Trustee Companies and the R&D Tax Incentive
The various iterations of the Research and Development (R&D) Tax Benefit programs have consistently prohibited trustee companies from being applicants for the program.
We have raised this issue with the Australian Tax Office and can confirm that operating companies, that are trustees, can benefit from the R&D Tax Incentive program by using a separate company as the ‘R&D Entity’ and applicant for the benefit, subject to the following conditions:
- On own behalf – The R&D Entity must be undertaking R&D ‘on own behalf’ – that is “R&D activities must be conducted for itself and not to a significant extent for some other entity. R&D activities conducted by another company may be conducted for the R&D entity if certain requirements are satisfied.”
- Majority of benefits – The R&D Entity must also receive the ‘majority of benefits’ arising from the expenditure on the R&D activities. Evaluation of this condition is achieved using three criteria and it is necessary to establish who:
- a. “‘effectively owns’ the know-how, intellectual property or other similar results arising from the R&D entity’s expenditure on the R&D activities;
- b. has appropriate control over the conduct of the R&D activities; and
- bears the financial burden of carrying out the R&D activities.”
- Payments to associates – “If an R&D entity incurs an amount of expenditure to an associate and pays the amount in the same year, then it can claim a notional deduction for that amount in that year (provided it meets all other eligibility requirements for the R&D tax incentive).”
- Expenditure not at arm’s length – “If the expenditure incurred in a non-arm’s length transaction or in a transaction with an associate is greater than the market value of the R&D activities, the expenditure is instead taken to have the market value.” This criterion deals with the potential for ‘Transfer Pricing’ of R&D Activities undertaken by associates – this is not allowed.
- 5. Expenditure not at risk – “Expenditure that is not at risk (for example, if there is guaranteed return under a financing arrangement or an indemnity) is not eligible for a notional R&D deduction but the ordinary deduction rules may apply.” “Expenditure is not at risk to the extent that, when the expenditure is incurred, the R&D entity (or an associate) could reasonably be expected to receive an amount of consideration:
- a. as a result of the expenditure being incurred or because of anything that happened before then; and
- irrespective of the results of the activities on which the entity incurs the expenditure.”
- 6. Disposal of R&D results – “The assessable income of an R&D entity includes an amount if:
- a. it is entitled to a notional deduction for expenditure on R&D activities or for using a depreciating asset for R&D activities; and
- b. it receives, or becomes entitled to receive, an amount for the results of any of the activities from the grant of access to, or the right to use, any of those results attributable to the entity having incurred the expenditure or having used the asset for R&D activities (including an amount that it is entitled to receive irrespective of the results of the activities); or
- from disposing of a CGT asset, or from granting a right to occupy or use a CGT asset, where the disposal or grant resulted in another entity acquiring a right to access or use any of those results.”
In summary, the above quotations, from correspondence with the ATO, can be boiled down to the following recommendations:
- Where a company (Operating Company) decides that it would be a beneficial strategy to establish an R&D Entity (R&D Company), where the Operating Company is established as a trustee company and cannot gain benefit from the R&D Tax Incentive program, there must be:
- a commercial licence agreement in place between the two entities:
i. that contains the provision for royalties to be paid by the company for the use of the intellectual property generated by the R&D Entity;
ii. the level of which should eventually, at least, cover the cost of the R&D activity.
- Where the Operating Company provides R&D services to the R&D Company, the costs of providing these services should be carefully recorded and charges for the services should not exceed market value.