Edited version of private advice

Authorisation Number: 1012635345092

Ruling

Subject: IT - PBR - Research and Development deductions and concessions.

Question 1

Is the Taxpayer entitled to deductions under the former section 73B of the Income Tax Assessment Act 1936 in respect of research and development expenses incurred during the 2011 income year?

Answer

Yes

Question 2

Is the Taxpayer entitled to deductions under the former section 73QA of the Income Tax Assessment Act 1936 in respect of research and development expenses incurred during the 2011 income year?

Answer

Yes

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The Taxpayer was registered with AusIndustry for the relevant financial year. AusIndustry issued a certificate in respect of this registration.

The Taxpayer registered two projects for the relevant financial year.

The application stated that at all times throughout the R&D activities the Taxpayer:

• bore the financial risk associated with the R&D activities;

• had complete control over the R&D activities; and,

• effectively owned the results of the R&D activities.

In their application, the Taxpayer stated that throughout the relevant year the eligible R&D activities undertaken by the Taxpayer's personnel included:

• developing hypotheses;

• developing trial methodologies;

• conducting experiments to test proposed solutions;

• observing and recording the results of these experiments; and,

• servicing and maintenance of R&D facilities and equipment in support of the R&D activities.

The Taxpayer identified the following other R&D expenditure:

• Costs of feed to meet health and nutritional requirements and the costs of storing and handling the feed;

• the costs of hiring contract labour;

• the costs of hiring contract labour to monitor R&D facilities, address health issues and maintain and repair R&D facilities;

• the costs of repair and maintenance on R&D facilities;

• the costs of materials for the maintenance and repair of equipment;

• fuel and oil for the vehicles used to service the R&D facilities, transport and provide feed, and transport personnel to the R&D facilities;

• leasing of vehicles;

• miscellaneous equipment such as testing equipment;

• administrative costs;

• utilities; and,

• statutory rights.

The Taxpayer received two funding grants in the relevant income year. The Taxpayer has treated these grants as being in respect of their R&D activities.

The Taxpayer has calculated the total R&D expenditure for the relevant income year and provided detailed figures on specific types of expenditure.

The Taxpayer had recorded eligible R&D expenditure that was deductible under section 73B of the Income Tax Assessment Act 1936 in their income tax returns for the 2008, 2009 and 2010 income years.

The Taxpayer has calculated their reduced expenditure on Australian owned R&D for the prior years.

In support of their application the Taxpayer provided contracts, invoices, payslips, records and other documents in order to demonstrate substantiation and the nexus between the expenses and the R&D expenditure claimed.

Relevant legislative provisions

Section 73B of the Income Tax Assessment Act 1936

Subsection 73B(1) of the Income Tax Assessment Act 1936

Subsection 73B(9) of the Income Tax Assessment Act 1936

Subsection 73B(14) of the Income Tax Assessment Act 1936

Subsection 73B(14B) of the Income Tax Assessment Act 1936

Section 73BA of the Income Tax Assessment Act 1936

Section 73BC of the Income Tax Assessment Act 1936

Section 73C of the Income Tax Assessment Act 1936

Section 73QA of the Income Tax Assessment Act 1936

Section 73RE of the Income Tax Assessment Act 1936

Section 39L of the Industry Research and Development Act 1986

Reasons for decision

Question 1

Is the Taxpayer entitled to deductions under the former section 73B of the Income Tax Assessment Act 1936 in respect of research and development expenses incurred during the 2011 income year?

During the relevant period section 73B of the Income Tax Assessment Act 1936 (ITAA 1936) provided a deduction to eligible companies against their taxable income for certain expenditure on research and development activities. As the Taxpayer was a company registered under Australian law that undertook research and development activities, they may be eligible to claim deductions under section 73B of the ITAA 1936.

Eligibility for the R&D deduction

The Commissioner's view on the application of section 73B of the ITAA 1936 is set out in the Guide to the R & D Tax Concession - Part C (the Guide). The Guide provides sets out the eligibility requirements for the R&D deduction at item C2-1:

Before claiming the concession, in addition to meeting the requirements particular to the deduction in question, companies must also satisfy themselves that:

• they are registered for that year of income by Innovation Australia (the Board (see Part B-2 Registration by the Board);

• they meet the threshold expenditure test, where applicable; and

• they have incurred expenditure in relation to R&D carried on by them, or on their behalf, and not for the purpose of R&D undertaken on behalf of any other person.

Registration

The Industry Research and Development Act 1986 (IR&D Act) sets out the registration requirements for a company seeking the claim the R&D tax deductions available under section 73B of the ITAA 1936. Companies must register every year with AusIndustry, which will issue a certificate which is binding on the Commissioner for the purpose of making an assessment of the company's taxable income.

For the relevant income year, the Taxpayer was registered with AusIndustry. They had also registered two R&D projects, which are the focus of the questions in this ruling. As the Taxpayer has a valid registration certificate the Commissioner accepts that the registration requirements are satisfied.

Threshold expenditure test

The Guide sets out the requirements of the threshold expenditure test at item C2.1.1:

In order to claim the concession, an applicant must spend over $20,000 in a year of income, unless the R&D is contracted to a Registered Research Agency (RRA). The $20,000 is calculated from the aggregate research and development amount and does not include any 25% concessional component. The $20,000 includes:

• R&D expenditure, which includes salary, contract expenditure to RRAs, and other expenditure (including eligible feedstock expenditure), and excluding residual feedstock expenditure

• the amount of core technology expenditure deductible under subsection 73B(12A) of the ITAA 1936 in the year of income

• one-third of total qualifying plant expenditure in respect of expenditure incurred on plant acquired or commenced to be constructed before 29 January 2001

• the amount of any notional Division 42 or 40 of the ITAA 1997 amount in any year of income, being the depreciation amounts allowable to the company in respect of any plant or depreciating asset used in carrying on R&D activities, where the plant or asset was acquired or constructed after 29 January 2001

• the amount of any deduction allowable under Division 10D (ITAA 1936) or Division 43 (ITAA 1997), because of the use by the company of a building for the purpose of carrying on research and development activities, and

• interest expenditure.

the Taxpayer has provided evidence that it incurred a specific amount of eligible R&D expenditure in the relevant income year for the purposes of section 73B of the ITAA 1936 and that the amount satisfies the threshold expenditure test.

R&D expenditure, in relation to the R&D activities, was undertaken by on or behalf of the claimant

Section 73B of the ITAA 1936 advises that expenditure incurred by an eligible company can qualify as research and development expenditure only if incurred in respect of R&D activities carried out by or on behalf of this company. For R&D activities to be carried out by or on behalf of a company, there must be a close and direct link between the company and the work undertaken.

Subsection 73B(1) of the ITAA 1936 defines research and development expenditure as;

…in relation to an eligible company in relation to a year of income, means expenditure…incurred by the company during the year of income, being;

(a) contracted expenditure of the company;

(b) salary expenditure of the company, being expenditure incurred on or after 1 July 1985; or

(c) other expenditure incurred on or after 1 July 1985 directly in respect of research and development activities carried on by or on behalf of the company on or after 1 July 1985;

…

Under subsection 73B(9) of the ITAA 1936, eligible companies generally cannot 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. It is not necessary that the company be acting as agent of the other, the question is whether, in all circumstances, the R&D is to be carried out in substance for the other. This will be a question of fact in each case.

Subsection 73B(9) of the ITAA 1936, provides:

A deduction is not allowable under this section…in respect of expenditure incurred by an eligible company for the purpose of carrying on research and development activities on behalf of any other person, and expenditure of that kind shall be disregarded for the purposes of the application of this section … to a company.

The requirements outlined in subsections 73B(1) and 73B(9) of the ITAA 1936 (collectively referred to as the 'on own behalf' requirement) effectively prevent companies making double deductions in respect of the same R&D activities by restricting entitlement to the concessional deductions to the company that:

• bears the financial risk associated with a R&D project

• has control over the R&D project, and

• effectively owns the project results.

This is representative of the decision made in Bartercard Australia Pty Ltd v FC of T 2010 ATC 10-167, where the Commissioner's refusal to allow the taxpayer concessional treatment for its R&D expenditure pursuant to subsection 73B(9) was upheld because the state of the evidence left the AAT unable to find on whose behalf the R&D activities were undertaken.

Therefore, for the Taxpayer to claim any amount under section 73B of the ITAA 1936, the relevant R&D activities must be carried out by or on behalf of the company and not on behalf of any other person.

Financial Risk

Financial risk is linked to the undertaking of the R&D activities. Where R&D activities are carried out on behalf of a company, it would generally be expected that the company would bear the financial risk of the activities undertaken. A deduction would not necessarily be prevented in circumstances where a company does not bear the financial risk of an R&D project, but effectively owns the results and controls the conduct of the R&D project. The company should also demonstrate financial risk in respect of the R&D project. This would seem to require a chance or possibility of exposure to commercial loss or other risk.

Where an eligible company performs R&D under contract for another person and does not bear the financial risk and does not have any entitlement to the results of that R&D, that company would not be entitled to claim a deduction under section 73B of the ITAA 1936 for the expenditure incurred in fulfilling its obligations under the contract.

All of the expenditure associated with the R&D activities is born by the Taxpayer; the Taxpayer is not reimbursed for any expenditure by a third party, nor have they entered into an agreement to abdicate the financial risk of the R&D activities. The Taxpayer also owns the results and controls the R&D activities.

Therefore it is considered the Taxpayer meets the financial risk limb of subsection 73(9) of the ITAA 1936.

Control

A company seeking to claim an R&D concession in relation to particular research and development activities must be able to demonstrate an appropriate degree of control over the conduct of the activities.

The Guide states that essential elements of control of the conduct of research and development activities are:

• The ability to choose the project of the R&D;

• The capacity to decide on major changes of direction in those activities;

• The ability to stop an unproductive line of research;

• The scope to follow up (or not) an unexpected result; and

• The power to end a project.

The Taxpayer chose the R&D projects and established the plans behind them, they retain the capacity to make major changes in direction on these projects should the need arise. They have the scope to follow up on an unexpected result, including rolling such activities into their usual course of business and ultimately are able to end the projects should they wish. While they have third parties (for example, contractors) working on the projects, the Taxpayer is ultimately able to control their conduct and activities in relation to the research activities.

Therefore it is considered the Taxpayer meets the control limb of subsection 73(9) of the ITAA 1936.

Ownership

A company seeking to claim the R&D concession must have effective ownership of the results of those activities.

Ownership does not necessarily require that the company must be the proprietor of a piece of intellectual property in any formal sense. It is possible for the formal owner of any resulting intellectual property to hold it on such terms that the company has all the advantages of ownership.

It is accepted that the Taxpayer will retain ownership of the results of the project, the Taxpayer has not entered into any agreements to dispose of or licence any intellectual property that results from the projects, and the Taxpayer's stated aims for the projects are set to provide commercial advantage in their ordinary business.

Therefore, the Taxpayer meets the requirements of subsection 73B(9) of the ITAA 1936.

Conclusion

The Taxpayer has demonstrated that it meets the eligibility requirements under section 73B of the ITAA 1936.

Eligible expenditure on R&D activities

The Guide, at item C.2.3.1, sets out the types of expenditure eligible for deduction under section 73B of the ITAA 1936:

Research and development expenditure, as defined in subsection 73B(1) of the ITAA 1936, includes salary expenditure, contract expenditure paid to Registered Research Agencies, and other expenditures (including overhead and consumables) that are incurred directly in respect of eligible R&D activities. This definition does not cover expenditures on core technology, interest, residual feedstock expenditure, excluded plant expenditure, depreciating assets, structural improvements and buildings - although some of these may attract deductions under other R&D provisions.

Salary expenditure

Salary expenditure for the purposes of the R&D concession includes salaries, wages, allowances, bonuses, overtime and penalty rate payments, annual, sick and long service leave, superannuation fund contributions (which are otherwise deductible under section 290-60 of the ITAA 1997), payroll tax and workers` compensation insurance premiums in relation to those employees who are engaged directly in carrying out an eligible R&D activity.

Salary expenditure only includes the expenditure in relation to those employees who are engaged directly in carrying out an eligible R&D activity, including:

• 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.

For salary expenditure, only that expenditure that is incurred directly in connection with the R&D activities is able to be deducted under section 73B of the ITAA 1936. This means that where the salary expenditure is only part directly in respect of the R&D activities it is necessary to apportion the expenditure. Item C2.3.1.1 explains that:

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.

In their application, the Taxpayer stated that throughout the relevant year the eligible R&D activities undertaken by the Taxpayer's personnel included:

• developing hypotheses;

• developing trial methodologies;

• conducting experiments to test proposed solutions;

• observing and recording the results of these experiments; and,

• servicing and maintenance of R&D facilities and equipment in support of the R&D activities.

The Taxpayer has claimed an amount of salary expenditure directly in respect of its R&D activities that is deductable under section 73B of the ITAA 1936. In support of this claim it supplied time sheets showing the apportionment that was applied for those employees who worked in part directly on the R&D activities. The Taxpayer relied on these timesheets in calculating the eligible proportion of wages, superannuation contributions, payroll tax and fringe benefits tax in respect of the employees engaged in eligible R&D activities.

The timesheets are completed on a daily basis, and include all relevant information including the date the work was carried out, the tasks carried out by each employee, the start time, finish time and total hours worked by each employee on that task, the signature of each staff member and the signature of their supervisor. In respect of work conducted on the R&D equipment and facilities the Taxpayer also supplied evidence in support of the R&D activities.

From the documentation supplied, the Commissioner is satisfied that the Taxpayer has correctly apportioned the salary expenditure for those employees for whom this was necessary in accordance with section 73B of the ITAA 1936, and has sufficiently substantiated its claim for salary expenditure directly incurred in respect of its R&D activities.

Other R&D expenditure

Item C2.3.1.2 of the Guide sets out the Commissioner's view on other R&D expenditure that is eligible for deduction under section 73B of the ITAA 1936:

A company will 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 limited to those 'incurred directly in respect of R&D activities'. The type of expenditure that qualifies for deduction under subsection 73B(14) of the ITAA 1936 depends on the facts of each particular case. It is considered that administrative costs and overheads are '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

• where the conduct of eligible R&D activities by the company could be materially impaired if the expenditure were not incurred.

In general, this expenditure falls into two classes.

The first class encompasses expenditure which could reasonably be expected to be identified as directly relating to an eligible research project.

…

The second class encompasses expenditure which may not be clearly identifiable as R&D expenditure because it relates to a number of business operations but some of that expenditure may nonetheless include a component which is applicable to an eligible R&D project. The onus is on a company to show the nexus ... between the incurrence of the expenditure and the relevant R&D project. A company would also be expected to demonstrate the accuracy of the amount of expenditure allocated to a particular R&D project.

The Taxpayer has incurred an amount of other R&D expenditure for the purposes of section 73B of the ITAA 1936 in the relevant income year. This includes an amount of contract expenditure and plant leasing expenditure.

Per the Guide, as a general rule the following expenses would be accepted as being other R&D expenses connected to eligible R&D projects:

• cleaning;

• consumables; for instance, expenses such as oils, grease and cloths used generally, including R&D activities;

• electricity gases and water;

• insurance premiums to the extent that they are relevant to R&D activities. (Insurance for loss of profits, product liability or finished products would not be eligible);

• leasing charges on office equipment;

• pay roll costs;

• postage;

• printing and stationery;

• rates and land taxes;

• recruitment;

• rent of a building used partly for R&D purposes;

• repairs and maintenance of a building used partly for R&D purposes;

• salaries of support staff that perform some duties connected with eligible R&D activities (for instance, cleaners, typists, supervisors) plus associated costs and on-costs;

• security;

• stationery;

• subscriptions to industry associations and for technical journals;

• telephone and telex; and,

• training.

Ineligible expenses are those expenses that are not directly in respect of eligible R&D activities and could include:

• advertising (for instance, of a company's product);

• audit fees;

• bad debts;

• company establishment and other fees incurred under the companies code in relation to the administration of the company;

• costs incurred in preparing taxation returns;

• decline in value of a depreciating asset (note section 73BA however);

• directors' fees;

• distribution and selling expenses;

• donations;

• employee benefits such as canteen and recreational facilities;

• entertainment expenses;

• factory overheads;

• grounds and gardens-maintenance costs;

• insurance premiums on matters unrelated to R&D such as loss of profits and product liability;

• legal expenses not associated with any approved research project, e.g., legal expenses incurred in carrying out a patent search prior to undertaking a research project or in taking out a patent after a successful project;

• patents and trademarks in marketing a new product or technology, or as a result of R&D activity;

• rent paid for premises which are not to any extent used in R&D activities;

• salaries, associated costs and on-costs of support staff not linked with R&D activities and of staff employed in areas such as distribution, sales, marketing and debt collection; and,

• tender costs.

First class of other R&D expenditure

The Taxpayer identified other R&D expenditure as belonging to first class of other R&D expenditure, being that "expenditure which could reasonably be expected to be identified as directly relating to an eligible research project":

In support of their claim, the Taxpayer has supplied copies of invoices and contracts for the above expenditure.

For example, they have supplied invoices for purchases which sets out cost, type, volume and supplier.

Similar documentation is supplied for the other items of expenditure; invoices detailing the materials needed for repairs and maintenance of R&D facilities, including to which facility the materials relate; invoices for the repair of equipment; copies of the contracts for the contractors; and details of the vehicles involved in the R&D activities and invoices for fuel showing cost, date and alignment to those vehicles.

The Commissioner accepts that these expenses are those that can be solely attributable to the registered R&D activities, and were necessary in order for the R&D activities to be conducted. The Commissioner is also satisfied, based on the documentary material provided, with the claim by the Taxpayer that these items of expenditure fall under the first class of other R&D expenditure.

Second class of other R&D expenditure

The Taxpayer identified numerous items of expenditure other R&D expenditure as belonging to second class of other R&D expenditure, being that "expenditure which may not be clearly identifiable as R&D expenditure". These included administrative costs, utilities, salaries of support staff, and the cost of leasing a licence.

In support of their claim the Taxpayer supplied documentation setting out the apportionment calculations used for the expenditure which is not clearly identifiable as R&D expenditure, and invoices and contracts demonstrating the cost of this expenditure.

In calculating the apportionment of the expenditure the Taxpayer relied on two methods. The first, in line with the suggested methodology set out in the Guide, apportions the expenses based on the proportion of eligible R&D salaries and wages to the total company salaries and wages. This method was utilised for the majority of expenditure items that come under the second class of other R&D expenditure. The second method was utilised for any costs associated with the repair and maintenance to vehicles used in R&D activities. This was calculated by taking the proportion of eligible fuel and oil costs to total fuel and oil costs. This methodology was adopted by the Taxpayer as it believed it was more appropriate for these expenditure items.

Most of the items of expenditure identified by the Taxpayer fit into the items listed in item C2.3.1.2 of the Guide. One item which does not is the cost of leasing of a licence. In order to conduct its regular business and perform the R&D activities the Taxpayer leased a number of licences during the relevant income year. The Commissioner accepts that, given the nature of the licences, they are not in themselves clearly identifiable as R&D expenditure, but the cost was, in part, in connection with the R&D activities. Therefore they may be included under the second class of other R&D expenditure.

The Commissioner is satisfied, based on the calculations provided and the documentary material supporting it that the claim by the Taxpayer that these items of expenditure fall under the second class of other R&D expenditure and that the methodology used in calculating the proportion of the expenditure relating to the R&D activities is appropriate.

R&D contract expenditure

Neither the legislation nor the Guide distinguishes between other R&D expenditure and contract expenditure. However, the Research and development tax concession schedule does provide a separate set of labels, titled "Contract - other".

The nature of the contract expenditure contemplated in the Taxpayer's application is different from the concept of "Contracted Expenditure" as explained in item C2.3.1.3 of the Guide. Such contract expenditure consists of payments by an eligible company to an organisation with Registered Research Agency (RRA) status, where the RRA performs R&D activities on behalf of the eligible company. In its application the Taxpayer makes no claim that the expenditure includes payments made to a RRA.

Notwithstanding the contents of the schedule, the Commissioner's view on other R&D expenditure is set out in the Guide, and this would include contract expenditure. Such contract expenditure may fall in either the first or second class of other R&D expenditure, and each such expense would need to be assessed to determine which class it would come under.

In its application the Taxpayer specified that it had incurred contract expenditure. This expenditure covers three categories of contracts:

• Hiring of contractors to monitor the R&D facilities;

• Hiring of contract labourers for engineering work directly related to the R&D activities and the hauling of items and goods used in the R&D activities; and,

• Hiring of other contract labour.

In support of its claim, the Taxpayer provided copies of the contracts entered into by the Taxpayer and the contractors utilised by them in their R&D activities.

In line with the reasoning above, the Commissioner considers that the claimed contract expenditure incurred by the Taxpayer in respect of its R&D activities is other R&D expenditure that fits into the first class. The substantiation provided by the Taxpayer sufficiently demonstrates the expenditure incurred and thus the Commissioner considers that the expenditure is deductible under section 73B of the ITAA 1936 as eligible other R&D expenditure.

Leased plant and buildings

Per item C2.3.1.2 of the Guide the Commissioner considers that any rent or lease payments by an eligible company in respect of plant or buildings used in R&D activities would constitute other R&D expenditure under section 73B of the ITAA 1936. Due to interactions with other R&D provisions in the ITAA 1936, leased plant and building expenditure needs to be separately identified by an eligible company.

The Taxpayer has identified the leasing of vehicles and a small amount of equipment used for R&D activities as falling under this category of other R&D expenditure. In support of their claim, the Taxpayer has supplied contracts and invoices detailing the leased plant expenditure.

In order to apportion the leased plant and buildings expenses that fall under the second class of other R&D expenditure, the Taxpayer applied the first methodology outlined above, whereby the expenses were apportioned based on the proportion of eligible R&D salaries and wages to the total company salaries and wages. The Commissioner accepts that this is an appropriate method of apportionment and is in line with what is set out in the Guide.

The Commissioner considers that the leased plant and building expenditure incurred by the Taxpayer in respect of its R&D activities has been sufficiently demonstrated by the documentary material supplied. The Commissioner also considers that the methodology applied to apportion the expenditure is appropriate in this case.

Conclusion

Based on the above reasoning, the Commissioner accepts the submissions from the Taxpayer as to the eligible other R&D expenditure deductible under section 73B of the ITAA 1936 for the relevant income year.

Feedstock expenditure

The definition of 'research and development expenditure' in section 73B of the ITAA 1936, excludes 'feedstock expenditure' but includes any 'eligible feedstock expenditure' that the company has in respect of related research and development activities.

Per section 73B of the ITAA 1936, feedstock expenditure is defined as:

feedstock expenditure, in relation to an eligible company, means expenditure incurred by the company in acquiring or producing materials or goods to be the subject of processing or transformation by the company in research and development activities, and includes expenditure incurred by the company on any energy input directly into the processing or transformation.

eligible feedstock expenditure is the amount by which the company's 'feedstock input' exceeds its 'feedstock output' in respect of the year of income in relation to related research and development activities.

residual feedstock expenditure is the lesser of the eligible company's feedstock input, or feedstock output in respect of the year of income in relation to related research and development activities.

feedstock input, in relation to an eligible company, is the actual 'feedstock expenditure' in respect of goods or materials that were processed or transformed by the company in the relevant research and development activities.

feedstock output, in relation to an eligible company, means the proceeds from the sale of, or the sale value of the product(s) obtained in relation to that feedstock input expenditure.

Deductions for feedstock expenditure may be available to an eligible company carrying out R&D activities as either:

• eligible feedstock expenditure which forms part of research and development expenditure (under subsection 73B(1) of the ITAA 1936). Eligible feedstock expenditure is deductible at the rate of 125% (subject to the $20,000 aggregate R&D amount threshold being satisfied); or,

• residual feedstock expenditure (under subsection 73B(14B) of the ITAA 1936). This is feedstock expenditure, which does not qualify as eligible feedstock expenditure and is deductible only at the rate of 100%.

The Taxpayer claims to have incurred an amount of residual feedstock expenditure, which if eligible is deductible under subsection 73B(14B) of the ITAA 1936. In calculating the amount of feedstock expenditure incurred by the Taxpayer, they determined that in all cases the cost of acquiring the feedstock inputs were less than the proceeds of selling the feedstock outputs, hence all are claimed as residual feedstock expenditure.

In their claim, the Taxpayer's residual feedstock is made up of four categories of expenses:

• the salary expenses incurred in respect of the Taxpayer's annual business activities;

• the salary of a specific employee who is employed to undertake a specific task in the R&D activities;

• the cost of fuel used by all vehicles in respect of the Taxpayer's annual business activities; and,

• the cost of the fuel for one specific vehicle for the entire income year.

In support of their claim the Taxpayer supplied documentary materials, including invoices and payslips, recording the expenses incurred.

As the Taxpayer is not claiming the 125% concessional deduction in relation to these expenses, the Commissioner is of the view that these expenses would be otherwise deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) where the Taxpayer did not wish to claim them under subsection 73B(14B) of the ITAA 1936. Given the documentation provided, and the eligibility of the expenses to be claimed as deductions incurred in the ordinary course of the Taxpayer's business under section 8-1 of the ITAA 1997, the Commissioner is satisfied that the expenses are deductible against the Taxpayer's assessable income in the 2011 income year.

Deduction for depreciating assets used in R&D activities

Under section 73BA of the ITAA 1936 an eligible company is entitled to a deduction if it has a notional Division 40 deduction for a depreciating asset.

Section 73BC of the ITAA 1936 defines what a notional Division 40 deduction is:

73BC Meaning of notional Division 40 deduction

(1) An eligible company has a notional Division 40 deduction for a section 73BA depreciating asset for a year of income if it would be entitled to a deduction under section 40-25 of the Income Tax Assessment Act 1997 for the asset for the year of income assuming the changes set out in this section were made.

First change: replacement of references to use or installation ready for use for purpose of producing assessable income or for taxable purpose

(2) The first change is that references in Division 40 of the Income Tax Assessment Act 1997 (other than for the purposes of sections 40-100, 40-105 and 40-110) to using the asset, or having it installed ready for use:

(a) for the purpose of producing assessable income; or

(b) for a taxable purpose;

are instead references to using the asset for the purpose of the carrying on by or on behalf of the eligible company of research and development activities.

Note: Section 73BG modifies sections 40-100, 40-105 and 40-110 (about effective life) so that a reference to the research and development purpose is added to the existing references, rather than replacing them.

Second change: method for working out decline in value where previous Division 40 deduction

(3) The second change is that, if the eligible company was actually entitled to a deduction under Division 40 of the Income Tax Assessment Act 1997 for the section 73BA depreciating asset for any period before the start of the first period for which the company will be entitled to a deduction for the asset under this subsection, the same method for working out the decline in value as the company was using for the asset for the earlier period is used.

Third change: treatment of expenditure to which section 73BD or 73BE applies

(4) The third change is that, in working out the cost of the section 73BA depreciating asset, any amount of expenditure ( section 73BA depreciating asset expenditure ) that would otherwise form part of that cost is to be ignored or treated in some other way if section 73BD or 73BE so provides for the purposes of this section.

Fourth change: certain provisions to be ignored

(5) The fourth change is that Division 40 of the Income Tax Assessment Act 1997 applies as if section 73BA of this Act, and section 40-425 and Subdivision 328-D of that Act, had not been enacted.

(6) In this section:

eligible company has the same meaning as in section 73B.

research and development activities has the same meaning as in section 73B.

section 73BA depreciating asset has the meaning given by section 73BB.

The Commissioner's view on the operation of section 73BA of the ITAA 1936 is set out in item C2.3.5.2 of the Guide.

In their application the Taxpayer stated that they had incurred an amount of depreciation in connection with their R&D activities. The Taxpayer has identified three main deprecating assets used solely in R&D activities. These three assets are all vehicles used to maintain and service the R&D facilities. In addition, the Taxpayer has claimed a number of other depreciating assets were also used solely in R&D activities. In support of this claim the Taxpayer has provided documentation showing which vessels were used in servicing which R&D facilities and documentation showing those assets used solely for R&D activities.

Based on the documentation supplied by the Taxpayer the Commissioner is satisfied that the assets in question meet the definition of an asset eligible for a notional Division 40 deduction. The Commissioner is also satisfied that the depreciation of the assets is a deductible expense under section 73BA of the ITAA 1936.

Clawback provisions

Section 73C of the ITAA 1936 operates to 'claw back', or offset the benefits of the R&D tax concession for companies that have received a government grant for the same project.

The Commissioner's view on the operation of section 73C of the ITAA 1936 is set out in item C8-2 of the Guide. Clawback is applied on a project basis, not to the entire claim.

Per item C8-2 of the Guide, section 73C of the ITAA 1936 operates where:

• there is an 'eligible company'

• expenditure (called 'relevant expenditure') is incurred by the company on or after 1 July 1985 on research and development activities

• the R&D activities form part or all of a particular project

• the project is carried on by or on behalf of the company; the company, or another person grouped with the company, has received or is entitled to receive (either before or after the commencement of section 73C of ITAA 1936), a recoupment or a grant for some or all of the relevant expenditure from:

- the Commonwealth

- a State or Territory

- an STB (State/Territory body); or

- an authority constituted by or under a law of the Commonwealth, a State or of a Territory.

The Taxpayer received two types of grant funding in the relevant income year. In their application the Taxpayer has stated that they have clawed back the R&D expenditure to the extent of the two grants received. The Commissioner accepts this position.

Conclusion

The Commissioner is satisfied that the Taxpayer is entitled to claim a deduction under former section 73B of the ITAA 1936 for expenses incurred in connection to the Taxpayer's registered R&D activities. The Taxpayer has supplied documentation that satisfactorily establishes the nexus between the expenditure and the R&D activities, and meets the substantiation requirements necessary to claim the deductions under section 73B of the ITAA 1936.

Question 2

Is the Taxpayer entitled to deductions under the former section 73QA of the Income Tax Assessment Act 1936 in respect of research and development expenses incurred during the 2011 income year?

Section 73QA of the ITAA 1936 allows eligible companies an extra deduction for increases in expenditure on Australian owned R&D. It states:

73QA  Extra deduction for increase in expenditure on Australian owned research and development

Prerequisites for deduction

(1) An eligible company may deduct an amount for the Y₀ year of income if:

(a) the company can deduct an amount for that year under subsection 73B(13) or (14) for incremental expenditure incurred in the company's group membership period; and

(b) for each of the Y_-1, Y_-2 and Y_-3 years of income, any of the following conditions is met:

(i) the eligible company could deduct for the year of income an amount under subsection 73B(13) or (14) for expenditure incurred in its group membership period;

(ii) one of the eligible company's other group members could deduct for the year of income an amount under subsection 73B(13) or (14) for expenditure incurred in its group membership period;

(iii) the eligible company received a start grant or commercial ready grant in respect of the year of income;

(iv) one of the eligible company's other group members received a start grant or commercial ready grant in respect of the year of income;

(whether or not the same condition is met for 2 or more of those years, and whether or not a condition is met by the same company for 2 or more of those years); and

(c) the amount (the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group) worked out under subsection (3) is more than zero.

Amount of deduction

(2) The amount of the eligible company's deduction for the Y₀ year of income is 50% of the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group.

(3) The eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group is the amount worked out using the formula:

where:

adjusted increase in expenditure on R&D by the group means the amount worked out under section 73RE.

increase in expenditure on Australian owned R&D by the eligible company means the amount worked out under subsection 73RA(1).

net increase in expenditure on Australian owned R&D by the group means the amount worked out under section 73RC.

net increase in expenditure on foreign owned R&D by the group means the amount worked out under section 73RD.

total increase in expenditure on Australian owned R&D by the eligible companies in the group means the amount worked out under subsection 73RA(2).

Note:          The amount worked out using the formula will not be more than zero if at least one of the following is zero:

(a) the increase in expenditure on Australian owned R&D by the eligible company;

(b) the net increase in expenditure on Australian owned R&D by the group;

(c) the adjusted increase in expenditure on R&D by the group.

Solitary company may be able to deduct under subsection (1)

(4) To avoid doubt, an eligible company for which there are no other group members may be able to deduct an amount under subsection (1).

Note:          For an eligible company for which there are no other group members, the values of the following components of the formula in subsection (3) will all be the same:

(a) the increase in expenditure on Australian owned R&D by the eligible company;

(b) the total increase in expenditure on Australian owned R&D by the eligible companies in the group;

(c) the net increase in expenditure on Australian owned R&D by the group.

The Commissioner's view on the operation of section 73QA of the ITAA 1936 is set out in item C6 of the Guide. To be eligible for the extra deduction under section 73QA of the ITAA 1936 a company must have its R&D activities registered with AusIndustry and be eligible for a deduction under either subsection 73B(13) or subsection 73B(14) of the ITAA 1936. Finally, the company must have been eligible for deductions under either subsection 73B(13) or subsection 73B(14) of the ITAA 1936 in the three income years prior to the one in which a deduction under section 73QA of the ITAA 1936 is sought.

As previously discussed, the Taxpayer had registered the two R&D activities that are the subject of this ruling with AusIndustry in the relevant year. Additionally, they are entitled to claim deductions under subsection 73B(14) of the ITAA 1936 for a number of the R&D expenses they incurred (such as salary expenditure and a number of items falling under the ambit of other R&D expenditure), as has been discussed in detail above. Finally, as per the income tax returns lodged by the Taxpayer for the prior years, the Commissioner assessed the Taxpayer as having incurred eligible R&D expenditure deductible under subsection 73B(14) of the ITAA 1936 in each respective year.

Therefore the Commissioner considers that the Taxpayer meets the basic eligibility criteria for claiming the extra deduction available under section 73QA of the ITAA 1936.

The final requirement for a company to be eligible for the extra deduction under section 73QA of the ITAA 1936 is that the amount available to deduct, as calculated per subsection 73QA(3) of the ITAA 1936 is more than zero.

The available deduction is based on the eligible company's share of the Australian owned part of the adjusted increase in expenditure on R&D by the group and is calculated by using the following formula:

The Taxpayer belongs to a consolidated group, but as it was the only member of the group to conduct R&D activities, it effectively stands as a solitary company. Per subsection 73QA(4) of the ITAA 1936 this does not preclude the Taxpayer from claiming the extra deduction, notwithstanding the elements in the above formula referring to amounts in respect of companies in the group. In effect, this makes the first division in the formula equal to one, as the increase in expenditure by the company will equal the increase in expenditure of all companies in the group.

The Taxpayer also does not have any foreign owned R&D expenditure, and is not associated with any foreign owned R&D activities. This has the effect of making the second division in the above formula also equal to one, as we would be dividing the net increase in expenditure by the same amount of net increase in expenditure.

The result of this is that the above formula, when applied to the Taxpayer, is as below:

In effect, the Taxpayer's share of the Australian owned part of the adjusted increase in expenditure on R&D will be equal to the Taxpayer's adjusted increase in expenditure on R&D, which is calculated under section 73RE of the ITAA 1936.

The adjusted increase in expenditure on R&D by the group is calculated under section 73RE of the ITAA 1936. This amount is calculated as the sum of the change in expenditure on Australian owned R&D and the change in expenditure on foreign owned R&D for all group members (will be positive or zero if negative). An adjustment balance is then subtracted from this result (will be positive or zero if negative).

Therefore the Commissioner is satisfied that the Taxpayer is eligible for the extra deduction under section 73QA of the ITAA 1936.