Guide to the R & D Tax Concession - Part C

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This document has been archived.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

(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 1997 section 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:

that cost does not exceed $300; and
you use the asset predominantly for the *purpose of producing assessable income that is not income from carrying on a *business; and
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
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

¹ The 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
Factory - direct - indirect	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
Administration - R & D staff - indirect	70,000 x (108,200 / 1,371,900)	5,521
Management - R & D - other	70,000 x (42,700 / 1,371,900)	2,179
Management - R & D - other	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

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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