Published on March 4, 2014
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. ii. Is based on principles of established science; and 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.
PURPOSE Dominant Purpose Test TIME
PURPOSE Dominant Purpose Test TIME
PURPOSE Dominant Purpose Test Self Assessed TIME
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? YES NO Covered by the CORE R&D activity exclusion list? NO CORE R&D activity NO Excluded activity YES Directly related to a CORE R&D activity? YES Covered by the CORE R&D exclusion list OR directly related to producing goods / service? NO SUPPORTING R&D activity YES Undertaken for the dominant purpose of supporting a CORE R&D activity? NO Excluded activity
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 Consolidated Proﬁt Total R&D Expenditure* Grant R&D Tax Beneﬁt R&D Clawback @ 10% of Project Expenditure* EﬀecLve Beneﬁt of R&D Credit, Less Clawback EﬀecLve Gain Loss Carried Forward? R&D Tax Credit -‐ 45% Nil Proﬁt, Nil Grant Nil Proﬁt + Grant Proﬁt + Grant > Expenditure + Grant $-‐ $-‐ $2,000,000 $-‐ $2,000,000 $-‐ $900,000 $2,000,000 $1,000,000 $900,000 $2,000,000 $1,000,000 $300,000 $4,000,000 $1,000,000 $1,800,000 $-‐ $-‐200,000 $-‐200,000 $-‐400,000 $900,000 $900,000 $700,000 $1,700,000 $100,000 $1,100,000 $1,400,000 $2,400,000 $300,000 $900,000 $1,600,000 $1,100,000
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 firstname.lastname@example.org
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 X Cost of producing feedstock output Cost of producing marketable product • 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 R&D Activities Feedstock Expenditure $10,000 Other R&D Expenditure $12,000 Total R&D Expenditure $22,000 Feedstock Output Cost $2,000 Further Processing Costs $3,000 Final Marketable Product Cost: $15,000 Sold: $20,000 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 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
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