Could you be getting your R&D tax claim wrong? What the ATO is focusing on

The ATO integrity measures are in place to ensure the RDTI program is accessed properly and while these rules have not changed, the ATO are still seeing a number of taxpayers incorrectly claiming across a number of key areas:

1. R&D expenditure to associates.
2. Claiming under the wrong entity.
3. Incorrect aggregated turnover calculations.
4. Claiming overseas expenditure.
5. Claiming expenditure ‘Not at risk’.

Associate payments

The ATO are finding companies claiming the offset for associate payments that have not been constructively paid in the year of claim. Companies can only claim the offset on associate amounts in the year the associates were paid, not when it is incurred.

Firstly, who is an associate and how does the ATO determine if an individual or company is an associate to the R&D entity?

Associates are defined in section 318 of the Income Tax Assessment Act 1936 as:

• A partner of the company or a partnership in which the company is a partner.
• A trustee of a trust estate under which the company or associate benefits.
• Another entity (including a natural person) that, acting alone or with another entity/entities, can sufficiently influence the company.
• An entity (including a natural person) that, either alone or with other associates, holds a majority voting interest in the company.
• A second company that can be sufficiently influenced by the company, or the company’s associate.
• A second company in which a majority voting interest is held by the company or the company.

Therefore, associates may be individuals or companies. For individuals, the ATO will assess whether they are an associate, by assessing the facts such as the shareholding or the level of control, influence or voting power the individual has over a company.

For companies who may be associates, the ATO will also look at shareholding, who has ownership rights, and who has control and decision-making power over the R&D entity. They can also be a related company that is sufficiently influenced or has voting interest held by the R&D entity or the R&D entity’s associate.

Secondly, the manner in which associates are paid has also raised the ATO’s attention.

Many companies in the cash strapped start-up stage may look at a range of ways to pay the amounts owed to their associates and then claim the offset. However the ATO does not consider payments to have been made to associates (and therefore cannot be claimed) when:

• payments are converted to a loan
• ‘round robin’ payments are made where the payment is returned so that the next payment can be made in a cyclical nature
• loans are being used as contingent payments (i.e. they are only made if the R&D tax offset is received)
• shares are being issued as payments
• the payment is offset by a non-arm’s length arrangement, including through a licensing agreement or purchase from the associate.

Companies need to be mindful of these arrangements when making associate payments that are part of the RDTI claim.

Is the correct entity claiming?

Another area of the ATO’s concern relates to whether the correct company is claiming the R&D tax offset, specifically, ‘For whom is the R&D is conducted for’. R&D activities must be conducted for the entity registering the activities under the program. If an entity is conducting R&D to a significant extent for another entity i.e. one who will receive the commercial benefit, they might be the incorrect registrant. For example, if a second company owns the IP and the rights to commercialise the product resulting from the R&D, the ATO may consider the IP entity as the correct claimant.

Under a review, the ATO will look at which entity will benefit from the R&D activities, including who:

• has effective ownership of the results of the R&D activities, including the IP
• has control and decision-making power over the type of R&D activities and how they will be conducted
• bears financial risk.

Again, this decision will be based on evidence provided to the ATO under a review including contracts, timing and commercialisation arrangements and it’s important for companies to consider these company structures and whether the correct company is claiming.

Aggregated turnover calculation

The ATO have identified issues with companies incorrectly calculating the aggregated turnover including companies who may be controlled by exempt entities. The aggregated turnover is important in assessing whether the company receives the refundable offset or non-refundable offset.

An R&D entity that is 50% controlled by exempt entities is only entitled to the non-refundable R&D tax offset, regardless of their aggregated turnover. Exempt entities refers to entities whose ordinary and statutory income is exempt from income tax or Commonwealth entities that do not pay tax.

Companies need to again look to the broader structure at the outset and when any changes to the company structure/ownership occurs to ensure that they are claiming the correct offset amount.

Claiming overseas expenditure without a positive Overseas Finding

Another common compliance issue relates to R&D entities claiming overseas expenditure without a positive Overseas Finding which must be applied for within the financial year and has additional eligibility criteria.

Companies with overseas expenditure must exclude these costs if no finding exists. Some supply of goods may be eligible but it’s wise for companies to discuss with their advisor before the year end as to whether an Overseas Finding will be required.

Claiming not ‘at risk’ expenditure in the RDTI

Lastly, the ATO has been focused on ensuring R&D entities are not claiming expenditure that is not at risk. This refers to payments that are incurred when an R&D entity could reasonably expect to receive an amount of consideration:

• as a result of the expenditure being incurred or due to a circumstance occurring before the expenditure was incurred
• irrespective of the results of the activities that the expenditure was incurred on

So if a company undertaking R&D and has a reasonable expectation to receive an amount regardless of outcome, e.g. an upfront payment, grant etc, the R&D expenditure is deemed to not be at risk and cannot be claimed as part of the RDTI. The ATO will review contracts and agreements, and timing of payments to assess whether it is deemed ‘at risk’.

The RDTI is a complex program and the onus is on the tax payer to get their claims right. If you have any concerns about these ATO areas, please contact us to discuss.