Occasionally someone will ask me the question: “does the R&D Tax Incentive affect my franking account”?
In the following piece I am going to answer the above question, but it will require quickly covering some background information, so bear with me!
To distill the question further, the underlying topic is, does the R&D tax incentive have a mechanism of reimbursement?
Step 1: How does the R&D Tax Incentive benefit work?
Understanding how the R&D Tax Incentive benefit operates in detail is crucial for a deep understanding of how the benefit will impact your company’s Franking Account. For a full explanation, have a read of this quick article.
For those who want the super concise explanation, just know that we must consider two perspectives:1. A loss-making company
Loss-making company: Ordinarily, a loss-making company will continue to accumulate and ‘roll-over’ losses to each financial year until the company (hopefully) turns a profit. If the company does eventually become profitable, it can leverage its accumulated losses to offset any profits. As a result, the company will pay less tax, or perhaps no tax at all despite earning a profit, until it has totally depleted its losses.
However, the R&D Tax Incentive allows companies to recover up to 43.5% of their eligible R&D related expenses in the form of cash in the immediate financial year after making the loss.
Thus, the R&D Tax Incentive allows a loss-making company to unlock the tax benefit of their losses today and not just in the future; an absolute blessing for entities that desperately need the injection of operational cashflow to make it to tomorrow.
Profit-making company: If a company deducts their expenditure through s8-1 General Deductions of the Tax Act, then the company would be eligible for a tax saving of 27.5% (or 30% depending on the company tax rate) on their deductions.
However, when using the R&D Tax Incentive, the company will in fact receive a 43.5% tax offset on their eligible R&D expenditure. Thus, the benefit for the company is an extra 16% (or 13.5% depending on the company tax rate) discount on their tax bill.
Note: The benefit works differently for companies with aggregated turnover in excess of $20M. Once again, we strongly encourage you to first read how the benefit works in detail.
Step 2: So where does the R&D Tax Incentive fit in with my company’s Franking Account?
By now you understand the R&D Tax Incentive benefit, although we also need to know what a Franking Credit is.
For those of you who are already familiar with this, keep on reading. For those who would appreciate a quick recap, check out this explanation from Commonwealth Bank before proceeding (otherwise the next part won’t make much sense).
If you haven’t quite made the connection yet between the R&D Tax Incentive and your company’s Franking Account, we don’t blame you. But here is where it should start coming together.
When a loss-making company utilises the refundable portion of the R&D Tax Incentive, the amount refunded is debited to the company’s franking account. Meaning, if the company becomes profitable and starts paying tax and therefore accumulating Franking Credits, those credits will be offset by the Franking Debits previously acquired through the R&D Tax Incentive.
Should the company decide to make a distribution to shareholders, there will be fewer or no Franking Credits for the shareholders to utilise, and therefore shareholders may be required to pay their full personal tax rate on the distribution received.
When a profit-making company utilises the non-refundable benefit of the R&D Tax Incentive, the company will subsequently pay less tax, thereby lowering the amount of franking credits recorded.
Step 3: Why does the R&D Tax Incentive work in this way?
After covering the above, you might be wondering why has the tax legislation been structured in this manner?
The purpose of the R&D Tax Incentive is to provide companies (both big and small) engaging in eligible R&D activity with access to operational cash flow. The purpose is not to provide additional wealth to shareholders via tax breaks.
Therefore, the Tax Act introduced this mechanism so that R&D funds are reinvested into the system by ‘successful’ businesses to contribute to the economy.
One measure of this ‘success’ is the distribution of dividends. Should profits of the company fall into the hands of shareholders, then the intention is that the operational cashflow from the R&D Tax Incentive is reinvested to facilitate more growth.
You may be interested to know if your business could use the R&D Tax Incentive.
We have put together a few quick questions for you to be able to assess your eligibility.
Click below if you want to know more:
He is a Chartered Accounting by profession but an Entrepreneur by passion.
Lior is a member of the Australian Institute of Chartered Accountants (ICAA) and The Tax Institute.