Senate

Tax Laws Amendment (2007 Measures No. 5) Bill 2007

Tax Laws Amendment (2007 Measures No. 5) Act 2007

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
This memorandum takes account of amendments made by the House of Representatives and to the Bill as introduced.

Chapter 11 - Premium 175 per cent research and development tax concession for Australian research and development activities on behalf of a grouped foreign company

Outline of chapter

11.1 Schedule 11 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to extend the premium 175 per cent research and development (R & D) tax concession to companies belonging to a multinational enterprise group for additional R & D expenditure on behalf of a grouped foreign company above a rolling three-year average of expenditure. Companies will also receive a specific base deduction for all expenditure that contributes to a company's calculation of additional R & D expenditure in that income year.

Context of amendments

11.2 The ITAA 1936 allows a tax concession for companies that incur expenditure on R & D activities. For a claimant to receive the R & D tax concession that R & D must be undertaken on behalf of the company, not have guaranteed financial returns to the company and be exploited for Australian benefit. These rules currently disqualify Australian companies who conduct R & D on behalf of a foreign company, from claiming the R & D tax concession.

11.3 The R & D tax concession comprises three main elements:

·
a base R & D tax concession that provides a higher rate of deduction of 125 per cent for all eligible expenditure on R & D activities;
·
a refundable R & D tax offset that provides a cash refund to the value of the deduction for small companies in a tax loss situation; and
·
a premium R & D tax concession that provides an additional deduction of 50 per cent to a total deduction for that expenditure of 175 per cent for all additional expenditure above the average of the three previous years of expenditure.

11.4 On 1 May 2007, the Prime Minister and the Minister for Industry, Tourism and Resources jointly announced that the Government would extend the premium 175 per cent R & D tax concession to multinational subsidiaries that choose to hold resulting intellectual property offshore and are currently unable to claim the R & D tax concession.

11.5 The extension of the premium 175 per cent R & D tax concession is intended to encourage additional R & D expenditure in Australia by multinational enterprise subsidiaries. An immediate 100 per cent deduction for expenditure on eligible R & D activities and an additional 75 per cent immediate tax deduction on expenditure above the average of the previous three years of expenditure on R & D, will be provided.

11.6 The amendments to the provisions for the premium 175 per cent R & D tax concession are intended to have minimal changes to the eligibility or entitlements of current claimants for the premium 175 per cent R & D tax concession under the existing rules if they do not conduct any R & D on behalf of a grouped foreign company. The three main exceptions for companies that conduct only Australian-owned R & D that may affect their entitlement to an additional deduction under the premium 175 per cent R & D tax concession are:

·
Clarification of the definition of 'incremental expenditure'.
·
The group for the calculation of the premium 175 per cent R & D tax concession will be expanded to include companies who deduct under the new base 100 per cent specific deduction.
·
The expenditure counted in the premium 175 per cent R & D tax concession will be reduced by an amount equal to twice the value of grants received.

11.7 This measure was included in the 2007-08 Budget and the Australian Government's Industry Statement of 1 May 2007.

Summary of new law

11.8 The extension of the premium 175 per cent R & D tax concession will include amendments to the existing R & D tax concession provisions of the ITAA 1936 to allow for an additional 75 per cent deduction for additional expenditure on foreign-owned R & D activities. A base 100 per cent specific deduction will be allowed for all R & D expenditure contributing to the calculation of the premium 175 per cent R & D tax concession.

11.9 Amendments will also be made to the Industry Research and Development Act 1986 (IR & D Act) to deliver the policy intent of this measure. These amendments will give the Industry Research and Development Board (IR & D Board) additional functions and powers relating to foreign-owned R & D activities.

11.10 The new law will include some key design features to deliver the policy intent of providing a higher rate of deduction at the rate of 175 per cent for additional R & D expenditure in Australia where the beneficial ownership of the results resides with a foreign company grouped with the eligible company. These are as follows:

·
The current definition of 'incremental expenditure' will be amended to specifically exclude expenditure that fails a deductibility test for a base R & D tax concession.
·
A new treatment for grants will be applied to both the foreign-owned and Australian-owned components of the premium 175 per cent R & D tax concession. An amount equalling twice the amount of any R & D grant will be removed from the calculation of the premium 175 per cent R & D tax concession. The existing grant clawback for the 125 per cent R & D tax concession will be unchanged.
·
Companies will be eligible for the extension of the premium 175 per cent R & D tax concession for expenditure incurred on behalf of a foreign company if at all times the eligible company is in a 'group', as defined by section 73L of the ITAA 1936. A foreign company is a body corporate incorporated under the law of a foreign country and which is a resident of a foreign country for the purposes of a double taxation agreement relating to that country to which Australia is a party.
·
To allow for immediate access to the premium R & D tax concession, companies who belong to a group that has had a presence in Australia will be deemed to have made deductions in previous years based upon their expenditure in their first full income year commencing after 30 June 2007 and before 1 July 2008.
·
Companies in groups that have not had a presence in Australia prior to the commencement of this measure will have immediate access to the new additional deduction for foreign-owned R & D expenditure component of the premium 175 per cent R & D tax concession with a zero rolling average.
·
The calculation of the premium 175 per cent R & D tax concession will pool foreign-owned and Australian-owned R & D expenditure such that increases to one type of expenditure will be reduced by any decrease to the other type of expenditure.

Comparison of key features of new law and current law

New law Current law
An extended premium R & D tax concession with an accelerated deduction at the rate of 175 per cent will encourage additional R & D activities by subsidiaries of multinational enterprises. Beneficial ownership provisions in the ITAA 1936 and the IR & D Act currently prevent companies who effectively own and exploit the results of R & D activities offshore from accessing the R & D tax concession.
A specific deduction at the rate of 100 per cent for all foreign-owned expenditure contributing to the calculation of an eligible company's additional 75 per cent deduction. R & D expenditure which does not satisfy the beneficial ownership provisions may or may not be deductible under other provisions in the income tax law.

Detailed explanation of new law

11.11 The object provision for the R & D tax concession will reflect the intention to encourage companies to conduct additional R & D activities in Australia. Currently, the object provision for the R & D tax concession only explicitly refers to making companies more internationally competitive. [Schedule 11, item 1, item 50]

11.12 Headings will be inserted into the R & D provisions to assist readers with the navigation and understanding of the law.

Australian-centred research and development activities

11.13 The existing definition of 'Australian research and development activities' in subsection 73B(1) of the ITAA 1936 forms the basis of a new definition of 'Australian-centred research and development activities'. This definition restricts the activities that are deductible as foreign-owned R & D to those that are conducted in Australia. This means that any expenditure incurred on activities conducted overseas will not be deductible. [Schedule 11, item 2]

11.14 The base 100 per cent specific deduction will only be allowed for directly related activities if they have a sole or dominant purpose of supporting a core R & D activity conducted in Australia. A core R & D activity is one that meets the criteria of systematic, investigative and experimental. The newly inserted definition of 'Australian-centred research and development activities' provides clarity by only including directly related activities if they are related to a core activity conducted in Australia as eligible for the deductions for foreign-owned R & D. [Schedule 11, item 2]

Foreign companies based in double tax agreement countries

11.15 Eligibility will be restricted to companies that conduct R & D on behalf of a foreign company that is a body corporate in a country with which Australia has a double tax agreement. The foreign company must be a resident of that foreign country as determined by the double tax agreement. This requirement is important for the effective administration of the concession as the information regarding the beneficial ownership of R & D results by the foreign company can be obtained through the double tax agreement. [Schedule 11, item 4]

On own behalf

11.16 The current law requires that expenditure is incurred on R & D activities carried on by, or on behalf of, an eligible company and not for the purpose of carrying on R & D activities on behalf of any other person. The rule in relation to foreign-owned expenditure is that the expenditure must be incurred by the eligible company for the purpose of carrying on Australian-centred R & D activities, and those activities must be carried on wholly or primarily on behalf of the foreign company. [Schedule 11, items 6 and 7]

Minimum expenditure of $20,000

11.17 The current law allows an exception to the minimum aggregate expenditure threshold of $20,000 for contracted expenditure incurred to a registered research agency. A similar exception for foreign-owned expenditure will not be available. Contracted expenditure is targeted at small Australian companies with constraints on their ability to conduct R & D and as such it is not applicable to multinational enterprises. [Schedule 11, item 5]

Base 100 per cent specific deduction for contributing R & D expenditure

11.18 A company will be eligible for the base 100 per cent specific deduction for foreign-owned R & D if they satisfy all of the following conditions:

·
Expenditure must be incurred at a time when the eligible company is grouped with the foreign company (under section 73L). By satisfying this provision it does not necessarily mean the expenditure is incurred in the eligible company's group membership period. This is determined under section 73R of the ITAA 1936. This means that expenditure incurred for the purpose of activities conducted on behalf of a foreign company at a time when the eligible company is not a group member of that foreign company will not be deductible.
·
Expenditure must be incurred by the eligible company for the purpose of carrying on Australia-centred R & D activities.
·
The activities must be carried on wholly or primarily on behalf of the foreign company.
·
The activities must be carried out under a written agreement between the eligible company and the foreign company for the performance of the R & D activities. The agreement must be directly between the eligible company and foreign company and no other parties. The activities themselves can be performed by the eligible company or can be performed by another person under an agreement to which the eligible company is party.
·
Expenditure will not be eligible for the base 100 per cent specific deduction if it is incurred by an eligible company (first eligible company) in connection with an agreement between it and another eligible company who is a group member under section 73L of the ITAA 1936 when the expenditure is incurred; and the agreement is for the activities to be performed by the first eligible company or by a third party under a separate agreement between the first eligible company and that third party.
·
Expenditure on foreign-owned R & D by the eligible company must be greater than $20,000.
·
All Australian-centred R & D activities to which a group incurred expenditure in the income year, regardless of whether they were covered by an R & D plan or not, must be registered by the eligible company and all of its group members with the IR & D Board. Registration for the activity is necessary if the company incurred expenditure in relation to it in the income year. If this is not satisfied the company will be ineligible for the base 100 per cent specific deduction and the additional deduction for all of its foreign-owned R & D expenditure. [Schedule 11, item 8]

11.19 The requirement for a written agreement between the foreign company and the eligible company is based on the existing definition of 'agreement' in the ITAA 1936. The forms of agreement covered are tightened by requiring them to be in a written form. The agreement must also be a direct agreement between the eligible company and the foreign company with no other parties to the agreement, and as such it will not allow for broad agreements between the foreign company and a number of eligible companies. This will identify the one appropriate eligible company which will be entitled to deduct. The definition of 'agreement' for the new concession would include, for example, a written company policy that all intellectual property resulting from R & D will be directly owned by the foreign company. It would also cover a contract covering the performance of a combination of services including certain R & D activities. The agreement does not need to explicitly provide the funding or include specific information regarding the carrying on of the activities in order to meet this condition. The agreement must, however, require the performance of R & D activities to meet the condition. The type of agreement that exists will also be an indicator that the Australian-centred R & D activities are carried out on behalf of the foreign company, which is a separate condition that the eligible company must satisfy to claim the deduction. [Schedule 11, item 8]

11.20 Foreign-owned R & D expenditure may be incurred under further subcontract agreements with other parties, and still be expenditure incurred directly or indirectly under the agreement between the eligible company and the foreign company. This is not intended to be restricted to agreements explicitly referred to in the primary agreement between the eligible company and the foreign company. This allows the eligible company to select subcontractors without being confined to those companies mentioned under the agreement or being restricted to undertaking the activities itself if no subcontracting was mentioned under that agreement at all. Parties who are contracted by the eligible company will not be separately eligible for the new concession. [Schedule 11, item 8]

11.21 Expenditure on foreign-owned R & D must be in relation to activities carried on wholly or primarily on behalf of a foreign company. As it is a requirement of the 125 per cent R & D tax concession that expenditure is incurred on R & D activities carried on by, or on behalf of, an eligible company and not for the purpose of carrying on R & D activities on behalf of any other person, any expenditure that is deductible under the new base 100 per cent specific deduction will not be eligible for a deduction under the existing 125 per cent R & D tax concession. [Schedule 11, item 8]

11.22 The new law also prevents subcontracted eligible companies from claiming the deduction, as the R & D will be performed under an agreement between the two eligible companies. In this way, two deductions under the new concession for the same expenditure will be prevented. [Schedule 11, item 8]

11.23 Whether activities are carried on wholly or primarily on behalf of the foreign company is determined by reference to the written agreement between the eligible company and that foreign company. This agreement should make it explicit that the R & D to be performed is to be wholly or primarily on behalf of the foreign company. [Schedule 11, item 8]

11.24 The requirement for the registration of all R & D activities by the eligible company and its group members means that if companies conduct R & D on behalf of a foreign company, they must include it in the calculation of the company's increase in foreign-owned R & D. This prevents groups artificially manipulating their history of R & D expenditure to increase their allowable additional deductions under the premium 175 per cent R & D tax concession in later income years. Registration of R & D activities that do not have an R & D plan is also required in the current income year to ensure that they will be included in the notional expenditure on foreign-owned R & D in section 73RB. [Schedule 11, item 8]

Example 11.1 Company Alpha is an Australian R & D company. It is conducting a $1 million project on behalf of company Beta that is a body corporate incorporated in the United States of America (US) and is a foreign resident for the purposes of the double taxation agreement between Australia and the US. Company Beta wholly-owns company Alpha and will directly own the intellectual property and exploitation rights of the R & D project under contract. Company Alpha incurs expenditure of $600,000 to an ungrouped and unrelated Australian subcontractor, company Sigma, and also incurs expenditure itself of $400,000. Company Alpha will be able to deduct the full $1 million.If company Alpha was owned by another US incorporated company, company Omega, when it had incurred expenditure to company Sigma on behalf of company Beta then that $600,000 will not be deductible.If company Alpha itself incurs a further $400,000 in expenditure in completing the R & D project on behalf of company Beta after being acquired by company Beta and under the company's agreement, this will be deductible under the new base 100 per cent specific deduction for foreign-owned R & D.

11.25 The base 100 per cent specific deduction will apply to all foreign-owned R & D expenditure that contributes to the calculation for the purposes of the additional deduction under the premium 175 per cent R & D tax concession for expenditure on foreign-owned R & D. [Schedule 11, item 8]

11.26 The method for determining a company's deduction at the base 100 per cent level is based on the new definition of 'incremental expenditure'. The company must then exclude expenditure which is not Australian-centred R & D activities. The company should then also exclude expenditure which does not meet the requirements of paragraph (b) of the proposed subsection 73B(14C). Any total group mark-up that is determined under subsection 73B(14AB) of the ITAA 1936 is also excluded from the deduction. Noting that the definition of 'incremental expenditure', where the company commences this method of working out their base 100 per cent specific deduction, should already exclude core technology, interest and feedstock expenditure. [Schedule 11, item 8]

Non-arm's length acquisition or construction

11.27 Subsection 73B(31) of the ITAA 1936 will be extended to cover expenditure that is incurred on behalf of a foreign company and deductible under this measure. [Schedule 11, item 9]

Certificates are binding on the Commissioner

11.28 Where the IR & D Board issues certificates in relation to foreign-owned R & D expenditure this will be binding on the Commissioner of Taxation (Commissioner) when determining a company's assessment. This is consistent with the current law under which certificates issued for the existing R & D tax concession are binding on the Commissioner. [Schedule 11, item 10]

11.29 Certificates will separate R & D activities into foreign-owned and Australian-owned and also indicate if certain activities without an R & D plan would meet the definition of 'research and development activities' if an R & D plan existed for them. This will be binding on the Commissioner in respect of the R & D activities. [Schedule 11, item 10]

Entities joining a consolidated group

11.30 With the new law removing initial clawback amounts from the calculation of incremental expenditure used for the premium 175 per cent R & D tax concession it is necessary in the case of consolidated groups to treat any grants received by joining entities' as having been received by the group. As the joining entity's history of R & D expenditure is assumed by the consolidated group, it is appropriate that initial clawback amounts relating to the joining entity be removed from the calculation of the premium 175 per cent R & D tax concession. [Schedule 11, items 12 and 13]

Guaranteed returns to investors

11.31 Section 73CA of the ITAA 1936 will not apply to foreign-owned incremental expenditure incurred that contributes to the calculation of the premium 175 per cent R & D tax concession and will receive the base 100 per cent specific deduction.

Refundable R & D tax offset

11.32 The refundable R & D tax offset will not be available for deductions for either the base 100 per cent specific deduction or the additional 75 per cent deduction for foreign-owned R & D expenditure. [Schedule 11, items 16 to 23]

Incremental expenditure

11.33 The current law defines 'incremental expenditure' as R & D expenditure excluding plant items. The new law amends the definition to clarify that expenditure must first meet all the deductibility tests under the base R & D tax concession before being counted in the calculations of the eligible company's additional deductions. This applies to both Australian-owned and foreign-owned R & D expenditure. [Schedule 11, item 27]

11.34 The new definition will operate from 1 July 2007 onwards to incremental expenditure counted in the calculations for both the current premium 175 per cent R & D tax concession and the new 175 per cent concession for foreign-owned R & D. Adjustments to previous income year tax returns will not be required. The R & D expenditure history used by claimants after 1 July 2007 will have to reflect this new definition of incremental expenditure. [Schedule 11, item 27]

R & D spend

11.35 The definition of 'R & D spend' is used as the basis for calculating an eligible company and its group members' adjustment balance in the section 73V of the ITAA 1936. This definition has been amended to encompass the same amounts that are taken into account in the calculations in sections 73RA to 73RE. Initial clawback amounts will reduce the amounts that are taken into account when calculating the adjustment balance. [Schedule 11, item 29]

Eligibility for the premium 175 per cent R & D tax concession

11.36 Eligibility for the additional deduction for the increase in expenditure on Australian-owned R & D in the premium 175 per cent R & D tax concession will be unchanged. Eligibility for the foreign-owned component will not establish eligibility for the Australian-owned R & D component and vice versa. [Schedule 11, item 34]

11.37 Companies will be eligible for the additional deduction for the increase in expenditure on foreign-owned R & D in the premium 175 per cent R & D tax concession if they could deduct, or an eligible group member could deduct, under the base 100 per cent specific deduction in the current claim year and each of the previous three R & D expenditure history years. Transitional arrangements will deem companies to have deducted under the base 100 per cent specific deduction in each of the three income years prior to the particular company's first full income year commencing after 1 July 2007. This does not preclude a company from qualifying with three previous nil expenditure years. [Schedule 11, item 34]

Immediate access with a zero rolling average

11.38 Foreign companies that establish a new presence in Australia after the commencement of this measure will have immediate access to the premium 175 per cent R & D tax concession for the additional expenditure on foreign-owned R & D expenditure with a nil expenditure year for each of the prior three years. Therefore, in the first income year all R & D expenditure will attract an additional deduction under the extended premium 175 per cent R & D tax concession. [Schedule 11, item 34]

11.39 The nil expenditure year will only be available if neither the eligible company nor any grouped eligible companies existed in that year or the 10 preceding years. Also, none of the following carried on business in Australia in the nil expenditure year or the 10 preceding years:

·
a foreign company grouped under section 73L with the eligible company at any time during the Y0, Y -1, Y -2, or Y -3 [1] years of income;
·
a foreign company grouped under section 73L with any section 73R group member of the eligible company; or
·
a person who was grouped under section 73L with the relevant foreign company.

[Schedule 11, item 34]

11.40 It is possible for a newly established company to have three nil expenditure years and qualify for the extended premium 175 per cent R & D tax concession on this basis for foreign-owned R & D expenditure. However, if in the next income year the newly established company becomes grouped with an Australian company that did exist in the nil expenditure year, or at some point in the previous 10 years, it will not qualify for the same nil expenditure year. In that subsequent year the company will be ineligible. [Schedule 11, item 34]

Example 11.2 Widget Pty Ltd is incorporated in Australia on 1 July 2007. Widget is wholly-owned up to and including 30 June 2008, by foreign company, Acme Pty Ltd, incorporated on 1 July 2007 in the US. Acme Pty Ltd has no other group members and has not experienced any change in control since incorporation. Widget Pty Ltd conducts Australian-centred R & D activities on Acme Pty Ltd's behalf and has incurred expenditure for the purpose of carrying on those activities during the year ending 30 June 2008 for which it can claim a deduction under subsection 73B(14C) for the 2007-08 income year. On 1 March 2008, Widget Pty Ltd acquires Oz Pty Ltd, a company incorporated in Australia on 1 July 1985. On 1 June 2008, Widget Pty Ltd sells Oz Pty Ltd to an unrelated third party. During the period that it was controlled by Widget Pty Ltd, Oz Pty Ltd incurred expenditure on R & D activities for which it could claim a deduction under subsection 73B(14).To be eligible for the extra deduction for an increase in expenditure on foreign-owned R & D, Widget Pty Ltd must meet the conditions in subsection 73QB(2) for the purposes of paragraph 73QB(1)(b) in relation to each of the Y -1 (the year before the current claim year), Y -2 (the year two years before the claim year) and Y -3 (the year three years before the claim year) years of income.Widget Pty Ltd did not itself exist during Y -1 or any earlier years. However, it must consider whether any other group member (under section 73R) existed at any time during Y -1 (or other nil expenditure year) or 10 immediately preceding years. Widget Pty Ltd must determine its group members in accordance with section 73R. Step 1 As at the last day of the Y0 year of income Acme Pty Ltd is grouped with the eligible company. Therefore Acme Pty Ltd and Widget Pty Ltd are primary group members. Step 2 Widget Pty Ltd and Acme Pty Ltd both have a group membership period of 1 July 2007 to 30 June 2008. Step 3 Oz Pty Ltd is grouped with a primary group member during its group membership period (both Widget Pty Ltd and Acme Pty Ltd) and is therefore a secondary group member. Step 4 and Step 5 Oz Pty Ltd has a group membership period of 1 March 2008 to 30 May 2008. Oz Pty Ltd is a group member of Widget Pty Ltd (under section 73R) because Oz Pty Ltd could deduct an amount under subsection 73B(14). As Oz Pty Ltd existed during each of the Y -1, Y -2 and Y -3 years of income (the nil expenditure years), Widget Pty Ltd will not meet the conditions of paragraph 73QB(2)(a).

11.41 The qualification of carrying on a business is intended to prevent those foreign companies that have not incorporated a company in Australia from receiving an advantage by the mere fact they did not incorporate a company. The nil expenditure years are intended to exclude those companies who did conduct R & D or had held any presence in Australia previously. [Schedule 11, item 34]

11.42 A year in which the eligible company existed at any time, including the year in which the company was incorporated, cannot be a nil expenditure year of the eligible company. This means that the year of incorporation of the eligible company and later years cannot be nil expenditure years. Therefore it will be impossible for companies to have a nil expenditure year in relation to an income year after which they made, or were able to make, a deduction for foreign-owned R & D expenditure. [Schedule 11, item 34]

11.43 In the income year following the establishment of a new presence in Australia the company will have a history of the amount spent in the prior year and two nil expenditure years. Therefore, the rolling three-year average in this income year would be the expenditure in the prior year divided by three. In subsequent years, nil expenditure years will be replaced with the actual expenditure by a company in the previous claim year. [Schedule 11, item 34]

Group membership

11.44 The amendments to subsection 73R(1) maintain the status quo for companies conducting Australian-owned R & D. They are group members under the same circumstances. [Schedule 11, item 35]

11.45 That is, for Australian-owned R & D a company is a group member if it deducted or received a commercial ready grant or start grant in any of the relevant years that are the current claim year and the three prior income years. [Schedule 11, item 35]

11.46 Companies that conduct R & D on behalf of a foreign company under the extended premium R & D tax concession may now be group members for the purposes of calculating the premium R & D tax concession. All companies in the group who incur foreign-owned R & D expenditure must register in order for eligible companies in the group to be eligible to deduct any amount under the base 100 per cent specific deduction. [Schedule 11, item 35]

11.47 The fact that a company is not eligible for an additional deduction because they did not claim any deductions in the current year does not mean the expenditure of that company in its group membership period is not counted in the calculation of the premium 175 per cent R & D tax concession. The expenditure incurred by that company in its group membership period will count in the group calculations even though the company does not qualify for an additional deduction. [Schedule 11, items 35 and 37]

Example 11.3 Company ABC conducts R & D activities. In relation to these activities, company ABC has incurred expenditure in the current year, and each of the three immediately preceding years, that is eligible for a deduction for Australian-owned R & D. The expenditure deductible in each year was incremental expenditure and was incurred during the group membership period of company ABC.Company ABC is grouped under section 73R with company XYZ. Company XYZ previously conducted Australian-centred R & D activities and incurred expenditure, during its group membership period, on foreign-owned R & D for which it deducted an amount under subsection 73B(14C).Company ABC has to calculate its entitlement to the extra deduction for an increase in expenditure on Australian-owned R & D. It must include in this calculation the expenditure on foreign-owned R & D incurred by company XYZ during its group membership period.

  Current claim year = Y0 Y -1 Y -2 Y -3
Company ABC $100 $80 $70 $60
Company XYZ - - $30 -
The group has an increase in expenditure of $30 on Australian-owned R & D. However, the expenditure on foreign-owned R & D incurred by company XYZ must be included in the calculation of the additional deduction for the increase in expenditure on Australian-owned R & D. This is the case even though no group member has incurred expenditure on foreign-owned R & D in the current claim year. The group has a decrease of $10 in expenditure on foreign-owned R & D. Therefore, company ABC will get an extra deduction for an increase in expenditure on Australian-owned R & D at the rate of 50 per cent of $20.The group will not be eligible for the extra deduction for an increase in expenditure on foreign-owned R & D as no group member satisfied the conditions of section 73QB.

Calculation and distribution of the premium 175 per cent R & D tax concession deduction

11.48 An eligible company must determine its entitlement to an additional deduction under the premium 175 per cent R & D tax concession by using the new method statements. The results of these method statements will form the basis for calculating the eligible company's share of the additional deduction for Australian-owned and foreign-owned R & D. [Schedule 11, item 37]

11.49 A company conducting only Australian-owned R & D in the current year and the previous three years will not have to make the calculations in proposed sections 73RB and 73RD as they relate solely to foreign-owned R & D. The outcomes of these calculations can be taken to be zero where they are used in calculating the adjusted increase in R & D for the group, and calculating the eligible company's share of the Australian-owned part of the adjusted increase in expenditure on R & D, by the group. [Schedule 11, item 37]

11.50 Grants reduce expenditure to the extent that they are attributable to either Australian-owned or foreign-owned incremental expenditure. This implies that if a grant is awarded wholly for a specific R & D project it is apportioned to incremental and non-incremental expenditure in the same proportion as the R & D project's proportion of incremental and non-incremental expenditure. [Schedule 11, item 37]

11.51 This is only prospectively applied to grants received after the commencement of this measure. As a company's R & D expenditure history is calculated in the current claim year this change will affect the R & D expenditure history of claimants from 1 July 2007 onwards.

11.52 For foreign-owned R & D, R & D that does not have an R & D plan will be included in the history years of the company for the purposes of calculating the increase or decrease in foreign-owned R & D expenditure. This will maintain an incentive for all companies conducting foreign-owned R & D to be covered by an R & D plan. R & D expenditure that contributes to an additional deduction in the claim year must be covered by an R & D plan. [Schedule 11, item 37]

11.53 There will be no incentive for groups to shift ownership of R & D results to manipulate the premium deduction that can be obtained for either Australian-owned or foreign-owned R & D expenditure. Total R & D will be pooled in determining an eligible company's deduction. If a group increased expenditure on Australian-owned R & D by the same amount they decreased foreign-owned R & D there would be no real increase in expenditure and no additional deduction could be obtained under the premium 175 per cent R & D tax concession. [Schedule 11, item 37]

Example 11.4 Company ABC is an Australian company and is grouped with company XYZ, which is also an Australian company. In this example company ABC and company XYZ are only conducting Australian-owned R & D. Neither company is conducting foreign-owned R & D. The entitlements to the premium 175 per cent R & D tax concession will only be different to the current law if a company receives a grant in an income year starting on or after 1 July 2007. Section 73RA: Calculating the increases in expenditures on Australian-owned R & D by eligible companies Subsection 1: Increase in expenditure on Australian-owned R & D by the eligible company Step 1

The incremental expenditure on Australian-owned R & D by company ABC and company XYZ for years Y0 to Y - 3
  Current claim year = Y0 Y -1 Y -2 Y -3
Company ABC $100 $35 $85 $75
Company XYZ $90 $100 $95 $90
Step 2 and Step 3 Company ABC: received a grant for Australian-owned R & D that is attributable to incremental expenditure of $5 in year Y0 (current claim year). Therefore, the R & D expenditure in Y0 is reduced to $90 (100 - (2 × 5)).Company XYZ: did not receive any grants for Australian-owned R & D that is attributable to incremental expenditure.
Reduced expenditure on Australian-owned R & D by company ABC and company XYZ
  Current claim year = Y0 Y -1 Y -2 Y -3
Company ABC $90 $35 $85 $75
Company XYZ $90 $100 $95 $90
Step 4 and Step 5 Company ABC: Add up the reduced expenditure on Australian-owned R & D for years Y0 to Y -3, which equals 195 ($35 + $85 + $75). Divide by 3 to get $65. This amount is company ABC's rolling three-year average for Australian-owned R & D.Company XYZ: Add up the reduced expenditure on Australian-owned R & D for years Y0 to Y -3, which equals 285 ($100 + $95 + $90). Divide by 3 to get $95. This amount is company XYZ's rolling three-year average for Australian-owned R & D. Step 6 Company ABC: Change in expenditure on Australian-owned R & D by the eligible company = $25 (90 - 65)Company XYZ: Change in expenditure on Australian-owned R & D by the eligible company = -$5 (90 - 95) Step 7 Company ABC: The increase in expenditure on Australian-owned R & D by the eligible company = $25Company XYZ: The increase in expenditure on Australian-owned R & D by the eligible company = $0 Subsection 2: Calculating the total increase in expenditure on Australian-owned R & D by the eligible companies in the group Step 1 and Step 2 Add together the two amounts worked out in step 7 of subsection 1.Total increase in expenditure on Australian-owned R & D by the eligible companies in the group = $25. Section 73RB: Calculating the increases in expenditure on foreign-owned R & D by eligible companies Since neither company ABC nor company XYZ conduct foreign-owned R & D, this section can be treated to be $0. Section 73RC: Calculating the net increase in expenditure on Australian-owned R & D by the group Step 1 Take the results of step 6 of subsection 73RA(1) which is $25 for company ABC and -$5 for company XYZ. Step 2 Add these together to get $20. This is the net increase in expenditure on Australian-owned R & D by the group. Section 73RD: Calculating the net increase on foreign-owned R & D by the Group Since neither company ABC nor company XYZ conduct foreign-owned R & D, this section can be treated to be $0. Section 73RE: Calculating the adjusted increase in expenditure on R & D by the group Step 1, Step 2 and Step 3 Add together the results of step 6 of subsection 73RA(1) for all companies, which is $20, with the results of subsection 73RB(1), which is $0, to get a total change in R & D expenditure of $20. Step 4 The adjustment amount required for Y0 (AA0) is $9 (refer to section 73T of the ITAA 1936). There is no adjustment amount for Y-1 (AA-1) therefore the total adjustment balance equals $9 (refer to section 73V of the ITAA 1936).Subtract the adjustment balance from the total change in R & D (Step 3) to get the adjusted increase in expenditure on R & D by the group, which equals $11. Subsection 73QA(3): Calculate each company's additional deductions The eligible company's share of the Australian-owned part of the adjusted increase in expenditure on R & D by the group can be calculated by:

The eligible company's share of the Australian-owned part of the adjusted increase in expenditure on R & D by the group

Company ABC: The deduction for Australian-owned R & D is:

25/25 * 20/(20 + 0) * 11 = 11

Therefore, for company ABC, the increase in expenditure on Australian-owned R & D eligible for the extra 50 per cent deduction is $11.Company XYZ: The deduction for Australian-owned R & D is:

0/25 * 20/(20 + 0) = 0

Therefore, for company XYZ, the increase in expenditure on Australian-owned R & D eligible for the extra 50 per cent deduction is $0.

Example 11.5 Company ABC and company XYZ belong to the same group for the purposes of the proposed subsection 73R(1). In this example, company ABC and company XYZ are conducting both Australian-owned R & D and foreign-owned R & D. They must work out their entitlements as a group under both the international premium and the 175 per cent premium. Section 73RA: Calculating the increases in expenditure on Australian-owned R & D by eligible companies Subsection 1: Increase in expenditure on Australian-owned R & D by the eligible company Step 1

The incremental expenditure on Australian-owned R & D by company ABC and company XYZ for years Y0 to Y -3
  Current claim year = Y0 Y -1 Y -2 Y -3
Company ABC $80 $100 $100 $100
Company XYZ $100 $60 $120 $90
Step 2 and Step 3 Company ABC and company XYZ did not receive any grants for Australian-owned R & D that is attributable to incremental expenditure. Therefore, the reduced expenditure on Australian-owned R & D is as per the Table in step 1. Step 4 and Step 5 Company ABC: Add up the reduced expenditure for Y -1, Y -2, and Y -3, which equals 300 ($100 + $100 + $100). Divide by 3 to get $100. This amount is company ABC's rolling three-year average for Australian-owned R & D.Company XYZ: Add up the reduced expenditure for Y -1, Y -2, and Y -3, which equals 270 ($60 + $120 + $90). Divide by 3 to get $90. This amount is company XYZ's rolling three-year average for Australian-owned R & D. Step 6 Subtract step 5 from the Y0 reduced expenditure on Australian-owned R & D by the eligible company.Company ABC: Change in expenditure on Australian-owned R & D by the eligible company = -$20Company XYZ: Change in expenditure on Australian-owned R & D by the eligible company = $10 Step 7 Company ABC: The increase in expenditure on Australian-owned R & D by the eligible company = $0Company XYZ: The increase in expenditure on Australian-owned R & D by the eligible company = $10 Subsection 2: Calculating the total increase in expenditure on Australian-owned R & D by the eligible companies in the group Add together the two amounts worked out in step 7 of subsection 1.Total increase in expenditure on Australian-owned R & D by the eligible companies in the group = $10 Section 73RB: Calculating the increases in expenditure on foreign-owned R & D by eligible companies
Expenditure on foreign-owned R & D
  Current claim year = Y0 Y -1 Y -2 Y -3
Company ABC $100 $70 $80 $60
Company XYZ $100 $70 $90 $60
Step 2 Company ABC has received a grant for $5 in Y0 for foreign-owned R & D. This amount is fully attributable to foreign-owned incremental expenditure so it is doubled ($10) and removed from the company's current year amount. Step 3 Company ABC
  Current claim year = Y0 Y -1 Y -2 Y -3
Foreign-owned R & D $100 $70 $80 $60
Grant for foreign-owned R & D $5 $0 $0 $0
Reduced foreign-owned R & D $90 $70 $80 $60
Company XYZ has not received any grants, so no adjustment to the amounts in step 1 is required.Step 4Company ABC had an R & D plan for all activities conducted in each history year. Its notional expenditure on foreign-owned R & D for Y -1, Y -2, and Y -3 is the same as the reduced expenditure on foreign-owned R & D.Company XYZ had R & D expenditure not covered by an R & D plan equally $10 in each of Y -2 and Y -3. Notional expenditure on foreign-owned R & D is therefore as in the following table. Company XYZ
  Y -1 Y -2 Y -3
Notional foreign-owned $70 $100 $70
Step 5 and Step 6 Neither company received a grant in a previous income year so they do not reduce notional foreign-owned expenditure on R & D. Step 7 and Step 8 Company ABC: Add up the reduced notional expenditure for Y -1, Y -2, and Y -3 on foreign-owned R & D, which equals $210 ($70 + $80 + $60). Divide by 3 to get $70. This amount is company ABC's rolling three-year average for foreign-owned R & D.Company XYZ: Add up the reduced notional expenditure Y -1,Y -2, and Y -3 on foreign-owned R & D, which equals $240 ($70 + $100 + $70). Divide by 3 to get $80. This amount is company XYZ's rolling three-year average for foreign-owned R & D. Step 9 Company ABC: Change in expenditure on foreign-owned R & D by the eligible company = $20Company XYZ: Change in expenditure on foreign-owned R & D by the eligible company = $20 Step 10 For both companies the change is positive so the increase in expenditure on foreign-owned R & D by each eligible company is the same as the results in step 9. Subsection 2: Calculating the total increase in expenditure on foreign-owned R & D by the eligible companies in the group Total increase in expenditure on foreign-owned R & D by the eligible companies in the group = $40. Section 73RC: Calculating the net increase in expenditure on Australian-owned R & D by the group Step 1 Take the results of step 6 of subsection 73RA(1), which is -$20 for company ABC and $10 for company XYZ. Step 2 Add these together to get -$10. As it is negative the net increase in expenditure on Australian-owned R & D by the group equals $0.Section 73RD: Calculating the net increase on foreign-owned R & D by the group Step 1 Take the results of step 9 of subsection 73RB(1) which is $20 for company ABC and $20 for company XYZ. Step 2 The net increase in expenditure on foreign-owned R & D by the group is $40.Section 73RE: Calculating the adjusted increase in expenditure on R & D by the group Step 1, Step 2 and Step 3 Add together the results of step 6 of subsection 73RA(1) for all companies which is -$10, with the results of step 9 of subsection 73RB(1) which is $40, to get a total change in R & D expenditure of $30. Step 4 The adjustment amount required for Y0 (AA0) is $20 (refer to section 73T of the ITAA 1936). There is no adjustment amount for Y-1 (AA-1) therefore the total adjustment balance equals $20 (refer to section 73V of the ITAA 1936).Subtract the adjustment balance from the total change in R & D (Step 3) to get the adjusted increase in expenditure on R & D by the group, which equals $10. Section 73QA: Calculate the extra deduction for increase in expenditure on Australian-owned R & D The eligible company's share of the Australian-owned part of the adjusted increase in expenditure on R & D by the group can be calculated by:

Company ABC: The deduction for Australian-owned R & D is:

0/10 * 0/(0 + 40) * 10 = 0

So company ABC gets an additional deduction of 50 per cent for $0 of expenditure.Company XYZ: The deduction for Australian-owned R & D is:

10/10 * 0/(0 + 40) * 10 = 0

So company XYZ gets an additional deduction of 50 per cent for $0 of expenditure.Section 73QB: Calculate the extra deduction for increase in expenditure on foreign-owned R & DThe eligible company's share of the foreign-owned part of the adjusted increase in expenditure on R & D by the group can be calculated by:

The eligible company's share of the foreign-owned part of the adjusted increase in expenditure on R[amp   ]D by the group

Company ABC: The deduction for foreign-owned R & D is:

20/40 * 40/(0 + 40) * 10 = 5

So company ABC gets an additional deduction of 75 per cent for $5 of expenditure.Company XYZ: The deduction for foreign-owned R & D is:

20/40 * 40/(0 + 40) * 10 = 5

So company XYZ gets an additional deduction of 75 per cent for $5 of expenditure.

11.54 The distribution of an additional deduction includes a number of different terms determined under sections 73RA to 73RE. If, in calculating the eligible company's share of the Australian-owned part of the adjusted increase in expenditure on R & D by the group in section 73QA, and the corresponding 'foreign-owned research and development' definition in section 73QB, the denominator of the first two terms is zero then the equation will be undefined. In this case, there is no premium deduction to be distributed to companies in the group. [Schedule 11, item 37]

Adjustment amounts and adjustment balance

11.55 The current law deems the adjustment amounts and the relevant adjustment balance to be zero when the company is eligible to claim an additional deduction in Y-1 or Y-2. To reflect the original policy intent of the adjustment balance and adjustment amounts these provisions will now refer to the eligible company being able to deduct, which will clarify that these amounts are only zero when an additional deduction was received by the eligible company in the relevant income year. [Schedule 11, items 39 and 41]

11.56 The adjustment balance will reduce the total increase in R & D (both Australian-owned and foreign-owned) by the amount of the adjustment balance. The distribution of additional deductions to eligible companies will never total an amount greater than the adjusted increase in total R & D expenditure. In this way, the adjustment balance will have an effect if total R & D expenditure in any history year, or the claim year, is less than 80 per cent of the prior history year. [Schedule 11, items 39 and 41]

Amendments to the Industry Research and Development Act 1986

For the benefit of the Australian economy

11.57 The current law describes the benefit to the Australian economy in terms of the exploitation of the R & D activities. In determining this, the IR & D Board is required to consider that profits or gains to residents of Australia accruing directly from the R & D activities are commensurate with the expenditure involved in carrying out the activity in Australia. [Schedule 11, item 51]

11.58 The current law is amended so that the undertaking of R & D activities in Australia meets the criteria of being for the benefit of the Australian economy. Similarly, overseas activities undertaken by an eligible company, for which the IR & D Board has granted a provisional certificate, will be taken to be for the benefit of the Australian economy. [Schedule 11, item 51]

11.59 The certificates currently issued by the IR & D Board in relation to the exploitation of results, or Australian content will now reflect that it is sufficient for R & D activities to be undertaken in Australia, rather than the more stringent requirement that the R & D be exploited for the benefit of Australia, to be for the benefit of the Australian economy. [Schedule 11, items 72 and 73]

Registration

11.60 The current law requires that for an eligible company to claim the R & D tax concession, the company must register annually its R & D activities for each income year, with the IR & D Board. It is intended that this requirement will apply equally to companies undertaking foreign-owned R & D. Accordingly the existing section 39J is amended to include Australian-centred activities undertaken by an eligible Australian company. [Schedule 11, item 62]

11.61 Amendments to the current law will also reflect the information required to register foreign-owned R & D. This includes information required in a registration application, the ability for companies to advance register and the grounds on which the IR & D Board is entitled to refuse the registration of an eligible company. [Schedule 11, item 62]

Certificates for Australian-centred R & D activities

11.62 The IR & D Board, under the new law, will be able to certify if activities are Australian-centred R & D activities. This certificate may be issued by the IR & D Board to the Commissioner or where it is requested, by the Commissioner from the IR & D Board. If the IR & D Board determines that the activities are not Australian-centred R & D activities it must issue a certificate to the eligible company stating the reasons. [Schedule 11, item 72]

11.63 As part of this certification, the IR & D Board will determine if directly related activities have the dominant purpose of supporting systematic, investigative and experimental R & D activities conducted in Australia. [Schedule 11, item 72]

11.64 Similarly, the IR & D Board will be able to certify if activities are, or were not, Australian-centred R & D activities apart from the existence of an R & D plan. Activities having the character and nature of R & D activities will be included in the calculation of a company's foreign-owned R & D expenditure history even if no R & D plan exists for the activities. [Schedule 11, item 72]

Record-keeping

11.65 For the purpose of performing any of its functions, the IR & D Board has the power under section 39N to require a registered company to provide particular information relating to activities carried on by, or on behalf of, the company. Failure to provide the information to the IR & D Board may result in a notice to the Commissioner resulting in denial of a claim for the R & D tax concession in relation to the activities. [Schedule 11, item 66]

11.66 Given that specific information relating to activities carried out on behalf of an overseas company may not easily be identified by the IR & D Board and may not relate to a registered company, section 39N is to be amended to avoid doubt that where the IR & D Board reasonably requires information it can identify the information by reference to any means it determines. That is, the information might be identified by reference to the particular function of the IR & D Board (eg, assessing an application) or by other criteria (eg, the IR & D Board might ask a company to provide proof, whatever documentary form that proof takes, of its eligibility. [Schedule 11, items 66 and 75]

Application and transitional provisions

11.67 Deductions will apply to expenditure incurred in a company's first full income year commencing after 30 June 2007 and later income years. [Schedule 11, item 78]

Transitional provisions for adjustment amounts and adjustment balances

11.68 As the provisions dealing with the adjustment amounts and the adjustment balance are being amended to refer to new provisions, transitional provisions will be in place to deem deductions under the current law to be deductions as if they were made under the new law. This ensures that adjustment amounts and the adjustment balance will continue to give an appropriate outcome for previous income years. [Schedule 11, item 79]

Transitional deemed history

11.69 To allow immediate access to the premium 175 per cent R & D tax concession by eligible companies that had a presence in Australia before the commencement of this measure, these companies will be deemed to have deducted an amount in the three years prior to the first income year after the commencement of this measure. This deemed expenditure history is worked out in respect of an eligible company's 100 per cent specific deduction in the first full income year after the commencement of this measure. The 100 per cent specific deduction is the expenditure incurred on foreign-owned R & D prior to the removal of grant expenditure from the calculation of the premium deduction. Therefore, the deemed history as set out in Table 11.1 does not necessarily result in an additional deduction. [Schedule 11, item 80]

Table 11.1

Income year before the company's first full income year commencing after 30 June 2007 Income year that is two years before the company's first full income year commencing after 30 June 2007 Income year that is three years before the company's first full income year commencing after 30 June 2007
The company is treated as having deducted 90 per cent of the eligible expenditure incurred in the first income year prior to any initial clawback amount being applied. The company is treated as having deducted 80 per cent of the eligible expenditure incurred in the first income year prior to any initial clawback amount being applied. The company is treated as having deducted 70 per cent of the eligible expenditure incurred in the first income year prior to any initial clawback amount being applied.

Example 11.6 Company Aqua is an established Australian company owned by company Beige (company Beige is a resident of the United Kingdom of Great Britain and Northern Ireland). Company Aqua has conducted R & D on behalf of company Beige since it was established. Company Aqua has an accounting period that commences on 1 July and ends on 30 June.In the 2007-08 income year, company Aqua was entitled to deduct $100 under new subsection 73B(14C) of the ITAA 1936 for expenditure incurred on foreign-owned R & D. Company Aqua meets the eligibility requirements in paragraph 73QB(1)(a) and so will be treated as having deducted $90, $80 and $70 in the three previous years respectively.If company Aqua received a grant attributable to foreign-owned incremental expenditure of $5, an amount of twice the size of the grant will be removed from expenditure that can be counted towards the increase in foreign-owned R & D for the company.Expenditure by company Aqua in 2007-08, after removing the initial clawback amount, is $90. An additional 75 per cent deduction for $10 of expenditure will be available in the 2007-08 income year.

Consequential amendments

11.70 References to amended provisions will be updated in both the IR & D Act and the income tax law. The income tax law references to the premium 175 per cent R & D tax concession will be amended to remove reference to the existing section 73Y and replacing them with sections 73QA and 73QB. References in the IR & D Act will also be updated to reflect the new income tax law provisions. [Schedule 11, items 38, 43 to 49, 52 to 55 and 61]


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