Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)
Chapter 8 - Research and development
8.1 The proposed amendments contained in Part 4 of Schedule 4 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to deny deductions under section 73B of the Act for expenditure incurred to a private tax exempt entity, if that expenditure is not fully at risk.
8.2 The proposed amendments will ensure that companies receive the same taxation treatment for expenditure incurred to private tax exempt entities as presently applies for expenditure incurred to public tax exempt entities under section 73CB.
8.3 The proposed amendments will apply to expenditures incurred at or after 7.30 pm Australian eastern standard time on 9 May 1995. Transitional rules apply to companies relying on a finance scheme approved by the Industry Research and Development Board before that time. [Item 14]
8.4 The R & D tax concession is available to an eligible company for expenditure incurred, on or after 1 July 1985, on qualifying R & D activities. The concession is in the form of a deduction up to 150 per cent of the expenditure incurred on qualifying R & D activities.
8.5 Where a company incurs expenditure in relation to R & D activities carried out on its behalf, the arrangements are often structured in such a way that the company receives a guaranteed return for its expenditure. Where a company incurs expenditure in relation to R & D on the basis that the company receives a guaranteed return, the rate of allowable deduction for such expenditure is reduced to 100 per cent of that expenditure as the return rises to 100 per cent of the expenditure, under section 73CA.
8.6 A company incurring R & D expenditure, that has a guaranteed return arrangement, to a tax exempt researcher will derive a tax benefit from the tax exempt status of that researcher. For example, a company might obtain a deduction for R & D expenditure incurred to a researcher. A taxable researcher will be assessed on the amount received for the R & D. If the researcher is exempt from income tax, the amount received for the R & D will not be taxable. An arrangement with a tax exempt researcher will therefore have more funds to return (in a guaranteed return arrangement) to the company. If the project fails, the company has obtained a tax deduction of all its expenditure on R & D activities (including core technology and plant) and later received a return for that expenditure. The company has in effect done little more than buy tax deductions from a entity that does not have them to sell. The tax exempt researcher is left with funds to cover direct costs related to the research, for example wages. If the project fails, both the company and the tax exempt researcher have been advantaged. The Commonwealth revenue has been disadvantaged. That is, the cost of the failed R & D project has been supported by the Commonwealth's income tax exemption of the researcher. The Bureau of Industry Economics Research Report 60, dated October 1994, on Syndicated R & D gives a detailed analysis of the operation, and the costs and benefits, of tax exempt entities in relation to R & D.
8.7 Section 73CB was introduced in 1992 to deny deductions under section 73B for expenditure on R & D activities incurred to a government authority or an associate of a government authority ( public tax exempt entities ) where there is a direct or indirect guaranteed return to the owner of the research. Expenditure incurred on R & D activities to private tax exempt entities that has a guaranteed return to the owner of the research may still be eligible for a deduction under section 73B.
8.8 Section 73CB does not apply to expenditure incurred to government authorities and their associates if they are listed on a Register of Commercial Government Bodies kept by the Industry Research and Development Board under the Industry Research and Development Act 1986. Listing is only available to bodies which meet a range of criteria, including being liable to income tax.
8.9 Section 73CB currently operates to deny deductions for expenditure incurred on R & D activities to a government authority or an associate of a government authority (public tax exempt entities) where that expenditure is not fully at risk. The proposed amendments will extend the operation of section 73CB to apply to expenditure incurred to both public and private tax exempt entities by repealing the current section 73CB and substituting a new section 73CB that will apply to all tax exempt entities or associates of tax exempt entities. [Item 13; new subsection 73CB(5)]
8.10 The new section 73CB will deny a company a deduction for expenditure incurred in connection with R & D activities that would otherwise be allowable under section 73B where the following conditions are satisfied:
- the expenditure was incurred to a tax exempt entity or an associate of a tax exempt entity; and
- at the time the expenditure was incurred there was at least some part of the expenditure for which the company was not at risk; and
- at the time the expenditure was incurred, it was not incurred to an entity or associate that was on the Register of Commercial Government Bodies that is kept under section 39HA of the Industry Research and Development Act 1986. That Register is relevant only to taxable government bodies, continuing the effect of the former paragraph 73CB(2)(c). [Item 13; new subsection 73CB (4) and (5)]
8.11 New section 73CB will continue to be construed as part of section 73B, which is the provision under which the R & D tax concession is provided. [Item 13; new subsection 73CB(4)]
8.12 Where the operation of new section 73CB is attracted, the Commissioner is able to go back at any time and amend an assessment under section 170 of the Act. This provision will remain unchanged under the new section 73CB. This is necessary, because the tax status of the entity to which expenditure was incurred may not be known for some time. [Section 170(10)]
8.13 New section 73CB applies to all expenditure in connection with R & D which is deductible under section 73B. It includes actual expenditures on 'R & D expenditure', 'core technology expenditure', plant expenditure and building expenditure that relate to qualifying R & D activities on behalf of the company incurring the expenditure. 'R & D expenditure' includes contract expenditure, salary expenditure and other expenditure directly in relation to R & D activities. 'Core technology expenditure' is expenditure incurred in acquiring core technology or the right to use it for the purposes of R & D activities. [Item 13; new subsection 73CB(4)]
8.14 Proposed section 73CB will apply to deny a deduction for all expenditures which are at least partly not 'at risk'. The current section 73CB ties in the concept of not being 'at risk' (for the company incurring the expenditure) to the same criteria as those under subsection 73CA(5), which generally reduces deductions to 100 per cent of expenditure to the extent that the company incurring the expenditure is certain of recouping its expenditure. [Item 13; new subsection 73CB(5) and (6)]
8.15 To avoid any confusion that may be caused by adopting the subsection 73CA(5) definition of 'at risk' to section 73CB, the definition of 'at risk' has been inserted into the new section 73CB . The meaning of 'at risk' remains unchanged. [Item 13; new subsection 73CB(6)]
8.16 The company is taken not to have been 'at risk' in relation to expenditure incurred to a tax exempt entity or its associate, if, in the Commissioner's opinion, the company or any associate of the company would receive or could be expected to receive any consideration as a direct or indirect result of incurring the R & D expenditure. The Commissioner must form such an opinion reasonably, and is subject to the normal avenues of review and appeal. [Item 13; new subsection 73CB (5) and (6)]
8.17 Subsection 73CB(6) does not ask whether the consideration is given expressly in relation to particular expenditure, it asks whether the consideration is given practically in relation to the expenditure. This continues the effect of the present law. [Item 13; new subsection 73CB(6)]
8.18 If the Commissioner is of the opinion that the amount of consideration received by a taxpayer, nominally on only some of the taxpayer's expenditure, is designed to ensure a minimum return on expenditure incurred on all its R & D projects, section 73CB will apply to deny a deduction for all that expenditure incurred. That is, as long as it can clearly be determined, from the facts of the case, that the guaranteed return also relates to expenditure incurred to the tax exempt entity in relation to another project, then this provision will apply to deny a deduction for the expenditure that has a direct guarantee and for the expenditure that is guaranteed indirectly. (The term 'guaranteed return' is used in respect of a company not being 'at risk' for its expenditure on R & D activities in terms of new section 73CB(6)) . [Item 13; new subsection 73CB(6)]
8.19 Where the consideration to be received is formally related to only part of a project's expenditure, for example core technology expenditure, section 73CB(5) may operate to deny a deduction for all the expenditure, not just on core technology, but on the R & D activities of the whole project. The company claiming deductions is not at risk in respect of part of its expenditure in connection with the R & D activities carried out on behalf of the company. So a deduction is not allowable to the company under section 73B for any part of the expenditure. The new wording reflects the former subsection 73CB(2). [Item 13; new subsection 73CB(5)]
8.20 New section 73CB may apply to expenditure incurred by both the company and its associate, where the R & D expenditure is incurred by the company to the associate, and the associate incurs expenditure which is not fully at risk to a tax exempt entity. In these cases, if the Commissioner is able to conclude that the associate incurred expenditure that was not fully at risk to a tax exempt entity in the expectation that the company will incur expenditure to it for the R & D, then section 73CB will apply to the expenditure incurred by the company and the associate. For example Company A incurs expenditure on core technology to a tax exempt entity and is to receive consideration as a result of that expenditure. Company A incurred that expenditure in the expectation that an associate will incur expenditure to acquire the core technology from it. Later, an associate, Company B, does so. Section 73CB will apply to deny a deduction for the core technology expenditure of both Company A and B. The same result follows where the company incurs expenditure to its associate in the expectation that the associate will incur expenditure to a tax exempt entity that is not fully at risk. [Item 13; new subsection 73CB(5) and (6)]
8.21 New section 73CB applies to R & D expenditures to all tax exempt entities. For the purpose of new section 73CB a tax exempt entity is a person, a body or association (whether incorporated or unincorporated), or a fund, that is not liable to income tax. This includes the Commonwealth, State or Territory governments and any authorities of the Commonwealth, State or Territory governments that are not liable to income tax. [Item 13; new subsection 73CB(1)]
8.22 A body is an authority of the Commonwealth, State or Territory if the Commonwealth, State or Territory has a controlling interest in that body; or if the Commonwealth, State or Territory has an interest in the body and the only other persons having an interest in the body are the Commonwealth, States or Territories or authorities of the Commonwealth, States or Territories. For example section 73CB will apply to R & D expenditures incurred to a tax exempt entity that is owned one third by a State government, one third by a Commonwealth authority and one third by a Territory authority. [Item 13; new subsection 73CB(2)]
8.23 Under the current section 73CB the term 'agreement' takes its meaning from section 73CA(6) because 'not at risk' takes its meaning from section 73CA(5).
8.24 In the proposed section 73CB, the concept of 'not at risk' is separately defined in section 73CB(6) for clarity of reading, and therefore the meaning of 'agreement' is also separately defined in the new section 73CB . [Item 13; new subsection 73CB(6)]
8.25 The meaning of 'agreement' remains unchanged from the existing meaning to that appearing in new section 73CB(1) . It means any agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied, and whether or not intended to be legally enforceable. [Item 13; new subsection 73CB(1)]
8.26 The meaning of the term 'associate' remains unchanged from the current section 73CB. It is defined in section 73B(3) to have the same meaning as in 26AAB and is extended in the present section 73CB to include 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 or Territory authorities. [Item 13; new subsection 73CB(3)]
8.27 The Government announced an amnesty period for companies relying on a finance scheme approved by the Industry, Research and Development Board (IR & D Board) before 7.30 pm Australian eastern standard time on 9 May 1995. For those companies, the proposed amendments will not apply if the expenditures incurred on or after 9 May 1995:
- are incurred in accordance with the terms of the finance scheme; and
- are incurred under a contract evidenced in writing that was entered into on or before 3 August 1995, and
- are incurred by members of syndicates (one or more eligible companies) which lodged an application for joint registration with the IR & D Board on or before 3 August 1995. [Item 14]
8.28 These transitional rules reflect the long lead times of R & D syndication. Because detailed contracts, and incurring of expenditure, only follow the approval of the finance scheme, there could be syndication arrangements which had not reached the stage of finalising contracts or registering the syndicate when the changes were announced. The Government decided to allow the former rules to apply to all those syndication arrangements which had finance scheme approval before the announcement, provided the syndicates concluded the necessary contracts and applied for registration as syndicates no later than 3 August 1995 - more than 12 weeks after the announcement. [Item 14]