Private ruling: Application of Subdivision 355-G of the Income Tax Assessment Act 1997 (ITAA 1997) to payments received under a Commonwealth Government Scheme
Published: September 2014
Ruling period: Years ending 30 June 2013 to 30 June 2017

Ruling: Q1: Are the payments received (or to be received) by Company A as a participant under the Commonwealth Government Scheme, that relate to expenditures incurred on research and development activities that are or will be notionally deductible under Division 355 of the Income Tax Assessment Act 1997 ( ITAA 1997), recoupments of expenditure incurred on or in relation to certain activities under subparagraph 355-445(b)(i) of the ITAA 1997, rather than recoupments that require expenditure to have been incurred, or to be incurred, on certain activities under subparagraph 355-445(b)(ii) of the ITAA 1997? | A1: Yes. | Q2: If the answer to Question 1 is 'yes', is the expenditure amount on which extra income tax is payable as determined under section 355-450 of the ITAA 1997 limited to the payment amounts received (or to be received) by Company A under the Commonwealth Government Scheme referred to in Question 1 to the extent that those amounts relate to expenditures which are deducted under Division 355 of the ITAA 1997? | A2: Yes. | Q3: Is the methodology detailed below in the 'Relevant facts and circumstances' under the heading 'Method for calculating extra income tax payable' an appropriate method of calculating the extra income tax payable for the relevant income year arising under Subdivision 355-G of the ITAA 1997 for the portion of Commonwealth Government Scheme payments Company A have received as a participant in relation to defined research and development under that scheme? | A3: Yes. | Q4: If the answer to Question 1 is 'no', and it is considered that the Commonwealth Government Scheme payments are subject to a requirement for expenditure to have been incurred, or to be incurred, on certain activities and therefore fall under subparagraph 355-445(b)(ii) of the ITAA 1997, how is the amount of that expenditure to be determined (for the purposes of paragraph 355-450(1)(a) of the ITAA 1997)? | A4: Not applicable.

Relevant facts and circumstances: Company A has elected to be the provisional head company of a multiple entry consolidated group under Part 3-90 of the ITAA 1997. Since 1 July 2011 Company A has been a participant under the Commonwealth Government Scheme in relation to defined research and development of itself and its wholly-owned subsidiary Company B. Company A has registered the eligible R&D activities of itself and Company B under section 27A of the Industry Research and Development Act 1986 (IRDA 1986) for the year ended 30 June 2013. Commonwealth Government Scheme payments Company A, as a participant under the Commonwealth Government Scheme, is entitled to receive payments if it meets the three conditions outlined in the regulations. Company A incurred expenditure on defined research and development as a participant in the year ended 30 June 2013 and otherwise satisfied all other conditions in the regulations. As a result, Company A received Commonwealth Government Scheme payments in respect of that defined research and development in the year ended 30 June 2013 which were calculated according to a methodology which is contained in several provisions of the regulations. The methodology is summarised in the steps below: 1. The total amounts of defined research and development was determined for: n the period for which the Commonwealth Government Scheme payment related; and n each prior defined period in relation to that period. 2. The adjusted defined research and development was determined for each period in accordance with the regulations (Note: this step involves imposing uplifts and caps on some of the amounts of defined research and development). 3. The adjusted defined research and development for each period was summed and the amount was divided by the total number of periods used in Step 1 above in accordance with the formula in the regulations. 4. The result of Step 3 was multiplied by X% and any other amounts of government assistance (as defined in the regulations) received by the participant in relation to the amounts in Step 2 above were subtracted in accordance with the formula in the regulations. 5. The amount from Step 4 above was multiplied by Y% for a participant for the period to which the Commonwealth Government Scheme payment related (in accordance with the regulations). 6. The amount from Step 5 was multiplied by Z% for a participant for the period to which the Commonwealth Government Scheme payment related (in accordance with the regulations). Notional R&D deductions Company A has claimed notional deductions under section 355-205 of the ITAA 1997 in the year ended 30 June 2013 in relation to the eligible R&D activities of itself and Company B which are registered under section 27A of the IRDA 1986. Method for calculating extra income tax payable Company A have proposed that the following methodology be used to calculate any extra income tax which is payable in a relevant income year as a result of Subdivision 355-G of the ITAA 1997 because a Commonwealth Government Scheme payment received in that year represented a recoupment of expenditure claimed as a notional deduction under Division 355 of the ITAA 1997: For each Commonwealth Government Scheme payment received in the relevant income year: 1. Determine the total amount of defined research and development (under the regulations) for: n the period to which the Commonwealth Government Scheme payment relates; and n each of the defined prior periods in relation to that period (as defined under the regulations). 2. Determine how much of each amount from Step 1 has been deducted under Division 355 of the ITAA 1997. 3. Determine a notional 'adjusted defined research and development' for each amount under Step 2 by applying the methodology in the regulations (Note: this step would generally include uplifting a portion of the Step 2 in accordance with the regulations). 4. Sum the amounts from Step 3 and divide by the number of periods used under Step 1 (consistent with the formula in the regulations) 5. Multiply the amount from Step 4 by X% (consistent with the formula in the regulations). 6. Multiply the amount from Step 5 by Z% for a participant for the period to which the Commonwealth Government Scheme payment related (consistent with the regulations). This amount is the amount on which extra income tax is payable under subsection 355-450(1) of the ITAA 1997 for that Commonwealth Government Scheme payment. 7. Multiply the amount from Step 6 by 10% (the rate set out in section 31 of the Income Tax Rates Act 1986 ) to determine the extra income tax payable for Company A in relation to the portion of the Commonwealth Government Scheme payment that relates to defined research and development. 8. Sum the results of step 7 for each Commonwealth Government Scheme payment received in the relevant income year to determine the amount the extra income tax payable for that year arising under Subdivision 355-G of the ITAA 1997 for the portion of Commonwealth Government Scheme payments Company A have received in relation to defined research and development under the Commonwealth Government Scheme. This methodology is based on: • Company A not receiving any other amounts of government assistance (as defined in the regulations); • 'Y%' for each Commonwealth Government Scheme payment that Company A receives being equal to 100%.

Relevant legislative provisions: ITAA 1997 Division 355, | ITAA 1997 Section 355-205, | ITAA 1997 Subdivision 355 -G, | ITAA 1997 Subparagraph 355-445(b)(i), | ITAA 1997 Subparagraph 355-445(b)(ii), and | ITAA 1997 Subsection 355-450(1).

Reasons for decision: Summary: Recoupments received from an Australian government agency in relation to expenditure on R&D activities may be taxable through the operation of Subdivision 355-G of the ITAA 1997. Any extra income tax payable in relation to Subdivision 355-G of the ITAA 1997 is referred to as a 'clawback adjustment' and is payable in the year that the recoupment is received, or the entitlement to receive the recoupment arises (known as 'the trigger year'). There are two types of recoupments that are taxable under Subdivision 355-G of the ITAA 1997: • Recoupment under subparagraph 355-445(b)(i) of the ITAA 1997 (recoupment of expenditure incurred); and • Recoupment under subparagraph 355-445(b)(ii) of the ITAA 1997 (recoupment that requires expenditure to be incurred or to have been incurred). Recoupment of expenditure incurred: subparagraph 355-445(b)(i) of the ITAA 1997 The first type of recoupment is recoupment under subparagraph 355-445(b)(i) of the ITAA 1997, which states: (i) the recoupment is of expenditure incurred on or in relation to certain activities Paragraph 3.118 of the Explanatory Memorandum to the Tax Laws Amendment (Research and Development) Bill 2010 (EM) provides some insight into what type of recoupment would be covered by subparagraph 355-445(b)(i): 3.118 The first way a recoupment can be considered to relate to R&D activities is where the recoupment explicitly relates to expenditure that has been incurred on or in relation to certain activities. This form of recoupment will be retrospective, typically a reimbursement … Additionally, in paragraph 3.121 of the EM the recoupment is described as a 'reimbursement recoupment'. The recoupment is referred to by the Australian Taxation Office (ATO) in the Research and development tax incentive - clawback adjustment guide as follows: If you have received or are entitled to receive a recoupment of all or some of the expenditure that you have already incurred on your R&D activities you may need to make a clawback adjustment. A recoupment of this type, which could include reimbursement, refund or recovery of expenditure, will typically be retrospective, as it is paid to you after expenditure has been incurred. This type of recoupment restores you to the position you would be in if you had not incurred that expenditure (to which the recoupment relates). As a result, you have not experienced any financial detriment in relation to the expenditure to the extent that it has been recouped. Recoupment that requires expenditure to be incurred or to have been incurred: subparagraph 355-445(b)(ii) ITAA 1997 The second type of recoupment is recoupment under subparagraph 355-445(b)(ii) of the ITAA 1997, which states: (ii) the recoupment requires expenditure (the project expenditure) to have been incurred, or to be incurred, on certain activities. Paragraph 3.119 of the EM provides some insight into what type of recoupment would be covered by subparagraph 355-445(b)(ii): 3.119 The other way a recoupment can be considered to relate to R&D activities is where a condition of the recoupment is that a specified amount (the mandated 'project expenditure') is spent on (possibly a menu of) specified activities, and some of the specified activities on which the mandated project expenditure is ultimately spent are eligible R&D activities. This form of recoupment is often referred to as a grant (see Example 3.10) 3.120 Grants are often made on a matching dollar-for-dollar basis, whereby the mandated project expenditure is double the amount of the grant. However, a recoupment can be treated as being of this grant type whether the mandated project expenditure is equal to, greater than, or less than the grant. Further, grants can be made in an income year before, at the same time as or after the actual project expenditure on R&D activities occurs. Additionally, in paragraph 3.121 of the EM the recoupment is referred to as a 'grant recoupment'. Which type of recoupment is received under the Commonwealth Government Scheme ? Commonwealth Government Scheme payments under the Commonwealth Government Scheme must be characterised as either being a 'recoupment of expenditure incurred' under subparagraph 355-445(b)(i) of the ITAA 1997 or a 'recoupment that requires expenditure to have been incurred' under subparagraph 355-445(b)(ii) of the ITAA 1997. Commonwealth Government Scheme payments under the Commonwealth Government Scheme are calculated with reference to expenditure that has already been incurred. Paragraph 3.121 of the EM provides insight into how a retrospective recoupment of expenditure may be characterised: 3.121 Whether a retrospective recoupment is of the reimbursement or grant type will depend on the relationship between the recoupment and the past expenditure. Where a recoupment is given because a specified amount has been spent on a specified activity, it will be a reimbursement, including where the entitlement to a reimbursement if the amount was spent was known in advance. Where a recoupment is given on the condition that a specified amount is spent on one or more specified activities, it will be a grant - including where that condition had been partly or completely satisfied prior to the R&D entity becoming entitled to the grant. A participant will be entitled to a Commonwealth Government Scheme payment if it meets the conditions in the regulations: Importantly, none of the conditions in the regulations require a specified amount of expenditure to be incurred. Entitlement to a Commonwealth Government Scheme payment does not arise on the condition that a specified amount is spent on one or more specified activities. Instead, entitlement arises because a specified amount has been spent on a specified activity; that is, because a particular amount of expenditure has been incurred in relation to defined research and development (as defined by the regulations). A Commonwealth Government Scheme payment provides a partial reimbursement for expenditure that has been incurred in relation to defined research and development. Accordingly, each Commonwealth Government Scheme payment received by Company A as a participant under the Commonwealth Government Scheme is a recoupment of expenditure incurred and is of the type referred to in subparagraph 355-445(b)(i) of the ITAA 1997. The amount on which extra income tax is payable under Subdivision 355-G of the ITAA 1997 is determined under subsection 355-450(1) of the ITAA 1997 which states: (1) The extra income tax is payable for the trigger year on an amount (the R&D expenditure) equal to the sum of: (a) so much of the expenditure referred to in section 355-445 that is deducted under this Division; and (b) for each asset (if any) for which expenditure referred to in section 355-445 is included in the asset's cost-each amount (if any) equal to the asset's decline in value that is deducted under this Division; in working out tax offsets under section 355-100 obtained by the entity (the recipient), or an entity mentioned in subsection (4), for one or more income years. As established in the answer to Question 1 above, a Commonwealth Government Scheme payment is a recoupment of the type referred to in subparagraph 355-445(b)(i) of the ITAA 1997. A distinction can be made between the expenditure on which a recoupment has been based and the expenditure that actually ends up being recouped. In the case of a full reimbursement the two amounts will be equal. However, a Commonwealth Government Scheme payment is only a partial reimbursement of the total expenditure on which that Commonwealth Government Scheme payment is based. As noted in paragraph 3.118 of the EM, a recoupment in the form of a partial reimbursement of total expenditure is treated as a recoupment of expenditure equal to the amount of the recoupment for the purposes of subparagraph 355-445(b)(i) of the ITAA 1997. As such, the recoupment of expenditure referred to in subparagraph 355-445(b)(i) of the ITAA 1997 is limited in the current circumstances to the amount of the partial reimbursement received under the Commonwealth Government Scheme. In addition, the words 'so much of the expenditure' in paragraph 355-450(1)(a) of the ITAA 1997 mean that it is only that amount of a Commonwealth Government Scheme payment (partial reimbursement) which represents a recoupment of expenditure that has been deducted under Division 355 of the ITAA 1997 that is the amount on which extra income tax is payable as determined under subsection 355-450(1) of the ITAA 1997. As established in answer to Question 2 above, the amount on which extra income tax is payable as determined under subsection 355-450(1) of the ITAA 1997 is the amount of a Commonwealth Government Scheme payment which represents a recoupment of expenditure that has been deducted under Division 355 of the ITAA 1997. The recipient of a Commonwealth Government Scheme payment under the Commonwealth Government Scheme must therefore determine how much of the expenditure recouped has been deducted under Division 355 of the ITAA 1997 in order to calculate the extra income tax payable under Subdivision 355-G of the ITAA 1997. Company A have proposed the methodology (detailed in the 'Relevant facts and circumstances' under the heading 'Method for calculating extra income tax payable') for calculating the extra income tax payable under Subdivision 355-G of the ITAA 1997. The underlying principle of that methodology is to apply a modified version of the methodology that was used to calculate the amount of Company A's Commonwealth Government Scheme payments (detailed in the 'Relevant facts and circumstances' under the heading 'Commonwealth Government Scheme payments'). The methodology Company A have proposed is appropriate for calculating the extra income tax payable for the relevant income year arising under Subdivision 355-G of the ITAA 1997. Not applicable.