20 February 2024
10 min read
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The Research and Development (R&D) Tax Incentive Program (R&D program) aims to boost competitiveness and productivity in Australia’s industries. Companies that undertake R&D will receive a tax offset of up to 48.5 per cent of costs incurred for their R&D activities.
On 27 October 2023, the Australian Taxation Office (ATO) provided further clarity on the integrity rules of the R&D program.
Given the numerous issues with R&D claims, the ATO has released additional guidance on tax transparency and expected compliance. It also identified the following areas where the R&D integrity rules had been misapplied:
An associate of a R&D entity is an entity with family or business connections that could be regarded as an associate of an entity.
R&D expenditure to associates can only be claimed in the year they are paid unless there is an irrevocable election. The ATO has confirmed that the following arrangements will not result in expenditure being paid to an associate:
On 14 December 2023, the ATO released Taxpayer Alert TA 2023/4 Research and development activities delivered by associated entities (TA 2023/4).
A Taxpayer Alert is an early warning system to the community, particularly taxpayers and advisors, that the ATO has concerns about particular higher-risk tax planning arrangements. It is a notification to show they are reviewing those arrangements, the course of action to be taken and the implications if that is not done. The aim of the Taxpayer Alert is to enable taxpayers who have or will enter an arrangement to make informed tax decisions and to prevent widespread adoption or promotion of higher-risk arrangements.
In TA 2023/4, the ATO expressed concerns over claims made by R&D entities involving arrangements that incorrectly purport an R&D entity as having incurred or paid the relevant expenditure under an agreement with an associate of the R&D entity (service provider). They are concerned with arrangements where the R&D entity claims an offset for expenditure on R&D activities purportedly conducted for their own benefit, but which are instead in substance being conducted (or to a significant extent) for the service provider.
In the arrangements that are being scrutinised, the service provider has traditionally conducted the group’s trading and research activities but is not itself entitled to claim an offset or is entitled to a lesser benefit. It conducts R&D activities under a service agreement with the R&D entity. It funds the R&D activities and invoices the service provider. In effect, it controls the decisions regarding R&D and has rights to exploit the IP know how or other results. The R&D entity borrows finance from the service provider and has few, if any employees, with the technical capability to itself conduct or supervise any R&D activities. If there are written agreements between the R&D entity and service provider, they are inconsistent with the commercial substance of the arrangement.
The ATO is reviewing the arrangements and engaging with taxpayers who have or are considering entering arrangements covered under TA 2023/4. They expect such taxpayers to contact them, seek independent advice, make a voluntary disclosure or seek a private ruling. The alert warns of penalties that may apply to taxpayers or promoters (which are significant and if legislation before Parliament is passed, could be a maximum of $780 million).
Taxpayers who have entered or are planning to enter such arrangements should carefully consider their approach.
R&D expenditure can only be notionally deducted if it is conducted for the R&D entity that has registered the activity and not where it is conducted to a ‘significant extent’ for another entity. This means that the entity must receive the major benefit of the entity. The test in assessing whether an activity has been conducted for a R&D entity includes an assessment of:
Aggregated turnover refers to the sum of the annual turnover for the R&D entity and any entity that is connected or affiliated to it (sections 328-125 and 328-130 of the Income Tax Assessment Act 1997 (Cth)).
If an R&D entity aggregated turnover is $20 million or greater, they are only eligible for the non-refundable tax offset. If the R&D entity has an aggregated turnover of less than $20 million, it is entitled to the refundable tax offset. However, irrespective of aggregated turnover, the R&D entity is only eligible for the non-refundable offset where it is 50 per cent controlled by an exempt entity.
Entities can claim a tax offset for R&D expenditure incurred overseas if there is an overseas finding issued by the Department of Industry, Science and Resources. The anticipated expenditure on these activities must be less than the expenditure on Australian activities over the life of the relevant activities. Without an overseas finding, claimants must demonstrate the work was carried out in Australia and not subcontracted or otherwise performed overseas.
On 14 December 2023, the ATO also released Taxpayer Alert TA2023/5 Research and development activities conducted overseas for foreign related entities. The ATO is reviewing arrangements where Australian-resident R&D entities claim a tax offset for expenditure incurred on R&D activities conducted overseas. They have seen instances where an R&D entity has purported that the R&D activities were conducted for their own benefit, but those activities were instead being conducted for (or to a significant extent, for) a foreign entity that is ‘connected with’, or is an ‘affiliate’ of the R&D entity (foreign related entity).
The ATO is concerned that R&D entities might be incorrectly claiming the R&D tax offset irrespective of whether:
The common features of these arrangements are as follows:
R&D activities that are conducted overseas purportedly for the benefit of AusCo are contracted out to a Contract Research Organisation (CRO). AusCo has limited ability to commercially exploit the developed IP itself, obtains an overseas finding and claims a notional deduction for the expenditure incurred by it to the CRO, and a tax offset under the R&D program.
On an objective review of the financing, licencing, service, corporate or other arrangements between AusCo and ForCo, it appears that ForCo is the sole or major beneficiary of AusCo's overseas activities.
The legal form of agreements may be inconsistent with the actual commercial substance of the arrangement between the entities.
The foreign related entity in substance and effect:
The ATO is concerned that the R&D entity does not qualify for an R&D tax offset as the R&D activities were:
Or alternatively,
The ATO is reviewing the arrangements they have identified and will continue to closely scrutinise these arrangements as they identify them and develop further website guidance on specific technical matters in due course. They expect taxpayers to contact them, seek independent advice, make a voluntary disclosure or seek a private ruling. They warn of penalties that may apply to taxpayers or promoters.
The ATO is also cracking down on sham arrangements and where the actual commercial substance does not match the formal agreements but rather indicates the benefit is for the foreign entity. Arrangements may often be more complex or complicated than addressed in TA 2023/5. It is very important that taxpayers who have or are planning to enter such arrangements seek advice on the associated risks and are ultimately able to show there are commercial reasons for the structures in place.
Expenditure is not at risk to the extent when, it incurs, the R&D entity could reasonably be expected to receive an amount of consideration:
If you have any questions regarding this article, please get in touch with a member of our team below.
Disclaimer
The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.
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