Private ruling: Research & Development
Date of advice: 6 July 2017
Published: November 2017
Ruling period: 1 July 2016 to 30 June 2017 | 1 July 2017 to 30 June 2018
Date scheme commenced: March 2017

Ruling: Q1: Is the acquisition of a depreciating asset used in conducting Research & Development (R&D) activities eligible for a R&D tax offset under paragraph 355-100(1)(a) of the Income Tax Assessment Act 1997 ? | A1: No | Q2: Is the acquisition of a depreciating asset used in conducting R&D activities eligible for a R&D tax offset for decline in value under paragraph 355-100(1)(b) of the Income Tax Assessment Act 1997 ? | A2: Yes | Q3: Where the depreciating asset used in conducting R&D activities is sold, are you entitled to a tax offset for an income year where you are entitled to deduct an amount under paragraph 355-100(1)(c) of the Income Tax Assessment Act 1997 ? | A3: Yes | Q4: When the depreciating asset and its improved parts attached are sold, are you required to include an amount in your assessable income as a feedstock adjustment under subsection 355-465(2) of the Income Tax Assessment Act 1997 ? | A4: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. ● You carry on a business that conducts Research and Development (R&D) on a depreciating asset and its parts. ● You are registered under section 27A of the Industry Research and Development Act 1986 for the 2016/17 income year and will be registered for the 2017/18 income year. ● You received a relevant Certificate under Section 28A of the Industry Research and Development Act 1986 from XYZ on a certain date in respect of a number of R&D activities for the following three income years. ● The relevant Certificate has determined that the activities are core R&D activities and supporting R&D activities for the purposes of the sections 355-25 and 355-30 of the Income Tax Assessment Act 1997 (ITAA 1997). ● Your R&D activities will take place in Australia. ● You are planning to acquire a number of depreciating assets in order to conduct the R&D activities on their parts. You require numerous assets of different varieties. ● You will incur other expenses as part of its R&D activities. ● The aim of the R&D activities is to be successful in producing new products that can be acquired by manufacturers of the asset or sold as improved individual parts. ● You intend to sell the depreciating assets with the improved parts (the subject of the R&D activities) attached following completion of the R&D activities after a certain period. ● You have an aggregate turnover for the current income year and is expected to have an aggregate turnover not exceeding $20million in each of the relevant income years. ● Your notional deductions will exceed $20,000 pursuant to subsection 355-100(2) of the ITAA 1997. Assumption ● You have not deducted an amount for the depreciating asset for an earlier income year under either Subdivision 329-D (capital allowances for small business entities) or under section 40-440 (low-value pools).

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 355

Reasons for decision: Summary: The acquisition of a depreciating asset used in conducting R&D activities is not eligible for an R&D tax offset under paragraph 355-100(1)(a) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: An R&D entity is entitled to a tax offset for an income year equal to the percentage set out in the table in section 355-100 of the ITAA 1997 of the amounts that the entity can deduct for the income year under a number of provisions. One of those provisions is section 355-205 where a notional deduction arises for deductions for R&D expenditure. Subsection 355-205(1) provides that an R&D entity can deduct for an income year (the present year) expenditure it incurs during that year to the extent that the expenditure: (a) is incurred on one or more R&D activities: (i) for which the R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year; and (ii) that are activities to which section 355-210 (conditions for R&D activities) applies; and (b) if the expenditure is incurred to the R&D entity’s associate – is paid to that associate during the present year. Subsection 355-205(1) provides that this section has effect subject to section 355-225 (excluded expenditure), Subdivision 355-F (integrity rules), and subsection 355-580(3) (CRC contributions). In your case, you would satisfy subsection 355-205(2) for the following reasons: ● you are an R&D entity which is registered under section 27A of the Industry Research and Development Act 1986 for the income year; ● the activities that you carry on have been considered as either core or supporting R&D activities pursuant to an XYZ Advanced Finding, and therefore are R&D activities pursuant to section 355-20; and ● The R&D activities are conducted in Australia. Section 355-225 outlines certain expenditure that cannot be notionally deducted. Paragraph 355-225(1)(a) relevantly includes expenditure included in the cost of a tangible depreciating asset for the purposes of Division 40 (as that Division applies as described in section 355-310 or otherwise). Section 40-30 of the ITAA 1997 defines a depreciating asset as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, expect trading stock amongst other things. In your case, the assets that you acquired are depreciating assets. The assets are not considered trading stock in your circumstances as it is not acquired for the purposes of manufacture, sale or exchange in the ordinary course of a business pursuant to section 70-10 of the ITAA 1997. The acquired asset will be used as part of the R&D activities and intended to be produced as a marketable product. | Detailed Reasoning - Conclusion: As your R&D asset is a tangible depreciating asset and excluded under subsection 355-225(1)(b) of the ITAA 1997, the expense cannot be claimed as a notional deduction under subsection 355-205(2) of the ITAA 1997. A tax offset for the full purchase price of the acquired asset is therefore not available under section 355-100 of the ITAA 1997. | Summary: The acquisition of a depreciating asset used in conducting R&D activities is eligible for a R&D tax offset for decline in value under paragraph 355-100(1)(b) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Paragraph 355-100(1)(b) of the ITAA 1997 provides that you are entitled to a tax offset for an income year on amounts that you can deduct under section 355-305 of the ITAA 1997 for the decline in value of assets. Section 355-305 of the ITAA 1997 provides that a notional deduction, equal to the amount of the decline in value that could be deducted under section 40-25, will arise for a decline in value expense if: (a) an R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year (the present year) for one or more R&D activities that are activities to which section 355-210 (conditions for R&D activities) applies; and (b) while a tangible depreciating asset is held by the R&D entity during the present year, the asset is used for the purpose of conducting one or more of those R&D activities; and (c) the R&D entity could deduct an amount under section 40-25 for the asset for the present year if Division 40 applied with the changes described in section 355-310; and (d) the R&D entity cannot deduct an amount for the asset for: (i) an earlier income year under Subdivision 328-D (capital allowances for small business entities); or (ii) an earlier income year under Division 40 (as that Division applies apart from this Division), in a case where section 40-440 (low-value pools) applied; In your case, you would satisfy paragraphs (a), (b), and (d) of subsection 355-305(1) for the following reasons: ● you are an R&D entity which is registered under section 27A of the Industry Research and Development Act 1986 for the income year; ● the activities that you carry on have been considered as either core or supporting R&D activities pursuant to an XYZ Advanced Finding, and therefore are R&D Activities pursuant to section 355-20; and ● you have not deducted an amount for an earlier income year under either Subdivision 328-D (capital allowances for small business entities); or under section 40-440 (low-value pools) applied. Paragraph 355-305(1)(c) however requires further consideration. It requires that the R&D entity could deduct an amount under section 40-25 of the ITAA 1997 for the asset for the present year if Division 40 applied with the changes set out in section 355-310. Section 40-25 provides that you can deduct an amount equal to the decline in value for an income year (as worked out under this Division) of a depreciating asset that you held for any time during the year. Division 40 ordinarily imposes a requirement that a decline in value deduction be reduced to the extent the asset is not used for taxable purpose, ie for a purpose that does not relate the producing of assessable income. Section 355-310, amongst other things, modifies Division 40 to remove the concept of taxable value and replaces it with the term “for the purpose of conducting one or more R&D activities”. In your circumstances you would be entitled to a decline in value deduction under section 40-25 (as modified by section 355-310) in a year where you held a legal or equitable interest in the depreciating asset. | Detailed Reasoning - Conclusion: Section 355-305 is satisfied and therefore you may claim a notional deduction for decline in value of a depreciating asset in the amount of the decline in value calculated under section 40-25 (as modified by section 355-310). You are entitled to claim a tax offset pursuant to paragraph 355-100(1)(b) of the ITAA 1997 for the income year equal to the percentage set out in the table in section 355-205 of the ITAA 1997. | Summary: Where the depreciating asset used in conducting R&D activities is sold, you are entitled to a tax offset for an income year where you are entitled to deduct an amount under paragraph 355-100(1)(c) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Paragraph 355-100(1)(c) of the ITAA 1997 provides that you are entitled to a tax offset for an income year on amounts that an entity can deduct under section 355-315 of the ITAA 1997 for balancing adjustments for R&D assets. Section 355-315 of the ITAA 1997 Act provides that a notional deduction or an amount may be included in your assessable income where you dispose of a depreciating asset. The section applies where: (a) a balancing adjustment event happens in an income year (the event year) for an asset held by the R&D entity; and (b) the R&D entity cannot deduct an amount under section 40-25, as that section applies apart from this Division and the former section 73BC of the Income Tax Assessment Act 1936 for the asset for an income year; and (c) the R&D entity is entitled under section 355-100 to tax offsets for one or more income years for deductions (the R&D deductions) under section 355-305 for the asset; and (d) the entity is registered under section 27A of the Industry Research and Development Act 1986 for one or more R&D activities for the event year; and (e) If Division 40 applied with the changes described in section 355-310: (i) the entity could deduct for the event year an amount under subsection 40-285(2) for the asset and the balancing adjustment event; or (ii) an amount would be included in the entity’s assessable income for the event year under subsection 40-285(1) for the asset and the balancing adjustment event. Paragraph 355-315(1)(a) would be satisfied as a balancing adjustment event occurs for a depreciating asset where you stop holding the asset. In your circumstances it is considered that you stop holding the depreciating asset when you sell it or stop using it. Paragraph 355-315(1)(b) would be satisfied as the R&D entity can only deduct an amount under section 40-25 of the ITAA 1997 as a result of the modifications in Division 355. As outlined above in question 2, the R&D entity could deduct an amount under section 40-25 as a result of the modifications in Division 355. Paragraph 355-315(1)(c) requires that the R&D entity is entitled to a deduction for a tax offset under section 355-100 for notional deductions for R&D decline in value claimed under section 355-305 of the ITAA 1997. As concluded in question 2 above, this provision is satisfied. Paragraph 355-315(1)(d) is satisfied as the entity is registered under section 27A of the Industry Research and Development Act 1986 for one or more R&D activities for the income year. Finally paragraph 355-315(1)(e) requires that the entity could deduct an amount under subsection 40-285(2) for a balancing adjustment or would include an amount in assessable income for the income year under subsection 40-285(1). In your circumstances it is expected that subsection 40-285(2) would apply and that the termination value (ie the amount the asset would be sold for) would be less than the adjustable value and therefore the difference is the amount that would be claimable as a notional deduction under subsection 355-315(2) of the ITAA 1997. | Summary: When the depreciating asset and its improved parts attached are sold, you are required to include an amount in your assessable income as a feedstock adjustment under subsection 355-465(2) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 355-465 provides that you are required to include an additional amount of income where you deduct amounts under Division 355 for R&D expenditure and as a result the R&D expenditure is transformed or processed into marketable products that are sold. The section applies where: (a) it incurs expenditure in one or more income years in acquiring or producing goods, or materials, (the feedstock inputs) transformed or processed during R&D activities in producing one or more tangible products (the feedstock outputs); and (b) it obtains under section 355-100 tax offsets for one or more income years for deductions under this Division: (i) for the expenditure; or (ii) for expenditure it incurs on any energy input directly into the transformation or processing; or (iii) for the decline in value of assets used in acquiring or producing the feedstock outputs; and (c) during the present year, a feedstock output, or a transformed feedstock output, (the marketable product) is: (i) supplied by the R&D entity to another entity; or (ii) applied by the R&D entity to the R&D entity’s own use, other than use for the purpose of transforming that product for supply. Paragraph 355-465(1)(a) is satisfied as expenditure would have been incurred in acquiring or producing goods or materials which were transformed or processed during the R&D activities in producing one or more tangible products (the feedstock outputs). When considering what the relevant expenditure is that has been incurred, ie the feedstock inputs, it is necessary to consider what tangible products or marketable product was produced from the R&D activities. In your circumstances, it is not considered that the expenditure in relation to your depreciating assets are feedstock inputs as they are not goods or materials that are transformed or processed during the R&D activities. The depreciating assets in question are not feedstock outputs. Whilst the acquired assets are not a feedstock input, paragraph 355-465(1)(b) will be satisfied in relation to other expenditure that would result in a notional deduction for R&D activities under Subdivision 355-D or Subdivision 355-E for the purposes of claiming a tax offset under section 355-100 of the ITAA 1997. Paragraph 355-465(1)(c) would also be satisfied when a feedstock output is sold to another entity or applied for your own use other than for the purposes of transforming that product for supply. In your circumstances it is considered that when you sell your assets, the marketable products which will be attached to the assets will be considered supplied to that other party for the purposes of paragraph 355-465(1)(c) of the ITAA 1997. | Detailed Reasoning - Conclusion: When the depreciating asset and its improved parts attached are sold, you are not required to include an amount in your assessable income as a feedstock adjustment under subsection 355-465(2) of the Income Tax Assessment Act 1997 . When calculating the feedstock revenue in accordance with section 355-470 of the ITAA 1997, the market value of the marketable product, the cost of producing the feedstock output and the cost of producing the marketable product will not include the value or cost of the particular depreciating assets sold as it is not a feedstock output or marketable product. Note that depreciating assets used directly in transforming the feedstock inputs into a feedstock output may be included in the calculation of feedstock revenue.

This notice must not be taken to imply anything about: | ● the binding nature of the private advice issued to the applicant | ● the correctness of other edited versions. | Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.