Consequential R&D amendments

2010 amendment to Income Tax Act clarifies the income tax rules for grants in relation to two new research and development incentives. Applies from 1 Oct 2010.

Sections CX 47 and DF 1 of the Income Tax Act 2007

Technology Development Grants and Technology Transfer Vouchers were two new R&D incentives announced in Budget 2010. Several consequential amendments have been made to the special income tax rules for grants to make the tax treatment of these incentives clear and to deal with a compliance issue.

Part of the payment under a Technology Development Grant may be paid after the end of the income year in which a relevant deduction is incurred. Dealing with the deduction and the payment under the special grant rules where the deduction arises in one year and the grant is received in a subsequent year can result in disproportionate compliance costs. This problem is addressed by these amendments.

Technology Transfer Vouchers deliver R&D support in a way which does not fall clearly within the normal grant rules. These rules have been amended to make the tax treatment of Technology Transfer Vouchers straightforward.

Background

As part of Budget 2010, the Government announced two new research and development (R&D) initiatives:

  • Technology Development Grants to be made to businesses. The amount claimed by the business under a grant will be paid out in instalments over the course of its R&D programme. However, a proportion of the grant amount will be withheld until the grant administrator is satisfied that the grant claims which have been made meet the eligible expenditure criteria that are a condition of the award of a grant. The grant administrator will initially be the Foundation for Research, Science and Technology and, from 1 February 2011, the Ministry of Science and Innovation (MSI).
  • Technology Transfer Vouchers. Under this initiative, the Government will pay 50% of the costs of R&D work which a business contracts out to a third party research provider.

The Technology Development Grant initiative takes effect from 1 October 2010 and the Technology Transfer Vouchers from 1 November 2010.

Tax legislation contains special rules which deal with grants. In short, grants are treated as excluded income, but the expenditure to which the grants relate is not deductible (or not depreciable, if the grants relate to expenditure on the acquisition of depreciable property).

Key features

The changes will:

  • provide the facility for businesses to "opt out" of the special grant rules when a payment is received in an income year later than the year in which the relevant expense was incurred; and
  • make the application of the special grant rules to Technology Transfer Voucher transactions clear.

Application date

The amendments apply from 1 October 2010.

Detailed analysis

Section CX 47 of the Income Tax Act essentially provides that, when a business receives a grant, and that grant relates to either deductible expenditure or expenditure on a capital asset which is depreciable, that grant is excluded income.

Two amendments have been made to section CX 47. Section CX 47(1) is replaced. Paragraph (b) has been amended to make it clear that section CX 47 cannot apply to a research provider who receives an amount from the Crown under a Technology Transfer Voucher arrangement. Paragraph (d) is amended to make the application to Technology Transfer Vouchers clear, and in the case of subparagraph (ii), to make it consistent with subparagraph (i).

The second amendment to section CX 47 is to insert a new subsection (4). Under this subsection, a person who receives a grant payment as a Technology Development Grant or under a Technology Transfer Voucher which has been withheld until the conditions of the grant are satisfied, and when the payment is received in a year subsequent to the year the expenditure was incurred can elect that section CX 47 not apply. If the person makes this election, the grant payment will be income of the person, and not excluded income.

Section DF 1 essentially provides that, if a person incurs expenditure which is either deductible or on an asset which is depreciable, and the person receives a grant which relates to that expenditure which is excluded income under section CX 47, that expenditure is not deductible, and no depreciation loss can be claimed in relation to it.

New subsection (1) excludes from the denial of deduction circumstances where a person has made an election under section CX 47(4). The section has generally been restructured, with subsection (1) providing a single point of entry into the section. This is the reason for the new subsection (1B), and the simplification of subsection (3).

Example 1: Receipt of a Technology Development Grant

AB Ltd has a 31 March year end. AB Ltd has been awarded a Technology Development Grant to support its R&D programme. The business's R&D programme will involve some of AB's staff, and they will design, build and test modifications to one of AB's production chains. Eligible R&D expenditure for the programme during the 2011-12 year totals $500,000, so the 2011-12 grant amount of 20% is $100,000.

The grant will support the business's R&D programme from August 2011, and claims for grant payments are submitted quarterly - at the end of September and December 2011 ($50,000 each quarter). The grant payments were made shortly after the claims were received, but 10% of the claim amounts were withheld, pending the satisfaction of MSI that the grant claims already made meet the eligible expenditure criteria that are a condition of the grant (in the case of AB Ltd, this involves submitting audited accounts to MSI; other businesses may need to send it externally certified accounts of R&D expenditure). AB Ltd therefore received two payments of $45,000.

AB Ltd will apply sections CX 47 and DF 1 to the payments received during the income year of $90,000. The amount of $90,000 will be treated as excluded income. To the extent to which the $90,000 represented staff wages, it will not be deductible, and to the extent to which the grant represented payment for the modifications made to the production chain, those costs will not be depreciable.

AB Ltd submits its audited accounts to MSI in May 2012, and receives the withheld amount of $10,000 in June 2012.

At this point AB Ltd has a choice.

It could adopt the "ordinary rules basis" and treat the final instalment of $10,000 as exempt income under section CX 47 in 2012-13, the year of receipt. This would mean that section DF 1 will apply to deny any claims for deductions or depreciation for the underlying expenditure in 2011-12. If AB Ltd has already filed its tax return for 2011-12, it may need to amend that return. If AB Ltd has not yet filed its return, it may be straightforward to deal with the denial of deduction and reduction in the depreciation amount.

Alternatively, it could elect to apply new section CX 47(4), which would mean it is required to treat the $10,000 proportion of the grant as ordinary income, but it can claim the deductions or depreciation amount which relate to the $10,000.

Example 2: Technology Transfer Voucher

DEF Ltd is a small company which is developing a non-toxic form of timber preservative suitable for use in children's playground equipment and marine farms. It does not have the ability to carry out the relevant R&D in-house, and has been awarded a Technology Transfer Voucher for the R&D to be performed by a third part research provider. Under the voucher arrangements, MSI will pay 50% of the costs of the R&D directly to the research provider. DEF Ltd will pay the other 50% of the costs directly to the research provider. For the purposes of this example, it is assumed that the R&D meets the deductibility tests in section DF 34.

Payments to the research provider by both MSI and DEF Ltd are ordinary income to the research provider.

There are two possible ways that DEF Ltd might treat the payments from MSI to the research provider:

  • It may treat the payments as income. If this is the case, section CX 47 will apply and treat the amount as exempt income (potentially subject to an election under new section CX 47(4)). A deduction will be denied for the book entry which DEF Ltd will record as the notional "on-payment" of the grant from itself to the research provider.
  • It may not treat the payments as income (that is, effectively ignore them). If this is the case, section CX 47 cannot apply, and there will be no deduction for section DF 1 to apply to.