Edited version of private advice

Authorisation Number: 1051828953443

Date of advice: 20 April 2021

Ruling

Subject: R&D Tax Offset - Notional Deductions

Question 1

Is the purchase price of the land and incidental costs associated with the acquisition (cost of land) a notional deduction for research and development (R&D) expenditure under section 355-205 of the Income Tax Assessment Act 1997 (Cth)?

Answer: No

Question 2

Is the cost of the land to the extent that it is a notional deduction for R&D expenditure excluded from forming part of the cost base of the land pursuant to section 110-45(2) of the Income Tax Assessment Act 1997 (Cth)?

Answer: Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

30 July 20XX

Relevant facts and circumstances

1.    Investment Co is the head entity of a tax consolidated group.

2.    Subsidiaries of Investment Co include Food Co and Recreation Co.

3.    For the year ending 30 June 20XX, Investment Co registered an R&D project with AusIndustry under section 27A of the Industry Research and Development Act 1986 (Cth).

4.    Investment Co registered one core activity under this project.

5.    Investment Co registered three supporting activities under their single core activity.

6.    On 31 July 20XX, Recreation Co entered into a contract to acquire land (the Land).

7.    The purchase price of the Land was $XX and stamp duty payable on the acquisition was $X.

8.    Once acquired, X xxxs were built and X were initially lined.

9.    A new xxx xxx was constructed, and the existing xxxs were cleaned out and began to be used for storage of xxx to facilitate the adjustment of xxx and xxx xxx volume.

10.  Trials to determine the most suitable design of the xxxs have been undertaken, going to factors such as xxx, xxx, xxx-xxx, xxx, xxx/xxx xxx, xxx xxx xxx, xxx, xxx and structural factors of the xxx design.

11.  Since being acquired, the Land has been used purely for the R&D project.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 43-70(2)(a)

Income Tax Assessment Act 1997 subsection 40-730(1)

Income Tax Assessment Act 1997 subsection 110-45(2)

Income Tax Assessment Act 1997 paragraph 355-105(1)(e)

Income Tax Assessment Act 1997 subsection 355-205(1)

Industry Research and Development Act 1986 section 27A

Reasons for decision

All subsequent legislative references are to the Income Tax Assessment Act 1997 (Cth).

Question 1

Is the purchase price of the land and incidental costs associated with the acquisition (cost of land) a notional deduction for research and development (R&D) expenditure under section 355-205 of the Income Tax Assessment Act 1997 (Cth)?

Summary

The purchase price of the land and incidental costs associated with its acquisition cannot be included as a notional deduction.

Detailed reasoning

12.  Subsection 355-205(1) provides that:

An *R&D entity can deduct for an income year (the present year) expenditure it incurs during that year to the extent that the expenditure:

(a) is incurred on one or more * R&D activities:

(i) for which the R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year; and

(ii) that are activities to which section 355- 210 (conditions for R&D activities) applies; and

(b) if the expenditure is incurred to the R&D entity's * associate--is paid to that associate during the present year.

13.  The phrase 'incurred on' in the context of subsection 355-205(1) has not been considered judicially. Further, no ATO public ruling specifically considers the use of the phrase in this context.

14.  ATO Interpretative Decision ATO ID 2007/142 Income Tax Capital Works: expenditure on acquiring land considers when expenditure will be incurred on something in the context of paragraph 43-70(2)(a):

Expenditure is not incurred 'on' a certain thing unless there is a sufficient connection and close association between the expenditure and the purpose, object or effect of the expenditure (Robe River Mining Co Pty Ltd v. FC of T 89 ATC 4606; (1989) 20 ATR 768). Expenditure should not be taken to also be directed to other, quite separate, ends.

Accordingly, for the purpose of paragraph 43-70(2)(a) of the ITAA 1997 the term 'on' takes a restrictive interpretation. That is, expenditure 'on acquiring' a nominated thing (here, 'land') means only expenditure directly associated with the act of acquiring a thing that is, when it is acquired, 'land' within its ordinary meaning.

15.  In Utah Development Co. v. Federal Commissioner of Taxation 75 ATC 4103 (Utah Development), the taxpayer was required to pay compensation to pastoral lease owners in order to obtain a mining lease over Crown land. Newton J held that those compensation payments were not spent in carrying on mining operations, but rather were costs for the purpose of acquiring a mining property or for the purpose of acquiring the right to use a property as a mining property. He stated at page 4116:

In my opinion, these two sums were each of them spent not in carrying on mining operations upon a mining property for the extraction of minerals from their natural site, but for the purpose of acquiring a mining property or for the purpose of acquiring the right to use a property as a mining property.

16.  Newton J went on to reason those costs were merely preparatory to, or a prerequisite of, carrying on mining operations. He stated at page 4116:

Expenditure for the purpose of acquiring a mining property, or for the purpose of acquiring the right to use a property as a mining property, is itself expenditure which is preparatory to, or a prerequisite of, the carrying on of mining operations on the property

17.  The Commissioner adopts this reasoning in Taxation Ruling TR 2017/1 Income tax: deductions for mining and petroleum exploration expenditure, in determining the scope and application of subsection 40-730(1).

18.  The Land is used entirely for its R&D project, i.e. no ordinary business activities are conducted on the Land. The purpose of acquiring the land was therefore to conduct R&D activities on that land.

19.  The Commissioner considers that the same reasoning applied in Utah Development should be applied here. The costs incurred acquiring the Land were preparatory to, or a prerequisite of, the R&D activities that were subsequently carried out on the land.

20.  The costs incurred acquiring the Land were therefore not incurred on the registered R&D activities of Investment Co, and are not capable of being a notional deduction under subsection 355-205(1).

Question 2

Is the cost of the land to the extent that it is a notional deduction for R&D expenditure excluded from forming part of the cost base of the land pursuant to section 110-45(2) of the ITAA1997?

Summary

Any cost of the land included as a notional deduction for R&D expenditure is excluded from forming part of the cost base of the land.

Detailed reasoning

21.  Subsection 110-45(2) provides:

(2) Expenditure (except expenditure excluded by subsection (1B)) does not form part of the cost base to the extent that you have deducted or can deduct it for an income year, except so far as:

(a) the deduction has been reversed by an amount being included in your assessable income for an income year by a provision of this Act (outside this Part and Part 3-3 and Division 243); or

Note: Division 20 contains some of the provisions that reverse deductions. Section 20-5 lists some others.

(ab) the deduction is under Division 243; or

(b) the deduction would have been so reversed apart from a provision listed in the table (relief from including a balancing charge in your assessable income).

22.  By operation of paragraph 355-105(1)(e), an amount included as a notional deduction is not excluded from the operation of subsection 110-45(2):

(1) An amount (the notional amount) that an * R&D entity can deduct under this Division is disregarded except for the purposes of:

(e) a provision (of this Act or any other Act) that excludes expenditure from:

(i) the * cost base or * reduced cost base of a * CGT asset; or

(ii) an element of that cost base or reduced cost base.

Note: An example is section 110- 45, which may exclude deductible expenditure from elements of the cost base of an asset.

23.  Therefore, any amount that Investment Co includes as a notional deduction under section 355-205 is excluded from forming part of the cost base of the Land.

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