R&D Unwound

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The R&D Tax Incentive (R&DTI) landscape has been particularly fluid over the last few years. As such, InCorp Advisory aims to provide timely updates covering key topics relating to the R&DTI to ensure claimants have the most up-to-date information. This covers areas such as changes to legislation, R&DTI-related news, case studies, and more.

This edition includes:

  • ATO Focus Area – R&D Associate Payments
  • R&D Time Substantiation

ATO Focus Area – R&D Associate Payments

Associate Payments – Overview

As you may know, amounts incurred to associates must be physically paid in order to be claimed under the R&DTI. For example, if you incur $50,000 to an associate for their assistance in conducting R&D activities, the $50,000 can only be claimed in the financial year where it is physically paid. Any unpaid amounts may be carried forward to be claimed in a future financial year, once they have been physically paid. As such, companies with a financial year end of 30 June 2024 must ensure that all associate amounts are physically paid by the end of the year for these amounts to be claimable in their 2024 R&DTI application.

Taxpayer Alert 2023/4

In December 2023, the ATO released a new taxpayer alert to raise awareness regarding a current area of concern. Specifically, TA 2023/4 addresses the ATO’s concerns about certain types of arrangements that a company may enter into in order to include associate expenditure in its R&DTI claims.

This Taxpayer Alert details arrangements under which R&D activities may be performed by associate entities that would not qualify for an R&D offset if they conducted the R&D activities for their own benefit. The specific arrangements of concern to the ATO have some or all of the following characteristics:

  • The R&D entity is a non-trading or special-purpose entity that is controlled by the associate entity.
  • The associate entity conducts the R&D activities as a contractor to the R&D entity. This generally occurs under a service agreement.
  • The associate entity effectively controls the strategic decisions of the R&D activities and has the primary rights to commercially exploit the intellectual property (IP) generated from the R&D activities.
  • The R&D entity conducted limited or no other business activities. For example, the R&D entity may only have a few employees and lacks the financial/economic capacity to exploit the IP developed and/or conduct the R&D activities itself.
  • For the R&D activities conducted, the R&D entity may ‘pay’ the associate entity via a loan with the associate as the lender, or a set-off arrangement against a licencing agreement or intra-group sales.

Arrangements of Concern

The following arrangements were specifically identified by the ATO as not meeting the necessary criteria to allow associate R&D expenditure to be claimed under the R&DTI:

  • Arrangement 1 – Converting the amount owing to an associate as a loan: Converting an amount owed to an associate to a loan, usually for a term of a number of years, is not payment to the associate. Rather, all that is occurring is converting a current liability to a deferred liability. The amount remains unpaid, and therefore a liability, but with a longer period to repay.

  • Arrangement 2 – Offsetting the amount owed to an associate for a fee that the associate owes for the use of the intellectual property being developed as part of the R&D project: In this arrangement, the R&D entity and the associate have entered into a licensing agreement whereby the associate can exploit the R&D being developed. The licence fee payable by the associate is offset against the amount that the R&D entity owes the associate for R&D services. The concern that the ATO has is that the intellectual property is still under development, resulting in the question of what is being exploited commercially.

  • Arrangement 3 – Round Robin Transactions: This arrangement involves the associate lending money within the financial year to the R&D entity to pay the amounts owed to the associate for R&D services rendered. Usually, these amounts are small and occur over a number of repeated transactions over a number of days where the associate lends the funds required. For example, a payment of $30,000 is made to the R&D entity via a loan from the associate to fund the R&D activities. The R&D entity then returns the $30,000 to the associate and claims that this amount has been paid to the associate – these transactions may be repeated to ‘pay’ larger amounts owed. These transactions between the R&D entity and the associate entity are considered to be artificial in nature and are not eligible under the R&DTI.

Payments to Associates

As mentioned above, R&D entities wishing to claim associate expenditure must ensure that the payments are incurred and physically paid to the associate within the financial year to include the amounts in their R&DTI claim. As part of this, the R&D entity, if wishing to claim associate R&D expenditure, must consider the following:

  • Whether evidence has been maintained to show that the associate amounts being claimed are charged at a market rate, and do not include any markups;
  • Implementing a statement of works or agreement between the R&D entity and the associate at the outset of the R&D activities, detailing the R&D services to be provided and the terms of the payment;
  • The funding arrangements of the R&D entity, such that it does not fall into one of the previously mentioned arrangements (i.e. no round robin or constructive loan payments); and
  • Ensuring that there is evidence of the physical payment to the associate. For example, if the associate is an employee of the R&D entity, evidence that may show physical payment are monthly pay slips and employment agreements. Similarly, for associate contractors, sample evidence may include invoices rendered, alongside bank statements for both the R&D entity and associate, showing the physical payment being made from the R&D entity to the associate.

R&D Time Substantiation

One of the requirements for entities wanting to lodge an R&DTI claim is that they must maintain contemporaneous records to support their R&D claims. As part of this, the R&D entity’s records must be sufficient to verify the:

  • Amount of expenditure incurred and relationship to the R&D activities: It is crucial for the R&D entity to have records to show who spent time on the core and supporting R&D activities (i.e. employees, associates, and contractors), alongside the quantum of time that was spent by each party on the R&D activities. In many cases, this is best represented via contemporaneous timesheets, showing the total time spent on conducting the R&D activities versus business-as-usual activities. Please note that although timesheets show the raw time spent on R&D, there should also be contemporaneous documentation that links the raw time to the R&D activities during the financial year (i.e. any timesheet entry must be supported by some form of documentation that justifies/verifies that the timesheet entry is accurate). Examples of these documents are covered below.

  • Nature of the R&D activities: Documentation examples may include but are not limited to the following:
    • Experimental protocols, test reports, test plans, and/or project plans
    • Records of trial runs and analysis reports of results;
    • Laboratory or meeting notes;
    • Task management extracts. Specifically for software R&D claims, Jira tickets or code commits showing the R&D activities undertaken, as well as the time spent on each activity;
    • Invoices for R&D-related expenses (e.g. contractor costs, direct inputs, overheads etc.); and
    • Contractor service agreements.

Please note that if the documentation above is not maintained, then the entity will not be able to claim the relevant R&D expenditure, and in some cases may not be able to lodge an R&DTI claim.

If you would like more information on any of the above points and the impact that these could have on your R&D Claim, please reach out to your InCorp Advisory R&D Consultant or Bailey Phillips at bailey.phillips@incorpadvisory.au.

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