R&D activities are captured for activities undertaken both domestically and, in some instances, overseas. This rate has been in place since 2016 – prior to that it had been 1.5% higher (i.e. 45% for companies paying a 25% corporate tax rate).

If a company’s tax rate is 30%, the potential offset could be up to 48.5%. Of course, this would be rare for companies earning under $20m as the 30% rate applies to companies earning above $50m, although there may be certain circumstances where it may apply.

It is more common for the incentive to be the company’s tax rate plus a certain number of percentage points, subject to the proportion of the company’s expenses dedicated to R&D. For companies spending 2% or more of their total expenditure on R&D, it is 16.5 percentage points, but for those that spend less than 2%, it is only 8.5 points.

There are also companies that provide advance R&D funding – in other words, provide the funding that companies anticipate receiving in the future, and requiring repayment when this money comes through. One such company is Endpoints Capital.

Which companies are eligible?

For a start, individual persons and partnerships are not eligible, only companies are eligible. All companies incorporated in Australia are eligible (or at least aren’t ineligible by mere virtue of their jurisdictions) except those that are exempt from income tax.

Some companies incorporated overseas are eligible, although there are certain criteria that apply, particularly carrying out business in Australia. And it needs to be an R&D entity to the extent it carries on business through that permanent establishment.

Companies that have received Australia’s R&D tax incentive

One is Recce Pharmaceuticals (ASX:RCE),

a company developing anti-infective solutions for various indications such as ABSSSI (Acute Bacterial Skin and Skin Structure Infections) and Diabetic Foot Infections (DFIs). For the year ending June 30, 2024, it received A$6.75m – all paid in cash, without caveat. For the prior year, it received A$11.2m.

Some of this was repaid to Endpoints Capital which provided advances on this money, although the company still managed to increase its total claimable R&D rebate over the period. Drawing and re-deploying R&D applicable expenditure through such a facility not only offsets applicable interest but also provides a net-positive surplus to the company having increased its total claimable R&D rebate over the period.

Another company to have received the tax incentive is Andromeda Metals (ASX:ADN) which has kaolin deposits, in regional South Australia. Its return for FY24 was $2.34m, off the back of its $5.4m in eligible R&D expenditure. The specific expenditure related to process development activities under Stage 1A+ of its Great White Project. Andromeda also told investors it was expecting ~$26m over the next 3 years, subject to estimated expenditure being actually incurred although this Advance Finding will be binding on the ATO. A Final Investment Decision on the Great White Project is expected in this calendar year.

Entyr (ASX:ETR), a company developing a tyre recycling technology, received $3.79m in cash for FY24. Optiscan (ASX:OIL), a developer of digital pathology and precision surgery hardware and software solutions enabling live optical biopsies, received $1.78m. And Microba (ASX:MAP), a biotech developing technologies for measuring the ‘human gut microbiome’ received just over $6m.

Conclusion

The Australia’s Research and Development Tax Incentive regime is just one of several tax incentives that small cap ASX companies can access. But it is one of the most useful, and one of the most generous. It provides cash without the burden of dilution or future repayments, enabling the undertaking of R&D work that can become the next major technologies of tomorrow and create shareholder value in the future.

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