Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 11 - Research and development
Overview
11.1 Schedule 11 of the Bill amends the research and development (R & D) provisions of the Income Tax Assessment Act 1936 (ITAA)(section 73B) consequent upon changes to those provisions contained in Taxation Laws Amendment Act (No. 3) 1996 (TLAA3).
Summary of the amendments
11.2 The amendments will:
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- apply the core technology deduction rules currently contained in subsections 73B(12), 73B(12A), 73B(12B), 73B(12C), 73B(27B) and 73B(27C) of the ITAA (the core technology rules) to companies in partnership, with the exception of those companies jointly registered under section 39P of the Industry Research and Development Act (IR & DA). The amendment will apply the same limitations on core technology deductions to companies in partnership as currently apply to other companies;
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- disallow deductions for companies registered jointly under section 39P of the IR & DA (syndicates) where an extension of the joint registration has been granted under section 39PB and the Industry Research and Development Board (the Board), having determined that the syndicate has breached a condition of that extension, issues a certificate to the Commissioner of Taxation under subsection 39PB(6);
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- ensure that the formula used to calculate deductible 'residual feedstock expenditure' deals appropriately with a taxpayer's multiple R & D activities within a year by permitting the deductions only on a "related R & D activity per annum" basis;
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- ensure a deduction for core technology expenditure is allowable in the year the expense was first incurred;
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- correct a paragraph citation;
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- change a heading in the depreciation table for post 23 July 1996 pilot plant; and
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- include a balancing adjustment provision for post 23 July 1996 pilot plant which is disposed of prior to the completion of the R & D activity.
11.3 The extension of the core technology rules to partnerships will apply to core technology expenditure incurred under contracts entered into on or after 8.30pm, by standard time in the Australian Capital Territory, on 13 December 1996.
11.4 The remaining amendments will apply as originally intended and announced, from 5pm by standard time in the Australian Capital Territory on 23 July 199
6. [Item 12]
Explanation of the amendments
11.5 Prior to the enactment of the TLAA3, core technology expenditure was wholly deductible under subsection 73B(12) of the ITAA in the year of income in which the expenditure was 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.
11.6 However, by amendments contained in TLAA3, 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 incurred during the year on particular research and development activities that are related to the core technology. Subsection 73B(1AB) defines the conditions under which core technology is related to particular research and development activities. Companies in partnership are not affected by the limit introduced by the amendments, however.
11.7 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 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.
11.8 If core technology is disposed of, the assessable income of the vendor includes any amount received or receivable on disposal. However, 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 deduction limitations described above - the assessable amount on disposal of the core technology is reduced to the extent that the core technology expenditure of the vendor has not been allowed as a deduction.
11.9 Item 13 ensures that the core technology deduction limits apply to companies in partnership, except companies jointly registered under section 39P of the IR & DA. This will place companies in partnership on the same footing as other companies in relation to deductions allowable for core technology expenditure.
Breach of conditions for extension of joint registration
11.10 TLAA3 amended section 39P of the IR & DA to prevent the Board from registering companies jointly, commonly known as syndicates, for the R & D tax concession.
11.11 Transitional arrangements, under section 39PB, allow the Board to extend the registration period for existing syndicates to allow sufficient time to complete the project. Syndicates may be granted extensions of the period of their registration only if they meet the criteria listed in subsection 39PB(4). If, after an extension is granted, the Board becomes aware that a syndicate no longer meets those criteria the Board must issue a certificate to the Commissioner under subsection 39PB(6).
11.12 The certificate must declare that the companies have incurred R & D expenditure or core technology expenditure other than as specified in the application for registration, or that total expenditure in respect of R & D activities exceeds that specified in the application and the date on which such "ineligible" expenditure was incurred.
11.13 New subsection 73B(33BA) will ensure that a deduction is not allowable for expenditure, specified in a certificate given to the Commissioner under subsection 39PB(6) of the IR & DA, that is incurred after the date specified by the Board in the certificate. [Items 10 and 11]
11.14 New subsection 73B(33BB) of the ITAA 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 individually registered under section 39J of the IR & DA. [Items 10 and 11]
11.15 The feedstock provisions of the R & D Tax Concession limit the concessional rate of deduction for the cost of R & D feedstock to the net costs of feedstock i.e., by excluding from the concession the cost of any valuable products derived from processing or transforming feedstock through R & D activities. In effect, the cost of the feedstock that is fully expended in the R & D process receives a 125 per cent deduction, but the portion of the feedstock cost absorbed in creating products receives only a 100 per cent deduction.
11.16 To do this, the feedstock provisions divide feedstock expenditure into eligible feedstock expenditure (subject to 125 per cent deduction) and residual feedstock expenditure (subject to 100 per cent deduction). While the formula used (and examples given in the explanatory memorandum to TLAA3) produce a correct result where there is only one R & D activity being undertaken in any one year, it may not be correct where there is more than one R & D activity being undertaken in any one year.
11.17 For example where, within the same year, the feedstock from each R & D activity is worth less at the end of the R & D activity than when it was fed into that activity, the formula works as intended. However where, within the same year, the feedstock from one R & D activity is worth less at the end of the activity, but the feedstock from another R & D activity is worth more at the end of the activity, the formula can have the unintended effect of providing deductions (concessional or otherwise) for non-existent costs. The following example illustrates the unintended effect:
Example (this example shows how the intended result can be distorted if a taxpayer has feedstock expenditure relating to more than one R & D activity and the feedstock output of one activity is worth more than the feedstock input, while the feedstock output of another is worth less than the feedstock input)
| Activity 1 ($,000) | Activity 2 ($,000) | Result using existing law ($,000) | Result as intended ($,000) | |
|---|---|---|---|---|
| A Feedstock Input | 700 | 800 | 1500 | |
| B Feedstock Output | 300 | 1100 | 1400 | |
| C Eligible Feedstock Expenditure (125%) (Amount A exceeds B) | 400 | 0 | 400 | |
| D Residual Feedstock Expenditure (100%) (Lesser of A or B) | 300 | 800 | 1400 | 1100 |
The result should be that, of $1500 feedstock input, $400 is eligible for the concessional 125% deduction while $1100 is deductible at 100%. By allowing the two different R & D activities to be combined, the formula produces the result that $400 is eligible for the concessional deduction and $1400 for deduction at 100%, i.e. $300 more altogether than was actually expended on feedstock.
11.18 The amendmentsensure that the formula properly deals with multiple R & D activities by the same taxpayer by applying it separately to each particular R & D activity undertaken by a taxpayer. [Items 1-3 and 8]
11.19 The core technology provisions of the R & D Tax Concession limit the deductions allowable on core technology (existing technology which is the basis for further R & D) expenditure to one third of the related R & D expenditure in any year. Any undeducted amount may be carried forward and deducted in a future year in which R & D activities related to the core technology occur. Subsection 73B(1AB) defines the conditions under which core technology is related to particular research and development activities.
11.20 At present, the core technology expenditure which is the basis of the deduction is defined as the expenditure on that core technology incurred in any previous year (to the extent that a deduction has not already been allowed for that expenditure). This definition means that, inadvertently, deductions for core technology expenditure will only be available from the year after the expenditure was first incurred, rather than from the year in which it was incurred.
11.21 The amendments ensure that the undeducted core technology expenditure that is available for deduction is the core technology expenditure incurred before or during the current year of income to the extent that a deduction has not yet been allowed for that expenditure. [Items 5 and 6]
11.22 Within the core technology calculation at subsection 73B(12B) of the Act there is a definition of 'current year core technology adjustment amount'. This definition contains a reference to paragraph 73B(27)(c), which should be a reference to paragraph 73B(27C)(c).
11.23 The amendment inserts the correct reference. [Item 7]
Pilot plant depreciation table
11.24 The pilot plant provisions of the R & D Tax Concession changed the method of calculating the deduction for expenditure incurred on pilot plant. In particular, subsection 73B(4H) of the Act contains a depreciation table for R & D pilot plant. This table requires the taxpayer to determine the 'annual deduction percentage' for calculating pilot plant depreciation by taking two-thirds of the percentage rate shown in the table. However, the table shows this percentage rate as the 'annual deduction percentage'. This creates something of a nonsense in that the 'annual deduction percentage' is two-thirds of the 'annual deduction percentage'.
11.25 The amendment changes the heading of the percentage rate in the table to 'percentage'. [Item 4]
Post 23 July 1996 pilot plant balancing amount
11.26 Subsection 73B(23) of the Act determines whether a balancing amount should be included in assessable income or a further deduction should be allowed where R & D plant is disposed of.
11.27 However, provisions enacted in 1996 excised from the definition of R & D plant, any plant which was post 23 July 1996 pilot plant. This was done to provide a new depreciation regime for post 23 July 1996 pilot plant, similar to the general depreciation provisions of the Act. The result is that a balancing adjustment of the kind provided under subsection 73B(23) for other R & D plant does not apply on the disposal of post 23 July 1996 pilot plant.
11.28 The amendment provides a balancing adjustment mechanism for post 23 July 1996 pilot plant disposed of prior to the completion of the relevant R & D activity. [Item 9, new subsection 73B(24B)]