What are the ATO’s latest concerns? New Taxpayer Alerts issued

The ATO releases Taxpayer Alerts if they are seeing a pattern of errors that companies are making in their RDTI claim and to indicate an area of focus for upcoming reviews. They aim to provide guidance to companies to further self assess and make adjustments to their claim if necessary.

It is essential for companies to understand these alerts to avoid having to pay back their offset, possibly with penalties. Here we discuss these new alerts and company arrangements which the ATO are focusing on.

Taxpayer Alert TA 2023/4: Paying associate entities

Associate payments within the RDTI program have been an area of ATO focus for a number of years. This recent alert indicates the ATO are still seeing errors and are undertaking reviews in companies where associate payments have been made to ensure they are being claimed correctly.

Taxpayer Alert TA 2023/4: Research and development activities provided by associated entities

The ATO are currently reviewing claims made by R&D entities for expenditure incurred under an agreement with an associate company who conducts the R&D activities themselves. An ‘associate’ is defined in section 318 of the Income Tax Assessment Act 1936 and includes an entity or related company that may have sufficient influence over the R&D entity. We have discussed associate payments previously in Is your claim compliant? Common R&D Tax Incentive program errors to avoid and the importance for companies to ensure these payments have been constructively paid in order to claim.

Specifically, the ATO has concerns with arrangements where:

• an R&D entity has not incurred or paid relevant expenditure in the claim year.
• the R&D entity obtains the tax offset for expenditure on R&D activities that are being conducted for, or to a significant extent for, an associate, not the R&D entity.
• the expenditure is not ‘at risk’ for the R&D entity for the purposes of section 355-405 of the ITAA 1997

The ATO highlighted that these arrangements are often entered into when the associate (who may have historically conducted the group’s trading and research activities) is not eligible themselves to claim the offset or is only entitled to a reduced benefit under the RDTI. In this scenario, the R&D entity has few (if any) employees and conducts limited or no activities other than R&D-specific arrangements outlined in the service agreement with the associate. The R&D entity may pay the associate through either a loan with the associate as lender, a new license arrangement, or set-off against other intra-group sales or service agreements.

Specific arrangements of concern include those where the associate has incorporated a new R&D entity or repurposed an existing non-trading company within the controlled group to become the new R&D entity. In these arrangements, the associate:

• conducts the R&D activities as a contractor for the R&D entity under a service agreement.
• may fund the R&D activities being conducted before invoicing the R&D entity a service fee or recharge amount.
• may control the strategic decisions regarding the R&D activities.
• has primary right to commercially exploit any developed IP or know-how.

Some of the important questions to ask in these arrangements include:

• Whose R&D is it?
• Who has the ability to commercialise the R&D?
• Is the expenditure being incurred by the claimant, ‘at risk’?
• Who is undertaking the risk?

More information can be found in our article, Could you be getting your R&D tax claim wrong? What the ATO is focusing on.

Taxpayer Alert TA 2023/5: Research and development activities conducted overseas for foreign related entities

TA 2023/5 was released by the ATO due to concerns that Australian resident R&D entities were claiming tax offsets for expenditure incurred on R&D activities conducted overseas for, or to a significant extent for, a foreign entity that is ‘connected with’ or is an ‘affiliate’ of the R&D entity.

While companies can claim ‘Foreign Owned R&D’ in which the Australian entity is undertaking the R&D activities on behalf of the related foreign entity providing they meet specific requirements, this only allows activities undertaken in Australia and our territories. No overseas expenditure can be claimed.

A problem the ATO are seeing is where the resident entity doesn’t set up under these arrangements and seeks to claim overseas expenditure on behalf of the foreign entity.

R&D entities may be incorrectly claiming the offset irrespective of whether the R&D entity has an overseas finding covering the activities being conducted, or both entities have a contractual agreement demonstrating the R&D entity’s interest in developed IP, know-how or results from the R&D activities.

The ATO is concerned with arrangements where the foreign related entity may:

• have established the Australian R&D entity.
• own the pre-existing IP and ultimately acquire the ownership rights of the developed IP.
• license the IP and impose restrictions on the R&D entity’s right to exploit, alienate and manage any developed IP - even when the R&D entity has ownership.
• fund the R&D entity to conduct the R&D activities.
• assume operational risk and controls the strategic decisions of the R&D activities.

While the ATO is concerned that the Australian entity arrangements:

• may not have a physical presence within Australia.
• may have one or more foreign resident directors either from or are appointed by the foreign entity.
• has an Australian based resident director that acts in accordance with the directions and wishes of the foreign related entity or its controllers.
• in the absence of funding from the foreign related entity or the RDTI, will lack the economic capacity to conduct R&D activities or exploit the developed IP.
• may have been incorporated shortly before the end of the relevant income year in which the RDTI is claimed.

In respect to these arrangements, the ATO is concerned that the R&D entities do not qualify for the R&D tax offset for expenditure incurred on R&D activities overseas as the activities were conducted to a significant extent for the foreign related entity. Therefore, the expenditure does not satisfy the conditions for eligible R&D activities, as outlined in Subsection 355-210(2) of the ITAA 1997. Additionally, where the R&D entity is an Australian resident and the activities are being conducted for the R&D entity’s benefit, the expenditure incurred by them may not be ‘at risk.’

Companies need to ensure that the correct arrangements are in place between entities where foreign related entities are involved to determine if they are eligible to claim.

Key takeaways

Both Taxpayer Alerts highlight that the ATO is concerned that R&D entities are claiming the tax offset when they are ineligible due to:

• the expenditure being not ‘at risk’ as the R&D activities were being funded by an associate or a foreign-related entity.
• the activities being conducted for, or conducted to a significant extent for, another entity. This could be either an Australian associate or a foreign-related entity.

In the alerts, the ATO highlights that even if the conditions of eligibility for the R&D tax offset are satisfied, if viewed objectively that one or more parties entered or carried out an arrangement for the purpose of obtaining either a refundable or non-refundable offset, the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) may still apply.

If you have any concerns about your RDTI claim or arrangements between related parties, contact us.