Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)
Research and Development Expenditure
Purpose of amendment: This Bill will amend the provisions of the Income Tax Assessment Act 1936 (the ITAA) relating to the research and development (R & D) tax concession to:
- retain indefinitely the deduction for the research and development expenditure at the rate of 150 per cent;
- remove the $10 million limit applying to pilot plant; and
- deny a deduction for R & D expenditure to companies involved in syndicates, or other financing schemes, which include government bodies or their associates where investors are guaranteed a return on their investment.
Date of Effect:
- the 1993-94 year of income; Amendment (b):
- plant acquired or commenced to be constructed on or after 19 August 1992: Amendment (c):
- companies which are registered or seeking registration under sections 39J or 39P of the Industry Research and Development Act 1986 on or after the 19 August 1992.
Purpose of amendment: This Bill will amend the Industry Research and Development Act 1986 (the IR & D Act) to provide the Industry Research and Development Board with:
- increased discretionary power over finance schemes to declare such a scheme to be an ineligible finance scheme;
- the authority and duty to develop and publish guidelines outlining the criteria by which this discretionary authority will be exercised in relation to finance schemes; and
- the authority to deny registration to a company, or to issue a certificate that will have the effect of denying tax deductibility to R & D expenditure, where it is of the opinion that an ineligible finance scheme exists in relation to particular research and development activities.
Date of Effect: 19 August 1992 - except for companies which:
- were or are registered under section 39J or section 39P; or
- applied for registration under either section 39J or section 39P; or
- applied for or were given an advance eligibility ruling;
between 31 March 1992 to 10 June 1992 (ie, within the "interim period").
The R & D concession is available to an eligible company for expenditure incurred, on or after 1 July 1985, on qualifying research and development in Australia. The concession is in the form of a 150 per cent deduction for expenditure on qualifying R & D activities. The concession was to be reduced to 125 per cent for expenditure incurred after 1 July 1993.
Expenditure on the acquisition or construction of plant (including pilot plant) that is used exclusively on R & D activities qualifies for deduction at the increased rate (ie, 150 per cent). The cost of such plant, increased by the relevant acceleration factor, is deductible over three years, subject to the R & D expenditure threshold.
Pilot plant is plant which is used for experimental purposes and which is not for use in commercial production (subsection 73B(1)). However, the cost of pilot plant that can be taken into account for the purposes of the R & D concession is limited to $10 million (subsection 73B(6)). Expenditure on pilot plant that exceeds $10 million can be depreciated under other provisions of the Act after the three years. That is, the cost of the pilot plant in excess of $10 million is depreciable after the deduction has been allowed under the R & D concession.
Under the R & D tax concession, syndicates can be formed to finance R & D expenditure. Many syndicates are structured in a way that ensures that investors are guaranteed at least a return on their original investment. Where research funded by a syndicate is undertaken on the basis that the investors are not at risk, the allowable deduction for such expenditure is limited to 100 per cent of that expenditure (section 73CA).
Where a tax-exempt researcher undertakes R & D activities for a syndicate and guarantees the syndicate a return on its investment, the syndicate derives a tax benefit because of the tax-exempt status of the researcher.
Under the proposed amendments qualifying R & D expenditure incurred after 30 June 1993 will be deductible at the maximum rate of 150 per cent indefinitely. This will be achieved by amending:
- the definition of "deduction acceleration factor" (the term used to describe the factor by which qualifying expenditure on R & D activities is multiplied to determine the amount of the deduction allowable) (subsection 73B(1)); and
- provisions relating to deductions allowable for contracted expenditure (subsection 73B(13)) and plant first used before the 1993-94 year of income (subsection 73B(15B)).
The $10 million limit on the cost of an item of pilot plant used exclusively for R & D purposes (subsection 73B(6)) will be removed. Thus pilot plant will qualify for the R & D concession on the same basis as other plant where the pilot plant:
- is acquired under a contract entered into on or after 19 August 1992; or
- the construction of which has commenced on or after 19 August 1992; or
- a contract was entered into on or after 19 August 1992 for the construction of pilot plant;
In the case of pilot plant acquired before 19 August 1992 the cost of the pilot plant will continue to be taken to be $10 million for the purposes of the R & D concession [Subclause 28(2), new subsection 73B(6)].
The Bill will amend the Principal Act to deny a company a deduction for expenditure on R & D activities that would otherwise be allowable (section 73B) where the following conditions are satisfied:
- the company has entered into a contract with the Commonwealth, a State or Territory or an authority of the Commonwealth, of a State or of a Territory or an associate of the above; and
- under the contract the company will receive a guaranteed return (section 73CA), directly or indirectly, from the Commonwealth, a State or Territory or an authority of the Commonwealth, a State or a Territory or an associate of the above [Clause 30, new section 73CB].
This new section will be construed as part of section 73B, which is the provision under which the R & D tax concession is provided [Clause 30, new subsection 73CB(1)].
Paragraph 73CB(2)(b) and subsection 73CB(3) tie in the concept of not being at risk (for the contracting company) to the same criteria as those under subsection 73CA(5). Broadly, a company will not be at risk if it could reasonably have expected a return or reimbursement for all or part of its investment [Clause 30, new paragraph 73CB(2)(b) and subsection 73CB(3)].
Universities, other educational institutions and research institutions that are owned by the public sector, will be taken to be authorities of the Commonwealth, a State or Territory, and therefore will be a government body, for the purposes of determining whether a deduction for R & D expenditure is allowable [Clause 30, new subsection 73CB(4)].
The meaning of the term "associate" (defined in section 73B(1) to have the same meaning as in 26AAB) will be extended to government bodies. Hence, Commonwealth, State and Territory authorities will be taken to be associates of their respective governments ( which include government departments, commissions etc) and of other authorities of the same government. In the same way, the respective governments will be associates of the respective Commonwealth, State of Territory authority [Clause 30, new subsection 73CB(5)].
For the purposes of the R & D tax concession "government body" means the Commonwealth, State or a Territory government, government department or commission etc., or an authority (extended definition) of the Commonwealth, a State or a Territory [Clause 30, new subsection 73CB(6)].
The Commissioner is to be able to go back at any time and amend an assessment under section 170 of the ITAA where the operation of section 73CB is attracted [Clause 31].
Section 73CB will apply on or after 19 August 1992 to companies making an application under section 39J or 39P of the IR & D Act seeking registration. Also, it will apply to companies making an application or registered prior to 19 August 1992 under section 39J or 39P and who enter into, or vary, a finance scheme on or after 19 August 1992 [Clause 32].
If a government body, or an associate of a government body
- undertakes contract research and development activities for a company or companies on an arms length basis; and
- there is no direct or indirect causal link between the government body and the guaranteed return;
new section 73CB will not operate to deny the deductions otherwise allowable for qualifying R & D expenditure. Even though new section 73CB will not automatically apply to the particular arrangements to deny the deduction, the arrangements will be required to satisfy the eligibility requirements contained in the new guidelines (see later notes under "guidelines") relating to finance schemes to be developed by the I R & D Board.
In summary, where any guarantee (including a guarantee in relation to core technology expenditure) comes into existence or is varied on or after 19 August 1992, and the researcher is a government body or an associate of a government body, then the company or companies involved in the R & D financing arrangement would be denied tax deductions under section 73B in relation to the R & D activities subject to the guarantee. (The term "guarantee is used in the sense of the company not being "at risk" in respect of the expenditure in the terms of section 73CA.) However, these provisions do not affect the deductibility of any expenditure or depreciation under other provisions of the Act.
A government body (which may or may not be taxable) contracts to do R & D for a private syndicate on or after the 19 August 1992. It sells core technology to the syndicate. The government body enters into an agreement that if the R & D it performs is not successful it, or an associate, must buy back the core technology as well as any 'value added' to the core technology. The price at which the core technology is bought back need not be the entire amount of R & D expenditure incurred by the syndicate. This arrangement would attract the operation of the new section 73CB and the whole of the R & D expenditures claimed (core technology, contract expenditure etc.) would not be allowable under section 73B.
Section 39P of the IR & D Act authorises the IR & D Board to jointly register two or more companies in respect of a year of income in relation to a proposed project or projects. Where the Board refuses to register the company no deduction is allowable for the R & D expenditure (section 73B(10) of the ITAA).
Under the amendments joint registrations of companies under section 39P of the IR & D Act will relate to specific projects. Hence when the Board refuses to register a particular project, the other projects that are registered or to be registered by a company will not be affected by one project's disqualification [Paragraph 28(3)(a), new subsection 73B(10)] .
The IR & D Board has the authority (under the IR & D Act) to issue a certificate to the Commissioner (under section 39M) where the Board is of the opinion that the company or jointly registered companies have not exploited the R & D results
- on normal commercial terms; or
- in a manner that is of benefit to the Australian economy; or
- the R & D activities do not have adequate Australian content.
Where a certificate is issued to the Commissioner, a deduction for expenditure in relation to R & D activities referred to in the certificate is not allowable (subsection 73B(33) of the ITAA).
Under the proposed amendments to the IR & D Act, the IR & D Board will be able to issue a certificate to the Commissioner under a new provision, section 39MA, to disallow deductions for R & D expenditure where an ineligible finance scheme (see later notes) exists in relation to those R & D activities. The deduction will be able to disallowed on the basis of a certificate issued under section 39MA of the IR & D Act (subsection 73B(33B)). Such deductions will not be allowable for all the R & D activities described in the certificate issued by the Board. The deductions will not just be disallowed from the time the company or companies were given notice by the Board [Paragraph 28(3)(b)].
When a company or companies seek registration the Board will determine, at the time of registration, whether or not the company or companies have entered into or carried out an ineligible finance scheme in relation to research and development activities. The Board will deny registration where there was or is such a scheme [Clause 101]
An ineligible finance scheme is a finance scheme that the IR & D Board has determined to be ineligible. A company or companies that is a party to such a scheme will not be able to be registered, or in the case of a company that is already registered, a certificate may be issued to the Commissioner of Taxation that will have the effect of denying tax deductions for any R & D expenditure incurred [Clause 100, new section 39MA] .
In making its decision the Board will have regard to finance scheme guidelines to be formulated.
The guidelines which will also confer particular functions and powers on the Board will be contained in a disallowable instrument under the Acts Interpretation Act 1901 and will published in the Commonwealth of Australia Gazette. They will be made available on request, without charge, to any eligible company. The guidelines will be developed in consultation with interested parties, within 90 days of the commencement of the provision [Clause 99, new subsection 39EA(2)] .
The need for guidelines, as opposed to the inclusion of the provisions within the legislation itself, reflects the complexity and diversity of the finance schemes currently operating in the market. Further, even were the legislation to delineate exhaustively the type of schemes currently considered unacceptable, financiers could relatively easily and quickly develop alternative schemes to circumvent the provisions. The result would be a continual process of "catch-up" legislative amendments.
Development of guidelines that also confer certain discretionary powers on the Board will act as a disincentive to companies to enter into ineligible finance schemes. At the same time, the process of consultation with interested parties prior to the drafting of the guidelines will ensure that all parties clearly understand the limits of such schemes which the Board deems to be consistent with the spirit and intent of the legislation and therefore acceptable.
The guidelines will identify a range of criteria by which both eligible companies and the Board will be able to determine whether or not particular finance schemes constitute ineligible finance schemes for the purpose of the legislation [Clause 99, new subsection 39MA(3)] .
These criteria will include but not be limited to:
- the form and substance of the agreements entered into;
- the intent of the parties entering into the agreement;
- the nature of the R & D to be undertaken as part of the syndicate;
- the likelihood that deductions under section 73B will be derived because there are guaranteed returns and a government body is involved, under new section 73CB (see above for discussion);
- the financial, legal and administrative arrangements to be entered into;
- the arrangements for commercialisation; and
- the experience of the commercialisation agency.
Where the Board is of the opinion that an ineligible finance scheme exists then the Board may issue a certificate to the Commissioner stating that it is of that opinion [Clause 100, new subsection 39MA(1)] .
The certificate referred to above will have the effect of deeming the concession never to have been allowable in respect of the research and development activities specified in the certificate. (See earlier notes under "Effect of a certificate issued by the Board") This mechanism will allow the Board to be selective in the application of its discretionary authority in those circumstances where a company may have entered into unacceptable arrangements with respect to only some of its activities.
The eligibility or otherwise of finance schemes will be assessed by the Board at the registration stage. This will increase the degree of certainty for both investors and researchers before funds are fully committed. It will not in any way restrict the ability of the Commissioner of Taxation to exercise his authority under the ITAA.
The new provisions will encourage both syndicated R & D as well as other forms of structured finance arrangements to focus more on commercially oriented R & D, to ensure that commercialisation is undertaken by those experienced in the technology and with a proven track record in commercialising technology and that the route to market is both known and established at the outset.
As with other decisions formalised in certificates issued by the Board, a certificate under new section 39MA will be subject to internal review and to review by the Administrative Appeals Tribunal [Clauses 102 and 103] .
The Board is also required to provide notice in writing to the company or companies in such circumstances advising them of their rights of appeal [Clause 104] .
Because of the nature of the administrative processes associated with syndication in particular, and the fact that the Government announced an amnesty period relating to syndicated proposals that were lodged and under active consideration by the Board, the legislation also defines the manner in which the new provisions are to apply [Clause 105].
The proposed amendments to the IR & D Act will not apply to existing finance arrangements where a company or companies:
- applied for an advance eligibility ruling under section 39P(1) in the period 31 March 1992 to 10 June 1992 (interim period);
- received an advance eligibility ruling from the Board in the period 31 March 1992 to 10 June 1992; or
- were registered under subsection 39P(3) before 10 June 1992.
[Subclauses 105(2) and (3)]
In all other circumstances, the Board will be able to make decisions in relation to ineligible finance schemes [Clause 105] .
The Bill makes it clear that the IR & D Board has power to jointly register companies in relation to a particular project or projects. Registration is granted by the Board in accordance with the provisions of section 39P(3) for a specified year or years of income [Clause 106] .