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Final R&D feedstock adjustment taxation ruling released

The ATO has issued a final ATO taxation ruling, TR 2013/3, which discusses its views and opinions on the application of the feedstock provisions contained within the research and development (R&D) provisions in Division 355 of ITAA 1997.

Where a claim has been made for the R&D tax incentive and the eligible R&D activities have resulted in tangible products that are, at any time, on-sold or used in the entity’s own business, a feedstock adjustment seeks to reduce or eliminate up to 10% of the concessional tax benefit of the R&D claim to the extent that it is unwarranted based on the profit made or the value derived. The feedstock adjustment will be a clawback amount included in assessable income in the income year of sale or use, and is very broadly based on the lower of the value of the tangible product, or the cost of the raw materials and energy used during the R&D activities. 

In practice, however, these provisions can be very difficult to apply, particularly within businesses that involve multi-stage production processes producing non-perishable tangible products, and are only applied to effectively arrive at a nil tax benefit position. As such, the ATO has consulted with business and set out certain practical and interpretative aspects of the provisions in this final taxation ruling.

The final ruling now makes the following key legally binding observations in respect of applying these provisions:

  • The cost of acquiring or producing the raw materials (that are subject to the R&D activities) must be calculated on a wide basis and will include all costs incurred to the point where the transformation or processing can occur. This will also include the total cost of production where the raw materials are themselves the ultimate product of a number of different production stages

  • A feedstock adjustment will arise when an entity actually uses the tangible product within its own business activities (as distinct from passively holding it for later supply). Transforming it or holding it for later supply will merely trigger the feedstock adjustment when the later supply occurs

  • A feedstock adjustment will occur on the use of a tangible product in the later stages of a production process where there will be no change in the appearance, condition, nature or character of the product. Its later supply will be precluded from triggering a second feedstock adjustment

  • If it can be shown on the balance of probabilities that the value of the tangible product is higher or lower than the combined cost of the raw materials and energy used, then it is acceptable to calculate the lesser amount with the proper amount of precision as is reasonably practicable. For example, accurately calculating only the appropriate cost allocation for R&D improvements in production processes for intrinsically high-value outputs because it can be properly inferred that the nature of the activities did not materially affect the value of the product

  • When required to calculate amounts that are reasonably attributable, this is similar to that of a reasonable estimate and must be based on the forming of an opinion or judgement based on reason that takes into account the individual circumstances of the case. Uniform attribution calculations across more complex different production runs would not satisfy this requirement

  • Tangible products can be accumulated as a single output if such a single calculation would not differ materially from the expected result without aggregation

  • Approximate methods of calculating the proportion of market value that should be used as feedstock revenue are acceptable provided that they are consistent and reflect the entity’s appropriate ordinary cost accounting systems.

A recent ATO ID, 2012/89, is also relevant in confirming that a feedstock adjustment will not apply to the development of a prototype that is not used to produce materials to be used in R&D activities.

Notably, entities claiming the 45% refundable R&D tax offset will always retain a permanent 5% net tax benefit since, for simplicity, this assessment mechanism will only claw back a maximum of 10% of the R&D net tax benefit claimed. The existence of tax losses carried forward can also preserve the full benefit of a refundable R&D tax offset.

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