R&D Clawback: Don’t Get Caught Out with Unexpected Tax

You will need to make an R&D clawback adjustment if you answer yes to all of the following three questions:

1) Have you received or are you entitled to receive a recoupment during the income year? These are most delivered as grants reimbursing prior spends.
2) Is the recoupment from an Australian government agency (other than under the Cooperative Research Centre [CRC] program) or a state/territory body (STB)?
3) Have you or a related entity claimed the R&D tax incentive (RDTI) tax offset for expenditure that relates to the recoupment?

One of the most important aspects of the clawback adjustment process is identifying the ‘trigger year’ associated with a recoupment. Recoupments are sometimes paid in instalments over more than one income year, in which case you would have more than one trigger year, and would be required to make a clawback adjustment for each trigger year. The extra income tax on the recoupment is payable in the trigger year determined, regardless of whether you claim the RDTI tax offset in the same year, or an earlier or later income year. Therefore, in certain circumstances you may have to amend past income tax assessments in order to make the clawback adjustment.

After determining that clawback applies and the timing (i.e., trigger years) of the clawback adjustment, you then need to calculate the amount of the clawback adjustment. The clawback adjustment is an amount of extra income tax at the rate of 10% of the amount of expenditure which relates to the recoupment for which you have received the RDTI. To determine your clawback adjustment, you need to identify your ‘R&D expenditure’ that is relevant to the recoupment, because the extra income tax of 10% is imposed on this amount.

Firstly, you need to know if the recoupment received is:
• for expenditure already incurred (i.e., reimbursement) in relation to certain activities (including R&D activities); or
• a recoupment that requires expenditure to be incurred on certain activities (often referred to as a grant, providing funding for specific purposes).

The following Case Study succinctly explains how to identify R&D expenditure used to calculate a clawback adjustment in the case of a reimbursement:

Case Study 1: Company A, which is involved in researching new and improved battery technology for electric vehicles, applied for funding from an Australian Government agency for expenditure it would incur in a specific R&D project in the income year ending 30 June 2020. In this same income year, Company A incurred expenditure of $450,000 on this R&D project, which qualified for a notional deduction under Division 355 of the ITAA 1997 and was also claimed as an RDTI tax offset.

The aforementioned Australian Government agency was able to provide the company with a reimbursement of $200,000 for its expenditure incurred on the R&D project in the same income year (i.e. ending 30 June 2020). Therefore, the R&D expenditure that Company A uses when calculating its clawback adjustment is $200,000 and Company A’s clawback adjustment in the income year ending 30 June 2020 is:

R&D expenditure ($200,000) × 10% = $20,000

If, on the other hand, you receive a recoupment that is a grant, then a cap applies to the amount of the extra income tax to be paid. This cap ensures that the amount of extra income tax you pay on your grant cannot exceed the amount of the grant that, on a pro-rata basis, is deemed to relate to the R&D expenditure. The following formula determines the maximum amount (i.e., the cap) of the extra income tax:

Net amount of the recoupment x (R&D expenditure ÷ Project expenditure)

In which “Net amount of the recoupment” means the total amount of the recoupment, less any repayments of the recoupment during an income year; and “Project expenditure” is expenditure that the recoupment requires to be or to have been incurred (see Case Study 2 below) on certain activities. Your grant agreement will state what your project expenditure should be in relation to each recoupment received, which are often paid in instalments over the period of a project.

The reason that the aforementioned cap for grants exists — and which assists greatly in understanding the R&D Clawback accounting process — is as follows: to ensure that, in relation to your R&D activities, when the RDTI is worth more than the grant, you will receive the RDTI tax offset instead of the grant. Case Study 2 illustrates this point:

Case Study 2: Grant for R&D expenditure and other expenditure that does not qualify for the RDTI.

In the income year ending 30 June 2020, Company B received a $180,000 grant from an innovation-focused Australian government agency in relation to certain activities that it conducts. The grant agreement between Company B and this government agency states that Company B is required to spend $2 million (including the grant funding) on a particular project, which it does so in the same income year. Of this amount, $200,000 must be spent on R&D activities that relate to expenditure for which Company B claims the RDTI tax offset. The remaining $1.8 million that Company B is required to spend relates to other activities that do not qualify for the RDTI.

The total project expenditure was $2 million, but only $200,000 of this expenditure was claimed under the RDTI. Company B determines that a clawback adjustment is required and calculates its clawback adjustment for the income year ending 30 June 2020 as follows:

The clawback adjustment (before considering the cap) is:
R&D expenditure ($200,000) × 10% = $20,000

But calculating the cap subsequently limits the clawback adjustment:
Net amount of the recoupment x (R&D expenditure ÷ Project expenditure)
= $180,000 × (200,000 ÷ 2,000,000) = $18,000

Therefore, the clawback adjustment is limited to the cap of $18,000: in other words, this lower amount is the extra income tax Company B will need to pay in the relevant income year.

Of course, if you have received a recoupment that is a reimbursement, no cap applies. This is because your clawback adjustment on the reimbursement cannot exceed 10% of the reimbursement, because the recoupment will always equal the expenditure being reimbursed.

Calculation of clawback adjustments also needs to take into consideration government recoupments received by R&D entities connected with you, or an R&D entity that is an affiliate of yours or that you are an affiliate of.

In the case of recoupments that must be repaid (either partially or fully), which could be for a number of reasons (e.g., due to a recoupment repayment agreement with the government entity that may depend on the success of the project, or breaching conditions of the recoupment agreement), this will obviously affect the clawback adjustment calculations for the years in which the recoupments were initially made, and amendments to the income tax returns for those respective years will need to be made.

Recoupments (including grants) you receive for R&D expenditure that you claim the RDTI for must be included in your total assessable income unless they are specifically exempt under the legislation.

The ATO has confirmed that payments received as part of the Cash Flow Boost and JobKeeper schemes are not subject to clawback as they are not a recoupment of expenditure incurred on or in relation to certain activities.

As a reminder however, JobKeeper payments trigger the ‘at-risk rule’ and salary amounts reimbursed by JobKeeper are not eligible notional deductions in the first instance.

In summary, some important points to keep in mind with the accounting associated with Clawback of R&D recoupments:
• Which government entity provided the recoupment;
• When the recoupment was authorized/received (trigger year), and in which financial year the R&D expenditure was actually incurred;
• How much the recoupment was for and how much of that amount was actually incurred in R&D expenditure and/or depreciation of R&D related assets;
• If adjustments need to be made to tax returns for previous financial years due to recoupments received;
• If an R&D entity that is an affiliate of yours, or that you are an affiliate of, has obtained recoupments.