Accounting for refundable research and development incentives

The Research and Development (R&D) tax incentive provides targeted R&D offsets designed to encourage more Australian companies to engage in R&D. The incentive has two core components as follows:

  • 43.5% refundable* tax offset for eligible entities with an aggregated turnover of less than $20 million per annum, or
  • 38.5% non-refundable tax offset for all other eligible entities (entities may be able to carry forward unused offset amounts to future income years).

*These R&D incentives are only ‘refundable’ in cash to the extent that the current income tax liability is insufficient to utilise the R&D incentive. For example, if the current income tax liability is $50,000 and the ‘refundable’ incentive is $70,000, $50,000 of the incentive will reduce the current income tax liability to $Nil, and cash of $20,000 will be received for the remaining $20,000 of the refundable incentive.

Using two examples, this article illustrates the accounting treatment when entities receive refundable R&D tax incentives, i.e. both entities have turnover less than $20 million per annum.

Which Accounting Standard?

It is not clear which accounting standard determines the appropriate accounting for R&D incentives (investment tax credits) because they are scoped out of both:

  • AASB 112 Income Taxes (refer paragraph 4), although temporary differences that arise from investment tax credits are accounted for under AASB 112, and
  • AASB 120 Accounting for Government Grants and Disclosure of Government Assistance - paragraph 2(b) specifically scopes out government assistance that is provided in the form of benefits that are available in determining taxable profit or loss, or determined or limited on the basis of the entity’s income tax liability.

In the absence of an Australian Accounting Standard that applies specifically to a transaction or event, paragraph 11 of AASB 108 Accounting Policies, Changes in Estimates and Errors, requires that we refer to the requirements in Australian Accounting Standards that deal with similar issues as our first point of reference when developing accounting policies for transactions and events.

Refundable offsets are more akin to government grants than investment tax credits because the entity has spent money on certain R&D items, and is given the assistance in the form of cash, in return for past compliance (having spent money on R&D items).

Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity…’.

Extract of definition of ‘government grant’ in AASB 120

AASB 112 specifically excludes government grants and investment tax credits from its scope. Refundable offsets are receivable based on R&D spend, regardless of the entity earning taxable income (i.e. cheque/payment is received from ATO if there are insufficient taxable profits to offset the incentive). Based on the above, refundable offsets should be accounted for as a government grant under AASB 120.

Example 1 – Loss-making entity

Before accounting for the refundable tax offset, Entity A has an accounting loss of $689,655, which is arrived at after deducting $689,655 of R&D expenditure, which has been expensed in profit or loss.

Entity A is also entitled to a refundable R&D incentive of $300,000 (i.e. 43.5% of R&D spend of $689,655).

Entity A’s tax rate is 30%.

Accounting for the refundable tax offset as a government grant, the accounting loss before tax of Entity A would therefore be reduced by $300,000, being the government grant income recognised for the refundable offset.

Calculation of income tax liability

  $
Accounting (loss) before R&D incentive   (689,655)
Reduce for effect of R&D incentive 300,000
Accounting (loss) after R&D incentive      (389,655)
Add: Non-deductible R&D expenses 689,655
Less: Non-taxable government grant income (300,000)
Taxable profits  NIL
Tax rate1 30%
Income tax payable NIL
Less: R&D incentive (non-taxable) (NIL)
Net tax liability NIL

Note 1: We have used 30% tax rate for illustrative purposes but in practice such entities may be subject to other tax rates.

Journal entries

The journal entry to recognise the refundable R&D incentives (to be received in cash as Entity A is loss-making) is:

Dr         Cash                                                     $300,000
Cr         Government grant income                                              $300,000                                  

Tax reconciliation                   

  $

Net (loss) before tax

$689,655-300,000

(389,655)
Prima facie tax – 30%1 (116,897)

Add: Non-deductible R&D expenses

$689,655 X 30%

206,897
Taxable profits  90,000

Less: Non-taxable grant income

$300,000 X 30%

(90,000)
Income tax expense NIL
Effective tax rate 0%
Net (loss) after tax (389,655)

Note 1: We have used 30% tax rate for illustrative purposes but in practice such entities may be subject to lower tax rates

Example 2 – Profit-making entity

Before accounting for the refundable tax offset, Entity B has accounting net profit of $310,345, which is arrived at after deducting $689,655 of R&D expenditure, which has been expensed in profit or loss.

Entity B is also entitled to a refundable R&D incentive of $300,000 (i.e. 43.5% of R&D spend of $689,655).

Entity B’s tax rate is 30%.

Accounting for the refundable tax offset as a government grant, the accounting profit before tax of Entity B would therefore be increased by $300,000, being the government grant income recognised for the refundable offset.

Calculation of income tax liability

$
Accounting profit before R&D incentive   310,345
Increase for effect of R&D incentive 300,000
Accounting profit after R&D incentive     610,345
Add: Non-deductible R&D expenses 689,655
Less: Non-taxable government grant income (300,000)
Taxable profits  1,000,000
Tax rate1 30%
Income tax payable 300,000
Less: R&D incentive (non-taxable) (300,000)
Net tax liability NIL

Note 1: We have used 30% tax rate for illustrative purposes but in practice such entities may be subject to other tax rates.

While the income tax liability owing by Entity B to the ATO is initially determined to be $300,000, it is reduced for the effect of the refundable R&D incentive (offset) of $300,000, resulting in a Nil income tax liability owing to the ATO.

Journal entries

The journal entry to recognise the income tax liability, prior to the effect of the R&D incentive is:

Dr         Income tax expense                                           $300,000
Cr         Income tax liability                                                                    $300,000         


The effect of the R&D government grant is then recognised as follows:

Dr         Income tax liability                                            $300,000
Cr         Government grant income                                                          $300,000          

Tax reconciliation                   

$

Net (loss) before tax

$310,345+$300,000

610,345
Prima facie tax – 30%1 183,103

Add: Non-deductible R&D expenses

$689,655 X 30%

206,897
Taxable profits  390,000

Less: Non-taxable grant income

$300,000 X 30%

(90,000)
Income tax expense 300,000
Effective tax rate 49.15%
Net profit after tax 310,345

Note 1: We have used 30% tax rate for illustrative purposes but in practice such entities may be subject to lower tax rates

Next month

Next month we will look at the accounting for non-refundable government grants.

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