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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RP

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Dominant Purpose Test

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Dominant Purpose Test

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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 b.wright@atp-innovations.com.au

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