Driving innovation or more tax deductions?

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Is the tax system the best mechanism for driving investment in innovation?

While the word around the Australian start up community as 2016 dawns is immensely up-beat, I do wonder whether the impetus provided by last year’s Federal Innovation Statement is going to drive capital where it needs to be.

The Redchip technology team, along with our tax specialists, has been looking more broadly at the investment behaviour the government is endeavouring to produce with the tax incentives it announced in December. This is an important question for both our start up clients and business advisers representing potential investors.

Driving social policy through the tax system

It’s definitely not uncommon for the government to use the tax system to drive social policy. Consider, for instance, our superannuation system. The purpose behind the introduction of compulsory super was to encourage Australians to invest for their retirement. Unfortunately, the inherent inequities in our marginal taxation system have resulted in the perception that superannuation has become an inheritance bonus for the rich, and, otherwise, merely an effective investment vehicle for many Australians.

The super example demonstrates the disconnect which can emerge when the taxation system is used to drive social or government policy measures, where in reality it’s the tax breaks that hold the appeal for most of us. Interestingly, research released recently by Ipsos Australia for MLC Wealth indicates that the highest income earners in Australia are loathe to lose tax breaks because they believe they are battling financially. In the survey of Aussie households, only 2% of high earners regard themselves as upper class in terms of income distribution.

Some very interesting questions arose in a recent discussion with Tax Specialist, Brian Richards, about this issue in the context of the Federal Government Innovation Statement. Whilst we agreed that it was clear the tax regime was being utilised to encourage Australians to invest in innovation, Brian questioned whether the tax system was the most effective mechanism to achieve this, or whether the government might have been better off establishing an investment pool.

The enabling legislation skews the investment opportunity to sophisticated investors (generally higher income earners) and, given the recent debate about who gets the advantages of tax concessions, it is not beyond question that in future years there will be debate about the economic advantages the innovation investment concessions provide to high income earners.

Is this about short term deductions or long term investment?

Our concern is that we will see a host of products developed and pushed into the market that are primarily aimed at delivering tax breaks, and not focussed on ensuring that capital is directed to the right start ups, technology or fast growth companies. Can the tax incentives delivered as part of the innovation statement guarantee that investments represent an appropriate commitment of resources, or are they just about shorter term deductions?

The tax offsets introduced by the Turnbull government are most certainly a terrific incentive, but what are they likely to achieve within a tax system which is not built around long term thinking? Our system only allows for decisions to be made based on the rules as we currently interpret them, whilst innovation is inherently about long term commitment and investment.

In this context, we now understand that “average” investors are less likely to participate in the innovation revolution. They are being excluded because of the risk factors inherent in start up investment, but conversely they are unable to take advantage of the economic opportunities innovation and start up business can potentially provide.

The government has certainly mitigated the downside for businesses that invest in innovation with the changes it introduced to the loss provisions. These will, in all likelihood, encourage people to take a risk because they can offset any losses, but is that really the driver of long term investment behaviour that the innovation sector requires?

I go back to my original question. Is the tax system the best mechanism for engineering the long term thinking and investment behaviour the government is trying to encourage? Whilst there’s always a role for attractive tax environments, I’d be urging any start up or investor to be clear about their objectives before diving in.

For more information on the proposed tax driven incentives anticipated in the innovation statement, feel free to contact us.

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