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This article is long and involves a complex area of R&D tax law. But if you can persevere, you will discover that the ATO’s current decision making process for specific R&D Tax Incentive concepts (specifically feedstock) and the resulting degradation in the robustness of Australia’s taxation system is a real and live issue. These concerns appeared to be confirmed during the recent ABC and Fairfax investigation into practices within the ATO which, in my view, only exposed the surface of the problem.
Some relevant background information
The current R&D Tax Incentive program was introduced in 2011 and replaced the former R&D Tax Concession. The publicly stated policy intention of the program is to incentivise companies to conduct R&D activities they would not have otherwise conducted, and to support R&D activities that have some flow on benefits to the wider scientific and business community.
While there are a significant number of differences between the former R&D Tax Concession regime and the current R&D Tax Incentive program, this article will focus on the differences in the application of the feedstock provisions.
The feedstock legislation
Under the former R&D Tax Concession regime, s 73B(1) of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’) defined feedstock expenditure as:
In relation to an eligible company, means expenditure incurred by the company in acquiring or producing materials or goods to be the subject of processing or transformation by the company in research and development activities, and includes expenditure incurred by the company on any energy input directly into the processing or transformation.
Under the current R&D Tax Incentive regime, s 355-465(1)(a) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) states that a feedstock adjustment to assessable income applies if:
…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).
During the public consultation process for the R&D Tax Incentive legislation, the new feedstock provisions were identified as an area of concern for companies affected. On the face of it, if a good or material is transformed or processed during R&D activities, it has to be included in the feedstock calculation. This would mean that any material or good that was somehow changed, transformed, or involved in a process as part of the R&D activities, would need to be included as feedstock (not just the goods and materials in the end product which the provisions are meant to claw back). This was seen as a significant divergence from the former legislation contained within s 73B(1) of the ITAA 1936, which only required materials or goods that were the subject of processing or transformation in R&D activities to be included in the feedstock calculation. If the materials or goods were not the subject of the processing or transformation (i.e. were involved in the R&D activities but not the ‘subject’ of the processing or transformation themselves) the expenditure on these materials and goods was not required to be included into the feedstock calculation and could be claimed (to the extent the activities and expenditure was eligible) as ‘other R&D expenditure’.