Q: Who could believe that that a 20-year-old idea with a record of failure overseas, and which has been opposed by Australia’s Chief Economist, holds the key to economic recovery?
A: Treasurer Josh Frydenberg, who in his Budget speech announced the introduction of a patent box – a reduced rate of tax on the income companies earn from patents.
According to the Treasurer, the patent box will create incentives for manufacturers to invest in R&D, even though it is applied at the end of the innovation process, not at the outset.
The patent box is an idea that has often been touted in the past two decades by multinational companies seeking to reduce their tax liabilities.
Until now, however, the idea has not survived scrutiny by those who have analysed how it would work in practice.
In 2015, the Chief Economist released a report arguing that introducing a patent box would result in a loss of revenue without necessarily providing incentives to invest in new R&D.
The report followed similar criticisms made by the EU Commission and the OECD, after studies of patent box programs in several European countries.
The G20 countries have had to introduce measures to counter erosion of their tax base and profit-shifting between jurisdictions by companies taking advantage of patent box schemes.
The Morrison Government has chosen to ignore all these warnings, however, just as it continues to ignore ideas that really would encourage innovation.
The 2016 ‘Three Fs’ review of the Research and Development Tax Incentive, for example, included a proposal for a premium rate of the Incentive for collaboration between industry and researchers.
Unlike a concessional rate for patent incomes, which would be applied at the end of the innovation process, the Tax Incentive applies at the beginning, which is when incentive is needed.
A premium rate for collaboration would bring science and industry together in shared projects and provide a built-in incentive to see those projects through to the commercialisation phase.
But, despite a 30 per cent fall in business investment in R&D after 2015, the Government has yet to grasp that the R&D Tax Incentive must be made more effective.
Instead it has placed its hopes on a patent box, at first for the biotech sector and later perhaps for clean energy projects as well.
Under the Government’s scheme, the tax rate on patent income for these companies will be cut to 17 per cent, down from 30 per cent for large firms and 25 per cent for small and medium-sized enterprises (SMEs).
The history of patent boxes in other countries suggests that we should be wary of measures that increase the risk of lost revenue without guarantees of compensatory increases in economic activity.
That is a net loss for the nation, especially if it results in a ‘race to the bottom’ with other countries offering similar inducements.
What patent boxes really do is create an incentive for multinational companies to move their intellectual property around between jurisdictions, which opens the possibility of rorting.
The EU Commission, in its study of patent boxes in 12 countries, found that lower taxes on patents encouraged companies to move their patents to the country with the lowest rate.
Relocation of the patent, however, did not necessarily mean that the companies would relocate their R&D centre, too. It is this that creates the drain on tax revenues and creates the ‘race to the bottom’.
There is a real risk that this could happen with the patent box announced by the Treasurer.
The UK’s patent box, for example, has a concessional tax rate of 10 per cent, not 17 per cent as proposed in Australia.
What if New Zealand were to announce that it is introducing a 10 per cent concessional rate on patents? The race to the bottom would have started.
To avoid getting caught in such a race, the Government must ensure that the concessional tax rate applied under Australia’s patent box is directly linked to R&D conducted in this country.
But if the Government really wants to create incentives for Australian manufacturers, it would be better to focus on improving the Research and Development Tax Incentive.
The proposed collaboration premium is an obvious way of doing that.
Patent boxes just don’t provide the same incentives. The Morrison Government’s decision to take the patent-box option indicates its confusion about innovation and industry policy in general.
This was first published in Campus Morning Mail on Wednesday, 26 May 2021.