House of Representatives

Taxation Laws Amendment (Research and Development) Bill 2001

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Research and development plant expenditure

Outline of chapter

2.1 This chapter explains the removal of the exclusive use test for R & D plant/assets and the introduction of 125% effective life write-off for R & D plant/assets; and a retrospective change made to the manner in which plant expenditure is claimed.

Context of reform

2.2 The measures adopt a fairer and more balanced approach to the treatment of expenditure on plant/assets used for R & D, including a more accurate reflection of the value of the plant/assets consumed in the R & D activities. This Bill includes the removal of the exclusive use test and the introduction of 125% effective life write-off for R & D plant/assets. The removal of the exclusive use test will enable companies to obtain the R & D tax concession on plant/assets which are not used exclusively for R & D. Therefore, companies, particularly smaller companies, who cannot dedicate plant for use on R & D activities for a whole year, will be able to receive concessional deductions for the period during which the plant is used for R & D.

2.3 Also, retrospective changes are being made to the manner in which plant expenditure is claimed, which will bring the interpretation of the law into line with commercial practice.

Summary of new law

2.4 From noon on 29 January 2001, deductions for depreciating plant used in carrying on R & D activities will no longer be deductible under section 73B of the ITAA 1936. [Schedule 2, Part 3, items 4, 5 and 7 to 10, definitions of aggregate research and development amount, excluded plant expenditure and research and development expenditure in subsections 73B(1), 73B(15AAA) and (15AAAA)]

2.5 From noon on 29 January 2001, deductions for depreciating plant and certain other items used in carrying on R & D activities will be worked out under section 73BH. Those deductions will be notionally worked out under Division 42 of the ITAA 1997, as modified by section 73BJ. [Schedule 2, Part 3, item 11, sections 73BH, 73BI, 73BJ, 73BL and 73BN]

2.6 From the commencement of the new uniform capital allowance regime on 1 July 2001, deductions for depreciating assets used in carrying on R & D activities will be worked out under section 73BA. Those deductions will be notionally worked out under Division 40 of the ITAA 1997, as modified by section 73BC. [Schedule 2, Part 3, item 54, sections 73BA to 73BC, 73BE and 73BG]

2.7 Balancing adjustments on plant depreciated under section 73BHwill be notionally worked out under Division 42 of the ITAA 1997, as modified by section 73BM. Adjustments to 125% concession entitlement will be made where a balancing adjustment is made [Schedule 2, Part 3, item 11, section 73BM] . Similarly, balancing adjustments on assets depreciated under section 73BA will be notionally worked out under Division 40 of the ITAA 1997, as modified by section 73BF [Schedule 2, Part 3, item 54, section 73BF] .

2.8 Rollover relief on the disposal of plant depreciated under section 73BHand on the disposal of assets depreciated under section 73BAis provided for in section 73EA. [Schedule 2, Part 3, items 19 and 61, sections 73EA and 73EB]

2.9 A retrospective amendment to the definition of plant expenditure in subsection 73B(1) is made to limit the time that R & D plant must be for use exclusively for the purpose of carrying on R & D activities to an initial period of time only. This will bring the interpretation of exclusive use into line with commercial practice. This change only has application until noon on 29 January 2001 because from that time only sections 73BA and 73BH apply and the exclusive use test no longer applies. [Schedule 2, Part 1, items 1 and 2, definition of plant expenditure in subsection 73B(1)]

2.10 R & D pilot plant is removed from the CGT provisions in line with the general removal of plant from the CGT provisions on 21 September 1999, effective from that date [Schedule 2, Part 2, item 3, section 118-24A of the ITAA 1997] . The existing R & D pilot plant provisions in section 73B also cease to have effect from noon on 29 January 2001 [Schedule 2, Part 3, item 5] .

Detailed explanation of new law

Depreciation based notionally on Division 42 of the ITAA 1997

What plant is eligible?

2.11 Plant which can be considered for a deduction under section 73BH (referred to as section 73BH plant) is plant which would have notionally been considered for a deduction under section 42-15 of the ITAA 1997, if Division 42 were amended to:

·
include trading stock (note: for the period that the trading stock is being used in carrying on R & D activities, it loses its character as trading stock). This will ensure that concessional depreciation deductions are allowed on trading stock that is used in R & D activities for experimentation, testing, analysis, etc., for the period of R & D use [Schedule 2, Part 3, item 11, subsection 73BH(5) and paragraph 73BI(1)(a)] ;
·
capital works (other than buildings) as described in Division 43 of the ITAA 1997. This will ensure that, for the period of R & D use, concessional depreciation deductions are allowed on experimental structural improvements used in R & D activities [Schedule 2, Part 3, item 11, paragraph 73BI(1)(b)] ; and
·
only apply to plant acquired, constructed or commenced to be constructed after noon on 29 January 2001 but before 30 June 2001 [Schedule 2, Part 3, item 11, subsection 73BI(2)] .

When is a deduction available?

2.12 A notional Division 42 deduction is available to a company if the company would have notionally been entitled to a depreciation deduction for plant under section 42-15 of the ITAA 1997 if Division 42 were amended to:

·
require that the plant was being used for the purposes of carrying on R & D rather than requiring it to be used for the purposes of producing assessable income [Schedule 2, Part 3, item 11, subsection 73BJ(2)] ;
·
ensure that the effective life and the method of calculating the deduction used for the plant is the same as that which existed before the application of section 73BH, if the company was previously eligible for an actual Division 42 deduction on that plant. Complementary, but opposite, provisions have also been added to Division 42 [Schedule 2, Part 3, items 11 and 33, subsection 73BJ(3) of the ITAA 1936 and subsection 42-25(4) of the ITAA 1997] ;
·
take into account any change resulting from the application of sections 73BK (discussed in paragraph 2.36) and 73BL (treatment of partnership expenditure) [Schedule 2, Part 3, item 11, subsection 73BJ(4)] ; and
·
ignore the depreciation pooling provisions [Schedule 2, Part 3, item 11, subsection 73BJ(5)] .

2.13 No notional Division 42 deduction is available to a company where the company was previously entitled to a deduction under the Division 42 pooling provisions. Conversely, where a notional Division 42 deduction is available to a company under section 73BH, the plant cannot be pooled under the Division 42 pooling provisions. [Schedule 2, Part 3, items 11, 40 and 41, subsections 73BH(3) and (4) of the ITAA 1936 and subsections 42-365(2) and 42-455(4) of the ITAA 1997]

What is the amount of the deduction?

2.14 Where the companys aggregate R & D amount is greater than $20,000, the amount deductible to the company is 125% of the notional Division 42 deduction. Otherwise, the deduction is the notional Division 42 deduction. [Schedule 2, Part 3, item 11, subsection 73BH(2)]

2.15 However, where use of the plant in R & D activities contributes to the production of a saleable product, part of the notional Division 42 deduction relating to that use, which would have otherwise received a 125% deduction, may only receive a 100% deduction. That part (which only receives a 100% deduction) is the amount by which the feedstock output exceeds the feedstock input, where such an excess exists. [Schedule 2, Part 3, item 11, subsection 73BH(6)]

Example 2.1 Manufacturing Co Pty Ltd is developing a new manufacturing process to produce widgets in a revolutionary way. It has constructed an experimental production scale plant to test this process, at a cost of $1,000. This plant has an effective life of 10 years (ignoring any risk that it will not be able to be successfully developed for production use - see paragraph 2.16), and its R & D use of testing, analysis and modification commences on 1 July in Year 1. In the initial stages of the R & D activities carried on, output from the machine was of poor quality and of little resale value. In Year 2, however, modifications and adaptations made to the plant during the course of the R & D activities have resulted in much improved quality and output. As a result, the R & D activities cease at the end of the second year and the plant is used in production from then on.

Year 1  
feedstock output $50
feedstock inputs $150
depreciation (diminishing value - 15% * $1,000) $150
As there is no excess of feedstock outputs over inputs in Year 1, the full amount of depreciation remains eligible for deduction at 125% (i.e. deduction is $187.50).
Year 2  
feedstock output $250
feedstock input $150
depreciation (15% * $850) $127.50
The excess of feedstock output over input is $100. Consequently, the R & D depreciation amount of $127.50 is deductible in the following way:

deductible at 100%: $100 (i.e. deduction is $100)
deductible at 125%: $27.50 (i.e. deduction is $34.38)

Effective life

2.16 Where it is reasonably likely that a company will use a unit of plant for the purposes of carrying on R & D activities, the plants effective life under Division 42 of the ITAA 1997 will be the longest period for which the plant can be used for R & D purposes, for assessable income purposes, or for exempt income producing purposes. That is, the effective life of the asset will be the longest period of use resulting from any one, or combination of 2 or more, of the purposes. [Schedule 2, Part 3, item 11, paragraph 73BN(2)(a)]

2.17 Further, in determining the effective life, it is to be concluded that the plant will not be scrapped because of the inherent technical risk of the R & D activities. In the event that the technical risk in the R & D activities should result in the early scrapping of the plant, the balancing adjustment provisions will ensure that the appropriate concessional write-off is given (see paragraphs 2.18 to 2.20). [Schedule 2, Part 3, item 11, paragraph 73BN(2)(b)]

Balancing adjustments

2.18 If an amount would have notionally been included in a companys assessable income or would have notionally been deductible from a companys assessable income because a balancing adjustment event notionally arises under Division 42, then that amount is assessable income or a deduction, as the case may be, of the company. [Schedule 2, Part 3, item 11, subsection 73BM(1)]

2.19 However, in working out the balancing adjustment amount under Division 42, Division 42 is taken to:

·
increase the assessable amount to recoup the appropriate proportion of the 125% deduction previously given on the balancing gain on disposal (to the extent that the gain relates to the use of the plant in R & D activities); and
·
increase the deductible amount to allow the appropriate further 125% deduction on the balancing loss on disposal (to the extent that the loss relates to the use of the plant in R & D activities).

[Schedule 2, Part 3, item 11, subsections 73BM(2) and (3)]

2.20 If an actual balancing adjustment event arises under Division 42 (rather than a notional) and an amount has been allowed under section 73BH, that amount will be treated as a depreciation deduction for the purposes of working out the balancing adjustment under Division 42. [Schedule 2, Part 3, item 39, section 42-220A of the ITAA 1997]

Example 2.2 Assume the facts of Example 2.1.In Year 3 the plant is used in production for the full year. Depreciation under Division 42 of $108 (15% $722) is claimed in Year 3, giving a written-down value of $614. At the end of this year, the plant is sold for $700.The balancing profit made on the plant of $86, to be included in Manufacturing Co Pty Ltds assessable income, is increased to recoup a portion of the 125% R & D tax concession previously given in respect of the R & D depreciation deductions. The proportion by which it is increased is as per the formula in section 42-220A of the ITAA 1997. That is:

(sum of all 1.25 rate notional deductions / total decline in value) * adjusted amount * 0.25

= ($177.50 / $386) * $86 * 0.25 = $10

The balancing profit to be included in Manufacturings assessable income is $96.

Example 2.3 Had the plant in Example 2.2 been sold for $500 instead of $700, the balancing adjustment on disposal of $114 loss would be allowable as a deduction, increased again under the same formula, as follows:

($177.50 / $386) * $114 * 0.25 = $13

The total additional deduction allowable in respect of this event is therefore $127.

Recoupment

2.21 Where the company receives an amount in respect of the results (or lack thereof) of R & D activities, and the company is eligible for (or would have been eligible if the company had not been exempt from tax) a deduction under section 73BH, the amount is assessable to the company. [Schedule 2, Part 3, item 11, subsections 73BM(4) to (6)]

Depreciation based notionally on Division 40 of the ITAA 1997

What assets are eligible?

2.22 Assets which can be considered for a deduction under section 73BA (referred to as a section 73BA depreciating asset) are assets which would have notionally been considered for a deduction under section 40-25 of the ITAA 1997, if Division 40 were amended to:

·
include trading stock (note: for the period that the trading stock is being used in carrying on R & D activities, it loses its character as trading stock). This will ensure that concessional depreciation deductions are allowed on trading stock that is used in R & D activities for experimentation, testing, analysis, etc., for the period of R & D use [Schedule 2, Part 3, item 54, subsection 73BA(5) and paragraph 73BB(1)(a)] ;
·
capital works (other than buildings) as described in Division 43 of the ITAA 1997. This will ensure that, for the period of R & D use, concessional depreciation deductions are allowed on experimental structural improvements used in R & D activities [Schedule 2, Part 3, item 54, paragraph 73BB(1)(c)] ; and
·
exclude intangible assets [Schedule 2, Part 3, item 54, paragraph 73BB(1)(b)] .

When is a deduction available?

2.23 A notional Division 40 deduction is available to a company if the company would have notionally been entitled to depreciation deduction for assets under section 40-25 of the ITAA 1997 if Division 40 were amended to:

·
only require that the assets were being used for the purposes of carrying on R & D rather than requiring them to be used for the purposes of producing assessable income [Schedule 2, Part 3, item 54, subsection 73BC(2)] ;
·
ensure that the effective life and the method of calculating the deduction used for the asset is the same as that which existed before the application of section 73BA, if the company were previously eligible for an actual Division 40 deduction on that asset. Complementary, but opposite, provisions have also been added to Division 40 [Schedule 2, Part 3, items 54 and 75, subsection 73BC(3) of the ITAA 1936 and subsection 40-65(6) of the ITAA 1997] ;
·
take into account any change resulting from the application of sections 73BD (discussed in paragraph 2.36) and 73BE (treatment of partnership expenditure) [Schedule 2, Part 3, item 54, subsection 73BC(4)] ; and
·
ignore the depreciation pooling provisions [Schedule 2, Part 3, item 54, subsection 73BC(5)] .

2.24 No notional Division 40 deduction is available to a company where the company was previously entitled to a deduction under the Division 40 low-value pooling provisions or entitled to a deduction under Subdivision 328-D (the STS pooling provisions). Conversely, where a notional Division 40 deduction is available to a company under section 73BA, no deduction can ever be available for that asset under the Division 40 low-value pooling provisions, or under the STS depreciation provisions. [Schedule 2, Part 3, items 54, 80 and 84, subsections 73BA(3) and (4) of the ITAA 1936 and subsections 40-425(8) and 328-175(9) of the ITAA 1997]

What is the amount of the deduction?

2.25 Where the companys aggregate R & D amount is greater than $20,000, the amount deductible to the company is 125% of the notional Division 40 deduction. Otherwise, the deduction is the notional Division 40 deduction. [Schedule 2, Part 3, item 54, subsection 73BA(2)]

2.26 However, where use of the asset in R & D activities contributes to the production of a saleable product, part of the notional Division 40 deduction relating to that use, which would have otherwise received a 125% deduction, may only receive a 100% deduction. That part (which only receives a 100% deduction) is the amount by which the feedstock output exceeds the feedstock input, where such an excess exists. [Schedule 2, Part 3, item 54, subsection 73BA(6)]

Effective life

2.27 Where it is reasonably likely that a company will use an asset for the purposes of carrying on R & D activities, the assets effective life under Division 40 of the ITAA 1997 will be the longest period for which the asset can be used for R & D purposes, for assessable income purposes or for exempt income producing purposes. That is, the effective life of the asset will be the longest period of use resulting from any one, or combination of 2 or more, of the purposes. [Schedule 2, Part 3, item 54, paragraph 73BG(2)(a)]

2.28 Further, in determining the effective life, it is to be concluded that the asset will not be scrapped because of the inherent technical risk of the R & D activities. In the event that the technical risk in the R & D activities should result in the early scrapping of the plant, the balancing adjustment provisions will ensure that the appropriate concessional write-off is given (see paragraphs 2.29 to 2.31). [Schedule 2, Part 3, item 54, paragraph 73BG(2)(b)]

Balancing adjustments

2.29 If an amount would have notionally been included in a companys assessable income or would have notionally been deductible from a companys assessable income because a balancing adjustment event notionally arises under Division 40, then that amount is assessable income or a deduction, as the case may be, of the company. [Schedule 2, Part 3, item 54, subsection 73BF(1)]

2.30 However, in working out the balancing adjustment amount under Division 40, Division 40 is taken to:

·
increase the assessable amount to recoup the appropriate proportion of the 125% deduction previously given on the balancing gain on disposal (to the extent that the gain relates to the use of the asset in R & D activities); and
·
increase the deductible amount to allow a further 125% deduction on the balancing loss on disposal (to the extent that the loss relates to the use of the asset in R & D activities).

[Schedule 2, Part 3, item 54, subsections 73BF(2) and (3)]

2.31 If an actual balancing adjustment event arises under Division 40 (rather than a notional) and an amount has been allowed under section 73BA, that amount will be treated as a depreciation deduction for the purposes of working out the balancing adjustment under Division 40. [Schedule 2, Part 3, item 79, section 40-292 of the ITAA 1997]

Recoupment

2.32 Where the company receives an amount in respect of the results (or lack thereof) of R & D activities, and the company is eligible for (or would have been eligible if the company had not been exempt from tax) a deduction under section 73BA, the amount is assessable to the company. [Schedule 2, Part 3, item 54, subsections 73BF(4) to (6)]

Rollover relief

2.33 Rollover relief is available on the disposal of plant or assets subject to sections 73BA and 73BH deductions (and no Division 40 or Division 42 deductions are allowable), where rollover relief would have been available under the capital gain provisions of Subdivision 126-B of the ITAA 1997. [Schedule 2, Part 3, items 19 and 61, subsections 73EA(1) and (2), 73EB(1) and (2)]

2.34 The rollover relief provides that the transferor has no balancing charge, provides that the transferee is entitled to deductions under sections 73BA and 73BH on the same basis as available to the transferor, provides detailed treatment for partnership disposals and provides that the subsequent disposal of the plant/asset by the transferee (or later transferees) will not be denied the ability to obtain rollover relief. [Schedule 2, Part 3, items 19 and 61, subsections 73EA(3) to (5) and 73EB(3) to (5)]

2.35 The rollover relief also requires the transferor to provide the transferee (within 6 months after the transferees year of income, unless the Commissioner extends this time) with sufficient information to allow the transferee to work out the rollover relief. The transferee must keep this information for at least 5 years after the loss or disposal of the asset by the transferee. A penalty of 30 penalty units applies where the information is not kept for the required time. [Schedule 2, Part 3, items 19 and 61, subsections 73EA(6) to (9) and 73EB(6) to (9)]

Special treatment of certain expenditure under section 73BA and 73BH

2.36 Sections 73BD, 73BE, 73BK and 73BL provide for special rules to apply in determining sections 73BA and 73BH deductions:

·
the detailed treatment of plant/asset expenditure by partnerships [Schedule 2, Part 3, items 11 and 54, sections 73BE and 73BL] ;
·
plant/asset expenditure by a company that has not registered under sections 39J or 39P of the IR & DA 1986 is ignored in working out deductions under sections 73BA and 73BH [Schedule 2, Part 3, items 11 and 54, subsections 73BD(1) and 73BK(1)] ;
·
the Commissioner can ignore some or all of the plant/asset expenditure between parties who are not dealing with each other at arms length [Schedule 2, Part 3, items 11 and 54, subsections 73BD(2) and 73BK(2)] ;
·
the Commissioner must ignore the plant/asset expenditure if the IR & D Board gives him a certificate under sections 39M, 39MA, 39N, subsections 39P(4) or 39P(6) of the IR & DA 1986 [Schedule 2, Part 3, items 11 and 54, subsections 73BD(3) to (8) and 73BK(3) to(8)] ;
·
plant/asset expenditure by a company on overseas R & D activities is ignored in working out deductions under sections 73BA and 73BH unless the IR & D Board has given a provisional certificate under section 39ED of the IR & DA 1986 [Schedule 2, Part 3, items 11 and 54, subsections 73BD(9) and 73BK(9)] ; and
·
plant/asset expenditure incurred on behalf of any other person (other than as a partner in a partnership) is ignored in working out deductions under sections 73BA and 73BH [Schedule 2, Part 3, items 11 and 54, subsections 73BD(10) and (11), 73BK(10) and (11)] .

Application provisions

2.37 The retrospective amendment to the definition of plant expenditure in subsection 73B(1) of the ITAA 1936, to limit the time that R & D plant must be for use exclusively for the purpose of carrying on R & D activities, applies to expenditure on plant acquired, constructed or commenced to be constructed on or after 1 July 1985. [Schedule 2, Part 1, item 2]

2.38 The amendment to remove pilot plant from the CGT provisions applies from 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999. [Schedule 2, Part 2, item 3]

2.39 The amendments to allow a notional Division 42 deduction under section 73BH apply to assessments for the income year in which 29 January 2001 occurs, and for later income years. [Schedule 2, Part 3, item 51]

2.40 The amendments to allow a notional Division 40 deduction under section 73BA apply to assessments for the income year in which 1 July 2001 occurs, and for later income years. [Schedule 2, Part 3, item 92]

Consequential amendments

2.41 There are numerous minor technical amendments which are consequential on the move of depreciation deductions from section 73B to sections 73BA and 73BH. These are:

·
ITAA 1936 - Schedule 2, Part 3, items 6, 12 to 18, 20 to 27, 52, 53, 55 to 60 and 62 to 68;
·
ITAA 1997 - Schedule 2, Part 3, items 28 to 32, 34 to 38, 42 to 44, 69 to 74, 76 to 78 and 81 to 83; and
·
IR & DA 1986 - Schedule 2, Part 3, items 45 to 50 and 85 to 91.


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