Guide to the R & D Tax Concession - Part C

C5 Incremental tax concession (175% premium)

This document has been archived.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

This section does not apply for years of income commencing after 30   June   2007. Please refer to sections C6 and C7. For more information refer to Timing in paragraph C5-2 , below.

Disclaimer

ATO position

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

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

Copyright

Commonwealth of Australia 2009

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

C5-1 Background

The Government has enhanced the R & D tax concession by providing a higher level of support for those companies that increase their level of R & D expenditure. These companies will be eligible to receive the incremental tax concession for additional expenditure on R & D made in years of income that commence after 30 June 2001.

This initiative is about encouraging sustained business investment in R & D on a long-term basis.

Key features of the incremental concession are:

• targeting of predominantly labour-related components of R & D expenditure, where the greatest benefits for the whole economy occur. Plant related expenditure items are excluded
• applies to additional R & D expenditure above the three year rolling average of the company group, subject to moderation where there has been significant volatility in prior years' R & D; and
• mandatory grouping rules and other anti-avoidance measures to avoid any potential abuse.

C5-2 Timing

The former incremental tax concession applies to expenditure incurred in years of income starting on or after 1   July   2002 up until the year of income ending on 30   June   2007. For information on expenditure incurred after this time, please refer to section C6 175% Australian Premium and C7 175% International Premium.

C5-3 Eligibility

Companies claiming the incremental concession must have been registered under the 125% Concession and eligible to deduct incremental expenditure in the claim year and in each of the three immediately prior years. An exception to the requirement for a company to have a three year claim history arises where the company is in a group and there are other companies in that group which have been able to deduct incremental expenditure incurred during their group membership periods. Provided that, between those identified group companies while they have been group members, there are eligible deductions in the group in each of the three immediately prior years, the company will have a three year history.

A company can also have a claim history for a particular year if it has not registered for that year but has been in receipt of a R & D start grant* or a commercial ready grant* in respect of that year of income. Companies to whom these latter circumstances apply will need to calculate the amount of incremental expenditure they incurred on R & D activities in that year, that they would have been eligible to claim as a deduction under the R & D concession for incremental expenditure if they had been registered. In summary, a combination of income years where there was either deductible R & D expenditure or receipts from R & D start or commercial ready grants is acceptable for the purposes of meeting the three year history requirement.

• A start grant is a payment to a company under the Government R & D program.
• A commercial ready grant is a payment to a company under the Government Commercial Ready program, which includes a component for R & D activities (ignoring the R & D plan requirement). The program began on 1   October   2004 and subsumed the former R & D Start program.

ITAA 1936 sections 73P , 73Q , 73R

If a company is in receipt of a start grant or a commercial ready grant in a year of income in which it is registered with Innovation Australian (the Board), then the grant is subject to clawback. If the company is in receipt of a start or commercial ready grant in an income year in which they are not registered with the Board, the grant may form part of the company's claim history for a particular year.

When working out eligibility for the additional deduction under section 73Y of the ITAA 1936, the company must determine which year(s) the start grant or commercial ready grant was received 'in respect of'. The years to which a grant relates, for the purposes of section 73Q of the ITAA 1936, may differ from those in which grant payments were actually received. For example, the grant approved may have been calculated on the basis of research and development activities undertaken prior to the date of application for the grant. This would mean that the grant is 'in respect of' an income year prior to the year in which the grant agreement was signed or approved and prior to the year in which the first payment was received.

For further information see: ATO Interpretative Decision ATO ID 2002/985 Research and development - 3 year history - Additional deduction. Does the taxpayer satisfy the requirement of establishing a three year history outlined in paragraph 73Q(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), for the three years preceding the 2002 financial year?

 

Terms used

For the purposes of applying the incremental concession rules, years of income are designated as follows:

Y ₀ is the year of income for which an eligible company is working out its assessable income and deductions.

Y _-1 means the year of income before the Y ₀ year of income

Y _-2 means the year of income 2 years before the Y ₀ year of income

Y _-3 means the year of income 3 years before the Y ₀ year of income

ITAA 1936 subsection 73P(6)

Example 5.1

Company A, which is not grouped with any other company, is seeking to claim the incremental concession for Y ₀ when it was entitled to deductions for incremental expenditure of $90,000.

In the previous year (Y _-1 ) Company A received a commercial ready grant of $25,000 and incurred incremental expenditure of $50,000, but had not registered for the 125% Concession.

In the two years immediately prior to that Company A was registered and entitled to deductions for incremental expenditure of $25,000 (Y _-2 ) and $20,000 (Y- ₃ ).

Company A may be eligible for the incremental concession in Y ₀ as it has the required three year history '(ie, for the Y _-1, Y _-2 andY- ₃ years of income)'.

Company	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Company A	90	50	25	20

C5-4 Calculation

Generally a company works out the amount that will be subject to the additional 50% deduction by subtracting its average incremental expenditure over the past three years from its current year incremental expenditure. That amount may be moderated where expenditure in any of the two previous years i.e. Y _-1 or Y- ₂ , has fallen below 80% of the previous year's expenditure.

Where there are several members in a group, these calculations are done on a group basis. The grouping rules are the same as those used for the tax offset. Special allocation rules then apply to determine the amount claimable by each of the companies within the group.

The amount determined in this way will attract an additional 50% deduction, in addition to the 125% deduction already available on that amount, providing a total premium rate of 175%.

ITAA 1936 sections 73S to 73Y

C5-5 Incremental expenditure

Incremental expenditure is defined to mean expenditure that is research and development expenditure with the exception of plant leasing expenditure, and any other expenditure incurred under a contract which is in substance for the acquisition of plant.

ITAA 1936 subsection 73P(2)

Incremental expenditure as defined in subsection 73P(2) means expenditure that is research and development expenditure as defined in subsection 73B(1) . This includes : contract expenditure to a Registered Research Agency (RRA) salary expenditure other expenditure directly in respect of R & D activities includes: contract expenditure to others for R & D activities, and eligible feedstock expenditure (not residual feedstock expenditure). Subsection 73P(2) excludes : expenditure to lease or hire plant, and expenditure under a contract that is in substance for the acquisition of plant and not for the receipt of services. Note : Expenditure which is not research and development expenditure as defined in subsection 73B(1) is not incremental expenditure. Items in this excluded category include plant depreciation, core technology, interest and residual feedstock expenditure.

The 'incremental expenditure' of a company eligible to claim the incremental tax concession includes all amounts of 'research and development expenditure', other than those in relation to plant (as specified above), regardless of whether the company:

• claimed a deduction for these amounts under the R & D tax concession, at either the 100% rate (for example because of the operation of the clawback provisions in section 73C of the ITAA 1936 on receipt of a grant, or the 'not at risk rules' in section 73CA of the ITAA 1936) or at the 125% rate
• was not eligible to claim a deduction under the R & D tax concession. This could occur, for example, where the company was not registered with AusIndustry in relation to the project for which the expenditure was incurred; where the company's aggregate research and development amount for the year was less than $20,000; or where the expenditure was for overseas expenditure and a provisional certificate under section 39ED of the Industry Research and Development Act 1986 was not issued.

Example 5.2

Company A (a company with no group members), wishes to claim the additional deduction for incremental expenditure, for Y _0, when it was entitled to deductions for incremental expenditure of $90,000 (all of which is eligible for deduction at the 125% rate). Its incremental expenditure for the other relevant years of income, including non-deductible amounts, is as follows:

Company A Incremental expenditure	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Deductible	90	30	30	15
Non-deductible	0	10	5	0
Total incremental expenditure	90	40	35	15

Total group markup

It should be noted that where any expenditure amounts are paid to an entity that is a member of the same group, any amounts of such payments which represent an intra-group markup are eliminated from that expenditure in calculating entitlement to both the 125% R & D tax concession and the incremental tax concession.

Where there is an entitlement to an additional deduction under section 73Y of the ITAA 1936, the intra group markup is also excluded when calculating the R & D spend of the eligible company for each of the Y _-1, Y _-2 and Y- ₃ years of income.

ITAA 1936 subsections 73B(14AA) to (14AD)

C5-6 Prepayments in the calculation of the 175% premium R & D tax concession

The prepayment rules apply to the calculation of the 125% R & D tax concession and the 175% premium R & D tax concession. From 1 July 2001, R & D prepaid expenditure is generally taken into account on a spread basis in the year to which the payment relates, not the year in which it is incurred. An exception relates to prepayments for contract expenditure to a Registered Research Agency, which attracts special treatment.

ITAA 1936 sections 82KZMA to 82KZMF

C5-7 Grouping rules for the incremental concession

The same grouping rules apply as those for the R & D tax offset.

C5.7.1 Company groups - entry and exit rules

There are rules covering the situation where companies enter or exit a group during the claim year and/or the three-year history period.

These rules work by identifying all of the companies who are required to be grouped with the claimant at the end of the claim year ( Primary group members ), and then by establishing the dates upon which the control of any of these companies last changed within the history period such that they became members of the group.

The period between these dates is the group membership period of each company. Any other companies with whom these members were required to be grouped in their group membership period (but which have subsequently left the group) are also identified ( secondary group members).

Therefore at any point in time, the members who are to be grouped together are identified, and their incremental expenditure during their period of group membership can be calculated.

C5.7.2 Substituted Accounting Periods

To determine its eligibility for the additional deduction under section 73Y of the ITAA 1936, a company must first determine whether the requirements of section 73Q of the ITAA 1936 are met in relation to the 'deduction year' (the Y ₀ year of income) and each of the preceding 3   years of income (the Y _-1 , Y _-2 and Y _-3 years of income).

The 'deduction year' for the purposes of sections 73Q , 73U , 73V , 73W and 73Y of the ITAA 1936 will be the 12-month period ending on the last day of the period for which the company seeking to claim the additional deduction will lodge its return of income for the year. This is so even where the company's return of income for the year is for a period of greater or less than 12 months. For example, if the return of income of the company for the 2003-04 income year is for the period from 1   July   2003 to 31   December   2003, the 'deduction year' is the 12-month period 1   January   2003 to 31   December   2003.

The preceding three years of income are the 3 preceding 12-month periods, i.e., 1   January   2002 to 31   December   2002, 1   January   2001 to 31   December   2001 and 1   January   2000 to 31   December   2000, representing the Y _-1 , Y _-2 and Y _-3 years of income, respectively.

If the company seeking to claim the additional deduction has a transitional period in one of the years of income representing the Y _-1 , Y _-2 or Y _-3 year of income, that year will be the 12-months ending on the last day of the period for which the return of income was, or will be, lodged. This 12-month period will be used when calculating 'R & D spend' for the purpose of sections 73T , 73U , 73V , 73W and 73Y of the ITAA 1936.

For example, where a company is working out its additional deduction for the 2003-04 income year, and:

• 1   January   2003 to 31   December   2003 represents the 2003-04 income year
• 1   January   2002 to 31   December   2002 represents the 2002-03 income year
• 1   July 2001 to 31   December 2001 represents the 2001-02 income year; and
• 1   July 2000 to 30   June 2001 represents the 2000-01 income year

then the deduction year and three preceding years for the purposes of the additional deduction will be:

• 1   January   2003 to 31   December   2003 representing the Y0 year of income
• 1   January   2002 to 31   December   2002 representing the Y-1 year of income
• 1   January   2001 to 31   December   2001 representing the Y-2 year of income
• 1   January   2000 to 31   December   2000 representing the Y-3 year of income

These periods are always worked out using the year of income or substituted accounting period of the company working out its deduction, and not the year of any group member. All information, for example, group membership and 'R & D spend' must be worked out using the 12-month periods representing the Y ₀ to Y _-3 years of income of the company working out its deduction. This process must be undertaken in respect of each group member working out its respective deduction as the periods may be different depending upon that company's own year of income.

Note: Where the company working out its additional deduction has a transitional period for the 'deduction year' (the Y ₀ year of income), it will use the 12-month period representing the Y ₀ year of income when determining the lesser amount under subsection 73Y(2) of the ITAA   1936.

For further information see: ATO Interpretative Decision ATO ID 2003/990 Research and development: Additional deduction for incremental expenditure where a group member company has a substituted accounting period. If an eligible company is grouped with another company that has a different accounting period, is the year of income referred to in paragraph (b) of the definition of R & D spend in subsection 73P(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that of the eligible company, and not that of the group member?

ATO Interpretative Decision ATO ID 2003/991 Research and development: Additional deduction for incremental expenditure where a company has a transitional substituted accounting period. If an eligible company in one of the three years prior to the deduction year, has lodged a return of income for a period other than 12 months, will this period represent any of the 'Y-1, Y-2 or Y-3' years when calculating 'R & D spend'?

ATO Interpretative Decision ATO ID 2004/973 Research and development: Additional deduction for incremental expenditure where a company has a transitional substituted accounting period in relation to the 'deduction year'. If an eligible company lodges a return of income for a period other than 12 months, will this period represent the year of income (the deduction year) for the purposes of determining the company's eligibility to claim an additional deduction for incremental expenditure, and also represent the Y0 year when calculating R & D spend?

Determining group membership

The detailed steps involved in determining group membership are:

Step   1:

Identify the primary group members (PGM ) - these are the claimant company, and other companies required to be grouped with the claimant company as at the end of the claim year (Y ₀ ).

Step   2:

Determine the group membership period of each of the PGMs. A PGM's group membership period extends from the day that its control changed (or from the date the PGM experienced another change as specified in step 2 of the method statement in section 73R of the ITAA 1936) to cause it to come into the group to the last day of the current income year. However, the group membership period cannot generally commence before the first day of the income year three years before the current income year.

Step   3:

Determine any other companies that are required to be grouped with each PGM at a time during the PGM's group membership period. Any company identified under this step is called a secondary group member (SGM).

These will be companies which were required to be grouped with a PGM for a least some part of the four year period under review, but which have left the group prior to the end of the current year.

Steps 4 & 5:

Determine the group membership period for each SGM. This extends from the day that its control or affiliates changed to cause it to come into the group to the day its control or affiliates changed to cause it to leave the group. However, as in Step   2, the group membership period cannot generally commence before the first day of the income year three years before the current income year.

The effect of these rules is that for the purposes of calculation of the total incremental expenditure of a group, the incremental expenditure of a company is only taken into account for the period of time that it is a member of the group.

ITAA 1936 section 73R

For further information see: ATO Interpretative Decision ATO ID 2005/152 Research and Development: group membership period under section 73R of the ITAA 1936 Where a company, now controlled by a person under section 73L of the Income Tax Assessment Act 1936 (ITAA 1936), was previously not controlled by any person within the meaning of that section, has there been change in control of the company for the purposes of paragraph 73R(2)(a) of the ITAA 1936?

Example 5.3

Companies A, B and C are companies that have been eligible to deduct amounts for incremental expenditure at some stage in the claim year and in the three immediately prior years. Companies A and B are primary group members in year Y ₀ as they are grouped on the last day of that income year (step   1). Company C is a secondary group member as C is grouped with B only in Y _-1, Y _-2 and Y _-3.

A modification to this rule occurs where any company enters or leaves a group with a 'viable business'.

C5.7.3 Viable business exception

The group membership periods of both primary and secondary group members can change under certain circumstances:

• where a secondary group member leaves the group with a viable business, its group membership period is deemed never to exist. As such, its incremental expenditure that was otherwise within its group membership period is no longer available for use in the calculation of the additional 50% deduction for the group that it departed from; or
• where either a primary group member or a secondary group member enters the group with a viable business, its group membership period is extended to include its group membership period from its previous group. As such, any incremental expenditure incurred from the 1 ^st day of the Y _-3 year during a previous group membership is taken into account in the calculation of the additional 50% deduction.

A company will join or leave the group with a viable business if all assets (which must include R & D assets) necessary to comprise a continuing business are transferred with the company and the vendor and purchaser agree in writing that they are transferring a viable business. The vendor must provide written details of the incremental expenditure that the transferred company incurred while in the former group. The written agreement and details of the incremental expenditure generally need to be provided by the end of the year in which the change of control took place. There is a transitional rule which requires that the written details relating to any change of control which occurred prior to 1 July 2002 be provided by 30 June 2002.

Where a company now controlled by a person or persons under section 73L of the ITAA 1936 was previously not controlled by any person within the meaning of that section, there is a change in control for the purposes of section 73R of the ITAA 1936. The group membership period of the company which experienced that change in control will be the period between the day on which the company became controlled by the current controller and the last day of the Y ₀ year of income.

ITAA 1936 subsections 73R(3) to (6)

For further information see: ATO Interpretative Decision ATO ID 2004/808 Research and development: 'Group membership period' and effect of viable business transfer. Is a viable business transfer necessary for an eligible company to claim the research and development additional deduction under section 73Y of the Income Tax Assessment Act 1936 (ITAA 1936), where that company has: deducted, under subsection 73B(13) or subsection 73B(14) of the ITAA 1936, an amount for incremental expenditure in the current year of income and in each of the preceding three years of income; and experienced a change in control during that time?

Example 5.4

Companies A, B, C and D are companies that have been eligible to deduct amounts for incremental expenditure at some stage in the claim year and in the three immediately prior years. Companies A and B are primary group members in year Y ₀ as they are grouped on the last day of that income year (step   1). Companies C and D are secondary group members as C is grouped with B in Y _-1 and Y _-2 and D is grouped with B in years Y _-2 and Y _-3 . When C became grouped in Y _-2 , it did not bring a viable business.

Companies	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20
Company C		60	50	0
Company D			20	20

Assume company D was liquidated on 30 June Y _-2 (and thus did not transfer a viable business) and company C was sold in Y _-1 with a valid transfer of a viable business (and thus all incremental expenditure is ignored and the company is deemed never to have had a group membership period).

Where a company, which has experienced a change of control during the period commencing on the first day of the Y _-3 year of income and ending on the last day of the Y ₀ of income, meets the requirements of section 73Q of the ITAA 1936 without relying on any group member (refer subsection 73Q(2) of the ITAA 1936), it may be entitled to an additional deduction under section 73Y of the ITAA 1936 regardless of whether there is a viable business agreement relating to that change in control.

However, the 'R & D spend' for the company will include only the incremental expenditure it incurred during the portion of its group membership period. This can mean that the company will have $0 R & D spend for one or all of the Y _-1 to Y _-3 years of income.

Example 5.5

Company A is an eligible company which undertakes research and development activities in Australia.

For the 2003-04 year of income, and for each of the preceding three years of income, Company A has deducted amounts for 'incremental expenditure' under subsection 73B(14) of the ITAA 1936. 'Incremental expenditure' is defined by section 73P of the ITAA 1936.

Company A was wholly owned by Company D until 30 April 2004 when it was acquired by Company E. No change to the business of Company A occurred.

Company D and Company E are foreign companies which are not liable to tax in Australia. They cannot and do not claim deductions for research and development in Australia.

Company A acquired 100% of shares in both Company B1 and Company B2 on 30 June 2003. Both Company B1 and Company B2 are eligible companies and undertake research and development activities in Australia. Both have deducted amounts for 'incremental expenditure' under subsection 73B(14) of the ITAA 1936, for the 2003-04 year of income.

The group is not consolidated and does not intend to consolidate.

 

Calculation of group membership periods

Control of Company A changed on 30 April 2004 when it was acquired by Company E. Therefore, Company A's 'group membership period' is 30 April 2004 to 30 June 2004 (inclusive). Control of Company B1 and Company B2 changed on 30 June 2003 when they were acquired by Company A. However, control of Company B1 and Company B2 also changed again, on 30 April 2004, when Company A was acquired by Company E, so their 'group membership period' is the same as that for Company A.

 

R & D Spend

The R & D Spend for Company A for Y ₀ will include only the incremental expenditure it incurred during the portion of its group membership period that falls within the Y ₀ year of income. That is, the incremental expenditure incurred from between 30 April 2004 and 30 June 2004. We have called this amount of expenditure 'XA'.

To this amount, is added the incremental expenditure of Company B1 and Company B2 incurred during the portion of their respective group membership periods that fall within the Y ₀ year of income. We have called these amounts 'XB1' and 'XB2'. The total of 'XA', 'XB1' and 'XB2' equals Company A's R & D spend for the Y ₀ year of income. We have called this total amount 'XX'. (There were no intra-group transactions).

No part of Company A's group membership period covers the Y _-1 , Y _-2 or Y _-3 years of income. Therefore, the amounts to be included under paragraph (a) of the definition of 'R & D spend' for each of these income years, is zero. Similarly, no part of the group membership periods of Company B1 and Company B2 fall within the Y _-1 , Y _-2 and Y _-3 years of income, so the amounts included in Company A's 'R & D spend' under paragraph (b) of the definition in section 73P of the ITAA 1936, for each of these years is also zero.

R & D Spend for Company A is therefore:

Company	Y 0	Y -1	Y -2	Y -3
Company A	$XA	0	0	0
Company B1	$XB1	0	0	0
Company B2	$XB2	0	0	0
TOTAL	$XX	0	0	0

Section 73W of the ITAA 1936 provides that the premium amount is based on the excess of the current year R & D Spend over the average R & D Spend for the previous three years, less any adjustment where annual incremental expenditure during the three year history fluctuated by more than 20%.

Under subsection 73X(1) of the ITAA 1936 the premium amount will only be distributed between group members who increased the incremental expenditure incurred during their individual group membership period for the Y ₀ year of income above the level of incremental expenditure incurred during their individual group membership period for the Y _-1 year. These group members are called 'increasing members'.

Company A incurred an amount of incremental expenditure ($XP) in the Y ₀ year of income during its group membership period. However, as Company A's group membership period is 30 April 2004 to 30 June 2004, Company A has incurred nil incremental expenditure during its group membership period for the Y _-1 year. Company A is therefore an 'increasing member' and can claim a deduction under section 73Y of the ITAA 1936 for the amount worked out under subsection 73Y(2) of the ITAA 1936.

C5.7.4 Consolidated groups

Where a company becomes a member of a consolidated group in a year of income, then for the purpose of determining entitlement to the Incremental tax concession and calculating the additional deduction:

• incremental expenditure amounts incurred by the joining company before it became a member are treated as if they were incurred by the head company of the group; and
• any amounts the joining company had deducted or can deduct for expenditure incurred prior to joining are treated as if they had been deducted by the head company of the group.

ITAA 1936, section 73BAC

Where a company ceases to be a member of a consolidated group in a year of income:

• incremental expenditure amounts actually incurred by the leaving company while it was a member of the group, are treated as if they were incurred by it and not by the head company; and
• any amounts deducted or able to be deducted by the head company of the group for that expenditure, are treated as if they had been deducted by the leaving company.

ITAA 1936, section 73BAD

These special rules effectively override the operation of the consolidation entry and exit history rules, which would otherwise allow both the joining (or leaving) company and the head entity to count the company's history prior to the joining (or leaving). They also prevent loss of entitlement to the incremental concession through the operation of the '125% cap' on the increment deduction amount (ITAA 1936 subsection 73Y(2)) from occurring, where the subsidiary with the history is not the entity which was entitled to claim the 125% concession (i.e. this being claimed by the head company) (see also Part C4-10 - Working out the additional 50% deduction).

For a company that has left a consolidated group, these rules put that company in the same position it would have been in if it had never been in the consolidated group.

Example 5.6

Companies A and B were not associated in any way during the Y-3 to Y-1 years. Company A took ownership of all of the shares in company B at the beginning of Y0, and elected to consolidate for tax purposes.

The amounts of incremental expenditure incurred by each of these entities is as follows:

Companies	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20

In calculating the entitlement of the head company, Company A to the incremental tax concession in Y0, company A will be regarded as having incurred the amounts of incremental expenditure that its subsidiary member, company B, had incurred prior to becoming consolidated with company A.

Thus company A's 'history', in this calculation, will become:

Companies	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Company A	180	50	20	20

Example 5.7

Companies A and B were part of a consolidated group during the period commencing at the start of Y _-3 to the end of Y _-1. During this period, only company A lodged tax returns as the Head Company of the consolidated group. (Company A had therefore been entitled to deduct the incremental expenditure incurred by its subsidiary Company B, under the R & D tax concession, in these years). At the end of Y _-1 , Company A sold 20% of the shares in Company B to another entity.

Whilst Companies A and B are no longer part of the same consolidated group in Y ₀ , they are grouped for R & D purposes, Company B being 80% owned by Company A. Companies A and B are therefore R & D primary group members in year Y ₀ as they are grouped on the last day of that income year. From the start of Y ₀ (i.e. after B's departure from the consolidated group), the history to be attributed to company B for Years Y _-3 to Y _-1 is the actual amount of incremental expenditure incurred by B, whilst in the consolidated group. From this time, the history amounts of both entities equal the amounts incurred by each, as per the table below.

Companies	Y 0 ($000)	Y -1 ($000)	Y -2 ($000)	Y -3 ($000)
Company A	100	0	0	0
Company B	80	50	20	20

Effectively, from the time that company B leaves the consolidated group, both entities are treated for the purposes of calculation of the incremental concession as though consolidation had never occurred.

C5-8 Premium calculation

Once the incremental expenditure for the current year and the three prior years has been ascertained, the next step is to calculate the premium amount which, after apportionment, can be claimed by the eligible company as an additional 50% deduction.

In simple terms, the premium amount is:

• based on the excess of the current year R & D spend over the average R & D spend for the previous three years, and
• may be reduced by an adjustment amount where any annual downswing in incremental expenditure during the three year history period exceeds 20%.

For the purposes of the calculation in a particular year, incremental expenditure of the eligible company incurred in its group membership period is summed with the incremental expenditure of other group members incurred in their respective group membership periods, where relevant. This amount is defined as the R & D spend . Where a company is not a member of a group, its incremental expenditure incurred its group membership period equals its R & D spend.

The steps to calculating the premium amount are set out in sections 73T , 73U , 73V and 73W of the ITAA 1936. These steps can be summarised as follows:

Step   1 (section 73T )	Step   2 (section 73U )	Step   3 (section 73V )	Step   4 (section 73W )
Determine the adjustment amount for the current year (Y 0 ) and the previous year (Y 1 ).	Determine the running averages for Y 0 and Y -1.	Determine the adjustment balance using the amounts determined in Steps 1 and 2.	Determine the premium amount . This is the R & D spend for Y 0 less the running average for Y 0 from Step   2 less the adjustment balance from Step   3.

Example 5.8

A company which is not grouped with any other company has the following R & D spend history:

Current year (Y ₀ ) is $110, Y _-1 is $90, Y _-2 is $60, Y _-3 is $30.

 

Step   1:

The adjustment amount for Y ₀ and Y _-1 = 0 as there is no decrease in R & D spend > 20% in either of the Y _-1 or Y _-2 years.

 

Step   2:

The running average for Y ₀ is 1/3 ^rd of the sum of the R & D spend for each of the Y _-1 , Y _-2 and Y _-3 years.

This equals (($90 + $60 + $30) / 3) = $60.

The running average for Y _-1 is 1/2 of the sum of the R & D spend for each of the Y _-2 and Y _-3 years.

This equals (($60 + $30) / 2) = $45.

 

Step   3:

The adjustment balance is zero as there are no adjustment amounts (See also step   1 above).

 

Step   4:

The premium amount is the current year eligible incremental expenditure less the current year running average .

This equals ($110 - $60) = $50.

Explanation of steps

Step   1

There may be an adjustment amount (AA ₀ ) where a company's R & D spend in the prior year decreased to an amount which is less than 80% of the prior year incremental expenditure amount. In order to determine this adjustment amount, the R & D spend in the year of the decrease is subtracted from 80% of the prior year R & D spend. There can also be an adjustment amount (AA _-1 ) where the R & D spend in the year before the prior year is less than 80% of the R & D spend of the year before that.

Example 5.9

A company, which is not grouped with any other company, has the following R & D spend history:

 

Current year (Y ₀ ) is $310, Y _-1 is $90, Y _-2 is $200, Y _-3 is $240

Adjustment amount (AA ₀ ) for Y ₀ = [($200 x 0.80) = $160 - $90] = $70.

 

There is no AA _-1 (adjustment amount for Y _-1 ) as the decrease in R & D spend from the Y _-3 to the Y _-2 year was less than 20%.

The adjustment amount for Y ₀ (AA ₀ ) will be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y _-1 year, and
• no group member underwent a change of control in Y ₀ resulting in the transfer of a viable business in the current year, and a change to the R & D spend of the eligible company for any of the three history years.

Also, AA _-1 (the adjustment amount for Y _-1 ) will be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y _-2 year, and
• no group member underwent a change of control resulting in the transfer of a viable business in the current year or the Y _-1 year, and a change to the R & D Spend of the eligible company for any of the three history years.

The adjustment amount will also be deemed to be nil where the result of the calculation is negative.

Step   2

Step   2 calculates the running average which provides the benchmark amount of expenditure which the current year R & D spend must exceed if it is to attract the additional 50% deduction.

The running average for the current year (RA ₀ ) is the sum of the incremental expenditure amounts in the previous three years divided by three.   The running average for the Y _-1 year (RA _-1 ) is the sum of the incremental expenditure amounts in the previous two   years divided by two. The running average calculation for Y _-1 is necessary to determine any adjustment balance in Step   3 below.

Step   3

Step   3 adds together any adjustment amounts (AA ₀ and AA _-1 ) where the prior year (Y _-1 ) R & D spend is less than or equal to the running average (RA _-1 ) for that year. The result is referred to as the adjustment balance . If the prior year R & D spend is more than the running average for that year, it reduces the sum of the adjustment amounts (AA ₀ and AA _-1 ) by the amount by which the prior year R & D spend exceeds the prior year running average (RA _-1 ).

Example 5.10

Where the R & D spend for Y ₀ = $250, Y _-1 = $60, Y _-2 = $150, Y _-3 = $180.

 

The running average for Y ₀ = [($60 + $150 + $180) /3] = $130.

The running average for Y _-1 = [$150 + $180] /2] = $165.

Adjustment amount (AA ₀ ) for Y ₀ = [($150 x 0.80) = $120 - $60] = $60.

 

There is no adjustment amount for Y _-1 as the decrease in R & D spend from the Y _-3 to the Y _-2 year was less than 20%. i.e. AA _-1 = 0

As the R & D spend in Y _-1 ($60) was less than the running average ($165) for that year, then the adjustment balance = $60 + 0 = $60.

The adjustment balance is deemed to be zero if:

• the eligible company or any of its group members were eligible to claim an additional 50% deduction for the Y _-1 year, and
• there was no change of control of the eligible company or its group members during the Y ₀ year resulting in the transfer of a viable business and a change to the R & D spend of the eligible company for any of the three history years.

The adjustment balance will also be deemed to be zero where the result of the calculation is negative.

Step   4:

Step   4 calculates the premium amount which will be eligible for the additional 50% deduction. The premium amount is calculated by summing the relevant incremental expenditures of the eligible company and other group companies to determine the R & D spend and then deducting the current year running average and the adjustment balance.

Example 5.11

Company A has the following R & D spend:

Y ₀ is $250, Y _-1 is $181, Y _-2 is $150, Y _-3 is $200

(Assume there was no eligibility to claim the additional 50% deduction in Y _-1 ).

Step   1:	adjustment amount in Y 0 = 0 adjustment amount in Y -1 = [($200 x 0.8) - $150] = $10
Step   2:	running average in Y 0 = $177 running average in Y -1 = $175
Step   3:	adjustment balance = ($175 + 0 + $10 - $181) = $4 (in other words the excess of the R & D spend over the running average in Y- 1 is deducted from the sum of the adjustment amounts)
Step   4:	premium amount = ($250 - $177 - $4) = $69

C5-9 Entitlement to share of premium amount

Having calculated the premium amount, there are two further steps involved in determining the amount available to be deducted by an eligible company. These steps are:

• determine the portion of the premium amount which is 'distributed' to the company. The aim of this provision is to distribute the premium amount between the members of the group that contributed to earning it.

• ITAA 1936 section 73X

• determine the amount of the deduction available in respect of this portion.

• ITAA 1936 section 73Y(2)

C5.9.1 Determining the company's distribution of the premium amount

Where there is more than one company in the group that has incurred incremental expenditure during the Y ₀ and Y _-1 years _, the premium amount may need to be apportioned.

The premium amount will only be distributed to group companies that have individually increased their incremental expenditure during their Y ₀ group membership period over the level of incremental expenditure incurred while they were a group member during the Y _-1 year.

Note: Where a group member has not incurred an amount of incremental expenditure in the year of income Y _-1, (i.e. their incremental expenditure amount is '0'), but has incurred an amount of incremental expenditure in the Y ₀ year of income, that group member will be considered an 'increasing member' for the purposes of calculating the distribution of the premium amount.

The premium amount will be apportioned among these companies on the basis of their proportionate share of the total increased incremental expenditure incurred by them.

Example 5.12

Company	Prior year ($000's)	Claim year ($000's)	Change ($000's)
Company A	60	40	-$20
Company B	10	15	5
Company C	30	70	40
Company D	15	25	10

Assume a premium amount of $50,000 is to be shared. This would be shared between B, C and D on the basis of B: 9.1%; C: 72.7%; D:     18.2%

ITAA 1936 section 73X

C5-10 Working out the additional 50% deduction

The additional 50% deduction is the lesser of:

• 50% of the premium amount distributed to the eligible company, or
• 50% of the eligible company's Y ₀ year of income incremental expenditure eligible for a deduction under section 73B of the ITAA 1936 at the rate of 125% (the '125% cap').

Circumstances in which the '125% cap' would operate in respect of incremental expenditure include:

• where clawback has operated to deny the additional 25% deduction for amounts of incremental expenditure (See Part C5-11 - The operation of the clawback provisions and the incremental concession.)
• where the 'at risk' rules in sections 73CA of the ITAA 1936 (guaranteed return to investors) or 73CB of the ITAA 1936 (expenditure incurred to tax-exempt bodies) have operated to deny the additional 25% deduction for amounts of incremental expenditure
• where the 'intra-group markup rules' in subsections 73B(14AB) -(14AD) of the ITAA 1936 have operated to deny the additional 25% deductions in respect of some of the incremental expenditure amount (see also section 2.3.11 - Reduce rate for group markup).

Example 5.13 (no operation of the '125% cap')

Company A's incremental expenditure for Y ₀ was $20,000, and its distribution of the premium amount was $5,000. All of its eligible expenditure was eligible for deductions under section 73B of the ITAA 1936 at the rate of 125%.

The additional 50% deduction that Company A is entitled to is $5,000 x 50% which equals $2,500.

C5-11 Operation of the clawback provisions and incremental concession

Where a company or a company group member receives a grant or a recoupment from the government for R & D activities, clawback provisions under section 73C of the ITAA 1936 apply to reduce the amount the company can claim at the rate of 125%. Expenditure to which the grant or recoupment relates can only be deducted at the rate of 100%. While clawback does not affect a company's eligibility for the premium, or the amount of incremental expenditure included in the calculations for the current or history years, it will affect the level of the claim.

The impact of clawback is taken into account in calculating the entitlement to the incremental concession through the operation of the '125% cap' in subsection 73Y(2) of the ITAA 1936. This subsection limits the amount of the incremental deduction to 50% of the lesser of the amount calculated (as above), or 50% of the amount of incremental expenditure incurred by the company in the current year that is eligible for a deduction at the rate of 125%.

Example 5.14

A company's incremental expenditure for year of income Y ₀ was $20,000, and its distribution of the premium amount was $5,000. If clawback operates to reduce the incremental expenditure eligible to be deducted at the rate of 125% in Y ₀ to $4,000, then the maximum premium deduction available to that company for Y ₀ would be $4,000 x 50% which equals $2,000.

ITAA 1936 subsection 73Y(2)

C5-12 Other anti-avoidance measures

There is an anti-avoidance measure to prevent companies from amending prior year R & D claims for the purpose of reducing their R & D history, thereby increasing their eligibility for the incremental concession. Where the Commissioner is of the opinion that the purpose of a debit amendment is to increase a company's entitlement to the additional 50% deduction, he or she may disregard that debit amendment for the purposes of working out a company's incremental expenditure, and only for that purpose. That is, the company's return will be amended, but the amended R & D figures will not be used for increment calculation purposes.

ITAA 1936 section 73Z

C5-13 Interaction between the incremental concession and the R & D tax offset

A company may claim its entitlement to the incremental concession as a tax offset if it meets the eligibility requirements contained in section 73J of the ITAA 1936.

Example 5.15

Assume Company A, who is not grouped with any other companies, has the following incremental expenditure and R & D spend history:

Company	Y 0 ($000)	Y -1 ($000 )	Y -2 ($000)	Y -3 ($000)
Company A	80	60	40	20

Company A is eligible to claim the full $80,000 incremental expenditure deductions at the 125% rate in Year Y ₀ .

Its premium amount, based on the above figures will be:

$80,000 - ($60,000 + $40,000 + $20,000)/3 = $40,000

Its entitlement to a deduction for the incremental tax concession will therefore be $20,000 (50% of $40,000).

Company A's entitlement to deductions under the R & D tax concession is therefore as follows:

Deductions under section 73B(14)	$100,000	($80,000 @ 125%)
Deduction for incremental tax concession	$ 20,000
Total:	$120,000

Company A's turnover is $200,000, and its aggregate research and development amount is $80,000, making it eligible to claim the R & D tax offset.

Prior to electing for the R & D tax offset, Company A's tax return showed a loss of $150,000. On electing the offset in its original taxation return, its carried forward loss will be reduced to the extent of its deductions under the R & D tax concession (i.e. reduced by $120,000 to $30,000), and it will be entitled to a cash amount for the R & D tax offset of $36,000 ($120,000 x 30 cents in $)

Example 5.16 (incorporating full clawback)

Assume for this example that Company A above received a grant of $40,000 in year Y ₀ in respect of the R & D activities it carried on in that year. As a result of applying clawback to $80,000 of its R & D expenditure (i.e. $40,000 grant x 2), none of Company A's R & D expenditure is eligible for the 125% concession. Consequently, company A is no longer entitled to a deduction for the incremental tax concession, because of the operation of the 125% cap.

Although this company is not eligible to claim any additional 25% concession or 50% incremental amount, it is still eligible to choose to claim the R & D tax offset.

But for choosing the R & D tax offset, Company A's tax return would have shown a loss of $110,000. On choosing the offset in its original taxation return, its carried forward loss will be reduced to the extent of its deductions under the R & D tax concession (i.e. reduced by $80,000 to $30,000), and it will be entitled to a cash amount for the R & D tax offset of $24,000 ($80,000 x 30 cents in $).