What entities are eligible for the R&D Tax Incentive?

The Research and Development Tax Incentive (R&D Incentive) encourages companies to engage in research and development which benefits Australia by providing a tax offset calculated against eligible expenditure (Notional Deductions), where the expenditure relates to eligible research and development activities (R&D Activities). The R&D Incentive is described in division 355 of the Income Tax Assessment Act 1997 (Cth) (ITAA97). The R&D Incentive was introduced by the Tax Laws Amendment (Research and Development) Act 2011 (Cth) (which received Royal Assent on the 8 September 2011) which added division 355 to the Income Tax Assessment Act 1997 (Cth) (ITAA97).

The R&D Incentive has two (2) core components:

a 43.5 per cent (43.5%) refundable tax offset for eligible entities (R&D Entities) whose aggregated turnover is less than $20 million and who are not controlled by an entity that is exempt from income tax; and
a 38.5 per cent (38.5%) non-refundable tax offset for all other R&D Entities.

These rates were reduced from forty-five per cent (45%) and forty percent (40%) respectively by the Budget Savings (Omnibus) Act 2016 (Cth) which received Royal Assent on 16 September 2016.

Clearly, the first step to determining whether a business is eligible for the R&D Incentive is to determine whether it is an eligible “R&D Entity”.

What is an R&D Entity?

Under section 355.35 of the ITAA97, in order to be eligible for the R&D Incentive, an entity must be a corporation that:

is:
- incorporated in Australia;
- incorporated under a foreign law but still an Australian resident for tax purposes;
- incorporated under a foreign law but carries on R&D activities through a permanent establishment in Australia; or
- acting as trustee of a public trading trust; and
pays income tax; and
is registered with AusIndustry.

Can a trust claim the R&D Incentive?

It can be seen from the above that a trust does not fit the definition of “R&D Entity”. However, a trust can reap the benefits of the R&D Incentive through one of two methods, either:

incorporating a company and transferring all of the trust’s assets to that company (Trust Rollover); or
incorporating a company and executing a licence agreement between the trust and the company, such that R&D Expenditure paid by the trust is offset with unpaid income from the trust – for example, licence fees for intellectual property (IP) owned by the company.

Transferring assets to obtain the R&D Incentive

Disposing of assets from a discretionary or unit trust to a company is a relatively straight forward process, but it is important to consider capital gains tax and stamp duty implications. For further information on this issue see “Trust restructures – relief from capital gains tax”.

Utilising a licence agreement to obtain the R&D Incentive

Under section 355.205(1)(b) of the ITAA97, R&D Entities can only obtain the incentive for R&D Expenditure they have incurred to an associated entity (Associate), when they actually incur and pay the amount in the same year. If the amount is not paid until a later income year, the R&D Entity can either:

claim a deduction under the normal income tax provisions (for example, section 8-1 of the ITAA97) for the income year in which the amount was incurred; or
claim a Notional Deduction in the year the amount is paid.

Pursuant to section 318 of the Income Tax Assessment Act 1936 (Cth) (ITAA36), an “Associate” is an entity that by reason of family or business connections, might be regarded as an associate of an R&D Entity, for example, a company that owns IP licenced by a trust.

An amount is taken to be paid from an R&D Entity to an Associate when the R&D Entity applies or deals with the amount in any way on the other’s behalf, or as the other directs, for example, paying an amount into a bank account.

The R&D Incentive can be obtained by establishing a loan account between the trust and the company. Outstanding loan balances generated as a result of taking up R&D Expenditure are reduced when applying licence fees from the trust. So long as the income amounts applied against the loan are sufficient, the balance is reduced to nil and thus R&D Expenditure is considered to be “paid” in the company. It is important that any outstanding balances in the loan account are periodically cleared through a cash payment. For example, if license fees are $5,000 and R&D Expenditure is $15,000 then an additional $10,000 will need to be paid into the loan account to ensure the entire R&D Expenditure can be claimed in the current financial year. This is a matter of the accounting matching the contracts.

Learning points

Broadly speaking, eligibility to claim the R&D Incentive will depend on whether or not a business is an R&D Entity and, if it is, whether or not it has incurred Notional Deductions. If a trust incurs R&D Expenditure, it is still possible to secure the benefits of the R&D Incentive, even though a trust does not prima facie meet the section 355.35 definition of “R&D Entity”. It is preferable to seek legal and financial advice when executing such arrangements to avoid wasted time and resources.

Links and further references

Legislation

Income Tax Assessment Act 1997 (Cth)

Income Tax Assessment Act 1936 (Cth)

Further information about R&D Incentives

If you need assistance structuring your business so as to be able to claim the R&D Incentive, please telephone me for an obligation free and confidential discussion.

Malcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.
Legal Practice Director
T: +61 7 3221 0013 (preferred)
M: +61 419 726 535
E: mburrows@dundaslawyers.com.au

Disclaimer

This article contains general commentary only. You should not rely on the commentary as legal advice. Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

What entities are eligible for the R&D Tax Incentive?