November 4th, 2022
A new AAT decision handed down in October 2022 (T.D.S BIZ PTY LTD and Commissioner of Taxation) considered the case of an R&D Entity attempting to claim the cost of overseas moulds, fabrication, CAD and assembly within their R&D Tax Incentive claim without having first attained an Overseas Finding from AusIndustry.
This is one of the only administrative decisions to consider the specific issue of:
- Is R&D expenditure related to the cost of components for conducting R&D activity in Australia; OR
- Is R&D expenditure related to the cost of overseas activity, which then triggers requirements for sufficing overseas R&D expenditure rules and to attain an Overseas Finding (a pre-approval to claim overseas activity expenditure) before expenditure can be claimed under the R&D Tax Incentive.
Key Background points from the case include:
- T.D.S BIZ PTY LTD (“The Applicant”) submitted a FY18 R&D claim for the design and development of an electric tricycle. This claim included $1,613,462 of contractor invoices from overseas entities:
- $1,280,742 invoiced from HK Flistar Limited for producing vehicle components; and
- $332,720 invoiced from Hefei Kelly Technology Investment Co Ltd for electrical components.
- The original R&D application for the period did not include any supporting activities;
- Following a review of the applicant’s tax return, The ATO (“The Respondent”) notified the applicant in July 2019:
- (a) The respondent will issue an amended assessment where $1,613,462 of the applicant’s R&D notional deductions will be reclassified as general deductions under section 8-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997);
- (b) The amount of $1,613,462 was comprised of the HK Flistar and Hefei Kelly invoices; and
- (c) The applicant did not have a finding under paragraph 28C(1)(a) of the IRDA 1986 (overseas finding) in respect of overseas activities conducted during the year ended 30 June 2018.
- A Notice of Assessment of Shortfall Penalty for FY18 was also imposed of an amount of $350,927.95;
- In July 2019, the applicant prepared and submitted an R&D Tax Incentive Registration Variation to AusIndustry (variation request), registering its supporting R&D activities. The variation request reclassified the construction and cost of the prototype from a ‘core R&D activity’ to a ‘supporting R&D activity’. The variation request made no mention of the fact that the supporting R&D activities were conducted overseas to produce the components for the prototype.
- In August 2019, AusIndustry issued to the applicant a Variation to R&D Tax Incentive Registration setting out variations to the applicant’s registration for FY18 consistent with the variation request.
- The applicant objected to the Notice of Assessment in September 2020, the respondent issued to the applicant a notice of objection decision (objection decision) advising that its objection was disallowed. The applicant has sought review of this decision in the AAT;
As part of this decision, The AAT sought to determine:
- Whether the applicant is entitled to the R&D tax incentive for its supporting R&D activities, noting that it did not have an overseas finding in that period;
- Whether the applicant is liable to an administrative penalty; and
- Whether remission of the administrative penalty imposed for the year ended 30 June 2018, in whole or in part, is warranted.
Key Extracts from the AAT ruling are below:
- Section 355-210 provides the conditions for which R&D activities need to be covered by for a notional deduction to arise under section 355-205:
- (1) An *R&D activity covered by one or more of the following paragraphs is an activity to which this section applies:
- (d) the R&D activity is:
- The R&D tax incentive is largely only available for activities solely conducted in Australia. The applicant accepts that the relevant supporting activities were conducted overseas. In limited circumstances, the law, has extended the benefit of the R&D tax incentive to overseas activities covered by a finding under paragraph 28C(1)(a) of the IRDA 1986 (overseas finding). An overseas finding is required for paragraphs 355-210(1)(d) and 355-210(1)(e) conditions, pursuant to subparagraphs 355-210(1)(d)(ii) and 355-210(1)(e)(ii) to apply.
- The respondent accepts that the applicant’s supporting R&D activities do constitute ‘supporting R&D activities’ for the purposes of section 355-30 of the ITAA 1997;
- The applicant now appears to contend that the approved supporting activities were the mere supply of parts and components from China for the dominant purpose of supporting the core R&D activities, which were solely conducted in Australia. In other words, that an overseas finding was not applicable as no R&D activities were conducted outside Australia.
- The applicant’s Response to ATO Review request for further information dated 20 November 2018, provides an explanation of the work conducted overseas. Relevantly, the applicant describes some of the work as
- Molds, …CAD Drawings…Metal Fabrication…Electrical assemblies…Assembly of prototypes
- Contrary to the applicant’s contentions, the applicant’s supporting R&D activities are not the mere supply of components. The approved supporting R&D activities plainly go beyond the mere supply of components.
- As such, the applicant’s supporting R&D activities are not covered by paragraphs 355-210(1)(d) or 355-210(1)(e) as these activities are conducted overseas and the applicant does not have an overseas finding.
- For these reasons, I find that notional deductions under section 355-205 of the ITAA 1997 do not arise from the applicant’s $1,613,462 expenditure on the supporting R&D activities during the year ended 30 June 2018.The applicant is not entitled to a tax offset in respect of this expenditure.
- Given the significant size of the amount of tax offset the applicant claimed, a reasonable person in the circumstances would have taken steps to ensure that it was entitled to claim the tax offset. The requirement for an overseas finding is not complex or difficult to ascertain, and the applicant, at the very least, should have advised that components of the R&D activities were being conducted overseas and sought clarification as to requirement for an overseas finding. For these reasons, I find that the applicant is liable to an administrative penalty pursuant to subsection 284-75(2) of schedule 1 to the TAA 1953.
This case serves as a reminder that where Australian companies are seeking to include the cost of overseas R&D Activities within their Australian R&D claims, they must both:
- Meet the requirements for overseas R&D activities as per paragraph 28C(1)(a) of the Industry Research and Development Act 1986; AND
- They must lodge an Overseas Finding Application with AusIndustry and attain a positive outcome.