SENATE

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 9 Research and development activities

Overview

9.1 The amendments contained in Schedule 4 of the Bill amend the research and development tax concession provisions contained in the Income Tax Assessment Act 1936 (ITAA) and the Industry, Research and Development Act 1986 (IR & DA) to give effect to various changes announced on 23 July 1996 and 20 August 1996.

9.2 The amendments to the ITAA are set out in Part 1 of Schedule 4 of the Bill and discussed in Section 1 of this Chapter.

9.3 The amendments to the IR & DA are set out in Part 2 of Schedule 4 of the Bill and discussed in Section 2 of this Chapter.

Section 1 - Amendments to the ITAA

Summary of the amendments

Purpose of the amendments

9.4 The amendments will:

•

reduce the deduction for expenditure on plant, contracted R & D and other R & D expenditures currently deductible under section 73B of the ITAA at 150 per cent to 125per cent [items 1 to 10] ;

•

make companies in partnership ineligible to claim expenditure on R & D activities under section 73B [items 11 to14] ;

•

limit to four years the period in which tax assessments may be amended to reduce tax liability by reason of deductions allowable for expenditure on R & D activities claimed under section 73B [items 15 to 17] ;

•

modify the deduction rules under section 73B for interest [items 18 to 22] , feedstock [items 23 to 32] , core technology [items 33 to 42] , and pilot plant [items 43 to 56] ;

•

clarify the definition of 'research and development activities' [items 57 to 61] .

Date of effect

9.5 The general reduction in the premium rate of deduction will apply to expenditure incurred from 7.30 p.m., by standard time in the Australian Capital Territory on 20August 1996 except expenditure that was required to be incurred by a contact entered into before that time other than a contract of service. [Item 10]

9.6 The change to limit the period for amending assessments applies to the amendment of assessments after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless a request for amendment was made before that time and the taxpayer had given the Commissioner sufficient information to decide the application. [Item 17]

9.7 The reduction in the rate of deduction for interest expenditure applies to interest expenditure incurred after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless the expenditure was incurred under a fixed term contract entered into before that time. [Item22]

9.8 The changed deduction rules for feedstock expenditure, core technology expenditure and pilot plant expenditure apply to expenditure incurred under contracts entered into after 5pm, by standard time in the Australian Capital Territory on 23 July 1996. [Items 32, 36, 56]

9.9 The changes to the definition of 'research and development activities' apply from 5pm, by standard time in the Australian Capital Territory on 23 July 1996. [Item 61]

Background to the legislation

(a) Reduce the rate of deduction from 150 per cent to 125per cent

9.10 Expenditure on plant (subsection 73B(15)), contracted expenditure (subsection 73B(13)) and other R & D expenditure (subsection 73B(14)) may give rise to a deduction equal to 1.5 times the amount of the expenditure incurred.

9.11 Where the 'aggregate research and development amount' (defined in subsection 73B(1)) during a year of income is greater than $20,000, the allowable deduction for 'research and development expenditure' (defined in subsection 73B(1)), other than contracted expenditure, incurred in a year of income is 1.5 times the amount of expenditure.

9.12 Where the 'aggregate research and development amount' during a year of income is greater than $20,000, the allowable deduction for plant expenditure (defined in subsection 73B(1)), is spread over 3 years at the annual rate of one third of the amount of the expenditure multiplied by 1.5. Where the 'aggregate research and development amount' during a year of income is less than or equal to $20,000 the allowable deduction in each of the 3 years is one third of the actual amount of expenditure.

9.13 The deduction allowable under subsection 73B(13) for contracted expenditure (as defined in subsection 73B(1)) is 1.5 times the amount of the expenditure.

(b) Partnerships ineligible for the R & D tax concession

9.14 Subsection 39P of the IR & DA allows companies to register with the Industry, Research and Development Board (the Board) for the R & D tax concession. Once registered each company in the partnership may be entitled to deductions under section 73B of the ITAA for expenditure incurred on R & D activities. Paragraph 73B(10) of the ITAA disallows deductions to a company which is not registered with the Board.

(c) Limit the period for amending assessments to four years

9.15 Subsection 170(10) of the ITAA permits income tax assessments to be amended at any time to allow a deduction for R & D expenditure incurred since the commencement of the R & D tax concession or to include in assessable income amounts receivable in respect of the recoupment etc. of R & D expenditure or the results of R & D activities.

(d) Modify the deduction rules for interest

9.16 Interest expenditure on debt used to finance R & D activities may fall within the meaning of 'research and development expenditure' and is therefore deductible under subsection 73B(14) at the rate of 150 per cent if the 'aggregate R & D amount' of the company for the year of income is greater than $20,000.

(e) Modify the deduction rules for feedstock

9.17 The cost of raw materials fed into processes that qualify as 'R & D activities' as defined in subsection 73B(1), may qualify for deduction at the concessional rate of 150 per cent under subsection 73B(14). However, the value of resultant product that may be commercially valuable or useable in further processes does not affect the quantum of the deduction.

(f) Modify the deduction rules for core technology

9.18 Core technology expenditure is wholly deductible under subsection 73B(12) in the year of income in which the expenditure is incurred. Core technology (defined in subsection 73B(1AB)) is existing technology in respect of which further research and development activities may be undertaken to produce new knowledge, products, processes, etc.

(g) Modify the deduction rules for pilot plant

9.19 Pilot plant expenditure (as defined in subsection 73B(1)) is deductible under subsection 73B(15). The relevant deduction is spread over 3 years of income. Where the 'aggregate R & D amount' (as defined in section 73B(1)) in a year of income exceeds $20,000, the amount of deduction for pilot plant expenditure is one third of the expenditure multiplied by 1.5.

(h) Clarify the definition of 'research and development activities'

9.20 'R & D activities' are defined in section 73B(1). Subsection 73B(2) excludes certain activities from the definition. A deduction is only available under section 73B for expenditure incurred in respect of eligible 'research and development activities'.

9.21 The Board's decision that particular activities are not 'R & D activities' is an appealable administrative decision to the administrative Appeals Tribunal.

9.22 Interpretation of the R & D activities that would be eligible for the R & D tax concession was widened with the decision of the Administrative Appeals Tribunal (AAT) in the recent AAT case of C harles IFE Pty Ltd & Industry Research and Development Board
95 ATC 2149 . The Tribunal overturned the Board's decision and held that the particular activities (adaptation of equipment) conducted by the applicant were R & D activities within the definition of section 73B. This decision underscored the need to clarify subsections 73B(1) and (2).

Explanation of the amendments

(a) Reduce the rate of deduction from 150 per cent to 125per cent

9.23 The deduction allowable at the concessional rate of 150 per cent in respect of research and development expenditure, contracted expenditure, plant expenditure and pilot plant expenditure is being reduced to 125 per cent. The reduced rate of deduction applies in respect of relevant expenditure incurred from 7.30 p.m., by standard time in the Australian Capital Territory on 20August 1996 except expenditure that was required to be incurred by a contact entered into before that time, other than a contract of service entered into before that time.

9.24 The reduction is being effected by items 1 to 9 of Division 1 of Part 1 of Schedule 4 of the Bill , and is reflected in amended subsection 73B(13) (contracted expenditure), amended subsection 73B(14) (R & D expenditure), amended paragraph 73B(15)(a) (qualifying plant expenditure deduction), amended subparagraph 73B(23)(e)(i) (loss of plant), amended subsection 73C(8) (contracted expenditure clawback), amended subsection 73C(9) (non contracted expenditure clawback), new subsection 73B(4E) (post 23 July 1996 pilot plant deductions) and new subsection 73B(15AB) (limit on post 23 July 1996 pilot plant deductions).

(b) Partnerships ineligible for the R & D tax concession

9.25 Existing rules contained in subsections 73B(3A) and 73B(9A) which permit expenditure incurred by a partnership or a partner in specified circumstances to qualify for deduction under section 73B are being changed so that only companies jointly registered under section 39P of the IR & DA and companies which are partners in a Co-operative Research Centre will continue to qualify under those rules. The changes are being effected by item 11 of Division 2 of Part 1 of Schedule 4 which restricts eligibility to a partnership comprising companies jointly registered under section 39P of the IR & DA or a Co-operative Research Centre. Item 14 ensures the changes apply with effect from 5pm, by standard time in the Australian Capital Territory on 23 July 1996.

9.26 Companies will not be eligible to jointly register with the Industry Research and Development Board (the Board) under section 39P of the IR & DA from 5pm, by standard time in the Australian Capital Territory on 23 July 1996 and therefore will not be able to claim a deduction under section 73B (refer to paragraphs 9.76 and 9.91) .

9.27 The IR & DA is being amended to provide transitional rules that will allow syndicates that have received advance approval from the Board before 24 July 1996, for their proposed R & D activities and finance scheme, to seek registration under section 39P from the Board. All syndicates registered under section 39P will continue to be eligible for the tax concession. (Refer to paragraphs 9.92 to 9.110)

(c) Limit the period for amending assessments to four years

9.28 The period in which tax assessments may be amended to reduce tax liability for the purpose of giving effect to section 73B and related provisions dealing with research and development expenditure is being limited to four years from the date of an assessment [item 15] . This is consistent with the general limit on amendments contained in the income tax law [amended subsection 170(10)] .

9.29 The Commissioner of Taxation's capacity to increase an assessment at anytime for that purpose will not change, because of design features within the research and development tax concession which may require increased assessments beyond the usual four year limit, under various circumstances. [Item 16]

9.30 A transitional rule will allow the Commissioner to amend an assessment, irrespective of when the tax under the assessment notice was due and payable, in relation to 'research and development activities', where an application was lodged by a company on or before 5pm, by standard time in the Australian Capital Territory on 23 July 1996 and all information necessary for the Commissioner to determine the amendment to the assessment was supplied. [Item 17]

(d) Modify the deduction rules for interest

9.31 Items 18 to 21 in Division 4 of Part 1 of Schedule 4 of the Bill have the effect that 100 per cent of interest on debt to finance research and development activities will be deductible as research and development expenditure. [New subsection 73B(14A)]

9.32 For that purpose, 'interest expenditure' will be defined to be interest, or an amount in the nature of interest, that is incurred by a company during the year of income for financing 'research and development activities'. [New definition in subsection 73B(1)]

9.33 The 100 per cent deduction rule will apply to interest incurred after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless under a fixed-term contract entered into before that time.

9.34 In conjunction with this change, the definition of 'aggregate research and development amount' is being amended to make clear that interest expenditure falls within the ambit of research and development activities. [Amended definition in subsection 73B(1)]

(e) Modify the deduction rules for feedstock

9.35 Items 23 to 31 of Division 5 of Part 1 of Schedule 4 of the Bill will apply so that the concessional rate of deduction for the cost of feedstock that qualifies as research and development expenditure will be limited to the net costs of the feedstock. This is to be achieved by subtracting the value of any products derived from processing or transforming feedstock as part of the research and development activities from the value of the feedstock that was used in that process or transformation.

Eligible feedstock expenditure

9.36 For this purpose, several new definitions are being included. The first is 'eligible feedstock expenditure', being inserted in subsection 73B(1) and defined in new subsection 73B(1A). Eligible feedstock expenditure is the amount (if any) by which the company's 'feedstock input' (refer to item 25 ) exceeds the company's 'feedstock output' (refer to item 26 )in respect of related research and development activities. By item 28 , 'eligible feedstock expenditure' is included within 'research and development expenditure' for the purposes of the concessional rate of deduction (150 per cent up to 7.30 p.m. on 20 August 1996 and 125 per cent thereafter) where the 'aggregate research and development amount' during the year of income exceeds $20,000.

Feedstock input

9.37 This new definition is being inserted in subsection 73B(1) by item 25 . It is the expenditure incurred on feedstock that was processed or transformed in a year of income.

Feedstock output

9.38 This new definition is being inserted in subsection 73B(1) by item 26 . It is the value of products derived from processing or transforming feedstock in a year of income. More particularly, it is the selling value of any such products sold during the year of income under arm's length transactions and the amount that could have been obtained if the remaining products were sold at the end of the year under arm's length transactions. If there is no ready market, that latter amount could be measured by reference to the arm's length price the taxpayer would be prepared to pay another person to obtain those products.

Residual feedstock expenditure

9.39 This new definition is being inserted into subsection 73B(1) by item 29 . It is the feedstock input or the feedstock output, whichever is the lesser. New subsection 73B(14B) , being inserted by item 31 , will authorise a deduction equal to the residual feedstock expenditure of a year of income against a company's assessable income of that year.

9.40 In applying the concessional rate of deduction for eligible feedstock expenditure [items 23 and 30] and the 100 per cent rate of deduction for residual feedstock expenditure [item 29] , it is necessary to have regard to the meaning of 'feedstock expenditure' being inserted in subsection 73B(1) by item 24 . It is expenditure incurred by a company in acquiring or producing materials or goods to be the subject of processing or transformation in research and development activities, including expenditure incurred on direct energy inputs to the processing or transformation.

Example 1

		Year 1	Year 2	Year 3	Year 4
		($,000)	($,000)	($,000)	($,000)
A	Feedstock Input	700	400	900	200
B	Feedstock Output	400	800	300	50
C	Eligible Feedstock Expenditure (Amount A exceeds B)	300	0	600	150
D	Residual Feedstock Expenditure (Lesser of A or B)	400	400	300	50

In this example, the company spent $2,200,000 of which $1,050,000 was deductible at the premium rate (eligible feedstock expenditure) and $1,150,000 was deductible at the 100 per cent rate (residual feedstock expenditure).

Example 2

		Year 1	Year 2	Year 3	Year 4
		($,000)	($,000)	($,000)	($,000)
A	Feedstock Input	400	800	700	400
B	Feedstock Output	600	500	300	600
C	Eligible Feedstock Expenditure (Amount A exceeds B)	0	300	400	0
D	Residual Feedstock Expenditure (Lesser of A or B)	400	500	300	400

In this example, the company spent $2,300,000 of which $700,000 was deductible at the premium rate (eligible feedstock expenditure) and $1,600,000 was deductible at the 100 per cent rate (residual feedstock expenditure).

(f) Modify the deduction rules for core technology

9.41 Items 33 to 41 of Division 6 of Part 1 of Schedule 4 of the Bill will apply to alter the basis of deduction under section 73B of core technology expenditure. The new deduction rule is contained in new subsection 73B(12A) .

9.42 New subsection 73B(12A) limits the deduction for core technology expenditure incurred in a year of income to a maximum of one-third of the amount of research and development expenditure (as defined in subsection 73B(1)) incurred during the year on particular research and development activities that are related to the core technology. Existing subsection 73B(1AB) defines the conditions under which core technology is related to particular research and development activities.

9.43 Any undeducted amount of the core technology expenditure may be carried forward and deducted in a future year in which research and development activities related to the core technology occur. The amount carried forward for deduction is called 'undeducted past expenditure' (see new subsection 73B(12B) ). It is simply that part of the relevant core technology expenditure as has not been allowed previously as a deduction. In any year, the deduction will be limited to one-third of the related research and development expenditure.

9.44 If core technology is disposed of, the existing law treats as assessable income of the vendor any amount received or receivable in relation to the disposal. To take account of the fact that, at the time of disposal, a proportion of the vendor's core technology expenditure may not have been deducted - because of the limitations expressed in new subsection 73B(12A) - the assessable amount on disposal of core technology will be reduced to the extent that the core technology expenditure of the vendor has not been allowed as a deduction under new subsection 73B(12A) . This is being achieved by item 41 which amends existing subsection 73B(27C) so that an amount included (under subsection 73B(27A)) in assessable income from the disposal of core technology only includes any excess of the amount receivable on disposal over the 'core technology adjustment amount' (see item 35 ).

9.45 Core technology adjustment amount means the total amount of a company's expenditure on the core technology, less amounts deductible in respect of that core technology under new subsection 73B(12A) .

9.46 In a year in which core technology is disposed of, the amount carried forward for deduction will be reduced by an amount called the 'current year core technology adjustment amount' (see new subsection 73B(12B) ). It is the lesser of the core technology adjustment amount (ie. the undeducted core technology expenditure) and any amount that would have been included in the vendor's assessable income except for being extinguished by the core technology adjustment amount (see definition of 'current year core technology adjustment amount' in new subsection 73B(12B) ).

Example

•

A company incurs core technology expenditure of $100,000.

•

Under subsection 73B(12A), it has been allowed deductions of $30,000.

•

It disposes of the core technology for $40,000.

On disposal, the amount of $40,000 is assessable under 73B(27A), but new paragraph 73B(27C)(c) requires the assessable amount to be reduced by the 'core technology adjustment amount', in this case $100,000 less $30,000 = $70,000. Therefore, no amount is included in assessable income.

The company's 'current year core technology adjustment amount' is the lesser of $70,000 (the core technology adjustment amount) and $40,000 (the amount that would have been assessable under subsection 73B(27A) but for new paragraph 73B(27C)(c). That means the undeducted past expenditure which may be carried forward for deduction is reduced by $40,000.

(g) Modify the deduction rules for pilot plant

9.47 Items 43 to 55 of Division 7 of Part1 of Schedule 4 of the Bill alter the basis of deduction under section 73B for the cost of pilot plant that is acquired or constructed under a contract entered into after 5pm, by standard time in the Australian Capital Territory on 23 July 1996. (See the definition of 'post - 23July pilot plant' being inserted by item 47 in subsection 73B(1) and explained in new subsection 73B(4C) [item 50] ).

9.48 New subsection 73B (15AA) [item 51] allows a deduction in respect of a unit of post - 23July 1996 pilot plant in a year of income for the 'deductible amount' of the qualifying expenditure in respect of the unit. Qualifying expenditure is expenditure incurred in the acquisition or construction by a company of a unit of pilot plant for use by the company exclusively for the purpose of carrying on by or on behalf of the company of research and development activities. (See new subsection 73B(4C) being inserted by item 50 ).

9.49 The 'deductible amount' is the qualifying expenditure (as defined in new subsection 73B(4C) ) multiplied by the 'annual deduction percentage' multiplied by 1.5 (see new subsection 73B(4E) being inserted by item 50 ). The 1.5 multiplier is reduced to 1.25 in respect of qualifying expenditure incurred after 7.30pm, by standard time in the Australian Capital Territory, on 20August 1996. (See the amendment to new subsection 73B(4E) by item 2 ).

9.50 The 'annual deduction percentage' is worked out in the same way as the annual depreciation percentage would be worked out under section 55 if the pilot plant were depreciable plant or articles to which section 54 applied. For that purpose, use in carrying on research and development activities is treated as use for assessable income-producing purposes, and the term 'useful life' is substituted for the term 'effective life' that is used in calculating depreciation allowances. (See new subsection 73B(4J) being inserted by item 50 ).

9.51 In summary, qualifying pilot plant expenditure is deductible on a straight line basis by multiplying the expenditure by the annual deduction percentage based on the useful life of the pilot plant. The new deduction rule means that the deduction allowable for pilot plant under section73B is the same as would be allowable under section54 at the prime cost rate calculated under paragraph 56(1)(b), i.e. 2/3rds of the annual depreciation percentage fixed under section55 according to the effective life of the pilot plant. One departure from the depreciation basis of deduction is that the deduction under section73B will not be subject to pro-rating (as under subsection 56(1A)) where the pilot plant is not used in research and development activities for the whole of the income year.

(h) Clarify the definition of 'research and development activities'

9.52 The definition of 'research and development activities' will be made more explicit by importing concepts from the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986 . This will make the definition of 'research and development activities' more effective in two ways:

•

firstly, the interpretation of the definition of 'research and development activities' is clearer at first glance, and will aid the policy of self assessment in taxation matters; and

•

secondly, it puts Parliament's intent for the meaning of 'research and development activities' into a statutory framework which is easier to interpret and administer.

9.53 This amendment specifically recognises the needs of small companies, who do not have the benefit of specialist advisers to provide guidance on the interpretation of the definition of 'research and development activities' when determining their taxable income. This is achieved while maintaining the original intent of Parliament.

9.54 The meanings of 'innovation', 'high levels of technical risk' and activities which are not taken to be systematic experimental or investigative for the purposes of the definition of 'research and development activities' are taken directly from the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986 .

9.55 The explanatory notes to the concept of 'innovation' in the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986 also apply in respect of the new provisions, namely that innovation may be assessed according to several criteria, including that:

•

the activities are seeking previously undiscovered phenomena, structures or relationships;

•

the activities are attempting to apply knowledge or techniques in a new way; or

•

the activities are likely to result in patentable or other protectable intellectual property.

9.56 Innovation is to involve an appreciable element of novelty. This means that a fairly large constituent part of the activity must involve novelty.

[Amended definition in subsection 73B(1), new subsections 73B(2B) and 73B(2C)]

Section 2 - Amendments to the IR & DA

Summary of the amendments

Purpose of the amendments

9.57 The amendments will:

•

remove the Industry Research and Development Board's (the Board) power to register syndicates under section 39P for the tax concession;

•

allow the Minister to provide formal advice to the Board and its committees;

•

ensure that the general administrative arrangements for research and development programs contained in the Industry, Research and Development Act 1986 will also apply to programs administered through delegated legislation authorised under sections 19 and 20.

Date of effect

9.58 The removal of syndication under section 39P of the Industry, Research and Development Act 1986 (IR & DA), and related provisions, apply from 5pm, by standard time in the Australian Capital Territory on 23 July 1996. Other measures apply from Royal Assent.

Explanation of the amendments

Clarification of grant provisions

9.59 Item 62 amends the definitions of 'agreement under this Act' in subsection 4(1), so that it conforms with modern practice for the drafting of legislation.

9.60 Item 63 amends the IR & DAs definition of 'agreement under this Act' so that the definition includes agreements made in the course of programs that are administered through delegated legislation.

9.61 In the past the administrative arrangements for industry research and development assistance programs were contained in the body of the IR & DA. The administrative arrangements for existing programs are contained in delegated legislation in the form of ministerial directions given to the Board under subsection 19(1) and section 20. Administrative arrangements for future programs will also be set out in delegated legislation made under subsection 19(1) and section 20.

9.62 The item 63 amendment is to ensure that sections 36 to 39 of the IR & DA will apply to agreements made in the course of programs governed by delegated legislation. Section 36 prevents the Board from making an agreement unless it is satisfied that the results of the project will be exploited on normal commercial terms for the benefit of the Australian economy. Section 37 allows the Board to reduce the amount of a subsidy to take into account other Commonwealth assistance given to the researcher for the same project. Section 38 protects the Commonwealths right to seek the repayment of a subsidy in the event of breach by the researcher. Section 39 restricts the payment of a subsidy to a person who has incurred the cost of the research and development project.

9.63 Item 64 amends the definitions of 'application' in subsection 4(1), so that it conforms with modern practice for the drafting of legislation. The definition of 'subsidy' is similarly amended by item66 .

9.64 Item 65 amends the IR & DAs definition of 'application' so that applications made in the course of programs that are administered through delegated legislation are included in the definition. The definition of 'subsidy' is similarly amended by item 67 .

9.65 The purpose of item 65 is similar to that of item 63 . This amendment ensures that section 35 will apply to applications made in the course of programs governed by delegated legislation. Section 35 requires that an application be in a form approved by the Board, deems that an application has not been made until the Board has received it and empowers the Board to refuse to consider an application unless the applicant provides further information.

9.66 Part III of the IR & DA specifically provides for four industry research and development assistance programs but the Board will not enter new agreements under these provisions. This item introduces a sunset clause for the national procurement development program in order to prevent any confusion between this program and existing or future programs that are administered through delegated legislation.

Clarification of Ministers powers of direction

9.67 As discussed at paragraph 9.66, the Board no longer enters into agreements under the programs specified in the IR & DA, ie: the discretionary grant program, the generic technology agreements program, the national interest agreements program and the national procurement development agreements program. Subsection 20(1) contains a list of examples of the Boards functions and powers in parentheses. The discontinued programs are included in the list. The amendment removes this list of examples as it is out of date and no longer aids in the interpretation of the section.

Introduction of new power for Minister to provide advice

9.68 Item 69 introduces new section 20A to the IR & DA. This new provision creates a power in the Minister to give advice to the Board or a committee of the Board.

9.69 The purpose of the amendment is to allow the Minister a formal channel of communication with the Board and its committees, one where the Board or committee is not bound by the terms of the communication. This new channel of communication is to be distinguished from the power in subsection 20(1). Subsection 20(1) empowers the Minister to instruct the Board as to how it must perform its functions. The new power in new subsection 20A(1) will allow the Minister to recommend that the Board or a committee take into account certain factors in the performance of its functions, but it is not obliged to do so.

9.70 Examples of the advice that the Minister may offer the Board and its committees include:

•

a recommendation that the Board take into account certain reference material when considering the research and development activities of companies in a particular industry; eg a report that discusses what is or is not innovative in the software industry; and

•

a recommendation as to how the Board or a committee might prioritise its workload.

9.71 The new section allows the Minister to provide advice to a committee of the Board for two reasons. Firstly, the subject of the advice may relate to the activities of a particular committee of the Board and in this case it would be more expedient for the Minister to provide the advice directly to the committee. Secondly, not all members of committees are also members of the Board and these members might not be informed if that advice could only be forwarded to the Board.

9.72 The provision of ministerial advice to the Board or a committee under this section is to be documented and included on the public record to ensure transparency and accountability in administration. The combination of new subsection 20A(2) , new subsection 20A(4) and amended subsection 46(2) achieve this purpose. New subsection 20A(2) requires that ministerial advice be in writing, expressly state that it is given under this section and be delivered to the Chairperson of the Board or committee. New subsection 20A(4) requires the Board or committee to acknowledge receipt of advice at its next meeting. Amended subsection 46(2) requires that the Board publicly acknowledge the receipt of ministerial advice in its Annual Report - see paragraph 9.75. Neither new subsection 20A(4 ) nor amended subsection 46(2) require the Board or committee to make any comment on how it will treat the advice received.

9.73 New subsection 20A(3) prohibits the Minister from offering advice on how the Board should perform its functions in respect of a particular person, natural or corporate. This subsection protects the principle of procedural fairness by preventing the Minister from offering advice that relates to a particular applicant.

9.74 Item 78 amends subsection 46(2) of the IR & DA so that it conforms with modern practice for the drafting of legislation.

9.75 Item 79 amends section 46(2) to require the Board to publish details of any advice given to the Board or a committee of the Board under section 20A in its Annual Report. The report need not contain a copy of the advice but should report the subject matter of the advice, any recommendations made by the Minister and the date of the meeting at which the Board or committee first considered the advice. The report need not include any other details of the Boards or committees consideration of the advice.

Cessation of Boards powers to register companies jointly

9.76 Item 71 modifies section 39P to take into account new section 39PA .

9.77 Item 72 inserts new section 39PA . Subsection 39PA(1) ends the Boards power to register companies jointly for the tax concession for research and development. Companies registered jointly under section 39P are commonly referred to as a syndicate. Subsections 39PA(2) and 39PA(3) introduce transitional provisions that permit the Board to consider two classes of unregistered syndicate proposals - for the first class see paragraphs 9.79-9.85 and 9.88-9.90; for the second class see paragraphs 9.86- 9.87.

9.78 The purpose of new section 39PA is to end the registration of syndicates, not merely restrict or alter it. Syndicate registration was introduced into the legislation to allow companies to work together on research and development projects that they were unable to attempt alone. The program has, however, become a focus for elaborate financial mechanisms that generate guaranteed returns to investors rather than for the purpose of undertaking R & D with a realistic prospect of successful commercialisation. New subsection 39PA(1) is introduced to prevent additional Commonwealth funds from being expended through an incentive program which has not met its objective at an acceptable cost to revenue.

9.79 Subsection 39P(2) is a transitional provision that allows the Board to register some syndicates. Syndicate proposals will only be eligible for consideration if they received a favourable advance approval opinion from the Board in respect of both their research and development activities and their finance scheme on or before 23 July 1996.

9.80 An advance opinion is a written statement of the Board that is given in response to a request from a person interested in applying for registration under section 39P. Advance opinions were given to facilitate that persons consideration of whether or not to apply for joint registration. The giving of an advance opinion is not essential for the Boards performance of its functions under Part IIIA of the IR & DA; it is not a decision made under the IR & DA or the finance scheme guidelines and is therefore not reviewable. However, this activity is relevant to the transitional arrangements that accompany these amendments. Accordingly, new paragraph 39PA(4) provides a statutory definition of a favourable advance approval opinion as advance approvals are not otherwise mentioned in the IR & DA.

9.81 New subsection 39PA(2) recognises and accommodates a practice that has grown among syndicate promoters and participants. Promoters have tended to seek the Boards advance opinion of the key elements of a syndicate, then use these advance opinions to seek out investors and further develop the syndicate proposal. Applications for registration under section 39P have usually been lodged at a very late stage in the development of a syndicate proposal. In recognition of this, new subsection 39PA(2) allows syndicate proposals that have received both components of a favourable advance approval opinion but have not lodged an application under section 39P(1) to lodge an application and have their proposal considered for registration. Syndicate proposals in this situation must lodge an application within 12 months of the commencement of the section.

9.82 It has been the Boards practice to place a nine month time limit on the validity of its advance approval for a syndicates R & D activities. This time limit has allowed for the fact that advancements in science and technology occur rapidly. Activities that were considered eligible research and development at the time of an advance opinion might not be considered innovative nine months later and hence be ineligible. This time limit was imposed to warn potential investors that the syndicates R & D activities may not be approved at registration stage, despite the existence of the advance opinion. This nine month time limit has no effect on a proposed syndicates eligibility to apply for registration under new subsection 39PA(2) . A favourable advance opinion of R & D activities that was given more than nine months before the commencement of the section is a favourable advance approval opinion of R & D activities for the purposes of the section.

9.83 New subsection 39PA(2) does not oblige the Board to register a syndicate proposal merely because the proposal has received a favourable advance opinion of its R & D activities and finance scheme. When making its decision on joint registration, the Board must consider all the criteria in subsection 39P(3). As has always been the case, it is open to the Board to depart from its advance opinion when making a registration decision under subsection 39P(3).

9.84 New subsection 39PA(2) only permits the Board to register a syndicate in relation to the same project for which the favourable advance approval opinion was granted: the advance opinion was given 'in relation to a proposed project' and the Board may register 'in relation to the project'. Unregistered syndicate proposals cannot remodel their proposals and seek registration of a different project under the guise of the project for which a favourable advance approval opinion was given. The following lists some examples of changes which would constitute a remodelled proposal:

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additional core technology; or

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significant, additional expenditure on core technology; or

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a different or modified technical objective; or

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a different researcher; or

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significant changes to the legal rights and obligations between syndicate participants; or

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significant changes to the syndicates finance scheme,

This list is not exhaustive

9.85 The terms of new subsection 39PA(2) allow a syndicate to change the year or years of income in which the participants will incur expenditure in relation to the project. The subsection empowers the Board to register the syndicate 'in respect of the year of income or years of income specified in the application'. It is possible that the years of income specified in the application will differ from the years of income the syndicate specified when the favourable advance approval opinion was given.

9.86 New subsection 39PA(3) allows the Board to register a syndicate where, before the commencement of this section, the Board had refused to register the syndicate under subsection 39P(3) but that decision to refuse registration has since been overturned on review.

9.87 New subsection 39PA(3) ensures that nothing in these amendments affects the rights of review of a person in respect of a joint registration decision made prior to the commencement of this section.

9.88 New subsection 39PA(4) defines favourable advance approval opinion. To have a favourable advance approval opinion a syndicate proposal must have the Boards advance approval of both its R & D activities and its finance scheme.

9.89 The provision expressly distinguishes an advance approval opinion in respect of a proposed finance scheme and decision made by the Board under the IR & DA or the finance scheme guidelines. It does this to avoid any potential confusion about the operation of subsection 39S(1A). Subsection 39S(1A) allows for the review of decisions made under the finance scheme guidelines. An advance opinion on the eligibility of a finance scheme is not a decision, and it is not made under the finance scheme guidelines:

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as discussed at paragraph 9.80, an advance opinion is not a decision but rather a service provided by the Board in order to facilitate a persons consideration of whether or not to apply for registration under section 39P(1); and

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when the Board considers the eligibility of a syndicates finance scheme it refers to the finance scheme guidelines but it does not make a decision under those guidelines.

9.90 Section 39EA(4) enables the Board to make finance scheme guidelines that confer functions and powers on the Board. Only decisions made in the exercise of functions and powers conferred by the finance scheme guidelines are decisions made under the finance scheme guidelines. To date, the Board has not created finance scheme guidelines that confer functions and powers on the Board. As the finance scheme guidelines do not confer a function or power to provide advance opinions subsection 39S(1A) does not apply to advance approval opinions.

9.91 Item 73 introduces a transitional provision which ensures that where the Board registers a syndicates proposal after 23 July 1996, being a proposal which does not meet the criteria contained in new subsections 39PA(2) and 39PA(3) , that registration has no effect.

Extension of registration to complete project

9.92 To date, the IR & DA has not made provision for the variation or extension of an existing syndicate registration. Any material variation was considered a new syndicate requiring new registration. In the past, syndicates wishing to vary the terms or extend the term of their registration under section 39P would make a new application under subsection 39P(1). With the introduction of new subsection 39PA(1) , syndicates will not be able to make new applications for registration therefore the right of a syndicate to vary its registration ceases.

9.93 However, item 74 inserts new section 39PB which creates a mechanism for the Board to approve an extension of a syndicates period of registration under section 39P. This mechanism is for extensions of time only; it cannot be used to approve a variation to a syndicates registration. - see paragraph 9.98.

9.94 Where changes to a project have been approved in writing by the Board after the date of registration and before 23 July 1996, the project as at 23 July 1996 is the project for which the companies have registration under section 39P.

9.95 This transitional provision has two purposes. The first is to allow syndicates whose R & D project has run overtime to complete the R & D activities for which they were registered and claim the tax concession for those activities. The second purpose is to encourage syndicates to commercialise the outcomes of their R & D projects by allowing them to lengthen the period in which they can claim deductions for interest expenditure.

9.96 Registered syndicates must lodge their applications for extension under new subsection 39PB(1) before their original period of registration expires. This will ensure that new section 39PB is not used to revive syndicates that are finished. Syndicates must lodge their applications for extension before 30 June 2000; this allows sufficient time for a syndicate to determine if the R & D project will run over time or if an extension is needed for successful commercialisation of the project outcomes.

9.97 New subsection 39PB(3) empowers the Board to extend the registration of a syndicate up to and including the 2004/2005 year of income; this period is sufficient for syndicates to complete and commercialise their R & D projects.

9.98 New subsection 39PB(4) provides criteria for the type of extensions that the Board can approve. These criteria are specified in order to prevent the Board from approving extensions which involve variations to the syndicate and/or which increase the cost of the syndicate to Commonwealth revenue. In particular, the Board may not extend the syndicates registration under section 39P of the IR & DA to cover additional expenditure on core technology or additional R & D activities for which the syndicate was not registered.

9.99 The prohibition on additional core technology expenditure will also prevent the revaluation of core technology that has already been the subject of a syndicates registration. This will prevent the transfer of funds that were earmarked for R & D activities to core technology expenditure in order to increase the tax benefit received by an investor.

9.100 New paragraph 39PB(4)(c) requires the Board to satisfy itself that a syndicate will exploit the results of the R & D project on normal commercial terms and for the benefit of the Australian economy prior to granting an extension of time. The syndicates project will be close to completion when an extension is sought under new section 39PB , thus assisting the syndicate to demonstrate the planned exploitation for the outcomes of the project.

9.101 New paragraph 39PB(4)(d) prevents syndicates from using the extension of time mechanism to increase the total amount of expenditure they will incur in respect of the research and development activities for which they are registered, as specified in accordance with paragraph 39P(2)(c) in the application for registration.

9.102 This means that the extension of time will apply only up to the point that a syndicate reaches the expenditure ceiling specified under paragraph 39P(2)(c). Syndicates cannot obtain the tax benefits that flow from section 39P registration for any expenditure above that ceiling even if the expenditure is in respect of R & D activities for which the syndicate had been registered.

9.103 Section 39PB allows the syndicate to incur that expenditure over a greater period of time. It does not allow the syndicate to increase its total expenditure, as this would involve an additional cost to Commonwealth revenue and be contrary to the action of subsection 39PA(1) to end syndicate registration.

9.104 For reasons of procedural fairness, the Board must give reasons for its decision to an applicant where it decides not to grant an extension of time. A refusal to grant an extension is reviewable by the Board under subsection 39S(1) of the IR & DA and also by the Administrative Appeals Tribunal.

9.105 New paragraph 39PB(6) provides an enforcement mechanism. Syndicates are granted extensions of the period of their registration only if they meet the criteria listed in new subsection 39PB(4) . If, after the extension is granted, the Board becomes aware that a syndicate no longer meets those criteria the Board must issue a certificate to the Commissioner of Taxation under new subsection 39PB(6) .

9.106 Where the Board becomes of the opinion that a syndicate has incurred expenditure which was not identified in the application for registration under paragraph 39P(2)(c), the Boards certificate must indicate the date from which the ineligible expenditure was incurred.

9.107 Once the Commissioner receives a certificate issued by the Board under new subsection 39PB(6) , new subsection 73B(33BA) of the Income Tax Assessment Act 1936 obliges the Commissioner to disallow any deductions for expenditure that were beyond the scope of the syndicates registration under section 39P. Where the Boards certificate indicates a date in which the limit of expenditure specified in the syndicates application under paragraph 39P(2)(c) was exceeded, the Commissioner will disallow deductions from that date.

9.108 New subsection 73B(33BB) of the Income Tax Assessment Act 1936 ensures that new subsection 73B(33BA) does not affect or restrict a syndicate participant from claiming expenditure in respect of R & D activities for which it is registered under section 39J of the IR & DA. This certificate mechanism only enforces the use of the extension provisions in new section 39PB , it does not affect other rights.

9.109 Before it issues a certificate under new subsection 39PB(6) , the Board must notify any companies affected that it is considering issuing such a certificate and provide reasons for this consideration. The Board must allow any affected company a reasonable opportunity to make a submission, and must give appropriate consideration to any submissions it receives.

9.110 Under section 39T(1), the decision to issue a certificate under new subsection 39PB(6) is reviewable by the Administrative Appeals Tribunal.

Modification to account for loans assistance

9.111 Item 77 modifies section 42 of the Act to reflect that the Commonwealth now provides assistance through the Act by way of loans, as well as by way of grants. The imposition of a three month limit on advances of subsidies may not be appropriate in the case of a loan, and the Board may now provide an advance in respect of a longer period where the Board considers this to be appropriate.

9.112 In some instances the Board may enter into an agreement, whereby the recipient of the financial assistance is required to repay that assistance from income generated as a result of the project supported by that assistance. Where this is the case, and the Board does not require the recipient to repay the assistance if there is no income generated as a result of the project supported by that assistance, then that assistance does not constitute a loan, and the three month limit on advances applies. In determining whether assistance is a loan, repayment of assistance as a result of a recipient breaching the terms of the agreement under which the assistance was provided should not be taken into account.