• Balancing adjustments for assets used for conducting R&D activities

    A notional R&D deduction for a balancing adjustment may be claimed where:

    • an R&D entity has used a depreciating asset only for R&D activities
    • it is or has been entitled to R&D decline in value deductions
    • a balancing adjustment event happens (for example, the entity sells or scraps the asset).

    This adjustment ensures your income tax position over time reflects the actual decline in value of the assets, rather than the estimates on which your decline in value deductions were based.

    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 its decline in value). Where this occurs for a depreciating asset used to carry on R&D activities, the tax treatment for the profit or loss (balancing adjustment) derived on disposal must be determined.

    Where a balancing loss is made (that is, the adjustable value exceeds the termination value), the loss is allowable as an additional deduction (and in some circumstances a notional R&D 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.

    Example: Balancing adjustment

    A new item of equipment costing $1,000,000 is used during the year for a purpose described in subsection 40-25(7) of the ITAA 1997. Assuming that the effective life is 10 years, the decline in value allowable as a deduction for the year is calculated as follows:

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

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

    Cost

     

     

    $

    1,000,000

    minus

    decline in value

    -

    $

    100,000

    equals

    adjustable value

    =

    $

    900,000

    minus

    termination value

    -

    $

    850,000

    equals

    balancing adjustment

    (loss)

    $

    50,000

    If the equipment had been disposed of for $925,000 rather than $850,000, a balancing adjustment profit of $25,000 would have been made.

    Where such a balancing adjustment occurs for an asset that has at some stage been used for R&D activities, a further adjustment may be required. The amount of this adjustment depends on whether or not the:

    • asset is a dedicated R&D use asset
    • company was otherwise entitled to claim the R&D tax offset in the year of disposal.

    Use the table below to determine the appropriate treatment for your assets.

    Asset use

    Conditions

    Treatment of balancing adjustment loss

    Treatment of balancing adjustment profit

    Asset used solely for R&D activities and not a taxable purpose described in subsection 40-25(7) of the ITAA 1997.

    Both:

    • registered in the event year
    • otherwise eligible for a notional R&D deduction.

     

    355 applies

    Adjustment loss included as a notional R&D deduction.

    355 applies

    Balancing adjustment profit uplifted by one-third and included in assessable income.

    Asset used solely for R&D activities and not a taxable purpose described in subsection 40-25(7) of the ITAA 1997.

    Either:

    • not registered in the event year
    • otherwise ineligible for a notional R&D deduction.

     

    No taxation treatment

    No taxation treatment

    Balancing adjustment for depreciating assets used only for R&D activities (including partnerships)

    Asset used for both R&D activities and a taxable purpose described in subsection 40-25(7) of the ITAA 1997.

    Both:

    • registered in the event year
    • otherwise eligible for a notional R&D deduction

     

    Division 40 applies

    No notional R&D deduction. R&D portion of balancing adjustment loss, calculated under section 40-285, claimed as an increased deduction amount.

    Division 40 applies

    R&D portion of balancing adjustment profit, calculated under section 40-285, uplifted by one-third and included in assessable income.

    Asset used for both R&D activities and a taxable purpose described in subsection 40-25(7) of the ITAA 1997.

    Either:

    • not registered in the event year
    • otherwise ineligible for a notional R&D deduction

     

    Division 40 applies

    No notional R&D deduction. R&D portion of balancing adjustment loss calculated under section 40-285, no increased deduction amount claimable (unless the R&D activities have been conducted by an R&D partnership and you are claiming your proportion of this amount).

    Division 40 applies

    R&D portion of balancing adjustment profit, calculated under section 40-285, uplifted by one-third and included in assessable income.

    Balancing adjustment for depreciating assets used for R&D activities and a taxable purpose described in subsection 40-25(7) of the ITAA 1997

    Balancing adjustment for depreciating assets used only for R&D activities (including partnerships)

    Where you have used an asset solely for R&D activities, the balancing adjustment results in either a further (catch-up) notional R&D deduction, or an increased amount being included in assessable income (to recover excessive deductions).

    For this notional balancing adjustment deduction to apply, you must register for the income year in which the balancing adjustment event happens and be otherwise eligible for the R&D tax incentive. Where you have ceased R&D activities in a previous income year and scrap an asset in the current income year, you cannot claim the enhanced benefits of the R&D tax incentive provisions for the decline in value that may have occurred (in whole or part) after R&D activities ceased. In these circumstances, an uplifted amount is not required to be included in assessable income.

    If you would have been entitled to a balancing deduction under the standard balancing adjustment provision of section 40-285External Link, and the asset has been used solely for R&D activities, you are entitled to a notional R&D deduction of an equivalent amount, provided you are registered for one or more R&D activities for the balancing adjustment event year. That notional R&D deduction is included in the calculation of your R&D tax offset.

    Conversely, if an amount would have been included in your assessable income under the standard balancing adjustment provision of section 40-285, the sum of that amount (the section 40-285 amount) plus an additional amount is included in your assessable income.

    The additional amount reflects that you have obtained enhanced benefits in the form of an offset at 38.5% or 43.5% of the decline in value. The additional amount is equal to one-third of so much of the section 40-285 amount as does not exceed the total decline in value. The factor of one-third is based on an offset rate of 38.5% (rather than the higher 43.5% rate that generally applies to R&D entities with an aggregated turnover of less than $20 million). Note, if an entity’s notional R&D deductions exceeds $100 million for an income year, the entity may reduce the adjusted section 40-285 amount in calculating the balancing adjustment.

    Example

    Balancing adjustment for depreciating assets used only for R&D activities - notional deduction

    B Pty Ltd was incorporated in Australia and carries on a business in Australia that includes R&D activities that it conducts wholly in Australia. Its aggregated turnover for each income year is under $20 million. B Pty Ltd has a standard income year ending on 30 June.

    On 1 July 2011, B Pty Ltd purchases a mass spectrometer for use in its R&D activities. The unit costs $30,000. B Pty Ltd assesses the effective life of the unit as five years and chooses the prime cost method for calculating its decline in value.

    During 2011-12 and 2012-13, B Pty Ltd uses the unit only in carrying on its R&D activities. It sells the unit on 31 December 2012 for $15,000.

    As B Pty Ltd only used the unit for R&D activities, it will work out a balancing adjustment under section 355-315 of the ITAA 1997. It is entitled to a notional R&D deduction equal to the amount calculated under subsection 40-285(2), which is equal to the termination value less the adjustable value. The termination value is $15,000. The adjustable value as at 31 December 2012 is equal to the opening adjustable value at 1 July 2012 less the part year decline in value during 2012-13. The opening adjustable value is $24,000. The party year decline in value is $3,000. Accordingly, the adjustable value is $21,000.

    B Pty Ltd is entitled to a notional R&D deduction of $6,000 ($21,000−$15,000) under subsection 355-315(2). Assuming B Pty Ltd has total notional R&D deductions over $20,000 for 2012-13, B Pty Ltd is entitled to an offset of $2,610 (43.5% of $6,000) for the sale of the unit.

    Balancing adjustment for depreciating assets used only for R&D activities- extra amount included in assessable income.

    If the termination value in the example above was $27,000 rather than $15,000, B Pty Ltd would be required to include an uplifted amount in its assessable income. This would be calculated by the termination value ($27,000) less the adjustable value ($21,000), uplifted by one-third. Accordingly, $8,000 would be included in the assessable income of B Pty Ltd.

    End of example

    Partners in an R&D partnership

    As a partner in an R&D partnership, you may also be able to claim a notional deduction for a balancing adjustment where:

    • a balancing adjustment event happens (for example, the R&D partnership sells or scraps the asset) for an asset held by the partnership in an income year
    • the asset was used for R&D activities
    • you are (or were) entitled to R&D decline in value deductions or notional deductions for the asset.

    You are entitled to a notional R&D deduction for your proportion of the balancing deduction under the standard balancing adjustment provision of section 40-285, and this amount is included in the calculation of your tax offset.

    Conversely, if an amount would have been included in the assessable income of the R&D partnership under the standard balancing adjustment provision of section 40-285, your proportion of the sum of that amount (the section 40-285 amount) plus your proportion of an additional amount is included in your assessable income. As above, the additional amount is equal to one-third of so much of the section 40-285 amount as does not exceed the total decline in value.

    Balancing adjustment for depreciating assets used for R&D activities and a taxable purpose described in subsection 40-25(7) of the ITAA 1997

    A balancing adjustment must also be worked out where you have used a depreciating asset partly for R&D activities and partly for another taxable purpose (for example, producing assessable income) under the capital allowance provisions. Taxable purpose is defined in subsection 40-25(7)External Link of the ITAA 1997.

    Attention

    In working out reductions in the balancing adjustment amount for non-taxable use, use for the purpose of conducting R&D activities is assumed to be use for a taxable purpose.

    End of attention

    If you are entitled to a balancing deduction under the standard balancing adjustment provision of section 40-285External Link of the ITAA 1997, and are entitled under section 355-100External Link of the ITAA 1997 to a tax offset for the event year, the amount of the balancing deduction is increased. The amount is increased by half if your aggregated turnover is less than $20 million and one third in other cases. The factors by which the deduction amount is increased are equivalent to the 43.5% and 38.5% rates at which R&D tax offsets are calculated.

    If you are not entitled under section 355-100 of the ITAA 1997 to a tax offset for the event year, the amount of the balancing deduction is not increased.

    If an amount is included in your assessable income under section 40-285 of the ITAA 1997, the amount assessable is increased by one third of an amount worked out under the formula provided in subsection 40-292(5)External Link of the ITAA 1997. Note, if an entity’s notional R&D deductions exceeds $100 million for an income year, the entity may reduce the adjusted section 40-285 amount in calculating the balancing adjustment.

    The formula adjusts the amount worked out under section 40-285 of the ITAA 1997 so that it does not exceed the asset's total decline in value. It then applies a factor so that the amount being taken back reflects the proportion of the decline in value of the asset represented by total notional R&D deductions.

    Attention

    Balancing adjustment loss amounts, where the depreciating asset has been used partly for R&D activities and partly for another purpose, do not form part of the calculation of your R&D tax offset. These amounts are treated separately for income tax purposes.

    End of attention


    Subsection 40-292(5) of the ITAA 1997 provides a formula for ensuring that the increased balancing adjustment amount deductible or assessable reflects the proportion of the decline in value of the asset used for R&D activities, as follows:

    Sum of your R&D deductions
         Total decline in value

    x

    Adjusted section 40-285 amount

    For this formula:

    • 'adjusted section 40-285 amount' means  
      • if the section 40-285 amount is a deduction - the amount of the deduction
      • if the section 40-285 amount is an amount included in your assessable income - so much of the section 40-285 amount as does not exceed the total decline in value
       
    • 'total decline in value' means the cost of the asset less its adjustable value.

    Example: Balancing adjustment for assets used partly for R&D activities

    C Pty Ltd was incorporated in Australia and carries on a business in Australia that includes R&D activities. Its aggregated turnover for each income year is under $20 million.

    On 1 July 2011, C Pty Ltd purchases a heating unit for use in its business at a cost of $30,000. C Pty Ltd assesses the effective life of the unit as five years and chooses the prime cost method for calculating its decline in value. C Pty Ltd uses the unit 50% of the time for carrying on ordinary business activities and 50% of the time for carrying on R&D activities.

    On 31 December 2012, C Pty Ltd sells the unit for $15,000. C Pty Ltd is entitled to a deduction under subsection 40-285(2) of the ITAA 1997 which is equal to the termination value less the adjustable value. The termination value is $15,000. The adjustable value is equal to the opening adjustable value less the decline in value during 2012-13. The opening adjustable value is $24,000. The decline in value is $3,000. Accordingly, the adjustable value is $21,000. C Pty Ltd is entitled to a deduction of $6,000 ($21,000−$15,000) under section 40-285 of the ITAA 1997.

    C Pty Ltd is entitled to an additional deduction under section 40-292 of the ITAA 1997. As a result of the use of the asset in R&D activities for 50% of the time it has been held by C Pty Ltd, C Pty Ltd is entitled to notional deductions of $4,500 (50%   ($6,000 + $3,000)) under section 355-305. Subsection 40-292(2) requires the company to calculate an amount under subsection 40-292(5) as follows:

    Sum of your R&D deductions
         Total decline in value

    x

    Adjusted section 40-285 amount

    $4,500   $6,000 = $3,000
    $9,000

    Subsection 40-292(3) provides that a company is entitled to increase its section 40-285 deduction by half of the amount worked out under subsection 40-292(5) (because it has an aggregated turnover of less than $20 million).

    C Pty Ltd is therefore entitled, under subsection 40-292(3), to increase its section 40-285 deduction by $1,500 (half of $3,000).

    Its increased section 40-285 deduction is therefore $7,500 ($6,000 + $1,500).

    Balancing adjustment for depreciating assets used partly for R&D activities- extra amount included in assessable income

    Assuming that the termination value in the example above was $27,000 rather than $15,000, C Pty Ltd would include an uplifted amount in its assessable income. This would be calculated by the termination value ($27,000) less the adjustable value ($21,000), this being $6,000. However, as this asset has been used partly for R&D activities, the amount calculated under subsection 40-292(5) is uplifted by one-third and also included in assessable income. The total amount included in the assessable income of C Pty Ltd would be:

    $1,000 (one-third of $3,000) plus $6,000 = $7,000 included in the assessable income of C Pty Ltd.

    R&D partnerships

    As a partner in an R&D partnership, you may also be required to calculate a balancing adjustment if:

    • a balancing adjustment event happens (for example, the R&D partnership sells or scraps the asset) for an asset held by the partnership in an income year
    • the asset was used for both R&D activities and general tax purposes
    • you have, or have been, entitled to R&D decline in value deductions or notional deductions for the asset.

    If the R&D partnership is entitled to a balancing deduction under the standard balancing adjustment provision of section 40-285, the amount of the balancing deduction for the partnership is increased by one-third. As the partner in the R&D partnership, you are entitled to a notional deduction for your proportion of the increased amount.

    If an amount is included in the R&D partnership's assessable income under section 40-285, the amount assessable is increased by one third of an amount worked out under a formula. You include your proportion of this increased amount in your assessable income.

    Unlike the rules for you as a single R&D entity, if you are conducting R&D in a R&D partnership and it has used the asset for R&D activities and another taxable purpose, the deductible and assessable amount is uplifted, regardless of whether the partner is otherwise eligible to claim an R&D tax offset in the event year.

      Last modified: 25 Oct 2016QC 25805