Guide to the R & D Tax Concession - Part C

C1 Overview of R&D tax concession

This document has been archived. It is current only to 30 June 2011.

C1-1 Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

C1-2 Self-assessment

Australia's tax system works on self-assessment. This means that you must show all your assessable income and claim only deductions and offsets to which you are entitled on your annual income tax return. The essence of self-assessment is that the details put on your tax return are usually accepted without query prior to an assessment issuing. However, though we may initially accept your tax return, we can later ask you to provide the records and information you used to complete your tax return.

You are responsible for proving the claims you have made in your company tax return and research and development tax concession schedule and your company records will be critical in substantiating your claims. When you sign your return you are taking responsibility for the claims you are making. We assume that you have completed your tax return in good faith. If you are aware that your return is incorrect, you must contact the Tax Office as soon as possible to correct the error.

C1-3 Australian Taxation Office taxpayers' charter

The Innovation Segment follows the service standards set out in our taxpayers' charter. For example:

If you request a private ruling or write to us about a matter:

We will give you a ruling within 28 days of receiving all necessary information from you. If required, we will request further information within 14 days. If we cannot meet the 28 day standard, for example, because of the complexity of the matter, we will discuss another arrangement within 14 days of receipt of the information and agree a reply date.

Full details of the charter are available on our website www.ato.gov.au

C1-4 What's New

The government announced in the 2009-10 Budget that it will replace the existing R&D Tax Concession with a new R&D Tax Credit. The R&D Tax Credit is intended to come into effect from 1 July 2010.

On 18 December 2009 the Treasury released The New Research and Development Tax Incentive - Exposure Draft Legislation and Explanatory Materials which stated that:

The new R&D tax incentive provides eligible entities with a tax offset for expenditure on eligible R&D activities and for the decline in value of depreciating assets used for eligible R&D activities. The new R&D tax incentive replaces the existing R&D Tax Concession for all income years commencing on or after 1 July 2010.

An interim measure, prior to the introduction of the proposed The New Research and Development Tax Incentive, increases the expenditure cap for eligibility to the R&D tax offset for the 2009-10 financial year from $1 million to $2 million. (Tax Laws Amendment (2009 Measures No. 4) Act 2009).

Information on the Government's announcement of the R&D Tax Credit is available at the Minister for Innovation, Industry, Science & Research's website www.minister.innovation.gov.au.

Information on the Government's Innovation Agenda, Powering Ideas - An Innovative Agenda for the 21st Century, is available at the Department's website www.innovation.gov.au.

C1-5 Taxation rulings

Providing advice is central to the role of the Tax Office. We offer you help and support in the self assessment system for lodging tax returns and assessing income tax liability. We provide many forms of written advice about the laws administered by the Commissioner. These different forms provide different levels of protection in terms of penalties, interest or primary liability, depending on the extent to which the advice relates to your specific circumstances. Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office sets out in detail the different forms of advice that the Tax Office provides, the circumstances in which such advice can be provided and the extent to which you can rely on it.

The key forms of advice that are relevant in this context are:

• public taxation rulings which issued prior to 1 July 1992
• public taxation rulings which issued after 1 July 1992 (including product rulings and class rulings)
• private rulings under Part IVAA of the Taxation Administration Act 1953 , and
• written general advice.

C1.5.1 Taxation rulings issued prior to 1 July 1992

These rulings are represented by the numbering series prefixed with IT. . They provide considerable guidance but are not legally binding on the Commissioner. However, the Tax Office will stand by what is said in these rulings and not depart from them unless:

• there have been legislative changes since the ruling issued
• a Tribunal or Court decision has affected the interpretation of the law since the ruling issued, or
• for other reasons, the approach adopted in the ruling is no longer considered appropriate.

The Tax Office has released four taxation rulings of particular relevance to the R&D tax concession.

Taxation Ruling IT 2442 - Concession for eligible research and development expenditure

This ruling was issued on 13 August 1987 and provides general information. This ruling was withdrawn on 6 August 2008.

Taxation Ruling IT 2451 - Investor funding of research and development activities

This ruling was issued on 26 November 1987 and discusses general issues relating to investment in R&D projects and collaborative arrangements. In particular it covers the issue of 'on own behalf'. This ruling was withdrawn on 6 August 2008.

Taxation Ruling IT 2552 and addendum - Research and development (R&D) - costing of expenditure

This ruling was issued on 17 August 1989 and provides detailed guidance on the calculation of expenditure incurred on eligible research and development. This ruling was withdrawn on 6 August 2008.

Appendix A - R&D conducted within the Administration Division

Appendix B - General accounts

Appendix C - R&D conducted by a separate cost centre

Appendix D - Factory rate

Appendix E - Common questions and answers

As a result of legislative changes some of the guidance contained in the above withdrawn rulings is no longer current.

Material which is current is now included in Part C of this Guide. The withdrawal of the rulings does not mean that the views expressed in them have changed.

The rulings continue to apply to arrangements that commenced before the withdrawal except for those parts of the rulings superseded by legislative change prior to the withdrawal. The withdrawn rulings do not apply to arrangements carried out after the withdrawal.

Where a public ruling issues on a matter and is less favourable than previous administrative practice, the new ruling applies only in relation to schemes that started after the publication date of the ruling (section 358-10 of Schedule 1 to the Taxation Administration Act 1953).

Taxation Ruling IT 2635 and addendum - Risk provisions and syndicated R&D

This ruling was issued on 9 May 1991 and discusses the following issues:

• syndication structures
• the fundamental element of risk
• guaranteed returns
• recoupments and grants
• forgiven debt
• limited-recourse or non-recourse debt
• early termination
• application of the general anti-avoidance provisions (Part IVA of the ITAA 1936)
• special accounts
• core technology
• management fees
• deduction rate for finance costs.

C1.5.2 Taxation rulings issued on or after 1 July 1992

These rulings set out the Commissioner's considered view on the way in which a tax law applies to a person or a class of persons in relation to an arrangement or class of arrangements that commenced on or after 1 July 1992. These rulings are represented by the numbering series TR YYYY/XX (for example TR 2001/1). A public ruling is binding on the Commissioner if it applies to a person and the person relies on the ruling by acting (or omitting to act) in accordance with the ruling. However, the Commissioner may apply a relevant provision in a way that it would apply if a person had not relied on a ruling if doing so would produce a more favourable result for that person. No time limit applies to prevent this. Refer to sections 357-60 to 357-70 of Schedule 1 to the Taxation Administration Act 1953.

The Commissioner has established a public rulings panel, which includes eminent tax experts, to ensure the quality of public rulings.

At the Tax Office we also release draft taxation rulings, which represent our preliminary, though considered views. They are generally issued before a final taxation ruling. Taxpayers and practitioners must not rely on these draft rulings. Only final taxation rulings represent authoritative statements by the Tax Office.

The Tax Office has released the following taxation rulings of particular relevance to the R&D tax concession. Extracts from these rulings have been included in this Guide and are identified as follows:

Taxation Ruling TR 2002/1: R&D plant expenditure

This ruling was issued in January 2002 and discusses the treatment of expenditure on plant (acquired or commenced to be constructed) prior to midday 29 January 2001 ('pre-29 January 2001 plant').

Note: although this ruling applies to 'pre-29 January plant' many of the concepts discussed in the ruling continue to be relevant in determining the application of the asset depreciation rules to plant/depreciating assets acquired or constructed under contracts entered into after 29 January 2001 and used in carrying on R&D activities. See for example, paragraphs 24 - 28 and 81 - 86 of TR 2002/1 - What is a prototype and can it be an item of plant?

Taxation Ruling TR 2002/6: Income tax: simplified tax system: eligibility - grouping rules (*STS affiliate, control of non fixed trusts)

This ruling deals with aspects of the former simplified tax system (STS) grouping rules (in particular, the 'affiliate' test) contained in subdivision 328-F of the ITAA 1997 (repealed by the Tax Laws Amendment (Small Business) Act 2007). However, this ruling provides useful guidance in relation to the R&D grouping rules.

Taxation Ruling TR 2002/11: Income tax: simplified tax system eligibility - STS average turnover

This ruling considers the definition of STS average turnover contained in subdivision 328-F of the ITAA 1997 (repealed by the Tax Laws Amendment (Small Business) Act 2007). Although this definition has been repealed, this ruling provides useful guidance in relation to 'R&D group turnover'.

C1.5.3 Product rulings and class rulings

These rulings are public rulings.

Product rulings enable the Commissioner to rule publicly on the availability of claimed tax benefits from an arrangement in which a number of persons individually enter into substantially the same transactions with a common entity or group of entities.

Class rulings enable the Commissioner to provide legally binding advice in response to a request from an entity seeking advice about the application of a tax law to a large number of persons in relation to a particular arrangement. This can obviate the need for a private ruling to be sought by or on behalf of every person who may be affected under the arrangement.

C1.5.4 Private rulings under Part 5-5 of the Taxation Administration Act 1953

You, your agent or your legal representative may apply for a private ruling on the way in which the Commissioner considers a relevant provision applies, or would apply, in relation to a specified scheme. These rulings differ from public rulings in that they are specific to a particular entity. Private rulings are legally binding on the Commissioner of Taxation. If the entity (rulee) chooses to rely on the ruling, we must apply the law in the way set out in the ruling (or in a way that is more favourable if we are satisfied that the ruling is incorrect and disadvantages the entity (rulee), and we are not prevented from doing so by a time limit imposed by the law). The protection is subject to two conditions: (1) the entity must supply all material facts to the Commissioner, and (2) the scheme entered into must reflect the scheme described in the private ruling. Entities who obtain and apply private rulings are protected against primary tax, shortfall penalty and interest should the ruling decision prove to be incorrect.

An ATO Interpretative Decision (ATO ID) is an edited and summarised version of a documented decision on an interpretative issue about the application of law administered by the Commissioner. ATO IDs may be based on decisions on interpretative issues arising from private rulings. In preparing an ATO ID we take care to ensure that we do not identify taxpayers, or disclose confidential information. These ATO IDs are available from the ATO legal database on the ATO website at www.ato.gov.au. Where appropriate, we refer to ATO IDs in this Guide.

See, Taxation Administration Act 1953, Schedule 1, Division 357

Taxation Ruling TR 2006/11 outlines the system of private rulings following the enactment of the Tax Laws Amendment (Improvements to Self Assessment) Act (No. 2) 2005. In respect of private rulings, that Act inserted new Divisions 357 (common rules) and 359 (private rulings) into Schedule 1 to the Taxation Administration Act 1953 (TAA) . You may object against a private ruling which applies to you if you are dissatisfied with it. However there are two instances where a private ruling may not be objected against:

• where an assessment has been made in respect of the year of income or accounting period covered by the private ruling. In this situation you can have the matter dealt with in the private ruling reviewed by lodging an objection against the relevant assessment or amended assessment; and
• where the private ruling relates to withholding tax or mining withholding tax that has become due and payable.

If the objection is disallowed to any extent you may have the objection decision considered by the Federal Court or the Administrative Appeals Tribunal.

C1.5.5 ATO interpretative decisions

An ATO interpretative decision (ATO ID) is an edited and summarised version of a decision on an interpretative issue about the application of law that is administered by the Commissioner. A current ATO ID sets out our viewpoint on an interpretative issue.

See, Practice Statement PS LA 2001/8.

ATO IDs are publications approved in writing by the Commissioner and may explain a general administrative practice. Accordingly, they may provide a level of protection from shortfall penalties and interest to taxpayers who rely on them.

If you rely on a current ATO ID where your own circumstances are not materially different from those described in the ATO ID, but the ATO ID is later found to be incorrect, you will be liable for any underpaid tax, (or any over-claimed credit, grant or benefit), unless a time limit imposed by the law precludes the liability. However, you will be protected against any shortfall penalty that would otherwise be imposed. In addition, if you rely reasonably in good faith on an ATO ID, you will be protected against interest charges on the shortfall up until 21 days after the Commissioner notifies you of the shortfall.

If you want certainty about the application of a tax law to your specific circumstances you should request a private ruling.

See, Practice Statements PS LA 2001/8, and PS LA 2003/3.

ATO ID references have been included in this Guide and are identified as follows:

For further information see: ATO Interpretative Decision ATO ID 2004/345 Research and development Tax Offset and Franking Accounts: companies in loss Does a refund of a research and development tax offset generate a franking debit under section 205-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

C1-6 Claiming the R&D tax concession

You can claim the R&D tax concession by completing the relevant boxes on your company tax return and Research and development tax concession schedule.

C1.6.1 Research and development tax concession schedule

In 2002 the Tax Office introduced a Research and development tax concession schedule to assist companies to comply with the legislative and administrative requirements for claiming deductions for R&D expenditure in their income tax returns. Detailed instructions accompany the schedule.

The R&D schedule must be completed by eligible companies which:

• have registered their research and development activities with Innovation Australia (the Board), through AusIndustry, for the income year ended 30 June 2002 and subsequent years, and
• are making a claim in their income tax returns in respect of these activities under the research and development tax concession (sections 73B to 73Y of the ITAA 1936).

The R&D schedule must be lodged with the Tax Office at the same time as the company tax return, or the relevant amendment request, in which the research and development tax concession claim is made. An automated Excel version of the R&D schedule is available and can assist with calculating a claim for the R&D tax concession. The Excel version of the R&D schedule is available from the ATO website at www.ato.gov.au/randd.

Electronic lodgement

For the 2003 and subsequent years, selected software packages now facilitate ELS (electronic lodgement system) lodgement of the R&D schedule with the company tax return.

For the 2004 and subsequent years, the R&D schedule must be lodged electronically with the Tax Office at the same time as the company tax return.

If you have requested an amendment

If your company has made a request for an amendment that includes changes to its R&D claim, you must complete an R&D schedule showing the amended figures. Send this schedule, with a letter requesting the amendment to:

Australian Taxation Office

GPO Box 5056

Sydney NSW 2001

C1-7 Record Keeping Requirements

Companies should substantiate their claims for the R&D Tax Concession. It is open to a company however, to demonstrate to the Commissioner that their basis for calculating an R&D deduction or tax offset produces, as far as practicable, accurate claims consistent with the law and its interpretation. A claim for R&D expenditure which cannot be substantiated by reference to reliable source documents cannot be allowed.

Companies intending to claim the R&D Tax Concession should maintain adequate contemporaneous records which substantiate the carrying on of the claimed R&D activities and the incurring of expenditure in relation to those activities. The types of records that are relevant are those records normally maintained to support tax expenditure claims and those that monitor the technical progress of the research and development.

Record keeping for tax purposes

Under tax law records must be kept:

• that specify and explain all transactions. This includes any documents that are relevant for the purpose of working out the company's tax liabilities. Companies should make records of transactions as soon as they occur or as soon as possible afterwards
• relating to all taxes for which this company is liable. This may include income tax, goods and services tax, pay as you go taxes, capital gains tax, and fringe benefits tax
• relating to any election, choice, determination or calculation made under a tax law, including the basis on which any were made.

These records must generally be kept for a minimum of five years. However, as the Commissioner for Taxation can amend assessments at any time to increase the liability of a taxpayer for the purposes of the R&D tax concession companies may want to keep their research and development records for longer.

How should records be kept?

Companies must keep all relevant tax records in English or in a form readily accessible and easily convertible into English. Records can be kept in any way that enables companies to meet their tax obligations and receive entitlements, whether this is on paper or in electronic form.

Penalties are imposed for not keeping proper records

The tax law imposes a penalty if proper records are not kept. The penalty amount is currently $2,200. Penalties may be remitted (partially or fully) if companies are trying to do the right thing. However, if no attempt is made to keep records or they are deliberately destroyed, companies will be unlikely to receive any remission of the penalty.

If proper records are not kept, even after the Tax Office has provided advice about record keeping and given the company an opportunity to improve their record keeping behaviour, the Tax Office will apply penalties as set out in the following table.

Record keeping behaviour	Remission level	Penalty amount
Genuine attempt made to improve record keeping practices	100% remission	$0
Some effort made but tax liability still not readily ascertainable	75%	$550
Very little effort made to improve record keeping practices	50%	$1,100
No effort made to improve record keeping practices	No remission	$2,200

Serious cases of non-compliance can be referred to the Director of Public Prosecution which may result in a fine of up to $10,000.

See Practice Statement PS LA 2005/2

Records for the R&D tax concession

A company will also need to be able to show that time has been spent on the research and development activities, in respect of which it is claiming an R&D deduction or tax offset.

A company's ordinary business records must be sufficient to verify the amount of the expenditure incurred on R&D activities, the nature of activities which are claimed to be R&D activities and the relationship of the expenditure to the activities. A company will also need to retain documentation such as reports detailing R&D activities carried on and details of whether the R&D activities were carried on by staff or contracted to another person and the nature of any such an arrangements.

A company should maintain documentation to support the apportionment of expenditure between research and development activities and other activities. It is the company's responsibility to satisfy the Tax Office of the accuracy of the method used to allocate expenditure between R&D and non-R&D activities. For example, to calculate salary expenditure that is deductible under subsection 73B(14) of the ITAA 1936, the most accurate methods of allocating time are to maintain timesheets or job cards. The more a company strays from this, the greater is the onus on the company to show that the allocation of time is accurate. The company must be able to satisfy an auditor of the accuracy of the system used, whether it is timesheets, job cards or another method. Substantiation of time spent on eligible R&D activities is required in respect of those R&D employees who carry out the R&D project (that is the researchers and technicians). These employees may need to demonstrate the time spent on R&D activities, as well as on non-R&D activities. No timesheets need to be retained for R&D substantiation purposes in respect of employees not engaged in carrying out R&D activities, even if a portion of their salaries may be allocated to R&D as a component of other expenditure.

If R&D is undertaken by a contractor, we would expect that invoices contain certain details. In addition to the invoice containing the date, ABN of the contractor and other information required to be included on a tax invoices for GST purposes, if applicable (as specified in section 29-70 of the A New Tax System (Goods and Services Tax) Act 1999 and Regulation 29-70.01 of A New Tax System (Goods and Services Tax) Regulations) 1999, we would also expect that invoices should contain the following details for R&D substantiation purposes:

• Sufficient detail to ascertain the amount of eligible R&D expenditure
• A description of the activities performed by the contractor in order to link the fee with a particular R&D project (or this information may be provided in the contract of performance or in the research report prepared by the contractor).

Documentation should also be sufficient to enable a determination to be made of whether the particular activities undertaken by a company, or by some other person on its behalf, are qualifying R&D activities for the purpose of section 73B of the ITAA 1936. That determination would, in appropriate cases, be made by the Board as a result of a request made by the Commissioner under subsection 73B(34) of the ITAA 1936.

A company can be denied deductions if it fails to register with the Board. The Tax Office will ask for evidence of registration. The Tax Office may also ask detailed questions about a research and development activity. For example:

• which activity is claimed to be research and development?
• who identified the activity as research and development, and was that person qualified?
• were other inquiries made before the person decided that the activity was research and development?
• what professional advice was obtained?
• what was done to verify that the activity was innovative? Were checks made to ensure that the innovation or product was not available elsewhere?
• were the Board guidelines on eligibility referred to?
• are there technical risks involved in the activity?
• how is the activity being managed?
• is there a dedicated research and development department?
• are separate cost centres keeping account of research and development expenditure?

If the records can answer such questions, then they are likely to be adequate.

For more information about what types of records taxpayers need to keep in relation to income tax and other taxes, refer to Taxation Ruling TR 96/7 Income tax: record keeping - section 262A - general principles and Taxation Ruling TR 2005/9 Income tax: record keeping - electronic records.

C1-8 Goods and services tax (GST) implications

From 1 July 1999, some eligible companies may have acquired goods or services in circumstances where they have an entitlement under the GST Act, to claim a credit in relation to the GST imposed in relation to that acquisition. This credit is known as an 'input tax credit'. An eligible company that is not registered under the GST Act will have no entitlement to claim any input tax credit.

However, where a company is entitled to claim input tax credits, Division 27 of the ITAA 1997, provides that when calculating an income tax deduction (including R&D deductions), the amount equal to the input tax credit is excluded. Therefore, an eligible company whose R&D expenditure includes any input tax credits they are entitled to claim, will exclude these amounts when calculating their income tax deduction.

Example 1.1

Wingding Pty Ltd intends to claim the R&D tax concession for the 2001-02 year of income and has incurred the following expenditure:

Research and development expenditure: $33,000 (includes $3,000 GST)

If Wingding is registered for GST:

Since Wingding is entitled to claim an input tax credit for the GST, it must exclude GST when claiming a deduction. Therefore its total expenditure for the calculation of the R&D tax concession is exclusive of GST:

Expenditure	$33,000
Less input tax credit	$3,000
	$30,000
Additional R&D tax concession component ($30,000 x 25%)	$7,500
R&D deduction	$37,500

If Wingding is not registered for GST:

Since Wingding is not entitled to claim an input tax credit for the GST it will include GST when claiming a deduction and, therefore, its total expenditure for the calculation of the R&D tax concession is inclusive of GST:

Expenditure (includes GST $3,000)	$33,000
Additional R&D tax concession component (33,000 x 25%)	$8,250
R&D deduction	$41,250

Grants and GST

The Tax Office has released a public ruling (GSTR 2000/11) which details the application of GST to grants of financial assistance. The ruling applies to grants made by the private and public sectors and details the circumstances when GST will apply to grants. This will depend on whether the grant represents consideration with a relevant connection to a taxable supply.

C2 Research and development deduction

This document has been archived. It is current only to 30 June 2011.

This section generally does not apply to the deduction available under subsection 73B(14C) of the ITAA 1936.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written general advice, as referred to in Practice Statement PS LA 2001/4, issued by the Commissioner of Taxation. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this general advice applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written general advice and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written general advice is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2008

This work is copyright. You may download, display, print and reproduce this material in unaltered form only (retaining this notice) for your personal, non-commercial use or use within your organisation. Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved. Requests and inquiries concerning reproduction and rights should be addressed to Commonwealth Copyright Administration, Attorney General's Department, Robert Garran Offices, National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

C2-1 Eligibility

Before claiming the concession, in addition to meeting the requirements particular to the deduction in question, companies must also satisfy themselves that:

• they are registered for that year of income by Innovation Australia (the Board (see Part B-2 Registration by the Board);
• they meet the threshold expenditure test, where applicable; and
• they have incurred expenditure in relation to R&D carried on by them, or on their behalf, and not for the purpose of R&D undertaken on behalf of any other person.

Eligibility for the concession can also be affected by any certificates issued by the Board regarding activities undertaken.

C2.1.1 Expenditure threshold

In order to claim the concession, an applicant must spend over $20,000 in a year of income, unless the R&D is contracted to a Registered Research Agency (RRA). The $20,000 is calculated from the aggregate research and development amount and does not include any 25% concessional component. The $20,000 includes:

• R&D expenditure, which includes salary, contract expenditure to RRAs, and other expenditure (including eligible feedstock expenditure), and excluding residual feedstock expenditure
• the amount of core technology expenditure deductible under subsection 73B(12A) of the ITAA 1936 in the year of income
• one-third of total qualifying plant expenditure in respect of expenditure incurred on plant acquired or commenced to be constructed before 29 January 2001
• the amount of any notional Division 42 or 40 of the ITAA 1997 amount in any year of income, being the depreciation amounts allowable to the company in respect of any plant or depreciating asset used in carrying on R&D activities, where the plant or asset was acquired or constructed after 29 January 2001
• the amount of any deduction allowable under Division 10D (ITAA 1936) or Division 43 (ITAA 1997), because of the use by the company of a building for the purpose of carrying on research and development activities, and
• interest expenditure.

Your aggregate research and development amount may also include expenditure on foreign owned R&D. (see Part C3 Deduction for expenditure on foreign owned R&D).

The aggregate research and development amount does not include expenditure on overseas research and development activities that is not certified expenditure.

Note: If the company has contracted a Registered Research Agency to carry out R&D on its behalf, the expenditure threshold for claiming the concession does not apply.

For further information see: ATO Interpretative Decision ATO ID 2005/358 Research and Development: 'Aggregate research and development amount' where core technology expenditure not deducted Where an eligible company chooses not to deduct an amount of core technology expenditure under subsection 73B(12A) of the Income Tax Assessment Act 1936 (ITAA 1936) , is the amount included in the company's 'aggregate research and development amount' as defined in subsection 73B(1) of the ITAA 1936?

C2.1.2 Eligibility of entities - on own behalf

Amongst other requirements, it is generally the case that an eligible company cannot claim a deduction for its expenditure under the R&D tax concession unless that expenditure is incurred in respect of R&D activities carried out by or on behalf of that eligible company. This requirement is set out in various provisions of the ITAA 1936, including the definitions of certain expenditure which may be deducted under the concession (see subsection 73B(1) of the ITAA 1936). In addition, under subsection 73B(9) of the ITAA 1936, an eligible company generally cannot claim a deduction at the concessional rate in respect of expenditure incurred for the purpose of carrying on R&D activities on behalf of any other person.

For further details regarding 'on own behalf' see Part C2-2.

C2.1.3 Certificates issued by the Board

As the R&D Tax Concession is jointly administered by the Board (supported by AusIndustry) and the Tax Office, certain determinations made by the Board can impact on whether or not an eligible company can claim a deduction for expenditure on research and development activities. The Board notifies the Commissioner of determinations it has made by issuing certificates.

Certificates that are binding on the Commissioner

Certain certificates issued by the Board are binding on the Commissioner for the purpose of making assessments of an eligible company's taxable income in relevant years of income. These certificates include those issued under the following provisions of the IR&D Act:

• Section 39L - Certificate as to R&D activities;
• Section 39ED - Provisional certificate regarding eligible overseas R&D;
• Section 39LA - Certificate as to core technology.

If a certificate is issued by the Board under section 39L of the IR&D Act, which indicates that activities conducted by an eligible company are not eligible R&D activities as defined in subsection 73B(1) of the ITAA 1936 in a particular year of income, the certificate is binding on the Commissioner for the purpose of making an assessment in that year. The company will not be entitled to a deduction under section 73B (and related provisions), in relation to these activities, unless the certificate is revoked or overturned on review or appeal.

Other certificates

Subsection 73B(33) of the ITAA 1936 prevents an eligible company from claiming a deduction under section 73B of the ITAA 1936 for expenditure incurred in respect of R&D activities if the Board gives a certificate to the Commissioner regarding those activities under section 39M or section 39MA of the IR&D Act. Circumstances in which certificates may be issued under section 39M of the IR&D Act include those in which results of R&D activities have been exploited otherwise than on normal commercial terms or if R&D activities do not have adequate Australian content. Certificates can be issued under section 39MA of the IR&D Act if it is determined that there was or is an ineligible finance scheme in relation to research and development activities.

In accordance with subsection 73B(33A) of the ITAA 1936, if the Commissioner receives a certificate from the Board stating that a company has failed to comply with a notice issued under section 39N of the IR&D Act in respect of particular activities, a deduction is also denied for expenditure incurred by that company in respect of those activities under section 73B of the ITAA 1936.

C2.1.4 Partnerships and joint ventures

Subsections 73B(3A) and (3B) of the ITAA 1936 permit eligible companies which are conducting R&D activities together, in a way where mutual rights and obligations exist between them, to claim deductions under the R&D concession. Subsection 73B(3A) applies to expenditure incurred by a partnership in which at least one partner was an eligible company and either each other company is an eligible company/registered research agency or the partnership was designated as a Co-operative Research Centre under the Co-operative

Research Centre Program. Where these provisions apply, each 'partner' is taken to have incurred so much of the R&D expenditure as was incurred out of money contributed by the partner (otherwise than by way of loan). Where the contribution is money's worth (for example an employee's time or plant used in the R&D activities), that contribution should be valued and this value will also constitute money contributed by the partner company for these purposes.

Where there is a partnership, subsection 73B(9A) of the ITAA 1936 provides that subsection 73B(9) of the ITAA 1936 does not apply in relation to expenditure incurred on behalf of a partnership by a partner in their capacity as a partner.

For further information see: ATO Interpretative Decision ATO ID 2006/74 Research and Development: subsection 73B(3B) - partnership Is there a 'partnership' under subsection 73B(3B) of the Income Tax Assessment Act 1936 (ITAA 1936), where two companies collaborate to conduct research and development activities, and to engage the services of a third to conduct some of these activities on their behalf?

In circumstances in which companies form a joint venture rather than a partnership, subsection 73B(9) of the ITAA 1936 will need to be considered. See Part 2-2 for further details.

Agency relationships

In some circumstances an agent may collect contributions from eligible companies and enter into contracts on their behalf for the performance of R&D activities. This could occur in joint venture arrangements. From the fund of contributions the agent will make payments as required by the contracts as they fall due. The question is whether the funding companies are entitled to deductions under section 73B of the ITAA 1936 for their contributions to the agent.

Funding companies cannot obtain deductions under section 73B of the ITAA 1936 for making such contributions. Deductions under section 73B of the ITAA 1936 (or related provisions) may be available when the companies incur expenditure through, not to, their agent. Expenditure through an agent may be expenditure met by the agent from the fund of contributions.

C2.1.5 Voluntary contributions or levy payments and the R&D tax concession

In recent years, a number of companies have sought to claim expenditure incurred to an industry group under the R&D tax concession, without fully understanding all the criteria that must be satisfied in order to qualify for the concession. The key issues that need to be considered before claiming voluntary contributions or levy payments under the R&D tax concession are listed below:

• each industry member who applies for the concession must be an eligible company and must register with the Board annually;
• each eligible company must have an aggregate R&D amount of $20,000 or more to qualify for the R&D tax concession, unless the R&D is contracted to a Registered Research Agency (RRA);
• the voluntary contributions or levy payments may only be claimed to the extent that they relate to expenditure on eligible R&D activities; and
• the R&D expenditure being claimed must be undertaken on behalf of the company claiming the concession. This issue can be very complex in relation to voluntary contributions and levy payments made to industry associations. Companies making these payments are urged to approach the Tax Office, which is responsible for the administration of expenditure issues, to discuss this requirement.

Registration

The registration requirements under section 39J of the IR&D Act apply to each company seeking to claim the R&D tax concession. Each individual member of the industry group that is eligible to register must apply for registration annually to be eligible to claim the R&D tax concession. The application requires you to specify R&D expenditure and detail the R&D activities. From the 2002 financial year onwards, companies are required to prepare and hold R&D plans covering all projects they commence.

Claiming the concession

In order to be eligible to claim the R&D tax concession, a company must spend over $20,000 in a year of income unless the R&D is contracted to a Registered Research Agency (RRA). The $20,000 is calculated according to the definition of the aggregate research and development amount and does not include the 125% multiplier. The only exception to this rule is that if the R&D activities are contracted to a Registered Research Agency then the $20,000 threshold does not apply (see Part C2.1.1 - Expenditure threshold).

A key issue for eligible companies who make voluntary contributions or levy payments is the requirement of subsection 73B(9) of the ITAA 1936 (see Part C2-2 On own behalf ). This requires that the research and development activities must be undertaken on behalf of the claimant company. As R&D activities funded from voluntary contributions or levy payments are invariably contracted out to another party, it is necessary for the member companies to show that they:

• bear the financial risk associated with the R&D
• have control over the R&D projects/activities, and
• effectively own the project results.

In addition, the voluntary contributions or levies can only be claimed under the R&D tax concession to the extent that they relate to expenditure on eligible R&D activities. Where the voluntary contribution or levy is wholly for R&D activities as defined in the legislation this may not be an issue. However, levies frequently support other activities, such as marketing, best practice projects and quality assurance. Where this occurs, the eligible expenditure needs to be apportioned.

Eligible companies can seek a ruling from the Tax Office to provide certainty as to their tax position.

Conclusion

Voluntary contributions and levy payments, where they support activities eligible as R&D, may be eligible for the R&D tax concession. However, companies must be able to establish that the R&D is undertaken on behalf of the company claiming the concession and that all the eligibility requirements of the R&D tax concession are met. As these issues can become quite complex, you should seek advice from the Tax Office and AusIndustry (see also Part B 5-8 Voluntary Contributions or Levy Payments and the R&D Tax Concession).

C2.1.6 Consolidation

The R&D provisions include sections intended to ensure that the research and development concession interacts properly with the consolidation regime in part 3-90 of the ITAA 1997.

These sections provide that:

• a head company is treated as qualifying for the R&D deductions while any of its subsidiary members do. The subsidiary members of the group who conduct R&D activities will continue to register their eligible activities with the Board as in the past, but the head company will be the claimant of the R&D tax concession;
• the expenditure history needed to access the deductions available under sections 73Y, 73QA or 73QB is not affected by the consolidation history rules where companies join or leave a consolidated group;
• clawing back the concessional part of an R&D deduction when expenditure is recouped or a grant received in respect of it is still possible, even though the deduction is claimed by the head company of a consolidated group when the recoupment was received by a company that leaves the group; and;
• consolidating does not allow two concurrent deductions for one amount of R&D expenditure. The allowance of such concurrent deductions could occur where expenditure on an item of pre-29 January 2001 plant or core technology is being written off under section 73B of the ITAA 1936 (subsections 73B(15) and 73B(12A) of the ITAA 1936) and, following consolidation, its depreciating assets are taken to have been acquired by the groups head company for a new payment (paragraph 701-55(2)(a) of the ITAA 1997). This deemed payment may give rise to a new right to deduct in respect of the same plant or technology, for example under section 73BC of ITAA 1936 (R&D depreciating assets regime), or Division 40 of ITAA 1997 (capital allowances). The allowance of concurrent deductions for one amount of R&D expenditure is prevented by requiring the post consolidation deductions to be reduced by the amount that is deductible under section 73B of ITAA 1936.

For further information see: ATO Interpretative Decision ATO ID 2005/85 Research and Development: Deductions under section 73BA of the ITAA 1936 in relation to an asset that becomes an asset of the head company under subsection 701-1(1) of the ITAA 1997 Can a deduction be claimed under section 73BA of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to an asset that becomes an asset of the head company under subsection 701-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) upon consolidation?

For further information see: ATO Interpretative Decision ATO ID 2006/135 Research and development: consolidated group - deductibility for head company - expenditure incurred by subsidiary as a corporate trustee Does subsection 73B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) prevent the head company of a consolidated group from claiming a deduction under section 73B of the ITAA 1936 for research and development expenditure incurred by a subsidiary member of the consolidated group in its capacity as a corporate trustee?

For further information see: ATO Interpretative Decision ATO ID 2006/137 Research and development: consolidated group - R & D activities of subsidiary member deemed to be carried out on behalf of head company - not on behalf of another person Does subsection 73B(9) of the Income Tax Assessment Act 1936 (ITAA 1936), when affected by the single entity rule (section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997), prevent the head company of a consolidated group from claiming a deduction under section 73B of the ITAA 1936, for expenditure on research and development activities carried out on behalf of a subsidiary member of the consolidated group?

Registration of R&D activities

A head company cannot claim the R&D tax concession for expenditure incurred in relation to unregistered R&D activities undertaken by any group member. This is because the head company is only treated as qualifying for the R&D tax concession in relation to expenditure incurred:

• by a group member that is an eligible company;
• on R&D activities that were registered with the Board by the eligible company undertaking the activities.

ITAA 1936 section 73BAB

Note: Section 73BAB of the ITAA 1936 depends on there being a subsidiary member of the consolidated group which is both an eligible company (as defined), and which is registered under section 39J of the IR&D Act (ie., registered in relation to 'its research and development activities'). The activities referred to in this context are those carried on by, or on behalf of, the relevant subsidiary member.

For further information see: ATO Interpretative Decision ATO ID 2006/138 Research and development: consolidated group - R & D activities of two subsidiary members - only one registered Can the head company of a consolidated group claim deductions under section 73B of the Income Tax Assessment Act 1936 (ITAA 1936) for research and development expenditure incurred by a subsidiary member where the only member of the consolidated group registered in relation to the relevant research and development activities is another subsidiary member?

Group markup and Consolidation

Members of a consolidated group are treated as a single entity (represented by the head company) for income tax purposes. This treatment occurs as a result of the 'single entity rule' which is contained in the consolidation provisions. A consequence of the single entity rule is that dealings which are solely between members of the same consolidated group will not result in income or a deduction to the group's head company.

It follows that the group markup provisions described in Part C2 - 2.3.11 (Reduced rate for group markup), are not relevant where the R&D expenditure is incurred in relation to the provision of goods or services between members of a consolidated group.

C2-2 On own behalf

Expenditure incurred by an eligible company can qualify as research and development expenditure as defined in subsection 73B(1) of the ITAA 1936 only if incurred in respect of R&D activities carried out by or on behalf of this company. This requirement also applies to other expenditure which may be eligible for an R&D deduction, for example the definition of core technology expenditure contains a similar requirement to the definition of research and development expenditure. Further, to determine whether a notional division 40 deduction is available under section 73BA of the ITAA 1936, it is necessary to determine whether the asset is used for the purpose of carrying on by or on behalf of the eligible company, research and development activities. For R&D activities to be carried out by or on behalf of a company, there must be a close and direct link between the company and the work undertaken.

Under subsection 73B(9) of the ITAA 1936, eligible companies generally cannot claim a deduction at the concessional rate in respect of expenditure incurred for the purpose of carrying on R&D activities on behalf of any other person. It is not necessary that the company be acting as agent of the other, the question is whether, in all circumstances, the R&D is to be carried out in substance for the other. This will be a question of fact in each case.

In certain circumstances, subsection 73B(9) of the ITAA 1936 does not apply and will not prevent a deduction under section 73B of the ITAA 1936. Subsection 73B(9) does not apply in relation to expenditure incurred on behalf of a partnership by a partner in their capacity as a partner (subsection 73B(9A), ITAA 1936).

Further, subsection 73B(9) of the ITAA 1936 does not apply to prevent a deduction under subsection 73B(14C) of the ITAA 1936 for 'expenditure on foreign owned R&D', determined in accordance with subsection 73B(14D) of the ITAA 1936. For further detail, see Part C3 Deduction for expenditure on foreign owned R&D (below).

These requirements in provisions such as subsection 73B(1) and subsection 73B(9) of the ITAA 1936 (collectively referred to as the 'on own behalf' requirement) effectively prevent companies making double deductions in respect of the same R&D activities by restricting entitlement to the concessional deductions to the company that:

• bears the financial risk associated with a R&D project
• has control over the R&D project, and
• effectively owns the project results.

Arrangements which in substance abdicate either ownership, financial risk or control could compel the conclusion that R&D activities were not being carried out by or on behalf of a company.

The on own behalf requirement cannot be satisfied in form only. The tests of when a company has R&D activities carried out by it or on its behalf, and when it incurs expenditure for the purpose of carrying on R&D activities on behalf of another, are tests which are determined on the facts. The outcome depends on the substance of arrangements and on the particular circumstances of the case. It follows that general conclusions about arrangements of a particular form cannot always be drawn. Cases will ultimately be considered on their individual circumstances.

C2.2.1 Financial risk

Where R&D activities are carried out on behalf of a company, it would generally be expected that the company would bear the financial risk of the activities undertaken. A deduction would not necessarily be prevented in circumstances where a company does not bear the financial risk of an R&D project, but effectively owns the results and controls the conduct of the R&D project. However, section 73C or section 73CA of the ITAA 1936 may reduce the deduction available in these circumstances.

The requirement that the eligible company bear the financial risk for the R&D activities does not preclude the company from contracting out some or all of the company's R&D work. An eligible company's expenditure on R&D activities performed on its behalf by another person may be deductible under section 73B (except under subsection 73B(14C) of the ITAA 1936). Where an eligible company performs R&D under contract for another person and does not bear the financial risk and does not have any entitlement to the results of that R&D, that company would not be entitled to claim a deduction under section 73B of the ITAA 1936 for the expenditure incurred in fulfilling its obligations under the contract.

A simple example of a company bearing the financial risk in relation to R&D activities is where these activities are merely incidental to the supply of a saleable product for a fixed price that bears no relationship to the extent of R&D activities the company may need to conduct in order to produce this product. On the other hand, if the company is receiving a fee for the design and testing of such a product, the associated R&D expenditure is arguably being recouped either wholly or in part from this fee.

Where an eligible company in a non consolidated group (for income tax purposes), incurs R&D expenditure which is reimbursed by another entity in the group that suggests this company is not bearing the financial risk in relation to the associated R&D activities. If this company lacked effective ownership of the results flowing from the R&D activities in question, then subsection 73B(9) of the ITAA 1936 would apply (assuming no foreign owned R&D is present). Whether or not a section 73B deduction would be allowable to the entity providing the reimbursement would depend on its circumstances, including whether or not it was registered, and whether or not it had effective ownership of the results.

C2.2.2 Control of the R&D activities

A company seeking to claim the concession under section 73B of the ITAA 1936 (except under subsection 73B(14C)) and other R&D provisions in relation to particular R&D activities must be able to demonstrate an appropriate degree of control over the conduct of the activities.

When R&D activities are carried out by or on behalf of a company, it would be expected that the company should exercise proper control over the conduct of those activities. Yet, as a practical matter, R&D activities will usually be carried on by experts in a particular field, whether an outside researcher engaged to carry out R&D on behalf of the company, or expert employees working within the company. In many cases, the company's management will be less expert than the research workers. In that context, there can be some questions regarding what the requisite level of control can entail.

Essential elements of control of the conduct of R&D activities are:

• the ability to choose the project of R&D;
• the capacity to decide on major changes of direction in those activities;
• the ability to stop an unproductive line of research;
• the scope to follow up (or not) an unexpected result; and,
• the power to end a project.

In circumstances in which R&D activities are performed by another party, for example, an independent researcher for the company, an eligible company must still maintain control of the conduct of the R&D activities. In some cases, there may appear to be less scope for changes to be made during the course of an R&D program, as detail regarding the program of R&D activities may be specified in advance, at the time the contract is entered into by the parties. Although it may appear that there is an absence of control in the circumstances, it may be the case that the eligible company has made its choices in advance, in the contract. Even then, if the company has control of the R&D activities, it would be entitled to check that he program was being carried out and compel the performance by the researcher according to the contract.

These requirements also apply where a researcher carries out a program of R&D activities on behalf of several companies. As a group, those companies must still have control over the conduct of the R&D activities, on the same basis as outlined above. Any terms of the arrangement between the companies and the researcher which regulate how they can exercise their control must not be such as to preclude the exercise of the companies' control in practice.

In some circumstances activities undertaken for a group of companies are overseen by a committee. Where companies have R&D activities carried out on their behalf, they may be able to exercise proper control over the conduct of those activities through a committee they have freely chosen. A committee appointed before the companies are involved in the R&D activities has no representative character, however, and does not become satisfactory merely because at some stage, possibly after all significant decisions have been taken, the companies may be able to replace committee members with their own.

C2.2.3 Ownership

A company seeking to claim the concession under section 73B of the ITAA 1936 (except under subsection 73B(14C) ) and other R&D provisions in relation to particular R&D activities must have effective ownership of the results of those activities.

This does not necessarily mean that the company must be the proprietor of a piece of intellectual property in any formal sense. First, the relevant formal regimes of intellectual property-copyright, patent, or registered design-may be unavailable to protect the results. Second, it is possible for the formal owner of any resulting intellectual property to hold it on such terms that the company has all the advantages of ownership. For instance, a company could have the right to use a patent, to require the patent to be licensed, to restrict or direct further development based on the patent, all without further fee or payment, and yet not be formally the holder of the patent. In most cases, a company with all those rights would have sufficient equity in the ownership of the patent and of the results embodied in it that the R&D activities could be said to have been carried out on its behalf.

Some theoretical rights of ownership may be given to others without denying this effective ownership to a claimant. For instance, a company having R&D carried out on its behalf might completely control commercial use of the results of that R&D, including further development of those results for commercial purposes, yet permit the researcher certain exclusive rights of scientific publication. The company would nevertheless be the effective owner of the results in the ordinary case. Similarly, actual use of particular results may only be possible in limited ways or for limited purposes, so that apparently limited rights can really amount to full effective ownership. For instance, exclusive rights of commercial use and development for only a few years might amount to full ownership in a particularly ephemeral area of R&D.

There might be pre-arrangements between companies seeking to claim deductions under section 73B and other parties involving a sale, option, or irrevocable and exclusive commercial licence of the results of a program of R&D activities, entered into before those results are known. Where a price or royalty percentage is fixed in advance, R&D activities are carried on for the benefit of the buyer, option-holder or licensee because the company's reward does not reflect the value of the actual R&D results; even in the percentage royalty example, the fixing of the percentage may not reflect the bargaining power of the holder of successful R&D results.

What is a proper interest in R&D results?

If several companies fund a project of R&D together as a partnership subsection 73B(9) of the ITAA 1936 does not apply in relation to expenditure incurred on behalf of a partnership by a partner in their capacity as a partner (subsection 73B(9A) of the ITAA 1936).

However, where several companies fund a project of R&D together (for example as a non-entity joint venture), if each company is to claim expenditure under the concession, each must have a proper and effective interest in the R&D results. Apart from special agreement, co-owners of results of R&D will be tenants in common, holding several (and not joint) interests in the results. Such co-owners can use the results individually for their own benefit without accounting to each other, can enforce rights over the results and obtain damages without joining their co-owners. However, such co-owners can license or assign their R&D results only by joint agreement. These principles extend to the statutory schemes of copyright, registered designs and patents, although in the latter cases a statutory method of resolving disputes between co-owners is provided.

Co-owners who can, as a practical matter, make use of their results in their individual activities often do not make any specific agreements about their rights as between themselves. For instance, members of industry associations may be effectively co-owners of the R&D results obtained on their behalf. Free individual use of those results is practical for them. Co-ownership of this kind may be consistent with the R&D having been carried out on behalf of the individual co-owners, each of whom has a proper and effective separate interest in the results. Where each such co-owner makes a contribution, even if the contributions vary somewhat, those contributions would not usually be regarded as having been made for the purpose of carrying out R&D activities on behalf of the other co-owners.

Co-owners who cannot make use of their results in their individual activities are more likely to make special agreements covering the use of their results. In cases where they must effectively share the results or their use, the question will be whether their individual share in those results is commensurate with their contribution. This is a question of fact, which may depend on the circumstances of the case. What is required is a comparison of the contributions of the co-owners to the R&D activities.

Contributions to R&D activities take many forms; for example, money, services (provided free, or to the extent that remuneration is clearly less than a proper fee), or depreciating assets or premises. A contribution may also take the form of existing research results. The key to comparing contributions in money and in kind is that contributions in kind are valued when contributed, not in hindsight after the contributions have been used in R&D activities.

We do not consider that a co-owner has necessarily received an appropriate share of R&D results because the value of their interest in the results of the completed R&D exceeds the cost of their contribution. A co-owner must have a proper share in the results, and what that share is does not depend on the ultimate value of the R&D results.

Valuation of existing research results brought to a further project of R&D may present some problems. Existing results of obvious commercial application can often be valued at a market price, as being clearly saleable. Where existing results may have a commercial value which is more indirect, a market price may prove to be below the cost of obtaining the results. In such a case, a valuation at cost may be reasonable, so that the shares of further project results going to each co-owner may be fairly allocated.

It is good practice for agreements to set out clearly the basis for the shares the parties will take in results of R&D.

R&D that builds on existing research results of another

A company may incur expenditure on R&D that builds on existing research results belonging to another person. For example, a company may fund a program of R&D activities, to be carried out on their behalf by a researcher, which builds on existing research results belonging to the researcher. It may be proposed that the company take an interest in the overall result, rather than being the owner of, but only of, the further R&D it has paid for. It may be proposed that all patents, registered designs, copyrights and the like are to be held by the researcher.

To determine whether the company has a proper interest in the R&D results, the substance of the proposed arrangements must be considered. The researcher has contributed its own research results. Commercial exploitation would require use of the researcher's existing results, as well as the results of the further R&D activities. The researcher's interest in the results may actually reflect this contribution. Provided the company's interest in the results is appropriate to its contribution to the overall research, it could be said that the further research was carried out 'by, or on behalf of' the company.

As mentioned above, it is good practice for agreements to set out clearly the basis for the shares the parties will take in results of R&D.

C2.2.4 Company groups and consolidation

Subsections 73B(1) and 73B(9) of the ITAA 1936 will need to be considered to determine eligibility for the R&D Tax Concession where companies that are part of the same group (that are not tax consolidated) carry out R&D activities for other companies in that group. For example, if the group of companies select a particular company to be the researcher for the group, it needs to be determined on whose behalf the R&D activities are conducted by the researcher, and whether the R&D activities are carried out on behalf of another to determine which company(ies) may be eligible to claim the R&D tax concession.

Eligible companies which are subsidiary members of tax consolidated groups are treated as part of the head company of the group (section 701-1 of the ITAA 1997). Expenditure incurred by these eligible companies on R&D activities they carry out, or which are carried out on their behalf, is taken to have been incurred by the head company. Where the R&D activities are being undertaken by or on behalf of a subsidiary member of a consolidated group, those activities are taken to be carried out on behalf of the head company of the consolidated group.

For further information on the R&D Concession and consolidation, see C2-1 (C2.1.6).

For further information see: ATO Interpretative Decision ATO ID 2006/136 Research and development: consolidated group - effect of single entity rule - R&D activities of subsidiary deemed to be carried out on behalf of head company Is the effect of the single entity rule (section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997)) such that the head company of a consolidated group is considered to have carried out on its own behalf the research and development activities carried out by or on behalf of its subsidiary member for the purposes of the definition of research and development expenditure, in subsection 73B(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Where these R&D activities are not carried out on behalf of any person outside the consolidated group subsection 73B(9) of the ITAA 1936 will not apply to claims under section 73B of the ITAA 1936 by the head company.

C2.2.5 Some examples

A company may undertake a program of R&D activities, on terms that another person will reimburse all costs incurred by the company, and that all results will only be available for commercial use by the other person. The company will be ineligible to claim any of its expenditure on the program under section 73B of the ITAA 1936 - the expenditure is incurred on behalf of the other person.

A company might enter into a contract to supply a new product meeting certain specifications, which cannot be met at present. The buyer and the company both know that a program of R&D will be needed for the company to fulfil its contract. Even if the buyer is the sole purchaser, or one of only a few potential purchasers, of the intended product, it is the company alone on whose behalf the R&D activities are carried out, as it alone controls and uses the R&D results. So the company may be eligible to claim its expenditure on the program of R&D under section 73B of the ITAA 1936 (subject to meeting other requirements).

A group of companies may establish another company in which they are the shareholders. This jointly owned company engages in R&D activities, or has them carried out. Those activities may be funded by the shareholder companies. The mere fact that shareholders expect an indirect benefit by way of dividends does not mean that the company in which they hold shares conducts its R&D activities on their behalf.

Eligible companies wanting legally binding advice on whether the Commissioner would regard certain expenditure to have been incurred on behalf of another person, for the purposes of subsection 73B(9) ITAA 1936, can apply to the Tax Office for a private ruling.

C2-3 Expenditure on research and development activities

The Tax Office administers the statutory provisions related to qualifying expenditure for the R&D tax concession. Questions regarding qualifying expenditure should be directed to the Tax Office.

Expenditure on R&D activities is dealt with in this chapter under the following headings:

• research and development expenditure, which includes:
  • salary expenditure
  • other expenditure
  • contracted expenditure;
• CRC contributions
• feedstock expenditure
• core technology expenditure
• deductions for plant and depreciating assets including pilot plant expenditure
• interest expenditure
• building expenditure

Expenditure allowable as a deduction under subsection 73B(14C) of the ITAA 1936 in relation to foreign owned R&D activities is not discussed in this section. Please refer to Part C3 Deduction for expenditure on foreign owned R&D.

In addition this chapter also covers:

• prepayments of R&D expenditure (including accelerated R&D expenditure)
• intra group markups
• certified overseas R&D expenditure
• anti-avoidance measures
• calculation of deductions - examples.

C2.3.1 Research and development expenditure

Research and development expenditure, as defined in subsection 73B(1) of the ITAA 1936, includes salary expenditure, contract expenditure paid to Registered Research Agencies, and other expenditures (including overhead and consumables) that are incurred directly in respect of eligible R&D activities. This definition does not cover expenditures on core technology, interest, residual feedstock expenditure, excluded plant expenditure, depreciating assets, structural improvements and buildings - although some of these may attract deductions under other R&D provisions.

C2.3.1.1 Salary expenditure

'Salary expenditure', forms part of 'research and development expenditure' and is comprehensively defined in subsection 73B(1) of the ITAA 1936, which also provides a basis for apportionment of some salary-related expenses. Salary expenditure for the purposes of the R&D concession includes expenditure incurred directly on eligible R&D activities by way of salaries, wages, allowances, bonuses, overtime and penalty rate payments, annual, sick and long service leave, superannuation fund contributions (which are otherwise deductible under section 290-60 of the ITAA 1997), payroll tax and workers` compensation insurance premiums in relation to those employees who are engaged directly in carrying out an eligible R&D activity, including:

• researchers undertaking the conception and/or creation of new knowledge and products
• employees undertaking technical tasks in support of the R&D activities, such as persons keeping records, preparing charts and graphs, operating equipment and writing computer programs, and
• supervisors of researchers and technical staff.

In addition, expenditure incurred by an employer to provide benefits (including fringe benefits) in lieu of paying such employees a cash salary because of an eligible salary sacrifice arrangement, may also be salary expenditure.

Where the expenditure on the employee is only in part directly in respect of the relevant R&D activities, an apportionment is necessary. It is expected that the company would be able to demonstrate - by way of appropriate records such as time sheets or job cards - the extent to which such an employee's services are directly related to qualifying R&D activities. Claims for salary expenditure should be based on actual expenditure and not upon standard salary rates that might be developed for internal costing purposes.

Salaries (and on costs) of support staff, for instance, general supervisors or administrative staff, who do not actually conduct the R&D activities should not be included as salary expenditure. A portion of this expenditure may qualify as other expenditure depending on whether the expenditure has a direct connection to the R&D activities conducted.

The salaries (and on costs) of company employees whose only connection with R&D activities is clearly indirect - for example, management staff who recruit other company employees for general duties not necessarily related to R&D activities - would not qualify as salary expenditure.

Expenditure must be 'incurred' as described in Taxation Ruling TR 97/7 before it is considered 'salary expenditure' for the purposes of subsection 73B(1) of the ITAA 1936.

For further information see: ATO Interpretative Decision ATO ID 2006/238 Research and development: unpaid wages Can an eligible company claim a deduction for certain 'unpaid wages' under subsection 73B(14) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Superannuation fund contributions

Superannuation fund contributions must first meet all legislative requirements to be generally deductible under section 290-60 of the ITAA 1997 before they can be eligible for concessional treatment as research and development expenditure.

For further information see: ATO Interpretative Decision ATO ID 2006/19 Superannuation deductions and the research and development tax concession Can an eligible company claim a deduction under subsection 73B(14) of the Income Tax Assessment Act 1936 (ITAA 1936) for superannuation contributions paid in respect of an employee that is engaged in research and development activities?

Note: ATO ID 2006/19 was withdrawn on 29 August 2008. Despite its withdrawal, ATO ID 2006/19 continues to be a precedential view on the former definition of 'contributions to superannuation funds' in respect of decisions for the income years up to, and including, the 2006-07 income year. The same conclusion applies to the current definition, in relation to expenditure that would be that otherwise allowable under section 290-60 of the Income Tax Assessment Act 1997.

Note: Because of the exclusions listed in the definition of 'research and development expenditure' contained in subsection 73B(1) of the ITAA 1936, some types of 'salary expenditure' incurred in respect of the construction of R&D plant, pilot plant, depreciating assets, structural improvements or buildings are not included in the definition of 'research and development expenditure'.

Apportionment

Expenditure on salaries, wages, bonuses, overtime and penalty rate payments is salary expenditure to the extent that this is incurred directly in respect of R&D activities. Expenditure on annual, sick and long service leave or superannuation contributions is deductible in the proportion that reflects the extent to which the employee was engaged in R&D activities in the year. For example, if during the year an employee had been engaged for 16 weeks on R&D activities for the company and 32 weeks on other activities, 1/3 of the salary paid to the employee during the remaining 4 weeks spent on annual leave would qualify as salary expenditure for the purposes of section 73B of the ITAA 1936.

Where an employee performs other activities in addition to work on eligible R&D projects, it will be necessary to apportion that employee's salary between R&D and non-R&D activities. It is expected that the company will be able to demonstrate, by reference to appropriate records such as timesheets, job cards or diaries, the amount of time spent on R&D activities. Where a company is unable to determine exactly what each employee has been paid for each hour worked on R&D, it would be acceptable to use an annualised hourly rate calculated on the following basis:

For example, in a case where salary and other payments totalled $30,000 and the employee worked 8 hours per day and 226 days in the year, the employee's hourly rate would be:

If the employee spent 120 hours on eligible R&D activities, the R&D expenditure of that employee would be:

120 hours x $16.59/hour = $1,990.80

These calculations must be made for each relevant employee to arrive at the company's 'R&D salary expenditure'. The average hours per day actually worked would need to be used to avoid inflating the amount of salary allocated to R&D.

Premiums for workers' compensation insurance and payroll tax are salary expenditure to the extent considered to be reasonable, taking into account the amounts deductible as salary expenditure for salaries, and leave, and the total expenditures on these amounts, and other matters that may be relevant. Such other matters would include any pay-roll tax exemptions or concessions available to the company. Similarly, in the case of worker's compensation premiums, any increased or decreased rate of premiums applicable to the employees carrying out the company's R&D activities would be taken into account in determining the deductible expenditure. Where payroll tax and workers' compensation premiums paid for R&D staff are known, the amounts should be added to the amount of R&D salary expenditure.

However, if the amounts cannot be separately identified, payroll tax and workers compensation premiums may be allocated to R&D as follows:

Adjustments would need to be made to respective amounts in the formula in the following circumstances:

• The amount incurred for salaries and wages would need to be reduced by the amount of salary and wages exempt from payroll tax.
• An appropriate adjustment would also need to be made where salaries of certain employees receive concessional treatment under the payroll tax law.
• Different employees may attract different workers' compensation premiums. For example, factory employees may attract a higher premium than that payable in respect of R&D staff. In these cases, the company should ensure that the amount allocated to R&D salary expenditure is representative of the expenditure that would have been incurred for R&D staff.
• Any rebate of workers' compensation premiums received or to be received will have to be deducted from total premiums paid.

Deductible contributions to a superannuation fund ought to be clearly identifiable from staff records and the relevant amounts added to the amount of R&D salary expenditure. Where this is not practicable, eligible contributions to a superannuation fund should be allocated to R&D in accordance with paragraph (b) of the definition of salary expenditure in subsection 73B(1) of the ITAA 1936 as follows:

The methods set out above for calculating salary expenditure incurred directly in respect of R&D activities are not intended to be definitive. However, where a method other than this method is adopted, the method should be consistent with the principles contained in the law. Where an alternative method is adopted, the taxpayer would need to demonstrate the appropriateness of the method used.

C2.3.1.2 Other expenditure

A company will incur a number of administrative costs and overheads as a result of conducting its R&D activities and as a result of employing R&D staff. For instance, these costs may include the salaries of a supervisor, typist, payroll and recruitment staff and their on-costs. It may also include overheads, such as rent, light and power, property rates and taxes, cleaning and certain types of insurance.

The expenses which can be claimed as 'other expenditure' are limited to those 'incurred directly in respect of R&D activities'. The type of expenditure that qualifies for deduction under subsection 73B(14) of the ITAA 1936 depends on the facts of each particular case. It is considered that administrative costs and overheads are 'directly in respect of' R&D activities:

• where the carrying on of eligible R&D activities contributed to the incurring of all or an identifiable part of the expenditure; or
• where the conduct of eligible R&D activities by the company could be materially impaired if the expenditure were not incurred.

In general, this expenditure falls into two classes.

The first class encompasses expenditure which could reasonably be expected to be identified as directly relating to an eligible research project. This may include:

• overseas and domestic travel by research and technical officers working on an approved project (note that an eligible company requires a certificate issued under section 39ED of the Industry Research and Development Act 1986 to claim a deduction for the 1994-1995 years of income and later years for a portion of expenditure on overseas research and development activities)
• motor vehicle expenses which could be apportioned to R&D projects on a basis similar to that required under the substantiation provisions contained in section 28-20) ITAA 1997
• parts and materials used in the course of a project and which can be clearly identified from invoices and other source documents (Note, however, some material costs used in R&D activities may be feedstock expenditure - see part C2.3.3)
• other expenses which are attributable solely to an approved project, for example, leasing charges for a computer used solely in connection with an approved project.

The second class encompasses expenditure which may not be clearly identifiable as R&D expenditure because it relates to a number of business operations but some of that expenditure may nonetheless include a component which is applicable to an eligible R&D project. The onus is on a company to show the nexus, in accordance with the principles ... explained above between the incurrence of the expenditure and the relevant R&D project. A company would also be expected to demonstrate the accuracy of the amount of expenditure allocated to a particular R&D project.

As a general rule, the following expenses (referred to later as 'eligible apportionable expenses') would be accepted as being connected to eligible R&D projects:

• cleaning
• consumables; for instance, expenses such as oils, grease and cloths used generally, including R&D activities
• electricity gases and water
• insurance premiums to the extent that they are relevant to R&D activities. (Insurance for loss of profits, product liability or finished products would not be eligible)
• leasing charges on office equipment
• pay roll costs
• postage
• printing and stationery
• rates and land taxes
• recruitment
• rent of a building used partly for R&D purposes
• repairs and maintenance of a building used partly for R&D purposes
• salaries of support staff that perform some duties connected with eligible R&D activities (for instance, cleaners, typists, supervisors) plus associated costs and on-costs
• security
• stationery
• subscriptions to industry associations and for technical journals
• telephone and telex
• training

Ineligible expenses are those expenses that are not directly in respect of eligible R&D activities and could include:

• advertising (for instance, of a company's product)
• audit fees
• bad debts
• company establishment and other fees incurred under the companies code in relation to the administration of the company
• costs incurred in preparing taxation returns
• decline in value of a depreciating asset (note section 73BA however)
• directors' fees
• distribution and selling expenses
• donations
• employee benefits such as canteen and recreational facilities
• entertainment expenses
• factory overheads
• grounds and gardens-maintenance costs
• insurance premiums on matters unrelated to R&D such as loss of profits and product liability
• legal expenses not associated with any approved research project, e.g., legal expenses incurred in carrying out a patent search prior to undertaking a research project or in taking out a patent after a successful project
• patents and trademarks in marketing a new product or technology, or as a result of R&D activity
• rent paid for premises which are not to any extent used in R&D activities
• salaries, associated costs and on-costs of support staff not linked with R&D activities and of staff employed in areas such as distribution, sales, marketing and debt collection
• tender costs.

Leased plant and buildings

Rent or lease payments by an eligible company in respect of plant or buildings used in R & D activities carried on by, or on behalf of, the company would constitute 'other expenditure' referred to in paragraph (c) of the definition of R & D expenditure. There is no requirement that such plant or buildings be used exclusively in the R & D activities, but where they are not so used, only the proportion of the expenditure that can be shown to be directly related to the R & D activities would qualify for deduction under section 73B of the ITAA 1936. The company may apportion rent on a floor area basis, or some other basis of apportionment where it can be shown that it produces an allocation of expenditure to R&D activities with a reasonable degree of accuracy.

Where a company uses leased plant or buildings to carry out R & D activities on its own behalf and on behalf of other persons, the proportion of the relevant lease payments attributable to the company's own R & D activities would potentially qualify for deduction under section 73B of the ITAA 1936.

Accountants' and consultants' fees

Deductibility of expenditure incurred on accountants' and consultants' fees under subsection 73B(14) of the ITAA 1936 depends upon whether:

• the activities associated with the work undertaken by the accountant and/or consultant, to which the fee relates, are 'supporting activities'; and
• the expenditure incurred was directly in respect of those R&D activities.

Generally, activities associated with work by accountants and consultants are ineligible activities under the R&D tax concession. Such ineligible activities include:

• preparation of a registration application for the R&D tax concession; and
• preparation of a tax return in order to claim the R&D tax concession.

However, where an activity is carried on for a purpose directly related to the carrying on of a systemic, investigative and experimental activity it is considered to be an R&D activity (see Part B3-1.4 - Directly related activities). It would be expected that such activities would be registered with the Board.

Expenditure incurred in relation to research and development activities is deductible under subsection 73B(14) as 'other' research and development expenditure.

Note that tax related expenses incurred for the management of a company's tax affairs may be deductible under section 25-5 of the ITAA 1997.

The eligibility of R&D activities is determined by the Board and should not be confused with eligible expenditure, which is determined by the Tax Office.

Apportionment

In respect of other eligible expenses directly in respect of R&D activities, it is accepted that it may be impracticable for many companies to examine each expense, and calculate the portion applicable to the R&D component. In these cases it would be open to the company to apportion the expenses on some basis upon which the company can allocate expenses to R&D activities with a reasonable degree of accuracy. The method of allocation, though, may depend on the internal accounting procedure adopted by a company. Internal accounting procedures generally come within one of the following:

• R&D is absorbed within the company's administration cost centre. Separate records are prepared for this cost centre in addition to records for other cost centres such as selling and distribution or manufacturing.
• R&D is undertaken by a separate section which is a cost centre in its own right. In such a case, records are prepared for this centre. Separate records are kept for the administration centre and other cost centres.
• Only one set of accounts is prepared.

In the first and third cases, the administration cost component of eligible R&D expenditure could be determined as follows:

In the second case, where R&D is undertaken by a separate section but administrative services are still provided by an administrative division, it is necessary to calculate the eligible expenses in the administration section as well as the eligible expenses of the R&D section.

The eligible expenses in the R&D section could be determined as follows:

The eligible expenses of the administration section can be determined as follows:

The above two formulae reduce to:

where

(a) = eligible apportionable expenses of R&D section

(b) = eligible apportionable expenses of administration section divided by total company salaries and wages

(c) = total salaries and wages of R&D staff

(d) = total indirect salaries and wages of R&D section

(e) = eligible R&D salaries and wages

NB. (c) + (d) = total labour of R&D section. This combined formula eliminates the need to calculate eligible indirect R&D salaries and wages separately.

If the R&D centre is self-contained in terms of administration, then the administration cost of R&D is simply:

The methods set out above for calculating other expenditure incurred directly in respect of R&D activities are not intended to be definitive. However, where a method other than these methods is adopted, the method should be consistent with the principles contained in the law. Where an alternative method is adopted, the taxpayer would need to demonstrate the appropriateness of the method used.

C2.3.1.3 Contracted expenditure

Contracted expenditure is defined in subsection 73B(1) of ITAA 1936 as payments by an eligible company to an organisation with Registered Research Agency (RRA) status, where the RRA performs R&D activities on behalf of the eligible company. Such expenditure is not subject to the $20,000 expenditure threshold and automatically qualifies for the concession at the accelerated rate - provided that the expenditure is in relation to eligible R&D activities and the associated eligibility criteria are also satisfied.

Subsection 73B(1B) of the ITAA 1936 provides that expenditure is not contracted expenditure unless when the expenditure was incurred, the eligible company that incurred the expenditure was capable of utilising, or had formulated a plan to utilise any results of the research and development activities directly in connection with a business that the company carried on or proposed to carry on.

Note: This restriction does not apply to expenditure on foreign owned R&D covered by subsection 73B(14C) of the ITAA 1936 (see Part C3 Deduction for expenditure on foreign owned R&D).

While it is possible for a RRA to perform R&D activities through an agent, the RRA would not be considered to perform those activities where it did not choose the agent, supervise the performance of the activities, or take responsibility to the eligible company for the agent's performance of the activities. Arrangements of this type under which, for instance, an eligible company made payments to a RRA for the performance of R&D activities on condition that the RRA would have the activities performed by a particular researcher, would have the consequence that the RRA could not be said to perform those activities on behalf of the eligible company. Rather, the payments would be made in consideration of the RRA doing no more than act as a conduit for the particular expenditure. In such a case, the payments would not be 'contracted expenditure'.

An eligible company is not limited to contracting out its R&D activities to an RRA. It may contract out some, or all, of its R&D activities to any person, company or other body, but if it does so, and this other entity is not an RRA, the expenditure incurred will not be contracted expenditure as defined in subsection 73B(1) of the ITAA 1936 and it will be subject to the $20,000 expenditure threshold (see also the section on 'other expenditure').

Some RRAs have been established to carry out activities, including R&D activities that are solely related to particular industries. Where a levy is imposed on industry members as a means of raising the funds to support its various activities, the levy payments incurred by members who are eligible companies may qualify for the 125% rate of deduction to the extent that the moneys are expended on qualifying R&D activities (as defined in section 73B of the ITAA 1936) on behalf of the members. In some instances, a RRA's R&D activities are also supported by government grants. Because those grants are received by the RRA and not the member companies, section 73C of the ITAA 1936 does not apply to decrease the deduction of such companies on R & D projects funded through such an RRA. As a practical matter, it may be the case that the full amount of the levies paid by member companies to such a RRA is eligible for the 125% concession if the RRA's expenditure on qualifying R&D activities in the year of income, other than expenditure on activities performed by the RRA under a specific contract and funded from the contracted fees, is equal to, or exceeds, the aggregate of the levies and any government grants received in that year.

In a case where such a RRA's expenditure on relevant R&D activities during the year of income is less than the aggregate of the levies collected and government grants received, a proportion of the levy paid by a member company will be deductible under section 73B of the ITAA 1936. The deduction allowable will be calculated as follows:

(relevant R & D expenditure-government grants) * individual levy/total levies collected

Rules regarding advance R&D expenditure may also be relevant to the timing of any deduction for contracted expenditure if the eligible service period in relation to the expenditure ends more than 13 months after the day on which the expenditure is incurred. These rules can be found in subsection 73B(11) of the ITAA 1936).

C2.3.2 Co-operative Research Centre contributions

Contributions to R&D partnerships, as defined in subsection 73B(3B) of the ITAA 1936, which are designated as Co-operative Research Centres, receive special treatment under the rules in subsection 73B(3A) of the ITAA 1936. Where expenditure is incurred by the CRC partnership, each partner is taken to have incurred so much of the expenditure as was incurred out of money contributed by that partner.

Partners in CRC programs should be individually registered with the Board under section 39J of the IR&D Act and should claim so much of the partnership's R&D expenditure as was incurred from their contribution, as their R&D deduction. Clawback provisions apply to partners' contributions in respect of grants and recoupments received by CRCs except in relation to Commonwealth grants made under the Co-operative Research Centres program.

ITAA 1936 subsections 73C(2A)

Where CRCs conduct research on a commercial basis, payments made by customers for R&D conducted on their behalf are treated according to the general expenditure rules for the concession.

C2.3.3 Feedstock expenditure

The feedstock provisions apply to expenditure incurred under contracts entered into after 5pm ACT legal time on 23 July 1996.

Subsection 73B(14) of the ITAA 1936 allows a company to claim a deduction for the amount of its 'research and development expenditure' multiplied by 1.25. The definition of 'research and development expenditure in subsection 73B(1) of the ITAA 1936 excludes 'feedstock expenditure' but includes any 'eligible feedstock expenditure' that the company has in respect of related research and development activities.

The concessional rate of deduction for the cost of feedstock that qualifies as R&D expenditure will be limited to the net costs of the feedstock (eligible feedstock expenditure). This is determined by subtracting the value of any products derived from processing or transforming feedstock as part of the R&D activities (feedstock output) from the value of the feedstock that was used in the process or transformation (feedstock input).

Definitions

feedstock expenditure, in relation to an eligible company, means expenditure incurred by the company in acquiring or producing materials or goods to be the subject of processing or transformation by the company in research and development activities, and includes expenditure incurred by the company on any energy input directly into the processing or transformation.

ITAA 1936 subsection 73B(1)

For example, the costs associated with acquiring or extracting ore for transformation into metal in an experimental smelter are likely to be feedstock expenditure.

eligible feedstock expenditure is the amount by which the company's 'feedstock input' exceeds its 'feedstock output' in respect of the year of income in relation to related research and development activities.

ITAA 1936 subsection 73B(1A)

residual feedstock expenditure is the lesser of the eligible company's feedstock input, or feedstock output in respect of the year of income in relation to related research and development activities.

ITAA 1936 subsection 73B(1)

feedstock input, in relation to an eligible company, is the actual 'feedstock expenditure' in respect of goods or materials that were processed or transformed by the company in the relevant research and development activities.

ITAA 1936 subsection 73B(1)

feedstock output, in relation to an eligible company, means the proceeds from the sale of, or the sale value of the product(s) obtained in relation to that feedstock input expenditure.

ITAA 1936 subsection 73B(1)

Deducting feedstock expenditure

Deductions for feedstock expenditure may be available to an eligible company carrying out research and development activities under the income tax legislation as either:

• Eligible feedstock expenditure which forms part of research and development expenditure (under subsection 73B(1) of the ITAA 1936). Eligible feedstock expenditure is deductible at the rate of 125% (subject to the $20,000 aggregate R&D amount threshold being satisfied, or
• Residual feedstock expenditure (under subsection 73B(14B) of the ITAA 1936). This is feedstock expenditure, which does not qualify as eligible feedstock expenditure and is deductible only at the rate of 100%.

The feedstock provisions operate in the following manner:

• whilst 'feedstock expenditure' is precluded from being 'research and development expenditure', 'eligible feedstock expenditure' (being the excess of feedstock input over any feedstock output) is specifically included, and therefore deductible at the concessional rate of 125 % under subsection 73B(14) of the ITAA 1936
• if feedstock output is greater than, or equal to feedstock input, the whole of the feedstock input becomes 'residual feedstock expenditure' and deductible at the rate of 100 % under subsection 73B(14B) of the ITAA 1936
• if feedstock input is greater than feedstock output, the excess is 'eligible feedstock expenditure', and is therefore 'research and development expenditure', deductible at the concessional rate. The lesser amount, being the feedstock output, is 'residual feedstock expenditure' and deductible at the rate of 100 %, and
• if there is no feedstock output, for example, if the goods or materials have been wholly consumed in the course of the research and development activities, then the whole of the feedstock input becomes 'eligible feedstock expenditure' and deductible at the concessional rate.

The feedstock provisions thus operate as a code for dealing with the cost of acquiring or producing the goods or materials in question, whether or not those goods or materials have been wholly consumed or partially consumed in the course of the research and development activities. The scheme of these provisions also caters for situations in which products obtained from one round of processing or transformation become themselves subsequently, materials or goods that are to be the subject of some processing or transformation in the course of the eligible company carrying out specific research and development activities.

Transformation and processing

Neither 'processing' nor 'transformation' are defined for the purposes of the feedstock provisions, and their ordinary meanings are considered to apply.

The ordinary meaning of processing includes situations where no new or different product is produced, and where no physical alteration of any goods or materials occurs. However, 'processing' ordinarily involves a substantial degree of uniformity of treatment, and does not cover the case of a good or materials being the subject of individual treatment.

'Transformation' normally involves a change in form, appearance, condition, nature or character.

Example 2.1: Feedstock

A	Feedstock input	700
B	Feedstock output (arms length value)	400
	Eligible feedstock expenditure (A-B)	300
	Residual feedstock expenditure (lesser of A or B)	400
	Deduction available for eligible feedstock expenditure is $300 x 125% =	375
	Deduction available for residual feedstock expenditure is $400 x 100% =	400
	Total deduction available	$ 775

Expenditure incurred on manufacture of a product

Where an eligible company has incurred expenditure on the manufacture of a product, this may be 'feedstock expenditure' and so will be subject to the feedstock provisions.

For further information see: ATO Interpretative Decision ATO ID 2007/122 Research and development: feedstock expenditure Is expenditure incurred by an eligible company on the manufacture of a product 'feedstock expenditure', as defined by subsection 73B(1) of the ITAA 1936?

C2.3.4 Core technology expenditure

A deduction may be available for expenditure incurred in acquiring, or acquiring the right to use, an item of intellectual property that is 'core technology', where that technology forms the basis for undertaking further research and development activities.

Core technology expenditure does not include expenditure incurred in developing core technology or a core process.

Definition

'Core Technology' in relation to research and development activities means technology that is core technology in relation to those activities as provided by subsection 73B(1AB)

ITAA 1936 subsection 73B(1)

Where subsection 73B(1AB) states: ...technology is core technology in relation to particular research and development activities if: the purpose of the activities was or is: to obtain new knowledge based on that technology; or to create new or improved materials, products, devices, processes, techniques or services to be based on that technology; or the activities were or are an extension, continuation, development or completion of the activities that produced that technology.

Whether technology is core technology in relation to R&D activities depends on the purpose of those activities and the way in which the technology is to be used in the performance of those activities. The technology must essentially be the basis of the activities.

Note. Core technology expenditure relates only to core technology as defined in subsection 73B(1AB) of the ITAA 1936 as set out above. Where technologies are acquired for use in carrying on R&D activities that are not core technologies they may still qualify for deduction as 'other' R&D expenditure.

Expenditure which satisfies the definition of core technology expenditure is not allowable as a deduction under any other provision of the ITAA.

Note. The expenditure must represent a real or valuable 'loss or outgoing' by the company. Where an eligible company actually issues and allots the shares in itself in exchange for 'core technology' there will be no 'core technology expenditure' for the purposes of subsection 73B(1).

For further information see: ATO Interpretative Decision ATO ID 2006/92 Research and development: deduction for 'core technology expenditure' where purchase consideration comprises allotment of shares Does the term 'core technology expenditure' for the purposes of subsection 73B(1) of the Income Tax Assessment Act 1936 (ITAA 1936) include the acquisition of core technology by an eligible company, where the purchase consideration to acquire the core technology consists of the allotment of shares in the eligible company?

Deducting core technology expenditure

Deductions for core technology are covered by the following legislation:

Where an eligible company incurs core technology expenditure during a year of income under a contract entered into before 5pm, by legal time in the Australian Capital Territory, on 23 July 1996, the amount of that expenditure is allowable as a deduction from the assessable income of the company of the year of income.

ITAA 1936 subsection 73B(12)

Subject to this section, if: an eligible company has, before or during the year of income, incurred core technology expenditure in respect of particular core technology (the "relevant core technology") under a contract entered into at or after the time referred to in subsection (12); and during the year of income the company incurs research and development expenditure that is related to the relevant core technology; there is allowable as a deduction from the company's assessable income of the year of income so much of the amount worked out using the formula in subsection (12B) in respect of that core technology as does not exceed one-third of the amount of that related research and development expenditure.

ITAA 1936 subsection 73B(12A)

Limitation on the amount of core technology expenditure that can be deducted

From 23 July 1996, there is a ceiling placed upon the amount of core technology expenditure which can be deducted in any year. Expenditure incurred on core technology prior to this date attracted a 100% deduction in the year incurred.

The ceiling is set at one-third of the amount of research and development expenditure incurred in respect of R&D activities that are related to the core technology. No amount of core technology expenditure can be deducted in a year for which there is no research and development expenditure incurred in respect of R&D activities that relate to the core technology.

Undeducted amounts of core technology expenditure from any year may be carried forward and deducted in future years in which research and development expenditure related to the core technology is incurred. The same formula is applied in those future years. That is, in any year, the core technology deduction will be limited to one-third of the related research and development expenditure.

In any year in which there is a disposal of any of the core technology, the amount carried forward as undeducted core technology expenditure may be reduced by the disposal proceeds. (See example 2.3 below.)

Calculating the deduction for core technology expenditure

The formula for the purposes of subsection (12A) is: Undeducted Expenditure minus Current year core technology adjustment amount Where: "undeducted expenditure" means so much of the core technology expenditure incurred by the company during the current year or previous years of income in relation to the relevant core technology under contracts entered into at or after the time referred to in subsection (12) as has not been allowed as a deduction from the company's assessable income in any of those previous years of income. "current year core technology adjustment amount", in relation to a company in relation to a year of income in which: (a) an amount or amounts are included in the company's assessable income under subsection (27A) because the company received or was entitled to receive an amount or amounts from the disposal of the relevant core technology; or (b) an amount or amounts would be so included apart from the operation of paragraph 73B(27C)(c); means: (c) the core technology adjustment amount in relation to the company in relation to that year of income in respect of the relevant core technology; or the amount or the sum of the amounts referred to in paragraph (b); whichever is the less.'

ITAA 1936 subsection 73B(12B)

A deduction in respect of core technology is not allowable from a taxpayer's assessable income of any year of income under any provision of this Act other than this section.

ITAA 1936 subsection 73B(12C)

Example 2.2: Deducting core technology expenditure

1998-99 core technology expenses $5m

Related research and development $3m

Deduction allowable in 1998-99 for core technology expenditure is $1m.

The remaining $4m is carried forward to the next year as undeducted expenditure. If a further $3m of related research and development were carried out in the year 1999-2000, then another $1m of the core technology would be deductible, with $3m carried forward into the year 2000-01, and so on.

Example 2.3: Disposal of core technology

A company incurs core technology expenditure of $100,000. Under subsection 73B(12A) the company has been allowed a deduction of $30,000. The company disposes of the core technology for $40,000.

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

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

Note: Once all rights to the core technology are disposed of there would be no further entitlement to a deduction for undeducted core technology expenditure.

Explanatory Memorandum to Taxation Laws Amendment Bill (No. 3) 1996, paragraph 9.18.

C2.3.5 Plant/Depreciating Asset Expenditure

This section discusses each of the different treatments of expenditure incurred to acquire or construct an asset that is used in carrying on research and development activities. This section also:

• explains some key terms and their relevance;
• provides a timeline to assist in determining which legislative provisions apply; and
• provides a flowchart to assist in determining whether expenditure incurred from 1 July 2001 is to be deducted under the 'new provisions' or whether it is eligible for immediate deduction.

Key terms - old provisions

The legislative regime that operated prior to 29 January 2001 (the old provisions) drew a distinction between 'plant' and 'pilot plant'. Note: the new provisions do not use these terms:

• plant - defined by subsection 73B(1) of the ITAA to mean:
  • things that are plant within the meaning of section 45-40 the Income Tax Assessment Act 1997; or
  • things to which section 45-40 of that Act would apply if the carrying on of research and development activities were the carrying on of a business for the purpose of producing assessable income; or
  • pilot plant other than post-23 July 1996 pilot plant.
• pilot plant- defined by subsection 73B(1) of the ITAA to mean an experimental model of other plant for use in research and development activities or for use in commercial production, being a model that is not for use in commercial production but that has the intended essential characteristics of the other plant of which it is a model.
• prototype- is not a defined term, but is a term commonly used loosely to refer to any experimental, generally 'first-off' item, developed as a result of research and development activities. Concepts associated with prototypes may be relevant to determining whether the item is a depreciating asset

Key terms - new provisions

From midday on 29 January 2001, assets that were previously described as plant or pilot plant are now referred to as 'depreciating plant' or 'depreciating assets.

Which provisions?

Generally, the treatment of expenditure incurred to acquire or construct an asset that is used in carrying on research and development activities depends upon whether the expenditure was incurred:

• prior to 29 January 2001 - plant expenditure and post-23 July 1996 pilot plant ;
• on or after 29 January 2001 but before 1 July 2001 - section 73BH plant ;
• on or after 1 July 2001 - section 73BA depreciating asset .

In certain circumstances expenditure incurred to acquire an asset that is used in carrying on research and development activities may be eligible for immediate deduction.

Practice Statement PS LA 2003/8 and ITAA 1997 subsection 40-80(2)

Plant expenditure incurred prior to 29 January 2001, pilot plant expenditure incurred prior to 29 January 2001 and plant/depreciating asset expenditure incurred on or after 29 January 2001, are each considered separately below.

Note: Expenditure for the acquisition or construction of an item of plant, incurred under a contract entered into prior to midday 29 January 2001, or that the company commenced to construct prior to this time, falls within the old R&D plant regime.

An asset that is acquired or constructed prior to 29 January 2001, but which did not meet the requirements for a deduction under section 73B(15) of the ITAA 1936 because it was not used, or installed ready for use, 'exclusively' for research and development, will be eligible for a deduction under section 73BA of the ITAA 1936, to the extent that it has a base value/adjustable value. The deduction for the decline in value will then be based on the 'notional Division 40 deduction'.

ITAA 1936 sections 73BA, 73BB and 73BC

C2.3.5.1 Plant expenditure prior to 29 January 2001

The former R&D plant regime applies to expenditure on plant that was acquired under a contract entered into, or commenced to be constructed, prior to 29 January 2001.

Definition of 'plant'

'plant' means: things that are plant within the meaning of section 45-40 the Income Tax Assessment Act 1997; or things to which section 45-40 of that Act would apply if the carrying on of research and development activities were the carrying on of a business for the purpose of producing assessable income; or pilot plant other than post-23 July 1996 pilot plant. ITAA 1936 subsection 73B(1)

Taxation Ruling TR 2002/1 discusses the meaning of 'plant'. The term includes chattels and fixtures kept for use in carrying on the company's research and development operations. In an R&D environment, plant can usefully be classified according to two main types:

• items of 'facilitative plant' (this category of plant covers those items used to carry out R&D activities in a facilitative way, that is, without themselves being the subject of the R&D activities), and
• items of 'end-result plant' that are used for the purpose of furthering the R&D activities (e.g. testing, analysis, data extraction, modification or development). 'End-result plant' is the end result or the object of a particular program of R&D activities, and testing or other analysis of its performance is integral to the R&D program,

where those items are not expected to be consumed or used up in R&D activities.

The concepts of plant and trading stock are mutually exclusive.

Taxation Ruling TR 2002/1, paragraphs 20-23

'Evolving' or 'merged' units of plant

The determination of what comprises a unit of plant depends upon a review of the function and purposes of the item in question and is a question of fact and degree. A unit of plant is an item that has a separate function, and is functionally complete in itself, even though it may not be self-contained or isolated.

When an item of end-result plant is being constructed it becomes a unit of plant at the time that it commences to serve a functional purpose in respect of the R&D operation being conducted. Relevant functions to which it might be applied include:

• testing the success of the plant and the research
• providing data for analysis, and
• adapting or modifying the item to further the research.

Whilst the item may not be 'complete' or considered to be a unit of plant in a conventional (production) sense at such a time, the R&D function that it is serving gives it the character of a unit of plant in respect of the R&D activities being conducted.

A unit of plant may, as a consequence of having had major alterations or additions carried out on it, or by being integrated with other units of plant, evolve or merge into a further unit of plant. This second unit of plant is then subjected to further testing or analysis in its expanded or integrated form. A new unit of plant occurs (as opposed to the original unit merely being modified) if the function or use played by the second unit is materially different from that performed by the original unit.

For example, an innovative pump may be developed and tested initially, and after testing and analysis, its performance found to be lacking. The innovative impeller in this pump is then replaced with one with a modified design. The unit is tested again and found to be successful. Only one unit of plant is considered to exist at this point. However, if the pump is then incorporated in an experimental cooling plant, with a materially different function for the pump, where the merged unit is subjected to further testing, including testing of the effectiveness of the pump within the cooling unit, a new unit of plant is considered to have been created.

The merging of the original unit into the second unit is not a cessation of use of the original unit by virtue of its ceasing to exist. Rather, both units co-exist. Therefore, the expenditure incurred on both units is eligible for deduction as long as the second integrated unit is applied to an R&D purpose or function (provided the other tests of deductibility are met).

Taxation Ruling TR 2002/1, paragraphs 29-34.

What is a prototype and can it be an item of plant

The term 'prototype' is not a defined term for the purposes of section 73B of the ITAA 1936. It is generally used to describe a range of end-result items produced as a result of undertaking research and development activities. The most common use of the term is to describe virtually any experimental, usually 'first-off' item. The expression may at times also be used to refer to items that are pilot plant as defined in subsection 73B(1) of the ITAA 1936. It is also often used to refer to an item that is the forerunner of a new line of trading stock, or to refer to an item of end-result plant that will be used in business operations on completion of R&D activities.

Reference is made to the term 'prototype' in the 1986 Explanatory Memorandum to the R&D tax concession legislation in the context of understanding what activities involved in the creation of a prototype might be eligible research and development activities. It was stated:

'A prototype is an original model on which something new is patterned. It is a basic model possessing the essential characteristics of the intended product; it is not an item intended for sale in its own right'.

The treatment under section 73B of the ITAA 1936 of the various forms of 'prototype' depends on whether or not they can be classified as a unit of plant or pilot plant , as follows.

• The section 73B treatment of any such items that fall within the subsection 73B(1) definition of pilot plant is specifically prescribed for both pre and post-23 July 1996 pilot plant (the operative provisions being subsections 73B(15) and(15AA) respectively).
• Expenditure on a 'prototype' that is a full scale end-result plant falls for consideration as plant expenditure .
• If the expenditure relates to an item that is a forerunner of a new line of trading stock, such as the first of a new line of life jackets, the treatment of that expenditure depends upon whether that 'prototype' performs a plant function in respect of the research and development operation being conducted. To the extent that the 'prototype' is to be used in carrying out the research and development activities, such as by submitting it to durability, longevity and strength testing, it performs such a plant function, or alternatively, is an article used in those operations. As such, the expenditure thereon (labour, materials and a portion of overheads) may fall for consideration as plant expenditure , subject to the exclusive use tests and the disposal provisions relating to plant expenditure.

A prototype is not an item of plant, however, if during the course of being used in the research and development activities, it is expected to be destroyed or rendered useless, or 'consumed' in the research and development operations. If the 'prototype' does not perform any plant function (use) in respect of the research and development operations, it is not an item of plant. In these circumstances, the expenditure is considered for deduction under subsection 73B(14) as research and development expenditure . Expenditure on the majority of items that are the forerunners of trading stock lines probably falls into this category.

Definition of 'plant expenditure'

'plant expenditure', in relation to an eligible company, means expenditure incurred by the company in: the acquisition, or the construction, under a contract entered into on or after 1 July 1985, of a unit of plant other than post-23 July 1996 pilot plant; or the construction by the company, being construction that commenced on or after 1 July 1985, of a unit of plant other than post-23 July 1996 pilot plant, being a unit of plant for use by the company exclusively for the purpose of the carrying on by or on behalf of the company of research and development activities at least for an initial period. ITAA 1936 subsection 73B(1)

The phrase, 'at least for an initial period', has been inserted by amendment with effect from 1 July 1985. The effect of the amendment is that expenditure on a unit of plant will qualify as plant expenditure if the company intends to use the plant in R&D activities at least for an initial period of time, even if it has other future intentions for the use of the plant.

To qualify for a deduction the following points must be satisfied:

• plant expenditure must be incurred by the company in acquiring or constructing a unit of plant;
• the company must commence to use the plant during the year of income exclusively for the purpose of carrying on R&D activities (see subsection 73B(4) of the ITAA 1936);
• the company must not cease to use the unit of plant exclusively for the purpose of carrying on of R&D activities in the year of income (see subsection 73B(5) of the ITAA 1936). Where this requirement and the one above are satisfied, there is an amount of qualifying plant expenditure. Once R&D activities have ceased, there can be no amount of qualifying plant expenditure in respect of that year or any subsequent year; and
• a deduction is available in respect of the year of commencement of use of the plant and the next 2 years, if there is an amount of qualifying plant expenditure in respect of each of those years.

Expenditures on 'end-result plant' or 'prototypes' that are plant

Where end-result plant or prototypes are constructed in a company's manufacturing/ engineering division, it will be necessary to identify the costs directly associated with the construction of the plant. This would also apply where other work is done in the manufacturing/engineering division in connection with other approved R&D projects.

Eligible expenditure would include the following costs: Labour: the labour costs of staff engaged directly in the construction of the prototype. All other labour costs (indirect labour of the foremen, factory managers, storemen, supervisors and cleaners) are to be included in the calculation of overheads. Materials: the costs of which could be substantiated from invoices and other source documents as having been applied to a particular prototype. Overheads: calculated on a reasonable apportionment of expenditure having regard to items of eligible and ineligible factory expenses. See discussion below. Design costs: see discussion below. Installation and transportation costs: see discussion below. Taxation Ruling IT 2552 (paragraph. 24) (IT 2552 is now withdrawn)

 

Overheads Eligible factory expenses for the purpose of calculating an appropriate portion of overheads may include: cleaning consumable items such as oil, grease and cloths which are used generally including the construction of the prototype costs of transporting a prototype to another location for testing electricity, gas and water freight in indirect materials and supplies leasing charges rent repairs and maintenance of plant, machinery and the building safety (for instance, protective clothing or fire protection) salaries and wages of eligible indirect staff (for instance, foremen, supervisors, cleaners) plus associated costs and on-costs security stationery telephone and telex tools and equipment, and waste removal.

 

Ineligible expenses would include: depreciation employee benefits such as canteen facilities factory amenities freight out gardening motor vehicle expenses, and royalties not associated with R&D activities. Taxation Ruling IT 2552 (paragraphs. 25, 26 (IT 2552 is now withdrawn))

Design costs

The general rule is that the costs of preparing specific design plans for the actual unit of plant, such as salary costs of preparing engineers' drawings/blueprints for the plant under construction, comprises expenditure on the construction of the unit of plant. These costs are included as plant expenditure , unless the costs are so insignificant and incidental as to be de minimus .

In contrast, expenditure incurred in the preceding general design and development of the concept of the new plant, (such as salary costs of basic and applied research, computer modelling, etc.) would not be included as expenditure on the construction of the unit of plant. This type of expenditure may qualify as 'other expenditure' within the meaning of research and development expenditure (see Part C2.3.1 Research and development expenditure).

Where the drawings/blueprints are prepared manually for the plant under construction the costs for these items will be readily identifiable and should be included as plant expenditure for that unit of plant. On the other hand, where full computerised and integrated computer assisted design (CAD) processes are used for the concept development, detailed design (materials and specifications), simulation, testing, evaluation and documentation phases, there may be no, or negligible additional cost involved in generating these drawings/blueprints, as these are created in parallel with, and 'fall out of' the other development phases. In these circumstances no amount is required to be allocated as specific design costs of the plant when calculating the amount of plant expenditure.

This view does not apply to expenditure incurred in running a rapid-prototyping program that drives the creation of a prototype that is a unit of plant. Such expenditure will comprise plant expenditure for that unit of plant.

Installation and transportation costs

Expenditure incurred in transporting and/or installing items of eligible (i.e., intended to be used for an initial period, and actually used, exclusively for R&D purposes) plant on-site falls for consideration for deduction under subsection 73B(15) of the ITAA 1936 as qualifying plant expenditure, not under subsection 73B(14) of the ITAA 1936 as research and development expenditure, in both the following circumstances:

• where the transportation and on-site installation occurs after the completion of the construction of the unit of plant , so that it can be used for R&D purposes on that site, and
• where the installation and transportation themselves are instrumental in bringing about a new unit of plant (e.g., where various components or other units of plant are integrated into a new unit of plant ).

Rate of deduction

The deduction available is:

• one-third of the amount of qualifying plant expenditure multiplied by 1.25 if the company's aggregate R&D amount in that year is greater than $20,000, or
• one-third of the amount of qualifying plant expenditure if the company's aggregate R&D amount in that year is less than or equal to $20,000.

ITAA 1936 subsection 73B(15)

Example 2.4

Assume $60,000 is spent over the period 1 January - 1 June 1997, on the construction of an asset intended to be used in an R&D project. The asset is first used on the project on 21 August 1997 and it is used continuously on the project, and for no other purpose, for the following five years. Deductions for the plant expenditure may be claimed over three years as follows, provided that the aggregate R&D amount for each of the years is greater than $20,000:

1997-8	$20,000 x 1.25 = $25,000
1998-9	$20,000 x 1.25 = $25,000
1999-0	$20,000 x 1.25 = $25,000

Note: Even though the unit of plant is not used for the full year in the 1997-98 year, one-third of the cost (plus 25%) is still claimable as a deduction for that year.

Commencement of use

A company is taken to ' commence to use . . . exclusively . . . ' the item at the time the unit is actually first applied to that use. This does not necessarily refer to the first date on which actual physical use occurs. Rather, it refers to the time when the unit of plant is sufficiently completed so as to be seen as being held exclusively for the purpose of carrying on R&D activities. It does not include the period of time in which the unit of plant is being constructed or assembled, and not being applied in carrying out the R&D activities.

Taxation Ruling TR 2002/1 (paragraph. 49)

Cessation of use

The term 'use' in the context of subsection 73B(5) of the ITAA 1936 is to be understood in its ordinary meaning of purpose served or object or end and is not confined to actual physical use.

A narrow interpretation of the term could lead to the conclusion that switching a unit of plant off at night or during a lunch break was a cessation of use.

Using a broad interpretation, where a company is holding or maintaining a unit of plant solely for the purpose of utilising it for specific research and development activities and, when required, is physically applying it to that purpose and to no other purpose, it is 'using' the unit of plant exclusively for the purpose of carrying on research and development activities. The operation of subsection 73B(5) is not triggered.

Subsection 73B(5) operates if either of the following events occur:

• the unit is physically applied to any other purpose; or
• the unit ceases to be held solely for the requisite purpose.

If an item of plant that was previously used exclusively in carrying on R&D activities, ceases to be so used in any of the first three years of its use, the special rate of write-off will not apply in the year of cessation of such use, or any later year. Where this occurs, the part of the cost of the plant not deducted under section 73B may qualify to be written off under the ordinary depreciation provisions of the ITAA.

ITAA 1936 subsections 73B(4), (5), (15) and (21),

Example 2.5

If the plant referred to in the previous example ceased to be used exclusively for R&D on 29 June 2000, no claim could be made under subsection 73B(15) of the ITAA 1936 in respect of the use of that plant in 1999-2000.

Its written down value will be one third of its original cost:

Original cost:	$60,000
Deductions allowed (ignoring concessional component):	$40,000
Written down value	$20,000

Thus $20,000 is available to be written off under the normal depreciation rules where eligible.

Alternatively, where the plant expenditure is deductible under subsection 73B(15), and the plant is disposed of, lost or destroyed prior to that expenditure being fully deducted under this subsection, the balance to be deducted (net of any disposal proceeds) is also deductible at the concessional rate of 125%.

ITAA 1936 subsection 73B(23)

Shared use of plant

After 20 November 1987, a company may provide others with access to plant which it uses exclusively for R&D purposes, without affecting its deduction entitlements. This is provided that the other party also uses the plant exclusively for carrying on R&D activities. Prior to this date, all plant was required to be used either exclusively by the claimant or on the claimant's behalf to be eligible for the concession. It is not necessary for the other party to be an eligible company or for the R&D activities of the other party to be the same as those of the owner of the plant.

ITAA 1936 subsections 73B(1C), (5AA) and (5AB)

If the owner of the plant is entitled to receive consideration (such as lease fees) for making the plant available to another party, the owner's deductible amount under section 73B of the ITAA 1936 will be reduced by one half of that consideration.

ITAA 1936 subsection 73B(15A)

Example 2.6

Assume plant costing $60,000 is purchased, installed and used exclusively for R&D purposes for the following three years. If, in its first year of operation, the owner receives $10,000 lease fees for making the plant available to another party for R&D purposes, then the amount to be claimed is as follows:

 

1997-98	$20,000 x 1.25	= $25,000
less half of lease fees	(-$5000)	= $20,000
1998-99	$20,000 x 1.25	= $25,000
1999-00	$20,000 x 1.25	= $25,000

Leased plant

The plant expenditure provisions relate only to plant that is acquired or constructed by the company. They do not relate to leased plant. Expenditure on leased plant is to be considered as research and development expenditure ('other expenditure' - see paragraph C2.3.1.2), and will be deductible under subsection 73B(14) to the extent the expenditure is directly in respect of R&D activities.

Election re plant depreciation

A company may elect not to claim its plant expenditure under section 73B and claim under the normal depreciation provisions.

ITAA 1936 subsection 73B(18)

Deductions under section 73BA of the ITAA 1936 for plant acquired or constructed prior to 29 January 2001

Section 73BA of the ITAA 1936 allows a deduction in respect of a 'section 73BA depreciating asset' (as defined by section 73BB of the ITAA 1936) for a year in respect of an asset used, or installed ready for use, for research and development).

Section 73BA of the ITAA 1936 applies to assessments for the income year in which 1 July 2001 occurs and for later income years. There is no exclusion of the operation of section 73BA of the ITAA 1936 on the basis of the time of the asset's acquisition or construction.

Division 40 of the ITAA 1997 can apply to an asset acquired or constructed prior to 29 January 2001 because of the operation of section 40-10 of the Income Tax (Transitional Provisions) Act 1997, as amended by the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001, which states that Division 40 of the ITAA 1997 will apply to assets acquired or constructed prior to 1 July 2001, where Division 42 of the ITAA 1997 applied in respect of that asset.

Therefore, an asset which was acquired or constructed prior to 29 January 2001, but which did not meet the requirements for a deduction under subsection 73B(15) of the ITAA 1936 because it was not used, or installed ready for use, 'exclusively' for research and development, will be eligible for a deduction under section 73BA of the ITAA 1936, to the extent that it has a base value/adjustable value. The deduction for the decline in value will then be based on the 'notional Division 40 deduction'.

Note: subsection 73B(20) and 73BA(7) of the ITAA 1936 and section 8-10 of the ITAA 1997 will prevent a deduction for the same expenditure being allowed under more than one provision.

Where an eligible company initially did meet the requirements for a deduction under subsection 73B(15) of the ITAA 1936, but, before the end of the second year of income, ceased to use the unit of plant exclusively for research and development, subsection 73B(21) of the ITAA 1936 states that subsection 73B(20) of the ITAA 1936 will not prevent a deduction for depreciation being allowed. Where a deduction becomes allowable due to subsequent use of the plant for another purpose, an eligible company can claim a deduction under section 73BA of the ITAA 1936 and/or Division 40 of the ITAA 1997 (if apportionment is required), based on the written down value of the asset.

Therefore, expenditure in relation to a pre-29 January 2001 asset may be claimed under section 73BA of the ITAA 1936 to the extent that it has a base/adjustable value (if the requirements of that section are met), even where the expenditure previously qualified for a deduction under subsection 73B(15) of the ITAA 1936.

For further information see: ATO Interpretative Decision ATO ID 2005/84 Research and development: Deductions under section 73BA of the ITAA 1936 in relation to an asset acquired or constructed pre-29 January 2001 Can deductions be claimed under section 73BA of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to a pre-29 January 2001 plant/depreciating asset?

C2.3.5.2 Plant/depreciating assets expenditure on or after 29 January 2001

The Government has adopted a more equitable treatment of expenditure on plant/depreciating assets and other assets used for R&D, effective from 29 January 2001. The new rules cover two periods:

• 29 January 2001 - 30 June 2001 - deductions under section 73BH of the ITAA 1936 for:
  • the decline in value of depreciating plant; and
  • capital works (excluding buildings);
• on or after 1 July 2001 - deductions under ITAA 1936 section 73BA for:
  • the decline in value of depreciating assets; and
  • capital works (excluding buildings).

In certain circumstances expenditure incurred to acquire an asset that is used in carrying on research and development activities may be eligible for immediate deduction.

Key features of the new rules are:

• plant/depreciating assets and capital works are depreciated over their effective lives and allowed at the rate of 125% for the period of time when the asset is used for R&D activities
• the exclusive R&D use requirements and the accelerated write off applicable under the former R&D plant regime no longer apply
• intangible assets are excluded from this regime
• for any periods of time that such plant/depreciating assets are used for activities other than R&D, such as quality control and production, in a year of income, normal capital allowance rules will apply
• the special provisions for pilot plant no longer apply - these assets are now covered in the R&D plant/depreciating asset regime

These changes will benefit companies whose R&D activities are not undertaken with dedicated plant, as pro-rata concessional depreciation is now available. As with the former regime, these rules apply to items of plant or depreciating assets which are used to facilitate the conduct of R&D activities, as well as experimental items which are developed as the object of R&D activities and which are used for testing, analysis, and data recording activities, in the R&D activities.

The expenditure associated with an experimental item, or test model, used by an eligible company in the conduct of its R&D activities will be deductible under section 73BA, provided the company has a 'notional Division 40 deduction' (within the meaning of section 73BC).

For further information see: ATO Interpretative Decision ATO ID 2006/259 Capital Allowances: depreciating asset - section 73BA depreciating asset - full-scale test model Is the full-scale test model of an item of equipment, which is the subject matter of the taxpayer's research and development (R&D) activities, a 'section 73BA depreciating asset' within the meaning of that term in section 73BB of the Income Tax Assessment Act 1936 (ITAA 1936) for which the taxpayer has a 'notional Division 40 deduction' within the meaning of section 73BC of the ITAA 1936?

Expenditure incurred by the company during the course of its R&D activities to refine that experimental item, or test model will form part of that item's cost base, and is deductible under section 73BA.

For further information see: ATO Interpretative Decision ATO ID 2006/260 Capital Allowances: cost - section 73BA depreciating asset - full-scale test model - refinement expenses Does the taxpayer's capital expenditure on refining the full-scale test model of their 'section 73BA depreciating asset' form part of the asset's cost for the purpose of working out the taxpayer's 'notional Division 40 deduction' under section 73BC of the Income Tax Assessment Act 1936 (ITAA 1936)?

For further information see: ATO Interpretative Decision ATO ID 2006/328 Capital Allowances: cost - 'section 73BA depreciating asset' - new full-scale test model - re-use of components from earlier test model Does the cost of the new full-scale test model of the taxpayer's 'section 73BA depreciating asset' include, pursuant to subsection 40-180(3) of the Income Tax Assessment Act 1997 (ITAA 1997), the cost attributed to those components of an earlier test model that have been re-used in building the new test model?

Timing

Generally, these rules apply to plant/depreciating assets that are acquired or constructed under contracts entered into after 12.00pm legal time in the ACT on 29 January 2001, or that the company commences to construct after that time.

Note: in some circumstances expenditure in relation to a pre-29 January 2001 asset may be claimed under section 73BA of the ITAA 1936 (see Deductions under section 73BA of the ITAA 1936 for plant acquired or constructed prior to 29 January 2001, above).

Expenditure on any items of plant acquired or constructed under contracts entered into prior to midday 29 January 2001, or that the company commenced to construct prior to this time, fall within the old R&D plant regime.

From midday on 29 January 2001, deductions for plant/depreciating assets acquired or constructed under contracts entered into after that time and used in carrying on R&D activities will no longer be allowable under section 73B of the ITAA 1936.

After this time, deductions for depreciating plant (as referred to in ITAA 1997 Division 42), and capital works, excluding buildings (as referred to in ITAA 1997 Division 43), used in carrying on R&D activities will be worked out under section 73BH of the ITAA 1936. This section requires that the amount allowable for depreciation on those assets for the period of R&D use be calculated notionally under the rules set out in the general depreciation rules contained in Division 42 of the ITAA 1997, applied with certain modifications. Division 42 only applies up until 30 June 2001, after which time the new uniform capital allowances regime (UCA) came into force.

From the commencement of the UCA on 1 July 2001, deductions for depreciating assets (as referred to in ITAA 1997 Division 40, but excluding intangible assets) used in carrying on R&D activities will be worked out under section 73BA of the ITAA 1936. This section requires that the amount allowable for depreciation on those assets for the period of R&D use be calculated notionally under the rules set out in Division 40 of the ITAA 1997, also applied with modifications.

The modifications which are made in notionally applying these depreciation rules to R&D assets include requirements that:

• the asset be used for the purpose of carrying on R&D activities, rather than for the purpose of producing assessable income, and
• the same method of calculating depreciation and effective life be used as applied before the R&D use, if relevant.

Apportionment for mixed use

Deductions for the decline in value of plant/depreciating assets used for R&D purposes for a portion of an income year can be claimed at the rate of 125% for that portion of use, and will be eligible for normal depreciation to the extent that they are otherwise used for qualifying income producing purposes.

Effective life estimates

The capital allowance rules in Divisions 42 and 40 of the ITAA 1997 allow taxpayers to choose whether to use the Commissioner's estimates of effective life for their depreciating plant or assets or whether to work it out yourself under the rules in those Divisions. In self-assessing the effective life of an asset that is reasonably likely to be used for the purpose of carrying on R&D activities, the plant's effective life will be the longest period for which the plant can be used for:

• R&D purposes
• assessable income producing purposes, or
• exempt income producing purposes.

This is determined having regard to the wear and tear the taxpayer would expect from the circumstances of use, and assuming the asset would be maintained in reasonably good order and condition. If, in working out this period, it is concluded that the asset would be scrapped before the end of that period, its effective life ends at the earlier time.

ITAA 1997section 40-105

In considering whether the asset is likely to be scrapped, the inherent technical risk in the R&D activities is not to be taken into account as a relevant consideration. In the event that the technical risk in the R&D activities does in fact lead to the early scrapping of the plant, the balancing adjustment provisions ensure that the appropriate concessional write-off is given.

ITAA 1936 subsections 73BG(2) and 73BN(2)

R&D assets and depreciation pools

A deduction for the decline in value of an asset cannot be claimed under the R&D tax concession where that asset has been included in an income tax depreciation pool. Once an asset is pooled, its tax identity and its adjustable value are lost, and the asset can no longer be distinguished from other assets in the pool. The types of pools that companies are able to elect to place their assets in include:

• common depreciation rate pools under Division 42-L of the ITAA 1997
• low value asset pools in Division 42-M of the ITAA 1997 and Division 40 of the ITAA 1997
• pools available under the simplified tax system (STS) for small companies.

ITAA 1936 subsections 73BA(4) and 73BH(3)

Treatment of expenditure on low cost items for taxpayers carrying on business

Practice Statement PS LA 2003/8 provides guidance to taxpayers carrying on a business to help them determine if expenditure incurred by them to acquire certain low cost tangible assets is either immediately deductible under section 8-1 of the ITAA 1997 or subsection 73B(14) of the ITAA 1936 or written-off under the capital allowance rules in Division 40 of the ITAA 1997 (or section 73BA of the ITAA 1936 for expenditure incurred to acquire or construct an asset that is used in carrying on research and development activities).

In accordance with this Practice Statement, expenditure of $100 or less incurred by a taxpayer to acquire a tangible asset in the ordinary course of carrying on a business can be assumed to be immediately deductible under section 73B(14) of the ITAA, provided all other R&D tax concession eligibility requirements are met. The $100 threshold is inclusive of any GST included in the price of the item ensuring there is no need to separately identify any GST applicable to individual items. Note, however, that Division 27 of the ITAA 1997 ensures that a deduction is not available for expenditure to the extent it relates to an input tax credit or decreasing adjustment under the GST legislation (see Part C2.1.17 - Goods and Services Tax (GST) Implications.)

Note: Practice Statement PS LA 2003/8 has a number of general qualifications and does not apply to expenditure incurred by businesses that have entered into the simplified tax system.

Decline in value of certain assets not used in carrying on a business

For the purposes of calculating a notional Division 40 deduction under section 73BC of the ITAA 1936, subsection 40-80(2) states that:

The decline in value of a *depreciating asset you start to *hold in an income year is the asset's *cost if:

1. that cost does not exceed $300; and
2. you use the asset predominantly for the *purpose of producing assessable income that is not income from carrying on a *business; and
3. the asset is not one that is part of a set of assets that you started to hold in that income year where the total cost of the set of assets exceeds $300; and
4. the total cost of the asset and any other identical, or substantially identical, asset that you start to hold in that income year does not exceed $300.

Following the application of the change set out in subsection 73BC(2) of the ITAA 1936, this results in expenditure that meets these criteria being immediately deductible rather than the deduction being calculated on the basis of the effective life of the asset.

Flowchart

This flowchart is to assist in determining whether expenditure incurred on or after 1 July 2001 is eligible for an immediate deduction or whether the deduction needs to be calculated on the basis of the effective life of the asset.

What is the amount of the deduction?

Where the company's aggregate R&D amount is greater than $20,000, the amount deductible to the company is 125% of the notional Division 42 or Division 40 deduction. Otherwise, the deduction is the notional Division 42 or Division 40 deduction.

ITAA 1936 subsections 73BA(3) and 73BH(2)

How do balancing charge rules work?

When an asset is disposed of, its value at the time of disposal may vary from its adjustable value which is the original cost of the asset less depreciation. Where this occurs in respect of an item of plant or depreciating asset used for the purpose of carrying on R&D activities, the tax treatment in respect of the profit or loss (balancing adjustment) derived on disposal is the same as applies under the normal tax depreciation regimes.

Where a balancing loss is made (that is, the adjustable value exceeds the termination value), the loss is allowable as an additional deduction, to the extent that the asset was used in deriving assessable income or conducting R&D activities over its life.

Similarly, where a balancing profit is made (that is the termination value exceeds the adjustable value), the profit is included in assessable income to the extent that the asset was used in deriving assessable income or conducting R&D activities over its life.

Where such a balancing adjustment occurs in respect of an asset that has at some stage been used in conducting R&D activities, a further adjustment is required in respect of the additional concession (25%) relating to that adjustment. If a balancing loss has been incurred, the portion of that loss that relates to the R&D use of the asset over its life will attract an additional 25% deduction. Where a balancing profit has been derived, the portion of that profit that represents depreciation in respect of R&D activities over its life that has been recouped will trigger the inclusion of an amount equal to 25% of that recouped depreciation.

Note: amounts claimed as a balancing adjustment under ITAA 1936 section 73BF are not eligible for the R&D tax concession as an offset.

ITAA 1936 section 73I

Example 2.7: Balancing adjustment

A new item of plant costing $1,000,000 is used in eligible R&D activities for 274 days in a year, and is then used in production activities for the remaining 91 days, before being sold at year's end. Assuming that the effective life is 10 years, the R&D depreciation that will be allowable for the 274 days R&D period is calculated as follows:

$1,000,000 x (274/365) x (100%/10) = $ 75,068

Deduction allowable increased by 25% = $93,835.

Normal depreciation allowable for the 91 days (non R&D period) production use is:

$1,000,000 x (91/365) x (100%/10) = $24,932

If the item is disposed of for the sum of $850,000 at the end of the year, a loss on disposal of $50,000 will have been incurred, calculated as follows:

Adjustable value

Cost $1,000,000 minus depreciation $100,000	= $900,000
Termination value	= $850,000
Loss incurred (difference)	= $50,000

Concession adjustment

Proportion of loss reflecting proportion of asset's R&D use over its life (ie 274/365) is increased by 25%, i.e. $50,000 x (274/365) x 25% = $9,384

Total deduction allowable in respect of disposal = $59,384

If the item had been disposed of for the sum of $910,000 at the end of the year, a profit of $10,000 would have been derived, calculated as follows:

Termination value	= $910,000
Adjustable value:
Cost $1,000,000 minus depreciation $100,000	= $900,000
Profit derived	= $10,000

Concession adjustment

Proportion of profit reflecting proportion of asset's R&D use over its life (i.e. 274/365) is increased by 25%, i.e. $10,000 x (274/365) x 25% = $1,877

Total amount assessable in respect of disposal = $11,877

For further information see: ATO Interpretative Decision ATO ID 2006/327 Capital Allowances: balancing adjustment event - 'section 73BA depreciating asset' - existing full-scale test model - discontinued use Does a balancing adjustment event occur under paragraph 40-295(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) for the existing full-scale test model of the taxpayer's 'section 73BA depreciating asset' if the taxpayer discontinues use of the test model because it could not operate in the manner required?

C2.3.6 Consolidation and asset expenditure

Deductions under section 73BA of the ITAA 1936

A deduction can be claimed under section 73BA of the ITAA 1936 in relation to certain assets that become assets of the head company upon consolidation under subsection 701-1(1) of the ITAA 1997.

Under subsection 701-10(4) of the ITAA 1997, the tax cost of each asset that an entity brings into a consolidated group when it becomes a subsidiary member of the group is set at that time at the asset's tax cost setting amount. The expression 'tax cost is set' has the meaning given by section 701-55 of the ITAA 1997. This section provides that, where any of

• Subdivisions 40-A to 40-D, sections 40-425 to 40-445 or Subdivision 328-D of the ITAA 1997, or
• sections 73BA or 73BF of the ITAA 1936

apply in relation to the asset, the cost for tax purposes is set on the basis that those provisions apply as though, inter alia, the asset was acquired by the head company at the time the entity became a subsidiary member of the consolidated group and for a payment equal to its tax cost setting amount.

Generally, an asset's tax cost is set by section 701-10 of the ITAA 1997 (cost to head company of assets that an entity becoming a subsidiary member brings into the group), such that the asset's 'tax cost setting amount' is worked out in accordance with Division 705 of the ITAA 1997. The tax cost of each asset of a joining entity is based on a share of the group's allocable cost amount (ACA) for that entity. The ACA consists of the cost of the membership interests in the entity together with its liabilities, which become liabilities of the group. Adjustments to this overall amount are made to reflect certain undistributed profits, distributions and losses of the joining entity and certain deductions to which the head company becomes entitled. Generally, the cost setting process requires market valuing of a joining subsidiary's assets at the joining time.

Once the tax cost of the asset is set, then the head company may be allowed a deduction under Division 40 of the ITAA 1997 or section 73BA of the ITAA 1936, in relation to the asset if the requirements for claiming a deduction under those sections have been met. See below 'preventing double deductions'.

Note: Where expenditure in relation to an asset is being claimed under subsection 73B(15) of the ITAA 1936 and, before the end of the third year, the company becomes a subsidiary member of a consolidated group, the deemed acquisition at the time the company became a subsidiary member will not preclude a deduction being claimed under subsection 73B(15) of the ITAA 1936 in relation to the asset, so long as the requirements for claiming a deduction under the section continue to be met. However, once the tax cost of the asset has been set, section 73BAF of the ITAA 1936 will operate to prevent a (double) deduction in relation to the asset under Division 40 of the ITAA 1997.

Preventing double deductions

The provisions within section 73B of the ITAA 1936 that give deductions for expenditure in relation to R&D assets do so by allowing a deduction for a portion of the amount of expenditure incurred, as opposed to allowing a deduction for the decline in value of the R&D asset over its effective life (e.g. core technology expenditure, pre 29 January 2001 plant expenditure and post 23 July 1996 pilot plant expenditure provisions). When a company enters a consolidated group, its depreciating assets are taken to have been acquired by the group's head company for a new payment (see paragraph 701-55(2)(a) of the ITAA 1997), which may give rise to a new series of deductions for the asset's decline in value (e.g. under section 73BA of the ITAA 1936 (R&D asset depreciation) or Division 40 of the ITAA 1997 (capital allowances)) for the same asset. Because that new payment is not the original R&D expenditure, the provisions that prevent double deductions for expenditure by providing that no other deduction be allowed for that R&D expenditure do not apply.

Specific provisions have now been enacted to prevent such double counting of deductions. They operate by reducing any deduction for the asset's decline in value under Division 40 of the ITAA 1997 and any 'notional Division 40 deduction' under section 73BC of the ITAA 1936 by the amount that is deductible under section 73B of the ITAA 1936.

ITAA 1936 subsections 73BAF(1) and (2)

Example 2.8: Deduction for asset's decline in value reduced

Formaldehyde Ltd spends $1 million to buy core technology in the form of the patent to a drug for the purposes of researching an improved drug. It then joins a consolidated group and the cost-setting amount for the patent becomes $1.2 million. In year 1, Formaldehyde spends $600,000 researching the improved drug and, because of the single entity rule, the group's head company, Benzedrine Ltd is taken to have spent that money. Because of the entry history rule, Benzedrine is also taken to have spent $1 million buying the patent, so it can deduct $200,000 of the core technology expenditure (that is, a third of the $600,000 research and development expenditure that is related to the relevant core technology) (see subsections 73B(12A) and (12B) of the ITAA 1936).

The notional Division 40 deduction for the patent is $60,000. The amendment will reduce that to nil because of the core technology deduction. The patent's adjustable value will still decline to $1.14 million even though the deduction for the asset's decline in value was reduced to nil.

If the deduction under section 73B of the ITAA 1936 exceeds the deduction for the asset's decline in value, the excess is carried over to reduce future years' deductions for the asset's decline in value.

ITAA 1936 subsection 73BAF(3)

Example 2.9: Carry forward of reduction amount

Continuing the previous example, Benzedrine spends $75,000 on research in year 2, so it can deduct a further $25,000 of the cost of the patent under the core technology provisions. That will reduce year 2's notional Division 40 deduction from $60,000 to $35,000. However, $140,000 of the reduction amount was unused from year 1, so that unused amount will reduce the notional Division 40 deduction to nil and the remaining $105,000 will carry forward to future years.

C2.3.7 Interest expenditure

Interest, or an amount in the nature of interest, incurred during the year of income in the financing of R&D activities, is deductible at 100% under subsection 73B(14A) of the ITAA 1936. Where interest has been incurred specifically to fund eligible R&D activities, the expenditure will qualify for a deduction. If an amount is borrowed to finance both R&D activities and for other purposes, the company would be expected to be able to establish the extent to which the expenditure was for the purpose of financing of R&D activities, as only that portion of the interest would qualify for a deduction under subsection 73B(14A) of the ITAA 1936.

Money might be borrowed by a company specifically to finance an R&D project but the whole of the principal borrowed is not immediately applied to R&D activities, e.g. part of the moneys may be deposited with a bank until it is needed to pay for particular activities. In such a case, provided the whole of the principal sum is within a reasonable time applied to R&D activities, the finance costs would be deductible in full, notwithstanding that, in the interim period of deposit, assessable income from interest had been received. What is reasonable in a particular case will depend on the circumstances, including the use to which the moneys are put during the interim period before it is applied to R&D activities.

Section 73B of the ITAA 1936 must be read subject to subsection 26-26(1) of the ITAA 1997, which prevents a deduction on a non-share equity distribution or a return that has accrued on a non-share equity interest. To the extent that 'interest expenditure' as defined by subsection 73B(1) of the ITAA 1936 is also a non-share distribution or a return that has accrued on a non-share equity interest, that amount is not deductible under subsection 73B(14A) of the ITAA 1936.

For further information see: ATO Interpretative Decision ATO ID 2005/61 Research and development: Deductibility of returns on a non-share equity interest under section 73B of the ITAA 1936 Are returns on a non-share equity interest deductible under the research and development provisions contained in section 73B of the Income Tax Assessment Act 1936 (ITAA 1936))?

C2.3.8 Building expenditure

A decline in value of buildings used for R&D is not eligible for concessional deduction. Deductions may, however, be available under the capital allowance provisions in Division 43 of the ITAA 1997. In order to claim a decline in value for building expenditure in this manner, companies must be registered for the concession and must use the buildings in connection with a business that is carried on for the purpose of producing assessable income.

ITAA 1997 section 43-35; section 43-195

C2.3.9 Cost of patents

Deductibility of expenditure incurred in taking out a patent on intellectual property, that is not core technology, depends upon whether:

• the patenting activity is a 'supporting activity' for the purposes of paragraph (b) of the definition of 'research and development activities' in subsection 73B(1) of the ITAA 1936; and
• the expenditure incurred was 'directly in respect of that R&D activity'.

Where an activity is carried on for a purpose directly in respect of the carrying on of a systemic, investigative and experimental activity it is considered to be an R&D activity (see Part B3-1.4 - Directly related activities). It would be expected that such activities would be registered with the Board.

Note: Commercial, legal and administrative aspects of patenting activities are not taken to be systematic, investigative and experimental activities for the purposes of paragraph (a) of the definition of 'research and development activities' in subsection 73B(1) of the ITAA 1936.

ITAA 1936 paragraph 73B(2C)(k)

The eligibility of R&D activities is determined by the Board and should not be confused with eligible expenditure, which is determined by the Tax Office.

Expenditure incurred in relation to research and development activities is deductible under subsection 73B(14) of the ITAA 1936 as 'other' research and development expenditure (see Part C2.3.1.2 -Other expenditure).

If expenditure is incurred before or after the undertaking of R&D activities it is not incurred directly in respect of those activities and is therefore not deductible as R&D expenditure under subsection 73B(14) of the ITAA 1936. Such expenditure may be deductible under other provisions of the Act.

Patent application costs incurred after the completion of the relevant R&D activities may not have the required connection to qualify as being 'directly in respect of' those activities, so as to be deductible under section 73B of the ITAA 1936. However, patents acquired in the course of conducting R&D activities may do so, bearing in mind that their costs of acquisition may also be core technology expenditure (see Part 2.3.4-core technology expenditure).

C2.3.10 Prepayments of R&D expenditure (including advanced and accelerated R&D expenditure)

The provisions relating to prepayment of R&D expenditure have been changed from 1 July 2001, so as to align them with the general prepayment regime applying to deductions incurred in deriving assessable income. Previously, R&D prepayments that related to periods of up to 13 months were deductible immediately, but where they related to periods in excess of this, were generally required to be spread over that period.

Under the new rules, most prepayments of R&D expenditure incurred by the following types of taxpayer, will be required to be claimed on a spread basis over the period for which the goods or services are provided:

• from 21 September 1999, non-small business companies (generally with a group turnover of more than $1m)
• from 1 July 2000, small business companies who have not elected to enter the simplified tax system (STS), or
• from 11 November 1999, under a 'tax shelter' agreement (certain managed arrangements).

Note: If applicable, the transitional, phasing-in rules in sections 82KZME-F of the ITAA 1936 will operate.

Generally, a prepaid expense will be immediately deductible to an STS taxpayer if it relates to an eligible service period of 12 months or less, that ends either in the year the expense was incurred, or in the next year.

Any prepayment that is less than $1,000, or required to be incurred by order of a Court of the Commonwealth, a State or Territory, or under a contract of service, or to the extent it is capital, private or domestic in nature, is not required to be spread, but remains deductible when incurred.

Example 2.10

A (non-small) company prepays the rent on its R&D laboratory for one year on 31 December 2001 for $2,600. It is eligible to claim $1,300 in the current income year ending 30 June 2002, and the remaining $1,300 in the following income year (assuming that the transitional prepayment rules have no operation).

Prepaid contracted expenditure

A further exception to the rules requiring spreading of prepaid amounts, is in respect of prepaid contracted expenditure. That is expenditure incurred by companies to Registered Research Agencies (RRAs). Such prepayments are called accelerated expenditure.

ITAA 1936 subsection 73B(1)

The rules applying to this type of prepayment were not changed on 1 July 2001. This expenditure is deductible immediately if the prepayment relates to a period of up to 13 months. Prepayments that relate to periods in excess of this are required to be spread over the period to which they relate (subject to the same exceptions referred to in the paragraph above the example). However, where such payments are required to be spread over two or more periods, any amounts so deferred can be 'brought forward', or accelerated, one year earlier.

ITAA 1936 subsection 73B(11)

Spreading of prepaid expenditure

Where prepaid expenditure is required to be deducted on a spread basis, it is taken to be incurred in equal proportions throughout its eligible service period. Essentially, this means that it will be apportioned on a pro-rata basis across each of the years covered by the eligible service period. Broadly, the proportion of the deduction to be allowed in each year is calculated by reference to the number of days in the eligible service period that occur in the year of income relative to the total number of days in the eligible service period.

The eligible service period starts on the first day that the thing to be done under the agreement for which the expenditure is incurred is required or permitted to be done (or the date of the expenditure if this is later), and ends on the last day on which this thing is required or permitted to cease to be done.

ITAA 1936 subsection 82KZL(1)

Example 2.11: Contracted expenditure

An eligible company incurs research and development expenditure of $1,000,000 to a Registered Research Agency on 1 May 2001 in respect of services that will be provided from 1 June 2001 to 31 May 2004.

	2000-1	2001-2	2002-3	2003-4	Total
Number of days in eligible service period	30	365	365	335	1,095
Proportion allowable	(30 / 1,095)	(365 / 1,095)	(365 / 1,095)	(335 / 1,095)	1,095
Expenditure taken to be incurred	$27,397	$333,333	$333,333	$305,937	$1,000,000
Accelerated allowed - deductions after first year bought forward one year	$360,730	$333,333	$305,937	$nil	$1,000,000
Deduction allowable @ 125%	$450,912	$416,667	$382,421	Nil	$1,250,000

C2.3.11 Reduced rate for group markup

The group markup rules aim to identify the total markup on the other entity's expenditure, forming part of the overall amount charged to the eligible company, and only allow the eligible company to claim the markup component at the rate of 100 %, rather than 125 %. These rules apply from the first year of income of an eligible company after 30 June 2001, where its research and development expenditure deductible under either subsections 73B(13) or (14) of the ITAA 1936 includes a group markup.

A group markup occurs where the eligible company's R&D expenditure includes a component related to acquiring goods or services from an entity with which it was grouped under section 73L of the ITAA 1936 at the time that the other entity in the group incurred expenditure relating to those goods or services (see also Part 2.1.6 - Group markup and Consolidation).

Note: Where the goods or services provided by an entity in the group ('the first group entity') to the eligible company, have before that, been acquired by the first group entity from another entity also in the group ('the second group entity'), the new rules apply to both the supply by the second group entity to the first group entity and by the first group entity to the eligible company. See the example below.

Example 2.12

XYZ Ltd contracts with its subsidiary company ABC Ltd, for the provision of R&D services for $500,000.

In order to fulfil that contract, ABC orders some supplies through another subsidiary SUP Co. for $100,000. SUP's costs of supplying those goods were $90,000 (cost of goods, salary and overhead costs).

ABC's costs were $450,000 (labour, supplies, overheads and plant depreciation).

XYZ registers its eligible R&D activities, and is entitled to deduct expenditure as follows:

Total group markup = total amounts charged less total actual cost

($500,000 + $100,000) - ($450,000 + $90,000)

= $60,000

The amount eligible for deduction by XYZ at 100% rate equals the total group markup: $60,000

The amount eligible for deduction by XYZ at 125% rate is the R&D amount less the total group markup, i.e. $500,000 - $60,000 = $440,000

ITAA 1936, subsections 73B(14AA), (14AB), and 14(AC)

C2.3.12 Expenditure on overseas R&D activities

Expenditure incurred by the company during the year of income on overseas R&D activities must be approved by the Board in advance of the R&D activities being undertaken (i.e. there must be a grant of a provisional certificate under section 39ED of the IR&D Act before the activities are undertaken). This requirement applies to all eligible R&D activities:

• systematic, investigative and experimental activities (also known as SIE or 'core' activities); and
• 'directly related' activities (also known as 'supporting' activities).

If advanced approval is not obtained, the overseas activities will be ineligible for the R&D tax concession even if they otherwise meet the criteria for eligible overseas expenditure. The Board has no statutory discretion to give approval once the activities have taken place (see Part B5-5 Overseas R&D Activities).

Incidental expenditure on overseas activities

Paragraphs 16 and 17 of IT 2442 (now withdrawn), issued by the Commissioner of Taxation in 1987, deal with ancillary or incidental activities carried on overseas in relation to an Australian R&D project. These paragraphs no longer apply as they relate to a definition of research and development activities that was amended in 1994 and the ruling has been withdrawn.

However, since 1994 the Commissioner of Taxation has administratively adopted a practice similar to that mentioned in IT 2442, of accepting minor amounts of expenditure on overseas R&D activities as being deductible without a provisional overseas certificate.

The kinds of expenditure accepted for this purpose are expenditures on overseas R&D activities that are incidental to, or de minimus of, an Australian R&D project.

Example 2.13:

Expenditure incurred by an eligible company in sending R&D staff overseas to observe techniques used in other countries or to attend relevant seminars may be accepted as research and development expenditure, where those activities are directly related to the company's R&D activities carried on in Australia.

The eligible overseas R&D activities are determined by the Board and should not be confused with deductible overseas expenditure which is determined by the Tax Office.

C2.3.13 Anti-avoidance measures

Subsections 73B(31), 73B(32) and 73BD(2) of the ITAA 1936 contain various anti-avoidance measures which may apply in circumstances where parties are not dealing with each other at arms length in relation to R&D transactions.

Subsection 73B(31) of the ITAA 1936 may apply if an eligible company:

• incurs research and development expenditure, core technology expenditure or expenditure incurred for the acquisition or construction of plant;
• is not dealing with the party to which the expenditure was incurred on an arms length basis; and
• the amount of the expenditure would have been less if the parties dealt with each other at arms length in relation to the incurring of the expenditure.

Where subsection 73B(31) of the ITAA 1936 applies, it operates to limit the deduction that an eligible company can claim to only so much of the expenditure that the Commissioner considers is reasonable having regard to the connection between the parties, what the expenditure would have been had the parties dealt at arm's length, and any other relevant matters. Subsection 73BD(2) of the ITAA 1936 provides a similar requirement for expenditure regarding a section 73BA depreciating asset.

Subsection 73B(32) of the ITAA 1936 applies to non arm's length sales or disposals of plant or buildings for less than their market value. It provides for the substitution of the consideration receivable in respect of the sale or disposal with this market value.

Note that the general anti-avoidance provisions of the income tax law may also apply to arrangements for the conduct of research and development activities. Nothing in section 73B of the ITAA 1936 excludes their operation.

C2.3.14 Calculation of deductions

This section gives some practical examples on how to solve problems when calculating amounts of eligible 'R&D expenditure'. The examples mainly relate to the identification and calculation of salary and other expenditure incurred directly in respect of R&D activities.

C2.3.14.1 Expenditure threshold

To claim a deduction at the concessional rate, a claimant company must spend more than $20,000 in a year of income unless they have incurred their expenditure on R&D under contract with a Registered Research Agency (RRA).

ITAA 1936 subsection 73B(13)

The legislation describes three circumstances where the expenditure threshold is waived. However, the only one of these which currently applies is in respect of payments to a RRA. Those circumstances described in the legislation are for expenditure incurred:

• to an Approved Research Institute between 1 July 1985 and 30 June 1988
• to a Registered Research Agency after 19 November 1987, or
• to the Coal Research Trust Account.¹

¹The Coal Research Assistance Act was amended to suspend coal levy collection by the Coal Research Trust Account with effect from July 1992. This function has now been undertaken by the newly incorporated 'Australian Coal Research Limited', which has been approved as a RRA and registered under section 39F of the IR&D Act with effect from 17 May 1993.

C2.3.14.2 Calculation of eligible expenditure

The 125% rate is applied to the total R&D expenditure of a company eligible for this treatment to determine the total deductible amount.

The following are some detailed working examples to demonstrate the calculation of total eligible R&D expenditure.

Example 2.14

R&D is absorbed within the company's administration cost centre. Separate records are prepared for this cost centre in addition to records for other cost centres such as selling and distribution, and manufacturing. The R&D staff spend approximately 50% of their time on eligible R&D activities.

Administrative expenses	Ineligible	Eligible-charged separately	Eligible-apportionable expenses
Advertising	13,200
Audit fees	42,100
Bad debts	10,600
Banking charges	7,400
Cleaning fee			32,600
Decline in value	11,800
Directors' fees	40,600
Electricity, gas and water			23,200
Entertainment (ineligible)	9,000
Insurance - fire and general			21,000
Leasing - general			62,000
Patents and trademarks (after R&D completed)	900
Postage			7,700
Printing and stationery			16,200
Provision for doubtful debts	11,500
Rent			32,300
Salaries - R&D staff		82,600
- indirect (administrative)			108,200
- R&D management			42,700
- other (eg legal)	72,000
Subscriptions			16,200
Superannuation - R&D staff		4,215
- indirect			5,521
- R&D management			2,179
- other	3,674
Telephone and telex			19,600
Travel (domestic)	41,600
TOTAL	$ 264,374	$ 86,815	$ 389,400

Total company salaries and wages

Factory - direct	731,600
- indirect	271,000
Administration (including R&D)	305,500
Selling and distribution	63,800
Total	$ 1,371,900

R&D staff prove that 50% of their time is spent on eligible R&D activities. Eligible R&D salaries are $41,300 (50% of $82,600 salary).

Administration cost of R&D

Allocation of superannuation

Assume that the employer contributions to the superannuation fund total $70,000. The scheme is identical for each employee. Superannuation contributions allocated to each section would be as follows:

Factory - direct - indirect	70,000 x (731,600 / 1,371,900)	37,329
	70,000 x (271,000 / 1,371,900)	13,828
Administration - R&D staff - indirect	70,000 x (82,600 / 1,371,900)	4,214
	70,000 x (108,200 / 1,371,900)	5,521
Management - R&D - other	70,000 x (42,700 / 1,371,900)	2,179
	70,000 x (72,000 / 1,371,900)	3,674
Selling and distribution	70,000 x (63,800 / 1,371,900)	3,255
Total	$1,371,900	$ 70,000

The on-cost of superannuation allocated to R&D is:

Total R&D claim

R&D salaries	41,300
R&D salary on-costs	2,107
Administration costs	11,723
Total	$ 55,130

Example 2.15

A company undertakes R&D and only one set of accounts is prepared for the whole company. R&D staff spent 20% of their time on eligible R&D activities. This time spent on R&D is readily ascertainable from timesheets.

General accounts

Expenses	Ineligible	Eligible- charged separately	Eligible-apportionable expenses
Accounting and audit fees	19,100
Advertising	22,600
Bank charges	2,000
Bad debts	13,200
Cleaning			8,900
Consumable stores			2,300
Decline in value	14,600
Electricity, gas and water			17,800
Employee benefits (sales staff)	3,700
Insurance - fire and general			4,500
Lease payments (office machines)			26,100
Marketing expenses	15,900
Postage			2,800
Payroll tax - R&D staff		800
- eligible administration			600
- other	300
Rent			29,200
Repairs and maintenance			21,600
Royalties	2,100
Salaries - R&D staff		140,000
- eligible admin.			100,000
-other	391,800
Staff recruitment			28,200
Stationary and office supplies			4,700
Subscriptions			5,900
Travel and accommodation (domestic)		19,300
Vehicle expenses		12,700
Workers' compensation premiums
- R&D staff		500
- eligible administration			2,000
- other	6,300
TOTAL	$ 491,600	$ 173,300	$ 254,600

Administration cost of R&D

Assuming that R&D staff spent 20% of their time on eligible R&D activities, eligible R&D salaries would be $28,000 (that is, 20% of $140,000).

Allocation of on-costs

Payroll tax and workers' compensation premiums have been separately identified and R&D staff spent 20% of their time on eligible R&D activities as above. The portion applicable to R&D salary expenditure would be:

20% x (800 + 500) = $260

Total R&D claim

R&D salaries	28,000
R&D salary on-costs	260
R&D travel and accommodation (assume 50%)	9,650
R&D vehicle expenses (assume 30%)	3,810
R&D administration costs	11,283
Total	$ 53,003

Example 2.16

A separate section of a company, which is a cost centre in its own right, undertakes R&D. In such a case, records are prepared for this centre. Separate records are kept for the administration centre and other cost centres. R&D staff spends 50% of their time on eligible R&D activities.

R&D conducted by a separate cost centre

R&D section expenses	Ineligible	Eligible - charged separately	Eligible - apportionable expenses
Consumables			5,100
Decline in value	16,200
Field expenses		2,600
Lease charge - general			10,200
Motor vehicle expenses		7,300
Parts and materials		13,100
Printing and stationery			1,900
Repairs and maintenance		2,700
Salaries - R&D staff		80,000
- indirect			24,900
Superannuation - R&D staff		9,782
- indirect			5,490
Telephone and telex			2,600
Travel (domestic)	8,000
TOTAL	$ 24,200	$ 115,482	$ 50,190

Assume that:

• eligible apportionable administration section expenses = $104,880
• total company salaries and wages including R&D salaries and wages = $400,000

R&D staff proved that 50% of their time is spent on eligible R&D activities.

Eligible R&D salaries are $40,000 (that is, 50% of $80,000).

R&D section expense component equals:

Administration expense component equals:

*[R&D indirect salaries and wages (as per R&D section expense formula above)]

= 24,900 x (40,000/80,000) = $12,450

Alternatively, using the combined formula:

where

a = eligible apportionable expenses of R&D section

b = eligible apportionable expenses of administration section divided by total company salaries and wages

c = total salaries and wages of R&D staff

d = total indirect salaries and wages of R&D section

e = eligible R&D salaries and wages

On-cost of superannuation

Total R&D claim

Field expenses (assume 100%)	2,600
Motor vehicle expenses (assume 40%)	2,920
Parts and materials (assume 80%)	10,480
Repairs and maintenance (assume 70%)	1,890
Salaries	40,000
Superannuation	4,891
Administration expenses	13,752
R&D section expenses	25,095
Total	$ 101,628

C3 Expenditure on foreign owned R&D

This document has been archived. It is current only to 30 June 2011.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

 

For the year of income commencing after 30 June 2007 and later years, the Government has extended the incremental tax concession (175% premium) to companies who incur expenditure on foreign owned R&D.

The extension of the 175% premium is intended to encourage additional R&D expenditure in Australia by multinational enterprise subsidiaries by providing Australian companies with an immediate 100% deduction for expenditure on eligible foreign owned R&D activities and an additional 75% immediate tax deduction on expenditure above the average of the previous three years of expenditure on foreign owned R&D activities.

This section is about the specific 100% base deduction for expenditure on foreign owned R&D. (For further information on the 75% deduction for increased expenditure on foreign owned R&D, please refer to C7 175% International Premium).

Key features of the 100% specific deduction on foreign owned R&D are as follows:

• the deduction will be restricted to Australian companies who, while grouped with a foreign company, incur expenditure on activities undertaken on behalf of that foreign company
• the activities must be carried on wholly or primarily on behalf of the foreign company who is grouped with the eligible company
• the foreign company on whose behalf the activities are undertaken must be a body corporate resident in a foreign country with which Australia has a double tax agreement, and must be a foreign resident for the purposes of that double tax agreement
• expenditure must be incurred for the purpose of carrying on activities that are conducted in Australia. Any expenditure incurred for the purpose of carrying on activities conducted overseas will not be deductible under the 100% specific deduction for expenditure on foreign owned R&D
• the activities must be carried on directly or indirectly under a written agreement between the eligible company and the foreign company
• the deduction is not available for expenditure incurred by an eligible company on activities it performed as a subcontractor under a contract with another eligible company who is its section 73L group member
• the eligible company must incur a minimum of $20,000 expenditure on eligible activities
• for any eligible company in a group to be able to deduct an amount for foreign owned R&D, all eligible companies in the group must register with Innovation Australia (the Board) for the year of income in relation to all eligible activities on which they have incurred expenditure in the year.

C3-1 Timing

Companies can claim the deduction for expenditure on foreign owned R&D incurred in their first year of income that commences after 30 June 2007, and later income years.

C3-2 Eligibility

An eligible company may deduct an amount for expenditure on foreign owned R&D if it satisfies all of the following conditions:

• the eligible company incurs expenditure in the year of income at a time when it is grouped under section 73L of the ITAA 1936 with a foreign company
• the expenditure is incurred for the purpose of the carrying on of 'Australian-centred research and development activities'
• the activities are carried on wholly or primarily on behalf of the foreign company that is a group member of the eligible company
• the activities are carried on, directly or indirectly, under a written agreement between the eligible company and the foreign company and no other parties, for the activities to be performed:
  • by the eligible company, or
  • by another person directly or indirectly under another agreement to which the eligible company is, or will become, a party
• the expenditure is not incurred in connection with an agreement that:
  • is between the eligible company and another eligible company that is grouped under section 73L with the eligible company when the expenditure is incurred, and
  • is an agreement for the activities to be performed either by the eligible company or by a person who is not party to the agreement and is to perform the activities directly or indirectly under another agreement to which the eligible company is or will become a party
• the expenditure on foreign-owned R&D by the eligible company for the year of income exceeds $20,000
• the eligible company, and each eligible company in its group at any time in the year of income, are registered with the Board for the year of income in relation to all Australian-centred R&D activities on which the eligible company (or group member) incurred expenditure in the income year, regardless of whether the activities were covered by an R&D plan.

C3.2.1 Grouped with a foreign company

The eligible company must incur the expenditure on foreign owned R&D in the year of income while grouped under section 73L of the ITAA 1936 with a foreign company. Expenditure on foreign owned R&D incurred at a time when the eligible company is not a group member of a foreign company is not deductible.

ITAA 1936 paragraph 73B(14C)(a)

For an explanation of when one company is grouped with another company under section 73L of the ITAA 1936, see 'Part C4-4 Grouping rules for the R&D tax offset'.

foreign company means a body corporate that: is incorporated under a law of a foreign country; and is a resident of a foreign country for the purposes of a double tax agreement (as defined in Part X) that relates to that foreign country. ITAA 1936 subsection 73B(1)

Example 3.1

Company A is an Australian proprietary company that manufactures glass products. Since its incorporation on 1 July 2000, Company A has been wholly owned by Company B, who is an Australian public company.

Foreign Company X is a body corporate incorporated in, and resident of, Ireland, as determined by the double taxation agreement between Australia and Ireland. On 1 July 2007, Foreign Company X contracts Company A to perform some R&D activities in respect of producing 'unbreakable' glass. Foreign Company X and Company A enter into a written agreement in respect of the performance of the R&D activities, to which no other person is a party. The agreement specifies that Foreign Company X will directly own the intellectual property and commercialisation rights of the R&D project under contract.

Between 1 July 2007 and 31 December 2007, Company A incurs $100,000 of expenditure performing the R&D activities for Foreign Company X. Foreign Company X recognises the growth potential of Company A, and on 1 January 2008, acquires Company A from Company B. Between 1 January 2008 and 30 June 2008, Company A incurs a further $150,000 performing the R&D activities on behalf of Foreign Company X pursuant to their agreement.

Company A may only deduct under subsection 73B(14C) of the ITAA 1936, amounts of expenditure incurred at a time when it is grouped under section 73L with a foreign company.

Company A only became a group member of Foreign Company X, under section 73L of the ITAA 1936, on 1 January 2008. Therefore, Company A cannot claim the $100,000 it incurred in the income year on behalf of Foreign Company X prior to this date, under subsection 73B(14C) of the ITAA 1936. However, Company A may be entitled to claim the deduction for expenditure on foreign owned R&D in relation to the $150,000 of expenditure it incurred between 1 January 2008 and 30 June 2008, while it was wholly owned by Foreign Company X.

C3.2.2 Australian-centred research and development activities

The expenditure incurred by the eligible company in the year of income at a time when it is grouped under section 73L of the ITAA 1936 with a foreign company, must be incurred for the purpose of the carrying on of 'Australian-centred research and development activities'.

ITAA 1936 paragraph 73B(14C)(b)

Australian-centred research and development activities means: Australian research and development activities that are covered by paragraph (a) of the definition of research and development activities; or Australian research and development activities covered by all of the following: the activities are not covered by paragraph (a) of the definition of research and development activities; the activities are carried on for a purpose directly related to the carrying on of other Australian research and development activities that are of the kind referred to in paragraph (a) of that definition; that purpose is the sole or dominant purpose for which the activities are carried on. ITAA 1936 subsection 73B(1)

 

Australian research and development activities means research and development activities that are carried on in Australia or in an external territory. ITAA 1936 subsection 73B(1)

 

research and development activities means : systematic, investigative and experimental activities that involve innovation or high levels of technical risk and are carried on for the purpose of: acquiring new knowledge (whether or not that knowledge will have a specific practical application); or creating new or improved materials, products, devices, processes or services; or other activities that are carried on for a purpose directly related to the carrying on of activities of the kind referred to in paragraph (a). ITAA 1936 subsection 73B(1)

Activities must be 'Australian research and development activities' before they can be 'Australian-centred research and development activities'. A deduction is not allowable under subsection 73B(14C) of the ITAA 1936 in respect of expenditure incurred for the purpose of the carrying on of research and development activities outside of Australia or an external territory.

There is a further restriction where activities fall within paragraph (b) of the definition of research and development activities. These are activities carried on for a purpose directly related to the carrying on of activities which satisfy paragraph (a) of the definition of research and development activities, and are generally referred to as 'supporting activities'. Activities which satisfy paragraph (a) of the definition of research and development expenditure are sometimes called 'systematic, investigative and experimental' or 'SIE' activities. Only supporting activities which directly relate to the carrying on of SIE activities undertaken in Australia or an external Territory can be Australian-centred research and development activities. Further, the sole or dominant purpose of these supporting activities must be to support the carrying on of the Australian SIE activities.

For more information about research and development activities, please refer to 'Part B, B3-1 Definition of R&D'.

Example 3.2

Company C is an Australian body corporate wholly owned by United States (US) company, Company Pharma. Company C has an agreement with Company Pharma to undertake R&D on its US parent's behalf. Under its R&D contract with Company Pharma, Company C undertakes meta-analysis of clinical trials undertaken by Company Pharma in the US, in order to give a precise estimate of the treatment effect of a new drug developed in the US by the Pharma group. All phase I, II and III clinical trials were undertaken in the US.

Company C cannot deduct expenditure incurred in undertaking the meta-analysis for its US parent. The meta-analysis undertaken by Company C does not come within paragraph (a) of the definition of 'research and development activities', nor is this activity carried on for a purpose directly related to the carrying on of other SIE activities conducted in Australia. Therefore, the R&D activity performed in Australia by Company C, on behalf of Company Pharma, is not an Australian-centred research and development activity. For this reason, the expenditure incurred by Company C in relation to this activity cannot be deducted under subsection 73B(14C) of the ITAA 1936.

For more information on the research and development of pharmaceuticals, including trials on humans, please refer to Part B, B4-2 Pharmaceuticals (Including Trials on Humans).

Certificate as to Australian-centred research and development activities

The Board may give the Commissioner a certificate under section 39LAAA of the IR&D Act advising whether particular activities were Australian-centred research and development activities. The Board must give the Commissioner such a certificate when requested to do so.

If the Board gives the Commissioner a certificate stating whether particular activities were Australian-centred research and development activities, and that certificate relates to activities in relation to which an eligible company incurred expenditure, then that certificate will be binding on the Commissioner for the purpose of making an assessment of the eligible company's taxable income for any year in which those activities were carried on.

ITAA 1936 subsection 73B(34)

The Board may also give the Commissioner a certificate under section 39LAAB of the IR&D Act stating whether particular activities were activities that would have been Australian-centred research and development activities apart from the need for an R&D plan. The Board must give the Commissioner such a certificate when requested to do so.

A determination as to whether particular activities would have been Australian-centred research and development activities apart from the need for an R&D plan, may be necessary in order to determine whether an eligible company has complied with the registration requirement contained in paragraph 73B(14C)(g) of the ITAA 1936 (refer paragraph C3.2.7 below). It is also necessary to know whether particular activities would have been Australian-centred research and development activities apart from the need for an R&D plan in order to work out a company's entitlement to the 175% Premium. (For more information on the 175% Premium, see C6 175% Australian Premium and C7 175% International Premium).

If the Board gives the Commissioner a certificate stating whether particular activities would have been Australian-centred research and development activities apart from the need for an R&D plan, and that certificate relates to activities in relation to which an eligible company incurred expenditure, then that certificate will be binding on the Commissioner for the purpose of making an assessment of the eligible company's taxable income for any year in which those activities were carried on.

ITAA 1936 subsections 73B(34AA) and 73B(35)

For further information on the role of the Board, see 'Part A, 4-4 Administration of the Concession'.

C3.2.3 Activities performed wholly or primarily on behalf of a foreign company

The deduction is restricted to expenditure incurred by the eligible company for the purpose of the carrying on of Australian-centred research and development activities wholly or primarily on behalf of a foreign company.

Under subsection 73B(9) of the ITAA 1936, eligible companies cannot generally claim a deduction under section 73B in respect of expenditure incurred for the purpose of carrying on R&D activities on behalf of any other person. However, subsection 73B(9) does not apply in relation to the deduction for expenditure on foreign owned R&D, where one of the requirements for a deduction under subsection 73B(14C) is that the activities are undertaken wholly or primarily on behalf of the foreign company.

When determining whether activities are performed wholly or primarily on behalf of a foreign company regard must be had to the written agreement between the eligible company and the foreign company, which should make it explicit that the R&D is to be performed wholly or primarily on behalf of the foreign company. The type of agreement that exists will also be an indicator that the Australian-centred R&D activities are carried out on behalf of the foreign company. The wording of the agreement alone however is insufficient to demonstrate that the activities are being performed wholly or primarily on behalf of a foreign company.

The eligible company must show that the expenditure is incurred wholly or primarily on behalf of the foreign company, taking into account:

• the financial risk associated with the R&D project
• control over the R&D project, and
• effective ownership of the project results.

For an explanation of these concepts see 'Part C2.1.2 Eligibility of entities - on own behalf '.

As it is a requirement of the 125% R&D tax concession that expenditure is incurred on R&D activities carried on by or on behalf of the eligible company and not for the purpose of carrying on R&D activities on behalf of any other person, any expenditure that is deductible under subsection 73B(14C) in relation to foreign owned R&D will not be deductible under any other provision of section 73B of the ITAA 1936.

ITAA 1936 paragraph 73B(14C)(c)

Example 3.3

Companies D, P, and E are grouped under section 73L of the ITAA 1936 and are members of a multinational group in which:

• Company D is an Australian body corporate
• Company P is a body corporate incorporated in, and resident of, France, as determined by the double taxation agreement between Australia and France, and
• Company E is a body corporate, incorporated in and resident of, the United Kingdom (UK), as determined by the double taxation agreement between Australia and the UK.

Company D performs R&D under written agreement with its French parent, Company P. Company P coordinates all R&D for the multinational group, chooses the R&D projects to be undertaken by Company D and decides whether particular lines of research should be pursued.

The group's general policy is that all R&D is to be commercialised in the United Kingdom by Company E, who will be the legal owner of all intellectual property resulting from R&D conducted by Company D. Limited access to results for use in their own business is given to all group members at no cost, however only Company E may exploit results of the R&D and all commercialisation proceeds are retained by Company E.

Company D will not be entitled to claim the deduction for expenditure on foreign owned R&D under subsection 73B(14C) of the ITAA 1936 because the Australian-centred R&D it undertakes is not wholly or primarily on behalf of the foreign company, Company P, with whom Company D has a written agreement to perform the R&D.

Example 3.4

Company B is an Australian public company which wholly owns AustCo, an Australian proprietary company and ForeignCo, a company incorporated in Singapore.

AustCo undertakes Australian-centred R&D under written agreement with ForeignCo. These activities are funded by Company B, whose Board chooses the R&D to be undertaken within the group, decides where this R&D should be undertaken, and sets the terms and conditions for the performance of the R&D and the exploitation of results.

Company B is the legal owner of all IP for the group, however ForeignCo has an exclusive licence to commercialise the results of the R&D undertaken by AustCo in the Asia-Pacific region. ForeignCo will exploit the results of the R&D to be undertaken by AustCo pursuant to their written agreement, and will retain 30% of commercialisation proceeds by agreement with Company B. All other proceeds go to Company B.

AustCo will not be entitled to claim the deduction for expenditure on foreign owned R&D under subsection 73B(14C) of the ITAA 1936 because the Australian-centred R&D it undertakes is not wholly or primarily on behalf of ForeignCo.

C3.2.4 Written agreement between the eligible company and the foreign company

The activities must be carried on directly or indirectly under a written agreement between the eligible company and the foreign company and no other parties. This agreement must be for the relevant activities to be performed either by;

• the eligible company; or
• another person directly or indirectly under another agreement to which the eligible company is, or will, become a party.

ITAA 1936 paragraph 73B(14C)(d)

This provision is an integrity provision to ensure that only one eligible company can claim the specific deduction for foreign-owned R&D. A broad agreement between a foreign company and a number of eligible companies will not be accepted, as it would not allow for identification of the single, appropriate eligible company that is entitled to the deduction.

The activities may be performed by the eligible company, or by another person to whom the eligible company subcontracts the performance of the R&D activities. This means that the activities may be performed by the eligible company who is party to the agreement, or by another person whom the eligible company subcontracts to perform the relevant activities.

Written agreement

agreement means an agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings. ITAA 1936 ITAA 1936 subsection 73B(1)

A written agreement for the purposes of the deduction for expenditure on foreign owned R&D means any written agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings.

The agreement requirement could be satisfied, for example, by:

• a written company policy that says that all intellectual property resulting from R&D will be directly owned by the foreign company, or
• a contract covering the performance of a combination of services including certain R&D activities.

The written agreement must require the performance of the R&D activities, although it does not have to explicitly include specific information about the funding or the carrying on of the activities.

 

C3.2.5 Subcontracting arrangements

Expenditure must not be incurred in connection with an agreement that:

• is between the eligible company and another eligible company that is grouped with the eligible company under section 73L when the expenditure is incurred, and is for the activities to be performed:
  • by the eligible company; or
  • by a third party under a separate agreement with the eligible company.

ITAA 1936 paragraph 73B(14C)(e)

This provision is an integrity measure to prevent multiple deductions in respect of the same expenditure.

One effect of this provision is that even if the eligible company has an agreement with the foreign company for the carrying on of Australian-centred R&D activities wholly or primarily on behalf of the foreign company, the eligible company cannot deduct its expenditure:

• for performing the activities as a subcontractor under a subcontract with another eligible company grouped under section 73L with the eligible company; or
• if the eligible company is a subcontractor to another eligible company grouped under section 73L with the eligible company, for further subcontracting the performance of the activities.

Example 3.5

Following on from Example 1 - Due to numerous last-minute orders for Christmas ornaments , Company A is unable to perform the R&D activities for which it has been contracted by Foreign Company X. Therefore, Company A enters into a written agreement with Company B, another wholly-owned Australian subsidiary of Foreign Company X to perform the R&D. Company B has a similar glass-manufacturing business and in fact is already under contract with Foreign Company X to undertake R&D to develop crack-resistant glass. Therefore, Company B is happy to perform the activities for Company A. Under the agreement between Company A and Company B, the activities will be performed by Company B for a price of $150,000, which Company A duly pays to Company B before the end of the income year. Company B incurred $120,000 in fulfilling its contractual obligations to Company A.

Company A

Company A is grouped under section 73L of the ITAA 1936 with Company B, because both companies are wholly-owned by Foreign Company X.

Under the agreement between Company A and Company B (which is another eligible company grouped with it under section 73L ), Company A has incurred $150,000 of expenditure, which means that Company A must consider whether it is precluded under the subcontractor rules from claiming the 100% specific deduction in respect of this amount.

Although the expenditure is incurred by Company A under an agreement between eligible group member companies (itself and Company B), the agreement between Company A and Company B is not for the R&D to be performed by Company A (the eligible company looking to claim in this instance). Nor is the agreement an agreement for the R&D to be performed by a third party under a separate agreement with Company A. Therefore, the $150,000 incurred by Company A was not incurred in connection with an agreement that provides for Company A to carry on the R&D activities as subcontractor for Company B. Consequently, Company A may be entitled to claim the $150,000 as a deduction under subsection 73B(14C) of the ITAA 1936.

Company B

Company B is grouped under section 73L of the ITAA 1936 with Company A, because both companies are wholly-owned by Foreign Company X. Company B has incurred $120,000 in fulfilling its obligations under its agreement with Company A for the performance of the R&D activities for Foreign Company X. However, this $120,000 has been incurred by Company B under an agreement with another eligible company (Company A) so Company B may be prevented by the subcontractor rules from claiming the $120,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.

The agreement between Company A and Company B is an agreement for the activities to be performed by Company B as subcontractor. Therefore, Company B is not entitled to deduct the $120,000 under subsection 73B(14C) of the ITAA 1936, despite its also having an agreement with Foreign Company X to perform R&D.

Example 3.6

MotorCorp, a German body corporate, has contracted with several of its Australian subsidiaries to undertake R&D to improve the fuel efficiency and reduce the carbon emissions of vehicles it manufactures. Company E, Company F and Company G all have individual written agreements with MotorCorp for R&D to be performed in Australia wholly on behalf of MotorCorp.

Under its contract with MotorCorp, Company E has agreed to provide the R&D services specified by MotorCorp for a service fee of $100,000. Company E is the manager for the Australian arm of the group and is responsible for overseeing and coordinating the performance of the R&D activities chosen and funded by MotorCorp. Company E subcontracts all activities covered by its agreement with MotorCorp to Company F, who agrees to take responsibility for the performance of the R&D activities for a fee of $100,000.

Company F specialises in fuel efficiency and so performs this part of the R&D itself. In performing this R&D, Company F incurs $60,000 of salary expenditure. However, as Company G has the expertise and facilities to carry on the activities relating to carbon emission, Company F pays Company G $40,000 to perform these activities. Company G incurs $40,000 of salary expenditure in undertaking the carbon emissions work.

This scenario may be represented as follows:

• Company E, Company F and Company G are all eligible companies and each has a written agreement with MotorCorp to which there are no other parties
• Company E subcontracts all R&D to Company F. Company E performs no activities itself and is not a party to the agreement between Company F and Company G
• Company F performs some of the R&D itself, and subcontracts the remainder to Company G
• Company G performs all activities subcontracted by Company F and is not a party to the agreement between Company E and Company F.

Company E

Company E has a written agreement with a foreign company, to which no other person is a party, that provides for R&D to be carried on by other parties under subcontracts with Company E. This is an agreement for Australian-centred R&D to be carried on directly or indirectly. Therefore, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.

Company E has incurred $100,000 in connection with an agreement entered into with Company F, who is an eligible company in its section 73L group. However, Company F cannot claim a deduction under subsection 73B(14C) if its expenditure was incurred in connection with an agreement between it and another eligible company group member, where the activities are performed by it, or by a third party under a separate agreement with it.

Therefore, Company E is not precluded from claiming the deduction because of paragraph 73B(14C)(e), and may be entitled to deduct the $100,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.

Company F

Company F has an agreement with MotorCorp (a foreign company) for the direct, or indirect, performance of R&D, and has incurred expenditure of $100,000 on foreign owned R&D. The agreement between Company F and MotorCorp allows for the R&D to be performed by Company F or by a third party under another agreement to which Company F is a party. Therefore the agreement with MotorCorp allows Company F to subcontract some or all of the R&D to Company G, which Company F does, under another agreement. Therefore, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.

However, Company F will be precluded from claiming the deduction if the expenditure was incurred in connection with an agreement between it and another eligible company group member, and the activities were performed by it or by a third party under a separate agreement with it.

Company F's expenditure was incurred in connection with such an agreement, as a third party (Company G) is to perform the activities. Therefore, Company F cannot deduct the $100,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.

Company G

Company G has an agreement with MotorCorp (a foreign company) for the direct, or indirect, performance of R&D, and has incurred expenditure of $40,000 on foreign owned R&D. The agreement between Company G and MotorCorp allows for the R&D to be performed by Company G or by a third party under another agreement to which Company G is a party. As company G performs the R&D activities, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.

However, Company G will be precluded from claiming the deduction if the expenditure was incurred in connection with an agreement between it and another eligible company group member, and the activities were performed by it, or by a third party under a separate agreement with it.

The expenditure was incurred in connection with an agreement with an eligible company group member (Company F), and the activities were performed by Company G (an eligible company). Therefore, Company G cannot deduct the $40,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.

C3.2.6 Threshold

Expenditure on foreign owned R&D by the eligible company for the year of income must exceed $20,000. No exception to the threshold exists for contracted expenditure to a Registered Research Agency, unlike under the domestic R&D concessional provisions.

ITAA 1936 paragraph 73B(14C)(f)

C3.2.7 Registration

The eligible company and every other eligible company grouped with it at any time in the income year under section 73L of the ITAA 1936, must register with the Board under section 39J of the Industry Research and Development Act 1986 all activities in relation to the year of income that:

• would be Australian-centred R&D activities performed wholly or primarily on behalf of a foreign company, apart from the need for an R&D plan, and
• are activities on which the eligible company or the other eligible company, as appropriate, incurred expenditure in the year of income.

ITAA 1936 paragraph 73B(14C)(g)

Subsection 73B(2BA) of the ITAA 1936 says that activities are not considered to be covered by the definition of research and development activities unless they are carried out in accordance with a plan that complies with any guidelines formulated by the Board under section 39KA of the Industry Research and Development Act 1986.

Registration of activities that do not have an R&D plan is required in the income year to ensure that they will be included in the calculation of notional expenditure on foreign owned R&D in accordance with the method statement in section 73RB of the ITAA 1936. (For more information on the calculation of the 175% International Premium, please refer to Part C7 of this guide).

C3-3 Amount of deduction for expenditure on foreign owned R&D

If all eligibility requirements of subsection 73B(14C) of the ITAA 1936 are met, the eligible company will be entitled to deduct the amount calculated in accordance with subsection 73B(14D) of the ITAA 1936, at the rate of 100%.

The amount of a company's deduction at the 100% rate is the amount that would be the eligible company's 'incremental expenditure' under section 73P of the ITAA 1936 for the year of income if:

1. the Australian-centred research and development activities covered by subsection 73B(14C) (ignoring paragraphs (14C(f) and (g)) were carried on, on behalf of an eligible company (and not on behalf of a foreign company); and
2. the only expenditure incurred by the eligible company in the year of income in relation to research and development activities had been expenditure on foreign owned R&D covered by subsection 73B(14C) (ignoring paragraphs (14C(f) and (g)); and
3. the total group mark up (if any) of the eligible company for the year of income were the amount (if any) that would be worked out if the company were working out the amount of a deduction under subsection (13) or (14) of ITAA 1936 (see Part C5-5 Incremental expenditure total group mark up for further information).

ITAA 1936 subsection 73B(14D)

This means that the eligible company must work out the amount that would be its incremental expenditure ignoring the requirements contained in subsection 73B(14C) regarding the $20,000 minimum expenditure threshold and the registration requirement. For this purpose, the Australian-centred R&D activities undertaken on behalf of the foreign company grouped with the eligible company, are deemed to have been undertaken on behalf of the eligible company.

The amount that would be the company's incremental expenditure does not include the amount of any group markup. (See below for how to work out the total group markup of the eligible company).

Paragraph 73B(14D)(b) of the ITAA 1936 is a measure to ensure that an amount of expenditure incurred by the company is not included in the company's 'reduced expenditure on Australian owned R&D' (see section C6 175% Australian Premium) as well as its 'reduced expenditure on foreign owned R&D' (see section C7 175% International Premium). To prevent double deductions, when an eligible company is working out the amount that would be its incremental expenditure for the purposes of the 100% specific deduction for expenditure on foreign owned R&D, it is deemed that the only expenditure incurred by the eligible company is that covered by subsection 73B(14C) of the ITAA 1936.

C3.3.1 Incremental expenditure

The first step in working out the amount of the deduction for expenditure on foreign owned R&D is to determine the amount that would be the company's 'incremental expenditure' under section 73P of the ITAA 1936 for the year of income, taking into account the modifications made by subsection 73B(14D) of the ITAA 1936.

incremental expenditure means expenditure that: is research and development expenditure except: expenditure to lease or hire plant; and expenditure under a contract to the extent that it is, in substance, for the acquisition of plant and not for the receipt of services; and can be taken into account in working out the amount of a deduction under subsection 73B(13) or (14) or could be taken into account in working out the amount of a deduction under subsection 73B(14) apart from paragraph 73B(14)(b). Note: The effects of paragraph (b) of the definition of incremental expenditure include preventing a company from counting as incremental expenditure: expenditure that the company is required by subsection 73B(9) to disregard because it was incurred by the company for the purpose of carrying on research and development activities on behalf of another person; and expenditure on overseas research and development activities that is not certified expenditure and so is expenditure for which subsection 73B(17A) denies a deduction under subsection 73B(13) or (14). ITAA 1936 subsection 73P(2) For the purposes of the definition of incremental expenditure in subsection (2), where expenditure under a contract is both for the acquisition of plant and for the provision of services, the expenditure must be apportioned on a reasonable basis between them. ITAA 1936 subsection 73P(3) None of the expenditure referred to in subsection (3) can be incremental expenditure if a reasonable apportionment is not possible. ITAA 1936 subsection 73P(4)

A company's incremental expenditure for a year of income excludes the total group markup of the company for that expenditure (as worked out under subsection 73B(14AC) ). ITAA 1936 subsection 73P(5)

'Incremental expenditure' as defined in subsection 73P(2) of the ITAA 1936 means expenditure that is research and development expenditure as defined in subsection 73B(1) of the ITAA 1936.

research and development expenditure, in relation to an eligible company in relation to a year of income, means expenditure (other than core technology expenditure, interest expenditure, feedstock expenditure, excluded plant expenditure or expenditure incurred in the acquisition or construction of a building or of an extension, alteration or improvement to a building) incurred by a company during the year of income being: contracted expenditure of the company; salary expenditure of the company, being expenditure incurred on or after 1 July 1985; or other expenditure incurred on or after 1 July 1985 directly in respect of research and development activities carried on by or on behalf of the company on or after 1 July 1985; and includes any eligible feedstock expenditure that the company has in respect of the year of income in respect of related research and development activities. ITAA 1936 ITAA 1936 subsection 73B(1)

Incremental expenditure therefore includes:

• contract expenditure incurred to a Registered Research Agency (RRA)
• salary expenditure
• other expenditure incurred directly in respect of R&D activities, which includes:
  • contract expenditure to others for R&D activities, and
  • eligible feedstock expenditure (not residual feedstock expenditure).

Expenditure which is not 'research and development expenditure' as defined in subsection 73B(1) of the ITAA 1936 is not 'incremental expenditure'. Items in this excluded category include: decline in value in relation to depreciating assets, core technology expenditure, interest expenditure and residual feedstock expenditure.

A company's incremental expenditure includes amounts that satisfy the definition of 'research and development expenditure' (except those amounts excluded by section 73P of the ITAA 1936), that the company could deduct under subsection 73B(13) or (14) regardless of whether the company actually claimed a deduction for these amounts under the R&D tax concession.

Note: A company's 'incremental expenditure' also includes expenditure which it could deduct under subsection 73B(14) of the ITAA 1936 (salary expenditure and other expenditure incurred directly in respect of R&D activities), ignoring the requirement in paragraph 73B(14)(b) that its aggregate research and development amount must be greater than $20,000.

What is excluded from incremental expenditure?

Subsection 73P(2) expressly excludes:

• expenditure to lease or hire plant
• expenditure under a contract that is in substance for the acquisition of plant and not for the receipt of services.

Where the expenditure under a contract is both for the acquisition of plant and for the provision of services, the expenditure is to be apportioned between the two on a reasonable basis. Where reasonable apportionment is not possible, none of the expenditure under that contract can be 'incremental expenditure'.

ITAA 1936 subsections 73P(3) and (4)

Subsection 73P(2) also excludes expenditure that cannot be taken into account in working out the amount of the deduction under subsection 73B(13) or (14) of the ITAA 1936 (apart from paragraph (14)(b)). This excludes, for example:

• expenditure a company is required by subsection 73B(9) of the ITAA 1936 to disregard
• expenditure for which a deduction is denied by subsection 73B(17A) of the ITAA 1936 (expenditure on overseas research and development which is not certified expenditure), and
• expenditure incurred in relation to activities that were not registered with the Board in relation to the year of income (subsection 73B(10) of the ITAA 1936).

C3.3.1.1 Contracted Expenditure

Contracted expenditure is defined in subsection 73B(1) of the ITAA 1936 as expenditure incurred by an eligible company to an organisation registered with the Board as an Australian research agency, i.e. an agency with Registered research agency (RRA) status, where the RRA performs R&D activities on behalf of the eligible company.

To determine the amount of its incremental expenditure, the eligible company must work out the amount of contracted expenditure that could be taken into account in working out the amount of a deduction under subsection 73B(13) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).

Subsection 73B(13) of the ITAA 1936 does not contain a threshold requirement and so contracted expenditure is not subject to the $20,000 expenditure threshold which generally applies in respect of research and development expenditure. Therefore, contracted expenditure generally automatically qualifies for the subsection 73B(13) deduction - provided that the expenditure is in relation to eligible R&D activities and the associated eligibility criteria are also satisfied.

When working out the amount of its deduction for expenditure on foreign owned R&D, an eligible company must ignore paragraph 73B(14C)(f) of the ITAA 1936, which contains the threshold requirement of eligibility for the 100% specific deduction and requires the eligible company to incur more than $20,000 of expenditure on foreign owned R&D in the year of income.

Note: although the threshold requirement is ignored when working out the amount of the deduction which will be available for expenditure on foreign owned R&D if all eligibility requirements are met, a company will not be eligible to claim a deduction under subsection 73B(14C) of the ITAA 1936 unless the total expenditure on foreign owned R&D by the eligible company for the year of income is greater than $20,000 (see 73B(14C)(f)) of the ITAA 1936).

Subsection 73B(1B) of the ITAA 1936 generally provides that expenditure is not contracted expenditure unless when the expenditure was incurred, the eligible company that incurred the expenditure was capable of utilising, or had formulated a plan to utilise, any results of the research and development activities directly in connection with a business that the company carried on or proposed to carry on.

This restriction does not apply to expenditure on foreign owned R&D covered by subsection 73B(14C) of the ITAA 1936. Subsection 73B(1BA) of the ITAA 1936 says that subsection 73B(1B) does not apply to expenditure eligible for the 100% specific deduction (ignoring the threshold requirement and the registration requirement).

ITAA 1936 subsection 73B(1BA)

While it is possible for a RRA to perform R&D activities through an agent, the RRA would not be considered to perform those activities where it did not choose the agent, supervise the performance of the activities, or take responsibility for the agent's performance of the activities. Arrangements of this type under which, for instance, an eligible company made payments to a RRA for the performance of R&D activities on condition that the RRA would have the activities performed by a particular researcher, would have the consequence that the RRA could not be said to perform those activities. In such a case, the payments would not be 'contracted expenditure'.

ITAA 1936 subsections 73B(1),(1B) and (1BA)

C3.3.1.2 Salary expenditure

To determine the amount of its incremental expenditure, the eligible company must work out the amount of salary expenditure that could be taken into account in working out the amount of a deduction under subsection 73B(14) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).

'Salary expenditure', forms part of 'research and development expenditure' and is comprehensively defined in subsection 73B(1) of the ITAA 1936, which also provides a basis for apportionment of some salary-related expenses.

Salary expenditure for the purposes of the R&D concession includes:

• expenditure by way of salaries, wages, allowances, bonuses, overtime payments or penalty rate payments for officers or employees of the company, incurred directly in respect of the company's eligible R&D activities, and
• expenditure in respect of annual leave, sick leave or long service leave, or contributions to superannuation funds (which are otherwise deductible under section 290-60 of the ITAA 1997), payroll tax and premiums for workers` compensation insurance in relation to those officers or employees engaged directly in carrying out the company's eligible research and development activities.

Such officers or employees can include:

• researchers undertaking the conception and/or creation of new knowledge and products
• employees undertaking technical tasks in support of the R&D activities, such as persons keeping records, preparing charts and graphs, operating equipment and writing computer programs, and
• supervisors of researchers and technical staff.

In addition, expenditure incurred by an employer to provide benefits (including fringe benefits) in lieu of paying such employees a cash salary because of an eligible salary sacrifice arrangement may also be salary expenditure.

Where the expenditure on the employee is only in part directly in respect of the relevant R&D activities, an apportionment is necessary. It is expected that the company would be able to demonstrate - by way of appropriate records such as time sheets or job cards - the extent to which such an employee's services are directly related to qualifying R&D activities. Claims for salary expenditure should be based on actual expenditure and not upon standard salary rates that might be developed for internal costing purposes.

The salaries (and on costs) of company employees whose only connection with R&D activities is clearly indirect - for example, management staff who recruit other company employees for general duties not necessarily related to R&D activities - would not qualify as salary expenditure.

Expenditure must be 'incurred' as described in Taxation Ruling TR 97/7 before it is considered 'salary expenditure' for the purposes of subsection 73B(1) of the ITAA 1936.

ITAA 1936 subsection 73B(1)

One of the requirements for deducting an amount under subsection 73B(14) of the ITAA 1936 is that the eligible company's 'aggregate research and development amount' exceeds $20,000 (see paragraph 73B(14)(b) of the ITAA 1936). However, when a company is working out the amount of its incremental expenditure under section 73P of the ITAA 1936, this requirement is ignored. The threshold requirement contained in paragraph 73B(14C)(f) of the ITAA 1936 is also ignored when the eligible company is working out the amount of its deduction for expenditure on foreign owned R&D in accordance with subsection 73B(14D) of the ITAA 1936.

C3.3.1.3 Other Expenditure

In order to fully calculate its incremental expenditure an eligible company must also work out the final component of its 'research and development expenditure' eligible for deduction under subsection 73B(14) of the ITAA 1936, referred to as 'other expenditure' (see subsections 73B(1) and 73P(2) respectively, regarding the definitions of 'research and development expenditure' and 'incremental expenditure'. The eligible company must also work out the amount of 'other expenditure' that could be taken into account in working out the amount of a deduction under subsection 73B(14) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).

A company may incur a number of administrative costs and overheads as a result of conducting its R&D activities and as a result of employing R&D staff. For instance, these costs may include the salaries of a supervisor, typist, payroll and recruitment staff and their on-costs. It may also include overheads, such as rent, light and power, property rates and taxes, cleaning and certain types of insurance. The expenses which can be claimed as 'other expenditure' are those 'incurred . . . directly in respect of' R&D activities.

Taxation Ruling IT 2552 (now withdrawn) provides the Commissioner's view about what is and what is not considered to be 'other expenditure' for the purposes of the R&D tax concession. The Tax Office considers that expenditure is incurred 'directly in respect of R&D activities' where:

• the carrying on of eligible R&D activities contributed to the incurring of all or an identifiable part of the expenditure, OR
• the conduct of eligible R&D activities by the company would be materially impaired if the expenditure were not incurred.

Expenses that may occur as a result of conducting R&D activities and employing R&D staff fall into two classes. The first class includes expenditure that can 'reasonably be expected to be identified as directly relating to an eligible research project'. The second class of expenditure, referred to as 'eligible apportionable expenses', is expenditure which may not be clearly identifiable as R&D expenditure because it relates to a number of business operations, but which nonetheless includes a component that is applicable to an eligible R&D project. The onus is on the company to demonstrate that this expenditure is 'directly in respect of' the particular R&D project. The company must also demonstrate the accuracy of the amount of the expenditure allocated to a particular R&D project.

Whether a sufficient nexus exists between an expense and a relevant R&D project will always depend on the circumstances of the particular case.

For a detailed explanation of 'other expenditure', see Part C2, 2.3.1.2 Other expenditure.

C3.3.1.4 'On own behalf'

Under subsection 73B(9) of the ITAA 1936, eligible companies cannot generally claim a deduction at the concessional rate in respect of expenditure incurred for the purpose of carrying on R&D activities on behalf of any other person. However, when an eligible company is working out the amount of its deduction for expenditure on foreign owned R&D under subsection 73B(14D), for the purposes of subsection 73B(14C) of the ITAA 1936, Australian-centred R&D activities undertaken on behalf of the relevant foreign company are deemed to have been carried on, on behalf of the eligible company and not the foreign company.

ITAA 1936 paragraph 73B(14D)(a)

C3.3.2 Total Group Markup

Subsection 73P(5) of the ITAA 1936 excludes from the definition of 'incremental expenditure' the total group markup of the company for that expenditure.

The total group markup in relation to the expenditure of an eligible company is the sum of amounts incurred by it to other persons grouped with it under section 73L of the ITAA 1936, for goods and services, in excess of the actual cost to those persons of providing those goods or services.

In calculating incremental expenditure, amounts that are incurred by an eligible company to a member of the same group need to be reduced by the total group markup. That is, any amounts incurred by an eligible company on R&D activities which represent an intra-group markup are eliminated from that expenditure when calculating 'incremental expenditure'.

For further information on amounts including a group markup refer to para 2.3.11.

ITAA 1936 subsections 73B(14AA) to (14AD), 73P(5)

Example 3.7

Company A is an Australian body corporate wholly owned by Company Q, a cola manufacturing company incorporated and resident in the United States as determined by the double tax agreement between Australia and the United States. Company Q enters into an agreement with Company A, to which no other person is a party, for Company A to invent a new type of soft drink that does not damage teeth. Company A is grouped under section 73L of the ITAA 1936 with Company B, an Australian body corporate controlled by Company Q. The activities are undertaken in Australia as three discrete projects, Project X, Project Y and Project Z. Assume Company A meets the eligibility requirements in subsection 73B(14C) unless otherwise stated. (For the purposes of subsection 73B(14D) of the ITAA 1936, the requirements of paragraphs (14C)(f) and (g) - the threshold and registration requirements - are ignored.)

Company A pays Company B $15,000 to perform some of the R&D activities required for Project X. It cost Company B $10,000 to perform the R&D services it provided for Company A.

Company A will work out the amount for which it may be entitled to a deduction under subsection 73B(14C) of the ITAA 1936 as follows.

During the year of income, while grouped with Company Q, Company A incurred $47,500 worth of expenditure in relation to its Australian-centred R&D activities on behalf of Company Q. This comprised the following expenses on Project X:

• $5,000 on salary and wages
• $2,000 on 'other expenditure'
• $15,000 was paid to Company B in consideration for work performed on R&D activities for Company A
• $500 on leasing equipment.

Company A has also incurred $25,000 of expenditure during the year of income on Project Y, another R&D project undertaken on behalf of Company Q under its agreement with that company. However, although it otherwise meets the definition of Australian-centred R&D and was registered with Innovation Australia in relation to the year of income, Project Y was not carried on in accordance with a plan that complied with guidelines formulated by the Board under section 39KA of the Industry Research and Development Act 1986.

Project X and Project Y:

Description of expenses	Amount incurred ($)	73B(14D) amount ($)
salary and wages	5,000	5,000
'other expenditure'	2,000	2,000
'contract - other' - work performed by group member Company B	15,000	10,000
leasing of equipment	500	0
Expenditure on activities not carried on in accordance with a plan.	25,000	0
Total	47,500	17,000

The cost of leasing equipment is excluded from the definition of 'incremental expenditure' under subsection 73P(2) of the ITAA 1936, and therefore cannot be included in the calculation of the 100% base deduction on foreign owned R&D under subsection 73B(14D) of the ITAA 1936.

A company's total group markup is also excluded from the definition of 'incremental expenditure'. Therefore the amount of $5,000 - the excess charged to Company A above the actual cost to Company B to provide the R&D services contracted to it - is excluded from the calculation of the amount of the deduction on foreign owned R&D.

Expenditure on activities that were not carried on in accordance with an R&D plan cannot be included when calculating the amount of the deduction available under subsection 73B(14C) of the ITAA 1936. However, these amounts may be required to be included in the calculations for the 175% Australian premium and 175% foreign premium, for example under Step 4 of the method statement in subsection 73RB(1) of the ITAA 1936. For more information refer to section C7 of this Guide.

All other expenditure items listed are within the definition of 'incremental expenditure' and can be included in working out the amount of Company A's expenditure on foreign-owned R&D. As shown above, Company A's expenditure on foreign owned R&D for the purposes of subsection 73B(14D) of the ITAA 1936 is equal to $17,000.

However, paragraph 73B(14C)(f) provides that an eligible company is not entitled to deduct an amount for expenditure on foreign owned R&D under subsection 73B(14C) unless the company has more than $20,000 of expenditure on foreign owned R&D. Consequently, Company A cannot deduct any amount under subsection 73B(14C) of the ITAA 1936, as the total of its expenditure on foreign owned R&D is only $17,000.

Note: although the expenditure incurred on Project Y, which was not carried out in accordance with an R&D plan as required by subsection 73B(2BA) of the ITAA 1936, cannot be included in Company's A 100% specific deduction under subsection 73B(14C) of the ITAA 1936, this amount may in the future be required to be included in Company A's notional expenditure on foreign owned R&D , when Company A, or its eligible company group members, are calculating their entitlement to the 175% premium. (For more information of the 175% premium, please refer to Parts C6 and C7 of this guide).

Example 3.8

In addition to its expenditure on Project X and Project Y, Company A has also incurred $51,000 of expenditure on Project Z, another project undertaken on behalf of Company Q under its agreement with that entity. Company A incurred the following expenses on Project X during the year of income:

• $25,000 on salary and wages
• $20,000 on 'other expenditure'
• $5,000 was paid to Company B in consideration for work performed on R&D activities for Company A, representing the actual cost to Company B to provide the contracted services
• $1,000 on interest expenditure.

Project Z:

Description of expenses	Amount incurred ($)	73B(14D) amount ($)
salary and wages	25,000	25,000
'other expenditure'	20,000	20,000
'contract - other' - work performed by group member Company B	5,000	5,000
interest expenditure	1,000	0
Total	51,000	50,000

Interest expenditure is specifically excluded from the definition of 'research and development expenditure' and so is not included in the definition of 'incremental expenditure'. The amount of $1,000 incurred on interest expenses therefore cannot be included in Company A's deduction for expenditure on foreign owned R&D.

As a result, Company A will be entitled to deduct the $17,000 of expenditure on foreign owned R&D incurred on Project X and the $50,000 of expenditure on foreign owned R&D incurred in relation to Project Z, in the year of income.

Example 3.9

Assume, in relation to Examples 7 and 8, that when Company A begins to prepare its R&D tax concession claims it realised that the activities for Project Z have not been registered with the Board.

Consequently, Company A is not entitled to claim any amount under subsection 73B(14C) of the ITAA 1936 in respect of any of the projects it undertook on behalf of Company Q, as paragraph 73B(14C)(g) of the ITAA 1936 is not satisfied.

C3-4 Consolidation and the deduction for expenditure on foreign - owned R&D

The R&D provisions include sections intended to ensure that the research and development concession interacts properly with the consolidation regime in part 3-90 of the ITAA 1997.

These sections provide that:

• a head company is treated as qualifying for the R&D deductions while any of its subsidiary members do. The subsidiary members of the group who conduct R&D activities will continue to register their eligible activities with the Board as in the past, but the head company will be the claimant of the R&D tax concession;
• the expenditure history needed to access the deductions available under sections 73Y, 73QA or 73QB is not affected by the consolidation history rules where companies join or leave a consolidated group, and
• clawing back the concessional part of an R&D deduction when expenditure is recouped or a grant received in respect of it is still possible, even though the deduction is claimed by the head company of a consolidated group when the recoupment was received by a company that leaves the group.

Registration of R&D activities

A head company cannot claim the R&D tax concession for expenditure incurred in relation to unregistered R&D activities undertaken by itself or by any other member of the consolidated group or MEC group. This is because the head company is only treated as if it were an eligible company registered with Innovation Australia in relation to particular activities in respect of a year of income during a period that a subsidiary member of the group is an eligible company registered with the Board in relation to those activities in respect of that year of income.

ITAA 1936 section 73BAB

Group markup and Consolidation

Members of a consolidated group are treated as a single entity (represented by the head company) for income tax purposes. This treatment occurs as a result of the 'single entity rule' which is contained in the consolidation provisions. A consequence of the single entity rule is that dealings which are solely between members of the same consolidated group will not result in income or a deduction to the group's head company.

It follows that the group markup provisions described in Part C2 - 2.3.11 (Reduced rate for group markup), are not relevant where the R&D expenditure is incurred in relation to the provision of goods or services between members of a consolidated group.

Subcontracting arrangements and consolidation

The conditions of eligibility for the deduction for expenditure on foreign owned R&D include the condition that expenditure must not be incurred in connection with an agreement that:

• is between the eligible company and another eligible company that is grouped with the eligible company under section 73L when the expenditure is incurred, and is for the activities to be performed:
  • by the eligible company; or
  • by a third party under a separate agreement with the eligible company.

As a consequence of the single entity rule (where members of a consolidated group are treated as a single entity, represented by the head company, for income tax purposes) this 'subcontractor rule' is not relevant with regard to agreements between members of a consolidated group or MEC group. This is because dealings which are solely between members of the same consolidated group will not result in income or a deduction to the group's head company.

However, where the consolidated entity is grouped with other eligible companies under section 73L of the ITAA 1936, that is, it has R&D group members who are not members of the consolidated group or MEC group, then the subcontractor rule may apply. See section 3.2.5 Subcontracting arrangements, above.

C3-5 Deduction for expenditure on foreign owned R&D and prepayments

The prepayment rules apply when working out the amount allowable as a deduction under subsection 73B(14C) of the ITAA 1936, in relation to a year of income. Most prepaid expenditure on R&D activities is taken into account on a spread basis in the year to which the payment relates, not the year in which it is incurred. Prepayments for contract expenditure to a Registered Research Agency attract special treatment and are not subject to the general prepayment rules.

For further information on the treatment of the prepayment of expenditure on R&D activities, see 'Part C-2, 2.3.10 Prepayment of R&D expenditure (including advanced and accelerated R&D expenditure)'.

ITAA 1936 section 82KZMA to 82KZMF

C3-6 Deduction for expenditure on foreign owned R&D and the 'at risk' requirement

Section 73CA of the ITAA 1936 generally applies to reduce the amount of the expenditure claimable to 100% if the Commissioner is satisfied that the expenditure was incurred at a time when the company was not 'at risk' in respect of whole or part of the expenditure.

A company is 'at risk' in respect of its expenditure on R&D activities if it does not have a guaranteed fixed return from the results of the R&D activities. For example, where a company performs R&D for a pre-determined price and has no right to commercialise the results of the R&D, that company bares no financial risk in relation to incurring that expenditure. For a fuller discussion of the 'at risk' requirement, see 'Part C-2, 2.1.2 Eligibility of entities - on own behalf .

However, section 73CA of the ITAA 1936 will not operate to exclude expenditure on foreign-owned R&D from being eligible for the base 100% specific deduction.

C3-7 Deduction for expenditure on foreign owned R&D and the operation of clawback

Clawback generally operates to reduce the rate of deduction for relevant expenditure from 125% to 100%. Therefore, because amounts of expenditure on foreign owned R&D are deductible under subsection 73B(14C) at the rate of 100%, the clawback provisions will not impact upon the deduction available under this subsection where a company has received a grant or recoupment in respect of its expenditure on foreign owned R&D.

However, where a company has received a grant or recoupment in respect of its expenditure on foreign owned R&D, this may impact upon its entitlement to the 175% Australian Premium and 175% International Premium. (See C8-6 Clawback and the 175% Australian Premium and C8-7 Clawback and the 175% International Premium).

C3-8 Deduction for expenditure on foreign owned R&D and the tax offset

The refundable R&D tax offset is not available in respect of amounts deductible under subsection 73B(14C) of the ITAA 1936. This means that an eligible company cannot choose an offset instead of a deduction in respect of expenditure on foreign owned R&D which it can deduct under subsection 73B(14C) of the ITAA 1936.

Where a company is entitled to a deduction under subsection 73B(14C) of the ITAA 1936 for expenditure on foreign owned R&D, and is also entitled to a deduction under another subsection of 73B, for example under subsection 73B(14) in relation to research and development expenditure, then the company may choose the offset in respect of the expenditure deductible under subsection 73B(14), but not in respect of its expenditure on foreign owned R&D. The latter is only eligible to be deducted.

For further information about the R&D tax offset, please see section C4 of this guide.

Example 3.10

Company Crays Alive (Crays Alive) is an Australian proprietary company that farms and supplies crayfish across Australia. Crays Alive is wholly owned by the Seafood R Us Company (Seafood R Us), which is a body corporate incorporated in, and resident of, the United States (US) as determined by the double taxation agreement between Australia and the US.

Project performed wholly on behalf of foreign company

In 2007, the percentage of crayfish that arrived at their interstate destination alive was only 75%. In order to increase this amount, Seafood R Us entered into a contract with Crays Alive. The contract is for Crays Alive to perform R&D activities to develop a new type of packaging which will result in fewer crayfish deaths in transit (Project Arrive Alive). The agreement specifies that Seafood R Us will directly own the intellectual property and commercialisation rights of the results produced under the contract. Crays Alive registers Project Arrive Alive with the Board for the year ending 30 June 2008.

In the income year ending 30 June 2008, Crays Alive incurs $100,000 of expenditure performing the R&D activities for Seafood R Us.

Crays Alive satisfies all the eligibility requirements in subsection 73B(14C) of the ITAA 1936 for a deduction for expenditure on foreign-owned R&D. Crays Alive is therefore eligible for a 100% deduction of the amount determined under subsection 73B(14D) of the ITAA 1936 for Project Arrive Alive ($100,000).

Project Arrive Alive was a discrete project, commenced and finalised within one financial year. Crays Alive is not entitled to a deduction for the 175% International Premium.

Project performed on own behalf

Crays Alive has also been trying to determine what diet produces the largest and happiest crayfish. Crays Alive has written an R&D plan for the project (Project Happy Cray) and registered the R&D activities with Innovation Australia for the year ending 30 June 2008.

It is determined that Crays Alive performs Project Happy Cray on its own behalf as it bears all financial risk in relation to the project, it is determining the direction of the R&D project and has effective ownership of the project results.

In October of 2007, work commenced on Project Happy Cray. Between October of 2007 and June 2008, Crays Alive incurred research and development expenditure of $60,000 in relation to Project Happy Cray. All expenditure incurred is eligible research and development expenditure.

Crays Alive is eligible for a deduction under subsection 73B(14) of the ITAA 1936 in the year ending 30 June 2008, as it has incurred research and development expenditure during a year of income and the aggregate research and development amount exceeds $20,000 for that year of income.

Crays Alive's return of income for the year ending 30 June 2008

Crays Alive experienced adverse trading conditions, and its total assessable income for the year of income in question was only $10,000. However as it met the eligibility criteria in section 73J of the ITAA 1936, it chose to claim the R&D tax offset under section 73I of the ITAA 1936 in its return of income. This choice only applies in this case, to the amount otherwise deductible under subsection 73B(14) of the ITAA 1936 ($75,000, being $60,000 x 125%), and not to the deduction allowable under subsection 73B(14C) of the ITAA 1936, of $100,000. Consequently, where its only allowable deductions relate to its R&D activities, the choice of the R&D tax offset means that the amount otherwise deductible under subsection 73B(14) does not come into the calculation of the company's taxable income (or loss), but instead forms part of the calculation of the R&D tax offset, as shown below:

Assessable Income	$10,000
R&D deduction under subsection 73B(14C) of the ITAA 1936	$100,000
R&D refundable tax offset under section 73J of the ITAA 1936	$22,500 (30% of $75,000, i.e. $60,000 x 125%)

Subsection 4-10(3) of the ITAA 1997 provides the following formula for determining a person's (which includes a company's) income tax liability for the income year:

Income tax = (taxable income x tax rate) - tax offsets.

Step 1 Work out taxable income for the income year

 

Taxable income or loss	= assessable income - less R&D deduction
	= $10,000 - $100,000
	= ($90,000)

 

Step 2 Work out basic income tax liability

 

As Crays Alive's deduction under subsection 73B(14C) of the ITAA 1936 exceeds its assessable income, they have no liability to pay income tax in the income year.

 

Step 3 Work out tax offsets for the income year

 

R&D Tax offset	= 30% of $75,000
	= $22,500

 

Step 4 Income tax liabilities for the income year

 

As the R&D tax offset is a refundable tax offset, Crays Alive receives a refund of $22,500.

As the R&D deduction on foreign owned R&D exceeds the assessable income by $90,000, Crays Alive can carry forward the loss of $90,000 which it may be able to utilise in a later year of income.

C3-9 Expenditure on foreign owned R&D and interaction with 175% Australian Premium and 175% International Premium

Expenditure on foreign owned R&D cannot be used to establish eligibility for the 175% Australian Premium. Conversely, expenditure deductible under another provision in relation to R&D undertaken by the eligible company, or on its behalf, and not on behalf of any other person will not establish eligibility for the 175% International Premium.

However, an eligible company's expenditure on foreign owned R&D, including certain expenditure which cannot be deducted under subsection 73B(14C) of the ITAA 1936 because it was not incurred in relation to a project carried out in accordance with an R&D plan, will impact upon the deductions available to the eligible company and its group members under sections 73QA (the 175% Australian Premium) and 73QB (the 175% International Premium) of the ITAA 1936.

Once the eligible company has worked out the increases and decreases in expenditure on both Australian-owned R&D and foreign-owned R&D for each eligible company in its group, the calculations for both the 175% Australian Premium and the 175% International Premium, effectively pool the results such that increases to one type of expenditure are reduced by any decrease to the other type of expenditure under section 73RE of the ITAA 1936.

For more information see Parts C6 175% Australian Premium and C7 175% International Premium.

C4 R&D tax offset for small companies (refundable tax offset)

This document has been archived. It is current only to 30 June 2011.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

 

The Government has enhanced the R&D tax concession by providing small companies, particularly those in tax loss, with a refundable tax offset, equivalent to the value of the R&D tax concession. The Government recognises the importance of supporting innovative, small companies, particularly those in tax loss who cannot gain immediate benefit from the R&D tax concession when claimed as a deduction.

This initiative will foster the growth of these companies by providing them with timely support and can increase the cash flow of such companies when they most need it - during their initial growth phase. Companies that currently carry forward their R&D-related tax losses can now realise these losses as a cash equivalent payment once their income tax return for the relevant year is processed.

Key features of the R&D tax offset are as follows:

• the offset is available to companies with an annual turnover of less than $5 million who spend up to $2 million (or $1 million for years of income starting before 1 July 2009) per year on R&D (both of these tests are subject to grouping rules)
• the offset is paid at the rate of 30 cents for each dollar of deduction that would have otherwise been claimable. Where expenditure is eligible for 125% deduction, this is equivalent to a benefit of 37.5 cents per dollar of eligible R&D expenditure, and 52.5 cents per dollar of any expenditure eligible for the 175% premium concession
• the refund will be offset against any other Commonwealth tax liabilities owed by the company, including GST, FBT and withholding taxes
• a refund of the Offset does not generate a franking debit in the company's franking account (see Part C-13 - Offset and franking accounts).

For further information see: ATO Interpretative Decision ATO ID 2004/345 Research and development Tax Offset and Franking Accounts: companies in loss Does a refund of a research and development tax offset generate a franking debit under section 205-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

ATO Interpretative Decision ATO ID 2004/346 Research and development Tax Offset and Franking Accounts: taxable companies Does a refund of a research and development tax offset generate a franking debit under section 205-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

C4-1 Timing

Companies can claim the R&D tax offset for expenditure incurred in their first income year commencing after 30 June 2001, and in later income years. The Tax Office administers the R&D tax offset and makes payment after the company lodges its annual income tax return.

An eligible company can choose the R&D tax offset either in its return of income, or by notice in writing to the Commissioner. If choosing the second option, an eligible company may make the choice within the following timeframes:

• if the relevant year of income commenced prior to 21 June 2007, then the choice must be made by notice in writing given to the Commissioner before the end of the period that the Commissioner could amend an assessment made on 21 June 2007; or
• if the relevant year of income commenced on or after 21 June 2007, then the choice must be made by notice in writing given to the Commissioner before the end of the period that the Commissioner could amend an assessment for the company for the tax offset year.

Information on where to send the notice and what should be included is available on the Tax Office website at www.ato.gov.au.

ITAA 1936 subsection 73I(2)

Generally, the period in which the Commissioner can amend an assessment of a company which is an STS taxpayer is two years after the day on which notice of the assessment is given to the company. For other companies the period of review is generally four years after the day on which notice of the assessment was given.

ITAA 1936 section 170

Note: Applicants must be registered with Innovation Australia (the Board)before a claim is made by the company in its income tax return lodged with the Commissioner of Taxation.

ITAA 1936 subsection 73B(10)

C4-2 Eligibility

To be eligible for the R&D tax offset, a company must comply with each of the following:

• the aggregate R&D amount as defined under subsection 73B(1) of the ITAA 1936 for the year must exceed $20,000
• for years of income commencing after 21 June 2007, either the aggregate R&D amount must exceed $20,000,or the company must have incurred an amount of contracted expenditure as defined under subsection 73B(1) of the ITAA 1936 (see Part C-2, page X - Contracted Expenditure)
• for years of income commencing on or after 1 July 2009, the aggregate R&D amount of the company and of persons with which it is grouped must not exceed $2 million
• for years of income beginning between 1 June 2001 and 30 June 2009, the aggregate R&D amount of the company and of persons with which it is grouped must not exceed $1 million
• the R&D group turnover must be less than $5 million
• the level of exempt entity (see below for the meaning of 'exempt entity') ownership of the company must be below 25%, such that where:
  • an exempt entity;
  • the affiliates of an exempt entity;
  • an exempt entity together with its affiliates;
  • 2 or more exempt entities; or
  • 2 or more exempt entities together with their affiliates;

  own or have the right to acquire at least 25% of the voting power, or 25% of the rights to distributions from the company, this eligibility requirement will not be met

• the amounts on which the calculation of the offset is based must, but for the choice to claim the offset, be otherwise deductible

ITAA 1936 section 73J

Exempt Entity

The definition of 'exempt entity' has recently been amended. The new definition will affect some companies' eligibility for the R&D tax offset. Transitional provisions ensure that the amendment does not apply retrospectively to deny tax offsets already claimed by R&D companies. R&D companies will not be affected by the new definition of 'exempt entity' until the first income year starting after 21 June 2007.

• for income years starting prior to 21 June 2007, the definition of 'exempt entity' generally includes those entities exempt from income tax because of Division 50 of the ITAA 1997
• for income years starting on or after 21 June 2007, the definition of 'exempt entity' is defined in subsection 995-1 of the ITAA 1997, and generally includes entities whose income is exempt from income tax under any Commonwealth law, and all untaxable Commonwealth entities

ITAA 1997 subsection 995-1

Note: For years of income commencing before 30 June 2007, an eligible company can only choose a tax offset instead of a deduction under sections 73B, 73BA, 73BH or 73Y of the ITAA 1936 for a year of income and not for other deductions available under the R&D tax concession. For example, an eligible company cannot choose a tax offset for any balancing adjustment deduction that is available under section 73BF of the ITAA 1936.

For years of income commencing after 30 June 2007, an eligible company can only choose a tax offset instead of a deduction under sections 73B (except subsection 73B(14C) ), 73BA, 73BH or 73QA for that year. For example, an eligible company cannot choose a tax offset instead of a deduction for expenditure on foreign owned R&D available under subsection 73B(14C), or instead of the extra deduction for increase in expenditure on foreign owned R&D available under section 73QB of the ITAA 1936.

ITAA 1936 subsection 73I(1) For further information see: ATO Interpretative Decision ATO ID 2003/660 Research and development Tax Offset: Exempt entities and affiliates with at least 25% of the voting rights or rights to distribution of income or capital in the company. Is a company eligible under section 73J of the Income Tax Assessment Act 1936 (ITAA 1936) to choose a research and development tax offset when two or more exempt entities, together with their affiliates, at any time during the tax offset year, own interests in the company carrying between them at least 25% of voting rights or rights to a distribution of income or capital?

Where an exempt entity is the registered (legal) owner of interests in the company which carry the right to greater than 25% of the voting power and/or right to receive greater than 25% of distributions by the company, but the beneficial owner of those shares is a tax-paying entity, the exempt entity rule may not be breached.

Where a separate beneficial owner of the interests can be identified, and it is that owner who enjoys all of the rights carried by those interests to the exclusion of the legal owner, then subsection 73J(2) of the ITAA 1936 will not operate to exclude a company from eligibility for the R&D Tax Offset on the basis of the interests held by the legal owner.

For example, where:

• an exempt entity holds shares in the company on trust for an individual who is not an exempt entity; and
• under the terms of the trust, the individual is beneficially entitled to all the income and capital distributions by the company and entitled to have the voting power in the company exercised as they direct; and
• the exempt entity, although the legal owner of the shares, cannot enjoy the benefits of them in any way, or dispose of them for its own benefit.

Then the company will not be prevented by subsection 73J(2) of the ITAA 1936 from choosing the R&D Tax Offset if it is otherwise eligible to do so.

An entity will not legally own interests for the purposes of subsection 73J(2) of the ITAA 1936, where the entity has not met the Corporations Act 2001 requirements for membership of a company.

For further information see: ATO Interpretative Decision ATO ID 2003/895 Research and development tax offset: Exempt entity registered holder of shares but tax paying entity beneficial owner. Is an eligible company able to choose the research and development tax offset under section 73I of the Income Tax Assessment Act 1936 (ITAA 1936), where an exempt entity is the registered holder of all the shares in the company, but those shares are beneficially owned by an individual who is not an exempt entity?   ATO Interpretative Decision ATO ID 2005/23 Research and development: Legal ownership of interests in a company by an exempt entity. Does an exempt entity legally own interests in a company within the meaning of subsection 73J(2) of the Income Tax Assessment Act 1936 (ITAA 1936), where the Corporations Act 2001 requirements for membership of a company have not been met?

In order for an eligible company to claim the R&D tax offset, a company must choose to do so in its income tax return for that year, or by notice in writing to the Commissioner within the relevant amendment timeframes. Once a company has so chosen, the full amount of its entitlements under the R&D provisions will be granted as a refundable tax offset. If a company makes the choice for the refundable tax offset there is no entitlement to R&D deductions in that year.

ITAA 1936 section 73I

C4-3 Definition of the R&D group turnover for purpose of the R&D tax offset

The definition of R&D group turnover for the R&D tax offset draws on the definition of turnover used for the former simplified tax system (STS) for small companies. Both of these utilise the concept of 'value of the supplies', a term defined in the GST Act. A company's R&D group turnover for an income year is the sum of the value of supplies made in the ordinary course of business:

• in the year of income by the company, and
• by other persons (including non-resident companies) grouped with the company for that year of income.

This sum is then reduced by:

• the value of the supplies the company made in the year of income to persons grouped with it while they were grouped with it, and
• the value of the supplies persons grouped with the company made in the year of income to the company while the company was grouped with them, and
• the value of the supplies another person made in the year of income to a third person while the other person and the third person were grouped with the company.

The value of the supplies a taxpayer makes during an income year is the sum of the values of the supplies in relation to taxable supplies and for other supplies the prices of the supplies, the taxpayer made during the course of the year in the ordinary course of carrying on a business or in the course of carrying on R&D activities, and is calculated exclusive of GST payable on supplies.

Section 9-75 of the GST Act explains the method of working out the value of a supply. Basically it depends upon whether or not the supply is a taxable supply.

If the supply is a taxable supply (that is, one on which GST is payable), its value is worked out as 10/11^th of the price of the supply (this effectively excludes the GST amount from the calculation).

If the supply is not a taxable supply, the price of all the non-taxable supplies made during the year in the ordinary course of carrying on a business is added to the value of all taxable supplies. The price of the supply is generally the amount of money a person pays for the supply. Supplies that are not taxable include those that are GST-free and input taxed for the purposes of the GST Act.

Note: there are special rules relating to gambling supplies in the GST Act.

Exclusions from R&D group turnover

R&D group turnover does not include:

• a supply that constitutes an insurance recovery;
• things that do not constitute the making of a supply; and
• where the R&D group member is an individual, income which that individual receives from passive investments or as salary or wages (i.e. amounts which do not arise in the ordinary course of business or in the course of carrying on research and development activities).

ITAA 1936 section 73K, 73H

Substituted Accounting Periods

The 'R&D group turnover' is calculated for the 'tax offset year' under section 73K of the ITAA 1936. The 'tax offset year' is the year of income for which the company wants to determine its eligibility for the R&D Tax Offset. Therefore the 'R&D group turnover' is calculated for the 12-month period representing the year of income of the eligible company.

Where a company is lodging a return of income for a period of greater or less than 12 months because of a transitional period, 'R&D group turnover' must be calculated for the 12-month period ending on the last day of the period for which the company is lodging its return of income. For example, if the return of income of the company for the 2003-04 income year is for the period from 1 July 2003 to 31 December 2003, the company must work out its 'R&D group turnover' for the 12-month period 1 January 2003 to 31 December 2003.

Where supplies are made for a period spanning more than one income year, or consideration is payable over more than one income year.

Where supplies are made for a period spanning more than one income year, the amount included in the calculation of the company's 'R&D group turnover' for the income year, is the value of the supplies made in the relevant period. That is, the amount included in 'R&D group turnover' is the value of that part of the supplies actually made within the relevant income year, and not the total consideration pre-paid in the income year. The company's 'R&D group turnover' will include this amount even where the entity has not yet been paid for the supplies.

To determine what part of the total consideration, or the total market value of all supplies, represents the value of that part of the supplies actually made in the relevant income year, an apportionment may be made based on sensible commercial grounds and, once made, only that part of the consideration (or market value) representing the value of supplies actually provided in the relevant year of income will be included in 'R&D group turnover' for that income year (see the example in paragraph 40 of Taxation Ruling TR 93/12).

Loans

Subsection 73K(3) of the ITAA 1936 provides that, when working out the value of supplies made by a person for the purposes of calculating 'R&D group turnover', to the extent that the supply is a loan, you disregard any repayment of principal, and any obligation to repay principal.

However, you must include in your 'R&D group turnover' all amounts of interest received or receivable by the company in the relevant income year on all outstanding loans, regardless of when those loans were written. That is, the 'value of supplies' made by the company includes the interest accrued on all outstanding loans for the relevant year, irrespective of when the loans were entered into.

Supplies made by a trustee company grouped with the eligible company.

Where the relevant person for the purposes of section 73L of the ITAA 1936, controls the company in its capacity as trustee, the 'value of supplies' made by that person is based only on those supplies made as trustee of the relevant trust estate, and not, for example, on supplies made by that person in some other capacity.

For further information see: ATO Interpretative Decision ATO ID 2003/343 Research and development tax offset: 'R&D group turnover' - licence fees payable over more than one year of income. What amount is included by the company in calculating the amount of R&D group turnover for the purposes of determining the company's entitlement to the research and development (R&D) tax offset under section 73J of the Income Tax Assessment Act 1936 (ITAA 1936), where a licence fee under an agreement is payable over four years of income?

ATO Interpretative Decision ATO ID 2003/989 Research and development tax offset: Eligibility where a group member company has a substituted accounting period. If an eligible company is grouped with another company that has a different accounting period, is it the eligible company's tax offset year that is used when determining the group aggregate research and development amount and the R&D group turnover amount, and not the year of income of the group member?

ATO Interpretative Decision ATO ID 2004/701 Research and development: 'R&D group turnover' - value of supplies made in the year of income - contract for provision of services. What amounts are included in the 'value of supplies' under paragraph 73K(1)(b) of the definition of R&D group turnover, in the Income Tax Assessment Act 1936 (ITAA 1936), for a year of income, for a company that has entered into an agreement for the provision of services over a number of years of income, where no precise portion of the consideration expressly relates to services provided in a specific year of income?

ATO Interpretative Decision ATO ID 2004/702 Research and development: 'R&D group turnover' - value of supplies made in the year of income - interest payments. In calculating the value of supplies under paragraph 73K(1)(b) of the definition of R&D group turnover, in the Income Tax Assessment Act 1936 (ITAA 1936), for a company that conducts business as a lender, are amounts of interest in respect of loans that were settled in a prior year of income, as well as interest in respect of loans that were settled in the current year of income, included?

ATO Interpretative Decision ATO ID 2004/703 Research and development: 'R&D group turnover' - supplies made in the course of carrying on business. In calculating the value of supplies under paragraph 73K(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) of the definition of R&D group turnover, for a company that has carried on a business of acting as a lender in providing mortgage loans, is the amount received for the assignment of its loan portfolio a supply made in the course of carrying on a business in the terms of the definition of value of supplies in sub-section 73H(2) of the ITAA 1936?

ATO Interpretative Decision ATO ID 2005/86 Research and development tax offset: 'R&D group turnover' where ownership of interests in an eligible company by an entity in capacity as trustee. Where an eligible company is controlled by a person in a capacity as trustee, is the 'value of supplies' made by this person, as defined by subsection 73H(2) of the Income Tax Assessment Act 1936 (ITAA 1936), based only on those supplies made by it as trustee?

C4-4 Grouping rules for the R&D tax offset

The threshold percentage for control for the offset is set at greater than 50%.

A person's turnover will be grouped with that of another person at a time in a year if, at that time:

• either person controls the other
• both entities are controlled by the same third person (directly or indirectly), or
• the entities are affiliates of each other.

The grouping rules are designed to ensure that companies that are part of a large group do not gain access to the tax offset.

Note: Where a group of 100% owned entities become members of a consolidated group, the head company will need to consider whether there are any 'less than 100% owned' entities with which it is required to be grouped for the purposes of the R&D grouping provisions.

C4.4.1 Who is an affiliate?

A person is your 'affiliate' if, in relation to the affairs of their business, or their research and development expenditure, they act, or could reasonably be expected to act:

• in accordance with your directions or wishes, or
• in concert with you.

Two or more persons in partnership are not each other's affiliates merely because one partner acts or could reasonably be expected to act in concert with the other in relation to the affairs of the partnership business.

ITAA 1936 section 73M

For more information on the types of circumstances in which persons are considered by the ATO to be affiliates, refer also to Taxation Ruling TR 2002/6: Income tax: simplified tax system: eligibility - grouping rules (*STS affiliate, control of non fixed trusts).

C4.4.2 Control of a company

Broadly, these rules operate so that a company is considered to control another company if:

• it legally or beneficially owns interests in the other company that carry the right to receive more than 50% of any distribution of capital or income, or
• it owns interests in the other company that carry the right to exercise more than 50% of the voting power in that other company.

ITAA 1936 section 73L

C4.4.3 Control of other entities

Special control rules apply where the controlled entity is a non-fixed trust, or a partnership, and if the controlling entity is a partnership.

To provide an indication of their breadth, certain of these rules, including the indirect control rule, are illustrated in the examples below in the section on indirect control of a person.

C4.4.4 Indirect control of a person

The control tests are designed to look through business structures that include interposed entities. However, only controlled persons are taken into account in tracing interests. The indirect control rule has been adopted to avoid complex tracing requirements for a person. If a person directly controls a second person, and the second person controls (whether directly or indirectly) a third person, the first person is also taken to control the third person.

ITAA 1936 section 73L

Example 4.1: Company group (percentages show voting power)

Mathew P/L controls Flinders P/L and King P/L. These two subsidiary companies would be grouped together to work out the R&D group turnover of Mathew P/L, as they are both controlled by it. Bass P/L will also be grouped for this purpose with Mathew P/L (indirect control by Mathew P/L through Flinders P/L).

To work out the R&D group turnover of either Flinders P/L or King P/L these companies will be grouped with Mathew P/L (the company that controls them both), and with each other (both are controlled by the same third entity - Mathew P/L). Bass P/L would also be grouped with both (Bass is directly controlled by Flinders and both it and King are controlled by the same third entity - Mathew P/L).

To work out its R&D group turnover Bass P/L would also be grouped with Flinders P/L and King P/L (with the former because it is controlled directly by that entity, and with the latter, because it and King P/L are both controlled by the same third entity - Mathew P/L, even though Bass P/L is only indirectly controlled by Mathew P/L). Bass P/L will also be grouped for this purpose with Mathew P/L (indirect control by Mathew P/L through Flinders P/L).

In summary, to work out the R&D group turnover of any of the four companies in this group, all the other three companies will be grouped with it.

Example 4.2: Small company group including a non-fixed trust

James controls Norfolk P/L and also the trustee of the Japines Non-fixed trust (and hence this trust). To work out the R&D group turnover of either Norfolk P/L or the trust both are grouped together (both are controlled by the same third entity, James). Pines P/L would also be grouped with Norfolk P/L, and vice versa (Pines is controlled by Norfolk).

Pines P/L is also indirectly controlled by James, through his control of Norfolk P/L. Therefore, to work out the R&D group turnover of either Pines P/L or the trust, both will be grouped together (both are also controlled by the same third entity, James).

In summary, to work out the R&D group turnover of any of the two companies or the trust in this group, all three of these entities are grouped together. Where James has no turnover in his own right, then obviously there is no need to group him with these entities.

C4-5 Grouped expenditure

One of the tests of eligibility for the R&D tax offset is that the company's aggregate research and development amount must be more than $20,000 but not more currently on a group basis than $2,000,000 (see C4-2 Eligibility below), or, for years of income commencing after 21 June 2007, that the company has incurred an amount of contracted expenditure as defined under subsection 73B(1), for the year of income. The calculation of the group aggregate research and development amount includes all aggregate research and development amounts of the company seeking to claim the tax offset for that income year and other entities grouped with it in that year of income.

The group 'aggregate research and development amount' must be calculated for the 'tax offset year'. The 'tax offset year' is the year of income for which the company wants to determine its eligibility for the R&D Tax Offset. Therefore the group 'aggregate research and development amount' is calculated for the 12-month period representing the year of income of the eligible company.

Where a company is lodging a return of income for a period of greater or less than 12 months because of a transitional period, their group 'aggregate research and development amount' must be calculated for the 12-month period ending on the last day of the period for which the company is lodging its return of income. For example, if the return of income of the company for the 2003-04 income year is for the period from 1 July 2003 to 31 December 2003, the company must work out its group 'aggregate research and development amount' for the 12-month period 1 January 2003 to 31 December 2003.

For further information see: ATO Interpretative Decision ATO ID 2003/989 Research and development tax offset: eligibility where a group member company has a substituted accounting period. If an eligible company is grouped with another company that has a different accounting period, is it the eligible company's tax offset year that is used when determining the group aggregate research and development amount and the R&D group turnover amount, and not the year of income of the group member?

C4-6 Calculations

The following table sets out the tax positions of two companies, and the impact of eligibility for the offset on their circumstances. Each company is assumed to be in tax-loss, and has eligible R&D expenses of $100,000 and is not eligible to receive the 175% premium R&D tax concession in this particular income year:

			Company A		Company B
Company tax return label			Offset not chosen(a)	Offset chosen(b)	Offset not chosen(a)	Offset chosen(b)
Item 6 Label S	Total Income		$100,000	$100,000	$0	$0
Item 6 Expenses (various)	less expenses - R&D expenses - Other expenses		- $100,000 - $50,000	- $100,000 - $50,000	- $100,000 - $50,000	- $100,000 - $50,000
Item 6 Label T	Total profit or loss		($50,000)	($50,000)	($150,000)	($150,000)
Item 7 Label D	add Accounting expenditure in item 6 subject to R&D tax concession		$100,000	$100,000	$100,000	$100,000
Item 7 - 'Add'	Subtotal		$50,000	$50,000	($50,000)	($50,000)
Item 7 Label L	less R&D tax concession - not including Label M		-$125,000	-$125,000	-$125,000	-$125,000
Item 7 - 'Less'	Subtraction items subtotal		($75,000)	($75,000)	($175,000)	($175,000)
Item 7 Label Y	Add R&D tax offset if chosen		Nil	$125,000	Nil	$125,000
Item 7 Label T	Taxable income or loss		($75,000)	$50,000	($175,000)	($50,000)
Calculation Statement Label B	Gross tax (at 30%)		Nil	$15,000	Nil	Nil
Calculation Statement Label U	Less R&D tax offset (30% of Item 7, Label Y)		Nil	-$37,500	Nil	-$37,500
Calculation Statement Label S	Total amount of tax payable or refundable(c)		Nil	$22,500 (refundable)	Nil	$37,500 (refundable)

(a) 125% eligible R&D expenditure deducted from gross assessable income.

(b) 30 cents per dollar of eligible R&D claim is offset against a company's Commonwealth tax liability. This provides a form of assistance, which is like a direct subsidy to the firm.

(c) Assumes no other tax liabilities.

The level of the offset available to eligible companies is 30% of their entitlement to deductions under the research and development tax concession provisions. The effective percentage of expenditure, which the offset represents, will therefore vary according to the rate of concession. For example, where a company is eligible for:

• a deduction at the rate of 100% under the R&D tax concession provisions, the offset effectively represents a cash benefit of 30 cents in the dollar. This would apply to residual feedstock expenditure, R&D interest expenditure, core technology expenditure, any expenditure that is denied concessional entitlement due to the operation of sections 73C, 73CA and 73B(14AB)-(14AD) of the ITAA 1936
• a deduction at the rate of 125% under the R&D tax concession the offset effectively represents a cash benefit of 37.5 cents for each dollar of expenditure. This can apply to eligible R&D expenditure such as wages and salaries, contract payments, and other expenditure. Similarly, deductions for the decline in value of depreciating assets may also attract an effective 37.5% offset. So if a company has eligible expenditure of $200,000 in a year of income, the offset could be $75,000
• the incremental concession, the offset effectively represents a cash benefit of 52.5 cents in the dollar for that portion of the expenditure eligible for the 175% rate.

C4-7 Clawback of grant funding or recouped expenditure

Where a company receives a grant or recoupment from the government, such as a commercial ready grant, for their R&D expenditure, prior to or during the claim year, the clawback provisions should be taken into account in calculating the deductions. As the amount of any deduction available may be reduced by the application of the clawback provisions the amount which is eligible to be cashed out as an R&D tax offset may also be reduced.

Where clawback applies deductions are claimed at the rate of 100% instead of 125%. Consequently, the application of the clawback provisions does not prevent a company from being eligible for the R&D tax offset so long as the eligibility criteria contained in section 73J of the ITAA 1936 have been met.

Note: A grant or recoupment received by an eligible company in connection with it undertaking R&D activities will generally be assessable income. Specifically, any amount which an eligible company receives, or is entitled to receive, which is:

1. in respect of the results of an any of the R&D activities the company has incurred expenditure on; or
2. attributable to the company having incurred that expenditure;

is assessable income under subsection 73B(27A) of the ITAA 1936. If not assessable under subsection 73B(27A) of the ITAA1936, an amount received as a recoupment for a loss or outgoing deducted under sections 73B, 73BA or 73BH of the ITAA 1936, is an assessable recoupment under section 20-20 of the ITAA 1997.

The total amount of a grant or recoupment should be included in your tax return as assessable income. It is not correct to subtract an assessable grant or recoupment from gross deductible amounts and include only the net deductible amounts in your tax return.

Example 4.3

Company A incurred $100,000 of research and development expenditure in relation to Project B and is eligible to claim the R&D tax offset. In the same year of income, Company A also received, or became entitled to receive, a commercial ready grant of $20,000 in respect of Project B. This is the only income the company receives in that year. Company A's initial clawback amount is 2*$20,000 = $40,000.

The clawback calculation applies:

Company expenditure		$100,000
Less Initial clawback amount		($ 40,000)
Expenditure eligible at 125% under the tax concession		$ 60,000
The balance of $40,000 ($100,000 - $60,000) is eligible to be claimed under the R&D tax concession at 100%.
The following offset calculation applies
Total income		$ 20,000
Less R&D expenses	$60,000 @ 125%
	$40,000 @ 100%	($115,000)
Taxable profit/loss		( $95,000)
Offset chosen in tax return R&D deduction forgone		$115,000
Taxable Income/Loss		$20,000
Tax on taxable income	($20,000 @30%)	$ 6,000
R&D Tax Offset	($115,000 x 30%)	$34,500
Net tax refund due		$28,000

Grant or recoupment received subsequent to the claim year

Should the grant or a recoupment be received subsequent to the claim year, the clawback provisions require that the deductions available in the claim year be reduced by amendment. Where these deductions were cashed out under the offset, that part of the deductions which is no longer allowable as a result of clawback applying will need to be repaid.

For further information on the application of clawback please refer to Part C8 - Interaction with other government assistance.

Note: there are special rules in relation to grants or recoupments attributable to incremental expenditure incurred by a company on Australian owned R&D, and to expenditure on foreign owned R&D. For further information, please refer to Part C8-6 Clawback and the 175% Australian Premium and C8-7 Clawback and the 175% International Premium.

C4-8 Offset against other tax liabilities

The R&D tax offset is subject to the refundable tax offset rules. The offset directly reduces tax payable by a company. This includes income taxes, GST, FBT and withholding taxes. Where the amount of the offset exceeds the amount of tax that the company would otherwise have had to pay, then the excess is refundable.

ITAA 1997 Division 67

C4-9 Offset and Franking Accounts

A refund of the R&D tax offset does not generate a franking debit under section 205-30 of the ITAA 1997. One circumstance in which a franking debit will arise is where there is a refund of income tax. An amount refunded to a company in the form of the R&D tax offset is not a return of an amount paid or applied by the company to satisfy its liability to income tax. There is no amount that has been returned to the company because the R&D tax offset arises from the operation of the law, and not from a payment made by the company in satisfaction of an income tax liability.

Example 4.4

During the income year, Shropshire Pty Ltd paid PAYG instalments totalling $20,000. The company was eligible to choose, and did choose, the R&D tax offset in its return of income. Shropshire Pty Ltd's taxable income for the income year is $100,000 and the company tax rate is 30%. The amount the company could have deducted under section 73B of the ITAA 1936 was $160,000. The company's R&D tax offset for the income year is $48,000.

Under section 4-10 of the ITAA 1997, Shropshire Pty Ltd will work out its income tax liability as follows:

Step 1	(work out taxable income)	$100,000
Step 2	(work out basic income tax liability)	$30,000	(company tax rate x $100,000)
Step 3	(work out tax offsets for the income year)	$48,000	(R&D Tax Offset)
Step 4	(income tax liability for the year)	0	(but $18,000 refundable due to Division 67)

The company has no liability to tax and will receive a refund of $18,000 generated by the R&D Tax Offset. In addition, the company will also have refunded to it the amount of $20,000 it paid in PAYG installments. The $20,000 representing a refund of PAYG installments paid to satisfy the entity's previous liability to income tax will generate a franking debit equal to that amount. The amount of $18,000 generated by the refundable R&D tax offset is not a refund of income tax and so will not generate a franking debit under item 2 of the table in section 205-30 of the ITAA 1997.

C4-10 Objecting in relation to the R&D Tax Offset

The Commissioner can now give a written notice specifying the amount of the R&D tax offset allowable to an R&D company. If the company is dissatisfied with the specified amount, it can object to it in the normal manner.

ITAA 1936 subsection 73IA

This change is retrospective and applies to years of income commencing on or after 1 July 2001. Information on lodging objections is available from the Tax Office website, www.ato.gov.au.

C5 Incremental tax concession (175% premium)

This document has been archived. It is current only to 30 June 2011.

This section does not apply for years of income commencing after 30 June 2007. Please refer to sections C6 and C7. For more information refer to Timing in paragraph C5-2, below.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca.

C5-1 Background

The Government has enhanced the R&D tax concession by providing a higher level of support for those companies that increase their level of R&D expenditure. These companies will be eligible to receive the incremental tax concession for additional expenditure on R&D made in years of income that commence after 30 June 2001.

This initiative is about encouraging sustained business investment in R&D on a long-term basis.

Key features of the incremental concession are:

• targeting of predominantly labour-related components of R&D expenditure, where the greatest benefits for the whole economy occur. Plant related expenditure items are excluded
• applies to additional R&D expenditure above the three year rolling average of the company group, subject to moderation where there has been significant volatility in prior years' R&D; and
• mandatory grouping rules and other anti-avoidance measures to avoid any potential abuse.

C5-2 Timing

The former incremental tax concession applies to expenditure incurred in years of income starting on or after 1 July 2002 up until the year of income ending on 30 June 2007. For information on expenditure incurred after this time, please refer to section C6 175% Australian Premium and C7 175% International Premium.

C5-3 Eligibility

Companies claiming the incremental concession must have been registered under the 125% Concession and eligible to deduct incremental expenditure in the claim year and in each of the three immediately prior years. An exception to the requirement for a company to have a three year claim history arises where the company is in a group and there are other companies in that group which have been able to deduct incremental expenditure incurred during their group membership periods. Provided that, between those identified group companies while they have been group members, there are eligible deductions in the group in each of the three immediately prior years, the company will have a three year history.

A company can also have a claim history for a particular year if it has not registered for that year but has been in receipt of a R&D start grant* or a commercial ready grant* in respect of that year of income. Companies to whom these latter circumstances apply will need to calculate the amount of incremental expenditure they incurred on R&D activities in that year, that they would have been eligible to claim as a deduction under the R&D concession for incremental expenditure if they had been registered. In summary, a combination of income years where there was either deductible R&D expenditure or receipts from R&D start or commercial ready grants is acceptable for the purposes of meeting the three year history requirement.

• A start grant is a payment to a company under the Government R&D program.
• A commercial ready grant is a payment to a company under the Government Commercial Ready program, which includes a component for R&D activities (ignoring the R&D plan requirement). The program began on 1 October 2004 and subsumed the former R&D Start program.

ITAA 1936 sections 73P,73Q,73R

If a company is in receipt of a start grant or a commercial ready grant in a year of income in which it is registered with Innovation Australian (the Board), then the grant is subject to clawback. If the company is in receipt of a start or commercial ready grant in an income year in which they are not registered with the Board, the grant may form part of the company's claim history for a particular year.

When working out eligibility for the additional deduction under section 73Y of the ITAA 1936, the company must determine which year(s) the start grant or commercial ready grant was received 'in respect of'. The years to which a grant relates, for the purposes of section 73Q of the ITAA 1936, may differ from those in which grant payments were actually received. For example, the grant approved may have been calculated on the basis of research and development activities undertaken prior to the date of application for the grant. This would mean that the grant is 'in respect of' an income year prior to the year in which the grant agreement was signed or approved and prior to the year in which the first payment was received.

For further information see: ATO Interpretative Decision ATO ID 2002/985 Research and development - 3 year history - Additional deduction. Does the taxpayer satisfy the requirement of establishing a three year history outlined in paragraph 73Q(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), for the three years preceding the 2002 financial year?

 

Terms used

For the purposes of applying the incremental concession rules, years of income are designated as follows:

Y₀is the year of income for which an eligible company is working out its assessable income and deductions.

Y_-1 means the year of income before the Y₀ year of income

Y_-2 means the year of income 2 years before the Y₀ year of income

Y_-3 means the year of income 3 years before the Y₀ year of income

ITAA 1936 subsection 73P(6)

Example 5.1

Company A, which is not grouped with any other company, is seeking to claim the incremental concession for Y₀ when it was entitled to deductions for incremental expenditure of $90,000.

In the previous year (Y_-1) Company A received a commercial ready grant of $25,000 and incurred incremental expenditure of $50,000, but had not registered for the 125% Concession.

In the two years immediately prior to that Company A was registered and entitled to deductions for incremental expenditure of $25,000 (Y_-2) and $20,000 (Y-₃).

Company A may be eligible for the incremental concession in Y₀as it has the required three year history '(ie, for the Y_-1,Y_-2andY-₃ years of income)'.

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	90	50	25	20

C5-4 Calculation

Generally a company works out the amount that will be subject to the additional 50% deduction by subtracting its average incremental expenditure over the past three years from its current year incremental expenditure. That amount may be moderated where expenditure in any of the two previous years i.e. Y_-1 or Y-₂, has fallen below 80% of the previous year's expenditure.

Where there are several members in a group, these calculations are done on a group basis. The grouping rules are the same as those used for the tax offset. Special allocation rules then apply to determine the amount claimable by each of the companies within the group.

The amount determined in this way will attract an additional 50% deduction, in addition to the 125% deduction already available on that amount, providing a total premium rate of 175%.

ITAA 1936 sections 73S to 73Y

C5-5 Incremental expenditure

Incremental expenditure is defined to mean expenditure that is research and development expenditure with the exception of plant leasing expenditure, and any other expenditure incurred under a contract which is in substance for the acquisition of plant.

ITAA 1936 subsection 73P(2)

Incremental expenditure as defined in subsection 73P(2) means expenditure that is research and development expenditure as defined in subsection 73B(1). This includes : contract expenditure to a Registered Research Agency (RRA) salary expenditure other expenditure directly in respect of R&D activities includes: contract expenditure to others for R&D activities, and eligible feedstock expenditure (not residual feedstock expenditure). Subsection 73P(2)excludes: expenditure to lease or hire plant, and expenditure under a contract that is in substance for the acquisition of plant and not for the receipt of services. Note: Expenditure which is not research and development expenditure as defined in subsection 73B(1) is not incremental expenditure. Items in this excluded category include plant depreciation, core technology, interest and residual feedstock expenditure.

The 'incremental expenditure' of a company eligible to claim the incremental tax concession includes all amounts of 'research and development expenditure', other than those in relation to plant (as specified above), regardless of whether the company:

• claimed a deduction for these amounts under the R&D tax concession, at either the 100% rate (for example because of the operation of the clawback provisions in section 73C of the ITAA 1936 on receipt of a grant, or the 'not at risk rules' in section 73CA of the ITAA 1936) or at the 125% rate
• was not eligible to claim a deduction under the R&D tax concession. This could occur, for example, where the company was not registered with AusIndustry in relation to the project for which the expenditure was incurred; where the company's aggregate research and development amount for the year was less than $20,000; or where the expenditure was for overseas expenditure and a provisional certificate under section 39ED of the Industry Research and Development Act 1986 was not issued.

Example 5.2

Company A (a company with no group members), wishes to claim the additional deduction for incremental expenditure, for Y_0,when it was entitled to deductions for incremental expenditure of $90,000 (all of which is eligible for deduction at the 125% rate). Its incremental expenditure for the other relevant years of income, including non-deductible amounts, is as follows:

Company A Incremental expenditure	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Deductible	90	30	30	15
Non-deductible	0	10	5	0
Total incremental expenditure	90	40	35	15

Total group markup

It should be noted that where any expenditure amounts are paid to an entity that is a member of the same group, any amounts of such payments which represent an intra-group markup are eliminated from that expenditure in calculating entitlement to both the 125% R&D tax concession and the incremental tax concession.

Where there is an entitlement to an additional deduction under section 73Y of the ITAA 1936, the intra group markup is also excluded when calculating the R&D spend of the eligible company for each of the Y_-1,Y_-2and Y-₃ years of income.

ITAA 1936 subsections 73B(14AA) to (14AD)

C5-6 Prepayments in the calculation of the 175% premium R&D tax concession

The prepayment rules apply to the calculation of the 125% R&D tax concession and the 175% premium R&D tax concession. From 1 July 2001, R&D prepaid expenditure is generally taken into account on a spread basis in the year to which the payment relates, not the year in which it is incurred. An exception relates to prepayments for contract expenditure to a Registered Research Agency, which attracts special treatment.

ITAA 1936 sections 82KZMA to 82KZMF

C5-7 Grouping rules for the incremental concession

The same grouping rules apply as those for the R&D tax offset.

C5.7.1 Company groups - entry and exit rules

There are rules covering the situation where companies enter or exit a group during the claim year and/or the three-year history period.

These rules work by identifying all of the companies who are required to be grouped with the claimant at the end of the claim year ( Primary group members ), and then by establishing the dates upon which the control of any of these companies last changed within the history period such that they became members of the group.

The period between these dates is the group membership period of each company. Any other companies with whom these members were required to be grouped in their group membership period (but which have subsequently left the group) are also identified ( secondary group members).

Therefore at any point in time, the members who are to be grouped together are identified, and their incremental expenditure during their period of group membership can be calculated.

C5.7.2 Substituted Accounting Periods

To determine its eligibility for the additional deduction under section 73Y of the ITAA 1936, a company must first determine whether the requirements of section 73Q of the ITAA 1936 are met in relation to the 'deduction year' (the Y₀ year of income) and each of the preceding 3 years of income (the Y_-1, Y_-2 and Y_-3 years of income).

The 'deduction year' for the purposes of sections 73Q, 73U, 73V, 73W and 73Y of the ITAA 1936 will be the 12-month period ending on the last day of the period for which the company seeking to claim the additional deduction will lodge its return of income for the year. This is so even where the company's return of income for the year is for a period of greater or less than 12 months. For example, if the return of income of the company for the 2003-04 income year is for the period from 1 July 2003 to 31 December 2003, the 'deduction year' is the 12-month period 1 January 2003 to 31 December 2003.

The preceding three years of income are the 3 preceding 12-month periods, i.e., 1 January 2002 to 31 December 2002, 1 January 2001 to 31 December 2001 and 1 January 2000 to 31 December 2000, representing the Y_-1, Y_-2 and Y_-3 years of income, respectively.

If the company seeking to claim the additional deduction has a transitional period in one of the years of income representing the Y_-1, Y_-2 or Y_-3 year of income, that year will be the 12-months ending on the last day of the period for which the return of income was, or will be, lodged. This 12-month period will be used when calculating 'R&D spend' for the purpose of sections 73T, 73U, 73V, 73W and 73Y of the ITAA 1936.

For example, where a company is working out its additional deduction for the 2003-04 income year, and:

• 1 January 2003 to 31 December 2003 represents the 2003-04 income year
• 1 January 2002 to 31 December 2002 represents the 2002-03 income year
• 1 July 2001 to 31 December 2001 represents the 2001-02 income year; and
• 1 July 2000 to 30 June 2001 represents the 2000-01 income year

then the deduction year and three preceding years for the purposes of the additional deduction will be:

• 1 January 2003 to 31 December 2003 representing the Y0 year of income
• 1 January 2002 to 31 December 2002 representing the Y-1 year of income
• 1 January 2001 to 31 December 2001 representing the Y-2 year of income
• 1 January 2000 to 31 December 2000 representing the Y-3 year of income

These periods are always worked out using the year of income or substituted accounting period of the company working out its deduction, and not the year of any group member. All information, for example, group membership and 'R&D spend' must be worked out using the 12-month periods representing the Y₀ toY_-3years of income of the company working out its deduction. This process must be undertaken in respect of each group member working out its respective deduction as the periods may be different depending upon that company's own year of income.

Note: Where the company working out its additional deduction has a transitional period for the 'deduction year' (the Y₀ year of income), it will use the 12-month period representing the Y₀ year of income when determining the lesser amount under subsection 73Y(2) of the ITAA 1936.

For further information see: ATO Interpretative Decision ATO ID 2003/990 Research and development: Additional deduction for incremental expenditure where a group member company has a substituted accounting period. If an eligible company is grouped with another company that has a different accounting period, is the year of income referred to in paragraph (b) of the definition of R&D spend in subsection 73P(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that of the eligible company, and not that of the group member?

ATO Interpretative Decision ATO ID 2003/991 Research and development: Additional deduction for incremental expenditure where a company has a transitional substituted accounting period. If an eligible company in one of the three years prior to the deduction year, has lodged a return of income for a period other than 12 months, will this period represent any of the 'Y-1, Y-2 or Y-3' years when calculating 'R&D spend'?

ATO Interpretative Decision ATO ID 2004/973 Research and development: Additional deduction for incremental expenditure where a company has a transitional substituted accounting period in relation to the 'deduction year'. If an eligible company lodges a return of income for a period other than 12 months, will this period represent the year of income (the deduction year) for the purposes of determining the company's eligibility to claim an additional deduction for incremental expenditure, and also represent the Y0 year when calculating R&D spend?

Determining group membership

The detailed steps involved in determining group membership are:

Step 1:

Identify the primary group members (PGM ) - these are the claimant company, and other companies required to be grouped with the claimant company as at the end of the claim year (Y₀).

Step 2:

Determine the group membership period of each of the PGMs. A PGM's group membership period extends from the day that its control changed (or from the date the PGM experienced another change as specified in step 2 of the method statement in section 73R of the ITAA 1936) to cause it to come into the group to the last day of the current income year. However, the group membership period cannot generally commence before the first day of the income year three years before the current income year.

Step 3:

Determine any other companies that are required to be grouped with each PGM at a time during the PGM's group membership period. Any company identified under this step is called a secondary group member (SGM).

These will be companies which were required to be grouped with a PGM for a least some part of the four year period under review, but which have left the group prior to the end of the current year.

Steps 4 & 5:

Determine the group membership period for each SGM. This extends from the day that its control or affiliates changed to cause it to come into the group to the day its control or affiliates changed to cause it to leave the group. However, as in Step 2, the group membership period cannot generally commence before the first day of the income year three years before the current income year.

The effect of these rules is that for the purposes of calculation of the total incremental expenditure of a group, the incremental expenditure of a company is only taken into account for the period of time that it is a member of the group.

ITAA 1936 section 73R

For further information see: ATO Interpretative Decision ATO ID 2005/152 Research and Development: group membership period under section 73R of the ITAA 1936 Where a company, now controlled by a person under section 73L of the Income Tax Assessment Act 1936 (ITAA 1936), was previously not controlled by any person within the meaning of that section, has there been change in control of the company for the purposes of paragraph 73R(2)(a) of the ITAA 1936?

Example 5.3

Companies A, B and C are companies that have been eligible to deduct amounts for incremental expenditure at some stage in the claim year and in the three immediately prior years. Companies A and B are primary group members in year Y₀ as they are grouped on the last day of that income year (step 1). Company C is a secondary group member as C is grouped with B only in Y_-1, Y_-2and Y_-3.

A modification to this rule occurs where any company enters or leaves a group with a 'viable business'.

C5.7.3 Viable business exception

The group membership periods of both primary and secondary group members can change under certain circumstances:

• where a secondary group member leaves the group with a viable business, its group membership period is deemed never to exist. As such, its incremental expenditure that was otherwise within its group membership period is no longer available for use in the calculation of the additional 50% deduction for the group that it departed from; or
• where either a primary group member or a secondary group member enters the group with a viable business, its group membership period is extended to include its group membership period from its previous group. As such, any incremental expenditure incurred from the 1^st day of the Y_-3yearduring aprevious group membership is taken into account in the calculation of the additional 50% deduction.

A company will join or leave the group with a viable business if all assets (which must include R&D assets) necessary to comprise a continuing business are transferred with the company and the vendor and purchaser agree in writing that they are transferring a viable business. The vendor must provide written details of the incremental expenditure that the transferred company incurred while in the former group. The written agreement and details of the incremental expenditure generally need to be provided by the end of the year in which the change of control took place. There is a transitional rule which requires that the written details relating to any change of control which occurred prior to 1 July 2002 be provided by 30 June 2002.

Where a company now controlled by a person or persons under section 73L of the ITAA 1936 was previously not controlled by any person within the meaning of that section, there is a change in control for the purposes of section 73R of the ITAA 1936. The group membership period of the company which experienced that change in control will be the period between the day on which the company became controlled by the current controller and the last day of the Y₀year of income.

ITAA 1936 subsections 73R(3) to (6)

For further information see: ATO Interpretative Decision ATO ID 2004/808 Research and development: 'Group membership period' and effect of viable business transfer. Is a viable business transfer necessary for an eligible company to claim the research and development additional deduction under section 73Y of the Income Tax Assessment Act 1936 (ITAA 1936), where that company has: deducted, under subsection 73B(13) or subsection 73B(14) of the ITAA 1936, an amount for incremental expenditure in the current year of income and in each of the preceding three years of income; and experienced a change in control during that time?

Example 5.4

Companies A, B, C and D are companies that have been eligible to deduct amounts for incremental expenditure at some stage in the claim year and in the three immediately prior years. Companies A and B are primary group members in year Y₀ as they are grouped on the last day of that income year (step 1). Companies C and D are secondary group members as C is grouped with B in Y_-1 and Y_-2 and D is grouped with B in years Y_-2 and Y_-3. When C became grouped in Y_-2, it did not bring a viable business.

Companies	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20
Company C		60	50	0
Company D			20	20

Assume company D was liquidated on 30 June Y_-2 (and thus did not transfer a viable business) and company C was sold in Y_-1 with a valid transfer of a viable business (and thus all incremental expenditure is ignored and the company is deemed never to have had a group membership period).

Where a company, which has experienced a change of control during the period commencing on the first day of the Y_-3year of income and ending on the last day of the Y₀ of income, meets the requirements of section 73Q of the ITAA 1936 without relying on any group member (refer subsection 73Q(2) of the ITAA 1936), it may be entitled to an additional deduction under section 73Y of the ITAA 1936 regardless of whether there is a viable business agreement relating to that change in control.

However, the 'R&D spend' for the company will include only the incremental expenditure it incurred during the portion of its group membership period. This can mean that the company will have $0 R&D spend for one or all of the Y_-1to Y_-3years of income.

Example 5.5

Company A is an eligible company which undertakes research and development activities in Australia.

For the 2003-04 year of income, and for each of the preceding three years of income, Company A has deducted amounts for 'incremental expenditure' under subsection 73B(14) of the ITAA 1936. 'Incremental expenditure' is defined by section 73P of the ITAA 1936.

Company A was wholly owned by Company D until 30 April 2004 when it was acquired by Company E. No change to the business of Company A occurred.

Company D and Company E are foreign companies which are not liable to tax in Australia. They cannot and do not claim deductions for research and development in Australia.

Company A acquired 100% of shares in both Company B1 and Company B2 on 30 June 2003. Both Company B1 and Company B2 are eligible companies and undertake research and development activities in Australia. Both have deducted amounts for 'incremental expenditure' under subsection 73B(14) of the ITAA 1936, for the 2003-04 year of income.

The group is not consolidated and does not intend to consolidate.

 

Calculation of group membership periods

Control of Company A changed on 30 April 2004 when it was acquired by Company E. Therefore, Company A's 'group membership period' is 30 April 2004 to 30 June 2004 (inclusive). Control of Company B1 and Company B2 changed on 30 June 2003 when they were acquired by Company A. However, control of Company B1 and Company B2 also changed again, on 30 April 2004, when Company A was acquired by Company E, so their 'group membership period' is the same as that for Company A.

 

R&D Spend

The R&D Spend for Company A for Y₀ will include only the incremental expenditure it incurred during the portion of its group membership period that falls within the Y₀ year of income. That is, the incremental expenditure incurred from between 30 April 2004 and 30 June 2004. We have called this amount of expenditure 'XA'.

To this amount, is added the incremental expenditure of Company B1 and Company B2 incurred during the portion of their respective group membership periods that fall within the Y₀ year of income. We have called these amounts 'XB1' and 'XB2'. The total of 'XA', 'XB1' and 'XB2' equals Company A's R&D spend for the Y₀ year of income. We have called this total amount 'XX'. (There were no intra-group transactions).

No part of Company A's group membership period covers the Y_-1, Y_-2 or Y_-3 years of income. Therefore, the amounts to be included under paragraph (a) of the definition of 'R&D spend' for each of these income years, is zero. Similarly, no part of the group membership periods of Company B1 and Company B2 fall within the Y_-1, Y_-2 and Y_-3 years of income, so the amounts included in Company A's 'R&D spend' under paragraph (b) of the definition in section 73P of the ITAA 1936, for each of these years is also zero.

R&D Spend for Company A is therefore:

Company	Y0	Y-1	Y-2	Y-3
Company A	$XA	0	0	0
Company B1	$XB1	0	0	0
Company B2	$XB2	0	0	0
TOTAL	$XX	0	0	0

Section 73W of the ITAA 1936 provides that the premium amount is based on the excess of the current year R&D Spend over the average R&D Spend for the previous three years, less any adjustment where annual incremental expenditure during the three year history fluctuated by more than 20%.

Under subsection 73X(1) of the ITAA 1936 the premium amount will only be distributed between group members who increased the incremental expenditure incurred during their individual group membership period for the Y₀ year of income above the level of incremental expenditure incurred during their individual group membership period for the Y_-1 year. These group members are called 'increasing members'.

Company A incurred an amount of incremental expenditure ($XP) in the Y₀ year of income during its group membership period. However, as Company A's group membership period is 30 April 2004 to 30 June 2004, Company A has incurred nil incremental expenditure during its group membership period for the Y_-1 year. Company A is therefore an 'increasing member' and can claim a deduction under section 73Y of the ITAA 1936 for the amount worked out under subsection 73Y(2) of the ITAA 1936.

C5.7.4 Consolidated groups

Where a company becomes a member of a consolidated group in a year of income, then for the purpose of determining entitlement to the Incremental tax concession and calculating the additional deduction:

• incremental expenditure amounts incurred by the joining company before it became a member are treated as if they were incurred by the head company of the group; and
• any amounts the joining company had deducted or can deduct for expenditure incurred prior to joining are treated as if they had been deducted by the head company of the group.

ITAA 1936, section 73BAC

Where a company ceases to be a member of a consolidated group in a year of income:

• incremental expenditure amounts actually incurred by the leaving company while it was a member of the group, are treated as if they were incurred by it and not by the head company; and
• any amounts deducted or able to be deducted by the head company of the group for that expenditure, are treated as if they had been deducted by the leaving company.

ITAA 1936, section 73BAD

These special rules effectively override the operation of the consolidation entry and exit history rules, which would otherwise allow both the joining (or leaving) company and the head entity to count the company's history prior to the joining (or leaving). They also prevent loss of entitlement to the incremental concession through the operation of the '125% cap' on the increment deduction amount (ITAA 1936 subsection 73Y(2)) from occurring, where the subsidiary with the history is not the entity which was entitled to claim the 125% concession (i.e. this being claimed by the head company) (see also Part C4-10 - Working out the additional 50% deduction).

For a company that has left a consolidated group, these rules put that company in the same position it would have been in if it had never been in the consolidated group.

Example 5.6

Companies A and B were not associated in any way during the Y-3 to Y-1 years. Company A took ownership of all of the shares in company B at the beginning of Y0, and elected to consolidate for tax purposes.

The amounts of incremental expenditure incurred by each of these entities is as follows:

Companies	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20

In calculating the entitlement of the head company, Company A to the incremental tax concession in Y0, company A will be regarded as having incurred the amounts of incremental expenditure that its subsidiary member, company B, had incurred prior to becoming consolidated with company A.

Thus company A's 'history', in this calculation, will become:

Companies	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	180	50	20	20

Example 5.7

Companies A and B were part of a consolidated group during the period commencing at the start of Y_-3 to the end of Y_-1. During this period, only company A lodged tax returns as the Head Company of the consolidated group. (Company A had therefore been entitled to deduct the incremental expenditure incurred by its subsidiary Company B, under the R&D tax concession, in these years). At the end of Y_-1, Company A sold 20% of the shares in Company B to another entity.

Whilst Companies A and B are no longer part of the same consolidated group in Y₀, they are grouped for R&D purposes, Company B being 80% owned by Company A. Companies A and B are therefore R&D primary group members in year Y₀ as they are grouped on the last day of that income year. From the start of Y₀ (i.e. after B's departure from the consolidated group), the history to be attributed to company B for Years Y_-3 to Y_-1 is the actual amount of incremental expenditure incurred by B, whilst in the consolidated group. From this time, the history amounts of both entities equal the amounts incurred by each, as per the table below.

Companies	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20

Effectively, from the time that company B leaves the consolidated group, both entities are treated for the purposes of calculation of the incremental concession as though consolidation had never occurred.

C5-8 Premium calculation

Once the incremental expenditure for the current year and the three prior years has been ascertained, the next step is to calculate the premium amount which, after apportionment, can be claimed by the eligible company as an additional 50% deduction.

In simple terms, the premium amount is:

• based on the excess of the current year R&D spend over the average R&D spend for the previous three years, and
• may be reduced by an adjustment amount where any annual downswing in incremental expenditure during the three year history period exceeds 20%.

For the purposes of the calculation in a particular year, incremental expenditure of the eligible company incurred in its group membership period is summed with the incremental expenditure of other group members incurred in their respective group membership periods, where relevant. This amount is defined as the R&D spend . Where a company is not a member of a group, its incremental expenditure incurred its group membership period equals its R&D spend.

The steps to calculating the premium amount are set out in sections 73T, 73U, 73V and 73W of the ITAA 1936. These steps can be summarised as follows:

Step 1 (section 73T)	Step 2 (section 73U)	Step 3 (section 73V)	Step 4 (section 73W)
Determine the adjustment amount for the current year (Y0) and the previous year (Y1).	Determine the running averages for Y0 andY-1.	Determine the adjustment balance using the amounts determined in Steps 1 and 2.	Determine the premium amount . This is the R&D spend for Y0 less the running average for Y0 from Step 2 less the adjustment balance from Step 3.

Example 5.8

A company which is not grouped with any other company has the following R&D spend history:

Current year (Y₀) is $110, Y_-1is $90, Y_-2 is $60, Y_-3 is $30.

 

Step 1:

The adjustment amount for Y₀ and Y_-1 = 0 as there is no decrease in R&D spend >20% in either of the Y_-1 or Y_-2 years.

 

Step 2:

The running average for Y₀ is 1/3^rd of the sum of the R&D spend for each of the Y_-1, Y_-2 and Y_-3 years.

This equals (($90 + $60 + $30) / 3) = $60.

The running average for Y_-1 is 1/2 of the sum of the R&D spend for each of the Y_-2 and Y_-3 years.

This equals (($60 + $30) / 2) = $45.

 

Step 3:

The adjustment balance is zero as there are no adjustment amounts (See also step 1 above).

 

Step 4:

The premium amount is the current year eligible incremental expenditure less the current year running average .

This equals ($110 - $60) = $50.

Explanation of steps

Step 1

There may be an adjustment amount (AA₀) where a company's R&D spend in the prior year decreased to an amount which is less than 80% of the prior year incremental expenditure amount. In order to determine this adjustment amount, the R&D spend in the year of the decrease is subtracted from 80% of the prior year R&D spend. There can also be an adjustment amount (AA_-1) where the R&D spend in the year before the prior year is less than 80% of the R&D spend of the year before that.

Example 5.9

A company, which is not grouped with any other company, has the following R&D spend history:

 

Current year (Y₀) is $310, Y_-1is $90, Y_-2 is $200, Y_-3 is $240

Adjustment amount (AA₀) for Y₀ = [($200 x 0.80) = $160 - $90] = $70.

 

There is no AA_-1 (adjustment amount for Y_-1) as the decrease in R&D spend from the Y_-3 to the Y_-2 year was less than 20%.

The adjustment amount for Y₀(AA₀) will be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y_-1year, and
• no group member underwent a change of control in Y₀resulting in the transfer of a viable business in the current year, and a change to the R&D spend of the eligible company for any of the three history years.

Also, AA_-1 (the adjustment amount for Y_-1) will be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y_-2 year, and
• no group member underwent a change of control resulting in the transfer of a viable business in the current year or the Y_-1 year, and a change to the R&D Spend of the eligible company for any of the three history years.

The adjustment amount will also be deemed to be nil where the result of the calculation is negative.

Step 2

Step 2 calculates the running average which provides the benchmark amount of expenditure which the current year R&D spend must exceed if it is to attract the additional 50% deduction.

The running average for the current year (RA₀) is the sum of the incremental expenditure amounts in the previous three years divided by three. The running average for the Y_-1 year (RA_-1) is the sum of the incremental expenditure amounts in the previous two years divided by two. The running average calculation for Y_-1 is necessary to determine any adjustment balance in Step 3 below.

Step 3

Step 3 adds together any adjustment amounts (AA₀ and AA_-1) where the prior year (Y_-1) R&D spend is less than or equal to the running average (RA_-1) for that year. The result is referred to as the adjustment balance . If the prior year R&D spend is more than the running average for that year, it reduces the sum of the adjustment amounts (AA₀ and AA_-1) by the amount by which the prior year R&D spend exceeds the prior year running average (RA_-1).

Example 5.10

Where the R&D spend for Y₀ = $250, Y_-1 = $60, Y_-2 = $150, Y_-3 = $180.

 

The running average for Y₀= [($60 + $150 + $180) /3] = $130.

The running average for Y_-1= [$150 + $180] /2] = $165.

Adjustment amount (AA₀) for Y₀= [($150 x 0.80) = $120 - $60] = $60.

 

There is no adjustment amount for Y_-1 as the decrease in R&D spend from the Y_-3 to the Y_-2 year was less than 20%. i.e. AA_-1 = 0

As the R&D spend in Y_-1 ($60) was less than the running average ($165) for that year, then the adjustment balance = $60 + 0 = $60.

The adjustment balance is deemed to be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y_-1 year, and
• there was no change of control of the eligible company or its group members during the Y₀ year resulting in the transfer of a viable business and a change to the R&D spend of the eligible company for any of the three history years.

The adjustment balance will also be deemed to be zero where the result of the calculation is negative.

Step 4:

Step 4 calculates the premium amount which will be eligible for the additional 50% deduction. The premium amount is calculated by summing the relevant incremental expenditures of the eligible company and other group companies to determine the R&D spend and then deducting the current year running average and the adjustment balance.

Example 5.11

Company A has the following R&D spend:

Y₀ is $250, Y_-1 is $181, Y_-2 is $150, Y_-3 is $200

(Assume there was no eligibility to claim the additional 50% deduction in Y_-1).

Step 1:	adjustment amount in Y0= 0 adjustment amount in Y-1 = [($200 x 0.8) - $150] = $10
Step 2:	running average in Y0 = $177 running average in Y-1 = $175
Step 3:	adjustment balance = ($175 + 0 + $10 - $181) = $4 (in other words the excess of the R&D spend over the running average in Y-1 is deducted from the sum of the adjustment amounts)
Step 4:	premium amount = ($250 - $177 - $4) = $69

C5-9 Entitlement to share of premium amount

Having calculated the premium amount, there are two further steps involved in determining the amount available to be deducted by an eligible company. These steps are:

• determine the portion of the premium amount which is 'distributed' to the company. The aim of this provision is to distribute the premium amount between the members of the group that contributed to earning it.

• ITAA 1936 section 73X

• determine the amount of the deduction available in respect of this portion.

• ITAA 1936 section 73Y(2)

C5.9.1 Determining the company's distribution of the premium amount

Where there is more than one company in the group that has incurred incremental expenditure during the Y₀ and Y_-1 years_,the premium amount may need to be apportioned.

The premium amount will only be distributed to group companies that have individually increased their incremental expenditure during their Y₀ group membership period over the level of incremental expenditure incurred while they were a group member during the Y_-1year.

Note: Where a group member has not incurred an amount of incremental expenditure in the year of income Y_-1,(i.e. their incremental expenditure amount is '0'), but has incurred an amount of incremental expenditure in the Y₀ year of income, that group member will be considered an 'increasing member' for the purposes of calculating the distribution of the premium amount.

The premium amount will be apportioned among these companies on the basis of their proportionate share of the total increased incremental expenditure incurred by them.

Example 5.12

Company	Prior year ($000's)	Claim year ($000's)	Change ($000's)
Company A	60	40	-$20
Company B	10	15	5
Company C	30	70	40
Company D	15	25	10

Assume a premium amount of $50,000 is to be shared. This would be shared between B, C and D on the basis of B: 9.1%; C: 72.7%; D:  18.2%

ITAA 1936 section 73X

C5-10 Working out the additional 50% deduction

The additional 50% deduction is the lesser of:

• 50% of the premium amount distributed to the eligible company, or
• 50% of the eligible company's Y₀ year of income incremental expenditure eligible for a deduction under section 73B of the ITAA 1936 at the rate of 125% (the '125% cap').

Circumstances in which the '125% cap' would operate in respect of incremental expenditure include:

• where clawback has operated to deny the additional 25% deduction for amounts of incremental expenditure (See Part C5-11 - The operation of the clawback provisions and the incremental concession.)
• where the 'at risk' rules in sections 73CA of the ITAA 1936 (guaranteed return to investors) or 73CB of the ITAA 1936 (expenditure incurred to tax-exempt bodies) have operated to deny the additional 25% deduction for amounts of incremental expenditure
• where the 'intra-group markup rules' in subsections 73B(14AB)-(14AD) of the ITAA 1936 have operated to deny the additional 25% deductions in respect of some of the incremental expenditure amount (see also section 2.3.11 - Reduce rate for group markup).

Example 5.13 (no operation of the '125% cap')

Company A's incremental expenditure for Y₀ was $20,000, and its distribution of the premium amount was $5,000. All of its eligible expenditure was eligible for deductions under section 73B of the ITAA 1936 at the rate of 125%.

The additional 50% deduction that Company A is entitled to is $5,000 x 50% which equals $2,500.

C5-11 Operation of the clawback provisions and incremental concession

Where a company or a company group member receives a grant or a recoupment from the government for R&D activities, clawback provisions under section 73C of the ITAA 1936 apply to reduce the amount the company can claim at the rate of 125%. Expenditure to which the grant or recoupment relates can only be deducted at the rate of 100%. While clawback does not affect a company's eligibility for the premium, or the amount of incremental expenditure included in the calculations for the current or history years, it will affect the level of the claim.

The impact of clawback is taken into account in calculating the entitlement to the incremental concession through the operation of the '125% cap' in subsection 73Y(2) of the ITAA 1936. This subsection limits the amount of the incremental deduction to 50% of the lesser of the amount calculated (as above), or 50% of the amount of incremental expenditure incurred by the company in the current year that is eligible for a deduction at the rate of 125%.

Example 5.14

A company's incremental expenditure for year of income Y₀ was $20,000, and its distribution of the premium amount was $5,000. If clawback operates to reduce the incremental expenditure eligible to be deducted at the rate of 125% in Y₀ to $4,000, then the maximum premium deduction available to that company for Y₀ would be $4,000 x 50% which equals $2,000.

ITAA 1936 subsection 73Y(2)

C5-12 Other anti-avoidance measures

There is an anti-avoidance measure to prevent companies from amending prior year R&D claims for the purpose of reducing their R&D history, thereby increasing their eligibility for the incremental concession. Where the Commissioner is of the opinion that the purpose of a debit amendment is to increase a company's entitlement to the additional 50% deduction, he or she may disregard that debit amendment for the purposes of working out a company's incremental expenditure, and only for that purpose. That is, the company's return will be amended, but the amended R&D figures will not be used for increment calculation purposes.

ITAA 1936 section 73Z

C5-13 Interaction between the incremental concession and the R&D tax offset

A company may claim its entitlement to the incremental concession as a tax offset if it meets the eligibility requirements contained in section 73J of the ITAA 1936.

Example 5.15

Assume Company A, who is not grouped with any other companies, has the following incremental expenditure and R&D spend history:

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	80	60	40	20

Company A is eligible to claim the full $80,000 incremental expenditure deductions at the 125% rate in Year Y₀.

Its premium amount, based on the above figures will be:

$80,000 - ($60,000 + $40,000 + $20,000)/3 = $40,000

Its entitlement to a deduction for the incremental tax concession will therefore be $20,000 (50% of $40,000).

Company A's entitlement to deductions under the R&D tax concession is therefore as follows:

Deductions under section 73B(14)	$100,000	($80,000 @ 125%)
Deduction for incremental tax concession	$ 20,000
Total:	$120,000

Company A's turnover is $200,000, and its aggregate research and development amount is $80,000, making it eligible to claim the R&D tax offset.

Prior to electing for the R&D tax offset, Company A's tax return showed a loss of $150,000. On electing the offset in its original taxation return, its carried forward loss will be reduced to the extent of its deductions under the R&D tax concession (i.e. reduced by $120,000 to $30,000), and it will be entitled to a cash amount for the R&D tax offset of $36,000 ($120,000 x 30 cents in $)

Example 5.16 (incorporating full clawback)

Assume for this example that Company A above received a grant of $40,000 in year Y₀ in respect of the R&D activities it carried on in that year. As a result of applying clawback to $80,000 of its R&D expenditure (i.e. $40,000 grant x 2), none of Company A's R&D expenditure is eligible for the 125% concession. Consequently, company A is no longer entitled to a deduction for the incremental tax concession, because of the operation of the 125% cap.

Although this company is not eligible to claim any additional 25% concession or 50% incremental amount, it is still eligible to choose to claim the R&D tax offset.

But for choosing the R&D tax offset, Company A's tax return would have shown a loss of $110,000. On choosing the offset in its original taxation return, its carried forward loss will be reduced to the extent of its deductions under the R&D tax concession (i.e. reduced by $80,000 to $30,000), and it will be entitled to a cash amount for the R&D tax offset of $24,000 ($80,000 x 30 cents in $).

C6 Extra deduction for increase in expenditure on Australian owned R&D (175% Australian Premium)

This document has been archived. It is current only to 30 June 2011.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca.

C6-1 Background

For the year of income commencing after 30 June 2007 and later years of income, the Government has extended the incremental tax concession (175% Premium) to companies who incur expenditure on behalf of a grouped foreign company above a rolling three-year average of expenditure. As a result, the 175% Premium has been divided into two separate deductions, the extra deduction for increase in expenditure on Australian owned research and development (the 175% Australian Premium) and the extra deduction for increase in expenditure on foreign owned research and development (the 175% International Premium).

Consequently, there are new methods to calculate a company's incremental tax concession. The new methods require a company to calculate the increases (and decreases) in expenditure on both foreign-owned R&D and Australian-owned R&D for each eligible company in the group, and then pool the results such that increases to one type of expenditure will be reduced by any decrease to the other type of expenditure.

For information on the new 175% International Premium, refer to Part C7.

Generally, the 175% Australian Premium will be available to eligible companies that increase their level of expenditure on Australian owned R&D above a three-year average, in years of income that commence after 30 June 2007.

This initiative is about encouraging sustained business investment in R&D on a long term basis.

Key features of the 175% Australian Premium:

• Targeting of predominantly labour related components of R&D expenditure, where the greatest benefits for the whole economy occur. Plant related expenditure items are excluded.
• Applies to additional R&D expenditure above the three year rolling average of the company group, subject to moderation where there has been significant volatility in prior years R&D.
• Where a government grant is received in respect of eligible expenditure, this will impact on the calculation of the 175% Australian Premium.
• Mandatory grouping rules and other anti-avoidance measures to avoid any potential abuse.

C6-2 Timing

Companies can claim the 175% Australian Premium for expenditure incurred in their first year of income that commences after 30 June 2007, and in later years of income.

C6-3 Eligibility

C6.3.1 Prerequisites for deduction

current year

An eligible company claiming the 175% Australian Premium for a year of income must register its R&D activities for the year of income with Innovation Australia (the Board) and be eligible to deduct an amount for that year under subsection 73B(13) or (14) of the ITAA 1936 for incremental expenditure incurred in its group membership period .

three immediately prior years

In addition, the eligible company must have been eligible to deduct an amount under subsection 73B(13) or (14) of the ITAA 1936 for expenditure incurred in its group membership period in each of the three immediately prior years (three year claim history).

An exception to the requirement for an eligible company to have a three year claim history arises where the company is in a group and one of the eligible company's group members could deduct an amount under subsection 73B(13) or (14) for expenditure incurred in its group membership period for the relevant year or years (see section C6-4 of this guide for how to determine group members and group membership periods) . Provided that, between the eligible company and its group members, an amount could be deducted under subsection 73B(13) or (14) of the ITAA 1936, for expenditure incurred in a company's group membership period, in each of the three immediately prior years, the eligible company will have a three year claim history.

An eligible company can also have a claim history for a particular year of income if it has not registered with the Board for that year, but the company or one of its group members has been in receipt of a start grant* or commercial ready grant* in respect of that year of income. When calculating the amount of the 175% Australian Premium, the eligible company, or group member, will need to determine the amount of incremental expenditure incurred in its group membership period that could be taken into account in working out the amount of a deduction under subsection 73B(13) or (14) of the ITAA 1936 (apart from paragraph 73B(14)(b)) for that year of income.

In summary, where in respect of each of the three prior years, in any combination, the eligible company, or any of its group members, could deduct an amount under subsection 73B(13) or (14) of the ITAA 1936 for expenditure incurred in its group membership period,or the eligible company, or any of its group members, received a start grant or a commercial ready grant, the eligible company will have a three year claim history.

• A start grant is a payment to a company under the government R&D start program.
• A commercial ready grant is a payment to a company under the Commercial Ready program that includes a component for research and development.

ITAA 1936 sections 73P, 73QA, 73RA

When working out eligibility for the 175% Australian Premium, the company must determine which year(s) the start grant or commercial ready grant was received 'in respect of'. The years to which a start grant or commercial ready grant relate, for the purposes of section 73QA of the ITAA 1936, may differ from those in which the grant payments were actually received. For example, the grant approved may have been calculated on the basis of research and development activities undertaken prior to the date of application for the grant. The grant in this case is regarded as being 'in respect of' that earlier year of income.

the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group

To be eligible to claim the 175% Australian Premium, an 'eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group' as determined under subsection 73QA(3) of the ITAA 1936 must also be greater than zero.

An eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group is determined by the following formula.

For more information regarding this requirement refer to the Calculation Overview in C6-5.

Terms used

For the purposes of applying the 175% Premium rules, years of income are designated as follows:

Y₀is the year of income for which an eligible company is working out its assessable income and deductions

Y_-1 means the year of income before the Y₀ year of income

Y_-2 means the year of income 2 years before the Y₀ year of income

Y_-3 means the year of income 3 years before the Y₀ year of income

ITAA 1936 subsection 73P(6)

Example 6.1

Company A, which is not grouped with any other company, is seeking to claim the 175% Australian Premium for Y₀, for which year it was entitled to deduct $100,000, under subsection 73B(13) or (14) of the ITAA 1936, for incremental expenditure incurred during its group membership period.

In each of the three years immediately prior to Y₀(Y_-1, Y_-2andY_-3), Company A was registered with the Board and entitled to deduct $90,000 (Y_-1), $70,000 (Y_-2) and $60,000 (Y_-3), under subsection 73B(13) or (14) for incremental expenditure incurred in its group membership period.

Company A may be eligible for the 175% Australian Premium in Y0 as it has the required three year claim history.

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	100	90	70	60

C6.3.2 Transitional accounting periods of greater or less than 12 months

This section applies where a company, or consolidated group, has adopted, or reverted from, a substituted accounting period in lieu of an income year ending on 30 June and so has a transitional period of greater or less than 12 months.

 

Y₀ year of income

To determine its eligibility for the 175% Australian Premium under section 73QA of the ITAA 1936, an eligible company must first determine whether the requirements of section 73QA of the ITAA 1936 are met in relation to the Y0 year of income and each of the three prior years of income (the Y_-1, Y_-2 and Y_-3 years of income).

The Y₀ year of income for the purposes of sections 73P to 73V of the ITAA 1936 will be the 12-month period ending on the last day of the period for the which the eligible company (the company seeking to claim the 175% Australian Premium) will lodge its return of income for the current year. This is so even where the company's return of income for the year is for a period of greater or less than 12 months. For example, if the return of income of the company for the 2008-09 year of income is for the period from 1 July 2008 to 31 December 2008, the Y₀ year of income is the 12-month period 1 January 2008 to 31 December 2008.

This 12-month period will be used when determining whether the eligible company can deduct an amount for the Y₀ year of income under subsection 73B(13) or (14) of the ITAA 1936 for incremental expenditure incurred during its group membership period, and when calculating the amount of the eligible company's extra deduction for increase in expenditure on Australian owned R&D.

Three immediately prior years

The three prior years of income are the 3 immediately preceding 12-month periods, i.e.,

• 1 January 2007 to 31 December 2007,
• 1 January 2006 to 31 December 2006, and
• 1 January 2005 to 31 December 2005,

representing the Y_-1, Y_-2 and Y_-3 years of income, respectively.

If the company seeking to claim the 175% Australian Premium has a transitional period in one of the years of income representing the Y_-1, Y_-2 or Y_-3 year of income, that year will be the 12-months ending on the last day of the period for which the return of income was, or will be, lodged. This 12-month period will be used when determining whether the eligible company has a three year claim history for the purposes of section 73QA of the ITAA 1936 and when calculating the amount of the eligible company's extra deduction for increase in expenditure on Australian owned R&D.

Example 6.2

Where a company is working out its additional deduction for the 2008-09

income year, and:

• 1 January 2008 to 31 December 2008 represents the 2008-09 income year;
• 1 January 2007 to 31 December 2007 represents the 2007-08 income year;
• 1 July 2006 to 31 December 2006 represents the 2006-07 income year; and
• 1 July 2005 to 30 June 2006 represents the 2005-06 income year,

then the Y₀ year of income and three immediately prior years for the purposes of the 175% Australian Premium will be:

• 1 January 2008 to 31 December 2008 representing the Y₀ year of income;
• 1 January 2007 to 31 December 2007 representing the Y_-1 year of income;
• 1 January 2006 to 31 December 2006 representing the Y_-2 year of income;
• 1 January 2005 to 31 December 2005 representing the Y_-3 year of income.

Transitional accounting periods of group members

These 12-month periods are always worked out using the year of income or substituted accounting period of the eligible company working out its deduction, and not the year of any group member. All information, for example, group membership and the amounts worked out under section 73RA of the ITAA 1936, must be calculated using the 12-month periods representing the Y₀ to Y_-3 years of income of the company working out its deduction. This process must be undertaken in respect of each group member working out its respective deduction as the periods may be different depending upon that company's own year of income.

C6-4 Grouping rules for the 175% Australian Premium

To determine its eligibility for, and to calculate, the 175% Australian Premium an eligible company is required to work out its group members. A company that is the head company of a consolidated group must work out whether it has any group members who are not members of the consolidated group of which it is head company.

Primary and secondary group members, and their individual group membership periods, are identified utilising the method statement in subsection 73R(2) of the ITAA 1936.

Section 73R relies on the grouping rules that apply for the R&D tax offset set out in section 73L of the ITAA 1936. (For more information on the grouping rules contained in section 73L of the ITAA 1936, see Part C4-4 of this guide).

For further information on the grouping rules for the R&D tax offset, refer to part C4-4.

ITAA 1936 section 73L, 73R

C6.4.1 Section 73R group members

Many of the R&D provisions refer to the claimant company's group members under section 73R of the ITAA 1936 and the group membership periods of those companies. To determine a claimant company's entitlement to the R&D tax concession, it is therefore necessary to establish who is a member of its section 73R group and the group membership periods of each member. This is worked out by following the method statement in subsection 73R(2) of the ITAA 1936.

Subsection 73R(1) of the ITAA 1936 provides that when applying section 73R, section 73L of the ITAA 1936 must be used to determine whether companies are grouped. For more information on section 73L group members, see C4-4. Once the eligible company has determined its section 73L group, it can proceed to Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936.

Determining who is a Primary Group Member (PGM)

Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936 provides that the eligible company must work out who are the primary group members in its group. Any companies grouped under section 73L of the ITAA 1936 with the eligible company on the last day of the Y₀ year of income, and the eligible company itself, are primary group members.

Example 6.3

Company A	is an eligible company (the claimant) seeking to work out its entitlement to the 175% Australian Premium. Company A was a listed public company, with no shareholder having a greater than 9% interest, up until the first day of Y-1 when the company was acquired by Company C.
Company B	is also an eligible company and undertook Australian owned R&D activities in the Y0 year of income in relation to which it incurred an amount of research and development expenditure. Company B was a wholly owned subsidiary of Company A for the period from the first day of Y-3 year up to and including the last day of the Y0 year.
Company C	is an Australian public company listed on the stock exchange. Company C is the parent company of Company A and has been since the first day of the Y-1 year. Company C is an investment vehicle and does not undertake any R&D activities or incur any expenditure on R&D.
Company D	incurred expenditure on Australian owned R&D activities for which it could deduct an amount under subsection 73B(13) of the ITAA 1936 in each of the Y0 to Y-3years of income. Company D was controlled by Company C until the last day of the Y-2 year of income, after which time it was controlled by another company.
Company E	incurred expenditure on Australian owned R&D activities in each of the Y0 to Y-3 years of income for which it could deduct an amount under subsection 73B(14) of the ITAA 1936. Company E was acquired by Company C on the first day of the Y-2 year of income, prior to which time it was controlled by another company.

Therefore, the primary group members of Company A, are:

• Company A, the claimant
• Company B, a wholly owned subsidiary of Company A on the last day of the Y₀ year
• Company C, the company who controlled Company A on the last day of the Y₀ year, and
• Company E, the company acquired by Company C on the first day of the Y_-2 year.

Company D is not a primary group member of Company A, as it was not grouped with Company A under section 73L of the ITAA 1936 on the last day of the Y₀ year of income, having been sold by Company C on the last day of the Y_-2 year.

However, completing Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936 does not identify all section 73R group members; it only identifies the primary group members . The eligible company's secondary group members are worked out at Step 3 of the method statement after the group membership periods of the primary group members have been determined. Once the eligible company's secondary group members have been identified, the group membership periods of the secondary group members must also be worked out.

C6.4.2 Group membership periods

There are rules to determine the group membership period of each section 73R group member, including the group membership period of companies entering or exiting an R&D group during the claim year and/or the three-year history period. (There are special rules for companies who join or leave a consolidated group, please see section 6.4.4 of this guide.)

These rules work by identifying all of the companies who are required to be grouped with the claimant at the end of the claim year ( primary group members ), and then by establishing the dates upon which the control of any of these companies last changed within the history period such that they became grouped with the claimant.

The period between these dates is the group membership period of each primary group member. Any other companies with whom these members were required to be grouped in their group membership period (but which have subsequently left the group) are also identified ( secondary group members ).

Therefore at any point in time, the members who are to be grouped together are identified, and their incremental expenditure during their period of group membership can be calculated. Where the claimant is not grouped with any other eligible company, it will be the only primary group member. A solitary company must still work out its group membership period in accordance with section 73R of the ITAA 1936.

Determining group membership periods

The detailed steps involved in determining group membership periods are:

Step 1:	Identify the primary group members (PGM) - these are the claimant company, and other companies required to be grouped with the claimant company as at the end of the claim year (the Y0 year).
Step 2:	Determine the group membership period of each of the PGMs. A PGM's group membership period extends from the day that its control changed (or from the date the PGM experienced another change as specified in step 2 of the method statement in section 73R of the ITAA 1936) to cause it to come into the group to the last day of the current income year. However, the group membership period cannot generally commence before the first day of the income year three years before the current income year (the Y-3year).
Step 3:	Determine any other companies that are required to be grouped with each PGM at a time during the PGM's group membership period. Any company identified under this step is called a secondary group member (SGM). These will be companies which were required to be grouped with a PGM for a least some part of the four year period under review, but which have left the group prior to the end of the Y0 year.
Step 4 & 5:	Determine the group membership period for each SGM. This extends from the day that its control or affiliates changed to cause it to come into the group to the day its control or affiliates changed to cause it to leave the group. However, as in Step 2, the group membership period cannot generally commence before the first day of the income year three years before the current income year (the Y-3year).

The effect of these rules is that for the purposes of calculation of the total incremental

expenditure of a group, the incremental expenditure of a company is only taken into account for the period of time that it is a member of the group.

Where a company now controlled by a person or persons under section 73L of the ITAA 1936 was previously not controlled by any person within the meaning of that section, there is a change in control for the purposes of section 73R of the ITAA 1936. The group membership period of the company which experienced that change in control will be the period between the day on which the company became controlled by the current controller and the last day of the Y₀ year of income.

For further information see: ATO Interpretative Decision ATO ID 2005/152 Research and development: group membership period under section 73R of the ITAA 1936 Where a company, now controlled by a person under section 73L of the ITAA 1936, was previously not controlled by any person within the meaning of that section, has there been change in control of the company of the purposes of paragraph 73R(2) of the ITAA 1936? ITAA 1936 section 73R

Example 6.4

Following on from Example 6.3 above, the method statement in subsection 73R(2) of the ITAA 1936 determines group members and group membership periods in the following manner:

Step 1 Determine primary group members

Company A, Company B, Company C and Company E are primary group members because each company was grouped under section 73L of the ITAA 1936 on the last day of the Y₀ year of income.

Step 2 Determine the group membership period of each primary group member

Company A was acquired by Company C on the first day of the Y_-1 year. Therefore, the day before the last day of the Y₀ year when Company A was controlled by a person other than Company C is the last day of the Y_-2 year. This means that the group membership period (GMP) of Company A is the period from the first day of the Y_-1 year to the last day of the Y₀ year.

Company B was controlled by Company A for the full period from the first day of the Y_-3year up to and including the last day of the Y₀ year. However, Company B experienced a change in control for the purposes of section 73L of the ITAA 1936 when its parent, Company A, was acquired by Company C. Therefore, the GMP of Company B is the period from the first day of Y_-1 year to the last day of the Y₀ year.

Company C has not undergone any change in control, its GMP includes the whole period from the first day of the Y_-3year to the last day of the Y₀ year.

Company E was acquired by Company C on the first day of the Y_-2 year and remained wholly owned by Company C for the period up to and including the last day of the Y₀ year. Therefore, the GMP for Company E is the period from the first day of the Y_-2year up to and including the last day of the Y₀ year.

Step 3 Determine secondary group members

Company D will be a secondary group member as it is grouped with a primary group member at a time during that PGM's group membership period (in this example, Company C and Company E).

Step 4 & 5 Determine the group membership period of each secondary group member

The group membership period of the secondary group member, Company D, will be the period when it was grouped with a primary group member. Company D was grouped with Company C (and also with Company E), on the first day of the Y_-3 year of income but ceased to be grouped with Companies C and E on the last day of the Y_-2 year of income. Therefore, the group membership period of Company D (the SGM) will be the period from the first day of the Y_-3 year of income to the last day of the Y_-2 year of income.

Companies A, B, D and E incurred the following amounts of incremental expenditure during the Y₀ to Y_-3 years of income (Company C did not incur incremental expenditure):

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	70	60	30	30
Company B	80	0	0	0
Company D	100	200	30	20
Company E	80	40	20	160
Total	330	300	80	210

Company A, B, D and E incurred the following amounts in their group membership periods :

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	70	60
Company B	80	0
Company D			30	20
Company E	80	40	20
Total	230	100	50	20

However, a company's group membership period is modified where a company enters or leaves a section 73R group with a 'viable business'.

C6.4.3 Viable business exception

The group membership periods of both primary group members and secondary group members can change under certain circumstances:

• where the secondary group member left the section 73R group with a viable business, its group membership period in relation to this prior group is deemed never to exist. This means that although the company may have incurred incremental expenditure, this expenditure will not be included in the calculation of the 175% Australian Premium for that company in relation to this prior group, as it was not incurred during the company's group membership period; and
• where a primary group member (an eligible company who remains a section 73R group member on the last day of the Y₀ year of income) or a secondary group member (an eligible company who entered the section 73R group on or after the first day of the Y_-3 year of income, but was not a group member on the last day of the Y₀ year of income) entered the section 73R group with a viable business, the company's group membership period is extended to include its group membership period from its previous group. As such, any incremental expenditure incurred from the 1^st day of the Y_-3 year of income during a previous group membership period may be taken into account in the calculation of the 175% Australian Premium for that company or any new group members of that company.

A company will join or leave the group with a viable business if all assets (which must include R&D assets) necessary to comprise a continuing business are transferred with the company and the vendor and purchaser agree in writing that they are transferring a viable business. The vendor must provide written details of the expenditure incurred on R&D by the company while in its former group and grants and recoupments received or entitled to be received in relation to that expenditure. The written agreement and details of the incremental expenditure, or expenditure on foreign owned R&D for which an amount could be deducted under subsection 73B(14C) of the ITAA 1936, generally needs to be provided by the end of the year in which the change of control took place. However, the Commissioner may exercise a discretion to allow the written agreement to be provided at some later date.

ITAA 1936 subsections 73R(3) to (6)

Example 6.5

Following on from Example 6.3 and Example 6.4, above:

• Company A, Company B, Company C, Company D and Company E are section 73R group members
• Company A, Company B, Company C and Company E are primary group members, with the following group membership periods:
  • Coy C: first day of the Y_-3 year to the last day of the Y₀ year
  • Coy A: first day of the Y_-1 year to the last day of the Y₀ year
  • Coy B: first day of the Y_-1 year to the last day of the Y₀ year
  • Coy E: first day of the Y_-2 year to the last day of the Y₀ year
• Company D is a secondary group member, its group membership period is:
  • Coy D: first day of the Y_-3 year to the last day of the Y_-2 year

Assume however, that Company D left the R&D group with a viable business. This means that, when working out Company A's entitlement to the 175% Australian Premium, the rules for determining Company D's group membership period are modified and the group membership period of Company D is treated as never having existed.

Assume also that Company E joined the group with a viable business. This means that, when working out Company A's entitlement to the 175% Australian Premium, the rules for determining Company E's group membership period are modified to extend Company E's group membership period to include its R&D history incurred while grouped with its former R&D group.

For the purposes of calculating the increase in expenditure on Australian owned R&D for each company under section 73QA, the incremental expenditure for Company A and Company B will be as per the table above. However, due to the exit from the group of Company D at the end of the Y_-1 year with a viable business, no incremental expenditure of Company D is taken into account by Company A. Due to Company E entering the group on the first day of the Y_-2 year, with a viable business, the incremental expenditure Company E incurred while grouped with its former group is taken into account by Company A.

The incremental expenditure incurred by members of the section 73R group during their group membership periods is:

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Company A	70	60
Company B	80	0
Company D
Company E	80	40	20	160
Total	230	100	20	160

C6.4.4 Consolidated groups

Where a company becomes a member of a consolidated group or MEC group, then for the purpose of determining entitlement to the 175% Australian Premium and calculating the extra deduction:

• expenditure amounts incurred by the joining company before it became a member are treated as if they were incurred by the head company of the group,
• any amounts the joining company has deducted or can deduct for that expenditure are treated as if they had been deducted by the head company of the group, and
• any recoupments of, or grants in respect of, that expenditure, received or receivable by the joining company or its former group are treated as being received by the head company of the group.

This is by virtue of section 73BAC of the ITAA 1936. This section applies after any application of subsections 73R(3) and (4) so that any viable business transfer exceptions to the group membership period rules for joining entities are applied before attributing the relevant amounts to the head company of the consolidated group.

The operation of section 73BAC of the ITAA 1936 is generally taken to be conditional upon one or more joining companies becoming members of the relevant consolidated group. After the time at which this occurs, and in subsequent income years, the deeming effects set out above will operate in respect of the head company of the group.

If a company joins a consolidated group during an income year, it will be required to calculate its income tax payable, taxable income or losses for the period it is not part of the consolidated group (non-membership period). Expenditure incurred by the company in its non-membership period will generally be deductible by the company if the eligibility requirements are met.

ITAA 1936 section 73BAC

Where a company ceases to be a member of a consolidated or MEC group:

• expenditure amounts actually incurred by the leaving company while it was a member of the group, are treated as if they were incurred by it and not by the head company; and
• any amounts the head company has deducted or can deduct for that expenditure are treated as if they had been deducted by the leaving company.

This is by virtue of section 73BAD of the ITAA 1936. This section applies before any application of subsections 73R(3) and (4) so that any viable business transfer exceptions to the group membership period rules for exiting entities are applied after attributing the relevant amounts to the leaving company.

ITAA 1936, section 73BAD

These special rules effectively override the operation of the consolidation entry and exit history rules, which might otherwise allow both the joining (or leaving) company and the head company to count the company's history prior to the joining (or after the exit).

For a company that has left a consolidated group, these rules are intended to put that company in the same position it would have been in if it had never been in the consolidated group.

If a company leaves a consolidated group during an income year, it will be required to calculate its income tax payable, taxable income or losses for the period it is no longer part of the consolidated group (non-membership period). Expenditure incurred by the company in its non-membership period will generally be deductible by the company if the eligibility requirements are met.

For more information on how the consolidation provisions interact with the R&D tax concession, refer to part 2.1.6 Consolidation and the R&D tax concession in Part C-2 of this guide.

C6-5 Calculation overview

The method for calculating the 175% Australian Premium is different from the method for calculating the additional deduction under former section 73Y of the ITAA 1936 (incremental tax concession) available in relation to years of income commencing before 30 June 2007.

An eligible company seeking to claim the 175% Australian Premium must work out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group using the following formula:

ITAA 1936 subsection 73QA(3)

In applying this formula:

• the increase in expenditure on Australian owned R&D by the eligible company is worked out under subsection 73RA(1) of the ITAA 1936,
• the total increase in expenditure on Australian owned R&D by eligible companies in the group means the amount worked out under subsection 73RA(2) of the ITAA 1936,
• the net increase in expenditure on Australian owned R&D by the group (the net increase is the result of taking into account any decreases in expenditure on Australian owned R&D by the eligible company or its group members), is worked out under section 73RC of the ITAA 1936,
• the net increase in expenditure on foreign owned R&D by the group (the net increase is the result of taking into account any decreases in expenditure on foreign owned R&D by the eligible company or its group members - if there is no expenditure on foreign owned R&D by the eligible company or its group members, this will be nil), means the amount worked out under section 73RD of the ITAA 1936, and
• the adjusted increase in expenditure on R&D by the group means the amount worked out under section 73RE of the ITAA 1936 (this calculation includes the adjustment balance worked out under section 73V of the ITAA 1936; there may be an adjustment balance where expenditure has decreased more than 20% from one year to the next in any of the history years).

Hence the formula for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group, can be represented in terms of the relevant provisions as:

Once the company has worked out the increases and decreases in expenditure on both Australian-owned R&D and foreign-owned R&D for each eligible company in the group, the calculation effectively pools the results such that increases to one type of expenditure will be reduced by any decrease to the other type of expenditure.

The eligible company will be entitled to claim the 175% Australian Premium where the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group is greater than zero.

The amount allowable as a deduction to the eligible company for the Y₀ year of income will be 50% of the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group . The grouping rules are outlined at paragraph C6-4.

ITAA 1936 sections 73P to 73V

C6-6 Incremental expenditure

In order to work out the increase in expenditure on Australian owned R&D by the eligible company under subsection 73RA(1) of the ITAA 1936 and the total increase in expenditure on Australian owned R&D by eligible companies in the group under subsection 73RA(2) of the ITAA 1936, you must work out the 'incremental expenditure' incurred by each eligible company in its group membership period (as determined under section C6-4 of this guide), for each of the Y₀ to Y_-3 years of income.

'Incremental expenditure' as defined in subsection 73P(2) of the ITAA 1936 means expenditure that is research and development expenditure as defined in subsection 73B(1) of the ITAA 1936.

Subsection 73P(2) therefore includes:

• contract expenditure incurred to a Registered Research Agency (RRA)
• salary expenditure
• other expenditure incurred directly in respect of R&D activities, which includes:
  • contract expenditure to others for R&D activities, and
  • eligible feedstock expenditure (not residual feedstock expenditure).

Expenditure which is not 'research and development expenditure' as defined in subsection 73B(1) of the ITAA 1936 is not 'incremental expenditure'. Items in this excluded category include: decline in value in relation to depreciating assets, core technology expenditure, interest expenditure and residual feedstock expenditure.

A company's incremental expenditure includes amounts that satisfy the definition of 'research and development expenditure' (except those amounts excluded by section 73P of the ITAA 1936), that the company could deduct under subsection 73B(13) or (14) regardless of whether the company actually claimed a deduction for these amounts under the R&D tax concession, at either the rate of 125%, or at the rate of 100% (for example, because of the operation of the clawback provisions in section 73C of the ITAA 1936 on receipt of a grant, or the 'not at risk rules' in section 73CA of the ITAA 1936).

Note: A company's 'incremental expenditure' also includes expenditure which it could deduct under subsection 73B(14) of the ITAA 1936 (salary expenditure and other expenditure incurred directly in respect of R&D activities) if the requirement in paragraph 73B(14)(b) that a company's aggregate research and development amount is greater than $20,000 were ignored. While paragraph (14)(b) is not ignored when an eligible company is working out whether it satisfies the prerequisites for claiming the extra deduction for increase in expenditure on Australian owned R&D , amounts which come within paragraph (14)(a), in relation to a year of income, must be included when the eligible company is working out the increases and decreases in expenditure on Australian owned R&D for each eligible company in the group.

What is excluded from incremental expenditure

Subsection 73P(2) expressly excludes:

• expenditure to lease or hire plant,
• expenditure under a contract that is in substance for the acquisition of plant and not for the receipt of services.

Where the expenditure under a contract is both for the acquisition of plant and for the provision of services, the expenditure is to be apportioned between the two on a reasonable basis. Where reasonable apportionment is not possible, none of the expenditure under that contract can be 'incremental expenditure'.

ITAA 1936 subsections 73P(3) and (4)

Subsection 73P(2) also excludes expenditure that cannot be taken into account in working out the amount of the deduction under subsection 73B(13) or (14) of the ITAA 1936 (apart from paragraph (14)(b)). This excludes, for example:

• expenditure a company is required by subsection 73B(9) of the ITAA 1936 to disregard,
• expenditure for which a deduction is denied by subsection 73B(17A) of the ITAA 1936 (expenditure on overseas research and development which is not certified expenditure), and
• expenditure incurred in relation to activities that were not registered with the Board in relation to the year of income.

Total group markup

Subsection 73P(5) excludes from the definition of 'incremental expenditure' the total group markup of the company for that expenditure.

The total group markup of the company is excluded from incremental expenditure. The group markup of a company is the amount paid by it to a group member (see section 73L of the ITAA 1936) for goods or services in excess of the actual cost to that group member of providing those goods or services. A company's total group markup is the sum of all such amounts.

In calculating incremental expenditure, amounts that are incurred by an eligible company to a member of the same group need to be reduced by the total group markup. That is, any amounts incurred by an eligible company on R&D activities which represent an intra-group markup are eliminated from that expenditure when calculating the 175% Australian Premium.

For further information on amounts including a group markup refer to para 2.3.11.

ITAA 1936 subsections 73B(14AA) to (14AD), 73P(5)

C6-7 Prepayments in the calculation of the 175% Australian Premium

The incremental expenditure amount utilised in calculating any entitlement to the 175% Australian Premium is based on amounts allowable as a deduction under s73B(13) or (14) of the ITAA 1936 (ignoring paragraph (14)(b)).

The prepayment rules apply when working out the amount allowable as a deduction under subsections 7B(13) or (14) of the ITAA 1936, in relation to a year of income. Most prepaid expenditure on R&D activities is taken into account on a spread basis in the year to which the payment relates, not the year in which it is incurred. Prepayments for contract expenditure to a Registered Research Agency attract special treatment and are not subject to the general prepayment rules. For further information on the treatment of the prepayment of expenditure on R&D activities, refer to paragraph 2.3.10.

ITAA 1936 section 82KZMA to 82KZMF

C6-8 Calculating the 175% Australian Premium

The steps to calculating the components to be used in the calculation of the 175% Australian Premium amount are set out in sections 73RA, 73RC, 73RD and section 73RE of the ITAA 1936.

The formula for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group can be represented in terms of the relevant provisions in the following manner:

The steps for each component can be summarised as follows:

Subsection 73RA(1)	Subsection 73RA(2)	Subsection 73RC	Subsection 73RD	Subsection 73RE
Calculates each eligible company's increase in expenditure on Australian owned R&D	Calculates total increase in expenditure on Australian owned R&D for the eligible company's group	Calculates net increase in expenditure on Australian owned R&D by the eligible company's group	Calculates net increase in expenditure on foreign owned R&D by the eligible company's group	Calculates the adjustment to the increase in expenditure on R&D by the eligible company's group

C6.8.1 Increase in expenditure on Australian owned R&D

Working out the incremental expenditure incurred by the eligible company and its eligible company group members in their group membership periods, is the first step in determining the increase in expenditure on Australian owned R&D by the eligible company, and eligible companies in its group.

The increase in expenditure on Australian owned R&D is based on the excess of the current year incremental expenditure over the average incremental expenditure for the previous three years, for each company.

However, the amount of incremental expenditure included in this calculation may be reduced where the company has received a recoupment or grant that is attributable to that expenditure.

 

C6.8.1.1 Operation of the 'clawback' provisions and 175% Australian Premium

Where a company or a company group member receives a grant or a recoupment from the government for an R&D project, the clawback provisions in section 73C of the ITAA 1936 apply to reduce the amount the company can deduct at the rate of 125%. Expenditure to which the grant or recoupment relates can only be deducted at the rate of 100%.

Where the grant or recoupment received by the eligible company relating to expenditure incurred by the company on R&D is attributable to incremental expenditure incurred in the company's group membership period, then the amounts the company can include in its calculation for the 175% Australian Premium are reduced.

To be 'attributable' to incremental expenditure incurred by the company, the purpose of the grant being received must generally be viewed as being paid in relation to, or regarded as an effect of, incurring the expenditure. A causal or contributory connection between the grant and the expenditure will generally be required, and it will be sufficient if the cause was only one of a number of causes. That is, the grant amount need not be paid as a sole, dominant or direct cause or effect of having incurred the expenditure. In addition, the term 'attributable' implies that apportionment of the grant amount between the incremental expenditure incurred by the company and other type of expenditure is possible.

The incremental expenditure to be included in the calculation of the 175% Australian Premium is reduced by the 'initial clawback amount' relating to expenditure that is attributable to incremental expenditure incurred in the company's group membership period, in each of the years Y₀ - Y_-3. The 'initial clawback amount' is equal to two times the amount of the grant attributable to the incremental expenditure. The clawback-adjusted incremental expenditure amounts are then used to determine the increase in expenditure on Australian owned R&D by the eligible company, and its eligible company group members.

C6.8.1.2 Increase in expenditure on Australian owned R&D by the eligible company - 73RA(1)

The increase in expenditure on Australian owned R&D by the eligible company is calculated by following the steps of the method statement set out in subsection 73RA(1) of the ITAA 1936. Where the eligible company does not have an increase in expenditure on Australian owned R&D in the Y₀ year of income, it will not be entitled to the extra 50% deduction available under section 73QA of the ITAA 1936.

Step 1:	The first step is to work out the eligible company's incremental expenditure incurred during its group membership period for each of the Y0, Y-1, Y-2 and Y-3 years of income.
Step 2:	In the event that the company has received a grant, work out how much of the initial clawback amount (twice the amount received) relating to expenditure incurred by the company is attributable to the incremental expenditure incurred by the eligible company in its group membership period.
Step 3:	The result of Step 2 is subtracted from the company's incremental expenditure worked out under Step 1.
	The result is the reduced expenditure on Australian owned R&D. This is to be calculated for each of the Y0, Y-1, Y-2 and Y-3 years of income.
	Note: The result of Step 3 cannot be less than zero.

Example 6.6

Company J incurred an amount of incremental expenditure on Australian owned R&D activities in its group membership period for each of the Y₀, Y_-1, Y_-2 and Y_-3 years of income:

Company J	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
	100	90	60	60

Company J received a commercial ready grant of $10,000 in Y₀ in relation to expenditure incurred in Y₀on an Australian owned R&D project. The 'initial clawback amount' is $20,000. There were no other grants or recoupments received by Company J in the Y₀to Y_-3years of income. The $10,000 grant received by Company J in Y₀is wholly attributable to the incremental expenditure incurred by the company in Y₀on the Australian owned R&D project. Therefore, the $20,000 initial clawback amount is subtracted from Company J's incremental expenditure incurred in its group membership period for Y₀ to give the reduced expenditure on Australian owned R&D by the eligible company in its group membership period for that year of income.

The reduced expenditure on Australian owned R&D by Company J is:

Company J		Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Step 1	incremental expenditure	100	90	60	60
Step 3	initial clawback amount	(20)	0	0	0
Step 3	reduced expenditure on Australian owned R&D	80	90	60	60

Step 4:	Add up the reduced expenditure on Australian owned R&D by the eligible company in its group membership period for the Y-1, Y-2 and Y-3 years of income.
Step 5:	Divide the result of Step 4 by 3.

Example 6.6 cont.

Company J	($000)
reduced expenditure on Australian owned R&D for Y-1	90
reduced expenditure on Australian owned R&D for Y-2	60
reduced expenditure on Australian owned R&D for Y-3	60
Step 4	210
Step 5	70

Step 6:	Subtract the result of Step 5 from the reduced expenditure on Australian owned R&D by the eligible company in its group membership period for the Y0 year of income (this was worked out at Step 3).
	The result is the change in expenditure on Australian owned R&D by the eligible company.
	Note: This amount may be a negative number, a positive number or zero.

Example 6.6 cont.

Company J	($000)
reduced expenditure on Australian owned R&D for Y0	80
result of Step 5	(70)
change in expenditure on Australian owned R&D by the eligible company	10

Step 7:

The increase in expenditure on Australian owned R&D by the eligible company is either: the change in expenditure on Australian owned R&D by the eligible company , or zero, if the result of Step 6 is a negative number. Note: if the result of Step 7 is zero, the eligible company is not entitled to the 175% Australian Premium.

Example 6.6 cont.

The increase in expenditure on Australian owned R&D by the eligible company, for Company J, is $10,000. Company J will input this amount into its calculation for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group .

ITAA 1936 subsection 73RA(1)

C6.8.1.3 Total increase in expenditure on Australian owned R&D by the eligible companies in the group - 73RA(2)

The method statement in subsection 73RA(2) sets out the steps for calculating the total increase in expenditure on Australian owned R&D by the eligible companies in the group . This is the sum of the increase in expenditure on Australian owned R&D by each of the eligible companies in the group.

Steps 1 to 7 above, are performed for each eligible company in the group. The results are then added together to give the total increase in expenditure on Australian owned R&D by the eligible companies in the group.

If an eligible company seeking to claim the 175% Australian Premium is a solitary company, the total increase in expenditure on Australian owned R&D by the eligible companies in the group will be the same as the increase in expenditure on Australian owned R&D by the eligible company.

ITAA 1936 subsection 73RA(2)

Example 6.7

Company J has three section 73R group members. Company K, Company L and Company M are primary group members of Company J. The group members incurred an amount of incremental expenditure on Australian owned R&D activities in the group membership period for each of the Y₀, Y_-1, Y_-2 and Y_-3 years of income as follows:

Step 1 The increase in expenditure on Australian owned R&D for Company J was worked out above. This amount is $10,000. The increase in expenditure on Australian owned R&D for the group members of Company J who are eligible companies is:

Step 2 Total the results of Step 1.

The total increase in expenditure on Australian owned R&D by the eligible companies in the group is:

$10,000 + $40,000 + $60,000

= $110,000

Company J will input this amount into its calculation for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group .

C6.8.2 Net increase in expenditure on Australian owned R&D by the group - 73RC

The method statement contained in section 73RC sets out how to calculate the net increase in expenditure on Australian owned R&D by the group .

This is worked out by adding together the change in expenditure on Australian owned R&D by the eligible company of each eligible company in the group. This is the sum of the amount calculated under steps 1 to 6 of the method statement in subsection 73RA(1) for each company.

If an eligible company seeking to claim the 175% Australian Premium is a solitary company, the net increase in expenditure on Australian owned R&D by the group will be the same as the total increase in expenditure on Australian owned R&D by the eligible companies in the group and the increase in expenditure on Australian owned R&D by the eligible company.

Note: Remember that the change in expenditure on Australian owned R&D by the eligible company worked out using Steps 1 to 6 of the method statement in subsection 73RA(1) of the ITAA 1936 can be a negative number.

If the amount worked out under the method statement in section 73RC of the ITAA 1936 is zero, the eligible company is not entitled to the 175% Australian Premium.

ITAA 1936 section 73RC

Example 6.8

Step 1	For each group member that is an eligible company work out, under steps 1 to 6 inclusive of the method statement in subsection 73RA(1), the change in expenditure on Australian owned R&D by the eligible company . This was worked out for Company J above. The change in expenditure on Australian owned R&D by the eligible company for each group member is:
Step 2	Total the results of Step 1. If the result is a negative, the net increase in expenditure on Australian owned R&D by the group is zero instead.
	$10,000 + $40,000 + ($10,000) + $60,000
	= $100,000

Company J will input this amount into its calculation for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group .

C6.8.3 Net increase in expenditure on foreign owned R&D - 73RD

The method statement in section 73RD sets out the steps for calculating the net increase in expenditure on foreign owned R&D by the group.

This is calculated as the sum of steps 1 to 9 of the method statement in subsection 73RB(1) which works out the increase in expenditure on foreign owned R&D by the eligible company , for each of the eligible companies in the group. The result of Step 9 of the method statement in subsection 73RB(1) is equivalent to the change in expenditure worked out in relation to Australian owned R&D using steps 1 to 6 of the method statement in subsection 73RA(1) of the ITAA 1936.

If no amount of expenditure on foreign owned R&D was incurred by the eligible company, or group member, in its group membership period, for the Y₀, Y_-1, Y_-2 or Y_-3 years of income, then the net increase in expenditure on foreign owned R&D by the group will be nil.

For more information on expenditure on foreign owned R&D, please see Part C3 Deduction for expenditure on foreign owned R&D.

Note: A detailed explanation of how to calculate the net increase in expenditure on foreign owned R&D by the group is given in section 7.8.2 of this guide in part C7 Extra deduction for increase in expenditure on foreign owned R&D (175% International Premium). Note that if this amount is a negative number, the net increase in expenditure on foreign owned R&D by the group is zero.

ITAA 1936 section 73RD

C6.8.4 Adjusted increase in expenditure on R&D by the group - 73RE

The adjusted increase in expenditure on R&D by the group is calculated under section 73RE of the ITAA 1936. This amount is calculated as the sum of the change in expenditure on Australian owned R&D and the change in expenditure on foreign owned R&D for all group members (will be positive or zero if negative). An adjustment balance is then subtracted from this result (will be positive or zero if negative).

The adjustment balance is calculated under section 73V of the ITAA 1936 and will be relevant where there is any annual downswing in the combined total of incremental expenditure and expenditure on foreign owned R&D during the three year history period that exceeds 20%. In other words, that amount may be moderated where expenditure in any of the two previous years i.e. Y_-1 or Y_-2, has fallen below 80% of the expenditure in years Y_-2 or Y_-3 respectively. This adjustment exercise is determined by examining the incremental expenditure and expenditure on foreign owned R&D of the company's group.

ITAA 1936 section 73RE

Step 1	Step 1 For each group member that is an eligible company work out, under steps 1 to 6 inclusive of the method statement in subsection 73RA(1), the change in expenditure on Australian owned R&D by the eligible company .
Step 2	For each group member that is an eligible company to work out, under steps 1 to 9 inclusive of the method statement in subsection 73RB(1) the change in expenditure on foreign owned R&D by the eligible company .
Step 3	Add up all the results of steps 1 and 2. If the result is a negative number, the adjusted increase in expenditure on R&D by the group will be zero.
Step 4	Subtract the adjustment balance worked out under section 73V from Step 3. If the result is a negative number, the adjusted increase in expenditure on R&D by the group will be zero.

If the amount worked out under the method statement in section 73RE of the ITAA 1936 is zero, the eligible company is not entitled to the 175% Australian Premium.

C6.8.4.1 Adjustment amounts

To work out the adjustment amount, a company must first determine its R&D spend for the Y_-1, Y_-2 and Y_-3 years of income.

R&D spend of an eligible company and its group members for a year of income means the sum of: the amounts worked out for the year of income under steps 1, 2 and 3 of the method statement in subsection 73RA(1) as the reduced expenditure on Australian owned R&D by each eligible company in the group in its group membership period for the year of income; and the amounts worked out for the year of income under steps 4, 5 and 6 of the method statement in subsection 73RB(1) as the reduced notional expenditure on foreign owned R&D by each eligible company in the group in its group membership period for the year of income. ITAA 1936 subsection 73P(2)

There may be an adjustment amount (AA₀) where a company's R&D spend in the Y_-1 year of income is less than 80% of its R&D spend for the Y_-2 year of income. Similarly, there may be an adjustment amount (AA_-1), where a company's R&D spend in the Y_-2 year of income is less than 80% of its R&D spend for the Y_-3 year of income.

The adjustment amount of an eligible company and its group members for the Y₀ year of income (AA₀) is:

[R&D spend for Y_-2 year x 80%] - R&D spend for Y_-1 year

The adjustment amount of an eligible company and its group members for the Y_-1 year of income (AA_-1) is:

[R&D spend for Y_-3 year x 80%] - R&D spend for Y_-2 year

ITAA 1936 subsections 73T(1) and (2)

Exceptions

However, there are exceptions to these rules.

AA₀ will be zero if:

• the eligible company or any of its group members could deduct an amount under section 73QA or 73QB for the Y_-1 year of income, and
• there has been no change in control of the eligible company or any of its group members for the Y₀ year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73T(3)

Also, AA_-1 will be zero if:

• the eligible company or any of its group members could deduct an amount under section 73QA or 73QB for the Y_-2 year of income, and
• there has been no change in control of the eligible company or any of its group members for the Y₀ or Y_-1 year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73T(4)

The adjustment amount will also be deemed to be nil where the result of the calculation is negative.

ITAA section 73S

C6.8.4.2 Adjustment balance

If the R&D spend of the eligible company for the Y_-1 year of income is less than or equal to RA_-1, then

adjustment balance = AA₀ + AA_-1

Otherwise,

adjustment balance = (RA_-1 + AA₀ + AA_-1)- the R&D spend for Y_-1

ITAA 1936 section 73V

RA-1 (short for Running Average for the Y-1 year of income) means half the sum of the R&D spend of the eligible company and its group members for the Y-2 and Y-3 years of income. ITAA 1936 subsection 73P(2)

The adjustment balance is zero if the eligible company or any of its group members met the conditions in either paragraphs 73QA(1)(a) and (b) or in paragraphs 73QB(1)(a) and (b) of the Y_-1 year of income, and there has been no change in control of the eligible company or any of its group members for the Y₀ or Y_-1 year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73V(3)

The adjustment balance will also be deemed to be nil where the result of the calculation is negative.

ITAA section 73S

C6.8.4.3 Transitional rules

Transitional provisions operate to modify the application of paragraphs 73T(3)(a) and 73T(4)(a) and paragraph 73V(3)(a) for Y₀ that is the first year of income starting after 30 June 2007.

In effect, an eligible company may come within the exceptions to the adjustment amounts and adjustment balance where that company was eligible, or was deemed to be eligible, to claim an incremental tax concession (under section 73Y, 73QA or 73QB of the ITAA 1936) in the Y_-1 or Y_-2 year of income, as relevant.

Example 6.9

Continuing with Example 6.8 above, eligible company, Company J, and its group members, have the following:

• total increase in expenditure on Australian owned R&D by the eligible companies in the group (as calculated under subsection 73RA(2)) of $110,000
• net increase in expenditure on Australian owned R&D by the group (as calculated under section 73RC ) of $100,000

Company J, Company K, Company L and Company M did not undertake any foreign owned R&D in Y₀or any of the three previous years (Y_-1 to Y_-3). Therefore the net increase in expenditure on foreign owned R&D by the group as calculated by the method statement in section 73RD will be zero.

To calculate the adjusted increase in expenditure on R&D by the group under section 73RE there is a method statement to follow.

Step 1	For each eligible company that was a group member, work out under steps 1 to 6 (inclusive) of the method statement in subsection 73RA(1), the change in expenditure on Australian owned R&D by the eligible company.
	This amount has been calculated above and gave the following result:
Step 2	This step requires each eligible company that is a group member to worked out the change in expenditure on foreign owned R&D by the eligible company. This is calculated by following steps 1-9 of the method statement in subsection 73RB(1).

In this example, none of the group members have undertaken foreign owned R&D activities so the change in expenditure on foreign owned R&D by each of the eligible companies will be zero.

Step 3

Add up all of the results of Step 1 and Step 2. This amount is $100,000.

Step 3	Add together all the results of Step 1 and Step 2.
	This is $100,000.
Step 4	An adjustment balance calculated under section 73V of the ITAA 1936 is required to be subtracted from the result obtained at Step 3. If the result is a negative number, the adjusted increase in expenditure on R&D by the group will be deemed to be zero.
	To work out the adjustment balance, the first step is to determine the R&D spend of Company J for the Y-1, Y-2 and Y-3 years of income. Once the R&D spend has been calculated, the adjustment amounts AA0 and AA-1can be worked out. (See section 6.8.4.1 Adjustment Amounts and 6.8.4.2 Adjustment balance)
	The R&D spend of the eligible company for a year of income is the sum of the reduced expenditure on Australian owned R&D for each group member (worked out under steps 1, 2 and 3 of the method statement in 73RA(1)) and the reduced notional expenditure on foreign owned R&D for each group member (worked out under steps 4, 5 and 6 of the method statement in 73RB(1) ). (See section 6.8.4.1 for definition of 'R&D spend')
	In our example, the reduced notional expenditure on foreign owned R&D for each group member (worked out under steps 4, 5 and 6 of the method statement in 73RB(1) is zero. Therefore the R&D spend for Company J is worked out as follows:
	AA0is
		[R&D spend for the Y-2 year x 80%] - R&D spend for Y-1 year
		$136,000 - $210,000
		= zero
	AA-1 is
		[R&D spend for the Y-3 year x 80%] - R&D spend for Y-2 year
		$200,000 - $170,000
		= $30,000
	The running average for the Y-1 year of income (RA-1) for Company J is:
		Half the R&D spend for the Y-2 and Y-3 years
		i.e. (R&D spend for Y-2 + R&D spend for Y-3) / 2
		= ($170,000 + $250,000) / 2
		= $210,000
	From this it can be seen that that the R&D spend for Y-1 is equal to RA-1 so the adjustment balance is:
		AA0 + AA-1
		(0 + $30,000)
		= $30,000
	For the purposes of this example, no exceptions apply to reduce the adjustment amounts or the adjustment balance to zero (none of the eligible companies were entitled to deduct an amount under former section 73Y, or section 73QA or 73QB ).
	Step 4 of the method statement in section 73E requires the adjustment balance to be subtracted from the result of Step 3.
	$100,000 - $30,000
	= $70,000

Company J's adjusted increase in expenditure on R&D by the group is $70,000. Company J will input this amount into its calculation for working out the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group .

Company J will be entitled to a deduction for the Y₀ year of income of 50% of the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group.

That is, 50% of:

Through the examples above, the following have been worked out:

• the increase in expenditure on Australian owned R&D by the eligible company for Company J is $10,000
• the total increase in expenditure Australian owned R&D by the eligible companies in the group for Company J is $110,000
• the net increase in expenditure on Australian owned R&D by the group for Company J is $100,000
• the net increase in expenditure on foreign owned R&D by the group for Company J is zero
• the adjusted increase in expenditure on R&D by the group for Company J is $70,000.

Company J is entitled to a deduction under section 73QA of the ITAA 1936 of 50% of $6,364:

$6,364 x 50%

= $3,182.

C6-9 Other anti-avoidance measures

There is an anti-avoidance measure which applies where a company requests an amendment to an assessment for a year of income to reduce the amounts of its research and development expenditure for that year, and the Commissioner is of the opinion that the purpose of the amendment request is to increase the company's entitlement to the 175% Australian premium or the 175% International Premium.

Where the Commissioner is of the opinion that the purpose of a debit amendment is to increase a company's entitlement to the extra 50% deduction and/or the extra 75% deduction, the Commissioner may disregard that debit amendment for the purposes of working out a company's incremental expenditure and/or its notional expenditure on foreign owned R&D in its group membership period for the relevant year or years of income. The amended R&D figures will be ignored in working out the company's entitlement to the 175% Australian premium and /or 175% foreign premium.

ITAA 1936 section 73Z

C6-10 Interaction between the 175% Australian Premium and the R&D tax offset

A company can choose a tax offset instead of a deduction under section 73QA for its entitlement to the Australian owned R&D incremental concession if it meets the eligibility requirements to make that choice contained in section 73J of the ITAA 1936. (For further information on the R&D tax offset, see section C4).

Example 6.10

Following on from Examples 6.6 to 6.9 above, Company J is eligible to claim the $100,000 of research and development expenditure (incremental expenditure) incurred in the Y₀ year of income in relation to its R&D project under subsection 73B(14) of the ITAA 1936. As Company J received a Commercial ready grant of $10,000 in respect of this expenditure, the amount which the company can claim as a deduction at the rate of 125% is reduced by $20,000 (the initial clawback amount). The amount subject to clawback is eligible for deduction at the 100% rate.

From the information above, the section 73QA deduction for an increase in expenditure on Australian owned R&D for Company J will be $6,364 x 50% = $3,182.

Company J's entitlement to deductions under the R&D tax concession will therefore be:

If the R&D group turnover for Company J is less than $5,000,000 and the other eligibility criteria in section 73J are met, Company J will be able to choose the R&D tax offset for the current year of income.

Company J will be entitled to a cash amount for the R&D tax offset of

$36,954.60 ;  ($123,182 x 30%).

Note: Where, prior to choosing the R&D tax offset, Company J's income tax return for the current year shows a loss, Company J's carried forward loss will be reduced by the amount of deductions under the R&D tax concession i.e. by $123,182.

For further information on the eligibility requirements for the R&D tax offset see Part C4.

C6-11 Example of the calculation of the 175% Australian Premium

Company B wishes to claim a deduction under section 73QA of the ITAA 1936. Company A, Company B and Company C are Australian companies and are grouped for the purposes of section 73L of the ITAA 1936. Company A, Company B and Company C have undertaken Australian owned R&D activities and have not undertaken any foreign owned R&D activities. Each company incurred incremental expenditure on Australian owned R&D in its group membership period in the current year and the three previous years as outlined in the table below. The companies are group members for the purposes of section 73R of the ITAA 1936.

Company B received a grant of $10,000 in the Y₀ year of income attributable to the incremental expenditure incurred in its group membership period in the Y₀year. There were no other grants or recoupments received by Company B in the Y₀ to Y_-3years. Neither Company A nor Company C received any grants or recoupments attributable to the incremental expenditure below.

Increase in expenditure on Australian owned R&D by the eligible company - 73RA(1)

Step 1	Calculate the eligible incremental expenditure incurred by each eligible company in its group membership period for the Y0, Y-1, Y-2 and Y-3 years of income.
Step 2	Work out how much of the initial clawback amount, if any, is attributable to incremental expenditure incurred in the company's group membership period.
Step 3	Subtract this amount from the company's incremental expenditure to give the reduced expenditure on Australian owned R&D.
	* In the Y0 Year, Company B received a grant of $10,000 attributable to incremental expenditure incurred in its group membership period. Therefore, Company B must reduce its incremental expenditure by the initial clawback amount, which is twice the amount received: $200,000 - ($10,000 x 2) = $180,000.
Step 4	Add up the reduced expenditure on Australian owned R&D by the eligible company for the Y-1, Y-2 and Y-3 years of income.
Step 5	Divide the result of Step 4 by 3.
Step 6	For each company subtract the result of step 5 from the expenditure incurred by the company in the Y0 year. This gives the change in expenditure on Australian owned R&D by the eligible company.
Step 7	The increase in expenditure on Australian owned R&D is the amount worked out at Step 6 or, if the result of Step 6 is a negative amount, zero.

Total increase in expenditure on Australian owned R&D by eligible companies in the group - 73RA(2)

Step 1	For each group member that is an eligible company, work out the increase in expenditure on Australian owned R&D by the eligible company using Steps 1 to 7 of the method statement in subsection 73RA(1) (calculated above).
Step 2	Total the results of Step 1

Net increase in expenditure on Australian owned R&D by the group - 73RC

Step 1	For each group member that is an eligible company, work out the change in expenditure on Australian owned R&D by the eligible company using steps 1 to 6 (inclusive) of the method statement in subsection 73RA(1).
Step 2	Total the results of Step 1. The result cannot be less than zero.

Net increase in expenditure on foreign owned R&D by the group - 73RD

Step 1	For each group member that is an eligible company, work out the change in expenditure on foreign owned R&D by the eligible company using steps 1 to 9 (inclusive) of the method statement in subsection 73RB(1).
Step 2	Total the results of Step 1. The result cannot be less than zero.
	Company A, Company B and Company C did not incur any expenditure on foreign owned R&D in the Y0,Y-2, or Y-3 year of income. The net increase in expenditure on foreign owned R&D by the group is zero.

Adjusted increase in expenditure on R&D by the group - 73RE

Step 1	For each group member that is an eligible company, work out the change in expenditure on foreign owned R&D by the eligible company using steps 1 to 9 (inclusive) of the method statement in subsection 73RB(1).
Step 2	For each group member that is an eligible company, work out the change in expenditure on foreign owned R&D by the eligible company using steps 1 to 9 (inclusive) of the method statement in subsection 73RB(1).
Step 3	Add up all of the results of Step 1 and step 2
Step 4	Work out the adjustment balance and subtract this amount from the result of Step 3. This is the adjusted increase in expenditure on R&D by the group. This amount cannot be less than zero (if the result is a negative number it is taken to be zero instead).
	R&D spend
	AA 0 is:
		[R&D spend for the Y-2 year x 80%] - R&D spend for Y-1 year
		$136,000 - $260,000
		= zero
	AA-1 is
		[R&D spend for the Y-3 year x 80%] - R&D spend for Y-2 year
		$232,000 - $170,000
		= $62,000
	For the purposes of this example, no exceptions apply to reduce AA-1 to zero (none of the eligible companies were entitled to deduct an amount under former section 73Y, or section 73QA or 73QB).
	RA-1 is:
		(R&D spend for Y-2 + R&D spend for Y-3) / 2
		= ($170,000 + $290,000) / 2
		= $230,000
	R&D spend for Y-1 is greater than RA-1. The adjustment balance is therefore:
		(RA-1 + AA0 + AA-1) - R&D spend for Y-1
		($230,000 + 0 + $62,000) - $260,000
		= $32,000
	For the purposes of this example, no exceptions apply to reduce the adjustment balance to zero.
	The adjusted increase in expenditure on R&D by the group is
		$70,000 - $32,000
		= $38,000

The eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group

The extra deduction available to Company B is 50% of the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group

$15,200.

C7 Extra deduction for increase in expenditure on foreign owned R&D (175% International Premium)

This document has been archived. It is current only to 30 June 2011.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2009

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General's Department, 3-5 National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

C7-1 Background

For the year of income commencing after 30 June 2007 and later years of income, the Government has extended the Incremental tax concession (175% Premium) to companies who incur expenditure on behalf of a grouped foreign company above a rolling three-year average of expenditure. As a result, the 175% Premium has been divided into two separate deductions, the extra deduction for increase in expenditure on foreign owned research and development (the 175% International Premium) and the extra deduction for increase in expenditure on Australian owned research and development (the 175% Australian Premium).

Consequently, there are new methods to calculate a company's incremental tax concession. The new methods require a company to calculate the increases (and decreases) in expenditure on both foreign-owned R&D and Australian-owned R&D for each eligible company in the group, and then pool the results such that increases to one type of expenditure will be reduced by any decrease to the other type of expenditure. (For information on the new 175% Australian Premium, refer to section C6.)

The extension of the 175% Premium to multinational subsidiaries that choose to hold resulting intellectual property offshore is intended to encourage additional R&D expenditure in Australia by multinational enterprise subsidiaries. An immediate 100% deduction for expenditure on eligible R&D activities and an additional 75% immediate tax deduction on expenditure above the average of the previous three years expenditure on R&D will be provided. (For information on the 100% deduction please see Part C3 Deduction for expenditure on foreign owned R&D.)

Key features of the 175% International Premium are:

• The 'additional' component of the 175% International Premium provides a 75% deduction for increases in some Australian R&D activities carried on by a company incorporated in Australia, wholly or primarily on behalf of certain foreign companies.
• Qualifying companies in groups where no group member has had a presence in Australia in the prior 10 years may be eligible to claim a 175% deduction under the new concession for all of their relevant R&D expenditure in their first year of operation in Australia.
• Other eligible companies which undertake relevant R&D activities in Australia on behalf of a relevant foreign company in the first year of operation of this measure, and who meet the qualification tests, may have immediate access to the 175% International Premium. This transitional provision will not apply in subsequent years.
• Calculations of an eligible company's entitlement to the additional 75% deduction are performed on a group basis, and will take account of any decreases in relevant expenditure on 'Australian owned' R&D activities.
• A new treatment for grants, which will be applied to expenditure in relation to both foreign owned and Australian owned R&D. An amount equal to twice the amount of any R&D grant attributable to the relevant expenditures will be deducted when determining the expenditure figures used to calculate the additional deduction amounts.
• Annual registration with Innovation Australia (the Board) of both Australian-owned and foreign-owned R&D activities is a prerequisite.
• Mandatory grouping rules and other anti-avoidance measures to avoid any potential abuse.

C7-2 Timing

Companies can claim the 175% International Premium for expenditure incurred in their first year of income that commences after 30 June 2007, and in later years of income.

C7-3 Eligibility

C7.3.1 Prerequisites for deduction

Current year

An eligible company claiming the 175% International Premium for a year of income must be eligible to deduct an amount for that year under subsection 73B(14C) of the ITAA 1936 for expenditure incurred in its group membership period .

ITAA 1936 paragraph 73QB(1)(a)

Generally, a company will be eligible to deduct an amount under subsection 73B(14C) of the ITAA 1936, which gives an immediate 100% deduction for eligible expenditure on certain foreign owned R&D activities, if it satisfies all of the following conditions:

• The eligible company incurs expenditure in the year of income at a time when it is grouped under section 73L of the ITAA 1936 with a foreign company.
• The expenditure is incurred for the purpose of the carrying on of 'Australian-centred research and development activities'.
• The activities are carried on wholly or primarily on behalf of the foreign company that is a group member of the eligible company.
• The activities are carried on, directly or indirectly, under a written agreement between the eligible company and the foreign company and no other parties, for the activities to be performed:
  • by the eligible company, or
  • by another person directly or indirectly under another agreement to which the eligible company is, or will become, a party.
• The expenditure is not incurred in connection with an agreement that:
  • is between the eligible company and another eligible company that is grouped under section 73L with the eligible company when the expenditure is incurred, and
  • is an agreement for the activities to be performed either by the eligible company or by a person who is not party to the agreement and is to perform the activities directly or indirectly under another agreement to which the eligible company is or will become a party.
• The expenditure on foreign-owned R&D by the eligible company for the year of income exceeds $20,000.
• The eligible company, and each eligible company in its group at any time in the year of income, are registered with the Board for the year of income in relation to all Australian-centred R&D activities on which the eligible company (or group member) incurred expenditure in the income year, regardless of whether the activities were covered by an R&D plan.

For further information on each of these conditions of eligibility for the deduction available under subsection 73B(14C) of the ITAA 1936, please refer to Part C3 Deduction for expenditure on foreign owned R&D.

Three immediately prior years

In addition, further eligibility conditions apply in relation to each of the three immediately prior years. There are three conditions, which are referred to collectively in this Guide as the 'three year claim history'. Only one of these three conditions needs to be met in any one of the three years in question, ie., whilst a condition needs to be met for each of these three years, it need not be the same one each time.

The first condition is that the eligible company could deduct an amount under subsection 73B(14C) of the ITAA 1936, for expenditure in its group membership period.

ITAA 1936 subparagraph 73QB(1)(b)(i)

The second condition is that one of the eligible company's other group members could deduct an amount under subsection 73B(14C) of the ITAA 1936, for the year of income, for expenditure in its group membership period. (See section C7-4 below for how to determine group members and group membership periods).

ITAA 1936 subparagraph 73QB(1)(b)(ii)

The third eligibility condition is that the year of income be a nil expenditure year. (See the definition of nil expenditure year on the following page).

ITAA 1936 subparagraph 73QB(1)(b)(iii)

Provided that between the eligible company and its group members, an amount could be deducted under subsection 73B(14C) or there is a nil expenditure year in each of the three immediately prior years, the eligible company will have a three year claim history.

Terms used

For the purposes of applying the 175% Premium rules, years of income are designated as follows:

Y₀is the year of income for which an eligible company is working out its assessable income and deductions

Y_-1 means the year of income before the Y₀ year of income

Y_-2 means the year of income 2 years before the Y₀ year of income

Y_-3 means the year of income 3 years before the Y₀ year of income

ITAA 1936 subsection 73P(6)

Example 7.1

Company A, which is grouped with a foreign company, Company B, undertook foreign owned R&D activities on behalf of its parent company in the year of income ending 30 June 2011. Company A was entitled to deduct $100,000 under subsection 73B(14C) of the ITAA 1936 in relation to that year for the expenditure incurred in its group membership period.

In the Y_-1 year (the 2009-2010 income year) Company A did not register its R&D activities with the Board but received a Government grant of $40,000, in respect of its R&D, in relation to that year of income. In both of the Y_-2 and Y_-3 years of income (the 2008-09 and 2007-08 income years), Company A was able to deduct an amount under subsection 73B(14C) of the ITAA 1936 in relation to expenditure incurred in its group membership period.

Company A is not grouped with any other companies under section 73R of the ITAA 1936 and has not been so grouped at any time during the period commencing on the first day of the Y_-3 year, and ending on the last day of the Y₀ year.

Company A is not entitled to claim a deduction under section 73QB of the ITAA 1936 as it does not have a three year claim history. There is no alternative eligibility condition in section 73QB (as there was in former section 73Q), which can be satisfied by the receipt of a grant.

Nil expenditure year

For a year of income to be a nil expenditure year, the following conditions must be satisfied in relation to that year of income:

• neither the eligible company nor any other group member (determined under section 73R of the ITAA 1936) existed at any time in the year or the 10 immediately preceding years of income,
• at no time in the year, or the 10 immediately preceding years of income, did any of the following carry on business in Australia:
  • a foreign company grouped with the eligible company under section 73L of the ITAA 1936 at any time in the Y₀, Y_-1, Y_-2 or Y_-3year of income (for an explanation of these terms, please refer to 'terms used' below)
  • a foreign company grouped with a section 73R group member of the eligible company under section 73L (see section C6-4 of this guide for how to determine group members and group membership periods) at any time during the section 73R group member's group membership period
  • a person grouped under section 73L with a foreign company which is grouped under section 73L with the eligible company or with a section 73R group member of the eligible company at any time in the year of income or the 10 immediately preceding years of income.

ITAA 1936 subsection 73QB

Example 7.2

Company A is an Australian proprietary company incorporated on 1 July 2007. Since incorporation, Company A has been wholly owned by Company D, a United States company. Company D does not own, and never has owned, any interests in any other companies incorporated in Australia. Company D also does not, in any other way, control any other companies incorporated in Australia, nor has it done so at any time previously. At no time has Company D, or any person with whom Company D is grouped under section 73L of the ITAA 1936, carried on business in Australia and Company D has not previously had a permanent establishment in Australia. Company A is not, and never has been, grouped with any other companies incorporated in Australia.

In relation to the year of income ending 30 June 2008, Company A can deduct an amount under subsection 73B(14C) of the ITAA 1936 for expenditure on foreign owned R&D incurred in its group membership period.

Company A did not exist at any time prior to the current income year (Y₀), and, for the purposes of subsection 73QB(2) of the ITAA 1936, has no group members.

Example 7.3

Company X, a company incorporated in Germany, has decided to move some of its R&D operations to Australia. On 1 July 2007, Company X incorporated Company E as an Australian proprietary company. Company X has owned all issued shares in Company E from the date of its incorporation.

During the income year, Company X learns that Company W, an Australian body corporate, has recently acquired a licence to further develop some research which is complementary to the R&D that Company E is undertaking in Australia on behalf of Company X. To gain access to this new research and control the direction taken to ensure synergy with its existing operations, Company X acquires Company W on 1 December 2007. Company W has been carrying on R&D in Australia for 15 years, and has two subsidiary companies which it established 5 years ago for asset protection.

Company E can deduct an amount under subsection 73B(14C) of the ITAA 1936 for expenditure incurred in its group membership period for the year ending 30 June 2008 (the Y₀ year of income) and wishes to test its eligibility for the extra deduction available under section 73QB of the ITAA 1936.

Company E did not exist at any time prior to the current year. However, during the year it has become grouped under section 73L of the ITAA 1936 with another eligible company, Company W. Company W has incurred expenditure which it could deduct under subsection 73B(14) of the ITAA 1936 in previous years and is a group member of Company E (determined under section 73R) in the current year.

As Company W is a group member of Company E determined under section 73R of the ITAA 1936 and has been in existence for 15 years, neither the Y_-1, Y_-2or Y_-3 year can be a nil expenditure year for Company E. As well, although Company W can deduct amounts under subsection 73B(14) for each of the three previous years of income, it cannot deduct any amounts under subsection 73B(14C), and hence, the second eligibility condition cannot be satisfied. Company E will need to consider whether it comes within the transitional rules (discussed below) for eligibility to claim the additional component of the 175% International Premium in the 2007-08 income year.

Example 7.4

Company G is a Japanese company which manufactures farm machinery and undertakes R&D to develop better machines more adept at operating efficiently in difficult terrain. The company has not at any time controlled an Australian body corporate within the meaning of section 73L of the ITAA 1936. However, for the last seven years Company G has had a permanent establishment in Australia because it has a production facility located in Australia where items for sale are assembled and packed for distribution.

Company G becomes aware that it may be entitled to claim the Australian R&D tax concession if it restructures its business so that operations are conducted through an entity incorporated under Australian law. Therefore, on 1 July 2007, Company G incorporates Company L, an Australian proprietary company. Company L has no group members for the purposes of subsection 73QB(2) of the ITAA 1936 and Company G does not own any interests in any other companies incorporated in Australia. Nor does Company G in any other way control any other companies incorporated in Australia.

For the years of income ending 30 June 2009 (Y₀) and 30 June 2008 (Y_-1), Company L could deduct an amount under subsection 73B(14C) of the ITAA 1936 for expenditure incurred in its group membership period on activities undertaken in Australia on behalf of Company G.

Company L did not exist prior to the Y_-1 year and has no group members for the purposes of subsection 73QB(2) of the ITAA 1936. However, Company G, a foreign company grouped with Company L under section 73L of the ITAA 1936, did carry on business in Australia (through a permanent establishment) during the Y_-2 year and prior income years. Therefore Company L cannot have a nil expenditure year in the Y_-2or Y_-3 years of income, as a foreign company grouped with it during the Y₀ and Y_-1 years of income did carry on business in Australia in the Y_-2 and Y_-3 years of income (paragraph 73QB(2)(b)(i) of the ITAA 1936).

Example 7.5

Company T is a company incorporated in Finland which in the 1990s owned several Australian companies (Company S, Company Q and Company R), that carried on business and undertook R&D in Australia on Company T's behalf. On 30 June 1999, Company T sold all of its Australian interests to Company B, a Norwegian entity which was looking to expand its Asia-Pacific operations. Company T ceased all Australian operations at that time and focused on its New Zealand operations.

Company T decided to re-enter the Australian market when it heard about the new 175% International Premium, and on 1 July 2007 incorporated an Australian proprietary company, Company P. Since incorporation, Company P has not been grouped with any other person (other than with Company T) under section 73L of the ITAA 1936.

In relation to the years of income ending 30 June 2011 (the Y₀ year of income) and the two immediately prior years (the Y_-1 and Y_-2 years of income being the 2009-10 and 2008-09 income years, respectively), Company P incurred an amount of expenditure in its group membership period for which it was entitled to a deduction under subsection 73B(14C) of the ITAA 1936.

Company P did not exist at any time prior to the Y_-2 year of income and had no group members as determined under section 73R of the ITAA 1936. However, Company T was previously grouped with Company S, Company Q and Company R who, at a time during the 10 years immediately preceding the Y_-3 year of income, carried on business in Australia. Therefore, Company P cannot have a nil expenditure year in the Y_-3 year of income and so will not have the required three year claim history.

C7.3.2 Transitional rule - deemed three year claim history

Generally, to qualify for the 175% International Premium, an eligible company must have a three year claim history. A company will have a three year claim history where, between the eligible company and its group members, an amount could be deducted under subsection 73B(14C) of the ITAA 1936 for expenditure incurred in a company's group membership period, or there is a nil expenditure year, in each of the Y_-1, Y_-2 and Y_-3 years of income (see 7.3.1 Prerequisites for deduction).

However, for the year of income commencing after 30 June 2007 and before 1 July 2008, there is a transitional rule to allow companies who do not have a nil expenditure year in each of the Y_-1, Y_-2 and Y_-3 years of income immediate access to the 175% International Premium.

The transitional rule operates by providing an eligible company, who has satisfied the prerequisites for deduction in respect of the Y₀ year of income, with a deemed three year claim history. That is, for the purposes of paragraph 73QB(1)(b) of the ITAA 1936, the eligible company is taken to have been able to deduct an amount under subsection 73B(14C) for each of the relevant Y_-1, Y_-2and Y_-3 years of income.

The transitional rule may apply, where:

• the Y₀ year of income is the year of income starting after 30 June 2007 and before 1 July 2008
• in the Y₀ year of income, in its group membership period, the eligible company has incurred an amount of expenditure on foreign owned R&D
• the eligible company can deduct an amount under subsection 73B(14C) of the ITAA 1936 in relation to Y₀, and
• any of the three preceding years, Y_-1 to Y_-3, were not nil expenditure years.

For information on the deduction available under subsection 73B(14C) of the ITAA 1936, please refer to Part C3 of this guide. Please refer above for further information on the conditions for a nil expenditure year.

(For more information about the reduced notional expenditure on foreign owned R&D, see section 7.8.1 Increase in expenditure on foreign owned R&D).

C7.3.3 Transitional accounting periods of greater or less than 12 months

This section applies where a company, or consolidated group, has adopted, or reverted from, a substituted accounting period in lieu of an income year ending on 30 June and so has a transitional period of greater or less than 12 months.

Y₀ year of income

To determine its eligibility for the 175% International Premium under section 73QB of the ITAA 1936, an eligible company must first determine whether the requirements of section 73QB are met in relation to the Y₀ year of income and each of the three prior years of income (the Y_-1, Y_-2 and Y_-3 years of income).

The Y₀ year of income for the purposes of sections 73P to 73V of the ITAA 1936 will be the 12-month period ending on the last day of the period for which the eligible company (the company seeking to claim the 175% International Premium) will lodge its return of income for the current year. This is so even where the company's return of income for the year is for a period of greater or less than 12 months. For example, if the return of income of the company for the 2008-09 year of income is for the period from 1 July 2008 to 31 December 2008, the Y₀ year of income is the 12-month period 1 January 2008 to 31 December 2008.

This 12-month period will be used when determining whether the eligible company can deduct an amount for the Y₀ year of income under subsection 73B(14C) of the ITAA 1936 for expenditure on foreign owned R&D incurred during its group membership period, and when calculating the amount of the eligible company's extra deduction for increase in expenditure on foreign owned R&D under section 73QB of the ITAA 1936.

Three immediately prior years

The three prior years of income are the 3 immediately preceding 12-month periods, i.e.

• 1 January 2007 to 31 December 2007
• 1 January 2006 to 31 December 2006, and
• 1 January 2005 to 31 December 2005

representing the Y_-1, Y_-2 and Y_-3 years of income, respectively.

If the company seeking to claim the 175% International Premium has a transitional period in one of the years of income representing the Y_-1, Y_-2 or Y_-3 year of income, that year will be the 12-months ending on the last day of the period for which the return of income was, or will be, lodged. This 12-month period will be used when determining whether the eligible company has a three year claim history for the purposes of paragraph 73QB(1)(b) of the ITAA 1936 and when calculating the amount of the eligible company's extra deduction for increase in expenditure on foreign owned R&D.

Example 7.6

Where a company is working out its additional deduction for the 2008-09 income year, and:

• 1 December 2008 to 30 November 2009 represents the 2008-09 income year;
• 1 December 2007 to 30 November 2008 represents the 2007-08 income year;
• 1 July 2006 to 30 November 2007 represents the 2006-07 income year; and
• 1 July 2005 to 30 June 2006 represents the 2005-06 income year,

then the Y0 year of income and three immediately prior years for the purposes of the 175% International Premium will be:

• 1 December 2008 to 30 November 2009 representing the Y₀ year of income;
• 1 December 2007 to 30 November 2008 representing the Y_-1 year of income;
• 1 December 2006 to 30 November 2007 representing the Y_-2 year of income;
• 1 December 2005 to 30 November 2006 representing the Y_-3 year of income;

Transitional accounting periods of group members

These 12-month periods are always worked out using the year of income or substituted accounting period of the eligible company working out its deduction, and not the year of any group member. All information, for example, group membership and the amounts worked out under section 73RB of the ITAA 1936, must be calculated using the 12-month periods representing the Y₀ to Y_-3 years of income of the company working out its deduction. This process must be undertaken in respect of each group member working out its respective deduction as the periods may be different depending upon that company's own year of income.

C7-4 Grouping rules for the 175% International Premium

To determine its eligibility for, and to calculate, the 175% International Premium an eligible company is required to work out its group members. A company that is the head company of a consolidated group must work out whether it has any group members who are not members of the consolidated group of which it is head company.

Primary and secondary group members, and their individual group membership periods, are identified utilising the method statement in subsection 73R(2) of the ITAA 1936.

Section 73R relies on the grouping rules that apply for the R&D tax offset set out in section 73L of the ITAA 1936. (For an explanation of when one company is grouped with another company under section 73L of the ITAA 1936, see Part C4-4 of this guide).

ITAA 1936 section 73L,73R

C7.4.1 Section 73R group members

Many of the R&D provisions refer to the claimant company's group members under section 73R of the ITAA 1936 and the group membership periods of those companies. To determine a claimant company's entitlement to the R&D tax concession, it is therefore necessary to establish who is a member of its section 73R group and the group membership periods of each member. This is worked out by following the method statement in subsection 73R(2) of the ITAA 1936.

Subsection 73R(1) of the ITAA 1936 provides that when applying section 73R, section 73L of the ITAA 1936 must be used to determine whether companies are grouped. For more information on section 73L group members, see Part C4-4. Once the eligible company has determined its section 73L group, it can proceed to Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936.

Determining who is a Primary Group Member (PGM)

Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936 provides that the eligible company must work out who are the primary group members in its group. Any companies grouped under section 73L of the ITAA 1936 with the eligible company on the last day of the Y₀ year of income, and the eligible company itself, are primary group members.

Example 7.7

Assume Y₀ is the income year ending 30 June 2011.

Company A	is an eligible company (the claimant) that is an Australian public company listed on the stock exchange, and is not controlled by any person for the purposes of section 73L of the ITAA 1936. Company A has incurred expenditure on foreign owned R&D in the Y0 to Y-3 years of income. Company A has been entitled to a 100% deduction for its expenditure on foreign owned R&D under subsection 73B(14C) of the ITAA 1936 in each of those years and is working out its entitlement to the 175% International Premium.
Company B	is an Australian proprietary company wholly owned by Company A in the Y0 to Y-3 years of income. Company B also incurred expenditure on foreign owned R&D in the Y0 to Y-3 income years. However, it could not deduct any amount for this expenditure under subsection 73B(14C) of the ITAA 1936 for the Y-1 to Y-3 years because the activities were not carried out in accordance with an R&D plan as required by subsection 73B(2BA) of the ITAA 1936 in relation to those years.
Company C	is an Australian proprietary company, 60% owned by Company D since its incorporation on the first day of the Y-2 year. Company C carried on Australian-centred R&D activities in the Y0 to Y-2 income years and received an ACIS grant of $200,000 in each of the Y0 and Y-1 years attributable to its incremental expenditure on Australian owned R&D incurred in those years.
Company D	is a company incorporated in Singapore. In the Y0 to Y-3years of income, Company D is wholly owned by Company A.
Company E	is an Australian proprietary company, 40% owned by Company C and 60% owned by Company X. It incurred expenditure on Australian owned R&D activities in the Y-2 year of income, and was able to deduct an amount under subsection 73B(14) in respect of that expenditure.
Company F	is an Australian proprietary company that incurred expenditure on Australian owned R&D activities in each of the Y0 to Y-3 years of income for which it could deduct an amount under subsection 73B(13) of the ITAA 1936. Company F was wholly owned by Company B until the last day of the Y-1 year of income, after which time it was acquired by Company Z.

Therefore, the primary group members of Company A, are:

• Company A, the claimant
• Company B, a wholly owned subsidiary of Company A on the last day of the Y₀ year
• Company C, a company controlled by Company D (60% ownership), who is in turn a wholly owned subsidiary of Company A, on the last day of the Y₀ year, and
• Company D, the foreign company controlled by Company A on the last day of the Y₀ year.

Company E is not a primary group member of Company A because it was not grouped with Company A under section 73L of the ITAA 1936 on the last day of the Y₀ year of income. For the same reason, Company F also is not a primary group member of Company A as it was not grouped with Company A under section 73L of the ITAA 1936 on the last day of the Y₀ year of income.

However, completing Step 1 of the method statement contained in subsection 73R(2) of the ITAA 1936 does not identify all section 73R group members; it only identifies the primary group members . The eligible company's secondary group members are worked out at Step 3 of the method statement after the group membership periods of the primary group members have been determined. Once the eligible company's secondary group members have been identified, the group membership periods of the secondary group members must also be worked out.

7.4.2 Group membership periods

There are rules to determine the group membership period of each section 73R group member, including the group membership period of companies entering or exiting an R&D group during the claim year and/or the three-year history period. (There are special rules for companies who join or leave a consolidated group, please see section 7.4.4 of this guide).

These rules work by identifying all of the companies who are required to be grouped with the claimant at the end of the claim year ( primary group members ), and then by establishing the dates upon which the control of any of these companies last changed within the history period such that they became grouped with the claimant.

The period between these dates is the group membership period of each primary group member. Any other companies with whom these members were required to be grouped in their group membership period (but which have subsequently left the group) are also identified ( secondary group members ).

Therefore at any point in time, the members who are to be grouped together are identified, and their incremental expenditure and expenditure on foreign owned R&D during their period of group membership can be calculated. Where the claimant is not grouped with any other eligible company, it will be the only primary group member. A solitary company must still work out its group membership period in accordance with section 73R of the ITAA 1936.

Determining group membership periods

The detailed steps involved in determining group membership periods are:

Step 1:	Identify the primary group members (PGM ) - these are the claimant company, and other companies required to be grouped with the claimant company as at the end of the claim year (theY0 year).
Step 2:	Determine the group membership period of each of the PGMs. A PGM's group membership period extends from the day that its control changed to cause it to come into the group to the last day of the current income year. However, the group membership period cannot generally commence before the first day of the income year three years before the current income year (the Y-3 year).
Step 3:	Determine any other companies that are required to be grouped with each PGM at a time during the PGM's group membership period. Any company identified under this step is called a secondary group member (SGM). These will be companies which were required to be grouped with a PGM for a least some part of the four year period under review, but which have left the group prior to the end of the Y0 year.
Steps 4 & 5:	Determine the group membership period for each SGM. This extends from the day that its control changed to cause it to come into the group to the day its control changed to cause it to leave the group. However, as in Step 2, the group membership period cannot generally commence before the first day of the income year three years before the current income year (the Y-3 year).

The effect of these rules is that for the purposes of calculation of the increase in incremental expenditure on Australian owned R&D, and the increase in expenditure on foreign owned R&D, the relevant expenditure of a company is only taken into account for the period of time that it is a member of the group.

Where a company now controlled by a person or persons under section 73L of the ITAA 1936 was previously not controlled by any person within the meaning of that section, there is a change in control for the purposes of section 73R of the ITAA 1936. The group membership period of the company which experienced that change in control will be the period between the day on which the company became controlled by the current controller and the last day of the Y₀ year of income.

For further information see: ATO Interpretative Decision ATO ID 2005/152 Research and development: group membership period under section 73R of the ITAA 1936 Where a company, now controlled by a person under section 73L of the ITAA 1936, was previously not controlled by any person within the meaning of that section, has there been change in control of the company of the purposes of subsection 73R(2) of the ITAA 1936?

ITAA 1936 section 73R

Example 7.8

Following on from Example 7.7 above, the method statement in subsection 73R(2) of the ITAA 1936 determines group members and group membership periods in the following manner:

 

Step 1 Determine primary group members

Company A, Company B, Company C and Company D are primary group members because each company was grouped under section 73L of the ITAA 1936 on the last day of the Y₀ year of income.

 

Step 2 Determine the group membership period of each primary group member

Company A, Company B and Company D did not experience any change in control in the period from the first day of the Y_-3 year to the last day of the Y₀ year. This means the group membership period (GMP) of each company is the whole period from the first day of the Y_-3 year to the last day of the Y₀ year.

Company C was controlled by Company D for the full period of its existence from the first day of the Y_-2 year to the last day of the Y₀ year. Before this time, the company was not controlled by any person for the purposes of section 73L of the ITAA 1936. Therefore, the GMP of Company C is the period from the first day of the Y_-2 year to the last day of the Y₀ year.

 

Step 3 Determine secondary group members

Company F will be a secondary group member as it is grouped with a primary group member (in this example, Company A, Company B, Company C and Company D) at a time during the PGM's group membership period.

Company E is not a secondary group member as it is not grouped with a primary group member at any time during the PGM's group membership period.

 

Steps 4 & 5 Determine the group membership period of each secondary group member

The group membership period of the secondary group member, Company F, will be the period when it was grouped with a primary group member. Company F became grouped with Company A (and also with Company B and Company D) on the first day of the Y_-3 year of income. However, Company F left the control of Company A on the last day of the Y_-1 year of income when it was sold to Company Z. Therefore, the group membership period of Company F is the period from the first day of the Y_-3 year of income to the last day of the Y_-1 year of income.

Companies A, B, C and F incurred the following amounts of incremental expenditure and expenditure on foreign owned R&D during the Y₀ to Y_-3 years of income during their respective group membership periods. (Company D is not an eligible company and therefore cannot incur either type of expenditure).

However, a company's group membership period is modified where a company enters or leaves a section 73R group with a 'viable business'.

C7.4.3 Viable business exception

The group membership periods of both primary group members and secondary group members can change under certain circumstances:

• where the secondary group member left the section 73R group with a viable business, its group membership period in relation to this prior group is deemed never to exist. This means that although the company may have incurred expenditure on foreign owned R&D, this expenditure will not be included in the calculation of the 175% International Premium for that company or in relation to this prior group, as it was not incurred during the company's group membership period; and
• where a primary group member (an eligible company who remains a section 73R group member on the last day of the Y₀ year of income) or a secondary group member (an eligible company who entered the section 73R group on or after the first day of the Y_-3 year of income, but was not a group member on the last day of the Y0 year of income) entered the section 73R group with a viable business, the company's group membership period is extended to include its group membership period from its previous group. As such, any incremental expenditure incurred from the 1^st day of the Y_-3 year of income during a previous group membership period may be taken into account in the calculation of the 175% International Premium for that company or any new group members of that company.

A company will join or leave the group with a viable business if all assets (which must include R&D assets) necessary to comprise a continuing business are transferred with the company, and the vendor and purchaser agree in writing that they are transferring a viable business. The vendor must provide written details of the expenditure incurred on R&D by the company while in its former group and grants and recoupments received or entitled to be received in relation to that expenditure. The written agreement and details of the incremental expenditure, or expenditure on foreign owned R&D for which an amount could be deducted under subsection 73B(14C) of the ITAA 1936, generally needs to be provided by the end of the year in which the change of control took place. However, the Commissioner may exercise a discretion to allow the written agreement to be provided at some later date.

ITAA 1936 subsections 73R(3) to (6)

Example 7.9

Following on from Example 7.7 and Example 7.8 above:

• Company A, Company B, Company C, Company D and Company F are section 73R group members
• Company A, Company B, Company C and Company D are primary group members, with the following group membership periods:
  • Coy A: first day of the Y_-3 year to the last day of the Y₀ year
  • Coy B: first day of the Y_-3 year to the last day of the Y₀ year
  • Coy C: first day of the Y_-2 year to the last day of the Y₀ year
  • Coy D: first day of the Y_-3 year to the last day of the Y₀ year
• Company F is a secondary group member, its group membership period is:
  • Coy D: first day of the Y_-3 year to the last day of the Y_-1 year

Assume however, that Company F left the R&D group with a viable business. This means that, when working out Company A's entitlement to the 175% International Premium, the rules for determining Company F's group membership period are modified and the group membership period of Company F is treated as never having existed.

For the purposes of calculating the increase in expenditure on foreign owned R&D under section 73QB of the ITAA 1936 for Company A, the expenditure on foreign owned R&D for Company A and Company B and the incremental expenditure on Australian owned R&D for Company C will be as per the table above. However, due to the exit from the group of Company F at the end of the Y_-1 year with a viable business, no incremental expenditure of Company F is taken into account by Company A when working out its increase in expenditure on foreign owned R&D.

The expenditure incurred by members of the section 73R group during their group membership periods is therefore:

C7.4.4 Consolidated groups

Where a company becomes a member of a consolidated group or MEC group, then for the purpose of determining entitlement to the 175% International Premium and calculating the extra deduction:

• expenditure amounts incurred by the joining company before it became a member are treated as if they were incurred by the head company of the group,
• any amounts the joining company has deducted or can deduct for that expenditure are treated as if they had been deducted by the head company of the group, and
• any recoupments of, or grants in respect of, that expenditure, received or receivable by the joining company or its former group are treated as being received by the head company of the group.

This is by virtue of section 73BAC of the ITAA 1936. This section applies after any application of subsections 73R(3) and (4) so that any viable business transfer exceptions to the group membership period rules for joining entities are applied before attributing the relevant amounts to the head company of the consolidated group.

The operation of section 73BAC of the ITAA 1936 is generally taken to be conditional upon one or more joining companies becoming members of the relevant consolidated group. After the time at which this occurs, and in subsequent income years, the deeming effects set out above will operate in respect of the head company of the group.

ITAA 1936 section 73BAC

Where a company ceases to be a member of a consolidated group:

• expenditure amounts actually incurred by the leaving company while it was a member of the group, are treated as if they were incurred by it and not by the head company; and
• any amounts the head company has deducted or can deduct for that expenditure are treated as if they had been deducted by the leaving company.

This is by virtue of section 73BAD of the ITAA 1936. This section applies before the application of subsections 73R(3) and (4) so that any viable business transfer exceptions to the group membership period rules for exiting entities are applied after attributing the relevant amounts to the leaving company.

ITAA 1936, section 73BAD

These special rules effectively override the operation of the consolidation entry and exit history rules, which might otherwise allow both the joining (or leaving) company and the head company to count the company's history prior to the joining (or after the exit).

For a company that has left a consolidated group, these rules are intended to put that company in the same position it would have been in if it had never been in the consolidated group.

If a company leaves a consolidated group during an income year, it will be required to calculate its income tax payable, taxable income or losses for the period it is no longer part of the consolidated group (non-membership period). Expenditure incurred by the company in its non-membership period will generally be deductible by the company if the eligibility requirements are met.

For more information on how the consolidation provisions interact with the R&D tax concession, refer to paragraph 2.1.6 Consolidation in Part C-2 of this guide.

C7-5 Calculation overview

An eligible company seeking to claim the 175% International Premium must work out the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group using the following formula:

ITAA 1936 subsection 73QB(4)

In applying this formula:

• the increase in expenditure on foreign owned R&D by the eligible company is worked out under subsection 73RB(1) of the ITAA 1936,
• the total increase in expenditure on foreign owned R&D by the eligible companies in the group means the amount worked out under subsection 73RB(2) of the ITAA 1936,
• the net increase in expenditure on foreign owned R&D by the group (the net increase is the result of taking into account any decreases in expenditure on foreign owned R&D by the eligible company or its group members), means the amount worked out under section 73RD of the ITAA 1936,
• the net increase in expenditure on Australian owned R&D by the group (the net increase is the result of taking into account any decreases in expenditure on Australian owned R&D by the eligible company or its group members - if there is no expenditure on Australian owned R&D by the eligible company or its group members, this will be nil), is worked out under section 73RC of the ITAA 1936, and
• the adjusted increase in expenditure on R&D by the group means the amount worked out under section 73RE of the ITAA 1936 (this calculation includes the adjustment balance worked out under section 73V of the ITAA 1936; there may be an adjustment balance where expenditure has decreased more than 20% from one year to the next).

Hence the formula for working out the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group, can be represented in terms of the relevant provisions as:

Once the company has worked out the increases and decreases in expenditure on both Australian-owned R&D and foreign-owned R&D for each eligible company in the group, the calculation effectively pools the results such that increases to one type of expenditure will be reduced by any decrease to the other type of expenditure.

The eligible company will be entitled to claim the 175% International Premium where the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group is greater than zero.

The amount allowable as a deduction to the eligible company for the Y₀ year of income will be 75% of the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group .

ITAA 1936 subsection 73QB(3)

The grouping rules for the International Premium are outlined at C7-4.

C7-6 Expenditure on foreign owned R&D

In order to work out the increase in expenditure on foreign owned R&D by the eligible company under subsection 73RB(1) of the ITAA 1936 and the total increase in expenditure on foreign owned R&D by the eligible companies in the group under subsection 73RB(2) of the ITAA 1936, you must first work out:

• for the Y₀ year of income - the amount of the expenditure on foreign owned R&D by the eligible company (see subsections 73B(14C) and (14D) of the ITAA 1936) that was incurred by the company in its group membership period, for the year of income, and
• for each of the Y_-1, Y_-2 and Y_-3 years of income - the amount of expenditure incurred by the company in its group membership period for the year of income, that would have been expenditure on foreign owned R&D if the requirement for activities to be carried on in accordance with an R&D plan (the requirement in subsection 73B(2BA) of the ITAA 1936) had not been enacted.

That is, for the Y_-1, Y_-2 and Y_-3 years of income, you must include expenditure incurred by the eligible company in relation to activities that would have been Australian-centred research and development activities (see section C3.2.2 of this guide) apart from the R&D plan requirement, even though no deduction is allowable under subsection 73B(14C) of the ITAA 1936 in respect of this expenditure. Such amounts are known as the company's notional expenditure on foreign owned R&D. (See below, paragraph C7-8, which sets out the steps you must follow to calculate the 175% International Premium).

For an explanation of how to work out an eligible company's expenditure on foreign owned R&D, please see chapter C3 of this guide.

Example 7.10

In the Y₀ to Y_-3 income years, Green Wood Pty Ltd (Green Wood) and El Naturale Pty Ltd (El Naturale) undertook various R&D activities on behalf of Rainforest Inc (Rainforest), their foreign parent, to invent a manufactured type of material able to replicate woodchips in weight, texture and combustibility. All activities (including those that were not carried out in accordance with a plan) were registered with Innovation Australia.

However, in its first year (the Y_-3 year), El Naturale did not have an R&D plan that complied with guidelines formulated by the Board under section 39KA of the Industry Research and Development Act 1986. Although this omission was rectified for the Y_-2 to Y₀ years, as a consequence, El Naturale was entitled to claim a deduction for expenditure on foreign owned R&D for the Y₀ to Y_-2 years only. Green Wood was entitled to claim a deduction under subsection 73B(14C) for each of the Y₀ to Y_-3 income years.

The companies were entitled to deduct the following amounts under subsection 73B(14C) for expenditure incurred on foreign owned R&D:

In order to work out the increase in expenditure on foreign owned R&D for El Naturale and Green Wood, it is necessary to determine each company's expenditure on foreign owned R&D for the Y₀ year and the notional expenditure on foreign owned R&D for the Y_-1 to Y_-3 years, which can be different from the amount the company was entitled to deduct for that year under subsection 73B(14C) of the ITAA 1936.

The expenditure on foreign owned R&D for the Y₀ year and the notional expenditure on foreign owned R&D for the Y_-1 to Y_-3 years for the companies is:

For the purposes of the deduction available under section 73QB, El Naturale must work out the amount that would have been its expenditure on foreign owned R&D for the Y_-3 year apart from the R&D plan requirement (using subsections 73B(14C) and (14D) of the ITAA 1936). Although no deduction is available under subsection 73B(14C) of the ITAA 1936 for this expenditure, it must be included in the calculation for the 175% International Premium and 175% Australian Premium (refer section C6 of this Guide).

C7-7 Prepayments in the calculation of the 175% International Premium

The amount utilised in calculating any entitlement to the 175% International Premium is based on amounts allowable as a deduction under subsection 73B(14C) of the ITAA 1936.

The prepayment rules apply when working out the amount allowable as a deduction under subsection 73B(14C) of the ITAA 1936, in relation to a year of income. Most prepaid expenditure on R&D activities will be deductible in the year(s) of income to which the prepayment relates, and not solely in the year in which it is incurred. Prepayments for contract expenditure to a Registered Research Agency attract special treatment and are not subject to the general prepayment rules. For further information on the treatment of the prepayment of expenditure on R&D activities, refer to section 2.3.10.

ITAA 1936 section 82KZMA to 82KZMF

C7-8 Calculating the 175% International Premium

The steps to calculating the components to be used in the calculation of the 175% International Premium amount are set out in sections 73RB, 73RC, 73RD and 73RE of the ITAA 1936.

The formula for working out the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group can be represented in terms of the relevant provisions in the following manner:

The steps for each component can be summarised as follows:

Subsection 73RB(1)	Subsection 73RB(2)	Section 73RD	Section 73RC	Section 73RE
Calculates each eligible company's increase in expenditure on foreign owned R&D	Calculates total increase in expenditure on foreign owned R&D of the group	Calculates net increase in expenditure on foreign owned R&D by the group	Calculates net increase in expenditure on Australian owned R&D by the group	Calculates the adjusted increase in expenditure on R&D by the group

C7.8.1 Increase in expenditure on foreign owned R&D

The first step in determining the increase in expenditure on foreign owned R&D by the eligible company, and eligible companies in its group, is to work out the expenditure on foreign owned R&D incurred by the eligible company, and its eligible company group members, in their group membership periods.

The increase in expenditure on foreign owned R&D is based on the excess of the current year expenditure on foreign owned R&D over the average expenditure on foreign owned R&D for the previous three years, for each company. When working out the amounts of expenditure to be included in the calculation in respect of the Y_-1, Y_-2 and Y_-3 years of income, expenditure incurred on activities that were not carried out in accordance with an R&D plan must be included, even though such amounts are not deductible under subsection 73B(14C) of the ITAA 1936.

However, the amount of expenditure in relation to foreign owned R&D included in this calculation for each of the Y₀ to Y_-3 years of income may be reduced where the company has received a recoupment or grant that is attributable to that expenditure.

C7.8.1.1 Operation of the 'clawback' provisions and 175% International Premium

Generally, where a company or a company group member receives a grant or a recoupment from the government for an R&D project, the clawback provisions in section 73C of the ITAA 1936 apply to reduce the amount the company can deduct at the rate of 125%. Expenditure to which section 73C clawback applies can only be deducted at the rate of 100%.

Where the grant or recoupment received by the eligible company relating to expenditure incurred by the company on R&D is attributable to expenditure on foreign owned R&D incurred in the company's group membership period, then the amounts the company can include in its calculation for the 175% International Premium are reduced.

To be 'attributable' to the expenditure on foreign owned R&D incurred by the company, the purpose of the grant or recoupment being received must generally be viewed as being paid in relation to, or regarded as an effect of, incurring the expenditure. A causal or contributory connection between the grant or recoupment and the expenditure will generally be required, and it will be sufficient if the cause was only one of a number of causes. That is, the grant or recoupment amount need not be paid as a sole, dominant or direct cause or effect of having incurred the expenditure. In addition, the term 'attributable' implies that apportionment of the grant or recoupment amount between the foreign owned R&D expenditure incurred by the company and other types of expenditure is possible.

The expenditure on foreign owned R&D to be included in the calculation of the 175% International Premium is reduced by the 'initial clawback amount' relating to expenditure that is attributable to expenditure on foreign owned R&D incurred in the company's group membership period, in each of the years Y₀ to Y_-3. The 'initial clawback amount' is equal to two times the amount of the grant or recoupment attributable to the expenditure on foreign owned R&D. The clawback-adjusted expenditure amounts, known as reduced expenditure on foreign owned R&D in relation to the Y₀ year and as reduced notional expenditure on foreign owned R&D for the Y_-1, Y_-2 and Y_-3 years, are then used to determine the increase in expenditure on foreign owned R&D by the eligible company, and its eligible company group members.

C7.8.1.2 Transitional rule - deemed three year claim history

For the year of income commencing after 30 June 2007 and before 1 July 2008, there is a transitional rule under which an eligible company may be taken to have been able to deduct an amount under subsection 73B(14C) of the ITAA 1936 for each of the relevant Y_-1, Y_-2and Y_-3 years of income for the purposes of paragraph 73QB(1)(b) of the ITAA 1936. (see 7.3.2 Transitional rule - deemed three year claim history).

This transitional rule also provides an eligible company with a reduced notional expenditure on foreign owned R&D for the Y_-1, Y_-2 and Y_-3 years of income, calculated as a percentage of the amount of expenditure on foreign owned R&D incurred by the eligible company in its group membership period in year Y₀ (this is known as the 'paragraph (1)(a) amount').

Under the transitional rule, the reduced notional expenditure on foreign owned R&D for the Y_-1, Y_-2 and Y_-3 years of income is:

Year	Deemed history
Y-1	90% of the paragraph(1)(a) amount
Y-2	80% of the paragraph(1)(a) amount
Y-3	70% of the paragraph(1)(a) amount

 

Note This only applies where the Y₀ year of income is the year of income starting after 30 June 2007 and before 1 July 2008, i.e., the 2007-08 income year, which is generally the 12-month period from 1 July 2007 to 30 June 2008. For later years of income, the deemed history is not available and an eligible company must meet the conditions of eligibility described above at 7.3.1.

Example 7.11

Company Great Hair Pty Ltd (Great Hair) is an Australian proprietary company that manufactures hair care products. Since its incorporation on 1 January 2007, it has been wholly owned by beauty company, Company Beta (Beta) a body corporate incorporated in and resident of France.

Beta wants to create and market a new product designed to increase facial hair growth on men who have difficulty growing beards. Beta enters into a written agreement with Great Hair in relation to performing the R&D activities (Project Full Beard), to which no other person is a party. The agreement specifies that Beta will directly own the intellectual property and commercialisation rights of the R&D project under contract.

Great Hair commences Project Full Beard on 1 July 2007, and incurs $100,000 of expenditure on foreign owned R&D prior to 30 June 2008. Great Hair is eligible for a deduction, under subsection 73B(14C) of the ITAA 1936, of $100,000 in relation to expenditure incurred in its group membership period in the Y₀ year of income.

Great Hair could immediately qualify for the 175% International Premium if the Y_-1, Y_-2 and Y_-3 years of income were all nil expenditure years. However, as Great Hair came into existence on 1 January 2007, during the Y_-1 year of income, the Y_-1 year will not satisfy the conditions for a nil expenditure year contained in subsection 73QB(2) of the ITAA 1936. Nonetheless, Great Hair may have immediate access to the International Premium under the transitional rules because:

• the Y₀ year of income is the year of income starting after 30 June 2007 and before 1 July 2008,
• the Y_-1 to Y_-3income years are not all nil expenditure years,
• Great Hair has incurred an amount of expenditure on foreign owned R&D in its group membership period in the Y₀ year of income, and
• Great Hair can deduct an amount under subsection 73B(14C) of the ITAA 1936 in relation to the Y₀ year of income.

Great Hair's 'paragraph (1)(a) amount' is $100,000, which in this example is the same as its reduced expenditure on foreign owned R&D . Therefore, the company's reduced expenditure on foreign owned R&D for the Y₀ year and its deemed reduced notional expenditure on foreign owned R&D (its reduced notional expenditure on foreign owned R&D ) for the Y_-1, Y_-2 and Y_-3 years of income is:

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Great Hair	100	90	80	70

Example 7.12

Following on from example 7.6 above, assume Great Hair received a Commercial Ready grant of $20,000 in relation to the expenditure incurred by the eligible company in its group membership period for the Y₀ year of income. Under the transitional rules, the company's deemed reduced notional expenditure on foreign owned R&D (its reduced notional expenditure on foreign owned R&D ) is worked out on the basis of the company's paragraph (1)(a) amount, i.e., its Y₀ year expenditure on foreign owned R&D before clawback is applied. Therefore the deemed reduced notional expenditure on foreign owned R&D for Great Hair would still be:

Company	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Great Hair	90	80	70

However, as the company has received a grant attributable to the expenditure on foreign owned R&D incurred by it during the Y₀ year, the company's reduced expenditure on foreign owned R&D for the Y₀ year is not the same as its paragraph (1)(a) amount. The company's reduced expenditure on foreign owned R&D for the Y₀ year and its deemed reduced notional expenditure on foreign owned R&D (its reduced notional expenditure on foreign owned R&D ) for the Y_-1, Y_-2 and Y_-3 years is:

Company	Y0 ($000)	Y-1 ($000)	Y-2 ($000)	Y-3 ($000)
Great Hair	60	90	80	70

(steps 1 to 6, subsection 73RB(1) of the ITAA 1936)

Therefore Great Hair is not eligible for a deduction under section 73QB as there is no increase in Y₀ over the three year average.

For more information on clawback and reduced expenditure on foreign owned R&D , see section 7.8.1.1 of this guide.

C7.8.1.3 Increase in expenditure on foreign owned R&D by the eligible company - 73RB(1)

The increase in expenditure on foreign owned R&D by the eligible company is calculated by following the steps of the method statement set out in subsection 73RB(1) of the ITAA 1936. Where the eligible company does not have an increase in expenditure on foreign owned R&D in the Y₀ year of income, it will not be entitled to the extra 75% deduction available under section 73QB of the ITAA 1936.

For the Y₀ year of income ( reduced expenditure on foreign owned R&D) :

Step 1	The first step is to work out the eligible company's expenditure on foreign owned R&D (worked out under subsections 73B(14C) and (14D) of the ITAA 1936) incurred during its group membership period for the Y0 year of income.
Step 2	In the event that the company has received a grant or recoupment relating to expenditure incurred by the company in the Y0 year of income, work out how much of the initial clawback amount (twice the amount received) is attributable to the expenditure on foreign owned R&D incurred by the company in its group membership period for the Y0 year of income.
Step 3	The result of Step 2 is subtracted from the amount of expenditure on foreign owned R&D worked out under Step 1.
	The result is the reduced expenditure on foreign owned R&D.
	Note: The result of Step 3 cannot be less than zero.
	For each of the Y-1, Y-2 and Y-3 years of income ( reduced notional expenditure on foreign owned R&D ):
Step 4	Work out the amount of expenditure incurred by the eligible company in its group membership period for each of the Y-1, Y-2 and Y-3 years, that would have been expenditure on foreign owned R&D apart from the requirement to have an R&D plan (see subsection 73B(2BA) of the ITAA 1936).
	The result is the eligible company's notional expenditure on foreign owned R&D .
	Note: If all relevant activities were carried out in accordance with an R&D plan and the company's group membership period covers the whole year of income, the company's notional expenditure on foreign owned R&D is the same as its expenditure on foreign owned R&D for the year of income.
Step 5	In the event that the company has received a grant or recoupment relating to expenditure incurred by the company in any of the Y-1, Y-2or Y-3 years, work out how much of the initial clawback amount (twice the amount received) is attributable to the notional expenditure on foreign owned R&D incurred by the company in its group membership period for the year of income.
Step 6	For each of the Y-1, Y-2or Y-3 years of income, subtract the result of Step 5 from the notional expenditure on foreign owned R&D worked out for each year at Step 4.
	The result is the reduced notional expenditure on foreign owned R&D.
	Note: The result of Step 6 cannot be less than zero.

Example 7.13

To adopt the factual scenario used above in Example 7.7 and Example 7.8, the following table shows the reduced expenditure on foreign owned R&D and the reduced notional expenditure on foreign owned R&D of Company A and its eligible company group members:

Company B must include its expenditure incurred in the Y_-1 to Y_-3 years on activities that would have been Australian-centred R&D apart from the R&D plan requirement in its notional expenditure on foreign owned R&D, even though it was not entitled to a deduction under subsection 73B(14C) in respect of this expenditure in relation to those years. Neither Company A nor Company B received any grants or recoupments in relation to expenditure incurred attributable to its expenditure, or notional expenditure, on foreign owned R&D. Therefore, reduced expenditure on foreign owned R&D is the same as expenditure on foreign owned R&D and reduced notional expenditure on foreign owned R&D is the same as notional expenditure on foreign owned R&D.

Step 7	Add up the reduced notional expenditure on foreign owned R&D by the eligible company in its group membership period for the Y-1, Y-2 and Y-3 years of income.
Step 8	Divide the result of Step 7 by 3.

Example 7.13 cont.

Step 9	Subtract the result of Step 8 from the reduced expenditure on foreign owned R&D for the Y0 year of income worked out at Step 3, above.
	The result is the change in expenditure on foreign owned R&D by the eligible company.
	Note: This amount may be a negative number, a positive number or zero.
Step 10	The increase in expenditure on foreign owned R&D by the eligible company is either: the change in expenditure on foreign owned R&D by the eligible company worked out at Step 9, or zero, if the result of Step 9 is a negative number.
	Note: if the result of Step 10 is zero, the eligible company is not entitled to the 175% International Premium.

Example 7.13 cont.

Company A and Company B both have an increase in their expenditure for the Y₀ year over their average expenditure for the Y_-1 to Y_-3 years. Therefore, their change in expenditure on foreign owned R&D by the eligible company (worked out at Step 9) is the same as their increase in expenditure on foreign owned R&D by the eligible company (worked out at Step 10). If either company had experienced a decrease in the current year in relation to their average expenditure for the Y_-1 to Y_-3 years resulting in a negative number at Step 9, then the result of Step 10 would be zero.

C7.8.1.4 Total increase in expenditure on foreign owned R&D by the eligible companies in the group - 73RB(2)

The method statement in subsection 73RB(2) sets out the steps for calculating the total increase in expenditure on foreign owned R&D by the eligible companies in the group . This is the sum of the increase in expenditure on foreign owned R&D by each of the eligible companies in the group.

Steps 1 to 10 above, are performed for each eligible company in the group. The results are then added together to give the total increase in expenditure on foreign owned R&D by the eligible companies in the group.

If an eligible company seeking to claim the 175% International Premium is a solitary company, the total increase in expenditure on foreign owned R&D by the eligible companies in the group will be the same as the increase in expenditure on foreign owned R&D by the eligible company.

ITAA 1936 subsection 73RB(2)

Example 7.13 cont.

The table above shows the increase in expenditure on foreign owned R&D by the eligible company for Company A and Company B. The total increase in expenditure on foreign owned R&D by the eligible company for the claimant, Company A, is the total of each of the amounts worked out at Step 10 in respect of each eligible company group member.

The total increase in expenditure on foreign owned R&D by the eligible company for Company A is $600,000.

C7.8.2 Net increase in expenditure on foreign owned R&D by the group - 73RD

The method statement in section 73RD sets out the steps for calculating the net increase in expenditure on foreign owned R&D by the group.

This is worked out by adding together the change in expenditure on foreign owned R&D by the eligible company of each eligible company in the group. This is the sum of the amount calculated under Steps 1 to 9 of the method statement in subsection 73RB(1) of the ITAA 1936 for each company. Remember that the change in expenditure on foreign owned R&D by the eligible company worked out using Steps 1 to 9 of the method statement in subsection 73RB(1) of the ITAA 1936 can be a negative number.

If an eligible company seeking to claim the 175% International Premium is a solitary company, the net increase in expenditure on foreign owned R&D by the group will be the same as the total increase in expenditure on foreign owned R&D by the eligible companies in the group and the increase in expenditure on foreign owned R&D by the eligible company.

 

Note: If the sum of the change in expenditure on foreign owned R&D by the eligible company for each company in the group is a negative number, then the net increase in expenditure on foreign owned R&D by the group will be zero.

If the amount worked out under the method statement in section 73RD of the ITAA 1936 is zero, the eligible company is not entitled to the 175% International Premium.

ITAA 1936 section 73RD

Example 7.13 cont.

Company A and Company B both have an increase in their expenditure for the Y₀ year over their average expenditure for the Y_-1 to Y_-3 years. Therefore, their change in expenditure on foreign owned R&D by the eligible company (worked out at Step 9) is the same as their increase in expenditure on foreign owned R&D by the eligible company (worked out at Step 10). Consequently, the net increase in expenditure on foreign owned R&D by the group is the same as the total increase in expenditure on foreign owned R&D by the eligible companies in the group , i.e., $600,000.

C7.8.3 Net increase in expenditure on Australian owned R&D - 73RC

The method statement contained in section 73RC sets out how to calculate the net increase in expenditure on Australian owned R&D by the group .

This is calculated as the sum of steps 1 to 6 of the method statement in subsection 73RA(1) of the ITAA 1936 which works out the change in expenditure on Australian owned R&D by the eligible company for each company in the group. The result of Step 6 of the method statement in subsection 73RA(1) of the ITAA 1936 is equivalent to the change in expenditure on foreign owned R&D worked out using steps 1 to 9 of the method statement in subsection 73RB(1) of the ITAA 1936.

If no amount of expenditure on Australian owned R&D was incurred by the eligible company, or group member, in its group membership period, for the Y₀, Y_-1, Y_-2 or Y_-3 years of income, then the net increase in expenditure on Australian owned R&D by the group will be nil.

If the sum of the change in expenditure on Australian owned R&D by the eligible company for each company in the group is a negative number, then the net increase in expenditure on Australian owned R&D by the group will be zero.

Note: A detailed explanation of how to calculate the net increase in expenditure on Australian owned R&D by the group is given in part C6.8.2 Extra deduction for increase in expenditure on Australian owned R&D (175% Australian Premium).

ITAA 1936 section 73RC

Example 7.13 cont.

Adopting the factual scenario used above in Example 7.9 and Example 7.10, Company A has two group members worked out under section 73R of the ITAA 1936 who have incurred incremental expenditure on Australian owned R&D in their group membership periods at a time during the Y₀ to Y_-3 income years, Company C and Company F. Company F did not leave the group with a viable business transfer and so its expenditure must be included in Company A's calculation of the 175% International Premium.

Therefore the reduced expenditure on Australian owned R&D for eligible group members of Company A is:

Company C has decreased its expenditure incurred in the Y₀ year compared to its average expenditure for the Y_-1 to Y_-3 years. As Company F left the group at the end of the Y_-1 year, it also has not increased its expenditure over its average for the Y_-1 to Y_-3 years.

The sum of steps 1 to 6 of the method statement in subsection 73RA(1) of the ITAA 1936 for each company in the group is a negative number (-$240,000). Therefore, the net increase in expenditure on Australian owned R&D by the group for Company A is zero.

However, the amounts of incremental expenditure on Australian owned R&D incurred by Company C and Company F are also taken into account when working out the a djusted increase in expenditure on R&D by the group and so cannot be disregarded. The a djusted increase in expenditure on R&D by the group is explained below at 7.8.4.

C7.8.4 Adjusted increase in expenditure on R&D by the group - 73RE

The adjusted increase in expenditure on R&D by the group is calculated under section 73RE of the ITAA 1936. This amount is calculated as the sum of the change in expenditure on Australian owned R&D and the change in expenditure on foreign owned R&D for all group members (will be positive or zero if negative). An adjustment balance is then subtracted from this result (will be positive or zero if negative).

The adjustment balance is calculated under section 73V of the ITAA 1936 and will be relevant where there is any annual downswing in the combined total of incremental expenditure (incurred in relation to Australian owned R&D) and expenditure on foreign owned R&D during the three year history period that exceeds 20%. In other words, that amount may be moderated where expenditure in any of the two previous years i.e. Y_-1 or Y_-2, has fallen below 80% of the expenditure in years Y_-2or Y_-3 respectively. This adjustment exercise is determined by examining the incremental expenditure and expenditure on foreign owned R&D of the company's group.

ITAA 1936 section 73RE

Step 1	For each group member that is an eligible company work out, under steps 1 to 6 inclusive of the method statement in subsection 73RA(1), the change in expenditure on Australian owned R&D by the eligible company.
Step 2	For each group member that is an eligible company work out, under steps 1 to 9 inclusive of the method statement in subsection 73RB(1) the change in expenditure on foreign owned R&D by the eligible company.
Step 3	Add up all the results of steps 1 and 2. If the result is a negative number, the adjusted increase on R&D by the group will be zero.
Step 4	Subtract the adjustment balance worked out under section 73V from step 3. If the result is a negative number, the adjusted increase in expenditure on R&D by the group will be zero.

If the amount worked out under the method statement in section 73RE of the ITAA 1936 is zero, the eligible company is not entitled to the 175% International Premium.

C7.8.4.1 Adjustment amounts

To work out the adjustment amount, a company must first determine its R&D spend for the Y_-1, Y_-2 and Y_-3 years of income.

R&D spend of an eligible company and its group members for a year of income means the sum of: the amounts worked out for the year of income under steps 1, 2 and 3 of the method statement in subsection 73RA(1) as the reduced expenditure on Australian owned R&D by each eligible company in the group in its group membership period for the year of income; and the amounts worked out for the year of income under steps 4, 5 and 6 of the method statement in subsection 73RB(1) as the reduced notional expenditure on foreign owned R&D by each eligible company in the group in its group membership period for the year of income. ITAA 1936 subsection 73P(2)

There may be an adjustment amount (AA₀) where a company's R&D spend in the Y_-1 year of income is less than 80% of its R&D spend for the Y_-2 year of income. Similarly, there may be an adjustment amount (AA_-1), where a company's R&D spend in the Y_-2 year of income is less than 80% of its R&D spend for the Y_-3 year of income.

The adjustment amount of an eligible company and its group members for the Y₀ year of income (AA₀) is:

[R&D spend for Y_-2 year x 80%] - R&D spend for Y_-1 year

The adjustment amount of an eligible company and its group members for the Y_-1 year of income (AA_-1) is:

[R&D spend for Y_-3 year x 80%] - R&D spend for Y_-2 year

ITAA 1936 subsections 73T(1) and (2)

Exceptions

However, there are exceptions to these rules.

AA₀ will be zero if:

• the eligible company or any of its group members could deduct an amount under section 73QA or 73QB for the Y_-1 year of income, and
• there has been no change in control of the eligible company or any of its group members for the Y₀ year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73T(3)

Also, AA_-1 will be zero if:

• the eligible company or any of its group members could deduct an amount under section 73QA or 73QB for the Y_-2 year of income, and
• there has been no change in control of the eligible company or any of its group members for the Y₀ or Y_-1 year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73T(4)

The adjustment amount will also be deemed to be nil where the result of the calculation is negative.

ITAA 1936section 73S

C7.8.4.2 Adjustment balance

If the R&D spend of the eligible company for the Y_-1 year of income is less than or equal to RA_-1, then

adjustment balance = AA₀ + AA_-1

Otherwise,

adjustment balance = (RA_-1 + AA₀+ AA_-1)- the R&D spend for Y_-1

ITAA 1936 section 73V

RA-1 (short for Running Average for the Y-1 year of income) means half the sum of the R&D spend of the eligible company and its group members for the Y-2 and Y-3 years of income. ITAA 1936 section 73P(2)

The adjustment balance is zero if the eligible company or any of its group members met the conditions in either paragraphs 73QA(1)(a) and (b) or in paragraphs 73QB(1)(a) and (b) for the Y_-1 year of income, and there has been no change in control of the eligible company or any of its group members for the Y₀ year of income resulting in a company entering or leaving the group with a viable business and a change to the R&D spend of the eligible company for the Y_-1, Y_-2 or Y_-3 year of income.

ITAA 1936 subsection 73V(3)

The adjustment balance will also be deemed to be nil where the result of the calculation is negative.

ITAA 1936 section 73S

C7.8.4.3 Effect of the transitional rules

Transitional rule - deductions under former section 73Y of the Income Tax Assessment Act 1936

Transitional provisions operate to modify the application of paragraphs 73T(3)(a) and 73T(4)(a) and paragraph 73V(3)(a) for Y₀ that is the first year of income starting after 30 June 2007.

In effect, an eligible company may come within the exceptions to the adjustment amounts and adjustment balance where that company was eligible, or was deemed to be eligible, to claim an incremental tax concession under section 73QA of the ITAA 1936 in the Y_-1 or Y_-2 year of income, as relevant.

Example 7.14

This example is a continuation of Example 7.13. To calculate the adjusted increase in expenditure on R&D by the group under section 73RE there is a method statement to follow.

Step 1	For each eligible company that was a group member, work out under steps 1 to 6 (inclusive) of the method statement in subsection 73RA(1), the change in expenditure on Australian owned R&D by the eligible company.
Step 2	This step requires each eligible company that is a group member to work out the change in expenditure on foreign owned R&D by the eligible company. This is calculated by following steps 1-9 of the method statement in subsection 73RB(1).

The following amounts have been worked out above for Company A and its eligible company group members:

• the total of the amounts worked out for Company C and Company F under Steps 1 to 6 of the method statement in subsection 73RA(1) is -$240,000
• the total of the amounts worked out for Company A and Company B under Steps 1 to 9 of the method statement in subsection 73RB(1) is $600,000

These amounts are the results of Step 1 and Step 2 of the method statement in section 73RE.

Step 3

Add together all the results of Step 1 and Step 2.

The total of these two amounts is $360,000, which is the result of Step 3 of the method statement in section 73RE.

Step 4	An adjustment balance calculated under section 73V of the ITAA 1936 is required to be subtracted from the result obtained at Step 3. If the result is a negative number, the adjusted increase in expenditure on R&D by the group will be deemed to be zero.
	To work out the adjustment balance, the first step is to determine the R&D spend of Company A for the Y-1, Y-2 and Y-3 years of income. Once the R&D spend has been calculated, the adjustment amounts AA0 and AA-1can be worked out. (See section 7.8.4.1 Adjustment amounts and 7.8.4.2 Adjustment balance)
	The R&D spend of the eligible company for a year of income is the sum of the reduced expenditure on Australian owned R&D for each group member (worked out under steps 1, 2 and 3 of the method statement in 73RA(1) ) and the reduced notional expenditure on foreign owned R&D for each group member (worked out under steps 4, 5 and 6 of the method statement in 73RB(1)). (See also section 7.8.4.1 Adjustment amounts)
	Therefore the R&D spend for Company A is worked out as follows:
	AA0is
		[R&D spend for the Y-2 year x 80%] - R&D spend for Y-1 year
		$800,000 - $770,000
		= $30,000
	AA-1 is
		[R&D spend for the Y-3 year x 80%] - R&D spend for Y-2 year
		$840,000 - $1,000,000
		= zero
	The running average for the Y-1 year of income (RA-1) for Company A is:
		Half the R&D spend for the Y-2 and Y-3 years
		i.e. (R&D spend for Y-2 + R&D spend for Y-3) / 2
		= ($1,000,000 + $1,050,000) / 2
		= $1,025,000
	From this it can be seen that that the R&D spend for Y-1 is less than RA-1 so the adjustment balance is:
		AA0 + AA-1
		(0 + $30,000)
		= $30,000
	For the purposes of this example, no exceptions apply to reduce the adjustment amounts or the adjustment balance to zero (none of the eligible companies were entitled to deduct an amount under former section 73Y, or section 73QA).
	Step 4 of the method statement in section 73RE requires the adjustment balance to be subtracted from the result of Step 3.
		$360,000 - $30,000
		= $330,000

Company A's adjusted increase in expenditure on R&D by the group is $330,000. Company A will input this amount into its calculation for working out the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group .

Company A will be entitled to a deduction for the Y₀ year of income of 75% of the eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group.

That is, 75% of:

Through the examples above, the following have been worked out:

• the increase in expenditure on foreign owned R&D by the eligible company for Company A is $500,000
• the total increase in expenditure foreign owned R&D by the eligible companies in the group for Company A is $600,000
• the net increase in expenditure on foreign owned R&D by the group for Company A is $600,000
• the net increase in expenditure on Australian owned R&D by the group for Company A is zero
• the adjusted increase in expenditure on R&D by the group for Company A is $330,000.

Company A is entitled to a deduction under section 73QB of the ITAA 1936 of 75% of $275,000:

$275,000 x 75%

= $206,250.

C7-9 Other anti-avoidance measures

There is an anti-avoidance measure which applies where a company requests an amendment to an assessment for a year of income to reduce the amounts of its research and development expenditure for that year, and the Commissioner is of the opinion that the purpose of the amendment request is to increase the company's entitlement to the 175% Australian Premium or the 175% International Premium.

Where the Commissioner is of the opinion that the purpose of a debit amendment is to increase a company's entitlement to the extra 50% deduction and/or the extra 75% deduction, the Commissioner may disregard that debit amendment for the purposes of working out a company's incremental expenditure and/or its notional expenditure on foreign owned R&D in its group membership period for the relevant year or years of income. The amended R&D figures will be ignored in working out the company's entitlement to the 175% Australian Premium and /or 175% International Premium.

ITAA 1936 section 73Z

C7-10 Interaction between the 175% International Premium and the R&D tax offset

The refundable R&D tax offset is not available in respect of amounts deductible under subsection 73B(14C) or section 73QB of the ITAA 1936. This means that an eligible company cannot choose an offset instead of a deduction in respect of expenditure on foreign owned R&D or in respect of the extra deduction for increase in expenditure on foreign owned R&D. For further information of the R&D tax offset, see section C4.

C7-11 Example of the calculation of the 175% International Premium

Company S wishes to claim a deduction under section 73QB of the ITAA 1936. Company S, Company T and Company U are eligible companies who are group members worked out under section 73R of the ITAA 1936. Company S, Company T and Company U each incurred expenditure on foreign owned R&D in their group membership periods for the Y₀ toY_-3 income years, for which they were entitled to claim a deduction under subsection 73B(14C) of the ITAA 1936 as follows:

TABLE 1: expenditure on foreign owned R&D incurred in the eligible company's group membership period

Company T also incurred expenditure in the Y_-2 and Y_-3income years which would have been expenditure on foreign owned R&D apart from the requirement for activities to be conducted in accordance with a complying R&D plan (refer subsection 73B(2BA) of the ITAA 1936). Company T received a grant of $50,000 in respect of the expenditure incurred in the Y_-2 year.

TABLE 2: expenditure incurred in the eligible company's group membership period that would have been expenditure on foreign owned R&D apart from the R&D plan requirement

Company S and Company T also incurred incremental expenditure on Australian owned R&D in their group membership periods for each of the Y₀, Y_-1, Y_-2 and Y_-3income years, for which they were each entitled to claim a deduction under subsection 73B(14) of the ITAA 1936 in each of those years. Company S received a P3 grant of $300,000 in the Y₀ year in relation to expenditure incurred in that year, 80% of which was attributable to incremental expenditure incurred in its group membership period for the Y₀ year and 20% of which was attributable to expenditure on foreign owned R&D incurred in its group membership period for that year.

TABLE 3: incremental expenditure on Australian owned R&D incurred in the eligible company's group membership period

Increase in expenditure on foreign owned R&D by the eligible company - 73RB(1) (see 7.8.1.2)

Step 1	Calculate the expenditure on foreign owned R&D incurred by each eligible company in its group membership period for the Y0year of income.
Step 2	Work out how much of the initial clawback amount, if any, is attributable to the expenditure on foreign owned R&D incurred in the company's group membership period for the Y0 year of income.
Step 3	Subtract this amount from the company's expenditure on foreign owned R&D incurred in its group membership period in the Y0 year to give the reduced expenditure on foreign owned R&D. The result cannot be less than zero.
Step 4	For each for the Y-1, Y-2 and Y-3 years of income work out the eligible company's notional expenditure on foreign owned R&D . This is the amount of expenditure incurred in the eligible company's group membership period that would have been expenditure on foreign owned R&D apart from the requirement for activities to be conducted in accordance with a complying R&D plan (refer subsection 73B(2BA) of the ITAA 1936).
Step 5	For each for the Y-1, Y-2 and Y-3 years of income work, out what would have been the company's initial clawback amount, if any, attributable to the notional expenditure on foreign owned R&D incurred in the company's group membership period for the year.
Step 6	Subtract this amount from the company's notional expenditure on foreign owned R&D incurred in its group membership period in the year to give the reduced notional expenditure on foreign owned R&D for each of the Y-1, Y-2 and Y-3 years of income. The result cannot be less than zero.
Step 7	Add up the reduced notional expenditure on foreign owned R&D incurred by each eligible company in its group membership period for the Y-1, Y-2 and Y-3 years of income.
Step 8	Divide the result of Step 7 by 3.
Step 9	For each company, subtract the result of step 8 from the reduced expenditure on foreign owned R&D incurred by the company in its group membership period for the Y0 year. The result is the change in expenditure on foreign owned R&D by the eligible company. This can be a positive number, a negative number, or zero.
Step 10	The increase in expenditure on foreign owned R&D is the amount worked out at Step 9 or, if the result of Step 9 is a negative amount, zero.

Total increase in expenditure on foreign owned R&D by eligible companies in the group - 73RB(2) (see 7.8.1.3)

Step 1	For each group member that is an eligible company, work out the increase in expenditure on foreign owned R&D by the eligible company using Steps 1 to 10 of the method statement in subsection 73RB(1) (calculated above).
Step 2	Total the results of Step 1

Net increase in expenditure on Australian owned R&D by the group - 73RC (see 7.8.3)

Step 1	For each group member that is an eligible company, work out the change in expenditure on Australian owned R&D by the eligible company using steps 1 to 6 (inclusive) of the method statement in subsection 73RA(1).
	Increase in expenditure on Australian owned R&D by the eligible company - 73RA(1)
	Step 1	Calculate the eligible incremental expenditure incurred by each eligible company in its group membership period for the Y0, Y-1, Y-2 and Y-3 years of income.
	Step 2	Work out how much of the initial clawback amount, if any, is attributable to incremental expenditure incurred in the company's group membership period.
	Step 3	Subtract this amount from the company's incremental expenditure to give the reduced expenditure on Australian owned R&D.
	Step 4	Add up the reduced expenditure on Australian owned R&D by the eligible company for the Y-1, Y-2 and Y-3 years of income.
	Step 5	Step 5 Divide the result of Step 4 by 3.
	Step 6	For each company subtract the result of Step 5 from the expenditure incurred by the company in the Y0 year. This gives the change in expenditure on Australian owned R&D by the eligible company.
Step 2	Total the results of Step 1. The result cannot be less than zero.

Net increase in expenditure on foreign owned R&D by the group - 73RD (see 7.8.2)

Step 1	For each group member that is an eligible company, work out the change in expenditure on foreign owned R&D by the eligible company using steps 1 to 9 (inclusive) of the method statement in subsection 73RB(1).
Step 2	Total the results of Step 1. The result cannot be less than zero.

Adjusted increase in expenditure on R&D by the group - 73RE (see 7.8.4)

Step 1	For each group member that is an eligible company, work out the change in expenditure on Australian owned R&D by the eligible company using steps 1 to 6 (inclusive) of the method statement in subsection 73RA(1).
Step 2	For each group member that is an eligible company, work out the change in expenditure on foreign owned R&D by the eligible company using steps 1 to 9 (inclusive) of the method statement in subsection 73RB(1).
Step 3	Add up all of the results of Step 1 and step 2
Step 4	Work out the adjustment balance and subtract this amount from the result of Step 3. This is the adjusted increase in expenditure on R&D by the group. This amount cannot be less than zero (if the result is a negative number it is taken to be zero instead).
	R&D spend
	AA0is:
		[R&D spend for the Y-2 year x 80%] - R&D spend for Y-1 year
		$2,416,000 - $2,275,000
		= $141,000
	AA-1 is
		[R&D spend for the Y-3 year x 80%] - R&D spend for Y-2 year
		$3,360,000 - $3,020,000
		= $340,000
	For the purposes of this example, no exceptions apply to reduce AA-1 to zero (none of the eligible companies were entitled to deduct an amount under section 73QA or 73QB).
	RA-1 is:
		(R&D spend for Y-2 + R&D spend for Y-3) / 2
		= ($3,020,000 + $4,200,000) / 2
		= $3,610,000
	R&D spend for Y-1 is less than RA-1. The adjustment balance is therefore:
	AA0 + AA-1
		($141,000 + $340,000)
		= $481,000
	For the purposes of this example, no exceptions apply to reduce the adjustment balance to zero.
	The adjusted increase in expenditure on R&D by the group is
		$635,000- $481,000
		= $154,000

The eligible company's share of the foreign owned part of the adjusted increase in expenditure on R&D by the group for Company S is:

The extra deduction available to Company S is 75% of the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group

$52,088

C8 Interaction with other government assistance

This document has been archived. It is current only to 30 June 2011.

Disclaimer

ATO position

The Tax Office is responsible for providing you with this Guide to the R&D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.

The information contained in this Guide, as it relates to the matters listed above, consists of written general advice, as referred to in Practice Statement PS LA 2001/4, issued by the Commissioner of Taxation. That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this general advice applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written general advice and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written general advice is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.

Copyright

Commonwealth of Australia 2008

This work is copyright. You may download, display, print and reproduce this material in unaltered form only (retaining this notice) for your personal, non-commercial use or use within your organisation. Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved. Requests and inquiries concerning reproduction and rights should be addressed to Commonwealth Copyright Administration, Attorney General's Department, Robert Garran Offices, National Circuit, Barton ACT 2600 or posted at http://www.ag.gov.au/cca

C8-1 Grant or recoupment to be included in assessable income

A grant or recoupment received by an eligible company in connection with it undertaking R&D activities will generally be assessable income. Specifically, any amount which an eligible company receives, or is entitled to receive, which is:

1. in respect of the results of an any of the R&D activities the company has incurred expenditure on; or
2. attributable to the company having incurred that expenditure;

is assessable income under subsection 73B(27A) of the ITAA 1936. If not assessable under subsection 73B(27A) of the ITAA1936, an amount received as a recoupment for a loss or outgoing deducted under sections 73B, 73BA or 73BH of the ITAA 1936, is an assessable recoupment under section 20-20 of the ITAA 1997.

Where a grant funding agreement stipulates that payment is conditional upon the funds being applied to specific activities, and the agreement requires the funds be repaid if they are not applied to those activities, then the payment will not be assessable income until the funds have actually been applied in accordance with the funding agreement.

For further information see: ATO Interpretative Decision ATO ID 2006/122 Assessable income: derivation of Commonwealth funding - Cooperative Research Centres (CRC) Programme Are instalments paid to a taxpayer (CRC Company) under the Commonwealth Agreements for the 2004 and 2006 Selection Rounds of the CRC Programme (the Agreements), derived at the time of receipt for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

The total amount of a grant or recoupment should be included in your tax return as assessable income. It is not correct to subtract an assessable grant or recoupment from gross deductible amounts and include only the net deductible amounts in your tax return.

C8-2 Clawback and the R&D deduction

This section generally does not apply to deductions available under subsection 73B(14C), section 73QA or section 73QB of the ITAA 1936. However, concepts such as when an amount is 'received', the 'initial clawback amount' and when an amount is 'in respect of' certain expenditure, may be relevant.

Section 73C of the ITAA 1936 operates to 'claw back', or offset the benefits of the R&D tax concession for companies that have received a government grant for the same project. Clawback is applied on a project basis, not to the entire claim.

Note: Subdivision 20-A of the ITAA 1997 applies to make any otherwise non-assessable grants or recoupments covered by the subdivision assessable recoupments and these assessable recoupments are subject to section 73C of the ITAA 1936.

Subsection 73C(2) of the ITAA 1936 states that section 73C of the ITAA 1936 applies where:

• there is an 'eligible company'
• expenditure (called 'relevant expenditure') is incurred by the company on or after 1 July 1985 on research and development activities
• the R&D activities form part or all of a particular project
• the project is carried on by or on behalf of the company; the company, or another person grouped with the company, has received or is entitled to receive (either before or after the commencement of section 73C of ITAA 1936), a recoupment or a grant for some or all of the relevant expenditure from:

- the Commonwealth

- a State or Territory

- an STB (State/Territory body); or

- an authority constituted by or under a law of the Commonwealth, a State or of a Territory.

Where a grant is paid on an instalment basis, the company must work out what amounts it has received, or become entitled to receive, for the purposes of section 73C of the ITAA 1936. Where amounts have been approved but not yet paid, the company must determine whether it had an absolute or unconditional entitlement to receive these amounts in the relevant income year, or whether its entitlement was contingent. If, for example, entitlement to receive a grant payment is contingent upon meeting certain milestones and conditions, a company will not be 'entitled to receive' such amounts, for the purposes of the claw back provisions, until the milestones and conditions have been met, or the amounts are actually received.

Clawback is project related, and therefore does not impact on a company's expenditure on separate non-subsidised projects. Where the projects for which a grant is paid include a project or projects for which the company is not registered with the Board under section 39J of the IR&D Act 1986, expenditure in respect of the unregistered projects can still constitute relevant expenditure under section 73C of the ITAA 1936. That is, the company may claw back against expenditure on unregistered projects where the requirements of section 73C of the ITAA 1936 are met.

Where a company has incurred expenditure in relation to an item of pre-29 January 2001 plant, the total amount of expenditure incurred in the year of income may constitute 'relevant expenditure' on 'research and development activities' that form part of a project for the purposes of applying section 73C of the ITAA 1936. If this is so, the initial clawback amount will be applied against the total expenditure on plant, rather than only against the amount of any deduction related to the use of that plant.

For further information see: ATO Interpretative Decision ATO ID 2004/567 Research and development: Application of clawback against expenditure incurred on acquisition or construction of pre-29 January 2001 plant Is the total amount of expenditure incurred by a company on acquiring or constructing an item of pre-29 January 2001 plant, in relation to 'research and development activities' in a year of income, 'relevant expenditure' on 'research and development activities' that formed or form part of a particular project for the purposes of section 73C of the Income Tax Assessment Act 1936 (ITAA 1936)?

For further information see: ATO Interpretative Decision ATO ID 2004/568 Research and development: Clawback - when has a company received, or become entitled to receive, a grant or recoupment? Has an eligible company received, or become entitled to receive, the total agreed amount of an approved Government grant, for the purposes of applying section 73C of the Income Tax Assessment Act 1936 (ITAA 1936), where the grant has been approved but the total agreed amount has not yet been paid?

For further information see: ATO Interpretative Decision ATO ID 2004/569 Research and development: Application of clawback against other and core technology expenditure incurred on unregistered research and development activities. Can expenditure incurred by an eligible company on 'research and development activities', for which registration has not been obtained with the Industry, Research and Development Board, be 'relevant expenditure' for the purposes of section 73C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Co-operative Research Centres (CRCs) and clawback

The clawback provisions in section 73C of the ITAA 1936 do not generally apply to recoupments or grants from the Commonwealth under the Cooperative Research Centres Program (CRC Program) (see subsection 73C(2A) of the ITAA 1936). However, this is not the case where there is a 'partnership' for the purposes of subsection 73B(3A) of the ITAA 1936 which is not designated as a Cooperative Research Centre under the CRC Program (see paragraph 73B(3A)(da) of the ITAA 1936). This is so irrespective of whether it is the partnership which receives, or becomes entitled to receive the recoupment or grant, or just one eligible company in that partnership. In such cases section 73C of the ITAA 1936 may apply.

C8.2.1 How is the clawback amount calculated?

The initial clawback amount is taken to be twice the amount, or twice the total amounts, that the company or another person grouped with the company, has received, or became entitled to receive, as a recoupment or a grant in respect of R&D expenditure.

ITAA 1936 subsection 73C(3)

Example 8.1

Where the company incurs research and development expenditure of $100,000 in the year of income and receives a $20,000 grant, the following calculation applies:

Therefore, the company may claim $60,000 at 125% under the tax concession and $40,000 at 100%.

C8.2.2 What happens if a further grant/recoupment is received later in the same year?

If a further recoupment/grant is received, or entitled to be received in the same year in relation to the same project expenditure, the initial clawback amount is recalculated so as to include the additional grant.

Example 8.2

Where the company receives a further recoupment of $10,000 later that year (in addition to the $20,000 grant already received), the clawback amount is recalculated to be twice the total amount, i.e. 2 x (20,000 + 10,000) = $60,000.

How is the clawback amount offset against the relevant research and development expenditure?

The clawback amount is offset against the relevant expenditure:

• if the initial clawback amount is equal to or greater than the relevant expenditure, clawback applies to the whole of that expenditure;
• if the initial clawback is less than the relevant expenditure, then the clawback amount is fully applied to the relevant expenditure, and is exhausted in the following manner;
• first, it is applied against expenditure in the years (in chronological order) in which the grant or recoupment is received or entitlement to it arises (i.e. 'the year of grant');
• the remainder of the initial clawback amount is applied progressively against expenditure in the years prior to the year of grant in reverse chronological order;
• the balance to be applied in chronological order to each year of income not already covered (i.e. this means that any balance of the initial clawback amount after the above applications is applied progressively against expenditure in the years after the year of grant, in chronological order).

ITAA 1936 subsection 73C(7)

Example 8.3

A company begins an R&D project in the 1999-2000 income year, which is completed in the 2003-04 income year. The company receives a grant of $100,000 in the 2000-01 income year.

The company incurs the following relevant expenditure during the life of the project:

The initial clawback amount is 2 x $100,000 = $200,000

The initial clawback amount is fully exhausted in the 2002-03 income year. However, $10,000 of relevant expenditure in that year is not subject to clawback, and is hence eligible for the concessional deduction at the 125% rate. As none of the 2003-04 income year expenditure is subject to the clawback, the full amount is eligible for the concessional deduction at the 125% rate.

If a grant or recoupment is not received, or entitled to be received, until after the last year in which any relevant expenditure was incurred, the initial clawback amount is first offset against expenditure in the latest year in which a deduction was allowed/allowable under section 73B of the ITAA 1936, and then, progressively in reverse chronological order to each of the earlier years of income.

C8.2.3 What happens if a further grant/recoupment is received in a subsequent year?

If a further recoupment/grant is received, or entitled to be received, in a subsequent year that relates to the same project expenditure the initial clawback amount is recalculated so as to include the additional grant.

ITAA 1936 paragraph 73C(3)(b)

Example 8.4

Where the company receives a further recoupment of $10,000 in a subsequent year (in addition to the $20,000 grant already received), the clawback amount is recalculated to be twice the total amount, i.e.

 

2*($20,000 + $10,000) = $60,000

 

The process of offsetting the clawback amount against the relevant expenditure is slightly different to that shown in the example under the heading How is the clawback amount offset against the relevant research and development expenditure ? The clawback amount is offset in the following order:

• year of the first grant
• year of the second grant
• years previous to year of first grant
• years subsequent to year of first grant (excluding year of second grant).

Companies receiving government grants or other assistance subject to clawback should ask the Tax Office for advice on this matter.

C8.2.4 Consolidation and clawback

There can be cases where the head company of a consolidated group will claim the 125% or 175% deduction for expenditure made by a subsidiary, but the subsidiary will subsequently receive a grant for, or recoup that expenditure, after it has left the consolidated group. In these circumstances, clawback will operate in respect of the head company to the same extent that it would have in respect of the subsidiary, if the subsidiary had never been in the consolidated group.

The head company may not know the amount of the recoupment or grant that its former subsidiary has received or that the recoupment or grant was received. Consequently, the subsidiary is required to notify the head company of the amount that it will have to use for its clawback calculation. It must do so within 60 days of the end of the financial year in which the entitlement to the grant or recoupment arises. By that time the subsidiary will be in a position to calculate the information it must supply to the head company

ITAA 1936 subsection 73BAE(2)

A subsidiary may receive a grant in relation to certain of its R&D activities in a year of income for which it is not a member of a consolidated group. Clawback will apply to its R&D deductions for that year. In the next year of income it may continue to incur expenditure on those activities, but become part of a consolidated group. The consolidation rules will mean that clawback may also apply, for this later year of income, to the head company's R&D deductions in relation to those activities, where there is some clawback amount that still remains to be applied.

Similarly, where a grant in respect of expenditure on R&D activities is received by a subsidiary whilst in a consolidated group, but the subsidiary incurs expenditure on those activities after leaving the group, the consolidation 'exit history rule' (ITAA 1997 section 701-40) operates so that clawback applies to the subsidiary's expenditure on those activities after its departure.

A subsidiary which has incurred expenditure on R&D activities prior to joining a group, may receive a grant in respect of expenditure on those activities after it has joined a consolidated group. In this circumstance, the subsidiary will still be required to apply clawback to the expenditure incurred prior to consolidation. The 'single entity rule' in the consolidation provisions is only relevant for various purposes in any period in which the subsidiary is a member of the consolidated group . These rules therefore do not prevent clawback from applying to the subsidiary in the period prior to joining the group.

ITAA 1997 subsection 701-1(3)

C8.2.5 Clawback and guaranteed returns to investors

Section 73CA of the ITAA 1936 operates to reduce the benefits of the R&D tax concession in relation to expenditure if, at the time an eligible company incurred expenditure, the company was not at risk in respect of the whole or part of that expenditure.

For further information see: ATO Interpretative Decision ATO ID 2006/68 Research and Development: application of section 73CA of the ITAA 1936 to a reimbursement arrangement - expenditure 'not at risk' Does section 73CA of the Income Tax Assessment Act 1936 (ITAA 1936) apply where an eligible company is entitled to reimbursement for expenditure on research and development activities in the form of a fee paid by a related entity?

For further information see: ATO Interpretative Decision ATO ID 2009/107 R&D tax concession: is a company 'not at risk' if it can expect to recover its R&D expenditure because of the good technical prospects of its activities (rather than merely because of the terms of the relevant arrangement)? Under section 73CA of the Income Tax Assessment Act 1936 (ITAA 1936), is a company 'not at risk' in respect of an amount of expenditure if: the company incurs the expenditure in an effort to comply with a contractual obligation to deliver a certain product; and when it is incurred, it can reasonably be expected that, as a result, the company will earn a fee under the contract at least equal to the amount of the expenditure; and that expectation is held because there are good technical grounds to anticipate that the expenditure will result in a product that satisfies the contract, rather than merely because of the terms and conditions of the contract itself or any other similar circumstance of the arrangement between the parties?

If an eligible company also receives a grant or recoupment from the government in respect of that expenditure then, in accordance with paragraph 73CA(2)(a) of the ITAA 1936, the company would first need to apply the clawback provisions. Any amount of expenditure not subject to clawback would then be subject to the application of section 73CA of the ITAA 1936.

ITAA 1936 paragraph 73CA(2)(b)

C8-3 Clawback and the deduction for expenditure on foreign owned R&D

Companies can claim a deduction for expenditure on foreign owned R&D under subsection 73B(14C) of the ITAA 1936 for their first year of income commencing after 30 June 2007, and later income years.

Clawback generally operates to reduce the rate of deduction for relevant expenditure from 125% to 100%. Therefore, because amounts of expenditure on foreign owned R&D are deductible under subsection 73B(14C) at the rate of 100%, the clawback provisions will not impact upon the deduction available under this subsection where a company has received a grant or recoupment in respect of its expenditure on foreign owned R&D.

However, where a company has received a grant or recoupment in respect of its expenditure on foreign owned R&D, this may impact upon its entitlement to the 175% Australian Premium and 175% International Premium. (See C8-6 Clawback and the 175% Australian Premium and C8-7 Clawback and the 175% International Premium).

C8-4 Clawback and the R&D tax offset

Where a company receives a grant or recoupment from the government in relation to their R&D expenditure, prior to or during the claim year, the clawback provisions should be taken into account in calculating the deductions. As the amount of any deduction available may be reduced by the application of the clawback provisions the amount which is eligible to be cashed out under the offset may also be reduced.

Where clawback applies deductions are claimed at the rate of 100% instead of 125%. Consequently, the application of the clawback provisions does not prevent a company from being eligible for the R&D tax offset so long as the eligibility criteria contained in section 73J of the ITAA 1936 have been met. (See Part C4-7 - Clawback of grant funding or recouped expenditure).

C8-5 Clawback and the incremental tax concession (175% Premium)

Companies can claim the incremental tax concession for expenditure incurred in their first income year that commences after 30 June 2001, until the end of the 2006-07 year of income. This section does not apply in relation to expenditure incurred in years of income starting after 30 June 2007.

Companies claiming the incremental concession must have been registered under the 125% Concession and be eligible to deduct incremental expenditure in each of the three immediately prior years. An exception to the requirement for a company to have a three year claim history arises where the company or its group member received a start grant or a commercial ready grant in respect of that year of income. (see section C5-3 Eligibility).

Where a company has received a grant or recoupment from the government in relation to its 'incremental expenditure', this is taken into account in working out the additional deduction available under section 73Y of the ITAA 1936. The additional 50% deduction is the lesser of:

• 50% of the premium amount distributed to the eligible company, or
• 50% of the eligible company's Y₀ year of income incremental expenditure eligible for a deduction under section 73B of the ITAA 1936 at the rate of 125% (the '125% cap').

While clawback does not affect the amount of incremental expenditure included in the calculations for the current or history years, it will affect the level of the claim. The impact of clawback is taken into account in calculating the entitlement to the incremental tax concession through the operation of the '125% cap' in subsection 73Y(2) of the ITAA 1936, which limits the amount of the incremental deduction to the lesser of 50% of the premium amount distributed to the eligible company, or 50% of the amount of incremental expenditure incurred by the company in the Y₀ year of income that is eligible for a deduction at the rate of 125%. (See part C5-11 Operation of the clawback provisions and the incremental concession).

C8-6 Clawback and the 175% Australian Premium

Companies can claim the 175% Australian Premium (concerning 'Australian owned R&D') for expenditure incurred in their first year of income that commences after 30 June 2007 and later years of income.

To claim the 175% Australian Premium, an eligible company must have been able to deduct an amount under subsection 73B(13) or (14) of the ITAA 1936 for incremental expenditure incurred in its group membership period in each of the three years immediately preceding the deduction year. An exception to this requirement arises where the company or its group member received a start grant or a commercial ready grant in respect of that year of income. (See section C6-3 Eligibility).

Where a company has received a grant or recoupment from the government in relation to its 'incremental expenditure', this is taken into account in working out the extra deduction available under section 73QA of the ITAA 1936. If the grant or recoupment is attributable to incremental expenditure incurred by the eligible company in its group membership period, the company must reduce its incremental expenditure by the 'initial clawback amount' (twice the amount received). A company's entitlement to the 175% Australian Premium is calculated on the basis of the reduced amounts for the current year and the three immediately preceding years. (See 6.8.1.1 Operation of the clawback provisions and the 175% Australian Premium).

Where a company has received a grant or recoupment from the government in relation to its expenditure on foreign owned R&D, this is also taken into account when working out the 175% Australian Premium. The company's expenditure on foreign owned R&D is reduced by the initial clawback amount to the extent that the grant or recoupment is attributable to the expenditure on foreign owned R&D incurred by the eligible company in its group membership period. The reduced amount of expenditure on foreign owned R&D is used when working out a company's entitlement to the 175% Australian Premium (see 7.8.1.1 Operation of the clawback provisions and the 175% International Premium).

C8-7 Clawback and the 175% International Premium

Companies can claim the 175% International Premium (concerning 'foreign owned R&D') for expenditure incurred in their first year of income that commences after 30 June 2007 and later years of income.

To claim the 175% International Premium, an eligible company generally must have been able to deduct an amount under subsection 73B(14C) of the ITAA 1936 for expenditure incurred on foreign owned R&D in its group membership period in each of the three years immediately preceding the deduction year. There is no exception to this eligibility requirement of the 175% International Premium where the company or its group member received a start grant or a commercial ready grant in respect of that year of income. (See section C7-3 Eligibility).

Where a company has received a grant or recoupment from the government in relation to its expenditure on foreign owned R&D, this is taken into account in working out the extra deduction available under section 73QB of the ITAA 1936. If the grant or recoupment is attributable to expenditure on foreign owned R&D incurred by the eligible company in its group membership period, the company must reduce its expenditure on foreign owned R&D by the 'initial clawback amount' (twice the amount received). A company's entitlement to the 175% International Premium is calculated on the basis of the reduced amounts for the current year and the three immediately preceding years. However, if one or more of the immediately preceding three years is a nil expenditure year, the requirement concerning deductibility does not apply to that year. (See 7.8.1.1 Operation of the clawback provisions and the 175% International Premium).

Where a company has received a grant or recoupment from the government in relation to its expenditure on Australian owned R&D, this is also taken into account when working out the 175% International Premium. The company's expenditure on Australian owned R&D is reduced by the initial clawback amount to the extent that the grant or recoupment is attributable to the expenditure on incremental expenditure incurred by the eligible company in its group membership period. The reduced amount of expenditure on Australian owned R&D is used when working out a company's entitlement to the 175% International Premium. See 6.8.1.1 Operation of the clawback provisions and the 175% Australian Premium).

C8-8 AusIndustry and other programs subject to clawback

AusIndustry and other Commonwealth, Territory and State government programs are subject to 'clawback' where the programs provide a company with a 'recoupment or a grant in respect of, the whole or any part of the relevant expenditure on research and development activities'.

A variety of Commonwealth, State and Territory government assistance programs exist which provide support for companies undertaking R&D activities. Many of these programs will also support activities other than R&D activities as defined in subsection 73B(1) of the ITAA 1936 (for example, commercialisation of a product).

The application of the 'clawback' provision is limited to assistance received for R&D activities covered under subsection 73B(1) of the ITAA 1936 and applies on a project by project basis. Clawback will not be applicable to funding received for those activities undertaken by the company on a project which does not qualify as R&D activities within the definition in subsection 73B(1) of the ITAA 1936.

An assistance program may not necessarily specify that an objective of the funding is to support R&D activities. However, if the funding is provided in respect of R&D activities as defined in subsection 73B(1) of the ITAA 1936, clawback would apply to the assistance received for those activities.

AusIndustry has a range of products designed to support innovation within Australian industry. Where these programs support R&D activities through grants for R&D expenditure, or other forms of support that give rise to recoupment of expenditure, then clawback will apply when the company claims a deduction under the R&D tax concession.

Details of these products are available from the AusIndustry website.

For further information see: ATO Interpretative Decision ATO ID 2001/753 Section 73C Income Tax Assessment Act 1936 (ITAA 1936) and the Automotive Competitiveness and Investment Scheme. If a taxpayer receives credits under the Commonwealth Government's Automotive Competitiveness and Investment Scheme (ACIS) (which are calculated with reference to investment in approved research and development (R & D) plant and equipment or investment in approved (R & D)), do the clawback provisions in respect of expenditure on (R & D) activities (relevant expenditure) contained in section 73C of the ITAA 1936 apply? If so, does section 73C of the ITAA 1936 apply to all relevant expenditure, within the meaning of that term in paragraph 73C(2)(a) of the ITAA 1936, used in the calculation of a particular credit?

ATO Interpretative Decision ATO ID 2004/871 Research and development: Clawback (section 73C) for grants and recouped expenditure and the Pharmaceutical Industry Investment Program. Must a company apply the 'clawback' provisions of section 73C of the Income Tax Assessment Act 1936 (ITAA 1936) to all or part of the payments received under the Pharmaceutical Industry Investment Program (PIIP)?