Research and development expenditure on derecognised non-depreciable assets
Clause 85
Issue: Support for the proposals
Submission
(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY, KPMG, PwC)
Five submitters expressed their general support for the proposals.
We welcome the extension of the scope of the proposals from the original proposals consulted on in a Government discussion document, such that it is now proposed to allow tax deductibility for both successful and unsuccessful capitalised development expenditure towards intangible assets that are not depreciable for tax purposes (that is, not listed in schedule 14 of the Income Tax Act 2007). This extension of the scope of the proposed reforms should further assist in reducing distortions against investment in R&D caused by the current rules. (Chartered Accountants Australia and New Zealand)
We are pleased that officials have acted on submissions made in response to the original proposals consulted on. (PwC)
Comment
Officials note the general support for the proposed amendments.
Recommendation
That the submissions be noted.
Issue: Deductibility of impaired capitalised development costs
Submission
(Chartered Accountants Australia and New Zealand, EY)
It needs to be made clear that, when an asset has been impaired for accounting purposes and its carrying value is reduced by that impairment, the amount available to be deducted for income tax purposes upon derecognition of the asset for accounting purposes is the capitalised amount and not the book value of the asset net of impairments. (Chartered Accountants Australia and New Zealand)
Deductions should also be allowed for impairment expenses, preferably in the years they occur for financial reporting purposes or, alternatively, a deduction should be allowed for any such amounts in the year of final derecognition or write off (other than on disposal). (EY)
Comment
The policy intent is that upon derecognition (other than on disposal) of an intangible asset for accounting purposes, the amount that the taxpayer may deduct is the full amount of capitalised development expenditure they incurred, and not merely the book value of the asset net of impairments.
It is officials’ view that, as drafted, the proposed legislation achieves the policy intent. Existing section DB 34(1) of the Income Tax Act 2007 allows a taxpayer a deduction for expenditure they incur on research or development, if various circumstances described in any of subsections (2) to (5) are applicable to the taxpayer, and provided that the expenditure is not excluded by subsection (6). As a “trigger” for a deduction under proposed new section DB 34(3), the proposed legislation refers to derecognition (using the terminology of the new reporting standard) or write off (using the terminology of the old reporting standard) of an intangible asset for financial reporting purposes.
The amount available to be deducted under proposed new section DB 34(3) is further qualified to expenditure incurred on or after 7 November 2013 and before the occurrence of the “trigger” event. Aside from this qualification on when the expenditure must have been incurred, proposed new section DB 34(3) does not impose any restriction on the amount of expenditure able to be deducted under it. Therefore, the full amount of expenditure incurred within this time period will be able to be deducted under proposed new section DB 34(3), provided that section DB 34(1) is satisfied (that is, it is expenditure the taxpayer has incurred on research or development and it is not expenditure that is excluded by section DB 34(6)), and the taxpayer has not already deducted the expenditure (for instance, under section DB 34(2) for research or development expenditure incurred prior to asset recognition for financial reporting purposes).
For the purposes of the income tax legislation, it is irrelevant whether an asset has been impaired for financial reporting purposes and its carrying value reduced by that impairment. Therefore, officials do not consider that legislative clarification is required.
Officials do not consider that deductions should be allowed for impairment losses in the years that they occur for financial reporting purposes. The income tax legislation has its own tax depreciation framework that is separate from the accounting treatment. Because of the impact on tax revenue raised that tax depreciation deductions can have, officials consider that there is good reason for the tax system to have its own depreciation rules, and not merely follow the accounting treatment, which may not necessarily approximate true economic depreciation.
While officials support the use of derecognition for accounting purposes as the trigger for a tax deduction for capitalised expenditure in the specific instance of R&D-generated non-depreciable intangible assets, allowing tax depreciation to mirror the accounting treatment in the case of these assets would be inconsistent with the tax depreciation treatment of other assets under existing policy settings. Officials do not consider such an inconsistency to be justified.
Recommendation
That Chartered Accountants Australia and New Zealand’s submission be declined.
That EY’s submission as to their first preference be declined, and their submission as to their second preference be noted, together with officials’ comments.
Issue: Clarification of whether expenditure incurred when R&D “work in progress” is purchased is able to be deducted
Submission
(Corporate Taxpayers Group, EY)
It appears that the amended section DB 34 will apply to unsuccessful R&D that has been acquired from a third party. For example, this can occur when Business A has incurred expenditure developing an intangible asset but ultimately decides that, due to the direction of its business, it does not require that asset. It therefore sells the “work in progress” to Business B, who intends to continue the R&D and complete the asset. However, after some initial work, Business B abandons the project. Alternatively, Business B could complete the asset but later derecognise it for accounting purposes. We would appreciate that officials confirm, in a subsequent commentary, that it is intended that Business B receives a tax deduction for the value of the unsuccessful R&D under the proposed amendment to section DB 34. (Corporate Taxpayers Group)
It does not seem clear whether or not proposed new section DB 34(3) would allow a deduction upon derecognition or write off of purchased non-depreciable intangible assets. The position should be clarified, and if the deduction is intended to be limited to expenditure incurred on a taxpayer’s own R&D work, it may be preferable, for instance, to refer to “capitalised development [or R&D] expenditure”, rather than to “expenditure… on an intangible asset”. (EY)
Comment
The policy intent is that only expenditure incurred by a business in carrying out R&D is deductible under proposed new section DB 34(3). It is not intended that expenditure on purchasing non-depreciable intangible assets is deductible to the purchasing business upon derecognition for accounting purposes. In the absence of a capital gains tax applying to the sale of an asset, allowing the purchaser a deduction for the purchase cost upon derecognition of the asset for accounting purposes would be an asymmetrical tax treatment, and would pose a significant risk to the revenue base. It is intended that a purchaser of a non-depreciable intangible asset is able to receive a deduction upon derecognition of the intangible asset for any development expenditure they incurred on further developing the asset after purchasing it.
For example, assume Business A has carried out some R&D and recognised an intangible asset for accounting purposes. Assume Business A has incurred $200,000 in capitalised development expenditure further developing the asset subsequent to recognising the asset for accounting purposes. Assume the intangible asset is not depreciable for tax purposes as it is not listed in schedule 14 of the Income Tax Act 2007. Now assume Business A sells the incomplete intangible asset to Business B (which intends to continue the R&D and complete the asset) for $10 million. Business A has made an untaxed capital gain of $9.8 million. Assume Business B incurs $300,000 in capitalised development expenditure further developing the asset before abandoning the project and derecognising the asset. It is intended that Business B is able to receive a deduction under proposed new section DB 34(3) for the $300,000 they incurred in capitalised development expenditure. It is not intended that Business B is able to receive a deduction for the $10 million cost of purchasing the asset from Business A.
Officials’ view is that, as drafted, the proposed legislation is consistent with this policy intent. However, there may be some room to improve drafting clarity, and we will refer it to drafters.
Recommendation
That Corporate Taxpayer Group’s submission be declined.
That EY’s submission be accepted, and that the drafting be revisited with a view to refining it, in accordance with the policy intent.
Issue: Legislation should cover taxpayers not required to prepare general purpose financial statements
Submission
(EY)
Many taxpayers are no longer required to prepare formal general purpose financial reports, by virtue of the provisions of the Financial Reporting Act 2013. Technically, neither the old nor the new reporting standards referred to in section DB 34 will apply to them.
In principle, these taxpayers should be able to take advantage of the proposed deduction, just as much as those who are preparing formal general purpose financial reports and clearly applying the old or new reporting standards in doing so.
It should be clarified that taxpayers who are not required to, and who choose not to, prepare such statements may also claim deductions for capitalised development expenditure when it is written off in some manner.
Comment
The new reduced minimum financial reporting requirements under the Tax Administration Act 1994 that apply to many businesses are minimum requirements. Businesses subject to these minimum requirements can choose to comply with a higher level of accounting standard in relation to R&D, so are able to receive the deductions in this way. We note that compliance with a higher level of accounting standard than the new minimum requirements is generally required to receive tax deductibility for any R&D expenditure under the existing section DB 34 of the Income Tax Act 2007, so this is not exclusive to the proposed allowance of deductibility for capitalised development expenditure under proposed new section DB 34(3).
Because the aim of R&D is to create an asset, it is arguable from an economic perspective that all R&D expenditure should be capitalised. However, the tax rules follow the treatment for accounting purposes in allowing immediate deductibility for R&D expenditure up until the point that an intangible asset is recognised under the relevant accounting standard. This is arguably a concessionary tax treatment, but reflects the fact that the success of investment in R&D in resulting in a valuable asset is particularly uncertain, and the perceived desirability of investment in R&D. It would be inappropriate, from an economic perspective, to allow immediate deductibility for R&D expenditure incurred subsequent to the recognition of an intangible asset under the relevant accounting standard because the rules in the accounting standards are conservative about the recognition of an intangible asset and require a high degree of confidence that a valuable asset has been created.
Since it is not appropriate for all R&D expenditure to be immediately tax deductible, there should be a certain degree of rigour applied to the question of which R&D expenditure can be immediately deducted and which R&D expenditure should be capitalised. Adherence to the accounting standards referred to in section DB 34 provides a sufficient degree of rigour. Therefore, officials’ view is that taxpayers that wish to receive deductions for R&D expenditure should have to adhere to one of these accounting standards. While this will mean higher compliance costs than businesses will incur under the new minimum requirements, businesses would only incur these additional costs if they considered the benefit to them of the allowance of deductions for R&D expenditure outweighed these compliance costs.
It might be argued that businesses applying the new minimum financial reporting requirements should at least be able to receive a deduction for their R&D expenditure if the R&D undertaken is no longer of any value. However, since these businesses would never apply a test for intangible asset derecognition like those that adhere to the higher accounting standards, there would be no means of determining that their expenditure is of no on-going value, such that a tax deduction would, in principle, be warranted.
Recommendation
That the submission be declined.