Taxing moves in bioindustry

Australian bioindustry has a sweeping wish list of tax reform measures it desperately wants to see implemented. The trouble is, forcing through significant changes to the national tax structure has the same torturously long gestation period as developing a major new drug.

After consulting widely with members and with guidance from Ernst and Young, industry association AusBiotech is pushing a seven-point list of tax reforms covering two broad areas: people and capital. In terms of people, its recommended tax reforms centre on more productive ways of taxing shares, options and pension plans of bioindustry personnel. On the capital side, it proposes modifications of the tax treatment meted out to limited partnerships and business angels.

The list concludes by pressing for changes to the rules linking tax concessions with R&D expenditures and making them more effective for start-up companies. Biotech companies should be allowed higher R&D spending limits as well as more flexibility in how they calculate their tax concessions, it says. The industry association argues that barriers restricting the ability of Australian bioindustry to attract and retain skilled workers and managers can be lowered through tax initiatives that are "at least competitive with other leading biotechnology countries."

Under current rules, employees with share and option acquisition schemes can be taxed either up-front or at a later date then face a capital gains slug when the shares are sold. The problem is the tax liability arrives before the value of the asset is realized and many employees are forced to sell their shares to meet the tax bill. That can be an onerous undertaking, particularly for staff of young biotechs which have not yet achieved liquidity in their stock offerings.

The industry association is pushing for tax changes in which employees incur tax liabilities only at the time of on-selling their shares. And it wants to see that income treated as capital gains rather than as personal income which attracts marginal tax rates.

To heighten the chances of luring seasoned expatriate bioindustry managers back to Australia, AusBiotech believes it is imperative to do away with the potential for double taxation of their existing pension plans and other assets. Expats in senior management positions with US pharmas, for example, who want to return and shift their pensions or sell their US residences face Australian taxes on those transactions. AusBiotech suggests that hurdle can be broken down by such means such as allowing tax-free rollovers of their entitlements into Australian super funds.

A Bill allowing expats a five-year moratorium on capital gains tax on certain assets has been drafted, says Gilbert and Tobin tax partner Mark Goldsmith. The Bill would allow returned expats a five-year period during which they could dispose of assets they own in their former country of employment without being hit by an Australian capital gains tax. However, the Commonwealth government is experiencing difficulties in steering the Bill through the Senate, Goldsmith says. Nor is there any perceptible movement on industry preferences for tax reform of share and options treatment. The venture capital industry is keen to see changes in tax treatment of shares and options and its industry association AVCAL has made submissions on the topic. But in terms of actual legislation, "there is nothing on the horizon at the moment," says Goldsmith.

VC tax reform

The news is less gloomy when it comes to tax reform of the capital sector, specifically venture capital. Two Bills, the Taxation Laws Amendment (Venture Capital) Bill 2002 and the Venture Capital Bill 2002 are currently winding through Parliament. It is the last step in a long journey for the legislation which Gilbert and Tobin's Goldsmith believes could be passed before the Christmas break.

But it will take "some time for people to digest the implications of the Bills and the general view is that their impact [on investment flows] will take place maybe over the next six to 12 months," according to Goldsmith. The new legislation will be relevant only to funds created after July 1, 2002 and the process of forming such funds is "reasonably time-consuming," he says.

"So it is unlikely to have an immediate effect but over time the hope is it will generate further foreign investment."

How much new foreign venture capital investment will be triggered by the tax reform is a matter of debate, although a study by Australian economics group Econtech puts a ceiling of $1.1 billion on the figure. Econtech also estimates the changes will add $350 million to Australia's GDP. The changes rung in by the new Bills are aimed at venture capital companies, not bioindustry. They primarily remove capital gains taxes on profits made through Australian-backed venture capital investments by certain classes of foreign investors. Ironically, while driven by concerns raised during the IT investment splurge of a decade ago, the new rules should confer disproportionate advantages on the biotech sector which has taken over from IT as the investment spectrum hotspot.

One effect of the new Bills is that they will go a long way toward meeting the bioindustry association's call for tax limited partnerships set up as investment vehicles to pass through tax gains or losses to partners, as is done in the US and the UK. However, it is foreign investors rather than domestic ones which are the focus of the VC Bills.

Two other areas that the Bills don't address, but where bioindustry is pressing for tax reform, embrace capital gains tax rollover provisions for wealthy investors and R&D tax concessions. AusBiotech says Australia should follow in the footsteps of the US and UK by allowing business angels and other seed investors to re-invest gains from one biotech start-up in another without having the total sum attacked by the capital gains tax on its journey from the first company to the second.

Australian seed investors currently receive partial exemptions on such transactions but only if their net asset value is less than $5 million. The association points out that this limit works against the biotech industry in which many investors are high net worth individuals. The final items on the bioindustry tax reform wish-list have to do with the eligibility of biotechs seeking to recoup some of their R&D expenditures through tax rebates. Most biotech start-ups don't become tax positive for many years, so the 125 per cent R&D tax concession as originally formulated presented such companies with no immediate benefits. The 125 per cent concession does translate into tax losses which can be carried forward if the company survives long enough. However the ability to recoup even then can be jeopardised by changes to the ownership structure of the company.

To remedy that situation, more recent legislation provided cash refunds for R&D expenditure in lieu of carry-forward tax losses. However the new legislation also restricted eligible companies to those with R&D spending of $1 million or less and turnover of $5 million or less. The R&D figures are far less than the biotech industry average of $3.3 million in 2000-2001, rising to an estimated $4.4 million in 2001-2002, AusBiotech points out. In other words the reform leaves out the bulk of the biotech companies which it was intended to benefit.

Besides quintupling the R&D expenditure ceiling to $5 million in order to solve that disparity, the industry association recommends changes to the 175 per cent 'premium' R&D tax concession introduced as part of the Federal government's Backing Australia's Ability scheme.

It notes the premium concession, as now structured, discriminates against start-up companies because it requires a three-year registration history. That requirement should be waived for companies younger than three years, it suggests. It also suggests a self-assessment system for companies older than three years and pushes for inclusion of eligible labour-related R&D spending in the 175 per cent premium.

Overall, apart from some progress in capital gains tax rollover and tax limited partnerships thanks to the VC Bills, the bulk of AusBiotech's seven-point plan for tax reform looks like remaining a wish-list for the foreseeable future. In fact, its hopes may even have deteriorated in the R&D tax rebate area because of the withdrawal this year of eligibility from companies more than 25 per cent owned by public sector institutions.

"That really came out of nowhere and in our industry, probably accounts for 80 to 90 per cent of early stage companies," says bio-entrepreneur John Ballard, who helped shape the AusBiotech tax submission.

Adding to industry frustration levels is the perception that the reforms it is fighting for are seen as being expensive to government. Handled correctly, they would cost the government nothing in terms of tax revenues, Ballard says.

However the issues are complex and confusing -- exactly the type of scenario that can create maximum problems when dealing with the bureaucracy. So bioindustry may have polled its members and crystallised a set of commonly-supported action points. But it has a long haul ahead of it in trying to sway government around to its point of view. But it may have to apply to tax reform the same patient approach it adopts to drug development, because swaying the government around to its point of view is going to a "a long haul," says Ballard.