Jared Birbeck (Technical Director of Risk & Intelligence in the Risk Management & Strategy and Research & Development section of the Australian Taxation Office) spoke with Charmaine Chalmers (PwC’s National R&D Leader) about the recent feedstock case (GHP 104 160 689 Pty Ltd and the Commissioner of Taxation) and the subsequent Decision Impact Statement and the implications for claimants.
Charmaine asked Jared a number of questions not only about the specific implications of the case but about the ATO’s approach to feedstock more generally. His answers, which are shown below, provide a series of reflections on the case as well as important pointers to anyone who needs to consider the impact of feedstock on an R&D claim.
A reminder that 30 April is the last day for June balancers to register R&D activities with AusIndustry for the year ended 30 June 2014.
Charmaine: The recent AAT case related to an R&D claim made under the old R&D Tax Concession. In the ATO’s view, what learnings from the case (if any) are there for taxpayers in relation to the application of the Feedstock Provisions under the new R&D Tax Incentive program? And why?
Jared: The decision is relevant to the interpretation and application of the feedstock provisions under the R&D Tax Incentive program. In a number of respects, the case reinforced the ATO’s previous understanding of the applications of feedstock provisions – especially in relation to multiple-stage and overlapping processes. The AAT’s findings were fairly consistent with the content of our TR2013/3 ruling in many aspects but the ruling will need some modification to draw out the distinction the AAT found but TR 2013/3 may require some amendments between expenditure on materials or goods to be the subject of processing or transformation and expenditure on actions or processes which subject those materials or goods to processing or transformation.
In any event, the R&D Tax Incentive program is much clearer on the implications in trials that occur upstream/downstream. In relation to consumables we will take the Tribunal's reasoning into account in applying the R&D incentive provisions to analogous cases and this would be a question of fact and will depend on the circumstances.
Charmaine: From the ATO’s reading and interpretation of the case, is there any implication for whether a ‘product’ should be defined narrowly as a good produced from a large-scale, industrial process? Or does the term ‘product’ have a wider meaning in the Act, and can it also apply to lower-volume and less- repeatable goods, such as one-off prototypes?
Jared: We don’t think the case changes previous understandings of how the term ‘product’ should be interpreted. That term should not be read or defined narrowly. It is clear from the Explanatory Memorandum that it can refer to a one-off good. The case didn’t necessarily deal with the issue of what a ‘product’ is, but it did deal with whether the product(s) had value.
As far as the one-off prototypes are concerned, there is some relevant advice in our guide on the ‘Decline in value of assets used for conducting R&D activities’ . It deals with the issue of tangible, depreciating assets specifically in relation to the R&D Tax Incentive program.
Charmaine: In the ATO’s view, does this case provide conclusive guidance on the treatment of consumables? And, if so, what is that guidance?
Jared: The case certainly provided some pretty good, high level guidance on the treatment of consumables.
The Tribunal provided a clear principle that things acquired to be the subject of some process in an activity could not share a common identity with those acquired to subject them to that activity. That is, there is a distinction between expenditure on materials or goods to be the subject of processing or transformation and expenditure on actions or processes which thereby subject those materials or goods to processing or transformation. In that case, the Tribunal found that the ‘consumables’ were things that were acquired to subject goods or materials or transformation or processing during the R&D activities.
However, the real question is whether or not an item is a ‘consumable’ but whether the item is it to be the subject of processing or transformation?; Or is it something which subjects other things to processing or transformation?
Charmaine: What does the ATO understand the case says about any new factors or considerations that taxpayers need to take into account in respect of consecutive and overlapping production processes? Does this view change under the new R&D Tax Incentive program – and, if so, how and why?
Jared: From the ATO’s point of view, the findings in the case were consistent with the views that we have held for a long time about consecutive and overlapping production processes. Our position is explained in the discussion on multi-stage production processes in TR 2013/3.
That is, where a good or material is produced internally by the R&D entity, and it then becomes part of a later process, the entity picks up the full cost of production of that good or material as their feedstock input expenditure. And this is regardless of the fact that the earlier process, if that was the R&D activity, would only pick up a limited amount of the cost related to the production of that good or material.
Even where two separate companies are involved in undertaking ‘process one’ and ‘process two’ respectively, you would expect that the acquisition in the second company running ‘process two’ would pick up the full absorption cost in recognition of the fact that there needs to be a transfer of the goods or materials between the two entities.
Charmaine: Can you please comment on whether the ATO intends to take any follow-up action as a result of the case – for example, will there be any additional ATO guidance released or specific targeted reviews initiated?
Jared: We will be reviewing TR 2013/3 as outlined in the DIS, to provide greater clarity about the distinction between goods or materials to be the subject of processing or transformation versus actions or processes which subject those materials or goods to processing or transformation.
Further, feedstock continues to be an area of risk in relation to the R&D Tax Incentive program, particularly given the number of large claimants across a range of industries. We will therefore maintain our focus in this area and work towards clarifying the application of this part of the law. For example, a substantial amount of what needs to be looked at is activity-based. One of the key drivers from the ATO’s point of view is predominantly around establishing the relevant nexus between the activities that have been registered and the expenditure that has been incurred. And so that’s something that we continue to assess closely.
As a result of discussions at a number of National Reference Group meetings over the past 12 months, we have also been working with AusIndustry on developing some new guidance on what companies can (and can’t) potentially do to ‘opt out’ of being affected by the feedstock provisions.That is, entities can choose not to register certain activities that could give rise to a requirement to calculate a feedstock adjustment. AusIndustry have released a new specific industry guidance product outlining the process.
Charmaine: Is there likely to be a resumption at any time of the joint review process that the ATO used to conduct with AusIndustry - and, if so, when do you envisage that this will happen?
Jared: There are no plans to formally commence joint review activity but we are sharing more information to allow us to facilitate a more comprehensive risk management approach. We will continue to work closely with AusIndustry.