House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Schedule 1 - Accelerating the Personal Income Tax Plan

Schedule 1 to the Bill amends the income tax law to reduce the tax payable by individuals in the 2020-21 income year and later income years by bringing forward to 2020-21 the changes to income tax thresholds that were to commence in the 2022-23 income year.

Schedule 1 to the Bill also amends the income tax law to:

•

bring forward the increase in the amount of the low income tax offset to $700 (from $445) by two years to the 2020-21 income year and later income years (instead of the 2022-23 income year and later income years); and

•

retain the low and middle income tax offset for the 2020-21 income year, with the offset now ceasing to be available from the 2021-22 income year onwards.

Date of effect: The changes to the income tax thresholds and low income tax offset apply to the 2020-21 income year and later years.

The changes to the low and middle income offset apply to the 2021-22 income year and later years.

Proposal announced: Schedule 1 to the Bill fully implements the measure 'JobMaker Plan - Bringing forward the Personal Income Tax Plan and retaining the low and middle income tax offset' from the 2020-21 Budget.

Financial impact: This measure is estimated to have the following impact on revenue over the forward estimates period ($m):

Human rights implications: Schedule 1 to the Bill does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 9.

Compliance cost impact: This measure is expected to only have a minor regulatory impact.

Schedule 2 - Temporary loss carry back

Schedule 2 to the Bill amends the income tax law to allow corporate tax entities with an aggregated turnover of less than $5 billion to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

Date of effect: The measure will apply to assessments made in the 2020-21 income year and in the 2021-22 income year.

Proposal announced: Schedule 2 to the Bill fully implements the measure JobMaker Plan - temporary loss carry back to support cash flow from the 2020-21 Budget.

Financial impact: This measure is estimated to have the following receipts impact over the forward estimates period ($m):

Human rights implications: Schedule 2 to the Bill does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 9.

Compliance cost impact: Low.

Summary of regulation impact statement

Regulation impact on business

Impact: This proposal is expected to result in a low overall compliance cost impact, comprising a low implementation impact and low impact in ongoing compliance costs.

Main points:

•

The Government has introduced a number of initiatives (including temporary full expensing) to support businesses withstand and recover from the economic effects of the Coronavirus. However, the current tax treatment of company losses will limit the effectiveness of some of those initiatives. Furthermore, for companies that suffer tax losses due to the economic effects of the Coronavirus, the requirement to carry those losses forward will delay access to the loss's tax value.

•

Temporary loss carry back allows companies that paid tax in previous years to utilise their current losses rather than carry them forward. Conceptually, the loss is carried back to reduce the earlier profit and the corresponding reduction in tax is refunded to the company.

•

Past reviews and stakeholder consultations have established that there is justification and support for introduction of a loss carry back.

•

The gross benefits provided by temporary loss carry back are due to the reduction in company tax paid. These amounts are orders of magnitude larger than the direct regulatory costs. The revenue implications associated with temporary loss carry back generate economic benefits that will support the economic recovery from the effects of the Coronavirus.

Schedule 3 - Increasing the small business entity turnover threshold for certain concessions

Schedule 3 to the Bill amends the A New Tax System (Goods and Services Tax) Act 1999, Customs Act 1901, Excise Act 1901, Fringe Benefits Tax Assessment Act 1986, Income Tax Assessment Act 1936, Income Tax Assessment Act 1997 and Taxation Administration Act 1953 to enable eligible entities with an aggregated turnover of $10 million or more and less than $50 million to access the following small business entity tax concessions:

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a simplified accounting method for the purposes of GST, if determined by the Commissioner;

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the ability to defer excise-equivalent customs duty to a monthly reporting cycle;

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the ability to defer excise duty to a monthly reporting cycle;

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a fringe benefits tax exemption in relation to small business car parking;

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a fringe benefits tax exemption in relation to the provision of multiple work-related portable electronic devices;

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an immediate deduction for certain prepaid expenses;

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a two year amendment period in respect of amendments to income tax assessments;

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an immediate deduction for certain start-up expenses;

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the simplified trading stock rules; and

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the ability to calculate their PAYG instalments based on GDP-adjusted notional tax.

Date of effect: Schedule 3 to the Bill commences on the first 1 January, 1 April, 1 July or 1 October after the day the Bill receives Royal Assent. Eligible entities will be able to access these concessions in phases from 1 July 2020.

Proposal announced: Schedule 3 to the Bill implements the measure 'Increase the small business entity threshold' from the 2020-21 Budget.

Financial impact: These amendments are estimated to have the following receipts impact over the forward estimates period ($m):

Human rights implications: Schedule 3 does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 9.

Compliance cost impact: Schedule 3 to the Bill will result in a low compliance cost saving.

Schedules 4, 5 and 6 - Enhancing the R&D Tax Incentive

Schedule 4 to the Bill reforms the R&D Tax Incentive to help businesses that invest in R&D manage the economic impacts of the Coronavirus pandemic while providing incentives to undertake additional investments in R&D.

Schedule 5 to the Bill enhances the integrity of the R&D Tax Incentive by ensuring that R&D entities cannot obtain inappropriate tax benefits and by clawing back the benefit of the R&D Tax Incentive to the extent an entity has received another benefit in connection with an R&D activity.

Schedule 6 to the Bill improves the administrative framework supporting the R&D Tax Incentive by making information about R&D expenditure claims transparent, enhancing the guidance framework to provide certainty to applicants and streamlining administrative processes.

Date of effect: All of the amendments made by Schedules 4, 5 and 6 to the Bill commence on the first 1 January, 1 April, 1 July or 1 October to occur after the day the Bill receives the Royal Assent. The amendments in the schedules generally apply to income years commencing on or after 1 July 2021. Some administrative amendments in Schedule 6 apply from commencement.

Proposal announced: The Bill fully implements the 2020-21 Budget measure JobMaker Plan - Research and Development Tax Incentive - supporting Australia's economic recovery, which makes a number of changes to the 2019-20 Mid-Year Economic and Fiscal Outlook (MYEFO) measure, Better targeting the Research and Development Tax Incentive - refinements.

The 2020-21 Budget measure is estimated to have a cost to the budget of $2 billion over the current forward estimates period in underlying cash balance terms. This reflects the impact of the policy changes since the 2019-20 MYEFO.

Financial impact: Schedules 4 and 5 to the Bill are estimated to increase the cost of the R&D Tax Incentive by $240 million over two years in underlying cash balance terms ($m):

Human rights implications: Schedules 4, 5 and 6 to the Bill do not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 9.

Compliance cost impact: The measure is estimated to result in a total average annual regulatory cost for businesses of $24.7 million.

Summary of regulation impact statement

Regulation impact on business

Impact: The measure is estimated to result in a total average annual regulatory cost for businesses of $24.7 million.

Main points:

•

The Government is implementing reforms to the R&D Tax Incentive. The reforms help businesses that invest in R&D manage the economic impacts of the Coronavirus pandemic while providing incentives for business to undertake additional investments in R&D.

•

The Coronavirus pandemic has led to a period of domestic and global economic downturn and it is likely that it will take a number of years for the Australian economy to recover. In this environment, businesses are facing a range of pressures which are likely to constrain their ability to invest in R&D.

•

The reforms are expected to result in an overall compliance cost, arising from minor changes to the registration and claims processes, as well as the initial adjustment to the new program. This cost represents a small reduction compared to the 2019-20 MYEFO measure.

•

As the Bill implements aspects of the 2019-20 MYEFO measure outlined in the 2019 Bill, Chapter 7 of this Explanatory Memorandum includes the regulation impact statement prepared for that former Bill.

•

The Bill also makes a number of refinements to Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019. A supplementary regulation impact analysis of the 2020-21 Budget measure has also been provided outlining the estimated impact of these changes. These changes did not require a formal regulation impact statement or formal assessment by the Office of Best Practice Regulation.

Schedule 7 - Temporary full expensing of depreciating assets

Schedule 7 to the Bill amends the income tax law to allow businesses with an aggregated turnover of less than $5 billion to deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022. Businesses are also able to deduct the full cost of improvements to these assets and to existing eligible depreciating assets made during this period.

Schedule 7 to the Bill also amends the income tax law to extend the time by which assets that qualify for the enhanced instant asset write-off must be first used or installed ready for use for a taxable purpose until 30 June 2021.

Date of effect: The measure applies to depreciating assets that are first held, and first used or installed ready for use for a taxable purpose at or after the 2020 budget time.

Proposal announced: Schedule 7 to the Bill fully implements the measure JobMaker Plan - Temporary full expensing to support investment and jobs from the 2020-21 Budget.

Financial impact: This measure is estimated to have the following receipts impact over the forward estimates period ($m):

Human rights implications: Schedule 7 to the Bill does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 9.

Compliance cost impact: An exemption from the Regulation Impact Statement requirements applies because this measure is covered by the Prime Minister's exemption for Coronavirus related measures.

Chapter 1 - Accelerating the Personal Income Tax Plan

Outline of chapter

1.1 Schedule 1 to the Bill brings forward stage two of the Government's Personal Income Tax Plan to the 2020-21 income year from the 2022-23 income year. Schedule 1 to the Bill also retains the low and middle income tax offset for the 2020-21 income year rather than having it cease to be available at the commencement of the second stage.

1.2 The changes involved in stage two of the Government's Personal Income Tax Plan that are brought forward by Schedule 1 to the Bill are:

•

increasing the income tax thresholds for individuals (and certain other entities) for the 2020-21 income year and later income years; and

•

replacing the existing low income tax offset with a new increased low income tax offset for the 2020-21 income year and later income years.

1.3 These changes were previously legislated to apply from the 2022-23 income year onwards under the Treasury Laws Amendment (Personal Income Tax Plan) Act 2018 and the Treasury Laws Amendment (Tax Relief So Working Australians Keep More of Their Money) Act 2019.

1.4 The low and middle income tax offset was previously legislated to be removed at the commencement of stage two of the Personal Income Tax Plan (at the same time as the increase to the income tax thresholds and low income tax offset). However, Schedule 1 to the Bill retains the low and middle income tax offset for an additional year (being the 2020-21 income year). After this time, from the 2021-22 income year onwards, the low and middle income tax offset will cease to be available.

Context of amendments

Income tax rates for individuals and other entities

1.5 An entity's liability to pay income tax in Australia on a set amount of taxable income is calculated by reference to various rates and thresholds. As Australia has a progressive income tax system for individuals, higher rates of tax are payable by individuals on additional income as their income increases beyond particular thresholds.

1.6 Section 12 of the Income Tax Rates Act 1986 provides that individuals and other entities not dealt with elsewhere in the Act must generally pay income tax at the rates set out in Schedule 7 to that Act.

1.7 Under Schedule 7, in the 2020-21 income year, Australian resident taxpayers are currently generally:

•

not subject to tax on the part of their ordinary taxable income that does not exceed $18,200 (the tax-free threshold);

•

subject to tax at a rate of 19 per cent on the part of their taxable income that exceeds $18,200 but does not exceed $37,000;

•

subject to tax at a rate of 32.5 per cent on the part of their taxable income that exceeds $37,000 but does not exceed $90,000;

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subject to tax at a rate of 37 per cent on the part of their taxable income that exceeds $90,000 but does not exceed $180,000; and

•

subject to tax at a rate of 45 per cent on the part of their taxable income that exceeds $180,000.

1.8 Foreign resident taxpayers in the 2020-21 income year are generally subject to tax at a rate of:

•

32.5 per cent on the part of their taxable income that does not exceed $90,000;

•

37 per cent on the part of their taxable income that exceeds $90,000 but does not exceed $180,000; and

•

45 per cent on the part of their taxable income that exceeds $180,000.

1.9 Part III of Schedule 7 sets out special rules that apply to the income of working holiday-makers in Australia. Taxable income from these activities is generally taxed at the tax rates for Australian residents, whether or not the individual is an Australian resident. However, working holiday-makers do not benefit from the tax-free threshold and the rate of tax that applies to income not exceeding $37,000 is 15 per cent.

Tax offsets

1.10 The income tax law provides for a number of tax offsets - being reductions in the income tax otherwise payable by taxpayers that satisfy specified requirements. Many tax offsets are contained in Division 61 of the ITAA 1997.

1.11 Currently, section 159N of the ITAA 1936 provides a tax offset (referred to in the terminology of that Act as a rebate) for low income individuals (and certain trustees taxed in the place of these individuals) - more commonly known as the low income tax offset - that is available in income years before the 2022-23 income year.

1.12 Taxpayers are entitled to this offset for an income year if during that income year their taxable income (or the share of the income of the trust going to the relevant beneficiary in the case of a trustee) is less than $66,667 and they are an Australian resident. The amount of the offset (the amount by which a taxpayer's tax payable is reduced) is $445, reduced by 1.5 cents for every dollar of the amount by which their taxable income exceeds $37,000.

1.13 Subdivision 61-D of the ITAA 1997 currently provides for a tax offset - the low and middle income tax offset - for lower income individuals (and certain trustees taxed in the place of these individuals) in the 2018-19, 2019-20, 2020-21 and 2021-22 income years.

1.14 The amount of the low and middle income tax offset is:

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for taxpayers with taxable income not exceeding $37,000 - $255;

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for taxpayers with taxable income exceeding $37,000 but not exceeding $48,000 - $255 plus 7.5 per cent of the amount of income that exceeds $37,000;

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for taxpayers with taxable income exceeding $48,000 but not exceeding $90,000 - $1,080; and

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for taxpayers with taxable income exceeding $90,000 but not exceeding $126,000 - $1,080 less 3 per cent of the amount of income that exceeds $90,000.

1.15 Entitlement to the low and middle income tax offset is in addition to the low income tax offset.

Personal Income Tax Plan

1.16 The Government announced a series of changes to the personal tax system, referred to as the Personal Income Tax Plan, in the 2018-19 Budget. The Government subsequently announced further changes to this plan in the 2019-20 Budget.

1.17 The Personal Income Tax Plan involves changes to the general rates of income tax, tax thresholds and tax offsets in three stages. The first stage commenced in 2018-19, the second stage is scheduled to commence in 2022-23 and the third and final stage is scheduled to commence in 2024-25.

1.18 The second stage of the Personal Income Tax Plan broadly involves:

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increasing certain income tax thresholds so that the lower tax rates of 19 per cent and 32.5 per cent apply to a greater proportion of the taxable income of a resident individual (or similarly taxed entity), as well as the equivalent thresholds for foreign residents and working holiday-makers;

•

removing the current low and middle income tax offset; and

•

replacing the current low income tax offset with a new low income tax offset (that provides for an increased amount of up to $700 of income tax to be offset).

1.19 The existing legislative amendments that give effect to the Personal Income Tax Plan are set out in the Treasury Laws Amendment (Personal Income Tax Plan) Act 2018 and the Treasury Laws Amendment (Tax Relief So Working Australians Keep More of Their Money) Act 2019.

Summary of new law

1.20 Schedule 1 to the Bill amends the income tax law to:

•

bring forward the changes to the income tax thresholds (currently legislated to apply to the 2022-23 income year and later income years) to the 2020-21 income year and later income years;

•

bring forward the legislated changes to remove the existing low income tax offset and replace it with a new increased low income tax offset so that these changes apply for the 2020-21 income year and later income years; and

•

retain the low and middle income tax offset for the 2020-21 income year, with the offset now ceasing to be available in the 2021-22 income year and later income years.

1.21 Together, these changes reduce the income tax burden for tax paying individuals and boost consumption to support the economic recovery from the impacts of the Coronavirus on the Australian economy.

Comparison of key features of new law and current law

Detailed explanation of new law

1.22 Schedule 1 to the Bill amends the income tax law to bring forward the changes to the income tax thresholds (currently legislated to apply to the 2022-23 income year and later income years) to the 2020-21 income year and later income years.

1.23 Schedule 1 to the Bill also amends the income tax law to:

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bring forward the planned changes to remove the existing low income tax offset and replace it with a new low income tax offset to the 2020-21 income year and later income years;

•

retain the low and middle income tax offset for the 2020-21 income year; and

•

cease to make the low and middle income tax offset available for the 2021-22 income year and later income years.

1.24 In effect, the changes bring forward stage two of the Government's Personal Income Tax Plan, while retaining the low and middle income tax offset for a further year. This provides additional relief for taxpayers in light of the impact of the Coronavirus on the Australian economy and boosts consumption.

Bringing forward the increases to certain income tax thresholds

1.25 Schedule 1 to the Bill amends the Income Tax Rates Act 1986 to bring forward the changes to increase certain income tax thresholds that were previously legislated to apply for the 2022-23 and 2023-24 income years.

1.26 Under the existing law, the income tax rates and thresholds for Australian resident taxpayers, foreign resident taxpayers and working holiday-makers are changing in three stages to give effect to the Personal Income Tax Plan (see Schedule 7 of the Income Tax Rates Act 1986).

1.27 The changes to give effect to stage one of the Personal Income Tax Plan commenced for the 2018-19 income year and were to apply until the end of the 2021-22 income year.

1.28 In stage two of the plan, which was to apply in the 2022-23 and 2023-24 income years, further changes were to be made to the thresholds below which certain rates of personal income tax apply. Specifically, an Australian resident entity's taxable income would be subject to the 19 per cent marginal tax rate until it exceeds $45,000 rather than $37,000, and would then be subject to the 32.5 per cent marginal tax rate until it exceeds $120,000 rather than $90,000, and the same changes would apply to equivalent thresholds for foreign residents and working holiday-makers.

1.29 In stage three of the plan, applying in 2024-25 and subsequent income years, there are further changes to personal income tax rates and thresholds as set out in the Explanatory Memorandum to the Treasury Laws Amendment (Personal Income Tax Plan) Bill 2018 and Explanatory Memorandum to the Treasury Laws Amendment (Tax Relief So Working Australians Keep More of Their Money) Bill 2019.

1.30 Under the new law, the tax rates and thresholds that were to apply to the 2022-23 and 2023-24 income year apply to the 2020-21, 2021-22, 2022-23 and 2023-24 income years. [Schedule 1, items 3, 7 and 11, headings to tables dealing with tax rates for resident taxpayers, non-resident taxpayers and working holiday makers in Parts I, II and III of Schedule 7 to the Income Tax Rates Act 1986]

1.31 This change, combined with the related changes to tax offsets discussed below, has the effect of bringing forward stage two of the Personal Income Tax Plan by two years to provide earlier tax relief to taxpayers, especially low and middle income earners.

1.32 The date for the implementation of stage three of the Personal Income Tax Plan is unchanged.

Bringing forward the increased low income tax offset and retaining the low and middle income tax offset

1.33 Schedule 1 to the Bill amends section 61-110 of the ITAA 1997 to make the new low income tax offset available for the 2020-21 income year and later income years. [Schedule 1, item 19, subsections 61-110(1) and (2) of the ITAA 1997]

1.34 The base amount of the new low income tax offset is $700. However, this amount is reduced by 5 per cent of the amount by which the taxpayer's taxable income exceeds $37,500 but does not exceed $45,000 and by 1.5 per cent of the amount by which the taxpayer's taxable income exceeds $45,000. This is higher than the existing low income tax offset (set out in section 159N of the ITAA 1936), which provides for a tax offset of an amount of up to $445, and is intended to replace this offset.

1.35 Consistent with this intention, the existing low income tax offset ceases to be available for the 2020-21 income year and later income years. [Schedule 1, item 17, section 159N of the ITAA 1936]

1.36 Prior to the amendments made by Schedule 1 to the Bill, the replacement of the existing low income tax offset with the new low income tax offset was to occur in two years' time - for the 2022-23 income year - as part of the implementation of stage two of the Personal Income Tax Plan.

1.37 Schedule 1 to the Bill also amends the period for which the low and middle income tax offset is available.

1.38 The low and middle income tax offset is a temporary tax offset that was introduced as part of the Personal Income Tax Plan to provide immediate assistance to low and middle income earners. Before the amendments made in Schedule 1 to the Bill, it was to cease to apply with respect to the 2022-23 income year and later income years (at the same time as the changes to the low income tax offset and income tax thresholds were to take place under stage two of the plan).

1.39 However, the amendments made by Schedule 1 to the Bill mean that the low and middle income tax offset will not cease to apply when the stage two changes commence. Instead, the low and middle income tax offset is available for the 2020-21 income year and only ceases to be available from the 2021-22 income year onwards. [Schedule 1, items 25, 26 and 27, sections 61-105, 61-107 and heading to Subdivision 61-D of the ITAA 1997]

1.40 Bringing forward these changes to the low income tax offset and retaining the low and middle income tax offset for an additional year provides tax relief to eligible taxpayers. It supports the economic recovery from the impacts of the Coronavirus on the Australian economy by boosting consumption.

Consequential amendments

1.41 Minor amendments have been made to the income tax law to reflect the above changes, including updating the relevant guide material and removing references that have become redundant due to the changes. [Schedule 1, items 4, 8, 12, 18, 20, 21, 22 and 23 notes to the tables dealing with tax rates for resident taxpayers, non-resident taxpayers and working holiday makers in Parts I, II and III of Schedule 7 to the Income Tax Rates Act 1986, table item headed "low income earner" in section 13-1 of the ITAA 1997, item 17 of the table in subsection 63-10(1) of the ITAA 1997, notes 6 and 7 to paragraph 63-10(1)(f), of step 1 of the method statement in section 45-340 and paragraph (e) of step 1 in the method statement in section 45-375 in Schedule 1 to the Taxation Administration Act 1953]

Application and transitional provisions

General application and commencement provisions

1.42 The repeal and amendments made to the low income tax offset apply in relation to assessments for the 2020-21 income year or a later income year. [Schedule 1, item 8]

1.43 With the exception of the automatic repeal provisions discussed in paragraphs 1.48 and 1.49 below, the provisions of Schedule 1 to the Bill commence on the day after Royal Assent. [items 2, 4, and 6 of the table in section 2 of the Bill]

1.44 While the provisions relating to the low income tax offset and the changes to the tax rates and thresholds apply retrospectively, they do so in a way that is wholly beneficial for affected entities.

1.45 Given the new law overrides amendments to the existing law that were yet to have effect, those amendments that have not yet commenced have been repealed so as not to conflict with the new law. [Schedule 1, items 28, 29, 30 and 31, table items 3, 5 and 6 in subsection 2(1), Part 3 of Schedule 1 and Part 3 of Schedule 2 to the Treasury Laws Amendment (Personal Income Tax Plan) Act 2018]

Repeal of other spent provisions

1.46 Schedule 1 to the Bill includes amendments to repeal certain provisions in the income tax law when the provisions cease to apply. This ensures that the income tax law is not unnecessarily expanded and made more complex for the reader by retaining redundant provisions.

1.47 In particular, the tables setting out the tax rates on the taxable income for Australian resident taxpayers, foreign taxpayers and working holiday-makers for the 2018-19 and 2019-20 income years (set out in Schedule 7 of the Income Tax Rates Act 1986) will have no application to income years after the 2019-20 income year. As a result, they will be repealed on commencement of Schedule 1 to the Bill. [item 2 of the table in section 2 of the Bill and Schedule 1, items 1, 5 and 9, headings to tables dealing with tax rates for resident taxpayers, non-resident taxpayers and working holiday makers in Parts I, II and III of Schedule 7 to the Income Tax Rates Act 1986]

1.48 Similarly, the tables setting out the tax rates for the 2020-21, 2021-22, 2022-23, 2023-24 income years (also set out in Schedule 7 of the Income Tax Rates Act 1986) will also be repealed on 1 July 2024, following the end of the last income year to which they apply. [item 3 of the table in section 2 of the Bill and Schedule 1, items 13, 14 and 15, tables dealing with tax rates for resident taxpayers, non-resident taxpayers and working holiday makers in Parts I, II and III of Schedule 7 to the Income Tax Rates Act 1986]

1.49 The repeal of the provisions regarding the low and middle income tax offset applies in relation to assessments for the 2021-22 income year or later income years. [item 5 of the table in clause 3 of the Bill and Schedule 1, item 24]

1.50 The repeals to the tables setting out the tax rates are subject to transitional rules to make clear that the repeal does not affect the operation of those provisions in relation to the income years to which they apply. [Schedule 1, items 2, 6, 10 and 16]

Chapter 2 - Temporary loss carry back

Outline of chapter

2.1 Schedule 2 to the Bill amends the income tax law to allow corporate tax entities with an aggregated turnover of less than $5 billion to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

2.2 All legislative references in this chapter are to the ITAA 1997 unless otherwise indicated.

Context of amendments

2.3 The Government is supporting Australian businesses to invest, grow and create jobs.

2.4 Business investment is vital to Australia's short-term economic recovery as well as longer term productive capacity and wage growth.

2.5 The Government is providing temporary tax incentives to support new investment and increase business cash flow.

2.6 One of these tax incentives is to temporarily allow companies with turnover below $5 billion to offset tax losses against previously taxed profits to generate a tax refund. This incentive will be available to approximately one million companies employing up to 8.8 million employees.

2.7 Losses incurred up to 2021-22 can be carried back against profits made in or after 2018-19. Eligible companies may elect to receive a tax refund when they lodge their 2020-21 and 2021-22 income tax returns.

2.8 This will provide further cash flow support as well as encourage more businesses to take advantage of temporary full expensing while it is available and promote investment.

Summary of new law

2.9 The temporary loss carry back rules will allow corporate tax entities to carry back losses to earlier profitable income years as far back as the 2018-19 income year to generate a refundable tax offset. The rules are limited to corporate tax entities that:

•

have aggregated turnover of less than $5 billion in the year of the loss;

•

incur a tax loss in the 2019-20, 2020-21 or 2021-22 income years; and

•

have a profit in a relevant previous year as far back as the 2018-19 income year.

2.10 The amount of the refundable tax offset available to a corporate tax entity is based on the entity's tax rate in the loss year. However, the amount cannot exceed:

•

the amount of earlier tax paid by the entity; and

•

the entity's franking account balance at the end of the income year for which the refundable tax offset is claimed.

2.11 A corporate tax entity that has net exempt income in an income year it carries a loss back to must reduce the loss it carries back by that net exempt income before it works out its offset for the remaining amount of the loss.

2.12 A corporate tax entity will need to make a choice to claim the refundable tax offset when it lodges an income tax return for:

•

the 2020-21 income year; and

•

the 2021-22 income year.

2.13 Corporate tax entities will be allowed to carry back tax losses for the 2019-20 income year but these claims will be processed when income tax returns for the 2020-21 income year and the 2021-22 income year are lodged.

2.14 The loss carry back provisions include integrity rules consistent with the integrity rules that applied under the previous loss carry back rules that applied in Australia in 2013.

2.15 The temporary loss carry back rules will cease to apply after the 2021-22 income year.

Comparison of key features of new law and current law

Detailed explanation of new law

2.16 Under the temporary loss carry back refundable tax offset rules, a corporate tax entity with an aggregated turnover of less than $5 billion can choose to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

2.17 The choice to claim a loss carry back tax offset is an alternative to carrying tax losses forward as a deduction for future income years. Only tax losses can be carried back. Capital losses cannot be carried back because the capital gains tax regime operates on a realisation basis.

2.18 Generally speaking, an entity makes a 'tax loss' for an income year if its deductions exceed its assessable income for that income year.

Entitlement to a loss carry back tax offset

2.19 A corporate tax entity can choose to utilise a tax loss to obtain a loss carry back tax offset in the 2020-21 income year or in the 2021-22 income year.

2.20 A corporate tax entity is defined in section 960-115 to be an entity that is:

•

a company;

•

a corporate limited partnership; or

•

a public trading trust.

2.21 A corporate tax entity will be eligible for loss carry back in a particular income year only if:

•

the entity is a corporate tax entity throughout that income year;

•

the entity carries on a business and has an aggregated turnover of less than $5 billion in the income year that the entity incurred the loss; and

•

the entity was a corporate tax entity throughout the income year the loss is carried back to (disregarding any part of the year before the entity came into existence) and throughout any intervening income years.

[Schedule 2, item 2, sections 160-5, 160-20 and 160-25]

2.22 In addition, to be entitled to a loss carry back tax offset, a corporate tax entity must have lodged an income tax return for the current year and each of the five years immediately preceding it. [Schedule 2, item 2, section 160-5)]

2.23 The requirement for the corporate tax entity to have lodged an income tax return for the current year and each of the five years immediately preceding it in order to claim loss carry back provides a level of assurance that the entity's tax liabilities, tax losses and franking account entries for that period are likely to be accurate and able to be verified. The five year period covers:

•

the usual period for which the entity is required to retain its tax records under section 262A of the ITAA 1936; and

•

the usual period in which the entity's assessments can be amended.

2.24 In some cases, the entity might not have been required to lodge a return for a year. This does not prevent an entity from being entitled to a loss carry back tax offset. A common example of where an entity is not required to lodge a return for a year would be where the entity did not exist in that year.

Choice to claim a loss carry back tax offset

2.25 Loss carry back is optional, mirroring the existing choice corporate tax entities have about whether to deduct their tax losses (subsections 36-17(2) and (3)). An entity can choose to carry a tax loss back or not as it sees fit. That is, the entity can choose how much of its tax loss for the current year is to be carried back to an earlier year. [Schedule 2, items 2 and 34, subsection 160-15(1) and definitions of 'carry back' and 'loss carry back choice' in subsection 995-1(1)]

2.26 Tax losses not used for loss carry back in the current income year are available to reduce any taxable income in that income year or in a future income year, according to the usual rules for deducting prior-year losses in Division 36.

2.27 The choice to claim a loss carry back tax offset must be made in the approved form. The choice must specify that the entity wishes to claim the offset and:

•

each loss year that it wishes to carry an amount back from;

•

the amount of the tax loss it wishes to carry back for each income year; and

•

each year it wishes to carry the loss back to.

[Schedule 2, item 2, section 160-15]

2.28 The choice must be made by the time that the entity lodges its income tax return for the current income year, or within such further time as the Commissioner allows. [Schedule 2, item 2, section 160-15]

2.29 The approved form would usually be the corporate tax entity's income tax return, so the claim would normally be made at the same time as the income tax return is lodged.

2.30 However, there might be cases where the claim is not made in the income tax return. For example:

•

an entity that is not required to lodge an income tax return might claim the offset in a separate form; or

•

an entity might wish to claim the offset when an assessment for an income year is amended after it has lodged its income tax return, making loss carry back possible for the current year or changing the maximum amount of the offset available - in such a case, the Commissioner would have to allow the choice to be made after the date for lodging the income tax return.

Entitlement to a loss carry back tax offset for the 2020-21 income year

2.31 If the current year is the 2020-21 income year, a loss carry back tax offset may be available to a corporate tax entity if:

•

the entity has a tax loss in the 2019-20 income year and/or the 2020-21 income year;

•

the entity has an income tax liability in the 2018-19 income year and/or the 2019-20 income year; and

•

for the 2020-21 income year and each of the previous five income years, either:

-

the entity has lodged an income tax return;

-

the entity was not required to lodge a return; or

-

the Commissioner has made an assessment of the entity's income tax.

[Schedule 2, items 2 and 34, section 160-5 and definition of 'loss carry back tax offset' in subsection 995-1(1)]

Entitlement to a loss carry back tax offset for the 2021-22 income year

2.32 If the current year is the 2021-22 income year, a loss carry back tax offset may be available to a corporate tax entity if:

•

the entity has a tax loss in the 2019-20 income year, the 2020-21 income year and/or the 2021-22 income year;

•

the entity has an income tax liability in the 2018-19 income year, the 2019-20 income year and/or the 2020-21 income year; and

•

for the 2021-22 income year and each of the previous five income years, either:

-

the entity has lodged an income tax return;

-

the entity was not required to lodge a return; or

-

the Commissioner has made an assessment of the entity's income tax.

[Schedule 2, item 2 and 34, section 160-5 and definition of 'loss carry back tax offset' in subsection 995-1(1)]

Amount of the loss carry back tax offset

2.33 The amount of an entity's loss carry back tax offset for the current income year is the lesser of:

•

the sum of the entity's loss carry back tax offset components for:

-

the 2018-19 income year;

-

the 2019-20 income year; and

-

if the current year is the 2021-22 income year - the 2020-21 income year; and

•

the entity's franking account balance at the end of the current year.

[Schedule 2, item 2, subsection 160-10(1)]

2.34 An entity is entitled to only one loss carry back tax offset for the 2020-21 income year. However, that offset may have two components - that is:

•

a loss carry back tax offset component relating to the 2018-19 income year; and

•

a loss carry back tax offset component relating to the 2019-20 income year.

2.35 An entity is also entitled to only one loss carry back tax offset for the 2021-22 income year. However, that offset may have three components - that is:

•

a loss carry back tax offset component relating to the 2018-19 income year;

•

a loss carry back tax offset component relating to the 2019-20 income year; and

•

a loss carry back tax offset component relating to the 2020-21 income year.

2.36 The loss carry back tax offset is a refundable tax offset. However, the Commissioner's usual practice is to apply any refund amount arising from an offset towards paying another amount the entity owes to the Commissioner before an actual refund would be paid. [Schedule 2, item 1, section 67-23]

The loss carry back tax offset component for an income year

2.37 An entity's loss carry back tax offset component for an income year is worked out by applying a number of steps. These steps are applied in relation to each tax loss to be carried back to a particular income year.

Step 1: Work out the amount of the loss to be carried back

2.38 The first step is to work out the amount of the tax loss that the entity is carrying back to the income year. This will be the amounts the entity has chosen to carry back to the relevant year. [Schedule 2, item 2, step 1 of the method statement in subsection 160-10(2)]

Step 2: Reduce the step 1 amount by net exempt income

2.39 The second step is to reduce the step 1 amount by the net exempt income for the income year to the extent that the net exempt income has not already been utilised. This ensures that, for the purposes of the loss carry back tax offset, net exempt income is broadly applied in the same way as it is applied when working out the amount of deductible losses in an income year. [Schedule 2, item 2, step 2 of the method statement in subsection 160-10(2)]

Step 3: Convert the step 2 amount to a tax equivalent amount

2.40 The third step is to convert the step 2 amount into a tax equivalent amount by multiplying the step 2 amount by the entity's corporate tax rate for the loss year. [Schedule 2, item 2, step 3 of the method statement in subsection 160-10(2)]

2.41 The method statement for determining the amount of a loss carry back tax offset component applies separately for each tax loss year carried back to each gain year. The loss year can be one or more of:

•

the 2019-20 income year;

•

the 2020-21 income year; and

•

the 2021-22 income year.

2.42 If the entity is a base rate entity (that is, broadly, an entity with an aggregated turnover of less than $50 million for the income year) for a loss year, the entity's corporate tax rate for the loss year will be:

•

if the loss is the 2019-20 income year - 27.5 per cent;

•

if the loss year is the 2020-21 income year - 26 per cent; or

•

if the loss year is the 2021-22 income year - 25 per cent.

2.43 If the entity is not a base rate entity for a loss year, the entity's corporate tax rate for the loss year will be 30 per cent.

Work out the amount of the loss carry back tax offset component for an income year

2.44 If the entity does not, in its loss carry back choice, carry back any losses to the income year, the amount of the loss carry back tax offset component for the income year is nil. [Schedule 2, items 2 and 34, paragraph 160-10(2)(a) and definition of 'loss carry back tax offset component' in subsection 995-1(1)]

2.45 If the entity does, in its loss carry back choice, carry back losses to the income year, the amount of the loss carry back tax offset component for the income year is so much of the entity's income tax liability for the income year that does not exceed:

•

if the entity chooses to carry back only one tax loss to the income year - the tax equivalent amount worked out at step 3 of the method statement; or

•

if the entity chooses to carry back tax losses for two or three loss years to the income year - the sum of the tax equivalent amounts worked out at step 3 of the method statement for each of those tax losses.

[Schedule 2, item 2 and 34, paragraph 160-10(2)(b) and definition of 'loss carry back tax offset component' in subsection 995-1(1)]

2.46 This effectively limits the amount of loss carry back tax offset component for the income year to the amount of the income tax liability for that income year.

2.47 However, a tax loss can only be utilised once. Therefore, a tax loss can only be carried back once. In addition, if a tax loss is carried back and reflected in a loss carry back tax offset for an income year or used to reduce net exempt income for that year, it cannot be carried forward and deducted in a later income year. [Schedule 2, items 32 and 33, paragraphs 960-20(2)(c) and (4)(f)]

2.48 Similarly, if a tax loss is carried back to more than one income year, the tax value of the amount carried back to each income year is limited by the available income tax liability of that income year. Each part of a tax liability can only be used once to support a loss carry back. [Schedule 2, item 2, subsections 160-10(3) and (4)]

2.49 The amount of an entity's income tax liability for an income year is the amount of income tax assessed to the entity for the year. [Schedule 2, item 3, definition of 'income tax liability' in subsection 995-1(1)]

2.50 However, for the purposes of working out the available income tax liability for an income year, the head company of a consolidated or multiple entry consolidated group must disregard an income tax liability of a subsidiary member of the group that relates to a period before it joined the group and is taken to be an income tax liability of the head company because of the entry history rule (section 701-5). [Schedule 2, item 2, subsection 160-30(2)]

Loss carry back tax offset limited to the franking account balance

2.51 The maximum amount of a corporate tax entity's loss carry back tax offset for an income year is limited by the surplus balance of its franking account at the end of that income year. This ensures that the offset cannot exceed the value of past taxes paid by the entity that have not yet been distributed to shareholders as franking credits.

2.52 A corporate tax entity may have a surplus in its franking account because, for example, it has:

•

paid tax or received franked dividends; and

•

retained its profits.

2.53 The loss carry back tax offset for an income year is limited to the balance of the corporate tax entity's franking account at the end of that income year. This ensures that a corporate tax entity cannot both:

•

apply the balance of the franking credits in its franking account to frank distributions to shareholders for an income year; and

•

claim a refundable loss carry back tax offset for the same income year.

2.54 Therefore, this limitation will reduce the possibility of an entity's franking account going into deficit (which would create a liability to franking deficit tax under section 205-45) when it gets a refund of tax as a result of the offset. This reduces administrative churn in the tax system from companies that receive a loss carry back tax offset refund from having to return some or all of the amount refunded as franking deficit tax.

2.55 A debit will arise in a corporate tax entity's franking account when it gets a refund of tax as a result of the loss carry back tax offset on the day that the refund is received (item 2 and 2A of the table in subsection 205-30(1)). Since this debit will arise after the end of the relevant income year, the balance in the entity's franking account may have changed. Therefore, the debit could still put the franking account into deficit. If that deficit is not made up by the end of the year, the entity would be liable for franking deficit tax to make good the excess of its franking debits over its franking credits.

2.56 The franking account balance limit does not apply to a foreign resident entity with a permanent establishment in Australia that is not within the Australian imputation system. [Schedule 2, item 2, subsection 160-10(5)]

2.57 However, the franking account balance does limit the loss carry back tax offsets of New Zealand franking companies. These are companies resident in New Zealand that have chosen to be within the Australian imputation system.

2.58 Payments of Australian income tax by a New Zealand franking company does result in a credit arising in the company's franking account. Accordingly, the franking account limit applies to those companies to prevent them from obtaining an effective refund of tax that they have already passed on as a credit to their shareholders by paying a franked dividend.

2.59 Any debit to the franking account of a foreign resident entity (other than an New Zealand franking company) for a refund of tax arising from a loss carry back tax offset can only reduce the account balance to nil. It cannot put the franking account into deficit (item 2A of the table in subsection 205-30(1)).

Examples

Example 2.1 : Business benefits from temporary loss carry back

Due to the impact of Coronavirus restrictions on customer demand and its ability to trade, Company A makes a tax loss of $2 million in the 2019-20 income year.

In the 2020-21 income year, the reduced trading means Company A makes another tax loss of $500,000. Company A's franking account balance at the end of the 2020-21 income year is $550,000.

In the 2018-19 income year, Company A had taxable income of $5 million. Company A had no net exempt income in that income year.

As Company A had an aggregated turnover of less than $50 million in each of the relevant income years, it was liable to tax at the base rate entity corporate tax rate in each income year. In the 2018-19 income year, the base rate entity corporate tax rate was 27.5 per cent. Therefore, Company A paid income tax of $1,375,000 for that income year.

Company A makes a loss carry back choice to:

•

carry back the tax loss of $500,000 for the 2020-21 income year to the 2018-19 income year; and

•

carry back the tax loss of $2 million for the 2019-20 income year to the 2018-19 income year.

The loss carry back tax offset component for the 2018-19 income year is $680,000 - that is, the sum of:

•

$130,000, being the amount worked out by applying the method statement in section 160-10 for the 2020-21 income year - that is, $500,000 x 26 per cent (the base rate entity corporate tax rate for the 2020-21 income year); and

•

$550,000, being the amount worked out by applying the method statement in section 160-10 for the 2019-20 income year - that is, $2 million x 27.5 per cent (the base rate entity corporate tax rate for the 2019-20 income year).

As the result of the method statement in section 160-10 is less than its income tax liability for the 2018-19 income year ($1,375,000), Company A's loss carry back tax offset component for that income year is $680,000.

However, the amount of the loss carry back tax offset component exceeds the balance in Company A's franking account at the end of the 2020-21 income year ($550,000).

Therefore, when Company A lodges its income tax return for the 2020-21 income year, it will be entitled to a refundable loss carry back tax offset of $550,000 - that is, the lesser of:

•

$680,000 - that is, Company A's loss carry back tax offset component for the 2018-19 income year; and

•

$550,000 - that is, the balance in Company A's franking account at the end of the 2020-21 income year.

If Company A's loss carry back choice does not reflect this position, it can modify the choice to reduce the amount of tax losses carried back. As a result, the unutilised amount of the loss ($130,000) can be carried forward and deducted in future income years.

Example 2.2 : Business benefits from temporary full expensing and temporary loss carry back

On 1 November 2021, Company B purchases a truck for $1.5 million. Under the temporary full expensing measure explained in Chapter 8, Company B can deduct the full cost of the truck in the 2021-22 income year. As a result, Company B makes a tax loss of $400,000 for the 2021-22 income year.

In the 2020-21 income year, Company B had taxable income of $8 million. As Company B had an aggregated turnover of $80 million in that income year, it was liable to income tax at the standard corporate tax rate of 30 per cent. Therefore, Company B paid income tax of $2.4 million for that income year. Company B had no net exempt income in that income year.

Company B's franking account balance at the end of the 2021-22 income year is $1.3 million.

Company B makes a loss carry back choice to carry back the tax loss of $400,000 for the 2021-22 income year to the 2020-21 income year.

The result of the method statement in section 160-10 for the 2020-21 income year is $120,000 - that is, $400,000 x 30 per cent.

As this amount is less than Company B's income tax liability for the 2020-21 income year ($2.4 million) and its franking account balance for the current year ($1.3 million), Company B's loss carry back tax offset component for the 2020-21 income year is $120,000.

Therefore, when Company B lodges its income tax return for the 2021-22 income year, it will be entitled to a refundable loss carry back tax offset of $120,000.

Tax losses ineligible for carry back

2.60 An entity cannot carry back losses that have been transferred under:

•

Division 170 - transfers between companies in the same foreign banking group; or

•

Subdivision 707-A - transfers to the head company of a consolidated group or multiple entry consolidated group by an entity joining the group.

[Schedule 2, item 2, paragraph 160-30(1)(a) and subsection 160-30(2)]

2.61 In addition, the part of a tax loss that is deemed to exist when a corporate tax entity has excess franking offsets for an income year (section 36-55) is not eligible for carry back because it does not represent an economic loss. [Schedule 2, item 2, paragraph 160-30(1)(b)]

Loss carry back integrity rule

2.62 When deducting losses of earlier income tax years, corporate tax entities are subject to integrity rules (known as the continuity of ownership test and the business continuity test (that is, the same business test or the similar business test)). Applying the same integrity rules to entities that wish to carry their losses back to obtain a tax offset would have minimal impact on the entities where the existing owners continue to trade and wish to undertake planned and sensible risks.

2.63 However, potential new owners who wish to acquire an existing entity and introduce new technology, business practices and product lines that will better position it to meet the commercial challenges of the future may find that they do not satisfy the continuity of ownership and same business tests in some circumstances.

2.64 The specific integrity rule for loss carry back denies a corporate tax entity a loss carry back tax offset it would otherwise be entitled to where there has been a change in the control of the entity arising from a disposition of membership interests and, considering all of the relevant circumstances, one or more parties entered into a scheme to obtain the tax offset.

2.65 Losses that cannot be carried back as a result of the integrity measure can still be carried forward and claimed as a deduction against the income of future years provided the requirements for doing so are met.

What happens when the integrity rule is applied

2.66 When the integrity rule for loss carry back applies, the corporate tax entity cannot carry back a tax loss. Subject to meeting the ordinary requirements, the entity would still be able to deduct those losses in a future year.

2.67 There is no direct impact on an entity that disposed of a membership interest when the corporate tax entity is denied the tax offset.

2.68 There is also no direct impact on an entity that acquires the membership interest when the corporate tax entity is denied the tax offset.

When does the integrity rule apply

There must be a scheme

2.69 There must have been a scheme for the disposition of membership interests, or of an interest in membership interests, in

•

the corporate tax entity; or

•

an entity that had a direct or indirect interest in the corporate tax entity.

2.70 Scheme is a widely defined term used in other taxation provisions, including Part IVA of the ITAA 1936. Where there has been no disposition of membership interests, the loss carry back integrity rule does not apply. [Schedule 2, item 2, paragraph 160-35(1)(a)]

2.71 For these purposes:

•

a non-share equity interest in a corporate tax entity is treated in the same way as a membership interest in a corporate tax entity; and

•

an equity holder in a corporate tax entity is treated in the same manner as a member in a corporate tax entity.

[Schedule 2, item 2, subsection 160-35(3)]

2.72 This ensures that equity interests in corporate tax entities that are not shares are treated in the same manner as shares.

2.73 Where there has been a scheme that does not involve a disposition of membership interests, the Commissioner is able to consider the potential application of other integrity rules in the taxation law (such as Part IVA of the ITAA 1936).

2.74 The terms interest in membership interest and scheme for a disposition have the same meanings as in section 177EA of ITAA 1936. [Schedule 2, item 3, definitions of 'interest in membership interests' and 'scheme for a disposition' in subsection 995-1(1)]

2.75 An interest in a membership interest includes legal and equitable interests in a membership interest. Specific rules apply when the interest is held through a partnership or trust.

2.76 The term scheme for a disposition includes dispositions that include issuing or creating membership interests, entering into contracts, arrangements, etc. that affect the legal or equitable interest in membership interests and other means by which control or ownership of a membership interest can be changed.

2.77 The scheme must have been entered into or carried out between the start of the year the entity seeks to carry the loss back to and the end of the year it claims the loss carry back tax offset. [Schedule 2, item 2, paragraph 160-35(1)(b)]

The disposition must have resulted in a change in control

2.78 The disposition of membership interests must have resulted in a change in who controlled, or was able to control, (whether directly or indirectly through one or more interposed entities) the voting power in the corporate tax entity. [Schedule 2, item 2, paragraph 160-35(1)(c)]

2.79 When determining whether control of the entity has changed, dispositions of membership interests and interests in membership interests can be considered. The magnitude of the disposition of membership interests is not decisive.

The entity would be entitled to a loss carry back tax offset

2.80 The loss carry back integrity rule will apply only where, in the absence of the integrity rule:

•

an entity (other than the corporate tax entity) received or receives, in connection with the scheme, a financial benefit; and

•

that financial benefit was calculated by reference to one or more loss carry back tax offsets to which it was reasonable, at the time the scheme was entered into or carried out, to expect the corporate tax entity would be entitled.

[Schedule 2, item 2, paragraph 160-35(1)(d)]

2.81 Therefore, the loss carry back integrity rule will not apply if:

•

the corporate tax entity does not have an income tax liability for a year that a loss can be carried back to; or

•

the corporate tax entity does not have, or expect to have, a franking credit balance.

2.82 The company is not required to consider the application of the loss carry back integrity rule if it does not wish to carry back an eligible loss.

Purpose and relevant circumstances

2.83 The loss carry back integrity rule will apply only if, having regard to the relevant circumstances of the scheme, it would be concluded that one or more of the persons who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not a dominant purpose but not including an incidental purpose) of the corporate tax entity obtaining a loss carry back tax offset. [Schedule 2, item 2, paragraph 160-35(1)(e)]

2.84 To determine this purpose requires an examination of the facts and reasonable expectations of the persons at the time that the scheme was entered into. Subsequent events are not relevant except to the extent that they clarify what the true purpose of the parties was.

2.85 If at the time of entering into the scheme the expectation was that the corporate entity would not meet the requirements for getting a loss carry back tax offset because, for example, the entity was expected to be profitable, the purpose of the entity getting the loss carry back tax offset would not have existed. A subsequent unexpected loss would not change this.

2.86 However, an expectation that the corporate tax entity would be entitled to get the loss carry back tax offset will not always require that the offset be denied. Consideration must be given to the purpose of the persons who entered into or carried out the scheme. This is an objective question of fact that is established by looking at all the relevant circumstances.

What are the relevant circumstances?

2.87 To objectively establish what the purpose of the persons who entered into the scheme was, the relevant circumstances surrounding the scheme of disposition must be considered. None of these circumstances is decisive by itself. The circumstances should be considered collectively to determine whether the tax offset is denied.

2.88 The first relevant circumstance is the extent to which the corporate tax entity continues the same activities undertaken after the scheme for the disposition of membership interests has been implemented as prior to implementation. [Schedule 2, item 2, paragraph 160-35(2)(a)]

2.89 Activities in this sense are referring to what the entity did to earn assessable income. The entity will be undertaking the same activities notwithstanding that it has expanded or varied its product lines. For example:

•

a restaurant that specialised in Chinese cuisine which under new ownership started to provide a takeaway service would still be undertaking the same business activity; and

•

an entity that manufactured cosmetics that changed ownership and control would not be undertaking the same activity if it retooled to manufacture motor vehicle parts; and

•

a shop that switched from selling clothing to selling compact discs would not be undertaking the same activity.

2.90 Both the number of activities and their relative importance to the entity need to be considered. An activity may have been undertaken to such an extent and been of such importance to the entity that its continuation after the change in control was clearly the dominant purpose behind the change in control of the company. Conversely, the ending of that activity may indicate that continuing the activities of the entity was a very minor purpose of acquiring control and the entity obtaining a loss carry back tax offset was much more than an incidental purpose.

2.91 It is a matter of judgement as to whether the extent to which the same activities have been continued indicates whether the purpose of obtaining the loss carry back tax offset was incidental or of greater importance.

2.92 The second relevant circumstance is the extent to which the corporate tax entity continues to use the same assets. [Schedule 2, item 2, paragraph 160-35(2)(b)]

2.93 If the entity is acquired as a means to obtain control over assets of the entity, this may indicate that the purpose of the new owner was gaining control over the assets rather than the tax offset. This is more likely to be the case where the assets have unique characteristics that cannot be obtained other than through purchase of membership interests in the company. The assets do not need to be used for the same or a similar purpose as they were used by the former owners.

2.94 The extent to which the new controllers of the entity use the pre-existing assets does not preclude the replacement of those assets as part of the ordinary running of a business.

2.95 The third relevant circumstance is the matters referred in subsection 177D(2) of the ITAA 1936. [Schedule 2, item 2, paragraph 160-35(2)(c)]

2.96 These matters are:

•

the manner in which the scheme was entered into or carried out;

•

the form and substance of the scheme;

•

the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

•

the result in relation to the operation of the income tax law that, but for the integrity rule, would be achieved by the scheme;

•

any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

•

any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

•

any other consequence for the relevant taxpayer, or for any person connected with the relevant taxpayer, of the scheme having been entered into or carried out; and

•

the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person.

2.97 Whether a change in the membership interests in a company was done with the purpose of gaining access to a tax offset is a matter that can only be determined on its facts. Nonetheless, the more complex or artificial the arrangements that surround the change in membership interests, the more likely it is that the tax offset will not be allowed because the form and substance of the scheme and the manner in which it was entered into indicate a purpose of getting the tax offset rather than a normal commercial purpose.

2.98 Ordinarily, it would not be expected that a change of control that arises from generational change within family owned corporate tax entities would indicate that there was a purpose of obtaining a tax benefit. Considering the financial and other consequences for the vendors and purchasers and the nature of the connection between them, the handing over of the membership interests and control of the company as the older generation retires is more likely to reflect family dynamics rather than any purpose of obtaining a tax offset. This would remain the situation notwithstanding that the younger generation may wish to introduce changes to the company's business that initially could be expected to lead to losses that could be carried back.

2.99 Similarly, the transfer of membership interests that arise from a marital breakdown is unlikely to have anything more than an incidental purpose of obtaining a tax offset. Nor is a transfer of membership interests arising from the breakdown of personal and business relationships between shareholders likely to involve anything more than an incidental purpose of obtaining a tax offset. Corporate tax entities in these situations may experience losses due to the disruption of working relationships and lack of focus on the operation of the business. In the absence of any other aggravating factors, losses could be carried back and the tax offset would be allowed.

How the integrity rule will be administered

2.100 Corporate tax entities self-assess whether the integrity rule applies to their circumstances. In most instances, it will be clear that the integrity rule does not apply to their circumstances and they are then able to prepare their tax return and claim the refundable tax offset from the Commissioner.

2.101 Entities that may have doubts are able to seek the advice of the Commissioner.

Examples

2.102 The following examples illustrate how the integrity rule applies.

Example 2.3 : Entity conducting similar business

Pretty Flowers Pty Ltd is a profitable company. However, its profits are in long term decline. Its business activities are growing of flowers for sale of flowers from a shop. As required, flowers are purchased from suppliers for sale from the shop.

All of the shares that provide control of the company are purchased by Andrew and Melinda for $2 million. At that time, Pretty Flowers has a franking account balance of $250,000. Recent sales of nearby properties that had been used for agricultural but not floral purposes suggest that a fair market value of the flower farm and shop would be $1.85 million. The properties available do not have the arterial road access that Pretty Flowers has and would need to have new flower beds planted.

In accordance with their business plan, Andrew and Melinda refurbish the shop and add a café. They also expand the products sold from the shop to include the work of local artists. Andrew and Melinda expect that Visanna Flowers will incur a loss of $800,000 in the first year of operation but become profitable afterwards. The expected availability of the loss carry back tax offset is included in the cash flow projections provided to their banker.

On the evidence available, Andrew and Melinda's purpose is to implement changes that they expect will lead to Pretty Flowers being a more profitable business than it currently is. While Pretty Flowers is undertaking new business activities, it has also continued its initial business activities of growing and buying flowers for sale. The company has retained most of its pre-existing assets albeit that some have been refurbished.

While the cash flow benefit of the carry back of losses has been taken into account, in this particular instance, other factors such as the existing flower beds and arterial road access lead to the view that the carry back of the loss was an incidental purpose of acquiring of Pretty Flowers Pty Ltd.

Example 2.4 : Entity acquiring assets that are generic in nature

Gabrielle's Consulting Pty Ltd has a five-year lease over premises in a country town with an option to renew the lease for a further five years. There are many similar premises located within 500 metres that are available on similar terms. The company has been returning profits in excess of $500,000 in recent years and has a franking account balance of $400,000. Other than the lease and office equipment, the company has no significant assets.

Jackie acquires all of the shares in the company for $150,000. Gabrielle establishes a new company called Gabrielle's Consulting Services Pty Ltd and trades from one of the available premises located across the road. As the office equipment is of limited value to Jackie, she permits Gabrielle to buy what she wishes and take it with her.

Jackie renames the company Jackie's Promotions Pty Ltd and refurbishes the business premises to meet her needs. As expected from the business plan, Jackie's Promotions makes a loss of $800,000 in its first year of operation. Jackie insists that her primary purpose in purchasing the membership interest in what is now her company was to obtain a valuable long term lease.

Jackie is conducting a very different business to that of Gabrielle. While the company under her control has continued to use the same leased premises, comparable alternative premises were readily available. Jackie's claim that she wanted a valuable long term lease is not convincing. The payment of $150,000 by Jackie is providing a financial benefit to Gabrielle. Jackie will also receive a financial benefit in that the company now under her control can expect to receive a loss carry back tax offset of $240,000 (30 per cent of $800,000) in its first year of operation and possibly a further loss carry back tax offset should the second year's trading give rise to a loss.

Accordingly, the loss carry back tax offset would be denied.

Example 2.5 : Entity sells assets back to former owners

Tally Transport Pty Ltd owns vehicles, plant and equipment valued at $10.5 million. The company has a franking account balance of $600,000. Members of the King family acquire 100 per cent of the membership interest in Tally Transport for $10.8 million and rename the company King Plumbing Pty Ltd.

Within a matter of days, King Plumbing sells for $10.5 million all of the vehicles, plant and equipment to Tally Transport Service Pty Ltd, a company wholly owned by the former shareholders of Tally Transport.

King Plumbing then commences a new business that in its first year of operation is expected to incur a loss of $1.5 million and $1 million in its second year, before it becomes profitable.

The King family is conducting a very different business to that of the former owners of what is now King Plumbing. While very valuable assets were acquired with the company, the quick sale of those assets demonstrates that there was never any intention to use them in an income earning activity. The very substantial recoupment of the purchase price for the company by selling its assets has effectively led to a situation where the net cost to the King family was $300,000.

As the King family expects the company to have trading losses of $2.5 million, they can reasonably expect to be able to carry back losses so that King Plumbing will obtain tax offsets of $300,000 in both of the first two years of operation under their control.

It is probable that the availability of the tax offset over two years was a significant purpose of the transfer of membership interests. Both tax offsets would be denied.

Example 2.6 : No expectation of loss

Summertime Sun Pty Ltd has been a profitable company for many years and has a franking credit balance of $300,000. The market value of the underlying assets of the company is $2.8 million. The company's owner wishes to retire and the shares are acquired by two long standing employees for $2.9 million.

Following the change of ownership in the company, minimal changes are made to its operations or assets. Based on their intimate knowledge of the company, the new owners were confident that it would continue to be profitable. Some months after acquisition, due to a fire, the company loses a substantial amount of stock leading to a loss for the year.

Under its new owners, Summertime Sun made minimal changes to its business and retained most of its business assets. The price for the membership interest could suggest that it was calculated with reference to a financial benefit from the franking credit balance. However, as the price paid is fairly close to market value, it could also represent the respective bargaining strengths of the parties. The new owners had a reasonable expectation that the company would continue to be profitable.

As the fire could not be predicted and there was no expectation that the tax offset would be claimed, there would be no basis to deny the tax offset.

Interest on overpayments and late payments

2.103 A loss carry back tax offset forms part of the tax assessment of the current year. Loss carry back alters neither the tax liability of the year to which a loss is carried back nor the consequences of any failure to have paid that liability by the due date. It follows that claiming a loss carry back tax offset by carrying a loss back to a particular year does not:

•

give rise to a right to interest on overpayments in relation to the tax liability assessed for that year; or

•

reduce any general interest charge or shortfall interest charge arising from not paying the liability of that year.

Consequential amendments

The general anti-avoidance rule

2.104 The amendments modify the income tax general anti-avoidance rule in Part IVA of the ITAA 1936 so that it applies to schemes entered into with the purpose of obtaining a loss carry back tax offset.

2.105 The general anti-avoidance rule works by identifying a scheme and a tax benefit that is produced for a taxpayer by the scheme. The Commissioner can cancel the tax benefit if it can be concluded (after examining eight listed factors) that someone entered into the scheme for the dominant purpose of providing the taxpayer with the tax benefit.

2.106 A tax benefit is defined to include an amount not being included in the taxpayer's assessable income, a deduction or capital loss being incurred by the taxpayer, or a foreign income tax offset being allowable to the taxpayer. The amendments extend that definition to include a loss carry back tax offset being available to the taxpayer. [Schedule 2, items 4 to 6, the definition of 'loss carry back tax offset' in subsection 6(1), paragraphs 177C(1)(baa) and (ea) of the ITAA 1936]

2.107 As with the existing tax benefits, the tax benefit from gaining a loss carry back tax offset does not apply if the offset arises from making a choice expressly provided for by the income tax law unless the scheme was entered into for the purpose of enabling the choice to be made. [Schedule 2, items 7 to 10, subsections 177C(2) and (3) of the ITAA 1936]

2.108 In this regard, if a scheme is entered into to inflate the amount of a loss carry back offset, subsection 177C of the ITAA 1936 does not prevent Part IVA from applying to the scheme. Therefore, if a taxpayer is entitled to make a loss carry back choice for an amount that is lesser than the amount specified in the choice but inflates the amount under a scheme to which Part IVA applies, the Commissioner will be able to make a determination to cancel that part of the amount of the loss carry back offset that is the result of the scheme.

2.109 The bases for identifying tax benefits are also being extended to include whether or not the whole or part of a loss carry back tax offset is allowable to the taxpayer. [Schedule 2, item 11, paragraph 177CB(1)(ca) of the ITAA 1936]

2.110 If Part IVA is satisfied, the Commissioner can make a determination to cancel the tax benefit. The possible determinations, which separately cover each type of tax benefit, are extended to include determinations in relation to tax benefits from a loss carry back tax offset. [Schedule 2, item 12, paragraph 177F(1)(ca) of the ITAA 1936]

2.111 When the Commissioner makes a determination to cancel a tax benefit, he or she can also make any compensating adjustments needed to put any taxpayers into the tax position they would have been in if the scheme had not been entered into. The amendments allow the Commissioner to make compensating adjustments to provide taxpayers with the loss carry back tax offset that would have been available apart from the scheme. [Schedule 2, item 13, paragraph 177F(3)(ca) of the ITAA 1936]

Pooled development funds

2.112 A company that makes a tax loss in an income year that it ends as a PDF can only deduct that loss in a later income year in which it is a PDF for the whole year.

2.113 The amendments extend the same treatment to the loss carry back tax offset. They prevent a corporate tax entity carrying back a tax loss that arose in a year it ended as a PDF, unless it was a PDF throughout both the current year and the year the loss was carried back to. [Schedule 2, items 19, 20 and 24, sections 36-25 and 195-37]

2.114 As with the current law treatment of deductions for tax losses, there is no restriction on a PDF carrying back any tax loss that arose in a year it did not end as a PDF. Nor is there any restriction on carrying back a tax loss that arose in the part of a year before the company became a PDF. [Schedule 2, items 22 and 23, subsection 195-15(5)]

Venture capital and similar limited partnerships

2.115 The current law prevents a limited partnership from deducting a tax loss in an income year in which it is a venture capital limited partnership, an early stage venture capital limited partnership, an Australian venture capital fund of funds, or a venture capital management partnership.

2.116 These entities cannot be corporate tax entities and so cannot claim the loss carry back tax offset. However, if a limited partnership stops being one of these venture capital entities and becomes a corporate tax entity, it might claim the offset by carrying a loss back to a year in which it was one of those entities. That would provide the entity with an offset based on a year in which it was not a corporate tax entity and so would not have been able to deduct a tax loss. To preserve the symmetry with deducting tax losses, the amendments prevent a limited partnership carrying a tax loss back to a year in which it was a venture capital entity. [Schedule 2, items 21 and 25, sections 36-25 and 195-72]

2.117 Each partner in a venture capital partnership usually gets his or her share of the partnership's loss (subsection 92(2) of the ITAA 1936). However, a limited partner can only deduct its share of partnership losses to the extent of its contributions to the partnership (subsection 92(2AA) of the ITAA 1936). The remaining part of a limited partner's share of partnership losses is its 'outstanding subsection 92(2AA) amount' (subsection 92A(2) of the ITAA 1936). That amount can be deducted under some circumstances but can never be used to produce a tax loss for the limited partner (subsections 92A(1) and (3) of the ITAA 1936).

2.118 As the outstanding subsection 92(2AA) amount of a limited partner in a venture capital partnership cannot be part of a tax loss for the partner, it cannot be used to produce a loss carry back tax offset the limited partner might claim if it is itself a corporate tax entity. [Schedule 2, item 14, subsection 92A(3) of the ITAA 1936]

Life insurance companies

2.119 For income tax purposes, life insurance companies carry on two broad categories of business: complying superannuation business and ordinary business. The earnings on complying superannuation business are taxed in broadly the same way, and at the same rate, as earnings made by complying superannuation funds. Earnings on the ordinary business are taxed at the corporate tax rate.

2.120 To ensure that the tax treatment of the complying superannuation business of life insurance companies continues to be the same way as that of complying superannuation funds, loss carry back tax offsets are not available in respect of that complying superannuation business. They are available in respect of ordinary business. [Schedule 2, item 30, paragraph 320-149(2)(aa)]

Foreign hybrids

2.121 Foreign hybrid limited partnerships are entities that are partnerships under foreign law but would normally be treated as companies for the purposes of Australia's income tax law. A special regime ensures that they are generally treated as ordinary partnerships for purposes of the income tax law (Division 830).

2.122 Foreign hybrid limited partnerships are not eligible for loss carry back tax offsets (which are only available to corporate tax entities). However, a partner in such a partnership would get a share of the partnership loss and could, if it were itself a corporate tax entity, seek to claim a loss carry back tax offset. There are limits on the extent to which partners can claim a deduction for a tax loss flowing to them from a foreign hybrid limited partnership. To preserve symmetry with deducting tax losses, the amendments ensure that the same limits apply to the partner's use of that loss for loss carry back. [Schedule 2, item 31, subsection 830-65(3)]

Other minor amendments

2.123 Other minor amendments are made to:

•

update the non-operative lists of relevant provisions about tax offsets and tax losses are amended to include references to the loss carry back tax offset;

•

update notes to provisions; and

•

make minor technical corrections to the law.

[Schedule 2, items 15 to 18, 26 to 29, 35 and 36, sections 13-1, 36-25, 205-35 of the ITAA 1997, section 175 of the ITAA 1936 and section 45-340 in Schedule 1 of the Taxation Administration Act 1953]

Application and transitional provisions

2.124 The loss carry back tax offset rules apply to assessments for:

•

the 2020-21 income year; and

•

the 2021-22 income year.

2.125 The provisions in Schedule 2 to the Bill commence on the first day of the first quarter after Royal Assent. [Section 2 of the Bill]

SCHEDULE 2 - REGULATION IMPACT STATEMENT - TEMPORARY LOSS CARRY BACK

Background

2.126 The current treatment of losses does not contribute to companies' cash flow in an economic downturn, as they cannot access the tax value of a loss until they return to profitability. Additionally, the introduction of Temporary full expensing will generate large tax deductions for companies that invest in depreciable assets. In some cases this will create tax losses that would normally have to be carried forward and used to offset tax on future profits.

2.127 Individual taxpayers, including businesses operating as sole traders, can offset current year business losses against other income sources such as salary and wages and investment income. For large companies and consolidated groups that conduct a range of business activities, losses in one activity may be offset against profits from other activities, which provides some ability to utilise current losses.

2.128 However, companies that undertake only one business activity or suffer losses on the majority of their activities may not have other sources of income against which to offset their losses. These companies are required to carry that loss forward. Australia is not unique in this respect; it is common practice in other jurisdictions to require a loss to be carried forward, although various forms of loss carry back are available in a number of OECD countries, including Canada, France, Germany, Ireland, New Zealand, Singapore, the United Kingdom and the United States.

2.129 Tax loss carry back allows companies that paid tax in previous years to utilise their current losses rather than carry them forward. Conceptually, the loss is carried back to reduce the earlier profit and the corresponding reduction in tax is refunded to the company.

2.130 Tax loss carry back was introduced as a 2012-13 Budget measure. It was available for 2012-13 and was repealed after one year in 2014. It was designed to provide a permanent two year carry back, limited to a carry back amount of $1 million.

2.131 The economic analysis included in this RIS was made available to decision makers prior to a final decision being made. This RIS was finalised as part of the preparation of legislation after the final policy decision was made.

1. The problem

2.132 The Government has introduced a number of initiatives to support businesses withstand and recover from the economic effects of the Coronavirus. However, the current tax treatment of company losses will limit the effectiveness of some of those initiatives. Furthermore, for companies that suffer tax losses due to the economic effects of the Coronavirus, the requirement to carry those losses forward will delay access to the loss's tax value.

2.133 A key initiative aimed at helping businesses recover from the economic effects of the Coronavirus is Temporary full expensing. This time limited incentive allows companies to deduct the entire purchase cost of depreciating assets, rather than deducting this amount over time as the asset depreciates in value. By bringing these deductions forward, the after-tax cost of assets is reduced which creates an incentive for businesses to invest. This investment will boost Australia's productive capacity over the longer run, leading to higher wages and living standards for all Australians. This investment will increase long-term productivity in the economy providing support for wage growth. Temporary full expensing will be available until 30 June 2022, creating an incentive to make investments before the measure terminates to qualify.

2.134 This tax treatment will change the timing of deductions significantly which will have the apparent effect of moving profits and losses between years. In general, profits will move out of years where eligible investment are made and towards subsequent years. In some cases this movement will generate tax losses and in other cases losses under the counterfactual policy will simply become larger. The current company tax treatment of these losses will dilute the economic incentive provided by Temporary full expensing.

Example 1

Quaternion Construction Limited purchases a piece of equipment for $1 million. Under Temporary full expensing the entire purchase price is deductible in the year of the purchase so if Quaternion Construction's taxable income before the purchase was $1 million then the purchase would reduce its taxable income to zero, saving $300,000 in tax that year (at the 30 per cent company tax rate). However, if Quaternion Construction's taxable income was only $600,000 before the purchase, its tax outcome would be a tax loss of $400,000. The related tax saving would only be $180,000 because without loss carry back the tax value of the loss would have to be carried forward to offset future tax liabilities rather than being immediately accessible. The full tax value of the loss will eventually be realised if Quaternion Construction goes on to make sufficient profits but the delay in realising this value will reduce the attractiveness of Temporary full expensing and make the company less likely to change its decisions in favour of making new investments under the policy.

2.135 Temporary full expensing also changes tax outcomes in subsequent years because there are no depreciation expenses in those years for qualifying purchases. However, this does not eliminate the problem. The consequences of requiring tax losses to be carried forward still reduce the economic incentive created by Temporary full expensing because of the delay in accessing the tax value of the loss.

2.136 The other problem associated with loss carry-forward during an economic downturn is that while profits are taxed in the year they are realised, the tax value of losses generated by the downturn is not immediately available to affected companies. This asymmetry reduces the degree of economic stabilisation provided by the corporate tax system. With a more symmetric treatment of losses, corporate taxation would provide more support to the economy during downturns, and this support would be targeted towards firms that have been more seriously affected.

2. Why Government action is needed

2.137 The problems identified in the previous section occur within a regulatory system (the tax system). As a result, they can only be addressed by Government action. The objective of any reform to address these problems should be to provide earlier access to the tax value of losses for the period that Temporary full expensing is available at an acceptable fiscal cost without introducing further problems.

2.138 The main problems created by providing earlier access to the value of tax losses are related to the integrity of the tax system. Providing early access to tax losses significantly increases the difficulty of denying dishonest claims before they are processed under self-assessment and recovering amounts that have been paid out inappropriately.

2.139 More broadly this proposal is consistent with a number of policies the Government has introduced that aim to support the economy recover from the effects of the Coronavirus. The aim of supporting companies recover is consistent with the broad thrust of policy and it specifically complements Temporary full expensing by preserving the incentives it provides in certain cases.

3. Policy options

No change - option 1

2.140 While not changing the tax treatment of losses would not address the policy problem associated with delayed access to the tax value of losses, it would avoid the integrity problems associated with all of the identifiable reforms.

Loss Refundability - option 2

2.141 The first option that requires new policy would be a loss refundability measure. This would more closely resemble a purely symmetrical tax treatment of losses and profits by allowing tax losses to be refunded in the income year in which the tax loss occurs. For example, if a company makes a tax loss of $1 million, it would receive a $300,000 tax refund in their income tax assessment for the year in which the loss is realised (at the 30 per cent tax rate).

2.142 While this approach would meet the aim of providing earlier access to the tax value of losses, it would create significant integrity concerns. In particular, loss refundability raises the possibility of fraudulent taxpayers making a net profit from a tax scheme. The systems and laws used to administer the income tax system are not designed to mitigate this type of risk. For example, if a business ceases operating, there is little recourse for the Commissioner of Taxation to take action against a taxpayer to recover an inappropriately claimed refund. Other key integrity concerns include schemes to generate tax losses on paper to receive the tax refund, noting that once a refund is issued it is difficult to recoup. A related yet distinct concern is international corporations could artificially shift their losses to their Australian subsidiaries to receive the tax benefit using related party transactions. This option would also increase the risk of loss trading whereby failing businesses are acquired for the tax benefits of the losses. These integrity risks will deteriorate the existing tax base and unduly distort commercial decisions.

2.143 The level of resources required to mitigate these risks would be significant given that even with the current asymmetric treatment of tax losses, around one third of companies made a tax loss in a typical year when the economy is growing. Implementing loss refundability would require significant structural change, as it would be exceedingly difficult to implement loss refundability temporarily with sufficient integrity.

Temporary Loss Carry back - option 3

2.144 A third option is to allow companies to carry back losses incurred in a given year against taxed profits in earlier years. The primary difference compared to loss refundability is that Temporary loss carry back has a more limited application in that it requires profits in earlier years. It also raises fewer integrity issues because taxpayers can only ever claim back tax that was paid in the past.

2.145 For example, if Jamie's Coffee Pty Ltd had taxable income of $5 million and paid $1.5 million in income tax in 2018-19 but due to the impact of the Coronavirus restrictions makes a tax loss of $2 million in 2019-20. Under the treatment of losses in the current law, Jamie's Coffee Pty Ltd would carry these losses forward until it made a taxable profit. Under Temporary loss carry back it will receive a tax refund of $600,000 in recognition of this loss.

2.146 Temporary loss carry back has the advantage that it was previously designed and introduced in Australia in 2012-13 and was available until it was repealed in 2014. The previous experience with loss carry back means that many of the implementation and integrity issues were considered and the old framework provides an advanced starting point for a reintroduction. It should also be noted that when loss carry back was repealed, the repeal was part of the broad repeal of the Mineral Resources Rent Tax together with the measures that it funded, rather than identified short comings of the regime.

2.147 Temporary loss carry back also has the advantage that it is more targeted towards firms that were previously viable, reducing the risk that it supports firms that were already experiencing weakness prior to the current health crisis. Previously weak firms will have more limited access to the benefits of Temporary loss carry back due to a lack of prior taxed profits.

2.148 There are a number of design choices associated with a loss carry back regime. In this case, given the need to support Temporary full expensing, the policy should match the qualification criteria for that scheme. The key criteria are that Temporary full expensing ends on 30 June 2022 and that it is only available to businesses with turnover below $5 billion per year. The corresponding rules for Temporary loss carry back would be that it ends after the 2021-22 income year and that it has the same qualifying turnover limit.

2.149 One complicating factor associated with Temporary loss carry back is its interaction with the imputation system. This system uses tax credits to impute tax paid at the company level to domestic shareholders that receive dividends. Temporary loss carry back needs to be designed to prevent the refund of tax that has also generated imputation credits that have been distributed and claimed by shareholders. Such an outcome would effectively credit tax paid at the company level twice, resulting in net tax refunds when considered across the whole tax system. To prevent these outcomes, Temporary loss carry back can be limited to previous tax amounts that have not generated distributed credits.

2.150 The number of years that taxpayers can carry a loss back can be limited, with shorter carry back periods associated with lower fiscal costs, reduced integrity risks, and more precise targeting towards previously viable businesses. A shorter carry back period also reduces the number of companies that are limited by the imputation considerations described above. This proposal considers Temporary loss carry back to the last income year that was not affected by the economic effects of the Coronavirus, which is the 2018-19 income year. Other jurisdictions that have adopted loss carry back have opted for carry back periods of between one and three years.

2.151 Australia's previous loss carry back regime limited the amount of loss carried back to $1 million. This limit reduced the fiscal cost of the measure and managed the integrity risk. This proposal does not have a limit on the amount carried back, reflecting the aim of supporting Temporary full expensing (which is also unlimited). As there are natural limits to this measure, not having a dollar limit on the amount allowed to be carried back is not as much of a concern as with loss refundability (option 2). Its temporary imposition also limits the ability of taxpayers to create structures that exploit the regime, on top of the integrity rules that can be applied from the 2012-13 measure.

2.152 The integrity issues associated with Temporary loss carry back were largely considered during the design of the previous implementation of the regime in 2013. It would be appropriate to replicate the integrity rules that applied under the previous regime in 2013 which were designed to prevent schemes that have the purpose of claiming a tax loss carry back benefit. These schemes would work by combining, in a single entity, the three main characteristics required to claim a tax benefit. That is, a prior tax profit, a recent loss and a sufficient franking account balance. Only introducing loss carry back on a temporary basis would further limit integrity risks. Additional departmental funding to the Australian Taxation Office to upgrade internal systems would also assist in detecting integrity concerns associated with Temporary loss carry back.

Loosening Loss Integrity Rules - option 4

2.153 The final option is to temporarily amend the current loss integrity rules. The current rules limit the benefit a company receives for providing new equity or their ability to alter the goods or services or business model while retaining access to previous losses.

2.154 The two integrity rules that could be relaxed to provide an effective benefit are the Continuity of Ownership Test (COT) and the Business Continuity Test (BCT), as they limit the availability of losses through mergers or acquisitions. COT requires that 50 per cent of a company's shares carrying all voting, dividend, and capital rights are held by the same persons. The BCT requires the acquired entity to maintain the same or substantially similar business activities to those that it carried on prior to the change in ownership.

2.155 Relaxing integrity rules makes companies in a loss position more valuable to larger corporations, especially those with large franking credit balances. However, for companies to receive a benefit from the policy it requires acquisition to some extent. There is a risk that this option would not be very effective in an economic downturn as most companies would likely be financially constrained to buy other businesses.

2.156 Obviously any relaxation of the integrity rules would raise integrity risks. In this instance some of these risks are associated with old losses that accrued before the current health crisis. Providing recognition for these losses reduces the targeting of this measure, raising its cost by supporting firms that were struggling to be viable before the health crisis.

4. Impact analysis

2.157 These options only affect corporate taxpayers. That is, companies and entities that are taxed like companies. In all cases the regulatory burden imposed by these options would either be zero (for option 1) or overwhelmingly smaller than the impact on the amount of tax paid by companies. These regulatory burdens are discussed in this statement, but the main considerations in the choice between options are the policy outcomes for taxpayer behaviour and the structure of the tax system.

2.158 The integrity risk associated with option 2 is structural in magnitude. Annual corporate tax losses over recent years (which were not affected by the health crisis) have been between 15 to 20 per cent of gross tax profits. The administrative systems that support the income tax system would not be able to scrutinise refunds at this level of losses (or greater levels in a downturn). It would also not be possible to increase the capacity of tax administration in the short time that this policy is available to support taxpayers. The introduction of further integrity rules to mitigate this risk would not only increase the level of administration required, but likely create a significant regulatory burden for taxpayers. Globally, no major economies provide general loss refundability for corporate income tax payers.

2.159 There are integrity risks associated with option 4 also, but this option has a further weakness due to its imprecise targeting. Assistance would rely on the existence of healthy companies that are interested in purchasing loss making companies to access the tax value of their losses. In a scenario where losses are concentrated in particular sectors of the economy, the pairing of loss making companies with profitable purchasers is likely to be difficult within sectors, further reducing the likelihood of a successful match.

2.160 The policy considerations associated with option 3 are the level of targeting of assistance provided, the degree of integrity issues and the associated regulatory burden.

2.161 The level of assistance provided by these policies is linked to their long-term fiscal cost, so the level of targeting is a key policy consideration. Temporary loss carry back will be available to eligible companies, with the key criteria determining eligibility being the presence of tax profits and losses in the correct years, together with having a sufficient franking balance. Sufficient franking credits at the end of the loss year is a requirement because once a company distributes their franking credit, which they receive for paying tax, their shareholders will typically use the franked dividends to offset their personal income tax liability. Without this limit, Temporary loss carry back would generate double benefits because a refund of company tax would have to be paid both to the company and to its shareholders. Further, companies that have a franking account deficit at the end of the income year would be required to pay franking deficit tax (potentially with penalties). Data suggests that a lack of franking balance will affect only a small percentage of companies.

2.162 Temporary loss carry back is being proposed in conjunction with Temporary full expensing to encourage business investment. In recent years around 40 per cent of investment in new depreciating assets by companies is from those in a tax loss position. Providing Temporary loss carry back would increase the proportion of companies that receive an immediate tax benefit under Temporary full expensing. Without Temporary loss carry back, these companies would have to wait before accessing the tax value of these deductions, potentially deterring them from making investment decisions.

2.163 The incentive created by Temporary full expensing is due to the bring-forward in timing of deductions for the purchase of a depreciating asset, which would ordinarily be spread over the effective life of the asset. Under Temporary full expensing these deductions are brought forward, which increases their present value thereby creating the incentive to invest. However, without Temporary loss carry back, companies that experience a tax loss will have to wait until the tax loss is used to offset a future profit to enjoy the tax benefit, destroying the incentive. Temporary loss carry back preserves the incentive for eligible companies.

2.164 The presence of the appropriate profit and loss years targets the benefit provided by Temporary loss carry back to companies that were viable before the current health crisis. Requiring a current tax loss targets the benefit towards two broad populations. These are companies that have been negatively affected by the health crisis and companies that receive large tax deductions because they have taken advantage of Temporary full expensing (companies could have both of these attributes). In both cases Temporary loss carry back will produce a cash-flow benefit to the company, represented by the change in the underlying cash balance. In the case of companies that have utilised Temporary full expensing, there is an additional benefit derived from the preservation of the incentive created by Temporary full expensing. These measures encourage business investment which is an important factor in Australia's economic recovery and increasing productivity and wage growth. Treasury estimates that the combined economic impact of these measures will generate an increase in GDP of $21/2 billion in 2020-21 and $10 billion in 2021-22, and will create around 50,000 jobs by the end of 2021-22.

2.165 The regulatory burden placed on taxpayers by option 3 has been quantified using the Regulatory Burden Measurement Framework. The preferred option will increase compliance costs to corporate taxpayers and intermediaries by an average of $20 million per year. This includes a one-off compliance cost associated with moving from the current taxation treatment of losses to Temporary loss carry back. There is also an increase in recurring compliance costs associated with adding new labels to record keeping systems. This would add around $115 of additional compliance cost per taxpayer based on 175,000 possible entities that may claim the Temporary loss carry back. The regulatory impacts are provided in the table below. The calculation of the compliance cost and assumptions is provided at Appendix A.

2.166 The direct costs associated with option 3 is a reduction in receipts which is estimated at $4.9 billion over the forward estimates period. This is because the Temporary loss carry back would be used to offset previous tax paid, resulting in a tax refund to the company. The Australian Taxation Office would receive $4.4 million in funding to administer Temporary loss carry back and support taxpayers to understand and claim tax benefits.

2.167 The gross benefits provided by Temporary loss carry back are due to the reduction in company tax paid. These amounts are estimated in the associated revenue costing and are orders of magnitude larger than the direct costs. The indirect cost associated with option 3 is the opportunity cost of the revenue forgone. An assessment of how the overall costs and benefits compare relies on an assessment of the fiscal and macroeconomic impacts of the proposal.

5. Consultation

2.168 Past reviews and stakeholder consultations have established that there is justification and support for introduction of a loss carry back. Stakeholders expressed general support for a loss-carry back during consultation on the 2012-13 measure. General support for a loss carry back was echoed by business community stakeholders more recently in the Coronavirus context as a mechanism to provide cash flow support to businesses.

Australian tax reviews

2.169 Australia's Future Tax System (2009) recommended that companies should be allowed to carry back a revenue loss to offset it against the prior year's taxable income, with the amount of any refund limited to a company's franking account balance.

2.170 The review noted that a loss carry back would improve the asymmetric treatment of gains and losses and automatic fiscal stabilisers.

2.171 The 2011 Business Tax Forum and 2012 Business Tax working group undertook further work that developed the original 2012-13 policy. This culminated in the Final Report on the Tax Treatment of Losses (2012).

2019-20 Stakeholder views of loss carry back

2.172 A number of stakeholders have made recent representations to the Government supporting the introduction of loss carry back. The various proposals offered differed in detail but at least a two year carry back was most commonly proposed. There was some interest expressed in loss refundability, but as a larger structural change rather than a temporary recovery measure. A summary of these views is presented in the table below.

Stakeholder views of the 2012-13 measure

2.173 Prior the passage of the loss carry back in 2012-13, the Business Tax Working Group conducted extensive consultation with stakeholders and the business community. There were 24 submissions over the course of this consultation from representative bodies and companies. The summary of these views are:

•

Association of Mining and Exploration Companies: supports loss reform, however wants a targeted exploration credit instead of loss carry back.

•

Australian Chamber of Commerce and Industry: supports loss carry back but want it extended to all businesses, not just companies.

•

Australian Financial Markets Association: broadly supports loss carry back.

•

Australian Property Group: supports loss carry back with a three year carry back period because it isn't likely that a business will have one year in loss followed by a year in profit and so on. Cap on loss carry back is not mentioned.

•

BDO: rank loss reform as its highest priority. It prefers a carry back period of three years, with limit to carry back determined by franking account balances.

•

Associate Professor Dale Boccabella: refers to his article, "A loss carry back rule for business losses in Australia: Some initial thoughts", Weekly Tax Bulletin, Thomson Reuters, No 47, 11 November 2011 at paragraph 1770. Notes the importance of tax losses to the integrity of the tax system and recommends a higher onus of proof rule, particularly for trusts.

•

Business SA: supports loss carry back with a three year carry back period.

•

Corporate Tax Association: support a one year loss carry back, with exceptions for certain circumstances (e.g., GFC) and supports a cap on the losses carried back as in the European model.

•

CPA Australia: supports loss carry back for a two year period, with a modest cap as businesses are not prepared to give up much to fund loss carry back.

•

Ernst & Young: support a loss carry back limited to two years, but do not support a cap other than the franking account balance.

•

Grant Thornton: supports loss carry back with a two year carry back period.

•

Institute of Public Accountants: supports loss carry back with a one to three year carry back period. It supports a restriction to small businesses for the measure.

•

Master Builders Association: support loss carry back with a longer carry back period to support large capital investments.

•

National Tourism Alliance: supports loss carry back with a carry back period of more than one year.

•

Pennam Partners: notes that loss carry back will not benefit start-up companies.

•

Property Council of Australia: strongly prefers a loss carry back to other loss reforms, with a three year carry back period and be available to all businesses.

•

Real Estate Institute of Australia: supports loss carry back with a carry back period of three years.

•

The Institute of Chartered Accountants Australia: supports loss carry back, with a carry back period of two years, as a measure to support smaller businesses in better accessing their losses and supporting them during downturns.

•

The Tax Institute: support a limited loss carry back as outlined in the Australia's Future Tax System report.

•

Tourism and Transport Forum: strongly support loss carry back, with a three year carry back period, as it will provide a cushion against the shocks regularly experienced by this industry (weather and other natural events, transport shocks, etc).

•

Tourism Accommodation Australia: support loss carry back in some form as it will support capital investment in their industry.

•

Yarrawa Management Pty Ltd: Broadly support a loss carry back, with a three year carry back period, as the horticultural industry have longer peaks and troughs.

6. Option selection/Conclusion

2.174 The significant integrity issues associated with option 2 prevent its practical application to address the policy priorities identified in section 2. Policy considerations also suggest that option 4 is not preferred given the very conditional nature of support it provides firms in loss positions requiring the acquisition of other companies that are in a loss position and/or have large franking credit balances. However in an economic downturn, it is possible this support would not be readily accessible.

2.175 The key consideration is between options 1 (no policy change) and 3 (Temporary loss carry back). Option 3 is preferred on the basis of its contribution to the economic recovery from the Coronavirus.

7. Implementation and evaluation

2.176 The temporary nature of this proposal will mean there is limited opportunity for review whilst it is in operation. However, it will naturally be considered as part of the review of the Government's response to the Coronavirus that will also consider the associated Temporary full expensing policy.

2.177 Furthermore, the previous implementation of loss carry back was repealed to fund other spending priorities rather than because of the identification of any weaknesses in any historic evaluations.

Appendix A to the Regulation Impact Statement - Calculation of compliance cost assumptions

Chapter 3 - Increasing the small business entity turnover threshold for certain concessions

Outline of chapter

3.1 Schedule 3 to the Bill amends the A New Tax System (Goods and Services Tax) Act 1999, Customs Act 1901, Excise Act 1901, Fringe Benefits Tax Assessment Act 1986, Income Tax Assessment Act 1936, Income Tax Assessment Act 1997 and Taxation Administration Act 1953 to enable eligible entities with an aggregated turnover of $10 million or more and less than $50 million to access the following small business entity tax concessions:

•

a simplified accounting method for the purposes of GST, if determined by the Commissioner;

•

the ability to defer excise-equivalent customs duty to a monthly reporting cycle;

•

the ability to defer excise duty to a monthly reporting cycle;

•

a fringe benefits tax exemption in relation to small business car parking;

•

a fringe benefits tax exemption in relation to the provision of multiple work-related portable electronic devices;

•

an immediate deduction for certain prepaid expenses;

•

a two year amendment period in respect of amendments to income tax assessments;

•

an immediate deduction for certain start-up expenses;

•

the simplified trading stock rules; and

•

the ability to calculate their PAYG instalments based on GDP-adjusted notional tax.

3.2 Eligible entities will be able to access these concessions in phases.

Context of amendments

3.3 The Government is continuing to support businesses affected by the Coronavirus pandemic by simplifying regulatory obligations and expanding access to a range of small business tax concessions for eligible businesses.

3.4 Businesses can currently access most small business entity concessions if they are carrying on a business and have an aggregated turnover of less than $10 million.

3.5 This measure expands access to certain small business entity concessions by increasing the aggregated turnover threshold that is applied for the purposes of those concessions. The threshold is being increased to capture business with an aggregated turnover of less than $50 million.

3.6 Increasing the turnover threshold will reduce red-tape for around 20,000 businesses (such as reducing reporting or calculation requirements) and in some cases reduce their tax liability.

3.7 The aggregated turnover threshold was previously raised in 2017 from $2 million to $10 million for most small business entity concessions.

Summary of new law

3.8 Schedule 3 to the Bill makes amendments to enable eligible entities with an aggregated turnover of $10 million or more and less than $50 million to access certain small business entity tax concessions.

3.9 Eligible entities will be able to access the following concessions from 1 July 2020:

•

an immediate deduction for certain prepaid expenses; and

•

an immediate deduction for certain start-up expenses.

3.10 Eligible entities will be able to access the following concessions from 1 April 2021:

•

a fringe benefits tax exemption in relation to small business car parking; and

•

a fringe benefits tax exemption in relation to the provision of multiple work-related portable electronic devices.

3.11 Eligible entities will be able to access the following concessions from 1 July 2021:

•

a simplified accounting method for the purposes of GST, if determined by the Commissioner;

•

the ability to defer excise-equivalent customs duty to a monthly reporting cycle;

•

the ability to defer excise duty to a monthly reporting cycle;

•

a two year amendment period in respect of amendments to income tax assessments;

•

the simplified trading stock rules; and

•

the ability to pay PAYG instalments based on GDP-adjusted notional tax.

Comparison of key features of new law and current law

Detailed explanation of new law

3.12 The amendments made by Schedule 3 will enable businesses with an aggregated turnover of $10 million or more and less than $50 million to access certain small business tax concessions.

3.13 These amendments do not change the aggregated turnover threshold of $10 million for determining whether you are a small business entity in section 328-110 of the ITAA 1997. Rather, the amendments enable you to substitute a higher aggregated turnover threshold to work out whether you are eligible for certain small business entity concessions. This will ensure that the current aggregated turnover threshold will remain the threshold in respect of other small business entity concessions.

Amendments to the A New Tax System (Goods and Services Tax) Act 1999

Simplified accounting methods for GST

3.14 Schedule 3 makes amendments to allow eligible entities to access simplified accounting methods, as determined by the Commissioner.

3.15 Small enterprise entities, which include small business entities, can apply a simplified accounting method as determined by the Commissioner to simplify the management of their GST compliance (see Division 123 of the GST Act).

3.16 The Commissioner's power to create a simplified accounting method determination for GST purposes will be expanded to apply to businesses below the $50 million aggregated turnover threshold.

3.17 The amendments introduce a new class of entity that can be eligible for a simplified accounting method. This new class covers entities that would be small business entities if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 1 and 2, section 123-7(1) of the GST Act]

3.18 These amendments apply in relation to working out whether an entity is a small enterprise entity at or after the start of 1 July 2021. [Schedule 3, item 40(1)]

Amendments to the Customs Act 1901

Excise-equivalent customs duty

3.19 Schedule 3 makes amendments to allow eligible entities to defer settlement of excise-equivalent customs duty, for eligible goods, to a monthly reporting cycle.

3.20 Currently, small business entities as defined in the Customs Act 1901 can apply to the Comptroller-General of Customs to defer settlement of excise-equivalent customs duty, for eligible goods, to a monthly reporting cycle (see section 69 of the Customs Act). Other businesses are generally required to report on a weekly cycle.

3.21 The amendments create a new definition, an eligible business entity, for the purposes of expanding the businesses that are eligible to access this concession. [Schedule 3, item 3, section 4(1) of the Customs Act 1901]

3.22 Eligible business entities are entities that would be small business entities if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 4 and 6, section 69(1) of the Customs Act 1901]

3.23 Consequential amendments are also made as a result of the new definition of eligible business entity. [Schedule 3, items 5 and 7, section 69 of the Customs Act 1901]

3.24 These amendments will allow entities with an aggregated turnover of less than $50 million to be eligible to defer settlement of excise-equivalent customs duty to a monthly reporting cycle.

3.25 These amendments apply in relation to applications made under section 69(1) of the Customs Act 1901 on or after 1 July 2021. [Schedule 3, item 40(2)]

Amendments to the Excise Act 1901

Excise duty

3.26 Schedule 3 makes amendments to allow eligible entities to defer settlement of excise duty, for eligible goods, to a monthly reporting cycle.

3.27 Currently small business entities as defined in the Excise Act 1901 can apply to the Commissioner to defer settlement of excise duty, for eligible goods, to a monthly reporting cycle (see section 61C of the Excise Act). Businesses that are not small business entities are generally required to report on a weekly cycle.

3.28 The amendments create a new defined term, an eligible business entity, for the purposes of expanding the businesses that are eligible to access this concession. [Schedule 3, item 8, sections 4(1) of the Excise Act]

3.29 Eligible business entities are entities that would be small business entities if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 9 and 11, section 61C(1) of the Excise Act 1901]

3.30 Consequential amendments are also made as a result of the new defined term eligible business entity. [Schedule 3, items 10 and 12, section 61C of the Excise Act 1901]

3.31 These amendments will allow entities with an aggregated turnover of less than $50 million to be eligible to defer settlement of excise duty to a monthly reporting cycle.

3.32 These amendments apply in relation to applications made under section 61C(1) of the Excise Act 1901 on or after 1 July 2021. [Schedule 3, item 40(3)]

Amendments to the Fringe Benefits Tax Assessment Act 1986

Car parking exemption

3.33 Schedule 3 makes amendments to extend the fringe benefits tax exemption in relation to small business car parking.

3.34 Car parking benefits provided by an eligible employer to an employee where the employer is a small business entity are currently exempt from fringe benefits tax where certain conditions are met (see section 58GA of the Fringe Benefits Tax Assessment Act 1986).

3.35 The amendments introduce a new class of entities eligible for the exemption. This new class covers entities that would be small business entities if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 13 and 14, section 58GA(1) and 58GA(1A) of the Fringe Benefits Tax Assessment Act 1986]

3.36 These amendments will allow entities with an aggregated turnover of less than $50 million to be eligible for an exemption from fringe benefits tax on car parking benefits provided to employees.

3.37 These amendments apply to car parking benefits provided to employees from 1 April 2021. [Schedule 3, item 40(4)]

Multiple work-related portable electronic devices exemption

3.38 Schedule 3 makes amendments to extend the fringe benefits tax exemption in relation to the provision of certain work related items.

3.39 Work-related portable electronic devices provided to employees by their employers are exempt from fringe benefits tax. However the exemption does not apply to additional devices provided to employees that have substantially identical functions to devices previously provided. An exception to this is if it is a small business entity (section 58X of the Fringe Benefits Tax Assessment Act 1986).

3.40 The amendments introduce a new class of entities eligible for the exemption. This new class covers entities that would be small business entities if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 15 and 16, section 58X(4)(b) and section 58X(5) of the Fringe Benefits Tax Assessment Act 1986]

3.41 These amendments will allow entities with an aggregated turnover of less than $50 million to be eligible for an exemption from fringe benefits tax on additional portable electronic devices provided to employees.

3.42 These amendments apply to benefits provided to employees on or after 1 April 2021. [Schedule 3, item 40(4)]

Amendments to the Income Tax Assessment Act 1936

Immediate deduction for prepaid expenditure

3.43 Schedule 3 makes amendments to allow a wider range of entities to immediately deduct certain prepaid expenditure.

3.44 A small business entity can choose to deduct the full amount of prepaid expenditure relating to a service that will be provided across income years for a period of 12 months or shorter but that ends in the following income year (see section 82KZM of the ITAA 1936).

3.45 The amendments introduce a class of business, a medium business. These are businesses that would be a small business entity if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, items 18 and 19, section 82KZM(1) of the ITAA 1936]

3.46 A medium business will be able to also choose to deduct the full amount of prepaid expenditure relating to a service that will be provided across income years for a period of 12 months or shorter but that ends in the following income year.

3.47 These entities can also instead choose to apply section 82KZMD of the ITAA 1936 to deduct expenditure proportionally in each year of income relating to all or part of the eligible service period for the expenditure. However if an entity chooses to apply section 82KZMD, the immediate deduction under section 82KZM of the ITAA 1936 will be unavailable. [Schedule 3, items 20 and 21, sections 82KZMA(2)]

3.48 Consequential amendments have been made to the heading in section 82KZM and the note in section 82KZMD of the ITAA 1936. [Schedule 3, items 17 and 22, the heading to section 82KZM of the ITAA 1936 and the note to section 82KZMD of the ITAA 1936]

3.49 These amendments apply in relation to expenses incurred on or after 1 July 2020. [Schedule 3, item 40(5)]

Limited amendment period

3.50 Schedule 3 makes amendments to allow a wider range of entities to have a two year amendment period in relation to their income tax assessments.

3.51 Section 170 of the ITAA 1936 provides a limited period in which the Commissioner may amend a taxpayer's income tax assessment. Generally for a small business entity that period is two years.

3.52 The amendments introduce a new class of entity, a medium business entity. These are businesses that would be a small business entity if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year. [Schedule 3, item 24, section 170(14) of the ITAA 1936]

3.53 Medium business entities will have a limited amendment period of two years in relation to their income tax assessments, similar to that of small business entities currently. [Schedule 3, item 23, table items 1, 2, and 3 of the table in section 170(1) of the ITAA 1936]

3.54 The Commissioner continues to be able to amend an assessment at any time if the Commissioner is of the opinion there has been fraud or evasion, or to give effect to an objection made by the taxpayer or a decision on review or appeal.

3.55 These amendments apply in relation to assessments for income years starting on or after 1 July 2021. [Schedule 3, item 40(6)]

Amendments to the Income Tax Assessment Act 1997

Immediate deduction for certain start-up expenses

3.56 Schedule 3 makes amendments to allow a wider range of entities to immediately deduct certain start-up expenditure.

3.57 A small business entity can deduct certain expenditure relating to the structure or operation of a business in the income year in which the expenditure is incurred, rather than over five years as is the case for other businesses (see section 40-880 of the ITAA 1997). Expenses that are eligible for the immediate deduction include professional expenses associated with starting a new business such as expenses associated with professional, legal and accounting advice, and Australian government agency fees, taxes or charges associated with starting a new business.

3.58 These amendments introduce a new class of eligible businesses. The new class of eligible businesses are entities that would be a small business entity if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year, and make a consequential amendment. [Schedule 3, items 25, 26 and 27, sections 40-880(2A) and 40-880(2B)]

3.59 These amendments will allow entities with an aggregated turnover of less than $50 million to be able to immediately deduct certain start-up expenditure.

3.60 These amendments apply in relation to capital expenditure incurred on or after 1 July 2020. [Schedule 3, item 40(7)]

Simplified trading stock rules

3.61 Schedule 3 makes amendments to allow a wider range of entities to simplify the way they can account for changes in the value of trading stock.

3.62 Subdivision 328-E of the ITAA 1997 allows small business entities to choose not to conduct a stocktake of trading stock for an income year if the difference between the value of stock on hand at the start of the year and the reasonable estimate of the value of stock at the end of the year is not more than $5,000.

3.63 The amendments create a new class of medium business entities that will be able to make such an election. Medium business entities are entities that would be a small business if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year, and make a consequential amendment. [Schedule 3, items 34, 35 and 36, section 328-285(a) and section 328-285(2)]

3.64 Consequential amendments are made to headings and phrasing as a result of the new class of medium business entity. [Schedule 3, items 30, 31, 32 and 33, sections 328-280 and 328-285 of the ITAA 1997]

3.65 These amendments will allow entities with an aggregated turnover of less than $50 million to choose a simplified way of accounting for the changes in value of trading stock.

3.66 The amendments apply in relation to income years starting on or after 1 July 2021. [Schedule 3, item 40(8) ]

Amendments to the Taxation Administration Act 1953

PAYG instalments based on GDP-adjusted notional tax

3.67 Schedule 3 makes amendments to allow a wider range of entities to calculate their quarterly PAYG instalments based on GDP-adjusted notional tax.

3.68 Small business entities (except entities that would be small business entities under section 328-110(4) of the ITAA 1997) can elect to have their PAYG instalments calculated for them by the ATO as a quarterly payer who pays on the basis of GDP-adjusted notional tax (section 45-130(1)(d) of Schedule 1 to the TAA).

3.69 The amendments will introduce a new class of eligible entity that can choose to adopt this kind of quarterly payment cycle. This new class consists of entities that would be small business if the $10 million threshold in the aggregated turnover test were $50 million. The amendments also capture the operation of section 328-110(5) of the ITAA 1997 which provides for how to work out annual turnover if you do not carry on a business for the whole income year, and make a consequential amendment. [Schedule 3, items 37 and 38, sections 45-130(1) and 45-130(2A) of Schedule 1 to the TAA]

3.70 A consequential amendment has been made as a result of the introduction of this new class of eligible entity. [Schedule 3, item 39, sections 45-130(2A) and 45-130(3A) of Schedule 1 to the TAA]

3.71 These amendments apply in relation to income years starting on or after 1 July 2021. [Schedule 3, item 40(9)]

Consequential amendments

3.72 Amendments have been made to the notes in section 328-10(1) and 328-110(1) of the ITAA 1997 to alert readers that some small business entity concessions are available to medium business entities. [Schedule 3, items 28 and 29, sections 328-10(1) and 328-110(1) of the ITAA 1997]

Chapter 4 - Enhancing the R&D Tax Incentive

Outline of chapter

4.1 Schedule 4 to the Bill reforms the R&D Tax Incentive to help businesses that invest in R&D manage the economic impacts of the Coronavirus pandemic while providing incentives for businesses to undertake additional investments in R&D.

Context of amendments

The R&D Tax Incentive

4.2 The R&D Tax Incentive was introduced in 2011. The R&D Tax Incentive is intended to encourage R&D activities that might not otherwise be conducted in cases where the new knowledge gained is likely to have a wider Australian economic benefit. That is, the Incentive is intended to support additionality in R&D activities and spillover benefits to the broader economy.

4.3 Division 355 of the ITAA 1997 provides R&D tax offsets to R&D entities for a range of expenses and depreciation costs incurred on R&D activities. There are currently two R&D tax offsets available:

•

a 43.5 per cent refundable tax offset available to most small R&D entities - those with an aggregated turnover of less than $20 million. The refundable offset can be refunded as a cash payment to an R&D entity if the offset exceeds the entity's income tax liability; and

•

a 38.5 per cent non-refundable tax offset available to larger R&D entities and R&D entities controlled by one or more exempt entities. A non-refundable tax offset may be used to reduce an R&D entity's income tax liability for an income year but any remaining excess must be carried forward to be applied in future income years.

4.4 The basis for calculating R&D tax offsets is the concept of a notional deduction. A notional deduction is generally recognised for expenditure (Subdivision 355-D) on R&D activities and depreciation on assets held for R&D purposes (Subdivision 355-E) subject to conditions. These deductions are referred to as notional because they are only used to calculate an R&D entity's entitlement to the R&D tax offset and for some other discrete purposes (section 355-105). That is, the entitlement to the R&D Tax Incentive for a notional deduction replaces any entitlement to an underlying tax deduction.

4.5 The value of the R&D Tax Incentive (the 'incentive component') is generally the difference between the R&D entity's corporate tax rate and the R&D tax offset rate (plus the benefit of refundability where it applies). For example, the incentive component of a large R&D entity receiving the 38.5 per cent non-refundable offset and paying the 30 per cent corporate tax rate is generally 8.5 per cent.

4.6 Under the Government's reforms to corporate tax rates, the tax rate for companies with an aggregated turnover of less than $50 million has been reduced to 26 per cent and will be further reduced to 25 per cent from 1 July 2021. As the corporate tax rate has been lowered from 30 per cent for some taxpayers, the value of the incentive component of the R&D tax offsets has increased for these entities.

The $100 million expenditure threshold

4.7 The R&D Tax Incentive is subject to a $100 million expenditure threshold, sometimes referred to as an expenditure cap. Expenditure on R&D activities (notional deductions) in excess of $100 million is not eligible for the full rate of the relevant R&D tax offset. Rather, these notional deductions give rise to an offset at the R&D entity's corporate tax rate. That is, excess notional deductions give rise to the same benefit as if the expenditure had instead been claimed as an ordinary tax deduction, without any incentive component.

4.8 The $100 million expenditure threshold and some associated provisions are legislated to sunset on 1 July 2024 under Part 2 of Schedule 1 to the Tax Laws Amendment (Research and Development) Act 2015.

Review of the R&D Tax Incentive and impact of the Coronavirus

4.9 The Government's reforms are made in response to the economic impact of the Coronavirus pandemic, but also have regard to the recommendations of the 2016 Review of the R&D Tax Incentive (the Review).

4.10 The Review of the R&D Tax Incentive was commissioned as part of the Government's National Innovation and Science Agenda. The Review Panel was chaired by the then Chair of Innovation and Science Australia (ISA), Mr Bill Ferris AC, Australia's Chief Scientist, Dr Alan Finkel AO, and the then Secretary to the Treasury, Mr John Fraser. The Review Panel was asked to identify opportunities to improve the effectiveness and integrity of the program, including how its focus could be sharpened to encourage additional R&D activities in Australia.

4.11 The Review of the R&D Tax Incentive found that the Incentive was failing to fully achieve its objectives of generating additional R&D activities and was not well targeted, providing benefits for R&D activities that would have been undertaken without the R&D Tax Incentive.

4.12 The Review of the R&D Tax Incentive made recommendations to improve the integrity and effectiveness of the program. The Review of the R&D Tax Incentive also made recommendations to improve the administration of the R&D Tax Incentive. The ISA 2030 Strategic Plan, published in January 2018, made alternative recommendations informed by feedback provided on the Review of the R&D Tax Incentive's report. A number of the Review's recommendations were adopted by Government in the 2018-19 Budget.

4.13 The Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019 was introduced into the Parliament in December 2019. The former Bill proposed to make a number of changes to retarget support under the R&D Tax Incentive from 1 July 2019. The former Bill also proposed amendments to improve the integrity of the R&D Tax Incentive and improve the administration and transparency of the R&D Tax Incentive.

4.14 In light of the continuing economic consequences of the Coronavirus pandemic, further refinements to the R&D Tax Incentive are needed to support Australian firms that invest in R&D. The refinements are intended to provide business with greater support and certainty, and in doing so support a strong economic recovery.

Summary of new law

4.15 Schedule 4 to the Bill supports companies that invest in R&D through the following changes:

•

increasing the R&D expenditure threshold from $100 million to $150 million and making the threshold a permanent feature of the law;

•

linking the R&D tax offset for refundable R&D tax offset claimants to claimants' corporate tax rates plus a 18.5 percentage point premium; and

•

increasing the generosity of the R&D Tax Incentive for larger R&D entities with high levels of R&D intensity.

4.16 In particular, large R&D entities with aggregated turnover of $20 million or more for an income year are entitled to an R&D tax offset equal to their corporate tax rate plus one or more marginal intensity premiums.

4.17 The intensity premiums apply to notional deductions within a range of R&D intensity where the R&D entity's R&D expenditure (notional deductions) are expressed as a proportion of the entity's total expenses.

4.18 In addition, Schedule 5 to the Bill makes a number of amendments to improve the integrity of the R&D Tax Incentive and Schedule 6 to the Bill makes a number of amendments to improve the administration and transparency of the R&D Tax Incentive. See Chapters 5 and 6 of this Explanatory Memorandum for more information.

Comparison of key features of new law and current law

Detailed explanation of new law

Increasing the expenditure threshold

4.19 The $100 million expenditure threshold is increased to $150 million per annum. [Schedule 4, item 9, subsection 355-100(3) of the ITAA 1997]

4.20 The increase allows R&D entities to claim additional amounts of concessional R&D tax offset on R&D activities. The purpose of this amendment is to increase the incentive for large R&D entities to continue to engage in R&D activities when their R&D expenditure exceeds $100 million.

4.21 The current law provides that the expenditure threshold will no longer apply from 1 July 2024 and requires the Government to conduct a review of the threshold after 5 March 2020. In light of the Review of the R&D Tax Incentive and the changes to the threshold adopted by the Government, the requirement for the review is repealed and the increased threshold is made a permanent feature of the law. [Schedule 4, items 11, 12 and 13, section 355-750 of the ITAA 1997, table item 3 in subsection 2(1) of the Tax Laws Amendment (Research and Development) Act 2015 and Part 2 of Schedule 1 to that Act]

The refundable R&D tax offset for small R&D entities

4.22 An R&D entity with aggregated turnover of less than $20 million for an income year is generally entitled to a refundable R&D tax offset equal to their corporate tax rate plus 18.5 percentage points. [Schedule 4, item 4, table item 1 in subsection 355-100(1) of the ITAA 1997]

4.23 This refundable offset does not apply to an R&D entity controlled by one or more exempt entities. These R&D entities are instead entitled to the non-refundable R&D tax offset available to R&D entities with aggregated turnover of $20 million or more. [Schedule 4, item 5, table item 2 in subsection 355-100(1) of the ITAA 1997]

Example 4.1 The refundable offset

In the 2021-22 income year, Aperture Research has aggregated turnover of $15 million. Without taking into account its R&D activities, Aperture Research has an income tax liability of $500,000.

Aperture Research has incurred $20 million on R&D activities.

Aperture Research is entitled to an R&D tax offset of $8.7 million, which is $20 million multiplied by the entity's R&D tax offset rate of 43.5 per cent (where the offset rate is comprised of the entity's corporate tax rate of 25 per cent plus a 18.5 percentage point premium).

For the 2021-22 income year, Aperture Research is able to apply the refundable tax offset to obtain a cash refund of $8.2million.

Intensity-based R&D tax offset for large R&D entities

4.24 R&D entities with aggregated turnover of $20 million or more for an income year are entitled to an R&D tax offset equal to their corporate tax rate plus marginal intensity premiums determined with reference to the R&D intensity of their R&D expenditure on an incremental basis. [Schedule 4, items 5 and 7, table item 3 in subsection 355-100(1) and subsection 355-100(1A) of the ITAA 1997]

4.25 The intensity premiums in the table below apply to notional deductions within a range of R&D intensity for R&D expenditure where notional deductions are expressed as a proportion of the R&D entity's total expenses:

Table 4.1 R&D tax offset intensity premium

4.26 Example 4.2 demonstrates the R&D tax offset for large R&D entities.

Example 4.2 The R&D tax offset for large R&D entities

Contrast Industries has notional deductions of $160 million in the 2021-22 income year, exceeding the $150 million expenditure threshold. In the same income year, Contrast Industries had expenditure of $1 billion. Its aggregated turnover exceeds $50 million, meaning it is subject to the 30 per cent corporate tax rate.

Contrast Industries has an R&D intensity of 15 per cent ($150 million divided by $1 billion). The portion of the R&D expenditure in excess of the $150 million expenditure threshold ($10 million) is calculated separately (see below).

Contrast Industries' R&D tax offset for the income year is calculated as follows:

Tier	Intensity range	R&D premium	Notional deductions applied	Offset amount
Tier 1	0-2%	8.5%	$20m	$7.7m
Tier 2	>2%	16.5%	$130m	$60.45m
Excess	NA	Nil	$10m	$3m
		Totals:	$160m	$71.15m

R&D intensity

4.27 To calculate the R&D tax offset, a large R&D entity must determine its R&D intensity. The R&D intensity is the proportion of the R&D entity's total expenses spent on R&D expenditure for the income year:

4.28 This is intended to provide a higher rate of support for incremental R&D expenditure to R&D entities that devote a significant portion of their overall operations to R&D eligible for support under the R&D Tax Incentive.

Notional deductions

4.29 Notional deductions in excess of the $150 million expenditure threshold do not attract an intensity premium and are not counted for the purposes of calculating an R&D entity's R&D intensity (see Example 4.2). [Schedule 4, item 9, paragraph 355-100(3)(a) of the ITAA 1997]

4.30 If an R&D entity's notional deductions for an income year are less than $20,000, the entity's notional deductions for the purposes of calculating the entity's R&D tax offset only includes the notional deductions that satisfy the criteria in subsection 355-100(2): that the expenditure was incurred to a research service provider registered under Division 4 of Part III of the IR&D Act or was incurred under the Cooperative Research Centre Program. [Schedule 4, item 8, subsection 355-100(2) of the ITAA 1997]

Total expenses

4.31 An R&D entity's total expenses are reported in their company tax return. The expenses reported at item six of a company income tax return are the expense amounts taken from the company's financial statements. [Schedule 4, item 10, section 355-115 of the ITAA 1997]

4.32 The Australian Accounting Standards Board's Framework for the Preparation and Presentation of Financial Statements defines 'expenses' (at paragraph 70(b)) as:

•

decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

4.33 For companies that prepare a financial report for the income year in accordance with the accounting standards and other pronouncements issued by the Australian Accounting Standards Board, those standards and pronouncements apply. For other entities, total expenses are worked out in accordance with other commercially accepted principles relating to accounting. [Schedule 4, item 10, paragraph 355-115(2)(a) of the ITAA 1997]

4.34 An R&D entity's notional deductions are always included in its total expenses. If an amount of notional deductions is not otherwise included in an entity's total expenses, an adjustment is made to nevertheless include it. [Schedule 4, item 10, paragraph 355-115(2)(b) of the ITAA 1997]

4.35 Rules apply to prevent any double counting of amounts recognised at different times as notional deductions and total expenses. [Schedule 4, item 10, subsection 355-115(3) of the ITAA 1997]

Example 4.3 Total expenses

On 1 July 2021, Ace Designs acquires an asset for $20,000 that it uses exclusively in its R&D activities. The R&D entity claims an up-front notional deduction of $20,000 in the 2021-22 income year (section 355-205).

For its financial accounts, Ace Designs uses the straight line method to work out the asset's depreciation records. The asset has a useful life of four years. Ace Designs records an expense of $5,000 in each of the 2021-22 to 2024-25 income years for the asset (for simplicity, the effect of a leap year is ignored in this example).

An adjustment is required when the entity's total expenses are calculated for R&D purposes in the 2021-22 income year. $5,000 is included as an accounting expense under paragraph 355-115(2)(a). However, an adjustment is made to add a further $15,000 to the total expenses, under paragraph 355-115(2)(b). This reflects the additional amount of notional deductions that are claimed in the 2021-22 income year.

No amount is included in Ace Designs' total expenses for R&D purposes in the later income years in relation to the asset. In each of these years, the $5,000 accounting expenses would initially satisfy paragraph 355-115(2)(a). However, the amounts are disregarded because a corresponding amount was included under paragraph (2)(b) in the 2021-22 income year (applying paragraph (3)(a)).

Consequential amendments

4.36 A cross-reference to the expenditure threshold is amended to reflect the increase of the threshold from $100 million to $150 million. [Schedule 4, item 3, the heading to subsection 355-100(1) of the ITAA 1997]

4.37 A number of amendments are made to section 355-100 of the ITAA 1997 to accommodate and explain the introduction of R&D intensity premiums to the calculation of the non-refundable R&D tax offset. [Schedule 4, items 6 and 8, Note 2 to subsection 355-100(1) and subsection 355-100(2) of the ITAA 1997]

4.38 Similarly, subsection 355-100(3) is amended to reflect both the increased expenditure threshold and the changes to subsection 355-100(1). In turn, a consequential amendment is made to subsection 67-30(1). [Schedule 4, item 2, subsection 67-30(1) of the ITAA 1997]

Application and transitional provisions

4.39 The amendments commence on the first day of the quarter following Royal Assent. [Section 2 of the Bill]

4.40 The amendments in Schedule 4 apply to income years starting on or after 1 July 2021. [Schedule 4, item 14]

Chapter 5 - Enhancing the integrity of the R&D Tax Incentive

Outline of chapter

5.1 Schedule 5 to the Bill enhances the integrity of the R&D Tax Incentive by ensuring that R&D entities cannot obtain inappropriate tax benefits and by clawing back the benefit of the R&D Tax Incentive to the extent an entity has received another benefit in connection with an R&D activity.

Context of amendments

Recoupments

5.2 Where an R&D entity benefits from a government recoupment (such as a grant or reimbursement) in relation to expenditure that is also eligible for the R&D tax offset, a clawback applies to reverse the double benefit that arises (Subdivision 355-G). In this context, only the 'incentive component' of an R&D tax offset is intended to be clawed back.

5.3 The clawback takes the form of an additional tax on the recoupment (and any other expenditure required as a condition of the recoupment) at a rate of 10 per cent (sections 12B and 31 of the Income Tax Rates Act 1986). The 10 per cent rate was initially selected as a simplicity measure by making the assumption that the R&D entity obtained the initial lower offset rate of 40 per cent (now 38.5 per cent) rather than the higher rate of 45 per cent (now 43.5 per cent). The 10 per cent tax rate also assumes a fixed 30 per cent corporate tax rate for all R&D entities.

Example 5.1 Recoupments

Cross Innovations is committed to spending $2 million to undertake R&D activities, regardless of whether it is successful in obtaining a grant.

During the 2020-21 income year Cross Innovations receives a $1 million grant to undertake R&D activities. In addition to the grant, Cross Innovations must spend an additional $1 million of its own money as a condition of the grant. Cross Innovations receives an offset of $870,000 (applying the 43.5 per cent offset rate to the $2 million expenditure). Cross Innovations would have otherwise been entitled to a deduction worth $520,000 at the 26 per cent corporate tax rate. Therefore, the incentive component of the offset is the difference of $350,000.

In the same income year, the recoupment rules clawback only 10 per cent of the total $2 million spent under the terms of the grant, which is $200,000. Cross Innovations keeps the remaining $150,000 of the offset incentive. However, the grant alone is intended to constitute sufficient incentive without the additional $150,000 from the R&D tax incentive.

5.4 The recoupment rules also apply where an R&D entity receives a recoupment for expenditure incurred by another entity to which it is connected or affiliated (subsection 355-450(4)). In these situations, the R&D entity receiving the recoupment is subject to the clawback tax even though the other entity obtained the financial benefit of the R&D tax offset.

Feedstock adjustments

5.5 Feedstock adjustments apply to recoup the benefit of the R&D Tax Incentive to the extent it relates to goods, material or energy used to produce marketable products sold or applied to the R&D entity's own use (Subdivision 355-H).

5.6 The intended net outcome is that the R&D Tax Incentive is effectively enjoyed on feedstock expenditure to the extent that it is not offset by feedstock revenue. This is achieved by basing the adjustment on the lesser of feedstock expenditure and feedstock revenue.

5.7 Where feedstock revenue exceeds the feedstock output's related feedstock expenditure, the feedstock adjustment will be based on the feedstock expenditure - because the effective net cost of the feedstock inputs and energy was nil.

5.8 Where feedstock revenue is less than the feedstock output's related feedstock expenditure, the feedstock adjustment will be based on the feedstock revenue - because the effective net cost of the feedstock inputs and energy was reduced by that amount.

5.9 The adjustment is implemented by including one third of the lesser of feedstock expenditure or feedstock revenue in the R&D entity's assessable income (subsection 355-465(2)). As with the recoupments in Subdivision 355-G, the one third formula is intended to recoup 10 percentage points of the R&D Tax Incentive (based on a standard 30 per cent corporate tax rate).

5.10 In contrast to the recoupment provisions, feedstock adjustments are incorporated into the income tax equation in section 4-10 and do not create a new tax.

Example 5.2 Feedstock adjustments

In the 2020-21 income year, Wayland Enterprises, a large R&D entity, spends $100,000 on the development of a new product, producing one tangible product, which it then sells for $110,000. Wayland Enterprises is entitled to a $38,500 offset (with an incentive component of $8,500).

$33,333 is included in Wayland Enterprises' assessable income (one third of the feedstock expenditure). After applying the corporate tax rate to the amount included in assessable income, the feedstock adjustment would claw back 10 per cent: $10,000, which is more than the incentive component.

However, if Wayland Enterprises was a small R&D entity in the same position, it would claim an offset of $43,500 (with an incentive component of $17,500).

The $33,333 would be included in assessable income and taxed at the 26 per cent corporate tax rate. The feedstock adjustment would claw back just 8 ⅔ per centage points of the offset: $8,666.58.

5.11 The feedstock rules also apply where an R&D entity receives feedstock revenue in relation to an R&D tax offset obtained by another entity to which it is connected or affiliated (section 355-75). However, in these situations, the R&D entity originally entitled to the R&D tax offset is subject to the feedstock adjustment rather than the entity receiving the feedstock revenue. This represents a further inconsistency between the tax treatment of feedstock revenue and recoupments.

Balancing adjustments

5.12 Balancing adjustment events occur when an entity stops holding a depreciating asset, for example when the entity sells the asset (section 40-295). Balancing adjustment events require an entity to compare the economic value of the asset (its termination value (section 40-300)) with its written-down tax value (its adjusted value (section 40-85)).

5.13 If an asset's termination value exceeds its adjusted value, the difference (the balancing adjustment amount) is included in the entity's assessable income in the income year in which the balancing adjustment event occurs. If an asset's adjusted value exceeds its termination value, the entity is allowed a deduction for the difference. As such, the balancing adjustment ensures an entity's overall tax position reflects the true decline in value of the asset (section 40-285).

5.14 R&D entities can obtain an R&D tax offset for the decline in value of depreciating assets held for R&D purposes (an R&D asset) (section 355-305). This necessitates additional consequences arising from a balancing adjustment for the R&D asset:

•

for an R&D asset held only for R&D purposes where the balancing adjustment amount is included in the R&D entity's assessable income - the amount is generally increased by one third (subsection 355-315(3));

•

for an R&D asset held only for R&D purposes where the balancing adjustment amount is allowed as a deduction - the deduction is included in the R&D entity's R&D tax offset calculation (subsection 355-315(2));

•

for an R&D asset held partially for R&D purposes where the balancing adjustment amount is included in the R&D entity's assessable income - the part of the amount attributable to the asset's R&D use (the R&D component) is generally increased by one third (subsection 40-292(4)); and

•

for an R&D asset held partially for R&D purposes where the balancing adjustment amount is allowed as a deduction - the R&D component of the amount is generally increased by one third or (for small R&D entities) or one half (subsection 40-292(3)).

5.15 Similar rules apply to R&D assets held by R&D partnerships (sections 40-293 and 355-525).

5.16 Transitional rules apply in a similar way to R&D assets acquired prior to the introduction of the R&D Tax Incentive in 2011. These transitional rules further increase certain balancing adjustment amounts to reflect old 1.25 rate deductions available for R&D assets under the pre-2011 law (subsections 40-292(3), 40-293(3), 355-20(4) and 255-25(4) of the Income Tax (Transitional Provisions) Act 1997 (the ITTP Act)). These transitional rules do not apply to deductible balancing adjustment amounts in respect of R&D assets used only for R&D purposes.

5.17 As with the feedstock and recoupment adjustment rules, these R&D balancing adjustment rules rely on rough approximations of the incentive component of an R&D entity's R&D tax offsets.

Summary of new law

5.18 Schedule 5 to the Bill improves the integrity of the R&D Tax Incentive by:

•

extending the general anti-avoidance rules in the tax law to R&D tax offsets directly;

•

making the rate at which the offset is recouped more accurate in situations where the offset would otherwise result in an additional or double benefit; and

•

making that rate at which deductible balancing adjustment amounts incorporate the R&D Tax Incentive more accurate.

Comparison of key features of new law and current law

Detailed explanation of new law

Schemes to obtain an R&D tax benefit

5.19 Part 1 of Schedule 5 to the Bill explicitly extends the concept of tax benefits in the general anti-avoidance rule in Part IVA of the ITAA 1936 to include the R&D tax offset. These amendments ensure that the Commissioner can apply Part IVA to prevent R&D entities from being able to obtain tax benefits by entering into artificial or contrived arrangements to access a non-refundable or a refundable R&D tax offset. [Schedule 5, items 2 to 10, paragraphs 177C(1)(bd) and (h), 177C(2)(f), 177C(3)(cc) and (i), 177CB(1)(f), 177F(1)(f), 177F(3)(g) and subsection 177C(3) of the ITAA 1936]

5.20 Part IVA of the ITAA 1936 applies in situations where a scheme or arrangement is entered into in order to obtain a tax benefit. These rules allow the Commissioner to cancel the relevant tax benefit where the conditions under Part IVA are satisfied. For example, this can include situations where an R&D entity enters into an arrangement with a dominant purpose of securing a tax benefit that is an R&D tax offset. It can also include situations where an entity enters into an arrangement with a dominant purpose to enable it to obtain a refundable R&D tax offset, where it would have, or might reasonably be expected to have, obtained a non-refundable R&D tax offset if the scheme had not been entered into or carried out.

The uniform clawback rule

5.21 Part 2 of Schedule 5 to the Bill remakes and consolidates Subdivisions 355-G and 355-H of the ITAA 1997 (about the clawback of R&D recoupments and feedstock adjustments respectively) into a new Subdivision 355-G. This Subdivision also introduces a new uniform clawback rule that applies for recoupments, feedstock adjustments and balancing adjustment amounts that are included in an R&D entity's assessable income. The amendments ensure that an R&D entity must disgorge the entire benefit of an R&D tax offset to the extent it (or a connected entity or an affiliate entity where appropriate) receives a recoupment amount, feedstock adjustment or assessable balancing adjustment because of the offset. [Schedule 5, item 29, section 355-430 of the ITAA 1997]

5.22 Current Subdivisions 355-G and 355-H, and the various balancing adjustment rules, only partially reverse the benefit of an R&D tax offset in some circumstances. In light of the amendments discussed in Chapter 4, the current clawback rules would produce more anomalous outcomes if they are not amended. The amendments ensure the full benefit of the R&D tax offset is reversed, to remove the unintended benefits that arise in such situations.

Clawback amounts

Recoupment amounts and feedstock adjustment clawback amounts

5.23 Current Subdivision 355-G is remade into a single section and reference to the payment of extra income tax (a recoupment tax) is removed. Instead, the remade provision identifies an amount (a clawback amount) that represents the amount of notional deductions an R&D entity received or is entitled to receive in relation to a recoupment. [Schedule 5, item 29, section 355-440 of the ITAA 1997]

5.24 Current Subdivision 355-H is remade into a single section and the reference to the inclusion of an amount in assessable income is removed. Instead, the remade provision identifies an amount (a clawback amount) that represents the amount of notional deductions an R&D entity received or is entitled to receive in relation to a feedstock adjustment. The clawback amount is the lesser of the feedstock revenue received or the notional deductions attributable to the feedstock output. [Schedule 5, item 29, section 355-445 of the ITAA 1997]

Example 5.3 Clawback amounts

In a previous example, Contrast Industries had the following amounts for the 2021-22 income year (the offset year):

•

aggregated turnover in excess of $50 million;

•

expenditure of $1 billion;

•

notional deductions of $160 million; and

•

a non-refundable R&D tax offset of $71.15 million.

Further to this example, in the 2023-24 income year, Contrast Industries sells a tangible product developed during its 2021-22 income year R&D activities. The tangible product is sold for $20 million but cost $25 million to develop. All of the costs were included in Contrast Industries' notional deductions for the 2021-22 income year.

The clawback amount is the lesser of the market value of the tangible product on sale (feedstock revenue) and the tangible product's cost. Here, Contrast Industries has a clawback amount of $20 million.

Balancing adjustment clawback amounts

5.25 There are four clawback amounts that relate to assessable balancing adjustments. The primary clawback amount applies for R&D assets held only for R&D purposes. The clawback amount is the balancing adjustment amount capped at the level of the asset's total decline in value (its tax cost less its adjusted value). The cap ensures the clawback does not apply to the extent an R&D asset's has appreciated in value while held. [Schedule 5, item 29, section 355-446 of the ITAA 1997]

5.26 If the R&D asset was only held partially for R&D purposes, a different clawback amount applies. This clawback amount is calculated in a similar way to the primary clawback amount but it is reduced in proportion to its non-R&D use. [Schedule 5, item 29, section 355-447 of the ITAA 1997]

5.27 Different clawback amounts arise if the R&D asset is held by an R&D partnership. These two clawback amounts reflect the first two balancing adjustment clawback amounts: one for R&D assets used only for R&D purposes and one for assets held only partially for R&D purposes. These rules are necessary to ensure the clawback amount arises for the individual R&D entities that are partners in the R&D partnership. [Schedule 5, item 29, sections 355-448 and 355-449 of the ITAA 1997]

5.28 The four clawback rules outlined above apply in a modified way where the R&D asset was acquired before the introduction of the R&D Tax Incentive in 2011. [Schedule 5, items 41 to 45, 48 to 50, 53 and 54, subsections 40-292(3) and (3A), 40-293(3) and (3A), 355-320(4) and (4A), and 355-325(4) to (4D), and Note 1 to subsections 355-320(1) and 355-325(1) of the ITTP Act]

5.29 The clawback amount rules replace existing rules that estimated the incentive component of the R&D tax offset that need to be clawed back. [Schedule 5, items 17, 20, 28 and 32, subsections 40-292 (3) to (5), 40-293(3), 355-315(3), and 355-525(3) to (7) of the ITAA 1997]

Changes from the current law

5.30 The clawback amount is relevant for working out the amount that must be included in an R&D entity's assessable income to disgorge the benefit of an R&D tax offset. The clawback amount reflects the amount of R&D expenditure (notional deductions) tainted by the operation of the recoupment, feedstock or R&D balancing adjustment rules. The amendments calculate the amount of R&D tax offset tainted by the tainted expenditure. The incentive component of the tainted R&D tax offset, in turn, is the benefit to be clawed back.

5.31 The clawback amount picks up the amount worked out under each of Subdivisions 355-G and 355-H, and the balancing adjustment rules, in the current law immediately before adjustments are made to bring it to account: applying tax to it in the case of recoupments and including a third of the amount in assessable income in the case of feedstock and balancing adjustments. It is primarily these adjustments in the current law that are producing inappropriate outcomes and are subject to the amendments.

5.32 Except as outlined in this chapter, the remaking of Subdivisions 355-G and 355-H, and the R&D balancing adjustment rules, is not intended to alter the way recoupment amounts, feedstock adjustments or assessable balancing adjustments (a clawback amount in these amendments) are calculated. For further information on the operation of these provisions, refer to the Explanatory Memorandum to the Tax Laws Amendment (Research and Development) Bill 2011, and existing guidance materials and rulings issued by the Commissioner.

5.33 The table below outlines the provisions of the new law as amended that correspond with provisions of the current law.

Table 5.1 Remaking the clawback rules

5.34 For balancing adjustments, sections 40-292, 40-293, 355-315 and 355-525 (and section 40-285) continue to operate where appropriate to clawback the deduction component of the R&D tax offset (i.e. the amount of the offset that reflects the R&D entity's corporate tax rate). Similarly, feedstock revenue and government grants are generally assessable as ordinary income (section 6-5). The new provisions clawback the incentive component of the R&D tax offset.

The taxing point

5.35 Consistent with the existing law, the uniform clawback rule will include an amount in assessable income in the year the clawback amount arises (the present year). The underlying offset entitlement, whether in the same year, one or more earlier years or one or more later years (each an offset year) is unchanged. [Schedule 5, item 29, section 355-435 of the ITAA 1997]

5.36 The entity receiving a recoupment or feedstock revenue could be the R&D entity entitled to the R&D tax offset or an entity affiliated with or connected to the R&D entity. [Schedule 5, item 29, subsections 355-440(5) and 355-445(5) of the ITAA 1997]

5.37 The amendments unify the taxing point in cases involving related entities: where one entity has the R&D tax offset entitlement and the other entity receives the recoupment or feedstock revenue. The R&D entity that has received or is entitled to receive the R&D tax offset is the entity with the clawback amount and must include an amount in its assessable income. [Schedule 5, item 29, section 355-435 and subsections 355-440(1), (2) and (5), and 355-445(5) of the ITAA 1997]

Example 5.4 Related entities and clawbacks

It would not change the outcome in Example 5.3 if, instead of Contrast Industries selling the tangible product itself, the tangible product was sold by a related entity. Contrast Industries would be subject to the clawback amount.

5.38 For R&D assets of an R&D partnership that are partially used for R&D purposes, the clawback rule now includes an amount in the partner's assessable income rather than the partnership's assessable income. This aligns the taxing point with the taxing point for R&D assets held by an R&D partnership that are used wholly for R&D purposes. [Schedule 5, item 29, section 355-449 of the ITAA 1997]

The amount included in assessable income

5.39 When the clawback applies, the R&D entity entitled to the R&D tax offset includes an amount in assessable income in relation to each offset year in which it claimed an offset related to the clawback amount. [Schedule 5, item 29, section 355-450 of the ITAA 1997]

5.40 The amount included in assessable income is worked out as follows:

5.41 Each of the components of this formula is explained below.

Calculating the offset portion subject to the clawback

5.42 The first step in applying the formula is to calculate the portion of the R&D tax offset the R&D entity received that relates to the clawback amount. If the R&D entity received the R&D tax offset in multiple offset years in relation to the clawback amount that arises in the present year, the formula must be applied in relation to each offset year.

5.43 The primary way of working out the portion of the offset to be clawed back in an offset year is to compare the actual amount of the R&D tax offset in that year (the starting offset) with the amount of the offset (the adjusted offset) the R&D entity would have received if its notional deductions were reduced by the portion of the clawback amount that relates to the offset year. [Schedule 5, item 29, subsection 355-450(1) (definitions of 'adjusted offset' and 'starting offset') of the ITAA 1997]

5.44 This targets the clawback to the highest tiers of the R&D entity's offset entitlement (i.e. those received for the highest intensity expenditure, the last dollars the entity spent) for an offset year. If an R&D entity had notional deductions in excess of the $150 million expenditure threshold, the excess deductions would be reduced first, limiting the difference between the starting and adjusted offset. This, when combined with the operation of the deduction amount, is equivalent to the outcome achieved under table items 2 and 3 in subsection 355-720(2) in the current law.

Example 5.5 The starting offset and the adjusted offset

Further to Example 5.3, the portion of Contrast Industries' 2021-22 R&D tax offset that is subject to the clawback is worked out by subtracting the entity's adjusted offset from its starting offset.

Contrast Industries has a starting offset of $71.15 million, the amount of the offset it received for the 2021-22 income year.

Contrast Industries has an adjusted offset calculated as if its notional deductions for the 2021-22 income year were reduced from $160 million to $140 million by the value of the clawback amount. The entire clawback amount is included in the reduction because the entire amount relates to the 2021-22 income year.

The adjusted offset is calculated as follows:

Tier	Intensity range	R&D premium	Notional deductions applied	Offset amount
Tier 1	0-2%	8.5%	$20m	$7.7m
Tier 2	>2%	16.5%	$120m	$55.8m
Excess	NA	Nil	Nil	Nil
		Totals:	$140m	$63.5

The adjusted offset amount reflects that $10 million has been removed from the excess tier and $10 million has been removed from tier 2, the highest tier Contrast Industries reached on its level of R&D intensity.

The difference between the two offset amounts is $7.65 million.

Recursive calculations for multiple clawback amounts

5.45 The situation is more complex where an R&D entity's offsets in a particular offset year are clawed back multiple times because the entity receives multiple clawback amounts in relation to it or also receives a catch-up amount (see paragraph 5.59). In these circumstances, the clawback rule works in a recursive manner.

5.46 In recursive applications of the rule, the R&D entity must compare the offset amount that could have been claimed under the last counterfactual calculated and the amount that could have been claimed under a new counterfactual. In calculating the new counterfactual, the R&D entity must incorporate all previous adjustments to the notional deduction amount and make a further reduction for the new clawback amount. [Schedule 5, item 29, subsection 355-450(2) of the ITAA 1997]

Example 5.6 Recursive clawback

Flying Fox Innovations has an R&D tax offset entitlement based on $100 million of notional deductions. The entity receives two recoupment amounts: one of $10 million and one of $20 million.

For the first recoupment, the clawback is calculated by reference to the difference between the starting offset calculated on $100 million of notional deductions and the adjusted offset calculated on $90 million. For the second recoupment, the clawback is calculated by reference to the difference between the starting offset calculated on $90 million and the adjusted offset calculated on $70 million.

Allowing the benefit of the deduction

5.47 Regardless of whether the primary or recursive rule is applied in calculating the difference, once the difference is identified, it is not appropriate to bring the entire difference to account as an increased tax liability. Only the incentive component (or premium) is brought to account. Therefore, the second step of the above formula requires that the difference between the starting offset and the adjusted offset be reduced by the product of the portion of the clawback amount that relates to the offset year and the R&D entity's corporate tax rate in the offset year. This allows the R&D entity to retain the benefit of the R&D tax offset for the clawback amount to the extent it replaced the benefit of a deduction for the same expenditure. [Schedule 5, item 29, subsection 355-450(1) (definition of 'deduction amount') of the ITAA 1997]

Example 5.7 The deduction amount

Further to Example 5.5, Contrast Industries has a deduction amount equal to its clawback amount ($20 million) multiplied by its corporate tax rate in the offset year (30 per cent): $6 million. This is because while the expenditure is no longer eligible for the R&D Tax Incentive as a notional deduction, the expenditure would have been an eligible deduction.

The $7.65 million figure reached in Example 5.5 is reduced by the $6 million deduction amount to complete the numerator of the formula at paragraph 5.40. The resulting $1.65 million difference represents the additional amount of tax Contrast Industries must pay to reverse the incentive component of the R&D tax offset associated with the development of the tangible product.

Bringing the amount to account

5.48 The R&D entity must bring the amount to account as assessable income in the year in which the entity received the clawback amount. The amount calculated up to this point represents the full dollar-value of the incentive component of the R&D tax offset the R&D entity obtained in connection with the clawback amount. The amount of tax the R&D entity is required to pay equals this amount. As such, this amount is grossed-up by dividing it by the R&D entity's corporate tax rate for the present year to ensure its value is maintained when taxed.

Example 5.8 The denominator

Further to Example 5.7, Contrast Industries must divide the $1.65 million by its current corporate tax rate (30 per cent).

The resulting $5.5 million is included in the assessable income of Contrast Industries for the 2023-24 income year. Disregarding other assessable income and deductions, this will increase the income tax liability of Contrast Industries by the appropriate $1.65 million once the corporate tax rate applies to the entity's taxable income.

5.49 Bringing the amount to account as assessable income (rather than through a standalone tax) allows R&D entities to apply deductions from the current year and carried-forward losses against the clawback. Loss-making R&D entities that only obtained a non-refundable R&D tax offset in the offset year can apply the carried-forward offset against the amount included in assessable income. This ensures the clawback rule recovers the correct amount but does not have an unintended negative cash flow impact on R&D entities.

Catch-up rule for R&D balancing adjustments

5.50 The amendments introduce a new catch-up rule for R&D assets. This rule provides an additional deduction to R&D entities when a deductible balancing adjustment amount arises for an R&D asset. [Schedule 5, item 29, sections 355-455 and 355-460 of the ITAA 1997]

5.51 The catch-up rule mirrors the uniform clawback rule but operates in reverse, providing a deduction in lieu of an amount of R&D tax offset forgone rather than including an amount in assessable income. [Schedule 5, item 29, section 355-475 of the ITAA 1997]

5.52 As with the clawback amounts for balancing adjustments (see paragraphs 5.25 to 5.28), there are four different catch-up amounts to cover R&D assets either wholly or partially used for R&D, assets held by R&D entities and those held by R&D partnerships. The catch-up amounts reflect the amount an R&D entity can ordinarily deduct for the balancing adjustment event. [Schedule 5, item 29, sections 355-465, 355-466, 355-467 and 355-468 of the ITAA 1997]

5.53 These catch-up amounts are calculated in a modified way where the R&D asset was acquired before the introduction of the R&D Tax Incentive in 2011. [Schedule 5, items 41 to 44, 46, 47, 49, 51, 52 and 54, subsections 40-292(3) and (3A), 40-293(3) and (3A), 355-320(3) and (4A), and 355-325(3) and (4A) of the ITTP Act]

5.54 The catch-up amount rules replace provisions of the current law that either sought to estimate the value of the R&D tax offset forgone or replace it with a new R&D tax offset entitlement, neither option giving rise to an accurate catch-up. [Schedule 5, items 18, 20 to 26, 30 and 31, sections 355-105 and 355-300, subsections 40-292(3) and (5), and 40-293(3), paragraphs 355-100(1)(c) and (f), the heading to Subdivision 355-E, the headings to subsections 355-315(2) and 355-525(2), the notes to subsections 355-315(2) and 355-525(2) of the ITAA 1997]

5.55 It remains a condition for accessing the incentive component of the balancing adjustment (now the deduction for a catch-up amount) that the R&D entity be registered for R&D activities in the income year in which the balancing adjustment event occurs. However, for simplicity it is no longer a requirement that the R&D entity have $20,000 of notional deductions in that income year.

5.56 For R&D assets of an R&D partnership that are partially used for R&D purposes, the catch-up rule now makes each partner entitled to a deduction rather than the partnership. This mirrors the amendment outlined in paragraph 5.38. [Schedule 5, item 29, section 355-468 of the ITAA 1997]

5.57 The table below outlines the provisions of the new law as amended that correspond with provisions of the current law.

Table 5.2 Remaking of catch-up amount rules

5.58 Sections 40-292, 40-293, 355-315 and 355-525 (and section 40-285) continue to operate where appropriate to provide a catch-up for the deduction component of the R&D tax offset (i.e. the amount of the offset that reflects the R&D entity's corporate tax rate). The new provisions provide an additional catch-up for the incentive component of the R&D tax offset.

5.59 The amount allowed as a deduction for a catch-up amount for an offset year is worked out as follows:

5.60 This formula mirrors the formula discussed in paragraphs 5.40 to 5.48 with two important distinctions. Firstly, the initial operation requires the starting offset to be subtracted from the adjusted offset (rather than the reverse). Secondly, the adjusted offset is defined as the R&D tax offset the R&D entity would have received if its notional deductions for the offset year included the portion of the catch-up amount that is attributable to the offset year. [Schedule 5, item 29, section 355-475 of the ITAA 1997]

Example 5.9 Deductible balancing adjustment amounts

Spark Transformations is an R&D entity with an annual turnover of between $20 million and $25 million for the 2019-20 to 2021-22 income years. Spark Transformations is subject to the corporate tax rate for a base rate entity.

On 18 April 2020, Spark Transformations acquires a depreciating asset for $80,000. It has an effective life of five years. Spark Transformations used the asset entirely for R&D purposes.

Spark Transformations sells the asset on 1 July 2022 for $34,800.

Decline in value notional deductions

Spark Transformations uses the prime cost (straight line) method in section 40-75 to work out the asset's decline in value as follows:

Decline in value
Income Year	Days asset used	Decline in Value	Adjusted Value
2019-20	73	$3,200	$76,800
2020-21	365	$16,000	$60,800
2021-22	365	$16,000	$44,800

Spark Transformation is entitled to notional deductions for the asset's decline in value in each income year.

The R&D tax offset

For the 2019-20 income year, Spark Transformations is entitled to an R&D tax offset at the current 38.5 per cent rate. In relation to the depreciating asset, Spark Transformations is entitled to an R&D tax offset of $1,232. Spark Transformations has total notional deductions in excess of $20,000 (so subsection 355-100(2) does not apply) but it is not necessary to quantify them.

In the 2020-21 income year, Spark Transformations is entitled to an R&D tax offset of $6,160 in relation to the depreciating asset.

For the 2021-22 income year, it is necessary to consider the total R&D tax offset entitlement of Spark Transformations.

In the 2021-22 income year, Spark Transformations has notional deductions of $350,000 (inclusive of the decline in value notional deductions) and total expenses of $7.35 million. Therefore, Spark Transformations has an R&D intensity of 4.76 per cent. As it is subject to the corporate tax rate of 25 per cent in this income year, its R&D tax offset entitlement is worked out as follows:

2020-21 starting offset
Tier	Intensity range	R&D premium	Notional deductions applied	Offset amount
Tier 1	0-2%	8.5%	$147,000	$49,245
Tier 2	>2%	16.5	$203,000	$84,245
		Totals:	$350,000	$133,490

The catch-up amount portions

When the asset is sold, there is a balancing adjustment event. Because the asset's adjusted value ($44,800) exceeds its termination value ($34,800), Spark Transformations is entitled to a deductible balancing adjustment amount of $10,000. This amount is allowed as a deduction but is not a notional deduction and does not contribute towards the entity's R&D tax offset entitlement.

This gives rise to a catch-up amount of $10,000 that relates to the three income years (each an offset year) in which Spark Transformations claimed the R&D tax offset in relation to the asset's decline in value. It is necessary to work out the portion of the $10,000 catch-up amount that relates to each offset year. To do this, it is necessary to work out the decline in value recorded in each offset year as a proportion of the total decline in value of the asset ($35,200):

Spark Transformations has the following catch-up portions in the 2022-23 income year:

•

$909.09 for the 2019-20 income year; and

•

$4,545.45 for each of the 2020-21 and 2021-22 income years.

The adjusted offsets

The adjusted offset for each offset year is calculated by adding the catch-up portion to the R&D entity's notional deductions. This also impacts the calculations for total expenditure and R&D intensity.

It is not strictly necessary to calculate the adjusted offset for the 2019-20 or 2020-21 income years because the flat 38.5 per cent R&D tax offset rate applies.

The adjusted offset for the 2021-22 income year is calculated as follows:

2021-22 adjusted offset
Tier	Intensity range	R&D premium	Notional deductions applied	Offset amount
Tier 1	0-2%	8.5%	$147,090.91	$49,275.45
Tier 2	>2%	16.5%	$207,454.54	$86,093.63
		Totals:	$354,545.45	$135,369.08

Note that the R&D intensity for the adjusted offset calculation is 4.82 per cent in the 2021-22 income year. This incorporates the increase in notional deductions being included in total expenses.

The offset differential

The difference between the starting offset and the adjusted offset for the 2019-20 and 2020-21 income years can be simply calculated as the catch-up portion multiplied by the flat R&D tax offset rate of 38.5 per cent.

For the 2021-22 income year, the difference is derived by comparing the outcomes of the tables above.

Spark Transformations has the following offset differentials:

•

$349.99 ($909.09 multiplied by 38.5 per cent) in the 2019-20 income year;

•

$1,749.99 ($4545.45 multiplied by 38.5 per cent) in the 2020-21 income year; and

•

$1,879.08 ($135,369.08 less $133,490.00) in the 2021-22 income year.

The deduction amount

The deduction amount is the catch-up portion for an offset year multiplied by the corporate tax rate that applied in that year (27.5 per cent for the 2019-20 income year, 26 per cent for the 2020-21 income year and 25 per cent for the 2021-22). Spark Transformations has the following deduction amounts totalling $2,568.18:

•

$249.99 for the 2019-20 income year;

•

$1,181.81 for the 2020-21 income year; and

•

$1,136.36 for the 2021-22 income year.

These amounts are not available as deductions but are included in the 'deduction amount' in the catch-up rule formula (see paragraph 5.59).

Gross-up

The total of the differences between the adjusted offsets and the corresponding starting offsets is reduced by the deduction amounts and then grossed-up by the entity's current corporate tax rate (which in the 2022-23 income year, it is 25 per cent). Spark Transformations is entitled to a deduction for the result of the following equation:

The deduction will reduce the income tax liability of Spark Transformations by $1,410.91 once the current corporate tax rate is applied. This puts the entity in the position it would be in had the decline in value of the asset for tax purposes kept pace with the actual decline in value of the asset.

This reduction of the tax liability reflects that Spark Transformations is separately entitled to a $10,000 deduction for the balancing adjustment event under subsection 355-315(2). This balancing adjustment amount will result in Spark Transformations reducing its income tax liability by $2,500 for the 2022-23 income year.

Consequential amendments

5.61 Definitions of 'non-refundable R&D tax offset' and 'refundable R&D tax offset' linked to Division 355 of the ITAA 1997 are inserted into the dictionary in Part IVA of the ITAA 1936. [Schedule 5, item 1, subsection 177A(1) (definition of 'non-refundable R&D tax offset' and 'refundable R&D tax offset') of the ITAA 1936]

5.62 Consequential amendments are made to the remaking of the recoupment, feedstock and balancing adjustment provisions, and the introduction of the uniform clawback rule. This includes removing redundant provisions associated with the recoupment tax and repealing section 355-720, which dealt with the interaction between the expenditure threshold and the old recoupment, feedstock and R&D balancing adjustment rules. These functions are now consolidated in the new clawback rule. [Schedule 5, items 11 to 14, 33 to 36, 38 to 40, and 55, sections 4-25, 10-5, 355-530 and 355-720, table item 4A in subsection 9-5(1), table item 10 in section 20-5, subsections 355-715(2) and 995-1(1) (definition of 'feedstock revenue'), and Note 2 to subsection 355-715(2) of the ITAA 19997, and subsection 12(7), and sections 12B and 31 of the Income Tax Rates Act 1986, and section 355-720 of the ITTP Act]

5.63 Notes are added to explain the interaction between the R&D balancing adjustment provisions and the clawback and catch-up rules. [Schedule 5, items 15, 16, 18, 19, 27, 28, 31 and 32, notes to subsections 40-292(1), 40-293(1), 355-315(2), 355-315(3), 355-525(2) and 355-525(3) of the ITAA 1997]

5.64 As part of the remaking of Subdivision 355-G, the cap on recoupment amounts is amended to clarify the meaning of the numerator in the formula. [Schedule 5, item 29, subsection 355-440(4) (definition of 'R&D expenditure') of the ITAA 1997]

5.65 An amendment is made to the tax incentive for early stage investors to prevent the inclusion of clawback amounts in an R&D entity's assessable income denying the status of an early stage innovation company. [Schedule 5, item 37, subsection 360-40(2) of the ITAA 1997]

Application and transitional provisions

5.66 The amendments commence on the first day of the first quarter following Royal Assent. [Clause 2 of the Bill]

5.67 The amendments to Part IVA of the ITAA 1936 apply in relation to R&D tax benefits obtained on or after 1 July 2021, regardless of when the relevant scheme was entered into or carried out. [Schedule 5, subitems 56(1) and (2)]

5.68 The amendments to the recoupment, feedstock and R&D balancing adjustment rules, and the new clawback and catch-up rules, apply in relation to income years starting on or after 1 July 2021. The new clawback and catch-up rules may apply in an income year starting on or after 1 July 2021 in relation to an R&D tax offset received in an income year starting before that date (see Example 5.9 as it applies in relation to the 2019-20 income year). [Schedule 5, subitem 56(3)]

Chapter 6 - Improving the administration of the R&D Tax Incentive

Outline of chapter

6.1 Schedule 6 to the Bill improves the administrative framework supporting the R&D Incentive by making information about R&D expenditure claims transparent, enhancing the guidance framework to provide certainty to applicants and streamlining administrative processes.

Context of amendments

6.2 The R&D Incentive is jointly administered by the ATO (under the authority of the Commissioner) and the Board of ISA.

6.3 One of the conditions of an expense giving rise to a notional deduction is that the R&D entity has registered an R&D activity under section 27A of the IR&D Act (for example, subparagraph 355-205(1)(a)(i) of the ITAA 1997).

6.4 Under Part III of the IR&D Act, the Board of ISA may make findings about whether an R&D entity's activities are R&D activities. A finding binds the Commissioner for the purpose of working out an R&D entity's R&D tax offsets (section 355-705 of the ITAA 1997).

6.5 The Department of Industry, Science, Energy and Resources and its staff assist the Board of ISA to perform its functions. The Board and its committees may delegate their functions to a Senior Executive Service employee (subsections 21(1) and 22A(1) of the IR&D Act). The Government has identified that this limit on the delegation power has proved to be impractical and a significant barrier to the Board of ISA carrying out its functions.

Extensions of time

6.6 Part 3 of the Industry Research and Development Decision-making Principles 2011 (the Decision-making Principles) - made under section 32A of the IR&D Act - regulates the ability of the Board of ISA to grant extensions of time under the IR&D Act. This includes extensions of time for registration applications, providing requested information and applications for reviews (see subsection 3.1(1) of the Decision-making Principles).

6.7 The Board of ISA must grant extensions of up to 14 days if it is necessary and may grant a longer period if the applicant's ability to meet the deadline is impaired by events outside the applicant's control (section 3.2 of the Decision-making Principles). These extensions apply on top of the time limits in the IR&D Act (for example, registration applications under section 27D must be made within 10 months of the end of the income year unless extended).

6.8 The Government has observed that very long extensions for registration applications are granted, with applications often made and accepted a number of years after the relevant R&D activities were undertaken. This practice is inconsistent with the nature of the R&D Tax Incentive as expenditure that occurs without a business being aware of the Incentive would have occurred in the absence of the Incentive being available.

Summary of new law

6.9 Schedule 6 to the Bill makes a number of amendments to improve the administration and transparency of the R&D Tax Incentive. These include:

•

publishing information about R&D Tax Incentive claimants and their R&D expenditure;

•

allowing the Board of ISA to make binding determinations;

•

broadening the scope of the Board of ISA's delegation powers; and

•

imposing a three-month limit on extensions of time.

6.10 These legislative changes complement other aspects of the Government's reforms to the administration of the R&D Tax Incentive, including additional resourcing for additional compliance and legal activity, and the creation of improved guidance products for claimants.

Comparison of key features of new law and current law

Detailed explanation of new law

Transparency of R&D claimants and expenditure

6.11 Two years after the relevant income year, the Commissioner is required to publish information about the R&D activities of R&D entities claiming the R&D tax offset. This will improve public accountability for R&D claimants and encourage voluntary compliance with the program while balancing these objectives against the potentially commercially sensitive nature of the information being published. [Schedule 6, item 1, subsections 3H(1) and (2) of the Taxation Administration Act 1953]

6.12 The Commissioner must publish the following information:

•

the R&D entity's name;

•

the R&D entity's Australian Business Number, or Australian Company Number if that is the only number available; and

•

an amount representing the R&D entity's notional deductions claimed taking into account any feedstock adjustments for the year.

6.13 As noted in paragraph 5.24, an R&D entity's feedstock adjustment (if it has one) is the lesser of the entity's feedstock revenue or associated feedstock expenditure and is deducted from the entity's notional deductions. If the R&D entity's feedstock adjustment exceeds its notional deductions for the income year, the Commissioner must not publish a dollar figure for the entity but must still publish the entity's name and ABN or ACN. [Schedule 6, item 1, subsections 3H(3) and (4) of the Tax Administration Act 1953]

6.14 The criteria for the publication and the information published are based on concepts defined in the ITAA 1997. [Schedule 6, item 1, subsection 3H(8) of the Tax Administration Act 1953]

6.15 The Commissioner must publish the information as soon as practicable after the end of the period of two years starting at the end of the financial year that corresponds to the R&D entity's income year. It is envisaged that the Commissioner would publish the information of all R&D entities at one time. [Schedule 6, item 1, subsection 3H(2) of the Tex Administration Act 1953]

Source of information

6.16 The publication requirement will not apply in relation to R&D entities that do not lodge income tax returns or otherwise claim an R&D tax offset. In the case of consolidated groups and multiple entry consolidated groups, the information published will be that reported by the head company.

6.17 In determining whether the Commissioner is required to publish information about a specific R&D entity, the Commissioner can only have regard to the information that the entity has reported to the Commissioner.

6.18 Similarly, the Commissioner may only publish amounts that the R&D entity reports, subject only to simple calculations. The Commissioner is not permitted to substitute his or her own assessment of an R&D entity's information for the purposes of determining the figures to be published. However, the Commissioner may verify an R&D entity's identity before publication to ensure that the correct entity is identified.

Correction of errors

6.19 Provision for the correction of errors is an important safeguard.

6.20 The Commissioner may correct errors that are made in a publication in two circumstances: where the Commissioner has made an error and on the initiative of the relevant R&D entity.

6.21 Where the Commissioner has made an error, he or she has power to publish a correction. The correction must be made from the information the R&D entity has reported. [Schedule 6, item 1, subsection 3H(7) of the Tax Administration Act 1953]

6.22 The Commissioner may also make information publicly available that corrects an error that the R&D entity has brought to the Commissioner's attention. [Schedule 6, item 1, subsections 3H(5) and (6) of the Tax AdministrationAct 1953]

6.23 The Commissioner has discretion in deciding whether to publish a correction, including discretion as to the time and form of the publication.

ISA determinations

6.24 The Board of ISA may, by notifiable instrument, make a determination about how it will exercise its powers, and perform its functions and duties. However, a determination cannot relate to the exercise of powers, or the performance of functions or duties, in a particular case or in relation to a particular R&D entity. [Schedule 6, item 5, section 31C and subsections 31D(1) and (2) of the IR&D Act]

6.25 Determinations seek to augment the existing program guidance by allowing the Board of ISA to publicly state its position on the application of its functions and its interpretation of the legislation, including the definition of R&D activities or any other administrative matters where specific guidance would reduce the compliance burden for R&D entities.

6.26 This is intended to make compliance easier for R&D entities, as they will be able to better understand what is required to demonstrate eligibility for the R&D Tax Incentive. For example, the Board of ISA may make a determination about the validity of particular forms of evidence for R&D activities, thereby providing registrants with increased clarity on how to best evidence their R&D activities in their registration applications. This would improve compliance and reduce administrative workloads.

6.27 Determinations are generally binding on the Board of ISA. The ability to make determinations binding on itself allows the Board of ISA to provide certainty to R&D claimants and helps ensure R&D entities do not unintentionally misinterpret the meaning of the law. [Schedule 6, item 5, section 31D(3) and (4) of the IR&D Act]

6.28 However, determinations are not binding when an R&D entity seeks a review of a decision. Determinations are intended to operate in a similar manner to a taxation ruling issued by the Commissioner. Determinations are not binding on R&D entities. R&D entities may continue to self-assess their eligibility for the R&D Tax Incentive in a manner that is inconsistent with a determination but risk the Board of ISA contesting their position. If R&D entities believe a determination is incorrect, they may challenge it by seeking a review of a decision made consistently with the determination.

6.29 Determinations are notifiable instruments rather than legislative instruments (see sections 8 and 11 of the Legislation Act 2003). This reflects the fact they are not binding on R&D entities and the long-standing recognition that taxation rulings are not legislative instruments (section 7 of the Legislation (Exemptions and Other Matters) Regulation 2015). [Schedule 6, item 5, subsection 31D(1) of the IR&D Act]

6.30 Making determinations notifiable instruments increases the certainty they provide to registrants. The disallowable nature of legislative instruments would undermine the Board's ability to produce determinations that can be relied on by R&D entities. A disallowance period would create uncertainty about the validity of a determination until that period had ended.

6.31 Determinations are to be co-designed and developed in consultation with relevant stakeholders, including administrators, subject matter experts, tax advisers and peak bodies representing R&D entities by size and sector. Merits review (under Division 5 of the IR&D Act) and judicial review is available for R&D entities in the event of a dispute over a determination. The development process is intended to ensure that determinations are stable and reliable forms of guidance that can be relied upon by R&D entities over long periods of time.

Amending or revoking a determination

6.32 Subsection 33(3) of the Acts Interpretation Act 1901 provides that a power to make an instrument includes the power to revoke or vary the instrument.

6.33 These amendments provide specific circumstances when the Board of ISA must amend or revoke a determination by notifiable instrument. The amendments clarify that this does not limit the application of subsection 33(3) of the Acts Interpretation Act 1901 in relation to the power to make a determination. That is, the Board of ISA may amend or revoke a determination in a broader range of circumstances than those specified in the legislation. [Schedule 6, item 5, subsection 31E(3) of the IR&D Act]

6.34 A determination has no effect to the extent of any inconsistency with the IR&D Act, the Industry Research and Development Regulations 2011 or the Decision-making Principles. If such inconsistency exists, the Board of ISA must revoke or amend the determination to remove any inconsistency. [Schedule 6, item 5, subparagraph 31E(1)(b)(iii) and subsections 31D(4) and 31E(2) of the IR&D Act]

6.35 If the Board of ISA makes a finding specific to an R&D entity, it must be consistent with any relevant determinations. An R&D entity may still challenge a specific finding under Division 5 of the IR&D Act on the basis that the finding is incorrect and the underlying determination is similarly incorrect. An R&D entity may also challenge a finding on the basis that it is inconsistent with a determination.

6.36 In the event that a determination is found to be incorrect in a review decision or must be regarded as incorrect following a review decision, the Board of ISA must revoke or amend the determination so it is no longer incorrect. [Schedule 6, item 5, paragraph 31E(1)(a) and subsection 31E(2) of the IR&D Act]

6.37 The Administrative Appeals Tribunal may review an internal review decision of the Board of ISA. If a determination is inconsistent with a decision of the Administrative Appeals Tribunal, the Board of ISA must revoke or amend the determination so it is no longer inconsistent. [Schedule 6, item 5, subparagraph 31E(1)(b)(ii) and subsection 31E(2) of the IR&D Act]

6.38 The Board of ISA must also revoke or amend a determination that is inconsistent with a decision of a court. [Schedule 6, item 16, subparagraph 31E(1)(b)(i) and subsection 31E(2) of the IR&D Act]

ISA delegations

6.39 The Board of ISA and its committees may delegate some or all of their functions to members of the Australian Public Service staff assisting the Board. This expands the existing delegation power that authorised the Board to delegate to Senior Executive Service employees. [Schedule 6, items 7 and 8, subsection 22A(1) and paragraph 21(1)(e) of the IR&D Act]

6.40 The current limit on the delegation power has proved to be impractical and a significant barrier to the Board of ISA carrying out its functions necessary to the operation of the R&D Tax Incentive. These functions include the annual processing of around 12,500 registration applications as well as hundreds of compliance activities. It is unsustainable and impractical for a small number of Senior Executive Service delegates to be responsible for this volume of decision making.

6.41 The expansion of the delegations powers allows additional staff to be delegated responsibility for a number of administrative program tasks. This includes, but is not limited to, high-volume, low-risk functions such as the approval to grant an extension of time to submit applications, or the ability to request information on an application. Prior to the introduction of the current Senior Executive Service limit, a broader delegation power was used effectively and efficiently on a long-standing basis.

6.42 The expansion of the delegations powers also acknowledges the continual growth in the size of the R&D Tax Incentive and the consequent growth in resourcing needed to carry out the functions necessary for the R&D Tax Incentive's effective administration.

Extensions of time

6.43 Extensions of time granted under the IR&D Act may relate to an application to register R&D activities, provide further information requested by the Board of ISA, a form to continue registration as a research service provider or an application for review of a reviewable decision. An extension will apply on top of the time limits in the IR&D Act.

6.44 The Board of ISA must not grant extensions of time under the IR&D Act in excess of three months. [Schedule 6, item 9, subsection 3.2(3) of the Decision-making Principles]

6.45 Restricting extensions to three months mitigates the risk that long extensions granted by the Board of ISA result in applications being accepted a number of years after the relevant R&D activities are undertaken. Such timeframes are inconsistent with the objectives of the R&D Tax Incentive as expenditure that occurs without a business being aware of the R&D Tax Incentive would have occurred in the absence of the Incentive being available.

Further extensions for pending decisions

6.46 This restriction does not apply if the subject matter of the extension relates to a pending decision on another matter. That is, the restriction does not apply if the extension relates to a matter corresponding with the subject of a decision relating to the R&D entity where that decision has not been finalised. [Schedule 6, item 9, subsection 3.2(4) of the Decision-making Principles]

6.47 This allows the Board of ISA to grant an extension in excess of three months where this is necessary to provide a deadline due after the pending decision is made in relation to decisions of the Board of ISA under Division 2, 3 or 5 of Part III of the IR&D Act. This facilitates more administratively efficient outcomes.

Example 6.1 Granting extension pending ISA decision

Doppler Dynamics seeks a review of an unfavourable registration decision in relation to the 2021-22 income year. The review (including appeals) is finalised in May 2024.

During the course of the review, Doppler Dynamics needs to consider applying for registration in subsequent years for the same ongoing activities subject to the review. It would not be efficient for it to lodge applications that may need to be varied or that may lead to decisions that need to be set aside following the outcome of the review.

In these circumstances, it is reasonable for the Board of ISA to exercise its discretion to grant an extension of time until after the pending decision is made.

Amendments to the Decision-making Principles

6.48 The amendments made by the Bill to the Decision-making Principles do not prevent the Decision-making Principles from being amended or repealed by an instrument made under section 32A of the IR&D Act (see subsection 13(5) of the Legislation Act 2003). [Note to Section 3 of the Bill]

Consequential amendments

6.49 A note is amended to explain that the publication of R&D entities' R&D tax offset claims is not affected by the taxpayer secrecy provisions. [Schedule 6, item 2, note to section 355-50 in Schedule 1 to the Tax Administration Act 1953]

6.50 The simplified outline of Part III to the IR&D Act is amended to reflect the Board of ISA's new power to make determination about how it will exercise its powers, and perform its functions and duties. [Schedule 6, item 4, section 26A of the IR&D Act]

Application provisions

6.51 The amendments commence on the first day of the quarter following Royal Assent. [Section 2 of the Bill]

6.52 The transparency amendments apply to income years starting on or after 1 July 2021. [Schedule 6, item 3]

6.53 The Board of ISA's power to make determinations applies in relation to the exercise of powers, and the performance of functions and duties, by the Board of ISA on or after commencement. [Schedule 6, item 6]

6.54 The amendments to the Board of ISA's delegation and extension of time powers apply to delegations and extension of time decisions made on or after commencement. [Section 2 of the Bill]

Chapter 7 - Regulation impact analysis and statement for the R&D Tax Incentive

7.1 The enhancements to the R&D Tax Incentive contained in Schedules 4, 5 and 6 to the Bill make a number of refinements to what was proposed in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019. A supplementary regulation impact analysis of the 2020-21 Budget measure is provided below, and outlines the estimated impact of these changes.

7.2 Schedules 4, 5 and 6 to the Bill also implement aspects of the 2019-20 MYEFO measure outlined in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019. The regulation impact statement prepared for the former Bill is also set out below.

2020-21 Budget measure: Supplementary regulation impact analysis for R&D Tax Incentive

Background

7.3 Innovation is an important driver of productivity and economic growth, and R&D is an important input to innovation. The economic impact of business investment in R&D, however, goes beyond the benefits accruing to the firm undertaking the R&D and spills over to other firms and the economy as a whole.

7.4 Businesses may also have difficulty obtaining finance due to the uncertain returns from R&D activities. As a result, international research (including by the Organisation for Economic Co-operation and Development (OECD)) has found that firms typically underinvest in R&D relative to what is socially optimal. This represents a market failure and has been recognised internationally as justification for government intervention.

7.5 In Australia, the Government primarily supports business R&D through the R&D Tax Incentive (R&DTI). In the 2017-18 income year, over 11,000 R&D-performing companies claimed the R&DTI. According to the 2019-20 Science, Research and Innovation Budget tables, the estimated cost of the R&DTI program for 2017-18 was around $2.6 billion.

7.6 The R&DTI encourages companies to engage in R&D by providing a tax offset for eligible R&D activities. The currently legislated program has two core components:

•

a refundable tax offset (43.5 per cent) for companies whose aggregated turnover is less than $20 million. A company is entitled to a refund to any portion of the offset that exceeds their tax liability; and

•

a non-refundable tax offset (38.5 per cent) for all other companies. While the offset is not refundable, any tax losses can be carried forward to reduce future tax liabilities.

7.7 To be eligible for the program, a company must incur at least $20,000 eligible expenditure for the financial year. In addition, a company may only receive R&DTI benefits on the first $100m of R&D expenditure each financial year.

7.8 Eligibility for the R&DTI is self-assessed. Companies must first register their R&D activities with the Department of Industry, Science, Energy and Resources (DISER). Claims are then lodged by companies with the Australian Taxation Office (ATO) in their annual tax return.

7.9 In the 2018-19 Budget, the Government announced reforms to the R&DTI following the findings of reviews that the program was falling short of achieving its objectives of incentivising additional R&D activities and generating spillover benefits for the Australian economy. The reforms contained a number of measures to retarget support.

7.10 In December 2019, the Government introduced the 2019 Bill that made several refinements to these reforms. These refinements were made having regard to the findings of a Senate Economics Legislation Committee inquiry into the 2018-19 Budget reforms.

The problem

7.11 Drawing on work conducted by the Centre for International Economics (CIE), the 2016 review of the R&DTI, chaired by Australian Chief Scientist Alan Finkel AO, then Chairman of Innovation and Science Australia (ISA) Bill Ferris AC, and then Treasury Secretary John Fraser, found that the R&DTI program was not working as effectively as it could, particularly with regard to encouraging R&D activities that would not have occurred in the absence of Government support. The review identified a number of areas where improvements could be made in order to improve the effectiveness and integrity of the program, primarily by achieving a stronger focus on additionality.

7.12 On 30 January 2018, ISA released its report to the Government, Australia 2030: Prosperity through Innovation (the ISA 2030 Plan). The ISA 2030 Plan upheld the need for R&DTI reform and included some alternative recommendations aimed at improving the effectiveness of the program.

7.13 More recently, the Coronavirus pandemic has led to a period of domestic and global economic downturn and it is likely that it will take a number of years for the Australian economy to recover. In this environment, businesses are facing a range of pressures which are likely to constrain their ability to invest in R&D.

7.14 Smaller, innovative businesses typically rely on external investment to fund their operations, particularly when their products, processes and/or services are at a pre-commercial stage of development. It has been reported that many of these firms are experiencing difficulty in accessing finance due to the economic impacts of the Coronavirus, resulting in severe cash-flow difficulties.

7.15 For larger entities, the risky nature of investments in R&D means they are often amongst the first activities cut during times of economic weakness.

Case for government action/objective of reform

7.16 In light of the economic impacts of the Coronavirus, the Government has made significant outlays to support the economy in the immediate-term. Support measures have been designed to encourage business investment, preserve businesses through Coronavirus-related restrictions, and maintain the connection between employers and employees so that the economy is able to re-emerge when the crisis subsides.

7.17 The Government has also announced the JobMaker agenda, which will outline the reforms required to enable the Australian economy to emerge from the crisis and set up Australia for economic success over the next three to five years, supporting growth in jobs, investment and productivity in the medium-term. Announced areas of focus for the JobMaker agenda include reforms to Government support for research and science and Australia's taxation system.

7.18 The 2016 review of the R&DTI found a relatively low level of additionality under the program, as it provides the same level of support for all eligible R&D activities, and has no requirement to demonstrate that the R&D would not have occurred without government support. However, it should be noted that volume-based tax instruments tend to impose a lower regulatory burden on claimants, as eligibility is largely self-assessed. The review also found that the R&DTI provides effective support for small entities, reflecting the CIE's analysis that cash-constrained R&D start-ups and small entities are typically the most responsive to financial incentives. To address these findings, the review recommended improving additionality for larger businesses by redirecting government support to R&D-intensive companies - where intensity is defined as R&D expenditure as a proportion of total business expenditure. The CIE's analysis found that these claimants tend to make more efficient use of scarce R&D resources such as skilled labour and are more likely to be induced to increase their investment in R&D.

Policy options

7.19 The following three options were considered:

•

Option 1: Maintain the R&DTI as currently legislated;

•

Option 2: Proceed with the reforms currently before the Senate; or

•

Option 3: Refine the reforms to align with the Government's economic recovery measures.

Option 1: Maintain the R&DTI as currently legislated

7.20 Under this option, the R&DTI would continue in its currently legislated form. The program currently has two core components:

•

a 43.5 per cent refundable tax offset for eligible entities with a turnover of less than $20 million per annum; and

•

a 38.5 per cent non-refundable tax offset for all other eligible entities. Unused non-refundable offset amounts may be able to be carried forward to future income years.

7.21 The $100 million expenditure threshold would be maintained until the legislated sunset date of 1 July 2024.

Option 2: Proceed with the reforms currently before the Senate

7.22 This option would proceed with targeted reforms to the R&DTI as contained in the 2019 Bill. These reforms include:

•

an R&D premium that rewards companies that commit a greater proportion of expenses to R&D;

•

an increase in the R&D expenditure threshold from $100 million to $150 million;

•

a $4 million cap on cash refunds with an exemption for eligible expenditure on clinical trials;

•

linking the R&D tax offset rate to the claimant's company tax rate;

•

introducing a new power for the Board of ISA to make 'general determinations';

•

changes to anti-avoidance and clawback rules; and

•

requiring the publication of certain claimant details.

7.23 These changes would apply to the income years starting on or after 1 July 2019.

Table 7.1 : The R&DTI tax offsets as contained in the Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019

Option 3: Refine the reforms to align with the Government's economic recovery measures

7.24 Under this option, the 2019 Bill would be amended to increase support to R&DTI claimants and simplify the proposed changes, while retaining measures to improve the operation of the program.

7.25 The amendments would include:

•

streamlining the three-tiered intensity test into a two-tiered intensity test for calculation of the R&D premium for large companies;

•

increasing the R&D tax offset rates for both large and small companies;

•

not proceeding with the $4 million cap on annual refunds; and

•

delaying the start date of any changes to the current law to 1 July 2021.

7.26 See the table below for the new rates of offset under Option 3. Similar to Option 2, the rates of offset would be linked to each claimant's company tax rate, removing the need for ongoing legislative amendments to maintain the level of benefit provided by the R&DTI as company tax rates change.

Table 7.2 : The new R&D tax offsets under Option 3

Impact analysis of each option

Option 1: Maintain the R&DTI as currently legislated

7.27 Under this option, the current R&DTI continues unchanged. Therefore, there is no change to the regulatory costs of the program.

Benefits

7.28 The benefit of this option would be that there is no change to the regulatory burden for R&DTI claimants. Levels of support provided under the program would be maintained, providing entities undertaking R&D with some certainty while they manage the economic impacts of the Coronavirus.

Costs

7.29 None of the issues identified by the 2016 review of the program would be resolved. While retaining the current program settings would not alter the existing regulatory burden, the impacts of the Coronavirus mean that the ability to absorb that burden is likely to have been reduced for many businesses. All else remaining equal, the extent to which the program can be expected to incentivise businesses to spend more on R&D would remain sub-optimal.

Option 1 - Net benefit

7.30 While there would be no change to the regulatory burden on business, the identified issues in the program would continue. However, maintaining support under the program would be consistent with the Government's other measures to support economic recovery from the Coronavirus pandemic.

Option 2: Proceed with the reforms currently before the Senate

7.31 This option would implement the reforms in the 2019 Bill with no modification.

Benefits

7.32 The reforms would assist in improving the R&DTI's efficacy, administration and integrity by:

•

introducing an R&D premium for larger claimants would sharpen the focus on additionality by rewarding large companies for conducting a high intensity of R&D;

-

The review found that R&D-intensive companies are generally more responsive to fiscal incentives intended to support R&D. While this finding is contestable (a recent OECD study has reached a different conclusion), the review recommended targeting large R&D-intensive companies for a number of reasons. For example, the review found that targeting large R&D-intensive companies is likely to lead to more efficient use of scarce R&D resources and greater spillovers through the spread of additional knowledge.

•

an increase in the R&D expenditure threshold from $100 million to $150 million would encourage large companies to spend more on their R&D in Australia;

•

the exemption for clinical trials from the $4 million cap on cash refunds would ensure that support is maintained for critical drug and medical device development;

•

linking the R&D tax offset rate to the claimant's company tax rate would address the need for legislative amendments to account for future company tax rate reductions and ensure that the benefits of the non-refundable R&D tax offset are not determined by the claimant's turnover;

•

introducing a new power for the Board of ISA or other relevant authority to make 'general determinations' would assist in improving the clarity of advice provided to claimants, and would provide claimants with clearer guidance about eligibility and other requirements; and

•

changes to anti-avoidance and clawback rules would improve the integrity of the program.

Costs

7.33 It is expected that these changes would impose an additional regulatory burden on R&DTI claimants. This reflects the implementation costs related to the amount of learning and education required for the various changes to the incentive, particularly the complexities of the new intensity thresholds. Implementation costs will also arise from the need to adjust evaluation, planning and record-keeping systems in response to the changes.

7.34 The changes are estimated to reduce support for most claimants of the R&DTI. The 1 July 2019 start date of the R&DTI reforms contained in the current Bill also means that the measures would apply to the 2019-20 income year, which has just concluded. This has led to uncertainty among businesses around the tax framework under which they will be lodging their 2019-20 and future income tax returns, which may be causing some businesses to delay investment decisions, and may require some businesses to amend claims already made.

7.35 As noted for Option 1, the impacts of the Coronavirus mean that the ability of businesses to absorb any regulatory burden has been reduced.

Option 2 - Net benefit

7.36 The net result is that the R&DTI would be more focused towards supporting high intensity R&D expenditure and encouraging additionality and spillovers. However, this comes with a moderate additional regulatory burden and reduced support for some R&DTI claimants at a time where they are facing many other uncertainties and challenges resulting from the Coronavirus pandemic.

7.37 This option would result in an estimated additional total average annual regulatory cost for businesses of $26.3 million (OBPR 25318):

Table 7.3 : Regulatory burden estimate (RBE) table (Option 2) (OBPR 25318)

* Average annual impact (calculated over 10 years).

Option 3: Refine the reforms to align with the Government's economic recovery measures

7.38 This option would amend the current Bill to increase support to R&DTI claimants, reduce complexity of the proposed changes and align the R&DTI with the Government's economic recovery measures. Some measures to improve the operation of the program would be retained.

Benefits

7.39 As outlined in the impact analysis of Option 2, the changes to be retained would future-proof the R&DTI program and improve its effectiveness, transparency, integrity and administration. In addition to this:

•

delaying the start date of any changes to the current law to 1 July 2021 would maintain the current program as the economy recovers from the impact of the Coronavirus, and give businesses additional time to prepare for the changes;

•

streamlining the three-tier intensity threshold system for the non-refundable component of the R&DTI and not proceeding with a $4 million cap on annual refunds would reduce complexity of the reforms to the R&DTI;

•

increasing the R&DTI tax offset rates would mean more generous support for all R&DTI claimants in comparison with Option 2, assisting R&D-active businesses as they recover from the recent economic shocks from the Coronavirus pandemic.

Costs

7.40 Not all claimants will benefit from the new R&DTI tax rates relative to currently legislated settings. Due to the reductions in the company tax rate in recent years, the proposed R&DTI tax offset rates may provide a lower dollar benefit than the currently legislated offset rates for some companies with turnover between $20 million and $50 million and a low R&D intensity. However, the proposed rates will maintain the benefit from the R&DTI at a fixed margin over the company tax rate at a similar level to what existed before the company tax rate reductions began, and delays to the start date will also ensure that any dollar benefit from the R&DTI will remain unchanged in the short term.

7.41 By continuing to provide generous support for initial investments in R&D, the incentives to conduct additional R&D activities may not be as strong as under other options. However, the proposal employs other measures to target additional investment in R&D, such as by providing more generous support to small entities relative to larger entities through a higher offset rate and refundability. The 2016 review, international reports from the OECD, and academic literature all support the view that small and medium companies are more responsive to fiscal incentives to undertake R&D.

Option 3 - Net benefit

7.42 The net result is that the R&DTI would be providing more generous support to most R&DTI claimants compared with the measures proposed in the current Bill (Option 2), and with a small reduction in regulatory costs. By increasing support for small entities relative to the Bill and by retaining the intensity measure, the modified changes target support at entities that the 2016 review found were typically the most responsive to fiscal incentives.

7.43 While this option may still reduce the dollar value of support for some companies currently with turnover between $20 million and $50 million and a low R&D intensity, it would ensure that the rate of support from the non-refundable tax offset is consistent for all entities regardless of their turnover. It also helps to future-proof the R&DTI in the event of further reductions to the company tax rate. Firms in this range will also have an incentive to increase their R&D intensity to receive more support.

7.44 This option would result in an estimated total average annual regulatory cost for businesses of $24.7 million, which would be fully offset by regulatory savings of other Treasury proposals.

Table 7.4 : Regulatory burden estimate (RBE) table (Option 3) (OBPR 25318)

* Average annual impact (calculated over 10 years).

Consultation plan

7.45 There has been significant consultation on the reforms to the R&DTI.

7.46 The first round of public consultation occurred during the review of the R&DTI in early 2016, which included a program of targeted consultations with a variety of stakeholders from industry, the research sector, government and tax agents. The Government then undertook public consultations to inform its response to the review's recommendations, following the public release of the review report on 28 September 2016. Consultations included written submissions, roundtables with peak industry bodies, and multiple stakeholder forums in all states and territories.

7.47 Following the Government's announcement of reforms in the context of the 2018-19 Budget, draft legislation was released for public consultation from 29 June 2018 to 26 July 2018. Feedback from this process helped refine the reforms in the Bill. Following its introduction to Parliament, the legislation was referred to the Senate Economics Legislation Committee for review. The Committee released its report on 11 February 2019. A number of stakeholders made submissions to the Committee and appeared at its public hearing to voice their views. Further refinements to the legislation were made with the recommendations of the report in mind.

7.48 The resulting 2019 Bill was introduced on 5 December 2019 and was again referred to the Senate Economics Legislation Committee for inquiry. The Committee is currently scheduled to report on 12 October 2020.

7.49 In addition to the above formal consultations, the Minister for Industry, Science and Technology and DISER and the ATO have continued to engage with stakeholders (for example, through face to face meetings, roundtables and teleconferences), and will continue to do so throughout implementation of the reforms.

Option selection/conclusion

7.50 The preferred policy option is to implement the amendments to the R&DTI to align with the Government's economic recovery measures (Option 3). Option 3 would better support R&DTI claimants, helping them manage the economic impacts of the Coronavirus pandemic, while reducing the complexity of the proposed changes and proceeding with measures to improve the operation of the program. Business investment in R&D is central to the development of new products, processes and services that will help make Australia more competitive and create more jobs in the long-term.

Implementation and evaluation/review

7.51 Legislation is required to implement this proposal, and it will be delivered by the ATO and DISER in line with existing administrative arrangements.

7.52 To support R&DTI claimants in understanding their obligations under the reformed program, the ATO and AusIndustry will issue improved guidance products for claimants. This will be augmented by the proposed changes that permit the ISA to issue binding public guidance.

7.53 The ATO and ISA will continue to undertake their client feedback processes, which assist in identifying opportunities to improve the administration of the R&DTI. Treasury and DISER will also consider feedback from regulators and stakeholders as to how the reformed R&DTI is operating in practice.

7.54 Following the end of a financial year, there is a delay before complete registration and taxation data for that years' R&DTI registrants becomes available. This time lag means that analysing companies' behavioural responses will not be possible for some time, particularly given a number of years of data from the reformed program would be necessary.

7.55 Evaluations for the R&DTI are performed in consultation with DISER's internal evaluation unit, and the results are made public at Ministerial discretion.

7.56 General summaries of Government support provided for business R&D will continue to be published in the annual Science, Research and Innovation Budget Tables. In addition, the reforms to the R&DTI will ensure transparency of the program by publishing the names of companies, and their claim amounts, following a two year delay.

2019-20 MYEFO measure: Regulation impact statement

Background

7.57 Innovation is an important driver of productivity and economic growth, and Research and Development (R&D) is an important input to innovation. The economic impact of business investment in R&D, however, goes beyond the benefits accruing to the firm undertaking the R&D and spills over to other firms and the economy as a whole. Businesses may also have difficulty obtaining finance due to the uncertain returns from R&D activities. As a result, international research (including by the OECD) has found that firms typically underinvest in R&D relative to what is socially optimal.

7.58 The underinvestment by business in R&D represents a market failure and has been recognised internationally as justification for government intervention. In Australia, the Government primarily supports business R&D through the R&D Tax Incentive (R&DTI). While a socially optimal investment level is a theoretical construct and therefore unable to be quantified, providing support for business R&D is likely to represent a positive movement towards optimal investment.

7.59 The R&DTI program is the largest component of Australian Government support for business R&D. In the 2016-17 income year, over 12,000 R&D-performing companies claimed the R&DTI. According to the 2018-19 Science, Research and Innovation Budget tables, the estimated cost of the R&DTI program is around $2.0 billion in 2019-20.

7.60 In the 2018-19 Budget, the Government announced reforms to the R&DTI. The reforms sought to address the findings of the successive reviews of the R&DTI, while also taking into account the considerable stakeholder feedback received over a two year period between the release of the Review report in 2016 and the 2018-19 Budget.

7.61 The reforms were to commence on 1 July 2018 and contained a number of measures to better target the R&DTI towards additional R&D activities, and improve the fiscal sustainability, integrity and administration of the program. This included:

•

the introduction of a $4 million cap on cash refunds for the refundable component of the R&DTI with an exemption for clinical trials;

•

introducing a non-refundable R&D premium calculated with reference to the claimant's company tax rate and R&D intensity (R&D expenditure as a proportion of total business expenses). The premium increases with R&D intensity, rewarding companies for conducting a high intensity of R&D;

•

an increase in the R&D expenditure threshold from $100 million to $150 million;

•

linking the R&D tax offset rate to the prevailing company tax rate; and

•

changes to improve the integrity of the program.

7.62 A Bill to implement these reforms was introduced to the Parliament on 20 September 2018. The Bill was subsequently referred to the Senate Economics Legislation Committee, which released its report on 11 February 2019. In the report, the Committee acknowledged the need for reform of the R&DTI, but recommended that consideration of the Bill be deferred until further analysis of the impacts of the Bill could be undertaken.

7.63 The Bill lapsed when Parliament was prorogued on 11 April 2019. However, the Government considers that the case for reform remains, and is now reintroducing a Bill to implement the reforms with several amendments formulated following feedback from stakeholders and the findings of the Senate Inquiry.

The problem

Current government support for R&D does not fully meet its objectives

7.64 The National Innovation and Science Agenda (NISA) was launched on 7 December 2015. When launching the NISA, the Government committed to undertaking a review of the R&DTI (the Review).

7.65 The Review was conducted by a review panel comprising Mr Bill Ferris AC (then Chair of Innovation Australia), Dr Alan Finkel AO (Chief Scientist) and Mr John Fraser (then Secretary of the Department of the Treasury). The review panel was supported by an interdepartmental taskforce comprising officers from the Department of Industry, Innovation and Science (DIIS), the Treasury and the Australian Taxation Office (ATO).

7.66 The review panel, drawing on work conducted by the Centre for International Economics (CIE), found that the R&DTI falls short of meeting its stated objectives of additionality - encouraging R&D investment that would not occur in the absence of the program - and spillovers. The panel identified a number of areas where improvements could be made in order to improve the effectiveness and integrity of the program, primarily achieving a stronger focus on additionality.

7.67 On 30 January 2018, Innovation and Science Australia (ISA) released its report to the Government, Australia 2030: Prosperity through Innovation (the ISA 2030 Plan). The ISA 2030 Plan also found that reforms to the R&DTI were required to improve the program's effectiveness and integrity, and included alternative recommendations to reform the R&DTI.

Inherent difficulties in measuring program effectiveness

7.68 The intended outcomes of the R&DTI - additionality and spillovers - are very difficult to quantify and necessitate analysis that relies heavily on anecdotal and qualitative evidence.

7.69 In its program evaluation, the CIE stated that:

The two most crucial elements of the R&D TI (additionality and spillovers) turn out to be extremely difficult to empirically measure and evaluate.

Additionality cannot be directly measured and must be inferred through interviews, surveys, statistical analysis and modelling. Therefore, estimates of additionality will always be imprecise and subject to uncertainty.

Spillovers, while in principle evident from the techniques of growth accounting, have also proved to be extremely difficult to measure empirically.

7.70 Despite the difficulties noted above, the CIE attempted to measure additionality levels in Australia using a mix of survey data and statistical analysis. DIIS also commissioned the Centre for Transformative Innovation at Swinburne University to undertake an econometric analysis evaluating the level of program additionality.

7.71 The analyses found results broadly consistent with studies from other countries (0.3 to 1.5 additional dollars of R&D per dollar of tax forgone for CIE, and 0.8 to 1.9 for Swinburne). There is also common agreement that additionality is greater for small companies than large companies.

7.72 A key finding of the Review and the CIE is that, at a conceptual level, the program's volume based design (i.e. all R&D attracts the same benefit) is poorly targeted towards incentivising additional R&D.

7.73 The most recent estimate of spillovers in an Australian context was presented by the Productivity Commission (the PC) in 2007. The PC estimated that a 1 per cent increase in market R&D led to approximately 0.02 per cent increase in productivity or 65 cents of average spillover benefit from each dollar of R&D conducted. It should be noted that this estimate relates to market-induced business R&D (that is, R&D that would have occurred in the absence of government support).

7.74 There is limited data in relation to spillover benefits and it is not expected that the reformed program will assist in overcoming these measurement issues.

Case for government action/objective of reform

7.75 Businesses generally invest less in R&D than is socially optimal due to their inability to fully appropriate the returns; the inherently risky nature of R&D activities; and the related uncertainty around their outcomes. There is a widely agreed role for government intervention to address this market failure and encourage additional R&D.

7.76 The Review found that the current R&DTI falls short of meeting its objectives of encouraging additionality and spillovers. Reform of the R&DTI is required to ensure the efficacy and cost effectiveness of the program. The OECD has found that 'basic research' (i.e. experimental or theoretical work undertaken primarily to acquire new knowledge, without any particular application or use in view) results in larger spillovers than applied research (i.e. experimental or theoretical work directed primarily towards a specific practical aim or objective).

7.77 There is, however, no evidence that specific industries or types of R&D produce additionality and spillovers in greater amounts than other industries or types of R&D. Therefore it is important that the R&DTI is industry-neutral, aiming to incentivise novel R&D in all sectors of the economy. This is catered for under the R&DTI through the broad definition of what constitutes eligible R&D.

7.78 The Review found a relatively low level of additionality under the current R&DTI, stating that "volume-based tax instruments such as the Incentive not only subsidise this additional R&D but also support the activities a company would have done anyway." That is, the program provides the same level of support for all eligible R&D activities undertaken by a claimant, with no requirement to demonstrate that it is additional to 'business-as-usual' R&D that would have been progressed in the absence of government support. However, it should be noted that volume-based tax instruments tend to impose a lower regulatory burden on claimants, as eligibility is largely self-assessed.

7.79 The Review found that the program design could be improved by reducing support for business as usual activities and refocusing support towards additional R&D, particularly in the non refundable portion of the program (available to larger businesses with $20 million or more turnover per annum).

7.80 The Review recommended improving the R&DTI's additionality for larger businesses by redirecting government support to R&D intensive companies - R&D intensity was defined as R&D expenditure as a proportion of total business expenditure. Compared to companies with lower R&D intensity, these claimants make more efficient use of scarce R&D resources such as skilled labour and specific capital equipment and are more likely to be induced to increase their investment in R&D (i.e. generate increased additionality and thus produce greater spillover benefits). It is also acknowledged that most companies will undertake some R&D to keep up with competitive pressures and additional R&D will necessarily fall into higher intensity bands.

7.81 The Review found that although the R&DTI provides effective support for small and medium sized enterprises (SMEs) via its refundable component (available to companies with annual turnover below $20 million), the significant growth in the number of SMEs participating in the program since its introduction was placing upward pressure on program costs. To address this, the Review recommended keeping the rate of benefit unchanged, but capping cash refunds for refundable R&D tax offset claimants as a way of placing some restraint on the maximum level of payment that can be made (SMEs can currently 'cash out' their entire R&D tax offset if they are in a tax loss position).

7.82 New taxation data indicates that growth in the refundable component of the R&DTI has moderated since the release of the Review in April 2016. The main reasons for lower growth in refundable R&DTI claims include the post-mining-boom business investment environment and increased ATO and AusIndustry compliance activity. However, factors such as the current business investment environment may not persist over the longer-term and do not necessarily preclude the re-emergence of fiscal pressures in the future.

7.83 Further, companies would need to be spending very large amounts on R&D to exceed the cap on cash refunds for refundable R&D tax offset claimants. These companies that would be impacted by a cap are likely to have access to other sources of finance, in addition to the R&DTI, to support their R&D activities. As the Review put it, "Refundability is likely to provide fewer tangible benefits for SMEs with larger R&D expenditures, who will be able to find alternative sources of finance at relatively lower costs in comparison with firms with lower R&D expenditure."

7.84 The Review also noted that "...as the tax offsets under the program are at a fixed level, they are relatively more valuable when the company tax rate is lowered (in comparison to the deduction received for normally deductible expenses). Hence, the fixed level of the tax offset should always be calibrated to the level of the company tax."

7.85 The CIE's and other studies have shown that the companies most responsive to financial incentives are often cash constrained R&D start-ups, SMEs, and R&D-intensive companies (those companies whose core business is R&D-centric). These companies generally devote a greater proportion of their activities to R&D.

Policy options

7.86 This regulation impact statement compares the Government's proposed reforms to the R&DTI to two other potential policy responses: 1) no policy change; and 2) adopting the Review recommendations.

Option 1: No policy change

7.87 If the Government took no action the R&DTI would continue in its current form. The program currently has two core components:

•

a 43.5 per cent refundable tax offset for eligible entities with a turnover of less than $20 million per annum; and

•

a 38.5 per cent non-refundable tax offset for all other eligible entities. Unused non-refundable offset amounts may be able to be carried forward to future income years.

7.88 The $100 million expenditure threshold would be maintained until the legislated sunset date of 1 July 2024.

7.89 In the absence of the R&DTI, companies would deduct their expenses at the relevant standard company tax rate (currently 27.5 per cent for businesses with annual turnover less than $50 million and 30 per cent for all other businesses). If a company was in tax loss, however, they would not receive any immediate benefit.

7.90 The net benefit provided by the R&DTI is the difference between the R&D offset rate and what the company would otherwise receive in the absence of the program (i.e. the value of the standard tax deduction). These rates can be seen in Table 4.1 below. As the corporate tax rate for companies with a turnover of less than $50 million continues to decrease over the coming years, the net benefit for these companies will increase serendipitously if no change is made to the R&DTI.

Table 7.5 : R&DTI Net Benefit Rates, 2019-20

7.91 Under the refundable tax offset, if a claimant's offset exceeds their tax liability then the claimant receives the excess as a cash refund, rather than carrying forward an amount to offset tax liabilities incurred in future income years.

Option 2: The Review's Recommendations

7.92 The Review found that the program does not fully meet its stated policy objectives and proposed a range of recommendations to improve its effectiveness and integrity. The recommendations included initiatives to encourage additional R&D. The Review's recommendations are summarised in Table 4.2 below.

Table 7.6 : Review's recommendations

Option 3: Targeted reforms to the R&DTI (preferred option)

7.93 The Government's option is to proceed with targeted reforms to the R&DTI. These reforms comprise a number of targeted changes to the R&DTI including:

•

a $4 million cap on cash refunds with an exemption for clinical trials;

•

an R&D premium that rewards companies that commit a greater proportion of expenses to R&D;

•

an increase in the R&D expenditure threshold from $100 million to $150 million;

•

linking the R&D tax offset rate to the prevailing company tax rate;

•

introducing a new power for ISA to make 'general determinations'; and

•

changes to improve the integrity of the program.

7.94 The changes would apply to income years starting on or after 1 July 2019.

7.95 The reforms include a $4 million annual cap on cash refunds for R&D claimants with aggregated annual turnover less than $20 million. Amounts in excess of the cap would become a non-refundable tax offset to be carried forward into future income years. Expenditure on clinical trials would be excluded from the $4 million cap on cash refunds, recognising the critical role of clinical trials in developing life changing drugs and devices.

7.96 To help ensure support provided under the program is well targeted, the new R&D premium refocusses support for larger companies (with annual turnover of $20 million or more) towards those companies which devote a greater proportion of their expenses to R&D (i.e. with higher R&D intensity), while continuing to provide a baseline level of support for companies with lower R&D intensity. The R&D premium provides multiple rates of non-refundable R&D tax offsets, increasing with the intensity of companies' R&D expenditure. The increasing rate of support provides companies with a greater incentive to undertake additional R&D activities.

7.97 The current $100 million expenditure threshold would be increased to $150 million and made a permanent feature of the law. The higher expenditure threshold encourages large companies to spend more on R&D, as a greater proportion of their R&D expenditure will be eligible for the R&DTI.

7.98 See Table 4.3 for the rates of benefit provided by the R&D Premium. Box 1 provides an example of how the R&D Premium would operate in conjunction with the increased expenditure threshold.

7.99 The rates of the R&D tax offsets would be linked to each claimant's company tax rate, removing the need for ongoing legislative amendments to the R&DTI tax offset rates as company tax rates change (see Table 4.3). This ensures that companies receive a fixed premium (above the value of a standard tax deduction) for R&D expenditure as the Government's corporate tax cuts take effect. This also removes differences in support due to the disparity between the turnover thresholds that determine a company's corporate tax rate and its level of support under the R&DTI.

Table 7.7: The new R&DTI tax offsets

Box 1 - How does the expenditure threshold work?

7.100 The ISA Board would have the power to publish 'general determinations', which would be binding on the ISA Board. The general determinations would provide guidance on the circumstances in which the Board can exercise its powers or perform its functions or duties in relation to the R&DTI.

7.101 Lastly, the targeted reforms would improve the integrity of the R&DTI by strengthening anti avoidance rules, publishing claimant details and amounts of R&D expenditure claimed and improving guidance to help ensure that taxpayers do not make incorrect claims. The reforms would also make the rate at which the offset is recouped (i.e. feedstock and clawback rules) more accurate in situations where receiving the R&D tax offset would result in a company accruing an additional benefit.

Impact analysis of each option

7.102 To receive a benefit under the R&DTI, companies must go through a two stage process: registering R&D activities with the DIIS; and then claiming the incentive for the related expenditure in their annual tax return (including an R&D Tax Schedule) with the ATO. The activities associated with the registration and claiming processes comprise the R&DTI's regulatory costs. As with the rest of the taxation system, over 80 per cent of companies that register for the R&DTI use consultants to assist with their applications. The fees paid to these consultants impose a regulatory burden on registrants, and are therefore considered when determining the regulatory costs of the different options.

Option 1: No policy change

7.103 Under this option, no action would be taken by the Government and the current R&DTI continues unchanged. There is therefore no change to the regulatory cost of the program.

Benefits

7.104 The benefit of this option would be that there is no increase in regulatory burden for claimants.

Costs

7.105 The cost of this option would be that the Government continues to provide support to 'business as usual' R&D which would likely have been conducted anyway (i.e. in absence of the program). The R&DTI would continue to fail to fully meet the program's objective of encouraging greater additionality in R&D activities.

7.106 There would also be a risk that future growth in the number of companies in the program or claim amounts could place upward pressure on program costs, without an attendant increase in additionality.

7.107 Program costs will also continue to rise as the Government's company tax cuts come into effect. Without changes to offset rates, the lower company tax rates increase the effective benefit of the R&DTI and the resulting cost to government.

Option 1 - Net outcome

7.108 While there would be no change to the regulatory burden on business, the identified deficiencies in the efficacy of the program would continue, limiting the economic benefits and cost effectiveness of the R&DTI.

Option 2: R&DTI Review Recommendations

7.109 This option would implement the recommendations of the Review without any alterations.

Benefits

7.110 Introducing a minimum R&D intensity requirement would target support towards companies that are the most significant participants in Australia's R&D landscape. As the benefit would not be provided for R&D expenditure under the threshold (the Review found that at least such a level of expenditure would be expected as business as usual in a truly innovative company), the intensity threshold is more likely to direct support to companies investing in additional R&D.

7.111 Companies below the threshold would no longer be eligible to receive a benefit under the program, which, in some cases, may reduce the overall administrative burden. This would be due to fewer companies needing to complete the registration process and separately account for related expenses, therefore removing the need for associated record keeping and compliance-ready measures.

7.112 The Review also recommended that the $100 million expenditure threshold should be increased to $200 million so that large R&D intensive companies retain an incentive to increase R&D in Australia. The higher expenditure threshold, when combined with the intensity threshold, would likely sharpen the additionality of larger companies. This is because the companies in a position to benefit from the higher expenditure threshold would be able to register more R&D activities in order to receive the greater benefit.

7.113 A $2 million cap on cash refunds would constrain the costs of the refundable R&D offsets under the program. At the time of the Review, the refundable R&D offset was the most costly element of the program and was growing at unsustainable rates. However, it should also be noted that these companies were found by the Review to be the most responsive to support being provided and the most likely to reinvest the support provided into additional R&D.

Costs

7.114 The introduction of an intensity threshold in isolation is estimated to deny an R&DTI benefit to those claimants with intensities less than 1 or 2 per cent. Conceptually, the companies falling below the threshold are more likely to be undertaking 'business as usual' R&D than 'additional' R&D. While business as usual R&D is expected to continue without Government support, there may be an overall decline in R&D that would have been conducted in Australia. For example, this measure would impact some businesses for which R&D is complementary rather than central to their core activity - such as manufacturing. In these businesses, while R&D intensity might not be high due to the relatively high level of expenditure on other costs, the introduction of the threshold could reduce their incentive to conduct additional R&D.

7.115 A $2 million refund cap may deter some start-ups from investing in additional R&D and could significantly impact the development of new innovative start-up companies in Australia. The biotech and medical industries would be particularly affected. These industries are generally very R&D intensive, with long term R&D projects that require large amounts of persistent capital and financing. The industry frequently incurs large expenses before any returns on investment are made. There is often a long time between the initial R&D and commercialisation due to the rigorous safety and efficacy testing requirements required for new medications and medical devices. Without a specific exemption, the $2 million cap could force clinical trial activities offshore as the cash refund cap would limit cash flow.

7.116 The collaboration premium may be limited in its ability to effectively increase the level of collaboration. While the collaboration premium would reward companies for collaborating with publicly funded research organisations, factors such as the differing objectives of industry and universities in conducting research and poor mobility between academia and businesses would remain significant inhibitors of collaboration. Further, as with the R&DTI generally, additional support would be offered for collaborative R&D activity already underway at no additional benefit to the taxpayer. A collaboration premium also creates the potential for distortionary impacts and rorting. For example, a company with the internal capability to undertake R&D may choose to outsource the activity simply to receive a higher benefit rate. This would not be an efficient allocation of resources.

Option 2 - Net benefit

7.117 The net result would be lower regulatory costs for the R&DTI, largely driven by changes that effectively exclude companies from accessing the program.

7.118 The intensity threshold precludes a significant number of non-refundable claimants from accessing the R&DTI. As these companies would no longer be required to register their R&D activities or complete the R&D schedule to their tax return, their regulatory burden is reduced.

7.119 The $2 million refund cap proposed by the Review is significantly more restrictive than the $4 million refund cap included in the targeted reforms to the R&DTI (Option 3) and has no exemptions. It would be expected to adversely impact smaller companies with significant, longer term investments in R&D (including biotech, medtech and life science companies). These companies might have to go to significant effort and incur higher costs to secure alternative sources of financial support should they choose to continue their R&D activities in Australia.

7.120 The design elements of the collaboration premium - such as the specific definition of 'collaboration', the eligibility criteria and the claiming process - were not elaborated upon by the Review. While the Review proposes a premium rate for collaborative R&D, those activities are already eligible under the current program arrangements. The regulatory impact would require separating out the related expenses. This is likely to occur already through contract agreements, given intellectual property is being created. As a result, the regulatory impact from the measure is believed to be negligible.

7.121 Regulatory costings for the Review recommendations are lower than the Option 3 reforms as a result of companies being excluded from the program, which reduces registration, record keeping and audit costs for these companies.

7.122 Overall, this option would result in an estimated total average annual regulatory saving for businesses of $12.3 million.

Table 7.8 : Regulatory burden estimate (RBE) table (Option 2)

*Average annual impact (calculated over 10 years).

Option 3: Targeted reforms to the R&DTI (preferred option)

7.123 Under this option, the Government's targeted reforms to the R&DTI would be implemented.

Benefits

7.124 Introducing an R&D Premium for larger claimants would target support towards R&D intensive companies that are the most significant participants in Australia's R&D landscape. R&D intensive companies are considered to be more responsive to fiscal incentives intended to support R&D. Focussing on targeting these companies would therefore better target the program's focus on additionality and spillovers.

7.125 Under the R&D Premium, large companies with lower R&D intensities will have their R&D claims reduced, resulting from the reduction in the level of support for R&D expenditure that is more likely to be business as usual. The level of support will be increased for R&D that is more likely to be additional. The reduced support for business as usual R&D and increased support for additional R&D expenditure is expected to improve the additionality of the program.

7.126 Although companies with low R&D intensities are expected to have some behavioural response to the reduction in their overall support, their response may be quite small. This is because the reduction in support is for R&D expenditure that is more likely to be business as usual - that is, likely to be conducted even in the absence of the program.

7.127 There are a number of distinct benefits of targeting support for larger companies under the program towards those that are more R&D intensive. The Review found that large R&D intensive companies are more likely to:

•

use R&D inputs such as skilled labour and specialised equipment efficiently;

•

partner with other bodies, increasing prospects for spillover benefits; and

•

be undertaking basic research and novel R&D (found to generate greater spillovers).

7.128 The current $100 million expenditure threshold would be increased to $150 million and made a permanent feature of the law. The higher expenditure threshold would encourage large companies to spend more on their R&D in Australia.

7.129 The package of changes to the non-refundable R&DTI is estimated to provide a higher average level of support to approximately 25 companies compared to the existing program. This modelling is based on tax administration data reported for the 2016-17 income year.

7.130 A $4 million cap on cash refunds would sharpen the R&DTI's focus on additional R&D activity by ensuring that government resources are provided to those most in need. The $4 million cap would place a reasonable constraint on the amount of refund provided to a company in a given year. Companies would retain access to the full amount of their R&D offset but, refundable amounts exceeding $4 million would be carried forward as a non refundable tax offset for use in future years.

7.131 To be impacted by the cash refund cap of $4 million, a company needs to spend around $10 million on eligible R&D expenditure in an income year. R&D spending of this size cannot be sustained by tax refunds alone, resulting in the conclusion that these companies have access to alternative sources of finance. As one of the key rationales of the refundable component of the program is to support small, cash constrained SMEs, there is little policy rationale in providing unlimited Government funding to companies capable of obtaining finance through private means. As is the case with most other international jurisdictions offering cash refund for R&D activities (e.g. Denmark, Ireland and Spain), it is reasonable for an upper limit to be placed on the amount of cash benefit a company can receive in an income year.

7.132 The reforms to the refundable tax offset would also include a carve out for clinical trials. This carve out would mean that eligible expenditure incurred on clinical trials would be exempt from the $4 million cap. The carve-out would ensure that support is maintained for critical drug and medical device development.

7.133 Linking R&D offset rates to the company tax rate would address the expected program cost increases resulting from the proposed company tax rate reductions in a manner which avoids the need to amend the tax law in the future. In the absence of linking to company tax rates, the program would need to be amended every time the company tax rate was changed in order to maintain the level of benefit available under the R&DTI. The linking also removes the different levels of support that is caused by the disparity between the turnover thresholds that determine a company's corporate tax rate and its level of support under the R&DTI.

7.134 The ISA Board would have the ability to publish 'general determinations', which would be binding on the ISA Board and pertain to the circumstances in which the Board can exercise its powers or perform its functions or duties in relation to the R&DTI. The broad scope of general determinations would assist in improving the clarity of advice provided to industry claimants, and would provide program participants with clearer guidance about eligibility and other requirements. Practically, this is expected to result in reduced time and money devoted to program registration and dealing with compliance activities. Clearer guidance and eligibility will also result in a reduced need for companies to engage consultants and expert advice when engaging with the program.

7.135 Amending Part IVA of the Income Tax Assessment Act 1936, to include both the refundable and non-refundable R&D tax offsets in the definition of a 'tax benefit' would provide the ATO with the ability to challenge contrived tax arrangements that seek to utilise R&D tax offsets.

Costs

7.136 Around 1,030 (65 per cent) of companies claiming the non-refundable R&D tax offset currently have intensities of 4 per cent or lower, giving these firms access to the lowest R&D Premium. The remaining non-refundable offset recipients (approximately 550) have intensities greater than 4 per cent.

7.137 Some companies receiving the refundable R&D offset would see a reduction in their overall benefit amount as a result of linking to the company's tax rate.

7.138 It is estimated that a $4 million cap would impact the cash refund values of around 20 claimants receiving the refundable offset, taking into account other elements of the package. These registrants would no longer receive a cash refund for amounts in excess of the $4 million cap, however they would be able to carry forward the excess amounts to future financial years as a non-refundable tax offset.

7.139 For companies that are impacted by the cap on cash refunds, those conducting clinical trials would still be able to receive a cash refund above $4 million.

7.140 The linking measure will reduce the level of benefit available to profitable SMEs from 16 per cent to 13.5 per cent. However, this measure is required to reset the level of benefit to that which was available prior to the company tax cuts. Profitable SMEs have in the meantime been the beneficiaries of an unintended windfall arising from this anomaly.

7.141 Unprofitable SMEs will see a reduction in their refundable benefit of 2.5 per cent. This is an acknowledged policy consequence of the linking measure, and provides a consistent level of benefit for both profitable and unprofitable SMEs.

7.142 There are difficulties measuring the responsiveness of R&D expenditure incurred by smaller claimants that would allow an assessment of the likely impact of the measure on the aggregate level of R&D. While the level of benefit is being slightly reduced, the equivalent reduction in company tax rates will have more widespread positive cash flow consequences. Given the two policies will be implemented over a similar period, future analysis is also unlikely to be able to clearly disaggregate the effects of these two policies.

7.143 Given the changes being made to the program, the feedstock, clawback and balancing adjustment rules would need to be amended to ensure they correctly reverse the tax benefit of claiming R&D in situations such as where the R&D activities are funded by other forms of government support or the results of R&D activities are sold. This may result in some transitional costs for taxpayers already claiming under the program.

7.144 It is expected that the regulatory impact of the changes would be moderate. The intensity calculation for companies receiving the non-refundable offset would use information from existing tax return labels. As companies already collect the required information, making an additional calculation would impose limited additional costs. The introduction of the cap on cash refunds is not expected to change the way that companies would register or claim their R&D expenditure, except for those claiming a clinical trials exemption.

7.145 Increased regulatory burdens would largely lie with companies who would benefit under changes in the program. For example, the companies in a position to benefit from the higher expenditure threshold may choose to register additional R&D activities in order to maximise their benefits under the program.

Option 3 - Net benefit

7.146 The net result is that the R&DTI would be more focused towards supporting additional high intensity R&D expenditure, reducing support for activities likely to be business-as-usual and improving the returns to the economy and to taxpayers. The changes help reduce the cost of the program, delivering an estimated gain to the budget of $1.8 billion over the current forward estimates period in fiscal balance terms.

7.147 Under Option 3, the regulatory burden is higher than for Option 2, however this is due to retained access for all non-refundable claimants. These companies would still be able to access a baseline level of support even if their R&D intensity is less than one or two per cent. These lower intensity companies are excluded under Option 2, and so reduce the associated regulatory costs under that option.

7.148 The targeted reforms to the R&DTI would have minimal regulatory impact on program participants and the reforms do not exclude any companies from claiming under the R&DTI. Minor changes would be required to the registration and claims processes as a result of the changes. Record keeping requirements would remain largely unchanged, and information required to calculate a company's intensity (e.g. total expenses) is already available as part of the company tax return process. Accordingly, only a minor increase in compliance costs is expected.

7.149 The potential for companies to establish specific R&D entities for the purpose of accessing the higher R&D intensity benefits was considered during the legislation consultation process. Following stakeholder feedback, it was considered that the risk of this occurring is manageable and the ATO has advised that the anti-avoidance provisions in the tax law, which are being strengthened as part of this legislative package, may apply to such schemes.

7.150 This option would result in an estimated total average annual regulatory cost for businesses of $26.3 million:

Table 7.9 : Regulatory burden estimate (RBE) table (Option 3)

*Average annual impact (calculated over 10 years).

Consultation plan

7.151 There has been significant consultation on the reforms to the R&DTI.

7.152 The first round of public consultation occurred during the Review of the R&DTI in early 2016. To inform their deliberations, the Review Panel conducted a program of targeted consultations with a variety of stakeholders including those from industry, the research sector, and government and tax agents. The Review consultation period began on 13 January 2016 and ended on 18 March 2016.

7.153 The Review was released publicly on 28 September 2016. To inform its response to the Review's recommendations, the Government announced a four week public consultation period, which was undertaken following the public release of the Review report. In addition to written submissions, the then Minister for Industry, Innovation and Science convened a number of roundtables with peak industry bodies, and one-on-one meetings with targeted stakeholders and DIIS conducted multiple stakeholder forums in all states and territories to receive feedback. The written submissions are publicly available on the DIIS website at industry.gov.au.

7.154 Following the Government's announcement of reforms in the context of the 2018-19 Budget, draft legislation was released for public consultation from 29 June to 26 July 2018. In addition to written submissions, consultations included a series of face-to-face meetings with key stakeholders conducted by DIIS in consultation with the Treasury and the ATO. Consistent with the prior consultation processes, some stakeholders objected to the potential reduction of benefits under the proposed changes. However in general, feedback from this process helped refine the legislation with the following stakeholder suggestions being adopted:

•

amending the 'R&D premium' so that it is calculated as a portion of 'total expenses' and not 'total expenditure'. Stakeholders argued this would be easier to comply with as the information is more readily available in their accounting systems;

•

clarified the scope of the clinical trial exemption to remove ambiguity;

•

expanded the new mechanism for working out clawback and feedstock adjustments to include balancing adjustments for R&D assets, meaning a single mechanism is used for adjustments to the amounts of benefit received under the Incentive;

•

excluded clawback amounts from the income tests that apply to early stage investment companies (ESICs), to ensure the Incentive does not inadvertently impact eligibility for other Government programs; and

•

explicitly legislated a minimum 2 year delay for the ATO publishing R&DTI claimant details to help alleviate stakeholder concerns that data published soon after year end could be commercially sensitive in nature.

7.155 Following its introduction to Parliament, the legislation was referred to the Senate Economics Legislation Committee for review. The Committee received 75 written submissions and held three public hearings between 16 November 2018 and 31 January 2019. The Committee released its report on 11 February 2019. Further refinements to the legislation have been made with the recommendations of the report in mind, including a delay to the start date of the legislation to 1 July 2019 and the increased rate and changes to the calculation of the R&D Premium.

7.156 In addition to the above formal consultations, the Minister for Industry, Science and Technology and DIIS and the ATO have continued to engage with stakeholders (for example, through face to face meetings, roundtables and teleconferences), and will continue to do so throughout implementation of the reforms.

Option selection/conclusion

7.157 The preferred policy option is to implement the targeted reforms to the R&DTI (Option 3). Option 3 would better target the R&DTI by inducing greater additionality and spillovers, while improving the integrity of the program. Option 3 addresses the issues raised in the Review and provides a greater incentive to high R&D intensity companies than that recommended by the Review (Option 2). Option 3 implements a larger annual cap on cash refunds and provides a minimum base rate of support for claimants with low R&D intensity.

7.158 Although Option 3 is expected to result in higher regulatory costs, it continues to provide support to companies that would be completely excluded from the program under Option 2. It also addresses the policy concerns with the current program, which would have persisted under Option 1. It is therefore the preferred approach to reform the R&DTI.

Implementation and evaluation/review

7.159 Legislation is required to implement this proposal. The reforms to the R&DTI will apply for income years commencing on or after 1 July 2019. As such, legislation will need to be passed by 30 June 2020 as the measures apply to the 2019-20 year.

7.160 To support R&DTI claimants in understanding their obligations under the reformed program, the ATO and AusIndustry will issue improved guidance products for claimants. This will be augmented by the proposed changes that permit ISA to issue binding public guidance, increasing certainty for claimant's as to what is and is not eligible R&D activity under the R&DTI. Additional resourcing for the regulators is also being used to undertake greater enforcement activity, further improving the integrity of the R&DTI.

7.161 Following the passage of the legislation, the ATO and ISA will continue to undertake their client feedback processes, which assist in identifying opportunities to improve the administration of the R&DTI. Treasury and DIIS will also consider feedback from regulators and stakeholders as to how the reformed R&DTI is operating in practice.

7.162 Following the end of a financial year, there is a 16 month delay before complete registration and taxation data for that years' R&DTI registrants becomes available. This time lag means that analysing companies' behavioural responses to the proposed measures would not be possible for some time (late 2021 at the earliest). This is because a number of years of data from the reformed program would be necessary to perform a useful evaluation of the effects of any changes. Accordingly, any review performed before 2023/24 would be of limited value as the dataset would not cover a sufficient period.

7.163 Evaluations for the R&DTI are performed in consultation with DIIS's internal evaluation unit, and the results are made public at Ministerial discretion.

7.164 As discussed earlier in this document, there are longstanding challenges in evaluating program effectiveness against its objectives of additionality and spillovers. To again quote the CIE:

...there are significant difficulties in measuring additionality and spillovers arising from the R&D TI. This means that a sound quantitative estimate of the overall benefits of the scheme to the economy (or an estimate of the value that the taxpayer receives for their expenditure) will always be subject to considerable uncertainty.

7.165 It is not expected that the reformed program will assist in overcoming these data issues.

7.166 General summaries of Government support provided for business R&D will continue to be published publicly in the annual Science, Research and Innovation Budget Tables. In addition, the reforms to the R&DTI will ensure transparency of the program by publishing the names of companies, and their claim amounts, following a two year delay.

Chapter 8 - Temporary full expensing of depreciating assets

Outline of chapter

8.1 Schedule 7 to the Bill amends the income tax law to allow businesses with an aggregated turnover of less than $5 billion to deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022. Businesses are also able to deduct the full cost of improvements to these assets and to existing eligible depreciating assets made during this period.

8.2 Schedule 7 to the Bill also amends the income tax law to extend the time by which assets that qualify for the enhanced instant asset write-off must be first used or installed ready for use for a taxable purpose until 30 June 2021.

Context of amendments

8.3 The Government is supporting Australian businesses to invest, grow and create more jobs.

8.4 Business investment will support Australia's short-term economic recovery and longer term productive capacity and wage growth.

8.5 The Government is providing a temporary tax incentive to support new investment and deliver significant cash flow benefits to businesses.

8.6 This incentive will be available to around 3.5 million businesses (over 99 per cent of businesses) that employ around 11.5 million workers. It will apply to about $200 billion worth of investment, including 80 per cent of investment in depreciating assets by non-mining businesses.

8.7 From the 2020 budget time until 30 June 2022, businesses with turnover below $5 billion are able to deduct the full cost of eligible depreciating assets of any value in the year they are first held, and first used or installed ready for use for a taxable purpose. The cost of improvements to existing eligible depreciating assets made during this period can also be fully deducted.

8.8 Temporary full expensing supports businesses that invest as it significantly reduces the after-tax cost of eligible assets, providing a cash flow benefit. Temporary full expensing also creates a strong incentive for businesses to bring forward investment before it expires.

8.9 Temporary full expensing builds on the enhanced instant asset write-off and the accelerated depreciation previously announced through the backing business investment incentive.

Summary of new law

8.10 Schedule 7 to the Bill amends the income tax law to allow businesses with an aggregated turnover of less than $5 billion to deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022.

8.11 Businesses are also able to deduct the full cost of improvements to these assets and to existing eligible depreciating assets made during this period.

8.12 Generally, to be eligible for the temporary full expensing incentive, a depreciating asset must be:

•

first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022; and

•

located in Australia and principally used in Australia for the principal purpose of carrying on a business.

8.13 In addition, the depreciating asset must not be:

•

excluded from the uniform capital allowance rules in Division 40 of the ITAA 1997 (such as a building or other capital works); or

•

subject to the capital allowance rules in Subdivision 40-E (about low value and software development pools) or 40-F (about primary production depreciating assets) of the ITAA 1997.

8.14 If the entity has an aggregated turnover of $50 million or more, additional exclusions apply. For these entities, a depreciating asset that starts after the 2020 budget time is excluded from temporary full expensing if:

•

the entity entered into a commitment to hold, construct or use the asset before the 2020 budget time; or

•

the asset is a second hand asset.

8.15 These exclusions are broadly consistent with the backing business investment incentive exclusions.

8.16 Schedule 7 to the Bill also amends the income tax law to extend the time by which assets that qualify for the enhanced instant asset write-off must be first used or installed ready for use for a taxable purpose until 30 June 2021.

8.17 The provisions that prevent small business entities from accessing the simplified depreciation regime for five years if they opt out of the regime continue to be suspended for income years that include 30 June 2021 and 30 June 2022.

Comparison of key features of new law and current law

Detailed explanation of new law

8.18 Schedule 7 to the Bill amends the income tax law to allow businesses with an aggregated turnover of less than $5 billion to deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022.

8.19 Businesses are also able to deduct the full cost of improvements to these assets and to existing eligible depreciating assets made during this period.

8.20 For most entities, temporary full expensing is contained in Subdivision 40-BB of the ITTP Act. However, for small business entities (with an aggregated turnover of less than $10 million) that choose to apply the simplified depreciation rules, temporary full expensing is contained in modifications to those rules made by section 328-181 of the ITTP Act.

Temporary full expensing for entities (other than entities that apply the small business simplified depreciation rules)

8.21 The temporary full expensing rules for entities that do not apply the small business simplified depreciation rules are contained in Subdivision 40-BB of the ITTP Act.

8.22 If Subdivision 40-BB of the ITTP Act applies to work out the decline in value of a depreciating asset held by an entity for an income year, no other provision in the income tax law applies to work out that decline in value. [Schedule 7, item 1, section 40-145 of the ITTP Act]

Entities that qualify for the temporary full expensing

8.23 Temporary full expensing applies to an entity for an income year if the entity carries on a business and has an aggregated turnover of less than $5 billion for an income year. [Schedule 7, item 1, sections 40-155, 40-160 and 40-170 of the ITTP Act]

Assets that qualify for the temporary full expensing

8.24 A depreciating asset held by an entity qualifies for temporary full expensing if:

•

the entity starts to hold the asset at or after the 2020 budget time and on or before 30 June 2022; and

•

the entity starts to use the asset, or have it installed ready for use, for a taxable purpose on or before 30 June 2022.

[Schedule 7, item 1, subsections 40-150(1), 40-160(1) and 40-170(1) of the ITTP Act]

8.25 The term hold in relation to a depreciating asset is defined in section 40-40 of the ITAA 1997. The table in that section sets out when an entity is the holder of a depreciating asset.

8.26 The 2020 budget time is 7.30 pm, by legal time in the Australian Capital Territory, on 6 October 2020. [Schedule 7, item 1, section 40-140 of the ITTP Act]

Certain assets excluded

8.27 A depreciating asset held by an entity does not qualify for temporary full expensing if the asset is excluded from the uniform capital allowance rules in Division 40 of the ITAA 1997 because of section 40-45 of that Act - that is, for example, an asset that is a building or other capital works. [Schedule 7, item 1, subsections 40-150(2), 40-160(1) and 40-170(1) of the ITTP Act]

8.28 In addition, a depreciating asset held by an entity does not qualify for temporary full expensing if, at the time that the asset is first used or installed ready for use for a taxable purpose:

•

it is not reasonable to conclude that the entity will use the asset principally in Australia for the principal purpose of carrying on a business; or

•

it is reasonable to conclude that the asset will never be located in Australia.

[Schedule 7, item 1, subsections 40-150(3), 40-160(1) and 40-170(1) of the ITTP Act]

8.29 Finally, a depreciating asset held by an entity does not qualify for temporary full expensing if:

•

the asset is allocated to a low-value pool, or expenditure on the asset is allocated to a software development pool - the decline in value of these assets is worked out under Subdivision 40-E of the ITAA 1997; or

•

the entity, or another taxpayer, has deducted or can deduct amounts for the asset under Subdivision 40-F of the ITAA 1997 (which applies to primary production depreciating assets).

[Schedule 7, item 1, subsections 40-150(4), 40-160(1) and 40-170(1) of the ITTP Act]

Temporary full expensing for post-2020 Budget assets

Assets that start to be held after 2020 budget time and start to be used for a taxable purpose in the same income year

8.30 If an entity that has an aggregated turnover of less than $5 billion starts to hold an eligible depreciating asset after the 2020 budget time and starts to use the asset, or have it installed ready for use for a taxable purpose, in the same income year, then the decline in value of the asset for the income year is the asset's cost at the end of the income year (disregarding any amount included in the asset's cost after 30 June 2022). [Schedule 7, item 1, subsection 40-160(1) and paragraph 40-160(3)(a) of the ITTP Act]

8.31 In this regard, the asset's cost at the end of the income year is, broadly, the sum of:

•

the cost of the asset (the first element of cost); and

•

the amount paid during the income year to bring the asset to its present condition and location, such as the cost of improvements (the second element of cost).

8.32 Therefore, if an entity starts to hold an eligible depreciating asset, and starts to use the asset or have it installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2021, the entity is able to deduct the full cost (including the second element of cost) of the asset in the 2020-21 income year.

8.33 However, in working out the amount that can be deducted, any amount included in the asset's cost after 30 June 2022 is disregarded.

Assets that start to be held after 2020 budget time and start to be used for a taxable purpose in a later income year

8.34 If an entity that qualifies for temporary full expensing starts to hold an eligible depreciating asset after the 2020 budget time and starts to use the asset, or have it installed ready for use for a taxable purpose, in a later income year, then the decline in value of the asset for that later income year is the sum of:

•

the asset's opening adjustable value for that later income year; and

•

any amount included in the second element of cost in that later income year (disregarding any amount included in the asset's cost after 30 June 2022).

[Schedule 7, item 1, subsection 40-160(1) and paragraph 40-160(3)(b) of the ITTP Act]

8.35 Therefore, if an entity starts to hold an eligible depreciating asset between the 2020 budget time and 30 June 2021 but does not start to use the asset or have it installed ready for use for a taxable purpose until after 1 July 2021, the entity will be able to deduct the full cost (including the second element of cost) of the asset in the 2021-22 income year, less any decline in value in the 2020-21 income year for any non-taxable use in the 2020-21 income year.

8.36 However, in working out the amount that can be deducted, any amount included in the asset's cost after 30 June 2022 is disregarded.

Assets that start to be held after 2020 budget time where a balancing adjustment event happens in the same income year

8.37 If an entity starts to hold an asset after 2020 budget time and a balancing adjustment event happens to the asset in the same income year, the entity cannot deduct the cost of the asset under temporary full expensing. [Schedule 7, item 1, paragraph 40-160(1)(e) of the ITTP Act]

Exclusions for entities with an aggregated turnover of $50 million or more

8.38 If an entity has an aggregated turnover of $50 million or more for an income year, the decline in value of a depreciating asset that is a post-2020 Budget asset is not worked out under section 40-160 of the ITTP Act if:

•

a commitment in relation to the asset was made before the 2020 budget time; or

•

the asset is a second hand asset.

8.39 These exclusions are broadly consistent with the exclusions that apply under the backing business investment incentive.

Commitments already entered into

8.40 An entity cannot deduct the cost of a depreciating asset (including any second element of cost) under the temporary full expensing incentive if, before the 2020 budget time, the entity has already entered into a commitment to incur the cost in relation to the asset - that is, if before that time, the entity (or, in the case of a partnership, the partner) has:

•

entered into a contract under which it would hold the asset;

•

started to construct the asset; or

•

started to hold the asset in some other way.

[Schedule 7, item 1, subsections 40-160(2), 40-165(2), (3), (4) and (6) of the ITTP Act]

8.41 An option to enter into such a contract is not considered to be a commitment because an option does not require an entity (or partner) to, in fact, enter into the contract. [Schedule 7, item 1, subsection 40-165(5) of the ITTP Act]

8.42 If a commitment has already been entered into in relation to a depreciating asset before the 2020 budget time, temporary full expensing applies to allow a full deduction for the second element of cost of the asset that is incurred between the 2020 budget time and 30 June 2022.

Second hand assets

8.43 The cost of a depreciating asset does not qualify for temporary full expensing if the asset is a second hand asset. There are a range of circumstances in which an asset held by an entity is a second hand asset.

8.44 First, a depreciating asset held by an entity (the holding entity) is a second hand asset if another entity held the asset when it was first used, or first installed ready for use (other than as trading stock or merely for the purposes of reasonable testing and trialling). [Schedule 7, item 1, subsections 40-160(2) and paragraph 40-165(7)(a) of the ITTP Act]

8.45 However, if the asset is an intangible asset, this exclusion will not apply unless the asset was used by the other entity for the purpose of producing ordinary income before the holding entity first used it, or had it installed ready for use, for any purpose. For these purposes, any ordinary income derived by the other entity as a result of the disposal of the asset to the holding entity is disregarded). [Schedule 7, item 1, subsection 40-165(9) of the ITTP Act]

8.46 Second, a depreciating asset held by an entity is a second hand asset if the entity started to hold the depreciating asset because the asset was split or merged. [Schedule 7, item 1, subsection 40-160(2) and paragraph 40-165(7)(b) of the ITTP Act]

8.47 Third, a depreciating asset is also a second hand asset if:

•

the asset is a licence or a sub-licence in relation to an intangible asset; and

•

the intangible asset is a second hand asset.

[Schedule 7, item 1, subsections 40-160(2) and 40-165(8) of the ITTP Act]

8.48 Finally, if a depreciating asset is held by an entity that was previously a member of a consolidated group or multiple entry consolidated group, the asset is a second hand asset if the entity started to hold the asset at or after the 2020 budget time. [Schedule 7, item 1, subsection 40-160(2) and paragraph 40-165(7)(c) of the ITTP Act]

8.49 If an asset is a second hand asset, temporary full expensing applies to allow a full deduction for the second element of cost of the asset that is incurred between the 2020 budget time and 30 June 2022.

Temporary full expensing for the second element of cost

8.50 Temporary full expensing allows entities to deduct the full amount of the second element of cost of both post-2020 Budget depreciating assets and existing depreciating assets.

8.51 Therefore, the decline in value of a depreciating asset held by an entity that has an aggregated turnover of less than $5 billion for an income year is worked out under section 40-170 of the ITTP Act if:

•

either:

-

the entity starts to use the asset, or have installed ready for use, for a taxable purpose in the income year; or

-

the entity started to use the asset, or have installed ready for use, for a taxable purpose in an earlier income year;

•

the asset qualifies for temporary full expensing under section 40-150; and

•

the eligible second element of cost for the asset worked out under section 40-175 of the ITTP Act is greater than nil.

[Schedule 7, item 1, subsection 40-170(1) of the ITTP Act]

8.52 However, if a balancing adjustment event happens to the asset in the income year in which the second element of cost is incurred, the entity cannot deduct the second element of cost of the asset under temporary full expensing. [Schedule 7, item 1, paragraph 40-170(1)(e) of the ITTP Act]

8.53 The eligible second element of cost for a depreciating asset for an income year is the sum of any amounts included in the second element of the asset's cost at a time that is in both of the following periods:

•

the income year; and

•

the period between the 2020 budget time and 30 June 2022.

[Schedule 7, item 1, subsection 40-175 of the ITTP Act]

Decline in value otherwise worked out under the enhanced instant asset write-off rules

8.54 If the enhanced instant asset write-off in section 40-82 of the ITAA 1997 would otherwise apply to work out the decline in value of the asset for an income year, the decline in value of the asset for the income year is the sum of:

•

the amount that would be the asset's decline in value for the income year under the enhanced instant asset write-off (assuming that it did not apply to the second element of cost incurred after the 2020 budget time); and

•

the eligible second element of cost for the asset for the income year.

[Schedule 7, item 1, paragraph 40-170(2)(a) and subsection 40-170(3) of the ITTP Act]

8.55 Therefore, in practical terms, if a depreciating asset qualifies for the enhanced instant asset write-off rules for an income year, the decline in value of the asset for the income year is, broadly, the sum of:

•

the decline in value of the asset for the income year worked out under the enhanced instant asset write-off rules disregarding any amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022; and

•

the amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022.

Decline in value otherwise worked out under the backing business investment incentive rules

8.56 If the backing business investment incentive in Subdivision 40-BA of the ITTP Act would otherwise apply to work out the decline in value of the asset for an income year, the decline in value of the asset for the income year is the sum of:

•

the amount that would be the asset's decline in value for the income year under paragraph 40-130(2)(a) or (4)(a) of the ITTP Act in the backing business investment incentive rules, (assuming that those rules did not apply to the second element of cost incurred after the 2020 budget time);

•

the eligible second element of cost for the asset for the income year; and

•

the amount that would be the asset's decline in value for the income year, assuming that the asset's cost was reduced by the amounts worked out under paragraph 40-170(4)(a) and (b) of the ITTP Act (so that no amount is double counted).

[Schedule 7, item 1, paragraph 40-170(2)(b) and subsection 40-170(4) of the ITTP Act]

8.57 Therefore, in practical terms, if a depreciating asset qualifies for the backing business investment incentive for an income year, the decline in value of the asset for the income year is, broadly, the sum of:

•

the decline in value of the asset for the income year worked out under the backing business investment incentive rules disregarding any amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022; and

•

the amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022.

Decline in value otherwise worked out under the uniform capital allowances rules

8.58 If the uniform capital allowances rules in Division 40 of the ITAA 1997 would otherwise apply to work out the decline in value of the asset, the decline in value of the asset for the income year is the sum of:

•

the amount that would be the asset's decline in value for the income year under the uniform capital allowances rules disregarding any amounts included in the eligible second element of cost for the income year; and

•

the eligible second element of cost for the asset for the income year.

[Schedule 7, item 1, paragraph 40-170(2)(c) and subsection 40-170(5) of the ITTP Act]

8.59 Therefore, in practical terms, if the uniform capital allowances rules apply to a depreciating asset for an income year, the decline in value of the asset for the income year is, broadly, the sum of:

•

the decline in value of the asset for the income year worked out under the uniform capital allowances rules disregarding any amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022; and

•

the amount of the second element of cost for the asset which is incurred between the 2020 budget time and 30 June 2022.

Example 8.1 - Amounts incurred before 2020 budget time

J Pty Ltd has an aggregated turnover of $20 million.

J Pty Ltd acquired a depreciating asset for $100,000 on 1 July 2020. It immediately began using the asset for a taxable purpose.

J Pty Ltd carried out some improvements on the asset, incurring costs of $25,000 on 28 September 2020 for these improvements. These costs were included in the asset's second element of cost at that time.

J Pty Ltd is not eligible for temporary full expensing because these costs were incurred before 2020 budget time. However, as J Pty Ltd qualifies for the enhanced instant asset write-off in this period, it can deduct the first and second elements of the asset's cost incurred in this period under those rules.

Example 8.2 - Availability of temporary full expensing

M Pty Ltd has an aggregated turnover of $40 million.

M Pty Ltd acquired a depreciating asset for $50,000 on 30 October 2020. It immediately began using the asset for a taxable purpose.

On 30 March 2021, M Pty Ltd incurred costs of $30,000 to improve the asset. These costs were included in the asset's second element of cost at that time.

M Pty Ltd can deduct the full amount of the first and second element of the asset's cost (that is, $80,000) under temporary full expensing.

As the full amount of the asset's cost is deducted under temporary full expensing, the uniform capital allowance rules in Division 40 of the ITAA 1997 (including the enhanced instant asset write-off) do not apply to work out the asset's decline in value.

Example 8.3 - Exclusion for second hand assets

R Pty Ltd has an aggregated turnover of $600 million.

On 23 December 2020, R Pty Ltd acquired a second hand depreciating asset from another entity for $2 million. R Pty Ltd immediately began using it for a taxable purpose.

On 3 February 2021, R Pty Ltd incurred costs of $1 million to improve the asset (which were included in the asset's second element of cost at that time).

R Pty Ltd cannot deduct the first element of cost of the asset under temporary full expensing because of the exclusion for second hand assets for entities with an aggregated turnover of $50 million or more. However, R Pty Ltd is able to deduct the full amount of the asset's second element of cost ($1 million) under temporary full expensing.

Uniform capital allowance rules apply after 30 June 2022

8.60 Temporary full expensing ceases to apply on 30 June 2022. Therefore, deductions for the decline in value of depreciating assets after that time will be worked out under the uniform capital allowance rules. [Schedule 7, item 1, subsection 40-180(1) of the ITTP Act]

8.61 However, for the purposes of applying the uniform capital allowance rules:

•

if the prime cost method applies to a depreciating asset, the operation of the formula in subsection 40-75(1) is adjusted so that the later year is taken to be a change year; and

•

for the purpose of applying the balancing adjustment provisions in Subdivision 40-D of the ITAA 1997, the decline in value worked out under temporary full expensing is taken to have been worked out under the uniform capital allowance rules.

[Schedule 7, item 1, subsections 40-180(2) and (3) of the ITTP Act]

Temporary full expensing for small business entities that apply the simplified depreciation rules

8.62 Small business entities (with an aggregated turnover of less than $10 million) can choose to apply the simplified depreciation rules in Subdivision 328-D of the ITAA 1997. The simplified depreciation rules are modified by section 328-180 of the ITTP Act. Under those modifications, small business entities can deduct the full cost of a depreciating asset that costs less than $150,000 provided that:

•

the asset is first acquired after 7.30 pm (by legal time in the Australian Capital Territory) on 12 May 2015; and

•

the asset is first used or installed ready for use between 12 March 2020 and 31 December 2020.

8.63 In addition, small businesses entities can deduct the second element of cost, up to $150,000, of assets incurred in the period.

8.64 If a small business entity's general small business pool is less than $150,000 at the end of an income year in this period, the entity can deduct the entire balance of the pool.

8.65 The temporary full expensing rules for small business entities that apply the small business simplified depreciation rules are contained in modifications to the operation of Subdivision 328-D of the ITAA 1997. These modifications apply if, between the 2020 budget time and 30 June 2022, a small business entity that applies the small business simplified depreciation rules:

•

starts to hold an asset; and

•

starts to use the asset, or have it installed ready for use, for a taxable purpose.

8.66 In these circumstances:

•

paragraph 328-180(1)(b) of the ITAA 1997 (which sets a limit on the cost of an asset that qualifies for full expensing) is disregarded;

•

paragraph 328-180(2)(a) of the ITAA 1997 (which sets a limit on the amount of the second element of cost of an asset that qualifies for full expensing) is disregarded;

•

paragraph 328-180(3)(a) of the ITAA 1997 (which allocates an amount of the second element of cost of an asset to the general small business pool) is disregarded; and

•

the words 'less than $1,000' in subsection 328-210(1) of the ITAA 1997 (which place a cap on the value of a small business entity's general small business pool that can be fully deducted) are disregarded.

[Schedule 7, item 4, section 328-181 of the ITTP Act]

8.67 The 2020 budget time is 7.30 pm, by legal time in the Australian Capital Territory, on 6 October 2020. [Schedule 7, item 2, subsection 328-180(1) of the ITTP Act]

8.68 As a result, under temporary full expensing, between the 2020 budget time and 30 June 2022, small business entities that apply the simplified depreciation rules can deduct:

•

the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 Budget time and 30 June 2022;

•

the second element of cost of these assets and of existing eligible depreciating assets incurred during this period; and

•

the balance of their general small business pool.

Adjustments to the enhanced instant asset write-off

8.69 Currently, the enhanced instant asset write-off for small and medium sized business entities applies to a depreciating asset only if an asset is first used or installed ready for use by 31 December 2021. For assets acquired by 31 December 2020, this time is being extended until 30 June 2021. [Schedule 7, items 5 to 8 and 11, section 40-82 of the ITAA 1997 and section 328-180 of the ITTP Act]

8.70 In addition, the provisions that prevent small business entities from accessing the simplified depreciation regime for five years if they opt out of that regime continue to be suspended for income years that include 30 June 2021 and 30 June 2022. [Schedule 7, item 3, paragraph (b) of the definition of 'increased access year in subsection 328-180(1) of the ITTP Act]

Modification to the backing business investment incentive

8.71 The backing business investment incentive exclusion for second hand assets is being modified with effect from the 2020 budget time so that it is consistent with the temporary full expensing exclusion for second hand assets. Therefore, for the purposes of applying the exclusion, a depreciating asset is taken to be a second hand asset if:

•

the asset is a licence or a sub-licence in relation to an intangible asset; and

•

the intangible asset is a second hand asset.

[Schedule 7, items 9 and 10, subsection 40-125(7A) of the ITTP Act]

Consequential amendments

8.72 A consequential amendment is made to the consolidation tax cost setting rules that apply when an entity joins a consolidated group or multiple entry consolidated group. The amendment ensures that, if a joining entity holds a depreciating asset which qualifies for full expensing, the tax cost setting rules apply to the asset in the same way as they apply to a depreciating asset which qualifies for the enhanced instant asset write-off or the backing business investment incentive. [Schedule 7, item 25, subsection 40-125(7A) of the ITAA 1997]

8.73 In addition, minor consequential amendments to the income tax law:

•

update guide material; and

•

insert notes to clarifying the concurrent operation of the existing regimes with the new regime in Subdivision 40-BB.

[Schedule 7, items 12 to 24, 26 and 27, notes to subsections 40-65(1), 40-75(2), 40-82(2A), 40-82(3A), 328-180(1), 328-180(2), 328-180(3), 328-210(1), 328-250(1), 328-250(4) 328-253(4) of the ITAA 1997, notes to subsection 40-120(1) of the ITTP Act]

Application and transitional provisions

8.74 The amendments made to the ITAA 1997 and ITTP Act to give effect to temporary full expensing apply from 7.30pm (by legal time in the Australian Capital Territory) on 6 October 2020.

8.75 The provisions in Schedule 7 to the Bill commence on the first day of the first quarter after Royal Assent. [Section 2 of the Bill]

Chapter 9 - Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Schedule 1 - Accelerating the Personal Income Tax Plan

9.1 Schedule 1 to the Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

9.2 Schedule 1 to the Bill amends the income tax law to:

•

bring forward the legislated changes to remove the existing low income tax offset and replace it with a new low income tax offset so that these changes apply for the 2020-21 income year and later income years;

•

retain the low and middle income tax offset for the 2020-21 income year, with the offset now ceasing to be available in the 2021-22 income year and late income years; and

•

bring forward the changes to the income tax thresholds (currently legislated to apply to the 2022-23 income year and later income years) to the 2020-21 income year and later income years.

9.3 Together, these changes reduce the income tax burden for taxpaying individuals and are intended to support the economic recovery from the impacts of the Coronavirus on the Australian economy by boosting consumption.

Human rights implications

9.4 Schedule 1 to the Bill does not engage any of the applicable rights or freedoms. While the provisions relating to the low income tax offset and the changes to the tax rates and thresholds apply retrospectively, they do so in a way that is wholly beneficial for affected entities.

Conclusion

9.5 Schedule 1 to the Bill is compatible with human rights as it does not raise any human rights issues.

Schedule 2 - Temporary loss carry back

9.6 Schedule 2 to the Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

9.7 Schedule 2 to the Bill amends the income tax law to allow corporate tax entities with an aggregated turnover of less than $5 billion to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

Human rights implications

9.8 Schedule 2 to the Bill does not engage any of the applicable rights or freedoms.

Conclusion

9.9 Schedule 2 to the Bill is compatible with human rights as it does not raise any human rights issues.

Schedule 3 - Increasing the small business entity turnover threshold for certain concessions

9.10 Schedule 3 to the Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

9.11 Schedule 3 to the Bill makes amendments to enable eligible entities with an aggregated turnover threshold of $10 million or more and less than $50 million to access the following small business tax concessions:

•

a simplified accounting method for the purposes of GST, if determined by the Commissioner;

•

the ability to defer excise-equivalent customs duty to a monthly reporting cycle;

•

the ability to defer excise duty to a monthly reporting cycle;

•

a fringe benefits tax exemption in relation to small business car parking;

•

a fringe benefits tax exemption in relation to the provision of multiple work-related portable electronic devices;

•

an immediate deduction for certain prepaid expenses;

•

a two year amendment period in respect of amendments to income tax assessments;

•

an immediate deduction for certain start-up expenses;

•

the simplified trading stock rules; and

•

the ability to calculate their PAYG instalments based on GDP-adjusted notional tax.

Human rights implications

9.12 Schedule 3 to the Bill does not engage any of the applicable rights or freedoms.

Conclusion

9.13 Schedule 3 to the Bill is compatible with human rights as it does not raise any human rights issues.

Schedules 4, 5 and 6 - Enhancing the R&D Tax Incentive

9.14 Schedules 4, 5 and 6 to the Bill are compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

9.15 Schedule 4 to the Bill reforms the R&D Tax Incentive to better target the program, and improve its effectiveness and integrity.

9.16 Schedule 5 to the Bill enhances the integrity of the R&D Tax Incentive by ensuring R&D entities cannot obtain inappropriate tax benefits and by clawing back the benefit of the R&D Tax Incentive to the extent an entity has received another benefit in connection with an R&D activity.

9.17 Schedule 6 to the Bill improves the administrative framework supporting the R&D Tax Incentive by making information about R&D expenditure claims transparent, enhancing the guidance framework to provide certainty to applicants and streamlining administrative processes.

Human rights implications

9.18 Schedules 4, 5 and 6 to the Bill do not engage any of the applicable rights or freedoms.

Conclusion

9.19 Schedules 4, 5 and 6 to the Bill are compatible with human rights as they do not raise any human rights issues.

Schedule 7 - Temporary full expensing for depreciating assets

9.20 Schedule 7 to the Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

9.21 Schedule 7 to the Bill amends the income tax law to allow businesses with an aggregated turnover of less than $5 billion to deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the 2020 budget time and 30 June 2022. Businesses are also able to deduct the full cost of improvements to these assets and to existing eligible depreciating assets made during this period.

9.22 Schedule 7 to the Bill also amends the income tax law to extend the time by which assets that qualify for the enhanced instant asset write-off must be first used or installed ready for use for a taxable purpose until 30 June 2021.

Human rights implications

9.23 Schedule 7 to the Bill does not engage any of the applicable rights or freedoms.

Conclusion

9.24 Schedule 7 to the Bill is compatible with human rights as it does not raise any human rights issues.