ATO ID 2006/92: Research and development: deduction for 'core technology expenditure' where purchase consideration comprises allotment of shares
Date of decision: 30 August 2005
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Does the term 'core technology expenditure' for the purposes of subsection 73B(1) of the Income Tax Assessment Act 1936 (ITAA 1936) include the acquisition of core technology by an eligible company, where the purchase consideration to acquire the core technology consists of the allotment of shares in the eligible company?

Decision
No. The term 'core technology expenditure' for the purposes of subsection 73B(1) of the ITAA 1936 does not include the acquisition of core technology by an eligible company, where the purchase consideration to acquire the core technology consists of the allotment of shares in the eligible company.

Facts
The company is an 'eligible company', and undertakes 'research and development activities' as defined by subsection 73B(1) of the ITAA 1936. These activities were registered with the Industry Research and Development Board under section 39J of the Industry Research and Development (Cth) Act 1986 , for the 2003-04 income year. In the 2003-04 income year, the company entered into an agreement to acquire a patent. The patent is 'core technology' within the meaning of subsection 73B(1AB) of the ITAA 1936, in relation to the particular 'research and development activities' of the company. The consideration given by the eligible company for the patent was an issue of shares in the eligible company to the vendor of the patent. This was a direct exchange under a single agreement. It was not intended, nor was it the case, that the liability to acquire the patent for a particular sum was incurred as a pecuniary liability and subsequently settled by an issue of shares in a separate transaction.

Reasons for decision
Summary: Subsection 73B(12A) of the ITAA 1936 states that, Subject to this section, if: there is allowable as a deduction from the company's assessable income of the year of income so much of the amount worked out using the formula in subsection (12B) in respect of that core technology expenditure as does not exceed one-third of the amount of that related research and development expenditure. The company is an eligible company, as defined by subsection 73B(1) of the ITAA 1936, and the agreement to purchase the patent was entered into after 5 pm legal time in the Australian Capital Territory, on 23 July 1996. To meet the requirements of this provision, the company must have incurred 'expenditure' in relation to the core technology consisting of the patent. The question is whether the issue and allotment of shares qualifies as 'expenditure'. In Lowry v. Consolidated African Selection Trust Ltd (1940) AC 648; [1940] 2 All ER 544, the House of Lords held that the issue of shares to a company's employees did not involve the company in any expense for the purpose of its trade. Similarly, in Ord Forrest Pty Ltd v. FC of T [1974] 130 CLR 124; (1974) 4 ATR 230; 74 ATC 4034 the High Court found that an allotment of shares by a company does not involve any conveyance or transfer by the company of property of the company. In Pilmer v. Duke Group Ltd (in liq) (2001) 207 CLR 165 (the Kia Ora case). McHugh, Gummow, Hayne and Callinan JJ said that: If attention is confined to the transaction in which Kia Ora did engage, it gave up, or lost, only the money which it outlaid and the opportunity of turning the shares which it did issue to some other more advantageous use in a different transaction. Otherwise it gave nothing up by issuing and allotting the shares (at CLR 192). . . . The answer to the inquiry [about what Kia Ora gave up or lost because it made the takeover] must be that Kia Ora outlaid cash and whatever may have been the administrative costs of issuing the shares. If a claim had been made, it may well be that some allowance would be made for the consequential effect on its capacity to raise other equity or debt finance. Otherwise, however, it gave up, or lost nothing by the issue of its shares (at CLR 195). Therefore, the expense or outlay involved in issuing and allotting shares comprises only the administrative costs of the issue, and not any value placed upon the shares themselves. A commitment by a company to issue and allot its shares is not itself a commitment to any loss, outgoing or expenditure by the company. Nor does the company incur any loss, outgoing or expenditure when it actually issues and allots the shares. The eligible company issued shares to the vendor in consideration for the acquisition of the relevant core technology. This purchase did not involve any expenditure by the company and so the company cannot be said to have incurred an amount of 'core technology expenditure' as required for a deduction under subsection 73B(12A) of the ITAA 1936. Therefore, no deduction is allowable to the company under that subsection, in respect of the value of the shares issued to acquire the core technology. However, this is not to deny the existence of a valid contract under which the company has issued its shares for consideration in-kind. This is matched by the consideration in-kind (the patents) to be provided by the shareholder. The effect of this transaction, from the perspective of the company, is that it has acquired an asset for consideration.

Legislative references: Income Tax Assessment Act 1936 subsection 73B(12A) subsection 73B(1) subsection 73B(12C) section 73B section 73B(1AB) section 73BA section 73BB(1)
Case references: Lowry v. Consolidated African Selection Trust Ltd (1940) AC 648 ([1940] 2 ALL ER 545
Subject references: Research and development expenses Core technology expenses Financial arrangements