Are you impacted by R&D tax changes?

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1 Are you impacted by R&D tax changes? Core R&D The government now has confirmed that the new R&D legislation, will replace existing R&D tax concession legislation established in The new legislation will take effect for financial years commencing on or after 1 July Questions to consider in assessing this change: To what extent is our industry sector impacted How have the tax benefits changed Are we impacted by definitional changes How will we distinguish core and supporting R&D activities Will dominant purpose or the feedstock rules impact us Will the new grouping rules impact us Can we claim for R&D undertaken overseas Can we claim for R&D undertaken for our parent company Has the registration and claim process changed This briefing highlights the critical components of the legislation. KPMG s R&D Tax Incentives team understands these changes and is working to assist companies respond effectively. The team is available to discuss specific questions and the implications for your business.

2 Core R&D of changes The new R&D takes effect for financial years commencing on or after 1 July Key changes: new benefits for more companies increase in base rate for those eligible, the refundable credit will have no limit on R&D expenditure modified definition, including dominant purpose test for support activities changes to compliance process particularly distinguishing between core and supporting activities industry impact varies across sectors and business life cycle potential quarterly payment of refundable credit Companies that have been claiming the R&D tax concession, and those that previously may not have been eligible, should reassess their position with regard to the new regime.

3 Core R&D How have the benefits changed? Two core components of the new R&D : 45 percent refundable R&D for eligible entities with a group turnover of less than $20 million non-refundable 40 percent R&D for all other eligible entities R&D tax concession deductions will no longer be available: 125 percent base deduction (7.5 percent tax benefit) 175 percent premium Australian deduction (22.5 percent tax benefit) 175 percent foreign-owned premium (22.5 percent tax benefit) Refundable offset for companies with turnover less than $5 million (37.5 percent tax benefit) Importantly, unlike under the R&D tax concession, those eligible for the refundable credit will have no limit on the levels of R&D expenditure which can be refunded.

4 Core R&D Important dates The R&D applies for expenditure incurred in income years starting on or after 1 July Year End First period of new rules 30 June 1 July 2011 to 30 June September 1 October 2011 to 30 September December (early or late balancing) 1 January 2012 to 31 December March 1 April 2012 to 31 March 2013 The change in legislation is an opportunity to review the impact of the R&D on your R&D claim profiles and to transition from a retrospective claim process to a prospective R&D approach the following page outlines recommended steps.

5 Five transition steps Companies should adopt a five step process to help optimise arising from the R&D. Core R&D Through this process analysis suggests there will be many scenarios where positive impacts will be identified. Our R&D Tax Incentives team has the experience, processes and tools to support you through this transition process.

6 Core R&D Core R&D activities In essence, the definition of core R&D activities under the new R&D is a single composite test of conceptually similar requirements to the past although removing specific references to innovation or high levels of technical risk. Core R&D activities are defined as: Experimental activities where the outcome is not known or cannot be determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work that: is based on principles of established science evolves from hypothesis, to experiment, to observation / evaluation, and leads to logical conclusions are conducted for the purpose of generating new knowledge (including knowledge about the creation of new or improved materials, products, devices, processes or services) It should be noted the new R&D retains similar exclusions to Core R&D activities that existed under the R&D tax concession.

7 Core R&D activities As in the past, the criteria for eligibility of supporting R&D activities requires that they be directly related to the core R&D activities. However, if an activity is: an excluded core R&D activity produces goods or services is directly related to producing goods or services then the activity is only eligible as a supporting activity, if it is undertaken for the dominant purpose of supporting the core R&D activities. In addition to the obvious narrowing of eligibility of costs incurred in supporting activities, this further test places an additional compliance burden on taxpayers as to its practical application in an industrial or commercial context.

8 Core R&D Dominant purpose The intention of the dominant purpose test is to exclude those supporting activities that would have been undertaken as a part of normal operations. For example, production activities will only be eligible where the dominant purpose of conducting them is to support core R&D. Production activities are those that produce goods and services, along with their directly related activities. Production activities can range from a one-off activity to mass production. Dominant purpose means the prevailing or most influential purpose, recognising that activities can be conducted for more than one purpose. Accordingly, the fact that an activity serves as a commercial objective as well as being directly related to R&D does not preclude it from qualifying as supporting R&D. Conversely, the fact that certain activities are necessary for core R&D to occur is not sufficient to show those activities are undertaken for the dominant purpose of supporting core R&D. Substantiation of the purpose of R&D activities will be crucial to support a company s R&D claim.

9 Core R&D Opportunities Grouping New grouping rules apply to access the refundable offset connecting entities with control of 40 percent or greater Exempt entities (for example, universities) can control up to 50 percent of the R&D entity. The existing R&D tax concession limits exempt entities to 25 percent control or ownership Multinational groups The R&D will be available for companies that undertake R&D activities on behalf of a related foreign company Overseas activities Up to 50 percent of the Australian core activities may be undertaken overseas if certain conditions are met and approval is obtained from AusIndustry. This is increased from the current limit of 10 percent Payments to related entities If expenditure is incurred with a related entity, an R&D credit cannot be claimed in relation to that expenditure until it is paid

10 Core R&D Changes impacting software related R&D: `Multiple-sale test removed Where software is developed for the dominant purpose of internal administration of business functions it is excluded from being a core R&D activity The above restriction is not intended to extend to software developed in-house which is of an applied nature. For example, forming an integral part of an electrical or mechanical device being developed Examples of how the changes may impact you: developed for commercialisation to only a single customer with no further intention to commercialise appears to be now eligible developed for use primarily by internal company personnel for business administration functions, even if access to this is licensed to third parties, is no-longer eligible as a core R&D activity

11 Core R&D Changes impacting R&D activities related to the production of a tangible product: is not confined to mass production activities The costing method is different from the current process and will require case by case assessment of it s impact on a claim Examples of how the changes may impact you: Products such as cheese or wine which are produced in 1 year and sold 2 years later. The producer will be entitled to claim the R&D in the year the product is made When the product is later sold, the producer will include an additional amount in its assessable income to clawback the incentive component previously obtained If the product is not sold but used internally, such as the development of spare parts used on the producer s own production line, then a market value needs to be attributed to the product

12 Core R&D Lodgement process The R&D will continue to be a self-assessment program, with similar processes to the R&D tax concession. The registration time line remains 10 months after the end of a financial year. New requirements include: with regard to consolidated tax groups, registration will be required for the head entity only identification of core and supporting R&D activities must be done separately demonstration of dominant purpose will be required no R&D plans are proscribed, but additional registration information will be required An advanced findings process will be available to enable organisations to validate the eligibility of their R&D activities before registering. Limited amendment period The Commissioner of Taxation will now have a maximum of 4 years to revoke a finding or amend a taxpayer s claim for the R&D tax incentive -- consistent with general corporate income tax self-assessment time limits. Review and audit process AusIndustry is applying increased resources to compliance activities, including the introduction of detailed questionnaires to assess eligibility. Additionally, AusIndustry and the Australian Taxation Office have also announced greater co-operation in the context of compliance assessments, with risk-focused reviews commencing upon the lodgement of R&D applications.

13 R&D Industry Impacts Nature of R&D legislative change Industry Sector Benefit Definition of R&D activities Dominant purpose R&D R&D in Australia for foreign company undertaken overseas Grouping Energy & Natural Resources Information & Communication Technologies Finance Core R&D Manufacturing Engineering Consulting Infrastructure/Utilities Pharmaceutical Biotechnology Environmental Start-up entities Complex impact Change to process required Positive impact The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual, entity or industry sector. The specific impact may vary from that indicated above. Issues not highlighted for a specific industry should still be evaluated to determine the impact to actual R&D activities. No one should act upon such information without appropriate professional advice after a thorough examination of the particular circumstances. Additional information may be obtained from one of our R&D Tax Incentive specialists listed on the Contacts page.

14 Contacts R&D Incentives Core R&D National Lead Partner David Gelb Brisbane Adrian Carroll Melbourne Alan Garcia Mark Prentice Helen Gilfedder Gareth Newport Adelaide Mathew Herring Tony Petrilli Perth Steve Carroll Sydney Paul van Bergen Scott Olding Kristina Kipper KPMG s Tax practice is not licensed to provide financial product advice under the Corporations Act and taxation is only one of the that must be considered when making a decision on a financial product. You should consider taking advice from an Australian Financial Services Licence holder before making any decision on a financial product. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Additional information may be obtained from our offices KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. August NSWN08013TAX.