ATO clarifies R&D Tax program integrity rules
The ATO holds companies to a high standard when it comes to complying with, and understanding, R&D tax laws.
Recently, it released a news article to tax professionals outlining issues it has identified with the application of some of the R&D Tax Incentive (RDTI) program’s integrity rules.
R&D expenditure to associates
In broad terms, associates are those entities/individuals that by reason of family or business connections, might appropriately be regarded as being associates of a particular entity. Associates can usually exert sufficient influence over the R&D entity or, together with their associates, hold a majority voting interest in it. R&D expenditure to associates can include wages and salaries paid to the working directors of a company, management fees paid to their family trust or other associated entities, and more.
R&D expenditure to associates can only be claimed in the year they’re paid unless the R&D entity makes an irrevocable election.
The ATO regard the following arrangements as not resulting in the expenditure being paid to the associate:
- The amount owed to the associate is converted to a loan.
- The R&D entity and the associate enter a licencing agreement where the licence fee payable by the associate is offset against the amount the R&D entity owes the associate for R&D services. Further, the ATO comments that the amount being transacted is often more than market value (in non-arm’s length arrangements that expenditure claimed must be at market value)
- Circular, round robin type transactions that are artificial in nature and contrived to receive a taxation benefit.
The R&D activities must be ‘conducted for’ the R&D entity. Expenditure on R&D activities not conducted for the R&D entity or conducted to a significant extent for another entity is not notionally deductible.
In circumstances where other entities are involved in the same R&D activities, for example a contractor or customer, an ‘on balance’ assessment need to be made to decide which entity:
- benefits from the R&D activities and requires consideration of who bears the financial risk
- has effective ownership of the results of the R&D activities
- has control over the conduct of the R&D activities.
Aggregated turnover includes the sum of the R&D entity’s annual turnover plus all annual turnovers of any business entities that are connected or affiliated with the R&D entity. Broadly, annual turnover is the total ordinary income derived in the ordinary course of carrying on the business in that income year, excluding intra-group transactions.
To be entitled to the refundable R&D tax offset, the R&D entity’s aggregated turnover must be less than $20 million. If it’s $20 million or more, they’re entitled to the non-refundable R&D tax offset.
R&D entities that are 50% controlled by exempt entities, regardless of their aggregated turnover, are entitled to the non-refundable R&D tax offset.
This expenditure can only be claimed for activities conducted overseas where the entity has an overseas finding from the Department Industry, Science and Resources (DISR). Without one, claimants must demonstrate the work was carried out in Australia and not subcontracted out or otherwise performed overseas. The assessment is based on the physical location of where the R&D activity is conducted rather than the location of the business engaged in the work.
For example, the R&D entity may engage an Australian based software development firm to conduct some R&D activities on its behalf. While the R&D entity incurs contract expenditure to a local firm, to demonstrate it has control over its R&D, the ATO expects the R&D entity to be aware of the physical location of the individuals (either employees or subcontractors) working on R&D. For those located overseas, amounts paid to them must be excluded from the claim if an overseas finding is not in place. On the other hand, if the individual travelled to Australia to work on R&D, the costs associated with work done locally can be claimed if other criteria are met. In such cases, an overseas finding is not required.
Expenditure not at risk
You can’t notionally deduct expenditure under the R&D tax incentive if the expenditure is not at risk. Expenditure is not at risk to the extent that when it’s incurred, the R&D entity could reasonably be expected to receive an amount of consideration:
- as a direct or indirect result of the expenditure being incurred (the nexus to expenditure test)
- regardless of the results of the activities on which you incur the expenditure (results test)
In addition to the legislation the ATO has issued a ruling (TR2021/05) that sets out the ATO’s view as to what constitutes ‘at risk’. Several examples cover scenarios such as:
- Contract to conduct research under different arrangements (variable and fixed price)
- Subsidy as a result of incurring expenditure
- Consideration not reasonably expected
- R&D activities not necessary to perform contract/R&D activities necessary to perform contract
- Contract to conduct R&D activities and supply a tangible good
- Repayable prepayments under a contract
- Contract with instalment payments
- Repayable loan
- Related-party non-recourse loan
The R&D legislation is complex. Beyond the definitions of eligible R&D activities and expenditure, claimants must understand and apply the integrity rules.
The ATO’s news release marks its first commentary on integrity issues it is seeing within the R&D tax program in some time. It has urged tax agents and R&D consultants to review their clients’ claims and voluntarily disclose any errors. Using a responsible and experienced advisor has never been more important.
At NOAH, we proactively inform our clients of these integrity rules and ensure their claims are compliant. In our experience, this often requires careful analysis of commercial contracts, corporate structure, management agreements, IP agreements and more. Get in touch with us if you would like to discuss how we can assist in ensuring you are meeting the R&D tax program’s legislative requirements.