House of Representatives

Taxation Laws Amendment Bill (No. 4) 1991

Taxation Laws Amendment Act 1992

Explanatory Memorandum

(Circulated by the authority of the Treasurer,the Hon Ralph Willis, M.P.)

Chapter 12 Research and Development

Clauses: 28,29 and 63

Overview

Allows a maximum deduction of upto 150% of expenditure, for qualifying plant expenditure claimed over three years in three equal instalments, for each year if that plant is first used prior to 30 June 1993.

Limits deductions in respect of core technology expenditure to an arm's length amount.

Excludes expenditure on core technology from the calculation of the deduction to be allowed in the case where there are guaranteed returns to investors. This modification will ensure that the calculation of the reduced deduction is not diluted by the inclusion of core technology which already only attracts a deduction of 100%.

Research and Development

Summary of the proposed amendments

12.1 This Bill will amend the income tax law in regard to the research and development (R & D) tax concession in the following manner:

(a)
For qualifying plant expenditure claimed over three years in three equal instalments, a maximum deduction of up to 150% of expenditure is to be allowed for each year if that plant was first used prior to 30 June 1993.
(b)
Subsection 73B(31) is to be extended to include core technology. This provision restricts the deduction allowed in respect of specific expenditure to what is considered to be an arm's length amount.
(c)
Amounts incurred on core technology are to be excluded from the formula in subsection 73CA(4). This formula provides a calculation for the amount a deduction is to be reduced by where there are guaranteed returns to investors.

12.2 The amendment at point (a) is to take effect from the date of Royal Assent. The amendments listed at points (b) and (c) are to take effect from the date of introduction.

Background to the legislation

12.3 The R & D concession is available to an eligible company for expenditure incurred, on or after 1 July 1985, on qualifying research and development in Australia. The concession is in the form of a deduction against assessable income, of up to 150% (125% after 30 June 1993) of the expenditure incurred.

12.4 The deduction allowable to a company depends on the purpose of the expenditure. For expenditure on the acquisition or construction of plant for use by the company exclusively on R & D activities there is a deduction in equal instalments over three years at the appropriate deduction acceleration factor if the following criteria are met:

The aggregate R & D amount must exceed $20 000 in a year.
Where this amount is between $20 000 and $50 000 in a year, a formula provides a graduated rate of deduction of between 100% and 150% (or 125% after 30 June 1993).
A maximum rate of deduction of 150% (or 125% after 30 June 1993) is allowed where the aggregate R & D amount is $50 000 or more.

12.5 Core technology expenditure is deductible at only 100%.

12.6 Where a taxpayer has a guaranteed return from the results of the research the deduction that would otherwise be allowable is reduced by a formula to reflect the reduction in the risk to which the taxpayer is exposed.

Explanation of the proposed amendments

12.7 A maximum deduction of up to 150% is to be allowed in respect of expenditure incurred on eligible plant written off over three years where that plant was first used for R & D prior to 30 June 1993.

12.8 Where eligible expenditure is incurred on qualifying plant, in the year that the plant is first used exclusively for the purposes of carrying on by or on behalf of the company for R & D activities, one third of that expenditure may be claimed as a deduction under subsection 73B(15). Provided that the plant continues to be used as described above, one third of the expenditure may be claimed in each of the two subsequent years.

12.9 In any of the three years, where the aggregate R & D amount exceeds $20 000, the deduction will be calculated as one third of the eligible expenditure multiplied by the relevant deduction acceleration factor as defined in subsection 73B(1).

12.10 For years ended 30 June 1993 or an earlier year of income, the deduction acceleration factor is 1.5 if the aggregate R & D expenditure is over $50 000 (subparagraph (a) (ii)). Where the amount is less than $50 000, the deduction acceleration factor is to be reduced based on the formula provided in the definition at subparagraph (a)(i).

12.11 For years subsequent to 30 June 1993, the deduction acceleration factor is 1.25 if the aggregate expenditure is over $50 000 (subparagraph (b)(ii)), or if less than $50 000, then calculated using the formula at subparagraph (b)(i) of the definition.

Example of the current law

12.12 Assume that the aggregate R & D amount exceeds $50 000 in each year. If plant was first eligible to be claimed in the year ended 30 June 1993 the rate of deduction will be 150% of the expenditure. However, in the two subsequent years the rate of the deduction will be 125%.

Plant cost: $300,000
Deduction year ended 30 June 1993: (300,000/3) x 150%
= $150,000
Deduction year ended 30 June 1994: (300,000/3) x 125%
= $125,000
Deduction year ended 30 June 1995: (300,000/3) x 125%
= $125,000

12.13 The current provisions are to be amended so that expenditure incurred on plant that is first eligible to be claimed in the year ended 30 June 1993 or earlier, may be deductible at the same deduction acceleration factor formula for each of the three years of write off [subsection 73B(15B)]. This is provided that the aggregate R & D amount is greater than $20 000 in relation to the year of income as required by subsection 73B(15).

Example of the effect of the amendment

12.14 Assume that the aggregate R & D amount exceeds $50 000 in each year. If the plant was first eligible to be claimed in the year ended 30 June 1993 the rate of deduction will be 150%. Now in the next two years the rate of deduction will also be 150%.

Plant cost: $300 000
Deduction year ended 30 June 1993: (300 000/3) x 150%
= $150 000
Deduction year ended 30 June 1994: (300 000/3) x 150%
= $150 000
Deduction year ended 30 June 1995: (300 000/3) x 150%
= $150 000

12.15 This means expenditure will be written off on the basis of the maximum rate available when the plant was first used, rather than the maximum rate for plant first used in some later year.

Deductions in respect of core technology expenditure to be limited to an arm's length amount

12.16 Subsection 73B(31) reduces the deduction for certain expenditure claimed under section 73B to what is considered by the Commissioner of Taxation to be an "arm's length amount". That is an amount that is not artificially inflated.

12.17 This provision currently applies to: R & D expenditure (as defined in subsection 73B(1)); an amount of expenditure incurred in the acquisition or construction of plant; the acquisition or construction of a building or an extension, or alteration or improvement to a building. It does not currently include "core technology".

12.18 Paragraph 73B(31)(a) is to be amended to include core technology. That is, the Commissioner will be able to restrict deductions in respect of core technology to reasonable amounts. Although deductions claimed for core technology that are artificially inflated (not arm's length) may already attract the operation of Part IVA, this amendment will ensure that the valuation of core technology must be at arm's length. [Clause 28]

Expenditure on core technology is to be excluded from the calculation of the reduced deduction that is available in the case of guaranteed returns

12.19 In 1990, a new section (section 73CA) was inserted under which the deduction otherwise allowable for R & D is reduced in proportion to the reduced risk where the company is entitled to a guaranteed return on any of its R & D expenditure. The section applies to all R & D expenditure, including core technology expenditure.

12.20 Currently, where the Commissioner of Taxation is satisfied that part of the amount being claimed under section 73B is not at risk to the investor, the amount of the deduction is to be reduced by an amount calculated according to the formula prescribed in subsection 73CA(4):

Excess * (Part of expenditure not at risk / The amount of the expenditure)

"Excess" refers to the difference between the deduction allowed under the R & D provisions and the total expenditure incurred.
"Part of expenditure not at risk" means the part of the expenditure in respect of which the Commissioner is satisfied that the company was not at risk when the expenditure was incurred.
"The amount of the expenditure" means the total expenditure claimed.

12.21 Broadly, the intention of this provision is to reduce the maximum deduction to 100% where the expenditure is not at risk. This reduction is only to apply to that part which is not at risk.

12.22 The expenditure in this formula includes core technology expenditure which is already only deductible at the rate of 100% - see subsection 73B(12).

12.23 Core technology is to be removed from the expenditure referred to in the formula by defining expenditure in section 73CA as not including core technology expenditure. This is because the inclusion of core technology in the total expenditure component of the formula dilutes the effect of the provision. In addition, it may attract arrangements which involve artificially contrived core technology transfers and further reduce the intended impact of the provision. [Clause 29]

12.24 The following example illustrates this point:

Example

12.25 Assume total expenditure of $9 million made up of:

core technology expenditure of $3 million - deduction (100%) of $3 million;
expenditure deductible under section 73B (other than core technology expenditure) of $6 million - deduction (150%) of $9 million; and
a guaranteed return (i.e. expenditure not at risk) of $3 million

12.26 If there was no guaranteed return, the deduction available would be $12 million. However, as there is a guaranteed return, the deduction has to be reduced by applying the above formula:

(a)
As the law currently operates - core technology expenditure and other expenditure included in the calculation - the deduction would be reduced by:

$(12m - 9m) x (3m/9m) = $1 million

The allowable deduction is therefore reduced to $11 million.
(b)
Under the amendment, where core technology is excluded, the deduction would be reduced by:

$(9m - 6m) x (3m / 6m) = $1.5 million

The allowable deduction would therefore be $10.5 million.

Commencement date

12.27 The amendment that will enable qualifying plant expenditure to be deductible up to a maximum rate of 150% after 30 June 1993 rather than up to a maximum rate of 125% if the plant is used before or on 30 June 1993 is to take effect from the date of royal assent.

12.28 The amendment that will limit the deduction allowed in respect of core technology to an arm's length amount will take effect from the date of introduction of the legislation.

12.29 Similarly, the amendment that will exclude core technology expenditure from the operation of the formula which reduces the R & D deduction otherwise allowable where there are guaranteed returns to investors will also take effect from the date of introduction.

Clauses involved in the proposed amendments

Clause 28: Amends section 73B to insert new subsection (15A) to amend the existing provisions in relation to plant so that plant can be written off up to a maximum of 150% if used prior to 1 July 1993. It also amends paragraph (31)(a) so as to include "core technology".

Clause 29: Amends section 73CA by inserting in subsection (6) a definition of "expenditure" which excludes core technology.


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