Edited version of private ruling

Authorisation Number: 1011775048460

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Ruling

Subject: Eligibility for research and development tax concession

Question 1

Is X grouped with the Company under section 73L of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No because:

· X does not, either alone or with any affiliates, control the Company or any person grouped with the Company under section 73L of the ITAA 1936 according to the tests in section 73L of the ITAA 1936, and

· X is not an affiliate of the Company under section 73M of the ITAA 1936.

Question 2

Is Y grouped with the Company under section 73L of the ITAA 1936?

Answer

Yes because

· Y is taken to control the B Discretionary Trust under paragraph 73L(4)(a) of the ITAA 1936 because Y has received a distribution in excess of $100,000 from the B Discretionary Trust in one or more of the 4 years of income preceding the tax offset year, and the B Discretionary Trust is grouped with the Company under section 73L of the ITAA 1936, and also because

· Y controls C Pty Ltd under subsection 73L(3) of the ITAA 1936 because they legally and beneficially owns the shares in C Pty Ltd, and C Pty Ltd is grouped with the Company under section 73L of the ITAA 1936.

Question 3

Is the salary and wage income of Y included in the calculation of the R&D group turnover of the Company under section 73K of the ITAA 1936?

Answer

No, because where the person grouped with the eligible company under section 73L of the ITAA 1936 is an individual, income which that individual receives from salary or wages (i.e. amounts which do not arise in the ordinary course of business or in the course of carrying on research and development activities) are not included in R&D group turnover.

Question 4

Is the dividend income of Y included in the R&D group turnover of the Company under section 73K of the ITAA 1936?

Answer

No, because where the person grouped with the eligible company under section 73L of the ITAA 1936 is an individual, income which that individual receives from passive investments (i.e. amounts which do not arise in the ordinary course of business or in the course of carrying on research and development activities) are not included in R&D group turnover.

Question 5

Is the interest of X in Accountants included in the calculation of the R&D group turnover of the Company under section 73K of the ITAA 1936?

Answer

No, because neither X nor the partnership of accountants are grouped with the Company under section 73L of the ITAA 1936.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The Company is an Australian proprietary company limited by shares, incorporated in a previous year.

The Company is proposing to claim a tax offset under section 73I of the ITAA 1936 for the tax offset year ended 30 June 2010 in respect of research and development activities conducted by or on behalf of the Company.

The Company's directors are W and Z. The directors are not affiliates of either X or Y.

All of the shares in the Company are owned by D Pty Ltd. D Pty Ltd does not itself conduct any business or research and development activities (and has no tax file number or Australian business number). The issued capital of D Pty Ltd consists of a number of ordinary shares.

F Pty Ltd owns greater than 50% of the ordinary shares in D Pty Ltd as trustee for the G Unit Trust. X is a director of F Pty Ltd and legally and beneficially owns 50% of the shares of that company. Y is the other director of F Pty Ltd and legally and beneficially owns the other 50% of the shares of that company. F Pty Ltd does not operate other than as trustee of the G Unit Trust.

None of the remaining shares in D Pty Ltd are owned by X or Y or by any affiliates of X or Y. Nor do X or Y have a beneficial interest in any of those shares.

The G Unit Trust undertakes investment activities. E Pty Ltd, as trustee of the B Discretionary Trust, owns 100% of the issued units of the G Unit Trust.

X is a director of E Pty Ltd and legally and beneficially owns 1 share in that company. Y is the other director of E Pty Ltd and legally and beneficially owns the other shares in that company. E Pty Ltd does not conduct any business or research and development activities (and has no tax file number or Australian business number).

Y, as director of E Pty Ltd is not under any formal or informal obligation or in the habit of acting in accordance with X's wishes regarding the operation of the B Discretionary Trust. Y has not delegated any powers to X. X does not occupy any position (such as chair of director's meeting) where X has a deciding vote in director's meetings. Y, as majority shareholder, has the deciding vote in respect of any matter brought to such a vote.

The B Discretionary Trust conducts investment activities. The beneficiaries of the B Discretionary Trust are Y, X, and C Pty Ltd. The distribution history for the B Discretionary Trust for the relevant income years was supplied.

The directors and shareholders of C Pty Ltd are X and Y. C Pty Ltd does not operate besides receiving distribution income.

The shares owned by X and Y in F Pty Ltd, E Pty Ltd, and C Pty Ltd have rights to any distribution of income or capital, or to exercise or control the exercise of voting power in the respective companies, in relative proportion to their shareholdings.

X works as a partner of Accountants, the main activity of which is providing accounting services. In the relevant year the income of X includes a distribution from Accountants. Other than their activities as a partner of Accountants they did not conduct any business activities. They did not conduct any research and development activities or incur any research and development expenditure in the relevant year.

Accountants is not a member of the R&D group of the Company.

Y received salary and wage income from the V in the relevant year. They also received dividend income from shares in a public company. Their only other income for the relevant year is a capital gain distributed from the B Discretionary Trust (from the sale of shares and units). They did not conduct any business or research and development activities or incur any research and development expenditure.

X did not

· conduct or manage any business, or

· co-operate, collaborate or have a shared interest in respect of research and development activities or expenses,

with the Company or with Y.

Y did not

· conduct or manage any business, or

· co-operate, collaborate or have a shared interest in respect of research and development activities or expenses

with the Company or with X.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 73B

Income Tax Assessment Act 1936 Section 73H

Income Tax Assessment Act 1936 Section 73I

Income Tax Assessment Act 1936 Section 73J

Income Tax Assessment Act 1936 Section 73K

Income Tax Assessment Act 1936 Section 73L

Income Tax Assessment Act 1936 Section 73M

Industry Research and Development Act 1986 Section 39J

Industry Research and Development Act 1986 Section 39KA

Reasons for decision

Subsection 73I(1) of the ITAA 1936 provides that an 'eligible company' can choose a tax offset instead of a deduction under section 73B (except subsection 73B(14C)), 73BA, 73BH or 73QA for a year of income, if it is eligible to make that choice. The eligibility criteria are contained in section 73J of the ITAA 1936.

Subsection 73I(4) of the ITAA 1936 prevents an eligible company also claiming a deduction where it has chosen the tax offset. This section says that an eligible company cannot deduct any amount under section 73B, (except subsection 73B(14C)), 73BA, 73BH or 73Y of the ITAA 1936 for the tax offset year if it chooses the tax offset for that year.

Subsection 73J(1) of the ITAA 1936 provides that an eligible company can choose the tax offset for the tax offset year if:

(a) it could, apart from subsection 73I(4), deduct an amount under section 73B (except subsection 73B(14C)), 73BA, 73BH or 73QA for that year; and

(b) either:

(i) all or part of the amount that the company could, apart from subsection 73I(4), have deducted is contracted expenditure; or

(ii) its aggregate research and development amount for the tax offset year exceeds $20,000; and

(c) the aggregate research and development amount for the tax offset year of the company and of persons with which it is grouped (while they are grouped in that year) is not more than $2,000,000; and

(d) the R&D group turnover of the company for that year is less than $5,000,000.

Note that subsection 73J(2) of the ITAA 1936 contains an exception to eligibility to choose the tax offset. However the exception is not relevant to this ruling.

R&D group turnover is defined in section 73K of the ITAA 1936. Subsection 73K(1) states:

73K(1)  [Calculation of R&D group turnover]

The R&D group turnover of an eligible company for a year of income is the sum of:

(a) the value of the supplies the company made in the year of income; and

(b) the value of the supplies made in the year of income by other persons while they were grouped with the company;

reduced by:

(c) the value of the supplies the company made in the year of income to persons grouped with it while they were grouped with it; and

(d) the value of the supplies persons grouped with the company made in the year of income to the company while the company was grouped with them; and

(e) the value of the supplies another person made in the year of income to a third person while the other person and the third person were grouped with the company.

Note that subsections 73K(2) and 73K(3) of the ITAA 1936 provide for additional rules for the calculation of R&D group turnover. However they are not relevant to this ruling.

Section 73L of the ITAA 1936 specifies the rules under which a person is considered to be grouped with another person including for the purposes of calculating the R&D group turnover of an eligible company:

73L(1)  [Grouping of persons]

A person is grouped with another person at a time in a year of income if, at that time:

(a) either person controls the other person in the way described in this section; or

(b) both persons are controlled in that way by the same third person; or

(c) the persons are affiliates of each other.

73L(2)  [Application to persons who control, etc]

This section applies to a person that directly controls a second person as if the first person also controlled any other person that is directly, or indirectly by any other application or applications of this section, controlled by the second person.

73L(3)  Individuals, companies and fixed trusts.

A person controls another person if the first person, its affiliates or the first person together with the first person's affiliates:

(a) legally or beneficially own, or have the right to acquire the legal or beneficial ownership of, interests in the other person that carry between them the right to receive more than 50% of any distribution of income or capital by the other person; or

(b) if the other person is a company - 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, more than 50% of the voting power in the company.

73L(4)  Non-fixed trust estates.

A person controls a trust estate that is not a fixed trust estate if:

(a) the trustee has made a distribution, in any of the last 4 years of income (except the tax offset year) of $100,000 or more to the person, the person's affiliates or the person together with the person's affiliates; or

(b) the person, the person's affiliates or the person together with the person's affiliates:

(i) have the power, directly or indirectly, to obtain the beneficial enjoyment of any of the capital or income of the trust estate; or

(ii) are capable of gaining that enjoyment under an agreement; or

(c) a trustee of the trust estate is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the person, the person's affiliates or the person together with the person's affiliates.

73L(5)  Partnerships.

A person controls a partnership if the person, the person's affiliates or the person together with the person's affiliates have the right to more than 50% of the partnership net income, or have more than a 50% interest in assets used in the partnership business (except assets that are leased to the partnership).

73L(6)  [Partnership controls, etc]

A partnership (the controller) controls another person if a partner in the controller, or 2 or more partners in the controller, have the right to receive more than 50% of the partnership net income, or have more than a 50% interest in assets used in the partnership business, and:

(a) if the other person is a company - the same partner, or the same 2 or more partners, have the right to receive more than 50% of any distribution of income or capital by the company, or to exercise, or to control the exercise of, more than 50% of the voting power in the company; or

(b) if the other person is a fixed trust estate - the same partner, or the same 2 or more partners, have the right to receive more than 50% of any distribution of income or capital by the trustee; or

(c) if the other person is a trust estate that is not a fixed trust estate - a condition in a paragraph of subsection (4) is satisfied for the same partner, or the same 2 or more partners in relation to the trust estate; or

(d) if the other person is a partnership - the same partner, or the same 2 or more partners, have the right to receive more than 50% of the partnership net income, or have more than a 50% interest in assets used in the partnership business, of the partnership.

For the purposes of this ruling the 'R&D group' of the Company consists of the Company and those persons who are grouped with the Company under section 73L of the ITAA 1936.

'Affiliate' is defined in section 73M of the ITAA 1936:

73M(1)  [Affiliate]

A person is an affiliate of another person if the person acts, or could reasonably be expected to act, in accordance with the other person's directions or wishes, or in concert with the other person, in relation to the affairs of the person's business or research and development expenditure.

73M(2)  [Partner not affiliate]

Another partner in a partnership in which a person is a partner is not the person's affiliate only because the partner acts, or could reasonably be expected to act, in concert with the person in relation to the affairs of the partnership.

Based on the application of section 73L of the ITAA 1936 the following entities are included in the R&D group of the Company:

· D Pty Ltd because it owns all of the shares in the Company (and so controls the Company under paragraph 73L(3)(b) of the ITAA 1936),

· The G Unit Trust because it owns greater than 50% of the shares in D Pty Ltd (and so controls D Pty Ltd under paragraph 73L(3)(b) of the ITAA 1936 and is included in the R&D group of the Company through the operation of subsection 73L(2) of the ITAA 1936),

· The B Discretionary Trust because it owns 100% of the units in the G Unit Trust (and so controls the G Unit Trust under paragraph 73L(3)(a) of the ITAA 1936 and is included in the R&D group of the Company through the operation of subsection 73L(2) of the ITAA 1936), and

· C Pty Ltd because it has received distributions in excess of $100,000 in the specific income years (and so controls the B Discretionary Trust under paragraph 73L(4)(a) of the ITAA 1936 and is included in the R&D group of the Company through the operation of subsection 73L(2) of the ITAA 1936).

Question 1

Is X grouped with the Company under section 73L of the ITAA 1936?

Detailed reasoning

Former section 328-380 of the Income Tax Assessment Act 1997 (ITAA 1997) contained a definition of 'STS affiliate' as follows:

328-380(8) An entity is an STS affiliate of yours if the entity acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the entity's ^*business.

328-380(9) Another partner in a partnership in which you are a partner is not your STS affiliate only because the partner acts, or could reasonably be expected to act, in concert with you in relation to the affairs of the partnership.

Given the similarity of the definition of STS affiliate and the definition of affiliate in section 73M of the ITAA 1936, comments in Taxation Ruling TR 2002/6 Income tax: eligibility - grouping rules (*STS affiliate, control of non-fixed trusts), regarding the meaning of STS affiliate, are relevant. Paragraph 33 of the ruling states:

33. Significantly, it follows from the definition that an entity that does not carry on a business cannot be an *STS affiliate.

The ruling explains the dual nature of the term, that is, that you cannot be an affiliate of a person who is not an affiliate of you (paragraph 28). For the definition to apply a potential STS affiliate must act, or be expected to act, in the relevant way in relation to all or a substantial part of the potential STS affiliate's business as distinct from in relation to isolated transactions or on an irregular ad hoc basis (paragraph 31).

The definition of affiliate in section 73M of the ITAA 1936 is wider than the definition of STS affiliate in that it includes not only a business nexus but an alternative nexus in respect of research and development expenditure. However following on from the views given in TR 2002/6 a person who, at a particular time, does not carry on a business, or conduct research and development activities, or incur research and development expenditure, cannot be an affiliate under section 73M of the ITAA 1936 at that time.

X does not conduct any business activities other than in his capacity as a partner in the accountancy practice. He does not conduct any research and development activities or incur research and development expenditure.

Y does not carry on any business, or conduct research and development activities, or incur research and development expenditure. Despite having a personal relationship with Y, X is not her affiliate under section 73M of the ITAA 1936.

C Pty Ltd does not carry on any business, or conduct research and development activities, or incur research and development expenditure (it does not operate other than to receive distributions from the B Discretionary Trust). X is not an affiliate of C Pty Ltd under section 73M of the ITAA 1936.

For the purposes of this ruling it is an agreed fact that X did not conduct or manage any business together with the Company or collaborate, co-operate, or have a shared interest in respect of any research and development activities or expenditure with the Company. X is not an affiliate of the Company under section 73M of the ITAA 1936.

In addition it is an agreed fact for the purposes of this ruling that X is not an affiliate of the directors of the Company or of any of the minority shareholders of D Pty Ltd.

X, being a natural person, is not controlled by any other person according to the tests in section 73L of the ITAA 1936.

It follows that X will be a member of the R&D group of the Company if and only if X alone controls the Company or another member of the R&D group of the Company according to the tests laid down in section 73L of the ITAA 1936.

X does not control the Company because X does not legally or beneficially own, or have the right to acquire, ordinary shares in the Company. Nor does X legally or beneficially own, or have the right to acquire, ordinary shares in D Pty Ltd (ordinary shares being the only class of shares in both companies). Subsection 73L(3) of the ITAA 1936.

X does not control the G Unit Trust because X does not legally or beneficially own, or have the right to acquire, any units in the trust (they being the only interests having rights to any distribution of income or capital of the trust). Subsection 73L(3) of the ITAA 1936.

X does not control the B Discretionary Trust (a discretionary trust) because, despite being an object of the trust and being one of two directors of the trustee and being a minority shareholder of the trustee (the other director and majority shareholder being Y);

· X is not an affiliate of any of the other objects of the trust (they being Y and C Pty Ltd) as discussed above,

· the trustee has not made any distribution to him any of the last 4 years of income or the tax offset year (paragraph 73L(4)(a)),

· X does not have the power unilaterally to, directly or indirectly, obtain the beneficial enjoyment of any of the capital or income of the trust estate (such enjoyment would require the co-operation of the other director of the trustee, Y, who is not his affiliate) (subparagraph 73L(4)(b)(i)),

· there is no agreement in existence under which X is capable of obtaining the beneficial enjoyment of any of the capital or income of the trust estate (subparagraph 73L(4)(b)(ii)), and

· there is no evidence that the trustee is accustomed or under an obligation to act in accordance with their directions, instructions or wishes (such control would require the co-operation of the other director of the trustee, Y, who is not his affiliate) (paragraph 73L(4)(c)).

X does not control C Pty Ltd because they legally or beneficially owns only 1 of ordinary shares. Rights to distributions and voting power are proportionate to share holding. The other shares are legally and beneficially owned by Y who is not their affiliate. There are no other class of shares (subsection 73L(3) of the ITAA 1936).

Therefore X does not control any of the members of the R&D group of the Company.

X is not grouped with the Company under section 73L of the ITAA 1936.

Question 2

Is Y grouped with the Company under section 73L of the ITAA 1936?

Detailed reasoning

The B Discretionary Trust is a member of the R&D group of the Company. Y received the following distributions from that trust in the last four years of income (except the tax offset year).

Therefore Y is taken to control the B Discretionary Trust in the tax offset year. By virtue of the operation of subsection 73L(2), Y is therefore a member of the R&D group of the Company.

In addition, Y is the majority shareholder of C Pty Ltd. Rights to distributions and voting power in the company are proportionate to the shareholding. Therefore Y controls C Pty Ltd under subsection 73L(3) of the ITAA 1936. C Pty Ltd is a member of the R&D group of the Company. By virtue of the operation of subsection 73L(2), Y is therefore a member of the R&D group of the Company.

Question 3

Is the salary and wage income of Y included in the calculation of the R&D group turnover of the Company under section 73K of the ITAA 1936?

Detailed reasoning

The calculation of R&D group turnover in section 73K of the ITAA 1936 is based on the value of supplies made by the Company or persons grouped with the Company.

If the R&D group member is an individual, income that individual receives from passive investments or as salary or wages (i.e. amounts which do not arise in the ordinary course of business or in the course of carrying on research and development activities) are not included in R&D group turnover.

Question 4

Is the dividend income of Y included in the R&D group turnover of the Company under section 73K of the ITAA 1936?

Detailed reasoning

The calculation of R&D group turnover in section 73K of the ITAA 1936 is based on the value of supplies made by the Company or persons grouped with the Company.

If the R&D group member is an individual, income that individual receives from passive investments or as salary or wages (i.e. amounts which do not arise in the ordinary course of business or in the course of carrying on research and development activities) are not included in R&D group turnover.

Question 5

Is the interest of X in Accountants included in the calculation of the R&D group turnover of the Company under section 73K of the ITAA 1936?

Detailed reasoning

At question 1 we ruled that X is not a member of the R&D group of the Company in the tax offset year.

It is also an agreed fact for the purposes of this ruling that Accountants is not a member of the R&D group of the Company.

R&D group turnover is defined in section 73K of the ITAA 1936. Under subsection 73K(1) if a supply in a year of income is not a supply made by the Company or by a person grouped with the company then the value of the supply is not included in the R&D group turnover of the company for the year of income.

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