The Australian Tax Office (ATO) has recently altered the depreciation rules, affecting R&D tax claims for periods including 6 October 2020 7:30pm onward.
In claiming expenditure under the R&D Tax Incentive, eligible entities must assess their expenses to determine eligibility. While some expenditure is straightforward to identify, there are complexities associated with others. Depreciation or the cost of assets may only be included in an R&D tax claim when the underlying tax deduction is made within Division 401 (ITAA1997), which provides standardised rules for depreciating plant and equipment assets.
The Comparison
Previously, small businesses could accelerate the depreciation of certain assets under the Instant Asset Write-Off (IAWO), however this would preclude them being claimed under the R&D Tax Incentive. The recent addition of Temporary Full Expensing (TFE) permits the accelerated depreciation of certain assets while still allowing them to be claimed under R&D.
Instant Asset Write-Off
| Date (asset first used or installed ready for use) | Turnover below $10m | Turnover above or equal to $10m | Threshold (Individual asset must be less than this amount) |
|---|---|---|---|
| 2 April 2019 to 11 March 2020 | Small Business rules – sub-Division 328-D (no R&D claim available) | Turnover less than $50m:
Div40 (s40-82) applies Therefore R&D claim can be made for the proportionate R&D use. |
$30,000 |
| 12 March 2020 to 30 June 2021 (Important* - See note below: effective change from 7 October 2020) | Small Business rules – sub-Division 328-D (no R&D claim available) | Turnover less than $500m:
Div40 (s40-82) applies Therefore R&D claim can be made for the proportionate R&D use. |
$150,000 |
Note: For assets, you start to hold, and first use (or have installed ready for use) for a taxable purpose from 7.30pm (AEDT) on 6 October 2020 to 30 June 2022, the instant asset write-off threshold does not apply. You can immediately deduct the business portion of the asset's cost under temporary full expensing.
Special note for Small Business Entities (SBEs) – SBEs can still use the instant asset write off after 6 October, and there is no cap on the cost of assets. They can opt-out of the SBE regime for 2021 to access the Temporary Full Expensing regime instead; this will provide the same deduction under sub-Division 40BB under Division 328. Opting out of the SBE regime may have other consequences for the entity which should be considered.
Temporary Full Expensing
| Date (asset first used or installed ready for use) | Turnover below $50m | Turnover above or equal to $5 billion | Threshold (Individual asset must be less than this amount) |
|---|---|---|---|
| From 7.30pm 6 October 2020 to 30 June 2022 | Sub-Division 40BB Second-hand assets can be included Therefore R&D claim can be made for the proportionate R&D use. | Sub-Division 40BB Therefore R&D claim can be made for the proportionate R&D use. | No limit on asset cost (other than cars) |
Can claim under other depreciation rules if desired
If an asset qualifies for an immediate deduction under temporary full expensing in an income year, you can choose to claim a deduction using other depreciation rules. However, you must notify the ATO in an approved form that you have chosen not to apply temporary full expensing to the asset. The choice is unchangeable, and you must inform the ATO by the day you lodge your income tax return for the income year to which the choice relates.
WHAT TRAPS SHOULD I WATCH OUT FOR?
Balancing adjustment
The biggest one is balancing adjustments in later years. As the asset will have a zero residual value for tax, when sold, there will be a balancing adjustment required. If the asset has been claimed, in part or full, under Division 355 R&D, then an adjustment for R&D will also need to be made at that time.
Small Business Entities (less than $10m aggregated turnover)
Is the full cost of the asset being deducted under the Small Business Rules (Division 328) or Temporary Full Expensing (sub-Division 40BB) or possibly section 40-82? While the ordinary tax outcome is the same for each of these provisions only deductions determined within Division 40 (both 40-82 and 40BB) can be claimed within the R&D tax regime.
If a SBE opts out of the simplified depreciation rules, it may lose access to other benefits in FY21. This should be considered separately to determine which regime provides the most effective tax treatment. Note the lockout rules have been suspended for FY21 and FY22; so the SBE can return to the simplified depreciation rules immediately in FY23 if it opts out in FY21 and FY22.
Timing of Deduction
The TFE and IAWO are available in the year that the asset is used or installed ready for use. This may be different from when the cost of the asset is incurred or paid for. Remember that using an asset for R&D activities is a taxable use, and the asset can be deducted in the year.
For further detail, read on below where we cover the differences between, and relevance to the R&D Tax Incentive of, the following:
1. Instant Asset Write Off (IAWO) - prior to 7:30pm 6 October 2020
2. Temporary Full Expensing (TFE) - post 7:30pm 6 October 2020
1. Prior to 7.30pm 6 October 2020: What is the Instant Asset Write Off?
Under the IAWO, eligible businesses can claim an immediate deduction for the business portion of the cost of an asset in the year the asset is first used or installed ready for use. For companies that would otherwise have to depreciate the same asset over many years, this is a valuable tax benefit.
From 12 March through to 31 December 2020, an asset is eligible if its cost is less than $150,000 (up from $30,000) and eligibility has been expanded to cover businesses with an aggregated turnover of less than $500 million (up from $50 million). Under the current rules, businesses with an aggregated turnover:
· below $10 million claims the IAWO through sub-Division 328-D; and
· between $10 million to $500 million claim the IAWO through section 40-82.
How is this relevant to the R&D Tax Incentive?
Division 355 only allows you to claim a notional R&D deduction on a tangible depreciating asset that would be eligible for depreciation under Division 40.
If your aggregated turnover is less than $10 million, the IAWO is obtained through sub-Division 328-D (the simplified depreciation rules), not Division 40. Thus if you elect to apply sub-Division 328-D for an income year, you cannot claim a notional R&D deduction for the decline in value of any of those eligible assets under Division 355. This means you have a choice, and you can either claim:
· the IAWO for the newly installed assets by electing to apply sub-Division 328-D to all eligible assets; or
· the depreciation over the actual effective life of the asset under Division 40, and claim the R&D benefit as it arises each year (to the extent an asset is used for R&D during the year). However, if you elect to claim under Division 40, you must do so for all eligible assets, not just those used for R&D.
This means you should consider which treatment will provide the most benefit to your business, both in the immediate term and across the life of any eligible assets.
If your aggregated turnover is $10 million to $500 million, the IAWO provisions under s.40-82 automatically apply (i.e. you cannot choose not to apply them). Under section 40-82, your R&D use of the asset in the first year determines your notional R&D deduction for the entire cost of the asset. For instance, if in the year of installation, you:
· use the asset for R&D, and then you can claim a notional R&D deduction under Division 355 for its proportionate R&D use;
· do not use the asset for R&D, and then you can never obtain a notional deduction under Division 355 for any subsequent R&D use you might put the asset to.
2. Post 7.30pm 6 October 2020: What is Temporary Full Expensing?
Businesses with an aggregated turnover of less than $5 billion can immediately deduct the business portion of the cost of eligible new depreciating assets. The qualified new assets must be first held, and first used or installed ready for use for a taxable purpose, between 7:30pm AEDT on 6 October 2020 and 30 June 2022.
For businesses with an aggregated turnover of less than $50 million, temporary full expensing also applies to the business portion of eligible second-hand depreciating assets.
Businesses can also immediately deduct the business portion of the cost of improvements to eligible depreciating assets (and assets acquired before 7.30pm AEDT on 6 October 2020 that would otherwise be eligible assets) if those costs are incurred between 7.30pm AEDT on 6 October 2020 and 30 June 2022.
If your income year ends on 30 June, deductions under temporary full expensing are only available in the 2020–21 and 2021–22 income years.
If an asset qualifies for an immediate deduction under temporary full expensing in an income year, you can choose to claim a deduction using other depreciation rules. However, you must notify the ATO in an approved form that you have chosen not to apply temporary full expensing to the asset. The choice is unchangeable, and you must inform us by the day you lodge your income tax return for the income year to which the choice relates.
How is this relevant to the R&D Tax Incentive?
Temporary Full Expensing is available under sub-Division 40BB and therefore, your R&D use of the asset in the first year determines your notional R&D deduction for the entire cost of the asset.
However, SBEs with an annual aggregated turnover of less than $10 million can choose to apply the simplified depreciation rules in sub-Division 328-D of the ITAA 1997.
Under the temporary full expensing rules, SBEs that apply the simplified depreciation rules will deduct:
· the total cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose, between the Budget time and 30 June 2022;
· the second element of cost of these assets and of existing eligible depreciating assets incurred during this period; and
· the balance of their general small business pool.
SBEs can opt-out of the simplified depreciation rules and access TFE under sub-Division 40BB instead. Any other impacts of the decision to opt-out of simplified depreciation rules should be considered.
Links
For more information, please refer to the below links:
Instant asset write-off for eligible businesses - ATO
Temporary full expensing - ATO
Temporary full expensing of depreciating assets - Tax Banter
Temporary full expensing opt-out Bill has passed Parliament - Tax Banter
The above information is noted as a guide only and does not constitute tax advice.
Complexity in these areas is why we advise you speak to a professional to obtain the best guidance that would be relevant to your situation.
Please get in touch with us here.