Decline in value of assets used for conducting R&D activities
You can notionally deduct the decline in value of a tangible depreciating asset used for R&D activities (if certain other conditions are satisfied, as outlined below).
If a balancing adjustment event later happens for the asset, you may be able to notionally deduct a further amount under Division 355External Link or deduct a further amount under Division 40External Link (depending on how the asset has been used). Alternatively you may need to include an amount in your assessable income.
As a partner in an R&D partnership, you are entitled to a notional deduction for your proportion of the amount that the partnership would have been able to deduct under the depreciating asset provisions, provided the conditions listed below have been met.
Conditions to be met to claim a notional deduction for decline in value
To be eligible for an R&D notional deduction for a decline in value of a depreciating asset, you must be:
- registered for the income year in which you hold the asset for conducting R&D activities
- conducting your R&D activities in Australia (unless you have a positive overseas finding from Innovation Australia - see Expenditure on overseas activities for more details)
- using the asset during the income year for conducting R&D activities
- entitled to deduct an amount under the depreciating asset provisions (Division 40External Link) if those provisions applied with certain changes.
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. As a result you cannot notionally deduct an amount if either:
- the asset has been pooled with other assets for working out deductions for depreciating assets
- you have allocated a depreciating asset to a low value pool or one of the small business pools after the R&D depreciating asset provisions have applied to the asset.
Relationship between R&D decline in value rules and R&D expenditure rules
The R&D decline in value rules apply to the exclusion of the R&D expenditure rules. Where you incur an amount of expenditure that is included in the cost of a depreciating asset working out any notional deduction for decline in value occurs under Subdivision 355-EExternal Link. Your notional deduction in relation to this expenditure, and therefore the R&D tax offsets, is spread over the effective life of the assets.
Notional application of Division 40
Under the R&D tax incentive deductions for depreciating assets (as defined in Division 40External Link of the ITAA 1997, but excluding intangible assets) used in carrying on R&D activities will be worked out under sections 355-305External Link and 355-310External Link of the ITAA 1997. These sections require that the amount allowable for on the decline in value of those assets for the period of R&D use be calculated notionally under the rules set out in Division 40External Link of the ITAA 1997, as applied with certain modifications.
Working out whether you would be entitled to deduct an amount under the depreciating asset provisions (Division 40External Link) if those provisions were applied with certain changes, is called the 'Notional application of Division 40'. This notional application of Division 40External Link is for the purpose of working out the notional R&D deduction for the decline in the value of a depreciating asset and any balancing adjustment for a depreciating asset used only for R&D activities (and also amounts excluded from deduction as R&D expenditure).
The modifications made in notionally applying the Division 40External Link decline in value rules to R&D assets require that:
- the asset be used for the purpose of carrying on R&D activities, rather than for a taxable purpose
- the same method of calculating depreciation and effective life be used as applied before the R&D use, if relevant.
Purpose of conducting R&D activities
The main change made to Division 40 in working out the notional Division 40 deduction is that references to a taxable purpose are replaced with references to the purpose of conducting one or more R&D activities. For balancing adjustment calculations, references to a taxable purpose are replaced with a reference to the purpose of conducting one or more of the R&D activities to which the R&D deductions relate. The object is to work out the notional Division 40 deduction based on its use for R&D activities.
Buildings and capital works other than buildings
The second change made to Division 40 in working out the notional Division 40 deduction is to assume that Division 40 does not apply to a building (or an extension, alteration or improvement to a building) for which you can deduct an amount under the capital works provisions in Division 43, or could have deducted an amount under Division 43, if you had started work before a particular date or used the building for R&D activities.
The object is to replace the rule in Division 40 that excludes capital works for which you can deduct amounts under Division 43. The result is that you can get a notional R&D deduction (and therefore, a tax offset) for the decline in value of capital works that are not buildings used in R&D activities.
'Uses' to ignore
In working out the notional deduction for decline in value of a depreciating asset, it is necessary to ignore 'uses' of the asset that would not satisfy the various conditions. In particular, it is necessary to ignore uses for R&D activities that:
- are not registered for the income year in which they were conducted
- do not meet conditions about where activities must be conducted
- do not satisfy the 'on own behalf' test.
The capital allowance rules in Division 40 of the ITAA 1997 allow you either to use the Commissioner's estimates of effective life for your depreciating assets, or to work it out yourself under the rules in Division 40. In working out the effective life of a depreciating asset, you must estimate the period that the asset can be used by an entity for one or more of these:
- a taxable purpose
- the purpose of producing exempt income or non-assessable non-exempt income
- the purpose of conducting R&D activities, assuming that this is reasonably likely.
This applies both for self assessing effective life and for the Commissioner making a written determination of effective life.
Where it is reasonably likely that an asset will be used for the purpose of conducting R&D activities, it is also necessary to have regard to the period within which the asset is likely to be scrapped or abandoned, ensuring you disregard reasons attributable to technical risk in conducting R&D activities.
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 write-off is given.
No change in decline in value method
You generally have a choice of two methods - the prime cost method and the diminishing value method - in working out the decline in value of a depreciating asset. You cannot change methods. If an R&D entity has previously worked out actual deductions under Division 40 for an asset, it must use the same method in working notional deductions under Division 40, and vice versa.
R&D depreciating assets rules and the depreciation rules in Subdivision 328-D for small business entities
Division 328 provides certain concessions for small business entities (SBEs). If you meet certain eligibility requirements, you can take advantage of the simpler depreciation rules under Subdivision 328-D of the ITAA 1997. One of these rules is an immediate deduction for low cost assets (costing less than $1,000) under section 328-180External Link of the ITAA 1997.
SBEs generally calculate capital allowances under Subdivision 328-D instead of Division 40 of the ITAA 1997. However, subsection 328-175(9) says that you cannot deduct amounts for a depreciating asset for any period under Subdivision 328-D if you are entitled under section 355-100External Link to a tax offset for a notional deduction (under section 355-305External Link) for the asset for the same or an earlier period.
Subsection 355-310(4) of the ITAA 1997 says that to notionally apply Division 40 (to calculate the decline in value amount notionally deductible under the R&D tax incentive) you should assume that Subdivision 328-D has not been enacted. This means that low cost assets immediately deductible under 328-180 are not eligible for a notional deduction under the R&D tax incentive for their cost. However, if you choose not to use Subdivision 328-D for that asset, you can notionally deduct your decline in value amount calculated under Division 40 under the R&D tax incentive.
Assets used for both R&D activities and non-R&D activities
The notional deduction is reduced to the extent that the asset is used for a purpose other than R&D activities. The R&D entity may be entitled to an actual Division 40 deduction for that other use (for example, the other use is in carrying on a business for the purpose of producing assessable income).