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 4 - Research and development incremental tax concession

Outline of chapter

4.1 This chapter explains the incremental tax concession which allows companies to claim a deduction of 175% on certain adjusted amounts of eligible expenditure.

Context of reform

4.2 The incremental tax concession is designed to encourage additional business investment by eligible companies in R & D over and above prior year levels of spending on R & D. The concession is focused on the labour-related aspects of R & D which will provide the greatest benefits for the Australian economy.

4.3 The concession will increase the rate of the R & D deduction by an additional 50% to allow a total deduction of 175% for increases over prior year expenditure. This increase on certain expenditures is based on an average of expenditures taken over 3 years and moderated to account for significant prior year reductions in R & D spending.

Summary of new law

4.4 A company must have incremental expenditure which it is able to deduct under subsections 73B(13) or (14) of the ITAA 1936 in the year in which it is claiming the additional 50% deduction. [Schedule 4, item 5, paragraph 73Q(1)(a)]

4.5 To be eligible to claim the additional 50% deduction, a company must also have been eligible to deduct incremental expenditure under subsections 73B(13) or (14) in each of the 3 prior years or be grouped with companies which have been eligible to deduct incremental expenditure in these years. Subsection 73B(10) makes it necessary for a company to be registered under sections 39J or 39P of the IR & DA 1986 before it can claim an R & D deduction under these subsections. [Schedule 4, item 5, paragraph 73Q(1)(b) and subsection 73Q(2)]

4.6 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 3 years from its current year incremental expenditure. That amount (moderated where expenditure in any of the previous 2 years has fallen below 80% of the previous years expenditure), which represents the additional R & D, receives a further 50% deduction in addition to the 125% deduction allowed under section 73B, providing in total a premium rate of 175%. [Schedule 4, item 5, sections 73S to 73W and 73Y]

4.7 In determining the additional 50% deduction, companies are grouped with other related persons. Where a company is grouped and the other companies in the group also have current year incremental expenditure, the amount subject to the additional 50% deduction is allocated between all eligible companies which contributed to the increase. Special rules apply in determining the amount subject to the additional 50% deduction where companies enter or leave a group. [Schedule 3, item 5, section 73L; Schedule 4, item 5, sections 73R and 73X]

4.8A company which is eligible for the refundable tax offset and is also eligible for the additional 50% deduction may choose to take that deduction as a refundable tax offset. [Schedule 3, item 5, section 73I]

Detailed explanation of new law

What expenditure is eligible for the additional 50% deduction

4.9 The additional 50% deduction is derived primarily from a companys incremental expenditure. Where a company is in a group, it is necessary to sum the incremental expenditures incurred by the group members during their period of group membership (defined as R & D spend). The term incremental expenditure is defined to mean expenditure which is already defined as R & D expenditure in subsection 73B(1), with the exception of plant leasing expenditure and any other expenditure incurred under a contract which is in substance for the provision of plant [Schedule 4, item 5, definition of incremental expenditure in subsection 73P(2)] . The definition of research and development expenditure excludes expenditure on plant, core technology, interest, building and residual feedstock expenditure. Where a contract involves both the provision of plant and services it may be apportioned to exclude the plant expenditure for the purpose of determining incremental expenditure. If it is not possible to apportion the expenditure, no expenditure under the contract can be included as incremental expenditure [Schedule 4, item 5, subsections 73P(3) and (4)] .

4.10 Where a company is in a group, under section 73L, and its expenditure includes an amount of total group mark up as defined in subsection 73B(14AC), that amount is also excluded from incremental expenditure. [Schedule 3, items 2 and 5, subsection 73B(14AC) and section 73L; Schedule 4, item 5, section 73P(5)]

Which companies are eligible to claim the additional 50% deduction?

4.11 To be eligible to claim the additional 50% deduction, a company must be able to deduct incremental expenditurein the year of income under subsections 73B(13) or (14) and, in accordance with section 73B(10), it must be registered under sections 39J or 39P of the IR & DA 1986 for the year of income in which the expenditure is incurred. [Schedule 4, item 5, paragraph 73Q(1)(a)]

4.12 In addition, a company must also have been eligible to deduct incremental expenditure under subsections 73B(13) or (14) in each of the 3 prior years (a 3 year history). [Schedule 4, item 5, paragraph 73Q(1)(b)]

4.13 An exception to the requirement for a company to have a 3 year history arises where a company is in a group under section 73L and there are other companies in that group which have been eligible to deduct incremental expenditure under subsections 73B(13) or (14). Provided that, between those identified companies, there are eligible deductions in the group in each of the 3 prior years the company will have a 3 year history. [Schedule 3, item 5, section 73L; Schedule 4, item 5, subsection 73Q(2)]

Application of grouping rules

4.14 Eligible companies with incremental expenditure, must determine if they are in a group in accordance with section 73L. [Schedule 3, item 5, section 73L; Schedule 4, item 5, subsection 73R(1)]

Working out the prior history for eligible companies in the group

4.15 A method statement is provided to assist in working out which other companies with incremental expenditure should be grouped with the eligible company as group members. The method statement also determines the group membership period for each such company in the group. The incremental expenditure of group members during the group membership period ( R & D spend ) is used in determining the additional 50% amount. [Schedule 4, item 5, subsection 73R(2)]

4.16 Step 1 of the method statement determines which companies are grouped with the eligible company on the last day of the year of income. These companies are called primary group members.

4.17 Step 2 then determines the group membership period of the primary group members. The primary group members group membership period extends from the day their control changed which caused them to come into the group to the last day of the current income year. The group membership period will not commence before the first day of the income year 3 years before the current income year.

4.18 Step 3 then determines which companies were grouped with the primary group members during their group membership period. Any such company is called a secondary group member.

4.19 Steps 4 and 5 then determine the group membership period for each secondary group member. The secondary group members group membership period extends from the day their control changed which caused them to come into the group to the day their control changed which caused them to leave the group. The group membership period will not commence before the first day of the income year 3 years before the current income year.

Viable business exception

4.20 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 (see paragraph 4.21), 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 [Schedule 4, item 5, subsection 73R(3)] ; 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, its incremental expenditure from a previous group membership is available for use in the calculation of the additional 50% deduction [Schedule 4, item 5, subsection 73R(4)] .

4.21 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 and the vendor provides written details of the incremental expenditure that the transferring company incurred while in the former group. The written agreement and details generally need to be provided by the end of the year in which the change of control took place. [Schedule 4, item 5, subsections 73R(5) and (6)]

Example 4.1 Companies A, B, C and D are companies that have made incremental expenditure claims at some stage in the past 3 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 ($) Y-1 ($) Y-2 ($) Y-3 ($)
Co A 100 0 0 0
Co B 80 50 20 20
Co C   50 50 0
Co D     20 20
Assume company D was liquidated on 30/6/Y-2 (and thus did not transfer a viable business) and C was sold in Y-1 with a valid transfer of viable business (and thus all incremental expenditure is ignored and the company is deemed never to have had a group membership period). The incremental expenditures that could be grouped to A and B are $50,000 in Y-1, $40,000 in Y-2 and $40,000 in Y-3.

Working out the additional 50% deduction

4.22 Once the incremental expenditure for the current year and the 3 prior years has been ascertained, sections 73S to 73Y determine the premium amountwhich, after apportionment, can be claimed by the eligible company as an additional 50% deduction. [Schedule 4, item 5, sections 73S to 73Y]

4.23 For the purposes of the calculation, incremental expenditure of the eligible company is summed with the incremental expenditure of other group members, where relevant. This amount is defined as the R & D spend . Where a company is not a member of a group, its incremental expenditure equals its R & D spend. [Schedule 4, item 5, definition of R & D spend in subsection 73P(2)]

4.24 A simple guide of how to use the 4 steps of sections 73T, 73U, 73V and 73W is set out below:

Step 1 (section 73T)
Determine the adjustment amount for the current year and the previous year.
Step 2 (section 73U)
Determine the running average for the past 3 years.
Step 3 (section 73V)
Determine the adjustment balance using the amounts determined in Steps 1 and 2.
Step 4 (section73W)
Determine the premium amount . This is the R & D spend less the running average from Step 2 less the adjustment balance from Step 3.

Example 4.2 A company has the following eligible R & D spend history:current year (Y-0) is 110, Y-1 is 90, Y-2 is 60, Y-3 is 30Step 1: Adjustment amount for Y-0 and Y-1 = 0 as there is no decrease in R & D spend more than 20% in either of the Y-1 or Y-2 years.Step 2: The running average for Y-0 = $60 ($90 + $60 + 30 / 3).Step 3: There is no adjustment balance as there is no adjustment amount.Step 4: The premium amount = $50 ($110 - $60, that is, the current year eligible incremental expenditure less the running average ).

Step 1

4.25 There may be an adjustment amount (AA0) where a companys 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 [Schedule 4, item 5, subsection 73T(1)] . 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 [Schedule 4, item 5, subsection 73T(2)] .

4.26 However, the adjustment amount will be nil where the additional 50% deduction could have been claimed in the previous year and no group member underwent a change of control involving the transfer of a viable business in the current year. Also, the adjustment amount will be nil where the additional 50% deduction could have been claimed in the year before the previous year and no group member underwent a change of control involving the transfer of a viable business in the current year or the previous year [Schedule 4, item 5, subsections 73T(3) and (4)] . The adjustment amount will also be deemed to be nil where the result of the calculation is negative [Schedule 4, item 5, section 73S] .

Step 2

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

4.28 The running average for the current year is the sum of the incremental expenditure amounts in the previous 3 years divided by 3 [Schedule 4, item 5, subsection 73U(1)] . The running average for the previous year is the sum of the incremental expenditure amounts in the previous 2 years divided by 2. Determine if one of the exceptions in step 1 applies [Schedule 4, item 5, subsection 73U(2)] .

Example 4.3 Where Y-0 = 100, Y-1 = $180, Y-2 = $150, Y-3 = $200There is an adjustment amount of $10 for Y-1 [($200 0.8) - $150]The running average for Y-1 is $175 [($200 + $150) / 2]

Step 3

4.29 Step 3 adds together any adjustment amounts (AA0 and AA-1) where the prior year 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 (AA0 and AA-1) by the amount by which the R & D spend exceeds the prior year running average (RA-1). However, if the eligible company or any of its group members were eligible to claim an additional 50% deduction in the previous year, and there were no change of control of the eligible company or its group members during the current year involving the transfer of a viable business, the adjustment balance is deemed to be nil [Schedule 4, item 5, section 73V] . The adjustment balance will also be deemed to be nil where the result of the calculation is negative [Schedule 4, item 5, section 73S] .

Step 4

4.30 Step 4 calculates the premium amount which, once it is apportioned between group members, if any, will be eligible for the additional 50% deduction. The premium amount is the R & D spend less the current year running average and the adjustment balance. [Schedule 4, item 5, section 73W]

Example 4.4 Co A has the following eligible incremental expenditures:Y-0 is $250, Y-1 is $180, 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 = $10 [($200 * 0.8) - $150]Step 2: running average in Y-0 = $177; running average in Y-1 = $175Step 3: adjustment balance = $5 ($175 - $180 + $10 + 0)Step 4: premium amount = $68 ($250 - $177 - $5)

Apportionment of the premium amount between group members

4.31 Where there is more than one company in the group that has incremental expenditure in its group membership period the premium amount will be apportioned. The premium amount will only be distributed to companies that have individually increased their incremental expenditure in their group membership periods, in the year of income over their prior year incremental expenditure. The premium amount will be apportioned among these companies on the basis of their proportionate share of this increased incremental expenditure. [Schedule 4, item 5, section 73X]

Example 4.5

Company Prior Year (000s) Current Year Change
A $60 $40 -$20
B 10 15 5
C 30 70 40
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: 5 / 55; C: 40 / 55; D: 10 / 55

The additional 50% deduction

4.32 The additional 50% deduction is allowed on each eligible companys share of the premium amount. However, if the provisions of sections 73C, 73CA or 73CB have operated to reduce the eligible companys entitlement to the 125% concession on its incremental expenditure to an amount less than the premium amount, then the 50% deduction is only allowed on that lesser amount. [Schedule 4, item 5, section 73Y]

Anti-avoidance measure

4.33 For the purpose of working out the companys incremental expenditure, and only for that purpose, the Commissioner may disregard any debit amendment which reduces prior year R & D expenditure, where he is of the opinion that the purpose of the amendment is to increase a companys entitlement to an additional 50% deduction. [Schedule 4, item 5, section 73Z]

Application provisions

4.34 The incremental tax concession applies from the first income year occurring after 30 June 2001. [Schedule 4, item 11]

Consequential amendments

4.35 A consequential amendment is made to the clawback provisions of section 73C to ensure that its integrity is maintained where an R & D company is part of a group. The amendment ensures that where an R & D related recoupment or grant is received in respect of an eligible R & D companys R & D activities by a person who was grouped with the eligible R & D company, that recoupment or grant is taken to be received by the eligible R & D company for the purposes of the clawback provisions. [Schedule 4, items 1 to 4]

4.36 A consequential amendment is made to bring prepaid R & D expenditure within the general prepayments regime under the income tax law (Subdivision H of Division 3 of Part III of the ITAA 1936). However, the ability to obtain an immediate deduction for prepaid contracted expenditure under subsection 73B(11) remains unchanged. [Schedule 3, item 1; Schedule 4, items 6 to 8]


View full documentView full documentBack to top