November 26th, 2021
An AAT Case in November 2021 (XQDX v FC of T) has affirmed that a structure where a business operating as a trust and notionally invoicing R&D costs to associate company is NOT valid for the purposes of the R&D Tax Incentive.
The facts were broadly as follows:
- The Applicant (a company and the claimed R&D Entity) was incorporated in July 2007;
- The claimed R&D Entity was also the trustee of a trust. A business was conducted through the trust entity developing and manufacturing various commercial and residential shade solutions;
- The R&D entity did not have a bank account its own right in the relevant income years. Payments by clients were made to the Trust’s bank account;
- The R&D entity prepared and lodged income tax returns in its own capacity and in its capacity as trustee of the Trust;
- For the FY12 and FY13 years, the R&D entity did not lodge a BAS. The Trust did lodge BASs in this period, returning all sales, including the R&D jobs, and purchases, including all the materials and other expenses in relation to R&D jobs;
- The R&D entity’s expenditure claimed (e.g. staff and overhead costs associated with the R&D activities) was by means of a loan account. Repayment was claimed to occur using the R&D refund and/or funds generated by future sales of the businesses’ products or licensing of the intellectual property rights to the Trust or a third party (ie subject to a contingency);
- The applicant reported refundable R&D Tax Offsets totalling approximately $1.2M across the FY12 and FY13 periods;
- Compliance activity resulted in the ATO amending assessments in July 2016 nullifying the claimed R&D Tax Offsets and issuing penalties;
The issues of eligibility included:
- Whether the R&D entity had incurred expenditure if it was conducting R&D activity on its own behalf;
- Whether the entity that conducted the R&D Activity was an eligible entity as defined in s 355-35 of the ITAA 97 (an eligible entity includes a company but NOT a discretionary trust);
The AAT found that the claimed R&D entity could not be shown as “definitively committed to the obligation” to pay funds related to the R&D expenditure. The claimed R&D entity had not incurred the underlying expenditure and was found not eligible for the reported R&D Tax Offsets.
The AAT did not consider the issue of whether the activities were on behalf of the company, since it had failed the first issue of incurrence. Noting that there was little evidence that the claimed R&D entity was acting in its own capacity (including through its own bank account and via its direct engagement of suppliers) to conduct the R&D Activities, it is likely the AAT may have found the registered activities were NOT conducted for an eligible entity.
The case affirms that contrived structural arrangements put in place to attain R&D Tax Offsets are at high risk of compliance scrutiny, particularly where the requirements of the R&D Tax Incentive (including incurrence and that R&D activities must be conducted on behalf of an eligible entity) are not reflective of the commercial substance of a group’s structure.