The Australian Tax Office (ATO) has issued a reminder to companies seeking to claim the R&D tax offset. This follows a favourable outcome for the ATO in the federal court case, T.D.S Biz V FCT. The case resulted in T.D.S Biz losing 94% of their notional R&D deductions.
When T.D.S Biz lodged its R&D application, it included a mix of Australian and overseas expenditures. However, they failed to specify that the overseas component was in fact for activities undertaken abroad. Their overseas expenditure included the design, fabrication and supply of components needed for the company to develop its electric tricycle.
Navigating Overseas R&D Claims: Advanced Overseas Finding
While companies can claim overseas R&D, they are required to hold an Advanced Overseas Finding to be considered eligible. Unfortunately, T.D.S Biz failed to apply for this finding.
To qualify for an Advanced Overseas Finding, a number of criteria must be met:
- The overseas R&D activity must be an R&D activity
- There must be a significant scientific link to an Australian core activity
- The overseas R&D must be unable to be conducted within Australia
- The actual and reasonably anticipated expenditure for overseas R&D must be less than the costs of related R&D activities undertaken solely in Australia over the life of the project (majority cost test).
In the court proceedings, T.D.S Biz argued that they did not need to apply for an Advanced Overseas Finding as the overseas activity was conducted primarily to support their core activity. Further, they argued that the China-based supporting activity only related to sourcing raw materials.
However, the Commissioner contended that overseas findings could be core or supporting activities and that both are subject to the same eligibility criteria. As T.D.S Biz engaged two Chinese companies to fabricate and design the components, their supporting activity was found to be an overseas one. Therefore, in order to claim overseas expenditure, the company would need an Advanced Overseas Finding.
Majority Cost Test a Key Factor in Eligibility
Moreover, it was found that over the life of the project, 93.77% of expenditure was intended to be spent overseas. As a result, T.D.S Biz did not meet the majority cost test, rendering them ineligible. Without an Advanced Overseas Finding, the Commissioner concluded that the overseas expenditure could not be claimed.
In light of these findings, the Commissioner imposed a 50% administrative penalty of $350,928 on the basis of recklessness. The ATO amendments to the 2018 claim remain in place, and the notional R&D deductions were reduced from $1,720,635 to $107,173. As a result, their Refundable Tax Offset fell from $748,476 to $46,620.
Key Takeaways for Businesses: Navigating the R&D Tax Incentive
This case highlights several key points surrounding the R&D Tax Incentive, including:
- The importance of evaluating your eligibility against the legislative criteria;
- The need to apply for an Advanced Overseas Finding when undertaking R&D activities overseas; and
- The requirement for R&D entities to understand the obligations of the program and the penalties for failure to comply.
Following the case, the ATO has pledged to increase the transparency around the R&D tax offset whilst holding companies to a ‘high standard when it comes to complying with, and understanding, R&D laws.’
If you are an R&D entity and need help assessing your eligibility for the R&D Tax Incentive Program, please reach out to the R&D Tax team at RSM.
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Authors: Monique Mather (left/top) – Graduate, R&D Tax & Government Incentives; Tanya Brisbane – Senior Manager, R&D Tax & Government Incentives
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