ATO ID 2008/115 Income Tax Eligibility for Tax Offset: R&D tax offset and exempt entity ownership exception

August 20th, 2014

Does the exception in subsection 73J(2) of the Income Tax Assessment Act 1936 (ITAA 1936) apply, to prevent an eligible company choosing the tax offset under section 73I of the ITAA 1936, where the less than 25% exempt entity ownership requirement may not be breached if actual and potential future interests are taken into account?

Yes. The exception in subsection 73J(2) of the ITAA 1936 applies if the interests actually owned, by an entity or entities referred to in the subsection, carry at least 25% of the voting power in the eligible company or the right to receive at least 25% of a distribution of income or capital by the eligible company. It does not matter that the less than 25% requirement may not be breached if both actual and potential future interests are taken account of.

Company A is an eligible company which undertakes research and development (R&D) activities in Australia. All the conditions for Company A to be able to claim the R&D tax offset in section 73I of the ITAA 1936 are satisfied, other than the exception in subsection 73J(2) of the ITAA 1936.

For the ‘tax offset year’ in question (refer subsection 73I(1) of the ITAA 1936), Company B (an affiliate of an exempt entity for the purposes of subsection 73J(2) of the ITAA 1936), legally owns shares in Company A. These shares carry 27% of the voting power in Company A and the right to receive that same percentage of a distribution of income or capital by Company A.

Company A has issued to Company B and other entities, a number of convertible notes in Company A. These other entities are neither exempt entities nor affiliates of any exempt entity. The convertible notes give the holders the right to acquire shares in Company A in certain circumstances, but they do not carry any voting rights in Company A or rights to a distribution of income or capital by Company A. Both the existing shares and any shares to be acquired on conversion of the notes, are, or will be, ‘interests’ in Company A for the purposes of subsection 73J(2) of the ITAA 1936.

If a certain number of the convertible notes held by entities other than Company B are converted into shares, the voting power and the right to distributions of income or capital owned by Company B will fall below the 25% condition in subsection 73J(2) of the ITAA 1936.

Subsection 73J(2) of the ITAA 1936 prevents an eligible company from choosing the tax offset, instead of a deduction, under section 73I of the ITAA 1936, if an exempt entity, the affiliates of an exempt entity, an exempt entity together with its affiliates, or two or more exempt entities, at any time during the tax offset year, legally or beneficially own, or have the right to acquire, the legal or beneficial ownership of:

  • interests in the company that carry between them the right to exercise or control the exercise of, at least 25% of the voting power in the company; or
  • interests in the company that carry between them the right to receive at least 25% of any distribution of income or capital by the company.

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