Guide to the R & D Tax Concession - Part C
C3 Expenditure on foreign owned R & D
| This document has been archived. It is current only to 30 June 2011. |
Disclaimer
ATO position
The Tax Office is responsible for providing you with this Guide to the R & D tax concession. The Guide offers a commentary on all expenditure issues, taxation rulings, the tax offset, the incremental concession, on own behalf issues, Tax Office record keeping requirements, self assessment and clawback issues. The paragraph below outlines the current status of this Guide.
The information contained in this Guide, as it relates to the matters listed above, consists of written guidance, as referred to in Law Administration Practice Statement PS LA 2008/3 Provision of advice and guidance by the Tax Office . That is, the Guide contains information of a general nature about the operation of the law. As such, it is not binding on the Commissioner of Taxation. If you want to be certain about how this guidance applies to your individual circumstances, you should ask for a private ruling or, if applicable, obtain administratively binding advice from the Commissioner. However, if you follow information contained in this written guidance and, in doing so, make an honest mistake, you will be protected from any penalty on underpaid tax. Furthermore, if something in the written guidance is misleading or incorrect and you make an honest mistake as a result, you will be protected from any penalty and any interest on underpaid tax. You will, however, remain liable for the primary tax payable.
Copyright
Commonwealth of Australia 2009
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For the year of income commencing after 30 June 2007 and later years, the Government has extended the incremental tax concession (175% premium) to companies who incur expenditure on foreign owned R & D.
The extension of the 175% premium is intended to encourage additional R & D expenditure in Australia by multinational enterprise subsidiaries by providing Australian companies with an immediate 100% deduction for expenditure on eligible foreign owned R & D activities and an additional 75% immediate tax deduction on expenditure above the average of the previous three years of expenditure on foreign owned R & D activities.
This section is about the specific 100% base deduction for expenditure on foreign owned R & D. (For further information on the 75% deduction for increased expenditure on foreign owned R & D, please refer to C7 175% International Premium).
Key features of the 100% specific deduction on foreign owned R & D are as follows:
- the deduction will be restricted to Australian companies who, while grouped with a foreign company, incur expenditure on activities undertaken on behalf of that foreign company
- the activities must be carried on wholly or primarily on behalf of the foreign company who is grouped with the eligible company
- the foreign company on whose behalf the activities are undertaken must be a body corporate resident in a foreign country with which Australia has a double tax agreement, and must be a foreign resident for the purposes of that double tax agreement
- expenditure must be incurred for the purpose of carrying on activities that are conducted in Australia. Any expenditure incurred for the purpose of carrying on activities conducted overseas will not be deductible under the 100% specific deduction for expenditure on foreign owned R & D
- the activities must be carried on directly or indirectly under a written agreement between the eligible company and the foreign company
- the deduction is not available for expenditure incurred by an eligible company on activities it performed as a subcontractor under a contract with another eligible company who is its section 73L group member
- the eligible company must incur a minimum of $20,000 expenditure on eligible activities
- for any eligible company in a group to be able to deduct an amount for foreign owned R & D, all eligible companies in the group must register with Innovation Australia (the Board) for the year of income in relation to all eligible activities on which they have incurred expenditure in the year.
C3-1 Timing
Companies can claim the deduction for expenditure on foreign owned R & D incurred in their first year of income that commences after 30 June 2007, and later income years.
C3-2 Eligibility
An eligible company may deduct an amount for expenditure on foreign owned R & D if it satisfies all of the following conditions:
- the eligible company incurs expenditure in the year of income at a time when it is grouped under section 73L of the ITAA 1936 with a foreign company
- the expenditure is incurred for the purpose of the carrying on of 'Australian-centred research and development activities'
- the activities are carried on wholly or primarily on behalf of the foreign company that is a group member of the eligible company
- the activities are carried on, directly or indirectly, under a written agreement between the eligible company and the foreign company and no other parties, for the activities to be performed:
- by the eligible company, or
- by another person directly or indirectly under another agreement to which the eligible company is, or will become, a party
- the expenditure is not incurred in connection with an agreement that:
- is between the eligible company and another eligible company that is grouped under section 73L with the eligible company when the expenditure is incurred, and
- is an agreement for the activities to be performed either by the eligible company or by a person who is not party to the agreement and is to perform the activities directly or indirectly under another agreement to which the eligible company is or will become a party
- the expenditure on foreign-owned R & D by the eligible company for the year of income exceeds $20,000
- the eligible company, and each eligible company in its group at any time in the year of income, are registered with the Board for the year of income in relation to all Australian-centred R & D activities on which the eligible company (or group member) incurred expenditure in the income year, regardless of whether the activities were covered by an R & D plan.
C3.2.1 Grouped with a foreign company
The eligible company must incur the expenditure on foreign owned R & D in the year of income while grouped under section 73L of the ITAA 1936 with a foreign company. Expenditure on foreign owned R & D incurred at a time when the eligible company is not a group member of a foreign company is not deductible.
ITAA 1936 paragraph 73B(14C)(a)
For an explanation of when one company is grouped with another company under section 73L of the ITAA 1936, see 'Part C4-4 Grouping rules for the R & D tax offset'.
foreign company means a body corporate that:
ITAA 1936 subsection 73B(1) |
Example 3.1
Company A is an Australian proprietary company that manufactures glass products. Since its incorporation on 1 July 2000, Company A has been wholly owned by Company B, who is an Australian public company.
Foreign Company X is a body corporate incorporated in, and resident of, Ireland, as determined by the double taxation agreement between Australia and Ireland. On 1 July 2007, Foreign Company X contracts Company A to perform some R & D activities in respect of producing 'unbreakable' glass. Foreign Company X and Company A enter into a written agreement in respect of the performance of the R & D activities, to which no other person is a party. The agreement specifies that Foreign Company X will directly own the intellectual property and commercialisation rights of the R & D project under contract.
Between 1 July 2007 and 31 December 2007, Company A incurs $100,000 of expenditure performing the R & D activities for Foreign Company X. Foreign Company X recognises the growth potential of Company A, and on 1 January 2008, acquires Company A from Company B. Between 1 January 2008 and 30 June 2008, Company A incurs a further $150,000 performing the R & D activities on behalf of Foreign Company X pursuant to their agreement.
Company A may only deduct under subsection 73B(14C) of the ITAA 1936, amounts of expenditure incurred at a time when it is grouped under section 73L with a foreign company.
Company A only became a group member of Foreign Company X, under section 73L of the ITAA 1936, on 1 January 2008. Therefore, Company A cannot claim the $100,000 it incurred in the income year on behalf of Foreign Company X prior to this date, under subsection 73B(14C) of the ITAA 1936. However, Company A may be entitled to claim the deduction for expenditure on foreign owned R & D in relation to the $150,000 of expenditure it incurred between 1 January 2008 and 30 June 2008, while it was wholly owned by Foreign Company X.
C3.2.2 Australian-centred research and development activities
The expenditure incurred by the eligible company in the year of income at a time when it is grouped under section 73L of the ITAA 1936 with a foreign company, must be incurred for the purpose of the carrying on of 'Australian-centred research and development activities'.
ITAA 1936 paragraph 73B(14C)(b)
Australian-centred research and development activities means:
ITAA 1936 subsection 73B(1) |
Australian research and development activities means research and development activities that are carried on in Australia or in an external territory. ITAA 1936 subsection 73B(1) |
research and development activities means :
ITAA 1936 subsection 73B(1) |
Activities must be 'Australian research and development activities' before they can be 'Australian-centred research and development activities'. A deduction is not allowable under subsection 73B(14C) of the ITAA 1936 in respect of expenditure incurred for the purpose of the carrying on of research and development activities outside of Australia or an external territory.
There is a further restriction where activities fall within paragraph (b) of the definition of research and development activities. These are activities carried on for a purpose directly related to the carrying on of activities which satisfy paragraph (a) of the definition of research and development activities, and are generally referred to as 'supporting activities'. Activities which satisfy paragraph (a) of the definition of research and development expenditure are sometimes called 'systematic, investigative and experimental' or 'SIE' activities. Only supporting activities which directly relate to the carrying on of SIE activities undertaken in Australia or an external Territory can be Australian-centred research and development activities. Further, the sole or dominant purpose of these supporting activities must be to support the carrying on of the Australian SIE activities.
For more information about research and development activities, please refer to 'Part B, B3-1 Definition of R & D'.
Example 3.2
Company C is an Australian body corporate wholly owned by United States (US) company, Company Pharma. Company C has an agreement with Company Pharma to undertake R & D on its US parent's behalf. Under its R & D contract with Company Pharma, Company C undertakes meta-analysis of clinical trials undertaken by Company Pharma in the US, in order to give a precise estimate of the treatment effect of a new drug developed in the US by the Pharma group. All phase I, II and III clinical trials were undertaken in the US.
Company C cannot deduct expenditure incurred in undertaking the meta-analysis for its US parent. The meta-analysis undertaken by Company C does not come within paragraph (a) of the definition of 'research and development activities', nor is this activity carried on for a purpose directly related to the carrying on of other SIE activities conducted in Australia. Therefore, the R & D activity performed in Australia by Company C, on behalf of Company Pharma, is not an Australian-centred research and development activity. For this reason, the expenditure incurred by Company C in relation to this activity cannot be deducted under subsection 73B(14C) of the ITAA 1936.
For more information on the research and development of pharmaceuticals, including trials on humans, please refer to Part B, B4-2 Pharmaceuticals (Including Trials on Humans).
Certificate as to Australian-centred research and development activities
The Board may give the Commissioner a certificate under section 39LAAA of the IR & D Act advising whether particular activities were Australian-centred research and development activities. The Board must give the Commissioner such a certificate when requested to do so.
If the Board gives the Commissioner a certificate stating whether particular activities were Australian-centred research and development activities, and that certificate relates to activities in relation to which an eligible company incurred expenditure, then that certificate will be binding on the Commissioner for the purpose of making an assessment of the eligible company's taxable income for any year in which those activities were carried on.
ITAA 1936 subsection 73B(34)
The Board may also give the Commissioner a certificate under section 39LAAB of the IR & D Act stating whether particular activities were activities that would have been Australian-centred research and development activities apart from the need for an R & D plan. The Board must give the Commissioner such a certificate when requested to do so.
A determination as to whether particular activities would have been Australian-centred research and development activities apart from the need for an R & D plan, may be necessary in order to determine whether an eligible company has complied with the registration requirement contained in paragraph 73B(14C)(g) of the ITAA 1936 (refer paragraph C3.2.7 below). It is also necessary to know whether particular activities would have been Australian-centred research and development activities apart from the need for an R & D plan in order to work out a company's entitlement to the 175% Premium. (For more information on the 175% Premium, see C6 175% Australian Premium and C7 175% International Premium).
If the Board gives the Commissioner a certificate stating whether particular activities would have been Australian-centred research and development activities apart from the need for an R & D plan, and that certificate relates to activities in relation to which an eligible company incurred expenditure, then that certificate will be binding on the Commissioner for the purpose of making an assessment of the eligible company's taxable income for any year in which those activities were carried on.
ITAA 1936 subsections 73B(34AA) and 73B(35)
For further information on the role of the Board, see 'Part A, 4-4 Administration of the Concession'.
C3.2.3 Activities performed wholly or primarily on behalf of a foreign company
The deduction is restricted to expenditure incurred by the eligible company for the purpose of the carrying on of Australian-centred research and development activities wholly or primarily on behalf of a foreign company.
Under subsection 73B(9) of the ITAA 1936, eligible companies cannot generally claim a deduction under section 73B in respect of expenditure incurred for the purpose of carrying on R & D activities on behalf of any other person. However, subsection 73B(9) does not apply in relation to the deduction for expenditure on foreign owned R & D, where one of the requirements for a deduction under subsection 73B(14C) is that the activities are undertaken wholly or primarily on behalf of the foreign company.
When determining whether activities are performed wholly or primarily on behalf of a foreign company regard must be had to the written agreement between the eligible company and the foreign company, which should make it explicit that the R & D is to be performed wholly or primarily on behalf of the foreign company. 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. The wording of the agreement alone however is insufficient to demonstrate that the activities are being performed wholly or primarily on behalf of a foreign company.
The eligible company must show that the expenditure is incurred wholly or primarily on behalf of the foreign company, taking into account:
- the financial risk associated with the R & D project
- control over the R & D project, and
- effective ownership of the project results.
For an explanation of these concepts see 'Part C2.1.2 Eligibility of entities - on own behalf '.
As it is a requirement of the 125% R & D tax concession that expenditure is incurred on R & D activities carried on by or on behalf of the 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 subsection 73B(14C) in relation to foreign owned R & D will not be deductible under any other provision of section 73B of the ITAA 1936.
ITAA 1936 paragraph 73B(14C)(c)
Example 3.3
Companies D, P, and E are grouped under section 73L of the ITAA 1936 and are members of a multinational group in which:
- Company D is an Australian body corporate
- Company P is a body corporate incorporated in, and resident of, France, as determined by the double taxation agreement between Australia and France, and
- Company E is a body corporate, incorporated in and resident of, the United Kingdom (UK), as determined by the double taxation agreement between Australia and the UK.
Company D performs R & D under written agreement with its French parent, Company P. Company P coordinates all R & D for the multinational group, chooses the R & D projects to be undertaken by Company D and decides whether particular lines of research should be pursued.
The group's general policy is that all R & D is to be commercialised in the United Kingdom by Company E, who will be the legal owner of all intellectual property resulting from R & D conducted by Company D. Limited access to results for use in their own business is given to all group members at no cost, however only Company E may exploit results of the R & D and all commercialisation proceeds are retained by Company E.
Company D will not be entitled to claim the deduction for expenditure on foreign owned R & D under subsection 73B(14C) of the ITAA 1936 because the Australian-centred R & D it undertakes is not wholly or primarily on behalf of the foreign company, Company P, with whom Company D has a written agreement to perform the R & D.
Example 3.4
Company B is an Australian public company which wholly owns AustCo, an Australian proprietary company and ForeignCo, a company incorporated in Singapore.
AustCo undertakes Australian-centred R & D under written agreement with ForeignCo. These activities are funded by Company B, whose Board chooses the R & D to be undertaken within the group, decides where this R & D should be undertaken, and sets the terms and conditions for the performance of the R & D and the exploitation of results.
Company B is the legal owner of all IP for the group, however ForeignCo has an exclusive licence to commercialise the results of the R & D undertaken by AustCo in the Asia-Pacific region. ForeignCo will exploit the results of the R & D to be undertaken by AustCo pursuant to their written agreement, and will retain 30% of commercialisation proceeds by agreement with Company B. All other proceeds go to Company B.
AustCo will not be entitled to claim the deduction for expenditure on foreign owned R & D under subsection 73B(14C) of the ITAA 1936 because the Australian-centred R & D it undertakes is not wholly or primarily on behalf of ForeignCo.
C3.2.4 Written agreement between the eligible company and the foreign company
The activities must be carried on directly or indirectly under a written agreement between the eligible company and the foreign company and no other parties. This agreement must be for the relevant activities to be performed either by;
- the eligible company; or
- another person directly or indirectly under another agreement to which the eligible company is, or will, become a party.
ITAA 1936 paragraph 73B(14C)(d)
This provision is an integrity provision to ensure that only one eligible company can claim the specific deduction for foreign-owned R & D. A broad agreement between a foreign company and a number of eligible companies will not be accepted, as it would not allow for identification of the single, appropriate eligible company that is entitled to the deduction.
The activities may be performed by the eligible company, or by another person to whom the eligible company subcontracts the performance of the R & D activities. This means that the activities may be performed by the eligible company who is party to the agreement, or by another person whom the eligible company subcontracts to perform the relevant activities.
Written agreement
agreement means an agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings. ITAA 1936 ITAA 1936 subsection 73B(1) |
A written agreement for the purposes of the deduction for expenditure on foreign owned R & D means any written agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings.
The agreement requirement could be satisfied, for example, by:
- a written company policy that says that all intellectual property resulting from R & D will be directly owned by the foreign company, or
- a contract covering the performance of a combination of services including certain R & D activities.
The written agreement must require the performance of the R & D activities, although it does not have to explicitly include specific information about the funding or the carrying on of the activities.
C3.2.5 Subcontracting arrangements
Expenditure must not be incurred in connection with an agreement that:
- is between the eligible company and another eligible company that is grouped with the eligible company under section
73L
when the expenditure is incurred, and is for the activities to be performed:
- by the eligible company; or
- by a third party under a separate agreement with the eligible company.
ITAA 1936 paragraph 73B(14C)(e)
This provision is an integrity measure to prevent multiple deductions in respect of the same expenditure.
One effect of this provision is that even if the eligible company has an agreement with the foreign company for the carrying on of Australian-centred R & D activities wholly or primarily on behalf of the foreign company, the eligible company cannot deduct its expenditure:
- for performing the activities as a subcontractor under a subcontract with another eligible company grouped under section 73L with the eligible company; or
- if the eligible company is a subcontractor to another eligible company grouped under section 73L with the eligible company, for further subcontracting the performance of the activities.
Example 3.5
Following on from Example 1 - Due to numerous last-minute orders for Christmas ornaments , Company A is unable to perform the R & D activities for which it has been contracted by Foreign Company X. Therefore, Company A enters into a written agreement with Company B, another wholly-owned Australian subsidiary of Foreign Company X to perform the R & D. Company B has a similar glass-manufacturing business and in fact is already under contract with Foreign Company X to undertake R & D to develop crack-resistant glass. Therefore, Company B is happy to perform the activities for Company A. Under the agreement between Company A and Company B, the activities will be performed by Company B for a price of $150,000, which Company A duly pays to Company B before the end of the income year. Company B incurred $120,000 in fulfilling its contractual obligations to Company A.
Company A
Company A is grouped under section 73L of the ITAA 1936 with Company B, because both companies are wholly-owned by Foreign Company X.
Under the agreement between Company A and Company B (which is another eligible company grouped with it under section 73L ), Company A has incurred $150,000 of expenditure, which means that Company A must consider whether it is precluded under the subcontractor rules from claiming the 100% specific deduction in respect of this amount.
Although the expenditure is incurred by Company A under an agreement between eligible group member companies (itself and Company B), the agreement between Company A and Company B is not for the R & D to be performed by Company A (the eligible company looking to claim in this instance). Nor is the agreement an agreement for the R & D to be performed by a third party under a separate agreement with Company A. Therefore, the $150,000 incurred by Company A was not incurred in connection with an agreement that provides for Company A to carry on the R & D activities as subcontractor for Company B. Consequently, Company A may be entitled to claim the $150,000 as a deduction under subsection 73B(14C) of the ITAA 1936.
Company B
Company B is grouped under section 73L of the ITAA 1936 with Company A, because both companies are wholly-owned by Foreign Company X. Company B has incurred $120,000 in fulfilling its obligations under its agreement with Company A for the performance of the R & D activities for Foreign Company X. However, this $120,000 has been incurred by Company B under an agreement with another eligible company (Company A) so Company B may be prevented by the subcontractor rules from claiming the $120,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.
The agreement between Company A and Company B is an agreement for the activities to be performed by Company B as subcontractor. Therefore, Company B is not entitled to deduct the $120,000 under subsection 73B(14C) of the ITAA 1936, despite its also having an agreement with Foreign Company X to perform R & D.
Example 3.6
MotorCorp, a German body corporate, has contracted with several of its Australian subsidiaries to undertake R & D to improve the fuel efficiency and reduce the carbon emissions of vehicles it manufactures. Company E, Company F and Company G all have individual written agreements with MotorCorp for R & D to be performed in Australia wholly on behalf of MotorCorp.
Under its contract with MotorCorp, Company E has agreed to provide the R & D services specified by MotorCorp for a service fee of $100,000. Company E is the manager for the Australian arm of the group and is responsible for overseeing and coordinating the performance of the R & D activities chosen and funded by MotorCorp. Company E subcontracts all activities covered by its agreement with MotorCorp to Company F, who agrees to take responsibility for the performance of the R & D activities for a fee of $100,000.
Company F specialises in fuel efficiency and so performs this part of the R & D itself. In performing this R & D, Company F incurs $60,000 of salary expenditure. However, as Company G has the expertise and facilities to carry on the activities relating to carbon emission, Company F pays Company G $40,000 to perform these activities. Company G incurs $40,000 of salary expenditure in undertaking the carbon emissions work.
This scenario may be represented as follows:
- Company E, Company F and Company G are all eligible companies and each has a written agreement with MotorCorp to which there are no other parties
- Company E subcontracts all R & D to Company F. Company E performs no activities itself and is not a party to the agreement between Company F and Company G
- Company F performs some of the R & D itself, and subcontracts the remainder to Company G
- Company G performs all activities subcontracted by Company F and is not a party to the agreement between Company E and Company F.
Company E
Company E has a written agreement with a foreign company, to which no other person is a party, that provides for R & D to be carried on by other parties under subcontracts with Company E. This is an agreement for Australian-centred R & D to be carried on directly or indirectly. Therefore, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.
Company E has incurred $100,000 in connection with an agreement entered into with Company F, who is an eligible company in its section 73L group. However, Company F cannot claim a deduction under subsection 73B(14C) if its expenditure was incurred in connection with an agreement between it and another eligible company group member, where the activities are performed by it, or by a third party under a separate agreement with it.
Therefore, Company E is not precluded from claiming the deduction because of paragraph 73B(14C)(e) , and may be entitled to deduct the $100,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.
Company F
Company F has an agreement with MotorCorp (a foreign company) for the direct, or indirect, performance of R & D, and has incurred expenditure of $100,000 on foreign owned R & D. The agreement between Company F and MotorCorp allows for the R & D to be performed by Company F or by a third party under another agreement to which Company F is a party. Therefore the agreement with MotorCorp allows Company F to subcontract some or all of the R & D to Company G, which Company F does, under another agreement. Therefore, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.
However, Company F will be precluded from claiming the deduction if the expenditure was incurred in connection with an agreement between it and another eligible company group member, and the activities were performed by it or by a third party under a separate agreement with it.
Company F's expenditure was incurred in connection with such an agreement, as a third party (Company G) is to perform the activities. Therefore, Company F cannot deduct the $100,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.
Company G
Company G has an agreement with MotorCorp (a foreign company) for the direct, or indirect, performance of R & D, and has incurred expenditure of $40,000 on foreign owned R & D. The agreement between Company G and MotorCorp allows for the R & D to be performed by Company G or by a third party under another agreement to which Company G is a party. As company G performs the R & D activities, the requirements of paragraph 73B(14C)(d) of the ITAA 1936 are satisfied.
However, Company G will be precluded from claiming the deduction if the expenditure was incurred in connection with an agreement between it and another eligible company group member, and the activities were performed by it, or by a third party under a separate agreement with it.
The expenditure was incurred in connection with an agreement with an eligible company group member (Company F), and the activities were performed by Company G (an eligible company). Therefore, Company G cannot deduct the $40,000 of expenditure it has incurred under subsection 73B(14C) of the ITAA 1936.
C3.2.6 Threshold
Expenditure on foreign owned R & D by the eligible company for the year of income must exceed $20,000. No exception to the threshold exists for contracted expenditure to a Registered Research Agency, unlike under the domestic R & D concessional provisions.
ITAA 1936 paragraph 73B(14C)(f)
C3.2.7 Registration
The eligible company and every other eligible company grouped with it at any time in the income year under section 73L of the ITAA 1936, must register with the Board under section 39J of the Industry Research and Development Act 1986 all activities in relation to the year of income that:
- would be Australian-centred R & D activities performed wholly or primarily on behalf of a foreign company, apart from the need for an R & D plan, and
- are activities on which the eligible company or the other eligible company, as appropriate, incurred expenditure in the year of income.
ITAA 1936 paragraph 73B(14C)(g)
Subsection 73B(2BA) of the ITAA 1936 says that activities are not considered to be covered by the definition of research and development activities unless they are carried out in accordance with a plan that complies with any guidelines formulated by the Board under section 39KA of the Industry Research and Development Act 1986.
Registration of activities that do not have an R & D plan is required in the income year to ensure that they will be included in the calculation of notional expenditure on foreign owned R & D in accordance with the method statement in section 73RB of the ITAA 1936. (For more information on the calculation of the 175% International Premium, please refer to Part C7 of this guide).
C3-3 Amount of deduction for expenditure on foreign owned R & D
If all eligibility requirements of subsection 73B(14C) of the ITAA 1936 are met, the eligible company will be entitled to deduct the amount calculated in accordance with subsection 73B(14D) of the ITAA 1936, at the rate of 100%.
The amount of a company's deduction at the 100% rate is the amount that would be the eligible company's 'incremental expenditure' under section 73P of the ITAA 1936 for the year of income if:
- the Australian-centred research and development activities covered by subsection 73B(14C) (ignoring paragraphs (14C(f) and (g)) were carried on, on behalf of an eligible company (and not on behalf of a foreign company); and
- the only expenditure incurred by the eligible company in the year of income in relation to research and development activities had been expenditure on foreign owned R & D covered by subsection 73B(14C) (ignoring paragraphs ( 14C(f) and (g)); and
- the total group mark up (if any) of the eligible company for the year of income were the amount (if any) that would be worked out if the company were working out the amount of a deduction under subsection (13) or (14) of ITAA 1936 (see Part C5-5 Incremental expenditure total group mark up for further information).
ITAA 1936 subsection 73B(14D)
This means that the eligible company must work out the amount that would be its incremental expenditure ignoring the requirements contained in subsection 73B(14C) regarding the $20,000 minimum expenditure threshold and the registration requirement. For this purpose, the Australian-centred R & D activities undertaken on behalf of the foreign company grouped with the eligible company, are deemed to have been undertaken on behalf of the eligible company.
The amount that would be the company's incremental expenditure does not include the amount of any group markup. (See below for how to work out the total group markup of the eligible company).
Paragraph 73B(14D)(b) of the ITAA 1936 is a measure to ensure that an amount of expenditure incurred by the company is not included in the company's 'reduced expenditure on Australian owned R & D' (see section C6 175% Australian Premium) as well as its 'reduced expenditure on foreign owned R & D' (see section C7 175% International Premium). To prevent double deductions, when an eligible company is working out the amount that would be its incremental expenditure for the purposes of the 100% specific deduction for expenditure on foreign owned R & D, it is deemed that the only expenditure incurred by the eligible company is that covered by subsection 73B(14C) of the ITAA 1936.
C3.3.1 Incremental expenditure
The first step in working out the amount of the deduction for expenditure on foreign owned R & D is to determine the amount that would be the company's 'incremental expenditure' under section 73P of the ITAA 1936 for the year of income, taking into account the modifications made by subsection 73B(14D) of the ITAA 1936.
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incremental expenditure means expenditure that:
ITAA 1936 subsection 73P(2) For the purposes of the definition of incremental expenditure in subsection (2), where expenditure under a contract is both for the acquisition of plant and for the provision of services, the expenditure must be apportioned on a reasonable basis between them. ITAA 1936 subsection 73P(3) None of the expenditure referred to in subsection (3) can be incremental expenditure if a reasonable apportionment is not possible. ITAA 1936 subsection 73P(4) |
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A company's incremental expenditure for a year of income excludes the total group markup of the company for that expenditure (as worked out under subsection 73B(14AC) ). ITAA 1936 subsection 73P(5) |
'Incremental expenditure' as defined in subsection 73P(2) of the ITAA 1936 means expenditure that is research and development expenditure as defined in subsection 73B(1) of the ITAA 1936.
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research and development expenditure , in relation to an eligible company in relation to a year of income, means expenditure (other than core technology expenditure, interest expenditure, feedstock expenditure, excluded plant expenditure or expenditure incurred in the acquisition or construction of a building or of an extension, alteration or improvement to a building) incurred by a company during the year of income being:
and includes any eligible feedstock expenditure that the company has in respect of the year of income in respect of related research and development activities. ITAA 1936 ITAA 1936 subsection 73B(1) |
Incremental expenditure therefore includes:
- contract expenditure incurred to a Registered Research Agency (RRA)
- salary expenditure
- other expenditure incurred directly in respect of R
&
D activities, which includes:
- contract expenditure to others for R & D activities, and
- eligible feedstock expenditure (not residual feedstock expenditure).
Expenditure which is not 'research and development expenditure' as defined in subsection 73B(1) of the ITAA 1936 is not 'incremental expenditure'. Items in this excluded category include: decline in value in relation to depreciating assets, core technology expenditure, interest expenditure and residual feedstock expenditure.
A company's incremental expenditure includes amounts that satisfy the definition of 'research and development expenditure' (except those amounts excluded by section 73P of the ITAA 1936), that the company could deduct under subsection 73B(13) or (14) regardless of whether the company actually claimed a deduction for these amounts under the R & D tax concession.
Note: A company's 'incremental expenditure' also includes expenditure which it could deduct under subsection 73B(14) of the ITAA 1936 (salary expenditure and other expenditure incurred directly in respect of R & D activities), ignoring the requirement in paragraph 73B(14)(b) that its aggregate research and development amount must be greater than $20,000.
What is excluded from incremental expenditure?
Subsection 73P(2) expressly excludes:
- expenditure to lease or hire plant
- expenditure under a contract that is in substance for the acquisition of plant and not for the receipt of services.
Where the expenditure under a contract is both for the acquisition of plant and for the provision of services, the expenditure is to be apportioned between the two on a reasonable basis. Where reasonable apportionment is not possible, none of the expenditure under that contract can be 'incremental expenditure'.
ITAA 1936 subsections 73P(3) and (4)
Subsection 73P(2) also excludes expenditure that cannot be taken into account in working out the amount of the deduction under subsection 73B(13) or (14) of the ITAA 1936 (apart from paragraph (14)(b)). This excludes, for example:
- expenditure a company is required by subsection 73B(9) of the ITAA 1936 to disregard
- expenditure for which a deduction is denied by subsection 73B(17A) of the ITAA 1936 (expenditure on overseas research and development which is not certified expenditure), and
- expenditure incurred in relation to activities that were not registered with the Board in relation to the year of income (subsection 73B(10) of the ITAA 1936).
C3.3.1.1 Contracted Expenditure
Contracted expenditure is defined in subsection 73B(1) of the ITAA 1936 as expenditure incurred by an eligible company to an organisation registered with the Board as an Australian research agency, i.e. an agency with Registered research agency (RRA) status, where the RRA performs R & D activities on behalf of the eligible company.
To determine the amount of its incremental expenditure, the eligible company must work out the amount of contracted expenditure that could be taken into account in working out the amount of a deduction under subsection 73B(13) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).
Subsection 73B(13) of the ITAA 1936 does not contain a threshold requirement and so contracted expenditure is not subject to the $20,000 expenditure threshold which generally applies in respect of research and development expenditure. Therefore, contracted expenditure generally automatically qualifies for the subsection 73B(13) deduction - provided that the expenditure is in relation to eligible R & D activities and the associated eligibility criteria are also satisfied.
When working out the amount of its deduction for expenditure on foreign owned R & D, an eligible company must ignore paragraph 73B(14C)(f) of the ITAA 1936, which contains the threshold requirement of eligibility for the 100% specific deduction and requires the eligible company to incur more than $20,000 of expenditure on foreign owned R & D in the year of income.
Note: although the threshold requirement is ignored when working out the amount of the deduction which will be available for expenditure on foreign owned R & D if all eligibility requirements are met, a company will not be eligible to claim a deduction under subsection 73B(14C) of the ITAA 1936 unless the total expenditure on foreign owned R & D by the eligible company for the year of income is greater than $20,000 (see 73B(14C)(f)) of the ITAA 1936).
Subsection 73B(1B) of the ITAA 1936 generally provides that expenditure is not contracted expenditure unless when the expenditure was incurred, the eligible company that incurred the expenditure was capable of utilising, or had formulated a plan to utilise, any results of the research and development activities directly in connection with a business that the company carried on or proposed to carry on.
This restriction does not apply to expenditure on foreign owned R & D covered by subsection 73B(14C) of the ITAA 1936. Subsection 73B(1BA) of the ITAA 1936 says that subsection 73B(1B) does not apply to expenditure eligible for the 100% specific deduction (ignoring the threshold requirement and the registration requirement).
ITAA 1936 subsection 73B(1BA)
While it is possible for a RRA to perform R & D activities through an agent, the RRA would not be considered to perform those activities where it did not choose the agent, supervise the performance of the activities, or take responsibility for the agent's performance of the activities. Arrangements of this type under which, for instance, an eligible company made payments to a RRA for the performance of R & D activities on condition that the RRA would have the activities performed by a particular researcher, would have the consequence that the RRA could not be said to perform those activities. In such a case, the payments would not be 'contracted expenditure'.
ITAA 1936 subsections 73B(1) , (1B) and (1BA)
C3.3.1.2 Salary expenditure
To determine the amount of its incremental expenditure, the eligible company must work out the amount of salary expenditure that could be taken into account in working out the amount of a deduction under subsection 73B(14) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).
'Salary expenditure', forms part of 'research and development expenditure' and is comprehensively defined in subsection 73B(1) of the ITAA 1936, which also provides a basis for apportionment of some salary-related expenses.
Salary expenditure for the purposes of the R & D concession includes:
- expenditure by way of salaries, wages, allowances, bonuses, overtime payments or penalty rate payments for officers or employees of the company, incurred directly in respect of the company's eligible R & D activities, and
- expenditure in respect of annual leave, sick leave or long service leave, or contributions to superannuation funds (which are otherwise deductible under section 290-60 of the ITAA 1997), payroll tax and premiums for workers` compensation insurance in relation to those officers or employees engaged directly in carrying out the company's eligible research and development activities.
Such officers or employees can include:
- researchers undertaking the conception and/or creation of new knowledge and products
- employees undertaking technical tasks in support of the R & D activities, such as persons keeping records, preparing charts and graphs, operating equipment and writing computer programs, and
- supervisors of researchers and technical staff.
In addition, expenditure incurred by an employer to provide benefits (including fringe benefits) in lieu of paying such employees a cash salary because of an eligible salary sacrifice arrangement may also be salary expenditure.
Where the expenditure on the employee is only in part directly in respect of the relevant R & D activities, an apportionment is necessary. It is expected that the company would be able to demonstrate - by way of appropriate records such as time sheets or job cards - the extent to which such an employee's services are directly related to qualifying R & D activities. Claims for salary expenditure should be based on actual expenditure and not upon standard salary rates that might be developed for internal costing purposes.
The salaries (and on costs) of company employees whose only connection with R & D activities is clearly indirect - for example, management staff who recruit other company employees for general duties not necessarily related to R & D activities - would not qualify as salary expenditure.
Expenditure must be 'incurred' as described in Taxation Ruling TR 97/7 before it is considered 'salary expenditure' for the purposes of subsection 73B(1) of the ITAA 1936.
ITAA 1936 subsection 73B(1)
One of the requirements for deducting an amount under subsection 73B(14) of the ITAA 1936 is that the eligible company's 'aggregate research and development amount' exceeds $20,000 (see paragraph 73B(14)(b) of the ITAA 1936). However, when a company is working out the amount of its incremental expenditure under section 73P of the ITAA 1936, this requirement is ignored. The threshold requirement contained in paragraph 73B(14C)(f) of the ITAA 1936 is also ignored when the eligible company is working out the amount of its deduction for expenditure on foreign owned R & D in accordance with subsection 73B(14D) of the ITAA 1936.
C3.3.1.3 Other Expenditure
In order to fully calculate its incremental expenditure an eligible company must also work out the final component of its 'research and development expenditure' eligible for deduction under subsection 73B(14) of the ITAA 1936, referred to as 'other expenditure' (see subsections 73B(1) and 73P(2) respectively, regarding the definitions of 'research and development expenditure' and 'incremental expenditure'. The eligible company must also work out the amount of 'other expenditure' that could be taken into account in working out the amount of a deduction under subsection 73B(14) of the ITAA 1936 (see subsection 73P(2) of the ITAA 1936).
A company may incur a number of administrative costs and overheads as a result of conducting its R & D activities and as a result of employing R & D staff. For instance, these costs may include the salaries of a supervisor, typist, payroll and recruitment staff and their on-costs. It may also include overheads, such as rent, light and power, property rates and taxes, cleaning and certain types of insurance. The expenses which can be claimed as 'other expenditure' are those 'incurred . . . directly in respect of' R & D activities.
Taxation Ruling IT 2552 (now withdrawn) provides the Commissioner's view about what is and what is not considered to be 'other expenditure' for the purposes of the R & D tax concession. The Tax Office considers that expenditure is incurred 'directly in respect of R & D activities' where:
- the carrying on of eligible R & D activities contributed to the incurring of all or an identifiable part of the expenditure, OR
- the conduct of eligible R & D activities by the company would be materially impaired if the expenditure were not incurred.
Expenses that may occur as a result of conducting R & D activities and employing R & D staff fall into two classes. The first class includes expenditure that can 'reasonably be expected to be identified as directly relating to an eligible research project'. The second class of expenditure, referred to as 'eligible apportionable expenses', is expenditure which may not be clearly identifiable as R & D expenditure because it relates to a number of business operations, but which nonetheless includes a component that is applicable to an eligible R & D project. The onus is on the company to demonstrate that this expenditure is 'directly in respect of' the particular R & D project. The company must also demonstrate the accuracy of the amount of the expenditure allocated to a particular R & D project.
Whether a sufficient nexus exists between an expense and a relevant R & D project will always depend on the circumstances of the particular case.
For a detailed explanation of 'other expenditure', see Part C2 , 2.3.1.2 Other expenditure.
C3.3.1.4 'On own behalf'
Under subsection 73B(9) of the ITAA 1936, eligible companies cannot generally claim a deduction at the concessional rate in respect of expenditure incurred for the purpose of carrying on R & D activities on behalf of any other person. However, when an eligible company is working out the amount of its deduction for expenditure on foreign owned R & D under subsection 73B(14D) , for the purposes of subsection 73B(14C) of the ITAA 1936, Australian-centred R & D activities undertaken on behalf of the relevant foreign company are deemed to have been carried on, on behalf of the eligible company and not the foreign company.
ITAA 1936 paragraph 73B(14D)(a)
C3.3.2 Total Group Markup
Subsection 73P(5) of the ITAA 1936 excludes from the definition of 'incremental expenditure' the total group markup of the company for that expenditure.
The total group markup in relation to the expenditure of an eligible company is the sum of amounts incurred by it to other persons grouped with it under section 73L of the ITAA 1936, for goods and services, in excess of the actual cost to those persons of providing those goods or services.
In calculating incremental expenditure, amounts that are incurred by an eligible company to a member of the same group need to be reduced by the total group markup. That is, any amounts incurred by an eligible company on R & D activities which represent an intra-group markup are eliminated from that expenditure when calculating 'incremental expenditure'.
For further information on amounts including a group markup refer to para 2.3.11 .
ITAA 1936 subsections 73B(14AA) to (14AD) , 73P(5)
Example 3.7
Company A is an Australian body corporate wholly owned by Company Q, a cola manufacturing company incorporated and resident in the United States as determined by the double tax agreement between Australia and the United States. Company Q enters into an agreement with Company A, to which no other person is a party, for Company A to invent a new type of soft drink that does not damage teeth. Company A is grouped under section 73L of the ITAA 1936 with Company B, an Australian body corporate controlled by Company Q. The activities are undertaken in Australia as three discrete projects, Project X, Project Y and Project Z. Assume Company A meets the eligibility requirements in subsection 73B(14C) unless otherwise stated. (For the purposes of subsection 73B(14D) of the ITAA 1936, the requirements of paragraphs ( 14C)(f) and (g) - the threshold and registration requirements - are ignored.)
Company A pays Company B $15,000 to perform some of the R & D activities required for Project X. It cost Company B $10,000 to perform the R & D services it provided for Company A.
Company A will work out the amount for which it may be entitled to a deduction under subsection 73B(14C) of the ITAA 1936 as follows.
During the year of income, while grouped with Company Q, Company A incurred $47,500 worth of expenditure in relation to its Australian-centred R & D activities on behalf of Company Q. This comprised the following expenses on Project X:
- $5,000 on salary and wages
- $2,000 on 'other expenditure'
- $15,000 was paid to Company B in consideration for work performed on R & D activities for Company A
- $500 on leasing equipment.
Company A has also incurred $25,000 of expenditure during the year of income on Project Y, another R & D project undertaken on behalf of Company Q under its agreement with that company. However, although it otherwise meets the definition of Australian-centred R & D and was registered with Innovation Australia in relation to the year of income, Project Y was not carried on in accordance with a plan that complied with guidelines formulated by the Board under section 39KA of the Industry Research and Development Act 1986.
Project X and Project Y:
| Description of expenses | Amount incurred
($) | 73B(14D) amount
($) |
| salary and wages | 5,000 | 5,000 |
| 'other expenditure' | 2,000 | 2,000 |
| 'contract - other' - work performed by group member Company B | 15,000 | 10,000 |
| leasing of equipment | 500 | 0 |
| Expenditure on activities not carried on in accordance with a plan. | 25,000 | 0 |
| Total | 47,500 | 17,000 |
The cost of leasing equipment is excluded from the definition of 'incremental expenditure' under subsection 73P(2) of the ITAA 1936, and therefore cannot be included in the calculation of the 100% base deduction on foreign owned R & D under subsection 73B(14D) of the ITAA 1936.
A company's total group markup is also excluded from the definition of 'incremental expenditure'. Therefore the amount of $5,000 - the excess charged to Company A above the actual cost to Company B to provide the R & D services contracted to it - is excluded from the calculation of the amount of the deduction on foreign owned R & D.
Expenditure on activities that were not carried on in accordance with an R & D plan cannot be included when calculating the amount of the deduction available under subsection 73B(14C) of the ITAA 1936. However, these amounts may be required to be included in the calculations for the 175% Australian premium and 175% foreign premium, for example under Step 4 of the method statement in subsection 73RB(1) of the ITAA 1936. For more information refer to section C7 of this Guide.
All other expenditure items listed are within the definition of 'incremental expenditure' and can be included in working out the amount of Company A's expenditure on foreign-owned R & D. As shown above, Company A's expenditure on foreign owned R & D for the purposes of subsection 73B(14D) of the ITAA 1936 is equal to $17,000.
However, paragraph 73B(14C)(f) provides that an eligible company is not entitled to deduct an amount for expenditure on foreign owned R & D under subsection 73B(14C) unless the company has more than $20,000 of expenditure on foreign owned R & D. Consequently, Company A cannot deduct any amount under subsection 73B(14C) of the ITAA 1936, as the total of its expenditure on foreign owned R & D is only $17,000.
Note: although the expenditure incurred on Project Y, which was not carried out in accordance with an R & D plan as required by subsection 73B(2BA) of the ITAA 1936, cannot be included in Company's A 100% specific deduction under subsection 73B(14C) of the ITAA 1936, this amount may in the future be required to be included in Company A's notional expenditure on foreign owned R & D , when Company A, or its eligible company group members, are calculating their entitlement to the 175% premium. (For more information of the 175% premium, please refer to Parts C6 and C7 of this guide).
Example 3.8
In addition to its expenditure on Project X and Project Y, Company A has also incurred $51,000 of expenditure on Project Z, another project undertaken on behalf of Company Q under its agreement with that entity. Company A incurred the following expenses on Project X during the year of income:
- $25,000 on salary and wages
- $20,000 on 'other expenditure'
- $5,000 was paid to Company B in consideration for work performed on R & D activities for Company A, representing the actual cost to Company B to provide the contracted services
- $1,000 on interest expenditure.
Project Z:
| Description of expenses | Amount incurred
($) | 73B(14D) amount
($) |
| salary and wages | 25,000 | 25,000 |
| 'other expenditure' | 20,000 | 20,000 |
| 'contract - other' - work performed by group member Company B | 5,000 | 5,000 |
| interest expenditure | 1,000 | 0 |
| Total | 51,000 | 50,000 |
Interest expenditure is specifically excluded from the definition of 'research and development expenditure' and so is not included in the definition of 'incremental expenditure'. The amount of $1,000 incurred on interest expenses therefore cannot be included in Company A's deduction for expenditure on foreign owned R & D.
As a result, Company A will be entitled to deduct the $17,000 of expenditure on foreign owned R & D incurred on Project X and the $50,000 of expenditure on foreign owned R & D incurred in relation to Project Z, in the year of income.
Example 3.9
Assume, in relation to Examples 7 and 8, that when Company A begins to prepare its R & D tax concession claims it realised that the activities for Project Z have not been registered with the Board.
Consequently, Company A is not entitled to claim any amount under subsection 73B(14C) of the ITAA 1936 in respect of any of the projects it undertook on behalf of Company Q, as paragraph 73B(14C)(g) of the ITAA 1936 is not satisfied.
C3-4 Consolidation and the deduction for expenditure on foreign - owned R & D
The R & D provisions include sections intended to ensure that the research and development concession interacts properly with the consolidation regime in part 3-90 of the ITAA 1997.
These sections provide that:
- a head company is treated as qualifying for the R & D deductions while any of its subsidiary members do. The subsidiary members of the group who conduct R & D activities will continue to register their eligible activities with the Board as in the past, but the head company will be the claimant of the R & D tax concession;
- the expenditure history needed to access the deductions available under sections 73Y , 73QA or 73QB is not affected by the consolidation history rules where companies join or leave a consolidated group, and
- clawing back the concessional part of an R & D deduction when expenditure is recouped or a grant received in respect of it is still possible, even though the deduction is claimed by the head company of a consolidated group when the recoupment was received by a company that leaves the group.
Registration of R & D activities
A head company cannot claim the R & D tax concession for expenditure incurred in relation to unregistered R & D activities undertaken by itself or by any other member of the consolidated group or MEC group. This is because the head company is only treated as if it were an eligible company registered with Innovation Australia in relation to particular activities in respect of a year of income during a period that a subsidiary member of the group is an eligible company registered with the Board in relation to those activities in respect of that year of income.
Group markup and Consolidation
Members of a consolidated group are treated as a single entity (represented by the head company) for income tax purposes. This treatment occurs as a result of the 'single entity rule' which is contained in the consolidation provisions. A consequence of the single entity rule is that dealings which are solely between members of the same consolidated group will not result in income or a deduction to the group's head company.
It follows that the group markup provisions described in Part C2 - 2.3.11 (Reduced rate for group markup), are not relevant where the R & D expenditure is incurred in relation to the provision of goods or services between members of a consolidated group.
Subcontracting arrangements and consolidation
The conditions of eligibility for the deduction for expenditure on foreign owned R & D include the condition that expenditure must not be incurred in connection with an agreement that:
- is between the eligible company and another eligible company that is grouped with the eligible company under section
73L
when the expenditure is incurred, and is for the activities to be performed:
- by the eligible company; or
- by a third party under a separate agreement with the eligible company.
As a consequence of the single entity rule (where members of a consolidated group are treated as a single entity, represented by the head company, for income tax purposes) this 'subcontractor rule' is not relevant with regard to agreements between members of a consolidated group or MEC group. This is because dealings which are solely between members of the same consolidated group will not result in income or a deduction to the group's head company.
However, where the consolidated entity is grouped with other eligible companies under section 73L of the ITAA 1936, that is, it has R & D group members who are not members of the consolidated group or MEC group, then the subcontractor rule may apply. See section 3.2.5 Subcontracting arrangements, above.
C3-5 Deduction for expenditure on foreign owned R & D and prepayments
The prepayment rules apply when working out the amount allowable as a deduction under subsection 73B(14C) of the ITAA 1936, in relation to a year of income. Most prepaid expenditure on R & D activities is taken into account on a spread basis in the year to which the payment relates, not the year in which it is incurred. Prepayments for contract expenditure to a Registered Research Agency attract special treatment and are not subject to the general prepayment rules.
For further information on the treatment of the prepayment of expenditure on R & D activities, see 'Part C-2, 2.3.10 Prepayment of R & D expenditure (including advanced and accelerated R & D expenditure)'.
ITAA 1936 section 82KZMA to 82KZMF
C3-6 Deduction for expenditure on foreign owned R & D and the 'at risk' requirement
Section 73CA of the ITAA 1936 generally applies to reduce the amount of the expenditure claimable to 100% if the Commissioner is satisfied that the expenditure was incurred at a time when the company was not 'at risk' in respect of whole or part of the expenditure.
A company is 'at risk' in respect of its expenditure on R & D activities if it does not have a guaranteed fixed return from the results of the R & D activities. For example, where a company performs R & D for a pre-determined price and has no right to commercialise the results of the R & D, that company bares no financial risk in relation to incurring that expenditure. For a fuller discussion of the 'at risk' requirement, see 'Part C-2, 2.1.2 Eligibility of entities - on own behalf .
However, section 73CA of the ITAA 1936 will not operate to exclude expenditure on foreign-owned R & D from being eligible for the base 100% specific deduction.
C3-7 Deduction for expenditure on foreign owned R & D and the operation of clawback
Clawback generally operates to reduce the rate of deduction for relevant expenditure from 125% to 100%. Therefore, because amounts of expenditure on foreign owned R & D are deductible under subsection 73B(14C) at the rate of 100%, the clawback provisions will not impact upon the deduction available under this subsection where a company has received a grant or recoupment in respect of its expenditure on foreign owned R & D.
However, where a company has received a grant or recoupment in respect of its expenditure on foreign owned R & D, this may impact upon its entitlement to the 175% Australian Premium and 175% International Premium. (See C8-6 Clawback and the 175% Australian Premium and C8-7 Clawback and the 175% International Premium).
C3-8 Deduction for expenditure on foreign owned R & D and the tax offset
The refundable R & D tax offset is not available in respect of amounts deductible under subsection 73B(14C) of the ITAA 1936. This means that an eligible company cannot choose an offset instead of a deduction in respect of expenditure on foreign owned R & D which it can deduct under subsection 73B(14C) of the ITAA 1936.
Where a company is entitled to a deduction under subsection 73B(14C) of the ITAA 1936 for expenditure on foreign owned R & D, and is also entitled to a deduction under another subsection of 73B , for example under subsection 73B(14) in relation to research and development expenditure, then the company may choose the offset in respect of the expenditure deductible under subsection 73B(14) , but not in respect of its expenditure on foreign owned R & D. The latter is only eligible to be deducted.
For further information about the R & D tax offset, please see section C4 of this guide.
Example 3.10
Company Crays Alive (Crays Alive) is an Australian proprietary company that farms and supplies crayfish across Australia. Crays Alive is wholly owned by the Seafood R Us Company (Seafood R Us), which is a body corporate incorporated in, and resident of, the United States (US) as determined by the double taxation agreement between Australia and the US.
Project performed wholly on behalf of foreign company
In 2007, the percentage of crayfish that arrived at their interstate destination alive was only 75%. In order to increase this amount, Seafood R Us entered into a contract with Crays Alive. The contract is for Crays Alive to perform R & D activities to develop a new type of packaging which will result in fewer crayfish deaths in transit (Project Arrive Alive). The agreement specifies that Seafood R Us will directly own the intellectual property and commercialisation rights of the results produced under the contract. Crays Alive registers Project Arrive Alive with the Board for the year ending 30 June 2008.
In the income year ending 30 June 2008, Crays Alive incurs $100,000 of expenditure performing the R & D activities for Seafood R Us.
Crays Alive satisfies all the eligibility requirements in subsection 73B(14C) of the ITAA 1936 for a deduction for expenditure on foreign-owned R & D. Crays Alive is therefore eligible for a 100% deduction of the amount determined under subsection 73B(14D) of the ITAA 1936 for Project Arrive Alive ($100,000).
Project Arrive Alive was a discrete project, commenced and finalised within one financial year. Crays Alive is not entitled to a deduction for the 175% International Premium.
Project performed on own behalf
Crays Alive has also been trying to determine what diet produces the largest and happiest crayfish. Crays Alive has written an R & D plan for the project (Project Happy Cray) and registered the R & D activities with Innovation Australia for the year ending 30 June 2008.
It is determined that Crays Alive performs Project Happy Cray on its own behalf as it bears all financial risk in relation to the project, it is determining the direction of the R & D project and has effective ownership of the project results.
In October of 2007, work commenced on Project Happy Cray. Between October of 2007 and June 2008, Crays Alive incurred research and development expenditure of $60,000 in relation to Project Happy Cray. All expenditure incurred is eligible research and development expenditure.
Crays Alive is eligible for a deduction under subsection 73B(14) of the ITAA 1936 in the year ending 30 June 2008, as it has incurred research and development expenditure during a year of income and the aggregate research and development amount exceeds $20,000 for that year of income.
Crays Alive's return of income for the year ending 30 June 2008
Crays Alive experienced adverse trading conditions, and its total assessable income for the year of income in question was only $10,000. However as it met the eligibility criteria in section 73J of the ITAA 1936, it chose to claim the R & D tax offset under section 73I of the ITAA 1936 in its return of income. This choice only applies in this case, to the amount otherwise deductible under subsection 73B(14) of the ITAA 1936 ($75,000, being $60,000 x 125%), and not to the deduction allowable under subsection 73B(14C) of the ITAA 1936, of $100,000. Consequently, where its only allowable deductions relate to its R & D activities, the choice of the R & D tax offset means that the amount otherwise deductible under subsection 73B(14) does not come into the calculation of the company's taxable income (or loss), but instead forms part of the calculation of the R & D tax offset, as shown below:
Assessable Income | $10,000 |
R & D deduction under subsection 73B(14C) of the ITAA 1936 | $100,000 |
R & D refundable tax offset under section 73J of the ITAA 1936 | $22,500 (30% of $75,000, i.e. $60,000 x 125%) |
Subsection 4-10(3) of the ITAA 1997 provides the following formula for determining a person's (which includes a company's) income tax liability for the income year:
Income tax = (taxable income x tax rate) - tax offsets. |
Step 1 Work out taxable income for the income year
Taxable income or loss | = assessable income - less R & D deduction |
| = $10,000 - $100,000 |
| = ($90,000) |
Step 2 Work out basic income tax liability
As Crays Alive's deduction under subsection 73B(14C) of the ITAA 1936 exceeds its assessable income, they have no liability to pay income tax in the income year.
Step 3 Work out tax offsets for the income year
R & D Tax offset | = 30% of $75,000 |
| = $22,500 |
Step 4 Income tax liabilities for the income year
As the R & D tax offset is a refundable tax offset, Crays Alive receives a refund of $22,500.
As the R & D deduction on foreign owned R & D exceeds the assessable income by $90,000, Crays Alive can carry forward the loss of $90,000 which it may be able to utilise in a later year of income.
C3-9 Expenditure on foreign owned R & D and interaction with 175% Australian Premium and 175% International Premium
Expenditure on foreign owned R & D cannot be used to establish eligibility for the 175% Australian Premium. Conversely, expenditure deductible under another provision in relation to R & D undertaken by the eligible company, or on its behalf, and not on behalf of any other person will not establish eligibility for the 175% International Premium.
However, an eligible company's expenditure on foreign owned R & D, including certain expenditure which cannot be deducted under subsection 73B(14C) of the ITAA 1936 because it was not incurred in relation to a project carried out in accordance with an R & D plan, will impact upon the deductions available to the eligible company and its group members under sections 73QA (the 175% Australian Premium) and 73QB (the 175% International Premium) of the ITAA 1936.
Once the eligible company has worked out the increases and decreases in expenditure on both Australian-owned R & D and foreign-owned R & D for each eligible company in its group, the calculations for both the 175% Australian Premium and the 175% International Premium, effectively pool the results such that increases to one type of expenditure are reduced by any decrease to the other type of expenditure under section 73RE of the ITAA 1936.
For more information see Parts C6 175% Australian Premium and C7 175% International Premium.