Claiming a notional deduction under the R&D tax incentive
In most cases, before you can claim a notional deduction under the R&D tax incentive, an R&D activity must be conducted for you either:
- solely within Australia or an external territory
- overseas if the R&D activity is covered by a finding from Innovation Australia (under paragraph 28C(1)(a) of the Industry Research and Development Act 1986).
If parts of an R&D activity conducted for you are within Australia or an external Territory and parts are overseas, you must have a relevant finding from Innovation Australia for those parts conducted overseas.
Working out whether R&D activities are carried out for you involves working out the extent to which those activities are conducted for your benefit rather than the benefit of another entity.
Relevant factors to consider in working this out include who:
- has effective ownership of results from the R&D activities
- has an appropriate degree of control over the R&D activities
- bears the financial burden or risk of conducting the R&D activities.
Whether an R&D activity is conducted for you is a matter of fact. It is determined by whether the activity is conducted, in substance, to provide the majority of knowledge benefits arising from the activity, such as access to know-how or intellectual property, to you.
This requires a weighing up of all the relevant factors.
In some situations, you can claim a notional deduction for expenditure incurred on eligible R&D activities conducted for an associated foreign corporation. However, you cannot claim a notional deduction for expenditure incurred on:
- overseas R&D activities or
- supporting R&D activities that correspond with an overseas core R&D activity.
See R&D activities conducted for an associated foreign corporation.
Example 1: R&D activities conducted for an R&D entity
Under the terms of an agreement Company U, a company incorporated in the United States (US), agrees to conduct R&D activities solely in the US for Company A, an Australian company. The agreement specifies that Company A will benefit from all of the intellectual property obtained from the activities and will control how the activities are conducted.
Before the agreement begins, Company A obtains a favourable finding from Innovation Australia that those R&D activities could not be conducted in Australia, under paragraph 28C(1)(a) of the Industry Research and Development Act 1986.
As Company A will benefit from all of the intellectual property obtained from the activities, and controls the conduct of those R&D activities, the activities are being conducted solely for Company A. Therefore, if Company A meets the other eligibility criteria, they will be able to claim a notional deduction under the R&D tax incentive.
End of example
Example 2: R&D activities conducted for an R&D entity
Company Z is an R&D entity undertaking its business and R&D activities solely in its factory in Adelaide, South Australia. It is conducting R&D activities for itself solely within Australia and may be entitled to the R&D tax incentive.
Due to commercial reasons, Company Z decides to outsource its R&D activities to Company B, an R&D entity based in Melbourne, Victoria. Under the terms of the agreement between Company Z and Company B, Company B agrees to carry out the R&D activities for Company Z. The agreement provides Company B with broad direction about the specifications Company Z wants achieved by the work. Company Z is obliged to pay Company B for the cost of these services, irrespective of the results obtained. Company Z receives the major benefit of the R&D expenditure it has incurred through being the only entity which can access intellectual property arising from the R&D activities for its own commercial purposes. Company B does not benefit at all.
Although Company B is not an agent for Company Z, Company B conducts the R&D activities for Company Z and not to any extent for its own purposes.
Therefore, Company B cannot claim the R&D tax incentive. If Company Z meets the other eligibility criteria, they will be able to claim a notional deduction under the R&D tax incentive.
End of exampleEffective ownership of results
To work out whether you have effective ownership of the results you must look at the circumstances in which the R&D activities are conducted and what practical, as well as formal, rights you have to the results from those activities, such as the intellectual property, the know-how, or similar results arising from your R&D activities.
This does not necessarily mean that you must be the proprietor of a piece of intellectual property in any formal sense. These rights may not be available, or the formal owner of the resulting intellectual property may hold it on terms that you have all the advantages of ownership. For example, you may not be the formal holder of the patent but have the right (without further fee or payment) to:
- use a patent
- require the patent to be licensed
- restrict or direct further development based on the patent.
In most cases, a company with all those rights would have effective ownership of the results in question.
You may give some theoretical rights of ownership to intellectual property or results to others without denying your effective ownership of them. For example, you might completely control results of R&D activities, yet permit the contract researcher some exclusive scientific publication rights.
In some cases, use of results may only be possible in limited ways or for limited purposes, so that limited rights may amount to effective ownership. For example, exclusive rights of commercial use and development for only a few years might amount to full effective ownership in an area of R&D that is short-term.
Example: Effective ownership of results
Company C is an R&D entity carrying out its business and R&D activities solely in Australia. Company C enters into a contract with a buyer, Company Z, to supply a new product meeting certain specifications. Both companies know that Company C will need a program of R&D to fulfil its contract. In fulfilling the supply contract, Company C is under no obligation to supply working papers or background research to Company Z.
Even if Company Z is the sole purchaser, or one of only a few potential purchasers, of the intended product, Company C effectively owns the results of the R&D. This is because Company C alone controls and uses the R&D results. Therefore, Company C can claim the R&D tax incentive, subject to meeting other requirements.
End of exampleFunding an R&D project together
If you fund a project of R&D together with other eligible R&D entities as an R&D partnership, there are special rules about who the R&D activities of the partnership are conducted for.
If you are one of a number of entities that funds an R&D project as a group, but not as an R&D partnership, in order to satisfy the effective ownership test it is essential for each contributor to the project to have a proper and effective interest in the R&D results. Examples of situations where a number of entities may fund a R&D project include members of industry associations or members of certain a joint ventures.
Each member of the group eligible to claim the R&D tax incentive must separately register with AusIndustry.
Contributions to R&D activities can take many forms. For example a contribution may be of money, services (provided free or for less than a proper fee), or the use of depreciating assets or premises. A contribution may also take the form of existing research results. The key to comparing contributions in money and in-kind is that contributions in-kind are valued when contributed, not in hindsight after the contributions have been used in R&D activities.
If you and a number of other entities share results of an R&D project or their use, when working out if the effective ownership test is satisfied you must consider whether each party's individual share in those results is commensurate to their contribution made.
Whether each party's individual share in those results is commensurate to their contribution made is a question of fact which will depend on the individual circumstances of the arrangement.
Example 1: R&D conducted jointly
Company X and Company Y both operate in the same industry and decide to pool their resources and undertake R&D activities jointly in a field of common interest. They both contribute equally to a pool of funds to fund the R&D activities. They agree that they will both have the same right to use the results of those activities in their respective businesses on completion of the activities.
Despite conducting R&D activities jointly, Company X and Company Y are not partners for income tax purposes. They do not carry on a business in common and are not in receipt of any income jointly.
The interests of Company X and Company Y in the 'know-how' (developed from the expenditure on the R&D activities) are the same and commensurate with their respective expenditures. As a result, both entities have effective ownership of the results arising from their own expenditure.
The expenditure of each company is not a recoupment or reimbursement of the other's expenditure, so Company X and Company Y each bear their share of the financial burden of the R&D activities. While the R&D activities might be said in one sense, to be conducted for them both, their joint input into what activities are carried on, their sharing of the financial burden and the nature of their respective interests in the results, where neither can restrict use by the other, means that their individual contributions are not on R&D activities conducted to a significant extent for the other.
End of example
Example 2: Members of industry associations
Members of industry associations may effectively be co-owners of the R&D results obtained on their behalf. Free individual use of results is practical for them. Co-ownership of this kind is consistent with the R&D having been carried out for the members, with each having a proper and effective separate interest in the results. If each member makes a contribution, even if the contributions vary somewhat, those contributions would not usually be regarded as having been made for the purpose of carrying out R&D activities for another.
End of example
Example 3: Shareholders of a company conducting R&D activities
A number of Australian companies establish and become shareholders of another company (also incorporated in Australia). This jointly owned company conducts R&D activities, or has them carried out. Those activities may be funded by the shareholder companies. The fact that shareholders expect an indirect benefit by way of dividends does not mean that the shareholder companies effectively own the results of the R&D. Further, it does not mean that the company in which they hold shares conducts its R&D activities for them.
End of example