Edited version of private advice

Authorisation Number: 1052224586227

Date of advice: 27 May 2024

Ruling

Subject: Research and development tax incentive

Question 1

Will the applicant have an amount pursuant to paragraph 355-445(1)(a) of the Income Tax Assessment Act 1997 in relation to the expenditure incurred in acquiring or producing the feed used to feed its livestock during R&D activities?

Answer

Yes.

Question 2

If the answer to Question 1 is yes, should the expenditure subject to subparagraph 355-445(1)(b) of the Income Tax Assessment Act 1997 be apportioned pursuant to subparagraph 355-445(2)(b) between the different outputs (meat and manure) based on the scientifically calculable proportion of inputs attributable to each output (i.e. two feedstock adjustments are calculated - one for feed attributable to the livestock and one for feed attributable to the manure - which may then be applied to own use such as in a biogas plant)?

Answer

No.

This ruling applies for the following period:

1 July 20YY to 30 June 20YY

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

The applicant carries on a livestock farming operations in Australia.

The applicant has been registered for the R&D tax incentive for many years.

The applicant has conducted feeding trials in relation to its farming operations.

The experiment consists of feeding some livestock a conventional phase-feeding diet and others a single diet, to see if the single diet feed method could reduce feed costs without negatively effecting growth or carcass performance.

To date, the applicant has not claimed any animal feed as R&D expenditure (consumable or otherwise) in prior R&D tax claims.

The feed attributable to the weight gain of the animals and feed attributable to the waste products have been separated in the R&D project summary.

The livestock, or their offspring that are part of the R&D activity are expected to be sold.

At some sites, effluent (manure) is converted into biogas to generate electricity on farms. The applicant can track the portion of manure attributable to biogas production at these sites, and the value of the resultant biogas, and is able to calculate a feedstock output value for this portion of the manure.

Assumption

The "R&D activities" meet the definition of "R&D activities" in section 355-20 of the Income Tax Assessment Act 1997 (ITAA 1997).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 355-445

Reasons for decision

Issue

Research and development (R&D) tax incentive - feedstock

Question 1

Will the applicant have an amount pursuant to paragraph 355-445(1)(a) of the Income Tax Assessment Act 1997 in relation to the expenditure incurred in acquiring or producing the feed used to feed its livestock during R&D activities?

Summary

Yes, the cost of feeding livestock during the experiment would form part of feedstock inputs in the calculation of a feedstock adjustment when determining a claimable amount.

Detailed reasoning

All references are to the ITAA 1997 unless otherwise indicated.

1.    Division 355 generally allows an R&D entity that has engaged in registered R&D activities to claim either:

•         A refundable tax offset equal to the entity's company tax rate plus an 18.5% premium for eligible entities with an aggregated turnover of less than $20 million per annum, provided they are not controlled by income tax-exempt entities

•         a non-refundable tax offset for all other eligible entities equal to the entity's company tax rate plus a two-tiered premium determined on the notional R&D expenditure as a proportion of total expenditure for the income year. The new rates will be the company tax rate plus

o   8.5% for R&D expenditure up to 2% of total expenditure

o   16.5% for R&D expenditure above 2% of total expenditure.

2.      For the 20YY-YY and later income years, Subdivision 355-G may cause a clawback of a R&D tax offset for expenditure on registered R&D activities, where these activities involve the production of one or more tangible productions.

3.      These new provisions apply in the same circumstances as the former provisions of Subdivision 355-H and section 355-465.

4.      Subdivision 355-G applies to all activities for which the three conditions for a feedstock adjustment in subsection 355-445(1) are met.

5.      Subsection 355-445(1) states:

The R&D entity has an amount under this section if:

(a)  it incurs expenditure in one or more income years in acquiring or producing goods, or materials, (the feedstock inputs) transformed or processed during R&D activities in producing one or more tangible products (the feedstock outputs); and

(b) it obtains under section 355-100 tax offsets for one or more income years (each an offset year) for deductions under this Division:

                  (i)      for the expenditure, or

                  (ii)      for expenditure it incurs on any energy input directly into the transformation or processing:

                  (iii)      for the decline in value of assets used in acquiring or producing the feedstock inputs; and

(c) during the present year, a feedstock output, or a transformed feedstock output (the marketable product) is:

                  (i)      supplied by the R&D entity to another entity; or

                  (ii)      applied by the R&D entity to the R&D entity's own use, other than use for the purpose of transforming that production for supply.

6.      Paragraph 355-445(1)(a) requires a feedstock adjustment to arise when:

•         an R&D entity incurs expenditure in one or more income years in acquiring or producing goods, or materials (the feedstock inputs)

•         the feedstock inputs are transformed or processed, and

•         feedstock inputs are transformed or processed during R&D activities in producing one or more tangible products (feedstock outputs).

Meaning of the term "expenditure... in acquiring or producing goods or material" (Feedstock Inputs)

7.      In Taxation Ruling TR 2013/3 Income Tax: research and development tax offsets: feedstock adjustments (TR 2013/3) the Commissioner expresses his view on feedstock adjustments. Whilst TR 2013/3 considers former Subdivision 355-H, the guidance and views provided on feedstock adjustments remain relevant in considering Subdivision 355-G.

8.      Paragraph 19 addresses the meaning of 'expenditure ...in acquiring or producing goods, or materials' (feedstock inputs) as follows:

The phrase 'expenditure ... in acquiring or producing goods, or materials' in [former] paragraph 355-465(1)(a) refers to all expenditure incurred in the course of, or in connection with, or in the process or act of, acquiring or producing feedstock inputs. They are an important part of the first condition for a feedstock adjustment, and describe all types of expenditure incurred by an R&D entity in bringing the relevant goods or materials to a state where they can begin to be transformed or processed during R&D activities.

Meaning of the term feedstock inputs are 'transformed or processed':

9.      TR 2013/3 provides guidance on the phrase 'transformed or processed'.

10.   Paragraph 18 of TR 2013/3 states:

...the first condition [in subsection 355-445(1)] does not apply to expenditure on the transformation or process activities themselves. This limitation is consistent with the fact that where [former] section 355-465 [current 355-445] intends to bring such expenditure into the calculation of a feedstock adjustment it does so expressly; and then only where it is incurred on energy input directly into the transformation or processing; see [former] subparagraph 355-465 (1)(b)(ii) [current section 355-445(1)(b)(ii)]. This limitation also applies to expenditure on goods and materials which are merely acquired or created to subject other goods and materials to transformation or processing during R&D activities. Such items represent a cost of the process of transforming or processing other goods or materials, rather than something to be transformed or processed in their own right.

11.   Paragraph 173 of TR 2013/3 articulates further on the same point:

The text of [former] subsection 355-465(1) [current 355-445(1)] indicates that other types of expenditure incurred in the conduct of such transformation or processing (that is, what might be called the 'cost of conducting the actual R&D activities', as distinct from the expenditure on acquiring or producing the inputs to those activities), are not intended to come within the first and second conditions [of subsection 355-445(1)]. An example of such expenditure is an amount expended on employees of the R&D entity engaged in carrying out the transformation or processing in question.

12.   These two paragraphs above indicate that there is a distinction between something that is transformed or processed in its own right and the cost of the process of transformation. The earlier forming part of [former] paragraph 355-465(1)(a) while the latter is not.

13.   The question that needs to be considered to determine if feed is feedstock input as per [former] subsection 355-465(1) is whether the feed is a subject of transformation or merely part of the cost of the process of transformation.

14.   Further TR 2013/3 at paragraphs 18A-18C state:

18A. It is noted that there is an inherent link between feedstock inputs and feedstock outputs. This relationship is reflected in the distinction between:

•           those goods or materials which are themselves transformed or processed during R&D activities, and

•           those which are merely acquired or produced to subject other goods or materials to transformation or processing during such activities.

18B. In this context, a feedstock input will itself be transformed or processed where it continues to exist, in some form, in the output being produced. The provisions necessarily contemplate that inputs will be transformed or processed during R&D activities. Therefore, it is not a requirement that the feedstock input exist in the feedstock output in its original form. Nor is it a requirement that all of the feedstock input form part of the feedstock output. Once it is identified that the feedstock input continues to exist in the output being produced, other than in the form of a trace amount or as unwanted residue^[19B], the full amount of the expenditure on the feedstock input is feedstock input expenditure. This is the case, even though part of the feedstock input may not be present in the feedstock output.

18C. In contrast, a feedstock input will not itself be transformed or processed where it does not exist (in any form) as part of the output, or is only present in that output in trace amounts or as unwanted residue.

Footnote ^[19B]: These things can be disregarded on the basis that their amount or value is so trifling as to be negligible; Wilkes v. Goodwin 143 [1923] 2 KB 86; [1923] All ER 61.

15.   The recent case of GQHC and Commissioner of Taxation [2024] AATA 409 (GQHC) discusses research and development activities conducted in livestock farming, specifically poultry farming. The case considered feedstock adjustments for animal feed and the livestock industry.

16.   In GQHC, the Tribunal in discussing former section 355-465 [current 355-445] decided the text and context of former subsection 355-465(1) do not indicate that a narrow view should be adopted as to the meaning of the words 'transformed or processed' which would limit the words to things that relate to manufacturing, fabrication or some involvement of an external agent (force or effect) being applied to an object, or that tangible products cannot be biological or agricultural. It follows that the feedstock provisions can apply to basic farming activities of growing and raising livestock and crops[1].

17.   The Tribunal in GQHC found that:

774. ... the activities and operations undertaken by GQHC in relation to the chickens involved subjecting the chickens to a method or process. The chickens are processed for the purpose of human consumption through a series of steps.

775. The feed is transformed and processed through digestion and is either absorbed, excreted, or metabolised. The feed is transformed or processed in relation to the laying chickens and results in the production of a fertilised egg.

...

777. ...the chickens are not left by GQHC to grow "naturally", without intervention. They are "grown" in an entirely controlled environment. Their food and water intake, amount of light, and temperature conditions are all modified and controlled in a strict process in order to achieve a chicken of a desired weight within the desired time frame to minimise costs and maximise return.

778. The chicken feed given to the chickens has been tailored and prepared (either by the manufacturer or by GQHC in the case of the Broiler Improvement Project). That is, the feed has been processed. The feed was treated through the addition and combination of grains, minerals and so on, specifically chosen for the efficient and effective production of poultry products for human consumption. The experts were not in dispute about this.

779. The chicken is fed the feed (the feedstock input) and then undergoes a biological transformation, through digestion and metabolisation, where the feedstock (the chicken feed) is converted (digestively transformed) into an agricultural product (chickens for meat or eggs). The statute does not restrict the transformation to only non-biological. However, here, the biological transformation, as orchestrated by GQHC, is tweaked and contrived.

780. The chickens here are not growing au natural. Every stage of their short life is controlled, particularly in relation to their nutrient intake. Significant steps have to be taken by the poultry farmer to produce a product fit for human consumption. There is the consideration of the type and constituents of feed, the amount and timing of the feed, how the feed is mixed and processed (evidence was given of the trialling of pellets vs crumbled feed, for example). This is evidenced by the expertise on display during the hearing and the significant research that has been engaged in by industry and academia in relation to poultry science.

781. The Tribunal finds the feed and chickens were transformed and processed during the Registered Activities.

782. The chicken is the beneficiary of the feedstock. The output is the chicken meat and eggs.

18.   Paragraph 355-445(1)(a) demonstrates the link required between the feedstock inputs and the feedstock outputs. That is, the transformation or processing of feedstock inputs results in the production of one or more tangible products, the feedstock outputs.

19.   Paragraph 355-445(2)(b) then refers to the amounts referred to in paragraph 355-445(1)(b) and the amounts reasonably attributable to the production of the feedstock outputs.

Application to this circumstance

20.   Feed fed to the livestock is transformed or processed, for the purposes of paragraph 355-445(1)(a), through mechanical and chemical digestion, and metabolism. Some molecules of the ingredients in the feed become part of the body of the animal, others change state or are excreted - in every case the whole of the feed is transformed and processed.

21.   None of the feed would be considered a consumable.

22.   For the purposes of paragraph 355-455(1)(a):

•         the feed will be considered feedstock input

•         the feed will be transformed or processed

•         the feed will be transformed or processed during R&D activities in producing the livestock, the feedstock output.

23.   The whole of the expenditure on feed will be considered a feedstock input that has been transformed or processed during the R&D activities.

24.   A feedstock adjustment would be required where the livestock are sold at the end of the experiment and where the manure is converted to biogas.

Question 2

If the answer to Question 1 is yes, should the expenditure subject to subparagraph 355-445(1)(b) of the Income Tax Assessment Act 1997 be apportioned pursuant to subparagraph 355-445(2)(b) between the different outputs (meat and manure) based on the scientifically calculable proportion of inputs attributable to each output (i.e. two feedstock adjustments are calculated - one for feed attributable to the livestock and one for feed attributable to the manure - which may then be applied to own use such as in a biogas plant)?

Summary

No, whilst the expenditure should be apportioned between the different feedstock outputs, the appointment must be done based on a reasonable attribution of the production of the feedstock output. The appointment of expenses should be based on generally accepted accounting methodologies, in particular cost accounting methodologies.

Detailed reasoning

25.   As discussed in Question 1 and in paragraphs 24 to 26 above, the whole amount of the feed will be considered feedstock input and no amount would be considered a consumable.

26.   The applicant has advised that the feedstock outputs in relation to the R&D project are:

•         livestock, which are sold

•         manure, used for biogas production.

27.   In determining the feedstock adjustment required under section 355-455, a feedstock adjustment should be made for each feedstock output.

28.   Subsection 355-445(2) prescribes that the adjustment made is equal to the lesser of:

(a)    the feedstock revenue for the feedstock output; and

(b)    so much of the total of the amounts deducted as described in paragraph 1(b) as is reasonably attributable to the production of the feedstock output.

29.   TR 2013/3 provides guidance on what is reasonably attributable to the production of the relevant feedstock outputs.

30.   Paragraph 51 states:

The process of determining a reasonable attribution is similar to that for a reasonable estimate. There will be the forming of an opinion or judgment based on reason, made in good faith and not merely involving some arbitrary method that ignores the individual circumstances in the case in question.

31.   Paragraphs 223 and 224 state:

223. A reasonable method of attribution will have features resembling those for an estimate to be reasonable. The method will result from forming an opinion or judgment based on reason, made in good faith and not merely involving some arbitrary method that ignores the individual circumstances of the case in question.

224. Cost accounting methods that might otherwise already be in use by the R&D entity, such as those required under AASB 102, are considered to produce acceptable results, in that the method should involve one of 'systematic allocation', and occur on a 'rational and consistent basis'. ^[79]

Footnote [79]: In the Explanatory Memorandum at paragraph 3.150 the observation is made that a reasonable attribution need '... not entail feedstock expenditure being evenly attributed across disparate joint outputs'.

32.   In GQHC, the Tribunal in considering the meaning of 'reasonably attributable to the production of the feedstock output' for the purposes of former paragraph 355-465(2)(b), rejected the argument that when calculating the feedstock adjustment, only a portion of the poultry feed was transformed or processed to produce broilers or fertilised eggs.

789. GQHC submits that only a small amount of the entire amount of feed the chicken has consumed during its life remains in the chicken, and therefore the amount of expenditure incurred on feed that is reasonably attributable to the chicken is less than 100%.

790. The Tribunal does not accept this argument. It is uncontroversial that a proportion of feed is used by the chicken as part of its complex metabolic processes. However, assuming the proportion of feed remaining in the chicken at sale could be calculated with accuracy, it ignores the fact that 100% of the quantity of the feed has to be given to the chicken in order to produce the final tangible product. It is artificial to break this down in the way contended by GQHC.

Application to this circumstance

33.   The feedstock expenditure will need to be apportioned between the feedstock outputs, that is the livestock and the manure.

34.   The attribution is of the entire feedstock expenses and is not an apportionment of the goods and materials on a physical basis.

35.   The apportionment of the feedstock under paragraph 355-445(2)(b) should be made based on an amount reasonably attributed to each feedstock output.

36.   The Commissioner does not consider attribution based on scientific calculable proportion a reasonable method of apportionment.

37.   In this case, the feedstock outputs are livestock and manure. As the R&D project and activity relates to the feeding of livestock to ascertain growth and carcass quality, it is anticipated that most if not all, of the expenditure in relation to the feeding of the livestock will relate to the livestock feedstock output.

38.   As in the case of GQHC, the feed must be given to the livestock to produce the livestock that is sold. Therefore, 100% of the feed would be attributed to the feedstock outputs.

39.   Given, the purpose of the feeding the livestock is not to produce manure, but for the production of the livestock, the Commissioner would anticipate the majority, if not all, the feed should be attributed to the livestock.

40.   Any apportionment of the feedstock between the livestock and the manure should be based on cost accounting methods already used by the applicant.

[1] At [755-757], [764], [771-773].