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Australian tax incentive for research and development explained.
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Research & Development Tax Incentive - 2011
Research & Development Tax Incentive – State of Play –
• On 24 August 2011 the bills to establish the new R&D Tax Credit were passed by Parliament. The bills became law on 8th September 2011.
• AusIndustry and the ATO, as administrators of the R&D
Tax Credit, will release guidance material over the coming months.
Overview The program has a retrospective start date of 1 July 2011. Broadly, the new R&D tax incentive program takes a two-tiered approach: • a 45 per cent refundable R&D tax offset will be
available for companies with a grouped turnover of less than $20 million. This is equivalent to a 15c in the dollar benefit, and
• a 40 per cent non-refundable R&D tax offset will be
available for companies with a grouped turnover of more than $20 million. This is equivalent to a 10c in the dollar benefit.
How does this differ? • Increased R&D benefit. • De-coupled the R&D tax benefit from the company tax
rate. • Potential cash flow benefits with quarterly refundable
amounts from 1 January 2014. • Advanced findings administered by AusIndustry. • Increased overseas expenditure limit (25% to 50%). • Tax exempt entity ownership increase from 25% to 50% • Foreign entity R&D conducted within Australia. • Clawback – grants and feedstock.
Impact of the 45% Credit
• Minimum qualifying spend of $20k/year on R&D. • Maximum consolidated group revenue of $20m. • 45% refundable tax credit. • De-coupled from company tax rate. • Unlimited claim.
Impact of the 40% Offset
• Minimum qualifying spend of $20k/year on R&D. • Consolidated group revenue of more than $20m. • 40% non-refundable tax offset. • De-coupled from company tax rate. • Unlimited claim.
Leverage Benefit to SMEs YEAR 1 • Invest $1M on R&D activity • Obtain $450k R&D tax credit refund
YEAR 2 • Invest $450k on R&D activity • Obtain $202.5k R&D tax credit refund
YEAR 3 • Invest $202.5k on R&D activity • Obtain $91k R&D tax credit refund
The initial $1M investment results in a $744k refundable credit over 3 years following annual reinvestment into R&D.
Core Activities • R&D activities are defined as CORE or SUPPORTING. • Core R&D activities are defined as experimental activities and must
satisfy both of the following; a) The outcome cannot be known or determined in advance on the basis of
current knowledge, information or experience but can only be determined by applying a systematic progression of work that: i. Is based on principles of established science; and ii. Proceeds from hypothesis to experiment, observation, evaluation and leads to logical
conclusion; AND
b) That are conducted for the purpose of generating new knowledge,
including new knowledge in the form of new or improved materials, products, devices, processes or services.
Core Exclusions • Market research, market testing, marketing or sales development. • Management or efficiency surveys. • Activities associated with complying with statutory requirements. • Commercial, legal and administrative aspects of patenting, licensing or
other activities. • Research in social sciences, arts or humanities. • Pre-production including demonstration of commercial viability, tooling up
and trial runs. • Developing, modifying or customising computer software for the dominant
use of internal business administration or administration of business functions.
• Reproduction of a commercial product or process. • Prospecting, exploring or drilling for petroleum or minerals.
Exclusions can still be supporting R&D activities provided they satisfy the dominant purpose test.
Dominant Purpose Test • Supporting R&D activities are activities directly related to
core R&D activities If an activity:
a) Is an activity excluded from being a core activity; or b) Produces goods and services; or c) Is directly related to producing goods or services,
then, the activity is a supporting R&D activity only if it is undertaken for the dominant purpose of supporting core R&D activities.
Dominant Purpose Test
TIME
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Dominant Purpose Test
TIME
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Dominant Purpose Test
TIME
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Self Assessed
Supporting Activities
• R&D activities that are directly related to but are not core R&D.
• Undertaken for the dominant purpose of supporting
(assist in the conduct of) R&D activities. Self Assessed • Activities may serve or be conducted for more than one
purpose (dual purpose) but must be for the dominant purpose of R&D.
Summary of Eligibility An experimental activity whose outcome cannot be determined in advance AND is conducted for the purpose of gaining ne knowledge?
Covered by the C O R E R & D activity exclusion list?
CORE R&D activity
SUPPORTING R&D activity
Excluded activity
Excluded activity
Directly related to a CORE R&D activity?
Covered by the CORE R&D exclusion list OR directly related to producing goods / service?
Undertaken for the dominant purpose of supporting a CORE R&D activity?
YES
YES
YES
YES
NO
NO
NO
NO
NO
Exempt Entities • If the R&D entity is has tax exempt ownership of 50% or
more then it is ineligible for the 45% credit, but may still claim the 40% non-refundable offset.
Overseas Expenditure • Companies must apply to AusIndustry for an advanced finding in order to
be eligible for the overseas R&D tax offset or credit. • The overseas activity must meet the definition of core or supporting R&D • The overseas activity must have significant link to at least one core activity
in Australia. • The Australian R&D cannot be completed without the overseas activity
being completed. • The overseas activity cannot be conducted in Australia (time, money,
technology, expertise). • The overseas expenditure must be less than the total anticipated R&D
activity expenditure in Australia (<50%).
Advanced Finding Certificate • The R&D entity can seek an advanced finding, from Innovation Australia, on
whether an activity is an eligible R&D activity. • In order to claim overseas R&D expenditure the R&D entity must seek an
advanced finding. • The board can find that all or part of the activity is a CORE R&D activity, all
or part of the activity is a SUPPORTING R&D activity, or is neither. • The board can specify in its finding, the times to which the claim relates –
i.e. the current or a future income year. • Advanced finding applications will be available in October 2011.
R&D for Foreign Entities Australian entities can undertake R&D for foreign entities if: • The foreign entity resides in a country that has a double tax agreement with
Australia. • The foreign entity is incorporated under foreign law. • The core R&D activities are solely undertaken in Australia and the
supporting R&D activities relate to core R&D activities undertaken in Australia.
• The foreign entity is “connected or affiliated” with the Australian entity. • The R&D is undertaken subject to a binding written agreement. • If the Australian entity is reimbursed for the R&D expenditure, it will not
effect the eligibility of the R&D activities and associated expenditure.
Eligible Expenditure • Expenditure incurred on registered eligible R&D activities.
• The decline in value of eligible depreciating assets
• R&D expenditure paid to an associate.
• Partners portion of R&D expenditure.
• Payment to a Research Service Provider (RSP). This need not exceed the $20,000 minimum expenditure.
• Monetary contributions under a Cooperative Research Centre (CRC) program.
Grants • Clawback provision operates to adjust for the duplicated
benefit received by the R&D entity. • The adjustment imposes an additional income tax
component of 10% on the recoupment amount. • SMEs eligible for the 45% tax credit retain a 5% benefit
in receiving a grant. • Enterprises eligible for the 40% tax offset receive no
additional benefit.
Clawback Liability • The adjustment occurs on the date of the entitlement to
receipt of a grant. • The basic tax liability of the SME may increase after
application of the company tax rate to eligible income. • The 10% clawback may be payable even when a tax
loss occurs. • A cap will apply to ensure there is no detriment.
• CRCs waivered from the clawback provision.
Clawback Example
R&D Tax Credit -‐ 45% Nil Profit, Nil Grant Nil Profit + Grant Profit + Grant > Expenditure + Grant
Consolidated Profit $-‐ $-‐ $2,000,000 $-‐ Total R&D Expenditure* $2,000,000 $2,000,000 $2,000,000 $4,000,000 Grant $-‐ $1,000,000 $1,000,000 $1,000,000 R&D Tax Benefit $900,000 $900,000 $300,000 $1,800,000 R&D Clawback @ 10% of Project Expenditure* $-‐ $-‐200,000 $-‐200,000 $-‐400,000 EffecLve Benefit of R&D Credit, Less Clawback $900,000 $700,000 $100,000 $1,400,000 EffecLve Gain $900,000 $1,700,000 $1,100,000 $2,400,000 Loss Carried Forward? $1,100,000 $300,000 $900,000 $1,600,000
Feedstock Provision • Feedstock is marketable product that results from R&D
activities. If it has a purchase value, it is feedstock. Inputs into next R&D activity are excluded from feedstock provisions.
• A 10% adjustment (FSA) is imposed to clawback any
“incentive component” related to recouping feedstock expenditure.
• The incentive component = 10%, the difference between a
normal company tax deduction and an assumed 40% R&D offset.
• SMEs retain a 5% benefit on any expenditures on feedstock
output.
Feedstock Liability • The feedstock adjustment (FSA) occurs where the R&D
entity “supplies” a marketable output to another entity or uses it for its own purposes.
• The adjustment is added to assessable income of the
R&D entity only. • The R&D credit and associated FSA can therefore occur
in different income years. • There is no statute of limitation on feedstock provision
triggers.
How does this effect the way you do business?
• The scheme has dual administrators; – Innovation Australia – “The board” assesses eligible
activities and provides advanced findings. – Australian Taxation Office – The ATO determines the
amount of valid expenditure for eligible R&D activities.
• Contemporaneous documentation of R&D activities. • Account structure • Possible cash flow liabilities. • No statute of limitation on an audit of activities.
Registration • The head of a consolidated tax group is the relevant R&D entity.
Subsidiaries are ineligible. • Registration must occur within 10 months after the income year in
which the activities were conducted. • R&D entities must separately identify CORE and SUPPORTING
R&D activities. • SUPPORTING activities must be identified against a CORE activity,
including the time period to which they relate. • Advanced findings can be sought to provide certainty on claim
eligibility where an R&D entity: – Has completed the activity in an income year (before it was possible to register
for the activity) – Has yet to complete the activity in an income year, or – Has yet to conduct the activity, but can be reasonably expected to do so in the
current or next two income years.
Integrity Rules • Arms length – documentation is required to evidence the market value of
any transaction with associates. If the expenditure is higher than market value, an adjustment is required.
• Expenditure not at risk – if the R&D entity can reasonably expect to receive
consideration for its activities, the claim must be reduced by this amount. If the consideration is less than the expenditure on R&D activities, the entity may claim the difference as a notional deduction.
• Dominant benefit – contractors are unable to “double dip” the tax benefit.
The benefit goes only to the tax payer that satisfies the three dominant benefit provisions: – Financial risk – Control – Effective ownership over results of the project
Recap • Increased R&D benefit. • De-coupled the R&D tax benefit from the company tax rate. • Potential cash flow benefits with quarterly refundable amounts from
Q1 FY2014 (not yet confirmed). • Advanced findings administered by AusIndustry. • Investment certainty and leverage for R&D entities. • Increased overseas expenditure limit (25% to 50%). • Tax exempt entity ownership increase from 25% to 50% • Foreign entity R&D conducted within Australia. • Clawback – grants and feedstock. • Register < 10 months after the income year of the R&D activities. • Account structure important. • Enduring liability combated through solid documentation.
References: • Tax Laws Amendment (Research and Development) Act 2011
- No. 93, 2011
• R&D Tax Incentive, Frequently Asked Questions, AusIndustry - Version: 2 September 2011
Ben Wright Director, Commercial Development +61 402 117 565 [email protected]
Calculating Feedstock • Where the feedstock output is immediately sold or applied, the
feedstock revenue will be its market value at that point. • Where further expenditures are incurred on the feedstock output
between the R&D activity and the point of sale, then the feedstock revenue will be a proportion of the value of the marketable product that is sold.
Feedstock revenue is calculated as follows:
Market value of the marketable product
Cost of producing feedstock output Cost of producing marketable product
X
• The net effect of the feedstock adjustment is a 10% adjustment on the lesser of feedstock expenditure or feedstock revenue.
i.e. 1/3rd of the lesser value becomes taxable revenue at the company tax rate.
Feedstock Example
Feedstock Expenditure
$10,000
Other R&D Expenditure
$12,000
Total R&D Expenditure
$22,000
R&D Activities
Further Processing
Costs $3,000
Feedstock Output Cost
$2,000
Final Marketable Product
Cost: $15,000 Sold: $20,000
FSA equals 1/3rd of the lesser of feedstock expenditure or feedstock revenue. 1/3rd x $10,000 = $3,333 which is then taxed at 30%, so the feedstock liability is $999.90
Feedstock revenue = market value of marketable product x (cost of producing feedstock output / cost of producing marketable output)
Feedstock revenue = $20,000 x ( $12,000 / $15,000 ) = $16,000