Read about the adjustments that can occur to your income tax position when assets are used for R&D activities.
When and why a balancing adjustment can occur
Notional research and development (R&D) deductions can include the decline in value of tangible depreciating assets you use for R&D activities. When the asset stops being held there is a balancing adjustment event. Common examples are the sale or scraping of the asset. The balancing adjustment compares the economic value of the asset at that time (called its termination value) with its written-down tax value (called adjustable value). This can result in either an amount of assessable income or an additional deduction against assessable income.
This adjustment ensures your final income tax position reflects the actual decline in value of the assets over time, rather than the estimates on which your decline in value deductions were based. The adjustment is reduced for the non-taxable use of the asset and other reductions that apply to the decline in value deductions for the asset.
For assets that were only used for R&D activities, the balancing adjustment is worked out under section 355-315 of the Income Tax Assessment Act 1997 (ITAA 1997). For assets that were also used for other taxable purposes, the balancing adjustment is worked out under subdivision 40-D of the ITAA 1997 on the assumption that a taxable purpose includes using the asset for the purpose of conducting R&D activities.
A further clawback adjustment or catch-up deduction arises for the additional benefit of the R&D tax offset for these assets. The clawback adjustment or catch-up deduction for a balancing adjustment arises where:
- an R&D entity has used a depreciating asset for R&D activities
- it is or has been entitled to an R&D notional deduction for decline in value for the asset in any year
- a balancing adjustment event happens in the current year
- a balancing adjustment is included in assessable income or as deduction in the current year.
This further amount either claws back the incentive component of the R&D tax offset claimed for the asset in relation to the balancing adjustment, or it allows a further deduction to catch-up an equivalent amount to that incentive component that had not previously been claimed.
Basic balancing adjustment for R&D asset
When an asset is disposed of, or stops being held in another way, its value at the time of disposal may vary from its adjustable value (which is the original cost of the asset less its decline in value). Where this occurs for a depreciating asset used to conduct R&D activities, the tax treatment for the gain or loss (balancing adjustment) on disposal must also be considered.
A balancing adjustment gain is made when the value of the asset at the time of disposal (termination value) exceeds its adjustable value. This gain is included in assessable income to the extent that the asset was used in deriving assessable income or conducting R&D activities over its life.
A balancing adjustment loss is made when the adjustable value exceeds its termination value. This loss is allowable as an additional deduction to the extent that the asset was used in deriving assessable income or conducting R&D activities over its life.
Example: Basic balancing adjustment
A new item of equipment costing $1,000,000 is used during the year for a taxable purpose described in subsection 40-25(7) of the ITAA 1997. Assuming that the effective life is 10 years, the decline in value allowable as a deduction for the year is calculated, if choosing the prime cost method, as follows:
$1,000,000 × (365 ÷ 365) × (100% ÷ 10) = $100,000
If the equipment is disposed of for the sum of $850,000 at the end of the year, a balancing loss on disposal of $50,000 is incurred, calculated as follows:
- Cost is $1,000,000
- Minus decline in value of $100,000
- Equals adjustable value which is $900,000
- Minus termination value of $850,000
- Equals balancing adjustment (loss) of $50,000.
If the equipment had been instead disposed of for $925,000 rather than $850,000, a balancing adjustment gain of $25,000 would have been made.
Note: The termination value can exceed the cost of the asset resulting in a balancing adjustment gain that includes a gain over its original cost.
End of exampleAssets used partly for R&D purposes
If the asset was used for a taxable purpose as well as for R&D purposes, the balancing adjustment is worked out under section 40-285 of the ITAA 1997 on the assumption that a taxable purpose includes using the asset for the purpose of conducting R&D activities. This assumption is made under section 40-292 of the ITAA 1997 (or section 40-293 of the ITAA 1997 in the case of an R&D partnership).
Assets used only for R&D purposes
If the asset was used only for R&D purposes, the balancing adjustment is worked out under 355-315 of the ITAA 1997 (or section 355-525 of the ITAA 1997 in the case of an R&D partnership). In this situation, a balancing adjustment only applies if the company is registered for R&D with AusIndustry for the year in which the balancing adjustment event happens.
Additional clawback adjustment or catch-up deduction for R&D assets
Where a basic balancing adjustment arises for an asset that has been used for R&D activities, a further adjustment may be required. The further adjustment claws back or provides a catch-up deduction for the incentive component of the R&D tax offset. This is in addition to the basic balancing adjustment to which the company's corporate tax rate is applied. These rules apply on an equivalent basis to R&D partnerships with a proportionate approach applying to each partner.
Clawback amount and catch-up amount
A clawback adjustment is included in assessable income if a gain arises on the balancing adjustment event. Unlike the basic balancing adjustment, the calculation of the amount of the gain to be clawed back (called the clawback amount) is limited to a termination value up to the cost of the asset. Any part of the gain in excess of the cost of the asset is not included.
A catch-up deduction is included as a deduction from assessable income if the balancing adjustment event gives rise to a loss (the catch-up amount).
For an asset partly used for R&D activities the clawback amount or catch-up amount is reduced to that portion of the total decline in value for the asset that represents the total R&D decline in value deductions for the asset.
Calculating the clawback adjustment or catch-up deduction
A clawback adjustment included in assessable income is worked out as:
(Starting offset − Adjusted offset − Deduction amount) ÷ R&D entity's corporate tax rate for the present year
A catch-up deduction on a catch-up amount is worked out as:
(Adjusted offset − Starting offset − Deduction amount) ÷ R&D entity's corporate tax rate for the present year
The formula calculates an amount on a year by year basis and the total of the amounts worked out for each offset year is included in assessable income or deductions for the year in which the balancing adjustment event happens.
The starting offset is the actual amount of R&D tax offset the entity receives that includes an amount being clawed back. The formula is used separately for each offset year that includes an R&D decline in value claim for the asset.
The adjusted offset is the offset amount that the entity would have received for the offset year if its notional R&D deductions were either reduced by the amount being clawed back or increased for the catch-up amount.
The difference between these two amounts is the offset differential. This is the amount of tax offset on the balancing adjustment attributed to the offset year being clawed back or deducted. If the overall rate of tax offset is the same for the starting offset and adjusted offset, the calculation can for practical purposes be made directly by applying the tax offset rate to the balancing adjustment attributed to the offset year. This may not be possible for a tiered non-refundable offset or if expenditure exceeds the incentive cap.
The deduction amount is the amount being clawed back or the catch-up amount multiplied by the R&D entity's company tax rate for the offset year. By subtracting this, the clawback only includes the incentive component of the tax offset. The additional amount reflects the enhanced benefit that you have obtained or could have obtained through the R&D tax offset for the decline in value.
The amount worked out above is then grossed-up for the entity's company tax rate for the current year to work out the equivalent amount included in assessable income or deducted.
Additional adjustment for depreciating assets used only for R&D activities
For assets used solely for R&D activities, the additional balancing adjustment only applies if the company is registered with AusIndustry for any R&D activity for the year in which the balancing adjustment event happens. This additional balancing adjustment results in either a further (catch-up) deduction, or an additional amount being included in assessable income (to recover earlier notional R&D deductions).
Example: balancing adjustment for asset used only for R&D activities
B Pty Ltd was incorporated in Australia and carries on a business in Australia that includes R&D activities that it conducts wholly in Australia. Its aggregated turnover for each income year is under $20 million. B Pty Ltd has a standard income year ending on 30 June.
On 1 July 2020, B Pty Ltd purchases a mass spectrometer for use in its R&D activities. The unit costs $30,000. B Pty Ltd assesses the effective life of the unit as 5 years and chooses the prime cost method for calculating its decline in value. B Pty Ltd is entitled to depreciate $6,000 ($30,000 ÷ 5) in each of the 5 income years.
During 2020–21 and 2021–22 income years, B Pty Ltd uses the unit only in carrying on its R&D activities. It sells the unit on 31 December 2021 for $15,000.
Basic balancing adjustment loss
As B Pty Ltd only used the unit for R&D activities, it will work out a balancing adjustment under the R&D rules. This is worked out on the difference between its adjustable value and its termination value. The termination value is $15,000. The adjustable value as at 31 December 2021 is equal to the opening adjustable value at 1 July 2021 less the part year decline in value during 2021–22 income year. The opening adjustable value is $24,000. The part year decline in value is $3,000. Accordingly, the adjustable value is $21,000.
B Pty Ltd has made a balancing adjustment loss (the adjustable value exceeds the termination value) and the loss is allowable as an additional deduction. B Pty Ltd is entitled to a balancing adjustment deduction of $6,000 ($21,000−$15,000) in the 2021–22 income year.
Catch-up deduction
B Pty Ltd was registered for its ongoing R&D activities for the 2021–22 year. It is entitled to a further deduction for the catch-up amounts that relate to the two income years (each being an offset year) in which B Pty Ltd has claimed the R&D tax offset in relation to the asset's decline in value.
The catch-up amount is the $6,000 amount worked out above as the balancing adjustment loss.
B Pty Ltd works out the portion of the $6,000 catch-up amount that is attributable to each offset year. In this case, it follows the proportion of the decline in value claimed in each year. For 2020–21 this amount is $4,000 and for 2021–22 it is $2,000.
B Pty Ltd has total notional deductions of $500,000 in 2020-21 and $550,000 in 2021–22 income years and its company tax rate is 26% for 2020–21 and 25% for 2021–22.
Calculating the catch-up deduction for the 2020–21 income year
For the 2020–21 income year, B Pty Ltd calculates the offset differential by multiplying the catch-up amount for that year by the R&D tax offset rate for that year. It is calculated as the difference between the tax offset received for the year and the tax offset that would have been received had it included the catch-up amount for the year. This represents the additional R&D tax offset that would have applied to the balancing adjustment loss. In practice here it can be worked out directly on the catch-up amount for the year.
($504,000 x 43.5%)−($500,000 x 43.5%)
$4,000 × 43.5% = $1,740
B Pty Ltd determines the deduction amount by multiplying the catch-up amount by the company tax rate for the offset year.
$4,000 × 26% = $1,040
The difference between these amounts ($700) represents the premium or incentive component of the R&D tax offset for that year. A catch-up deduction is calculated on this amount by grossing up for the company's tax rate for the year in which the deduction is claimed.
($1,740−$1,040)/25% = $2,800
Calculating the catch-up deduction for the 2021–22 income year
For the 2021–22 income year, the calculation is as follows:
The offset differential is $870. This is the part of the catch-up amount for the offset year ($2,000) multiplied by the R&D tax offset rate for that year (43.5%).
The deduction amount is $500, calculated on the catch-up amount ($2,000) at the company tax rate for the offset year (25%).
The catch-up deduction is $1,480, calculated as the difference between these amounts ($370) and grossed up for the company's tax rate for the present year (25%).
Total catch-up deduction
The total catch-up deduction claimed in the 2021–22 income year is the sum of the amounts worked out for each year:
$2,800 + $1,480 = $4,280
Alternative assessable clawback adjustment
If the termination value in the example above was $27,000 rather than $15,000, B Pty Ltd would make a balancing profit (the termination value exceeds the adjustable value of $21,000), and so B Pty Ltd would be required to include the balancing adjustment gain of $6,000 in its assessable income, plus a further assessable clawback adjustment of $4,280.
Example: balancing adjustment for non-refundable tax offset
Ozzie Electric Pty Ltd has an aggregated turnover of over $20 million and below $50 million for each of the 2019–20 to 2021–22 income years. Its total expenses in the 2021–22 income year are $15 million. Its notional deductions for these years are:
2019–20 |
2020–21 |
2021–22 |
|---|---|---|
$355,000 |
$327,000 |
$298,000 |
On 18 April 2020, Ozzie Electric acquired a tangible depreciating asset for $80,000 and used the asset entirely for R&D purposes. The asset has an effective life of 5 years and Ozzie Electric uses the prime cost (straight line) method to work out the asset's decline in value as follows:
Income year |
Days asset used |
Decline in value |
Adjustable value |
|---|---|---|---|
2019–20 |
73 |
$3,200 |
$76,800 |
2020–21 |
365 |
$16,000 |
$60,800 |
2021–22 |
365 |
$16,000 |
$44,800 |
Total decline in value |
N/A |
$35,200 |
N/A |
Ozzie Electric sells the asset on 1 July 2022 for $34,900. It continues to be registered for R&D for the 2022–23 income year. When the asset is sold, there is a balancing adjustment event. As the asset's adjustable value of $44,800 exceeds its termination value of $34,900, Ozzie Electric is entitled to a deductible balancing adjustment amount of $9,900. This amount is allowed as a deduction against its assessable income in the 2022–23 income year.
Ozzie Electric is also entitled to a further deduction against assessable income on the balancing adjustment of $9,900. The catch-up deduction is worked out on the incentive component of the R&D tax offset if it were increased for that balancing adjustment.
The balancing adjustment and the catch-up deduction are considered in calculating taxable income in the year the balancing adjustment event happened. They are not notional deductions and are not considered in calculating the R&D tax offset.
Calculating the catch-up deduction
The catch-up deduction is worked out on the total of the additional tax offset on the portion of the balancing adjustment attributable to each offset year, using the following formula on a year by year basis:
(Adjusted offset − Starting offset − Deduction amount) ÷ R&D entity's company tax rate for the balancing adjustment year
A portion of the balancing adjustment (called the catch-up amount) is attributed to each offset year based on what the additional decline in value would have been for that year. The total catch-up amount of $9,900 is attributed to each year as follows:
Income year |
Original decline in value |
Revised decline in value |
Catch-up amount |
|---|---|---|---|
2019–20 |
$3,200 |
$4,100 |
$900 |
2020–21 |
$16,000 |
$20,500 |
$4,500 |
2021–22 |
$16,000 |
$20,500 |
$4,500 |
Total amount |
$35,200 |
$45,100 |
$9,900 |
The starting offset is the amount of the offset that was claimed each year. The adjusted offset and deduction amount are calculated considering the catch-up amount.
Income year |
2019–20 |
2020–21 |
2021–22 |
|---|---|---|---|
Offset rate |
38.5% |
38.5% |
Tiered rates |
Company tax rate |
27.5% |
26% |
25% |
Notional deductions |
$355,000 |
$327,000 |
$298,000 |
Starting offset |
$355,000 × 38.5% = $136,675 |
$327,000 × 38.5% = $125,895 |
All claimed at Tier 1 rate (company tax rate + 8.5%) $298,000 × (25% + 8.5%) = $99,830 |
Catch-up amount |
$900 |
$4,500 |
$4,500 |
Increased notional deductions |
$355,900 |
$331,500 |
$302,500
|
Tier 1 offset (company's tax rate + 8.5%) |
N/A |
N/A |
Applies to first $300,000 of notional expenditure: $300,000 × (25% + 8.5%) = $100,500 |
Tier 2 offset (company tax rate +16.5%) |
N/A |
N/A |
Applies to the remaining amount: $2,500 × (25% + 16.5%) = $1,037.50 |
Adjusted offset |
$355,900 × 38.5% = $137,021.50 |
$331,500 × 38.5% = $127,627.50 |
$100,500 + $1,037.50 = $101,537.50 |
Deduction amount (catch-up amount x company tax rate) |
$900 × 27.5% = $247.50 |
$4,500 × 26% = $1,170 |
$4,500 × 25% = $1,125 |
Catch-up deduction |
($137,021.50−$136,675−$247.50) ÷ 25% = $396 |
($127,627.50−$125,895−$1,170) ÷ 25% = $2,250 |
($101,537.50−$99,830−$1,125) ÷ 25% = $2,330 |
The total catch-up deduction for the 2022–23 income year for the balancing adjustment event for the asset is:
$396 + $2,250 + $2,330 = $4,976
End of exampleAdditional adjustment for depreciating assets used for R&D activities and a taxable purpose
For assets that were used for a taxable purpose and also used for R&D activities, the additional balancing adjustment applies whether or not the company is registered with AusIndustry for the year during which the adjustment event happens. However, it only applies only on that portion of the gain or loss attributable to their R&D use.
The clawback amount or catch-up amount on which the additional balancing adjustment is calculated is using the formula:
(Total R&D deductions/Total decline in value) ÷ Section 40-285 amount
In this formula:
Total R&D deductions is the total decline in value amounts for the asset for all income years included in notional R&D deductions.
Total decline in value is the cost of the asset less its adjustable value.
Adjusted section 40-285 amount is the balancing adjustment gain or loss on the balancing adjustment event. However, the gain is adjusted to exclude that part in excess of the cost of the asset. This means any assessable clawback amount is capped by the original cost of the asset using an adjusted section 40-285 amount.
Example: Balancing adjustment for assets used partly for R&D activities
C Pty Ltd was incorporated in Australia and carries on a business in Australia that includes R&D activities. Its aggregated turnover for each income year is under $20 million. Its total R&D expenditure was $150,000 in the 2020–21 income year and $160,000 in the 2021–22 income year.
On 1 July 2020, C Pty Ltd purchases injection mould for use in its business at a cost of $30,000. C Pty Ltd assesses the effective life of the unit as 5 years and chooses the prime cost method for calculating its decline in value. C Pty Ltd uses the unit 50% of the time for carrying on ordinary business activities and 50% of the time for carrying on R&D activities.
On 31 December 2021, C Pty Ltd sells the unit for $28,800 (its termination value). C Pty Ltd includes in assessable income an amount equal to the termination value less the adjustable value. The adjustable value is equal to the opening adjustable value less the decline in value during 2021–22 income year. The opening adjustable value is $24,000. The decline in value during the year is $3,000. Accordingly, the adjustable value is $21,000. C Pty Ltd includes assessable income of $7,800 ($28,800−$21,000).
C Pty Ltd includes a further amount in assessable income as a result of the use of the asset in R&D activities for 50% of the time it has been held by C Pty Ltd. C Pty Ltd is entitled to total notional R&D decline in value deductions of $4,500 (50% × ($6,000 + $3,000)).
It will need to calculate the additional clawback amount for each offset year relevant to the R&D decline in value claimed. The total clawback amount is attributed based on each year's proportion of the total decline in value. The clawback amount that relates to each year is calculated as:
- 2020–21 income year: ($3,000/$4,500) × $7,800 = $5,200
- 2021–22 income year: ($1,500/$4,500) × $7,800 = $2,600
Calculating the offset deferential and deduction amount for the 2020–21 income year
For the 2020–21 income year, in this case C Pty Ltd can calculate the offset differential by multiplying the clawback portion for that year by the R&D tax offset rate for that year as:
$5,200 × 43.5% = $2,262
C Pty Ltd determines the deduction amount by multiplying the clawback amount by the company tax rate for the year it claimed the notional deduction.
$5,200 × 26% = $1,352
The clawback adjustment for that year to be included in assessable income is calculated on the difference between these amounts and grossed up for the company's tax rate for the year in which the balancing adjustment event happens:
($2,262−$1,352)/25% = $3,640
Calculating the offset deferential and deduction amount for the 2021–22 income year
For the 2021–22 income year, the amount is calculated as:
Offset differential: $2,600 × 43.5% = $1,131
Deduction amount: $2,600 × 25% = $650
Clawback amount: ($1,131−$650)/25% = $1,924
Total catch-up deduction
The total clawback adjustment included as assessable income in the 2021–22 income year is the sum of the amounts worked out for each year:
$3,640 + $1,924 = $5,564
End of example