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 3 - Research and development tax offset

Outline of chapter

3.1 This chapter explains the tax offset which provides eligible small companies with access to the cash equivalent of the R & D tax concession.

Context of reform

3.2 The tax offset gives eligible small companies, in cases where the company is not yet profitable, the benefit of the R & D tax concession earlier. It could provide a cash flow when they need it most.

3.3 The grouping rules ensure that large businesses do not receive the tax offset by virtue of their operation being divided into several smaller units.

Summary of new law

3.4 An eligible company can claim a tax offset instead of deductions under sections 73B, 73BA and 73BH of the ITAA 1936. [Schedule 3, item 5, section 73I]

3.5 A company is eligible for the tax offset if its aggregate R & D amount for the year exceeds $20,000 and its grouped aggregate R & D amount for the year does not exceed $1 million. Further, a company will not be eligible for the tax offset where the turnover of the group is $5 million or more. [Schedule 3, item 5, subsection 73J(1)]

3.6 Some companies will not be eligible for the tax offset where they are linked with an exempt person. [Schedule 3, item 5, subsection 73J(2)]

Detailed explanation of new law

What is eligible for a tax offset?

3.7 An eligible company can claim a tax offset instead of deductions under sections 73B, 73BA and 73BH of the ITAA 1936. The choice to claim a tax offset is made by the company in its annual tax return. Once the choice is made to claim a tax offset, no deductions under sections 73B, 73BA and 73BH can be claimed in that year. [Schedule 3, item 5, section 73I]

3.8 The tax offset is paid at the rate of 30 cents for each dollar of deduction that would have otherwise been claimable. This means that where a company gives up a deduction that was 125% of the expenditure incurred, the tax offset would equate to 37.5% of the expenditure incurred. Similarly, where a company gives up a deduction that was 175% of the expenditure incurred, the tax offset would equate to 52.5% of the expenditure incurred. [Schedule 3, item 5, subsection 73I(3)]

Who is eligible for a tax offset?

3.9 To be eligible for the tax offset a companys:

·
aggregate R & D amount (as defined under subsection 73B(1) of the ITAA 1936) for the year must exceed $20,000;
·
aggregate R & D amount and the aggregate R & D amounts of each resident company with which the company is grouped must not exceed $1 million; and
·
R & D group turnover (see paragraph 3.11) must be less than $5 million.

[Schedule 3, item 5, subsection 73J(1)]

Exception

3.10 A company will not, however, be eligible for a tax offset where at least 25% of the voting power or 25% of the right to distributions from the company is held, legally or beneficially by an exempt person (or 2 or more exempt persons), or the affiliates of an exempt person, or any combination thereof. [Schedule 3, item 5, subsection 73J(2)]

What is R & D group turnover?

Meaning of R & D group turnover

3.11 A companys R & D group turnover for an income year is the sum of:

·
the value of the supplies made during the year by the company; and
·
the value of the supplies made by other taxpayers grouped with the company.

The R & D group turnover is reduced by any supplies made between the company and the other taxpayers grouped with the company (including non-resident companies), or between the other taxpayers grouped with the company. [Schedule 3, item 5, subsection 73K(1)]

Meaning of value of the supplies

3.12 The concept of the value of the supplies is based on the terms defined in the GST Act and is defined in subsection 73H(2) of the ITAA 1936.

3.13 The value of the supplies a taxpayer makes during an income year is the sum of the values of the supplies the taxpayer made during the year in the ordinary course of carrying on a business or in the course of carrying on R & D activities and is calculated exclusive of GST payable on supplies. [Schedule 3, item 5, subsection 73H(2)]

3.14 The GST Act explains the method of working out the value of a supply. Basically, it depends on whether or not the supply is a taxable supply.

·
If the supply is a taxable supply (i.e. one on which GST is payable), its value is worked out as 10/11th of the price of the supply. This calculation excludes the GST payable on the supply (the other 1/11th).
·
If the supply is not a taxable supply, the price of all the non-taxable supplies made during the year in the ordinary course of carrying on a business is added to the value of all taxable supplies. The price of a supply is generally the amount of money a person pays for the supply. Supplies that are not taxable include those that are GST-free and input taxed for the purposes of the GST Act.

Gambling supplies

3.15 To maintain consistency between the GST Act and the income tax laws, gambling supplies are accorded the same treatment. As such, the method used for calculating the value of the supplies in respect of gambling is different to that described in paragraph 3.14. Where a taxable supply that a taxpayer makes during the income year includes gambling supplies, an amount equal to 11 times the taxpayers global GST amount, as defined in section 126-10 of the GST Act, is included when working out the R & D group turnover. [Schedule 3, item 5, subsection 73K(2)]

Exceptions

3.16 R & D group turnover does not include:

·
a supply that constitutes an insurance recovery; and
·
things that do not constitute the making of a supply - for example, lending money.

[Schedule 3, item 5, subsection 73K(3)]

When is a persons turnover grouped?

3.17 A persons turnover will be grouped with that of another person and its affiliates where:

·
either person controls the other;
·
both entities are controlled by the same third person; or
·
the entities are STS affiliates of each other.

[Schedule 3, item 5, subsection 73L(1)]

3.18 The grouping rules are designed to ensure that businesses that are part of a larger group do not gain access to the tax offset. However, the grouping rules also ensure that unrelated persons are not inadvertently grouped and that only persons that are related to each other are grouped.

Who is an affiliate?

3.19 A persons affiliate is another person that:

·
acts or could reasonably be expected to act in accordance with the directions or wishes of the person in relation to the affairs of the persons business or R & D expenditure; or
·
acts in concert with the person in relation to the affairs of the persons business or R & D expenditure.

[Schedule 3, item 5, subsection 73M(1)]

3.20 Two or more partners in a partnership are not each others affiliatesmerely because one partner acts or could reasonably be expected to act in concert with the other in relation to the affairs of the partnership business. [Schedule 3, item 5, subsection 73M(2)]

Meaning of control

Companies, sole traders and certain trusts

3.21 A person would be regarded as controlling another person where that person either alone or together with its affiliates can enjoy a certain level of benefit from another person. Such a benefit can arise where the person either alone or together with its affiliates legally or beneficially owns, or has the right to acquire legal or beneficial ownership of, interests in the other person that give between them the right to receive:

·
more than 50% of any distribution of income or capital by the other person; or
·
the right to exercise or control the exercise of more than 50% of the voting power in the other person.

[Schedule 3, item 5, subsection 73L(3)]

Non-fixed trusts

3.22 The tests used to identify the control of a non-fixed trust for the purposes of the grouping rules look at the actual receipt of distributions from non-fixed trusts by the person or its affiliates. This test will only group a person with a non-fixed trust where the person or its affiliates, or the person and its affiliates, have received a distribution from the trustee of the trust of $100,000 or more in any one of the last 4 income years. [Schedule 3, item 5, paragraph 73L(4)(a)]

3.23 The other tests look at whether or not the person or its affiliates have the ability to influence the operation of the non-fixed trust. For example, if a person or its affiliates individually or together are able to directly or indirectly control the management of the non-fixed trust or control the application of the capital or income of the non-fixed trust, the turnover of the non-fixed trust will be grouped with that of the person and/or its affiliates. [Schedule 3, item 5, paragraphs 73L(4)(b) and (c)]

Partnerships

3.24 A person would be said to be controlling a partnership where the person and/or its affiliates between them have the right to receive more than 50% of the partnership net income or have more than 50% interest in assets used by the partnership in its business. [Schedule 3, item 5, subsection 73L(5)]

3.25 A partnership would be said to be controlling another person (namely, another partnership, a trust or a company) where a partner or partners in the partnership have the right to receive between them more than 50% of the partnership net income or have more than 50% interest in the assets used in the partnership business and the same partner or partners:

·
also have the right to receive between them more than 50% of:

-
any distribution of income or capital from a trust;
-
the net income of another partnership, or more than 50% interest in the assets used in that partnership business; or
-
any distribution of income or capital by a company, or have the power to exercise control of more than 50% of the voting power in the company; or

·
if the other person is a non-fixed trust it would be grouped with the trust under subsection 73L(4) for similar reasons as explained in paragraphs 3.22 and 3.23.

[Schedule 3, item 5, subsection 73L(6)]

Indirect control of a person

3.26 The control tests are designed to look through business structures that include interposed entities. However, only controlled persons are taken into account in tracing interests. The indirect control rule has been adopted to avoid complex tracing requirements for a person. If a person directly controls a second person, and the second person controls (whether directly or indirectly) a third person, the first person is also taken to control the third person. [Schedule 3, item 5, subsection 73L(2)]

Grouped expenditure

3.27 Where:

·
a company is part of a group under subsection 73L and can claim a deduction for expenditure under subsections 73B(13) or (14) in a year; and
·
another person in the group incurs expenditure, in that year or an earlier year, relating to the things for which the company can claim a deduction for expenditure under subsections 73B(13) or (14),

the amount of that expenditure which can be claimed at the concessional rate of 125% is reduced by an amount that represents the total group markup. The amount of the companys expenditure which could not be claimed at the concessional rate of 125% may be claimed at 100%. [Schedule 3, item 2, subsections 73B(14AA) and (14AB)]

3.28 For each year of income, the total group markup is obtained by adding all the amounts charged by persons within the group for goods and services relating to particular expenditure claimable under subsections 73B(13) or (14), and then deducting the actual cost to those persons of providing those goods or services. [Schedule 3, item 2, paragraphs 73B(14AC)(a) and (b)]

Example 3.1 XYZ Ltd conducts R & D activities as part of its business as a specialist equipment supplier for search and rescue craft.XYZ Ltd contracts with its subsidiary, ABC Co, for the supply of a new prototype beacon at $500,000. As a part of that contract, ABC Co orders component supplies through another subsidiary, SUP Co, for $100,000. SUP Co costs were $90,000 (cost of goods, salary and overhead costs). ABC Co costs were $450,000 (labour, component supplies, overheads and plant depreciation). XYZ Ltd registers the R & D activities and is entitled to deduct the expenditure as follows:total group markup =($500,000 + $100,000) - ($450,000 + $90,000)= $600,000 - $540,000= $60,000reduced R & D expenditure = $500,000 - $60,000 (total group markup)claim entitled to concessional rate of 125% = $440,000claim entitled to concessional rate of 100% = $60,000

Application provisions

3.29 The R & D tax offset is effective for assessments for the first income year occurring after 30 June 2001. The application of the T(IOEP)A 1983 to refundable tax offsets is effective from assessments occurring after 30 June 2001. [Schedule 3, item 19]

Consequential amendments

3.30 Section 73H is inserted to provide the definitions necessary for the interpretation of the R & D tax offset provisions. [Schedule 3, item 5, section 73H]

3.31 Subparagraph 73C(7)(c)(ii) and subsection 73F(2)(b) of the ITAA 1936 are amended, and subsections 82AM(2A), 632(2A) and 642(2A) of the ITAA 1936 are inserted, to take into account that a company will now have the choice of choosing a tax offset. [Schedule 3, items 3, 4, 6, 9 and 10]

3.32 In line with the new general prepayments regime in the income tax law, prepaid R & D expenditure (with the exception of accelerated expenditure as defined in subsection 73B(1)) will now be taken, under Subdivision H of Division 3 of Part III of the ITAA 1936, to have been incurred over its eligible service period. This treatment is similar to how prepaid expenditure was treated under subsection 73B(11) of the ITAA 1936. Accelerated expenditure will continue to access concessional treatment under subsection 73B(11). [Schedule 3, items 7 and 8; Schedule 4, items 6 to 9]

3.33 Section 13-1 and paragraph 43-70(2)(g) of the ITAA 1997 are amended to take into account that a company will now have the choice of choosing a tax offset. [Schedule 3, items 11 and 12]

3.34 The definition of income tax crediting amount in subsection 3(1) and subparagraphs 8E(1)(d)(i) and 8G(1)(d)(i) of the T(IOEP)A 1983 are amended, and subsection 67-25(3) of the ITAA 1997 and notes to subsections 8E(1) and 8G(1) of the T(IOEP)A 1983 are being inserted, to ensure that R & D tax offsets are subject to the refundable tax offset rules. [Schedule 3, items 13 to 18]

3.35 The amendment of assessment provisions of section 170 have been updated to include the tax offset and the deduction for the incremental concession. [Schedule 4, item 10]


View full documentView full documentBack to top