Australian tax incentive for research and development explained.

2. Research & Development
Tax Incentive - 2011

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.

12. PURPOSE
Dominant Purpose Test
TIME

13. PURPOSE
Dominant Purpose Test
TIME

14. PURPOSE
Dominant Purpose Test
Self Assessed
TIME

15. 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.

16. 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

17. 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.

18. 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%).

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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

25. 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.

26. 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.

27. 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.

28. 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.

29. 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

30. 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.

31. References:
• Tax Laws Amendment (Research and Development) Act 2011
- No. 93, 2011
• R&D Tax Incentive, Frequently Asked Questions, AusIndustry
- Version: 2 September 2011

32. Ben Wright
Director, Commercial Development
+61 402 117 565
b.wright@atp-innovations.com.au

34. 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.

35. 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