TDS Biz Pty Ltd v FC of T

Members:
A Poljak SM

Tribunal:
Administrative Appeals Tribunal, Sydney

MEDIA NEUTRAL CITATION: [2022] AATA 3543

Decision date: 25 October 2022

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A Poljak (Senior Member)

1. In December 2012, T.D.S Biz Pty Ltd, the applicant, was registered with the Australian Securities and Investments Commission. In the year ending 30 June 2014, the applicant commenced designing and developing an electric tricycle.

2. On 22 January 2018 and 29 May 2018, the applicant was issued invoices from HK Flistar Limited ( HK Flistar ) in the amounts of $1,092,062 and $188,680, to produce vehicle components.

3. On 5 February 2018, Hefei Kelly Technology Investment Co Ltd ( Hefei Kelly ) issued to the applicant an invoice for $249,540 USD ($332,720 AUD). The items described on the invoice include the production of electrical components. On 13 May 2018, Hefei Kelly issued to the applicant a payment receipt which confirmed the amount of $249,540 USD was paid in full.

4. On 23 August 2018, the applicant lodged its Research and Development ( R&D ) tax incentive application form to AusIndustry which included, among other information, a description of the applicant's R&D activities and expenditure for the year ended 30 June 2018. The applicant did not register any supporting R&D activities for the 2018 income year.

5. On 27 August 2018, AusIndustry issued to the applicant a Notice of Registration under section 27A of the Industry Research and Development Act 1986 (Cth) ( IRDA 1986 ) for the year ended 30 June 2018.

6. On 14 September 2018, the applicant lodged its income tax return for the year ended 30 June 2018 and its research and development tax incentive schedule for the year ended 30 June 2018. The applicant retained a refund of $748,476.23 in respect of the applicant's income tax return for the year ended 30 June 2018.

7. Following a review of the applicant's tax return, the respondent notified the applicant on 2 July 2019 of the following:

• (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.

8. As a result, an amended Notice of Assessment ( NOAA ) for the year ending 30 June 2018 was issued to the applicant on 10 July 2019. The following relevant adjustments were made:

• (a) Accounting expenditure in item 6 subject to R&D tax incentive was decreased from $1,720,635.00 to $107,173.00: a decrease by $1,613,462.

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  ATC 10761

• (b) Refundable tax offsets was decreased from $748,476.23 to $46,620.28: a decrease by $701,855.95
• (c) A Notice of Assessment of Shortfall Penalty ( Penalty Notice ) for the year ended 30 June 2018, imposing an administrative penalty of $350,927.95.

9. On 11 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 makes no mention of the fact that the supporting R&D activities were conducted overseas to produce the components for the prototype.

10. On 21 August 2019, AusIndustry issued to the applicant a Variation to R&D Tax Incentive Registration setting out variations to the applicant's registration for the year ended 30 June 2018 consistent with the variation request.

11. The applicant objected to the NOAA and on 23 September 2020, the respondent issued to the applicant a notice of objection decision ( objection decision ) advising that its objection to the NOAA and Penalty Notice for the year ended 30 June 2018 were both disallowed. The applicant has sought review of this decision in this Tribunal

Issues

12. The issues for determination in these proceedings are:

• (a) Whether, in relation to the year ended 30 June 2018, the Applicant is entitled to the R&D tax incentive in relation to its supporting R&D activities?
• (b) Whether, in relation to the year ended 30 June 2018, the Applicant is liable to an administrative penalty pursuant to section 284-75 of schedule 1 to the Taxation Administration Act 1953 (Cth) ( TAA 1953 )?
• (c) Whether remission of the administrative penalty imposed for the year ended 30 June 2018, in whole or in part, is warranted, under section 298-20 of Schedule 1 to the TAA 1953?

Consideration

13. 'R&D activities' is defined in section 355-20 of the ITAA 1997 to mean 'core R&D activities' or 'supporting R&D activities'. 'Supporting R&D activities' is defined in section 355-30 of the ITAA 1997:

• (1) Supporting R&D activities are activities directly related to *core R&D activities.
• (2) However, if an activity:
  • (a) is an activity referred to in subsection 355-25(2); or
  • (b) produces goods or services; or
  • (c) is directly relating to producing goods or services;

    the activity is a supporting R&D activity only if it is undertaken for the dominant purpose of supporting *core R&D activities.

14. Section 355-205 provides when notional deductions for R&D expenditure arise:

• (1) An *R&D entity can deduct for an income year (the present year ) expenditure it incurs during that year to the extent that the expenditure:
  • (a) is incurred on one or more *R&D activities :
    • (i) for which the R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year; and
    • (ii) that are activities to which section 355-210 (conditions for R&D activities) applies ; and …

[Emphasis added]

15. For a deduction for R&D expenditure to arise, the activities must be supported by at least one section 355-210 condition.

16. 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:
    • (i) conducted for the R&D entity solely outside Australia; and

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      ATC 10762

    • (ii) covered by a finding in force under paragraph 28C(1)(a) of the Industry Research and Development Act 1986 ;
  • (e) the R&D activity consists of several parts, with:
    • (i) some parts being conducted for the R&D entity solely within Australia; and
    • (ii) the other parts being conducted for the R&D entity outside Australia while covered by a finding in force under paragraph 28C(1)(a) of the Industry Research and Development Act 1986 .
• …

[Emphasis added]

17. 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.

18. Section 28D of the IRDA 1986 sets out conditions for a finding that overseas activities cannot be conducted in Australia. Broadly speaking, the conditions are that the activities must be an R&D activity; they must have a significant link to Australian core activities; must be unable to be conducted within Australia; and the expenditure must be less than that incurred on Australian core activities.

19. 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. This is consistent with the approved variation request on 21 August 2019.

20. 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 also contends that its overseas activities cannot meet the conditions in section 28D of the IRDA 1986.

21. In the variation request, the applicant described the supporting R&D activities to be '[t]he design, development and fabrication and/or supply of components for the assembly of the project's prototypes are for the dominant purpose of supporting the core R&D activities…'

22. 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

Fabrication/machining of plastic body component molds for external body elements, e.g. roof, sides, front, rear, door and interior panels and dashboard.

…

CAD Drawings

Preparation computer aided design (CAD) drawings to ensure dimensional control, shape and fit of individual components.

Metal Fabrication

Fabrication of items such as chassis, side sections, door sections, wheel chair turntable/ramp/restraint, computer numerically controlled (CNC) bending/profiling of tubing for vehicle side sections.

…

Electrical assemblies

Assembly of Australian Design Rule (ADR) compliant wiring harnesses for the prototypes.

…

Assembly of prototypes

23. In a response to the ATO dated 28 August 2020, the applicant stated:

The Chinese company HK Flistar produced fabricated components, e.g. chassis, etc. from designs provided by the company

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ATC 10763

derived from the new knowledge established from the Australian core R&D activities.

Hefei Kelly supplied 'off-the-shelf' items, e.g. motor controller, etc. which were required for the construction/assembly of the prototypes in Australia to enable the continuation of the core R&D activities in Australia as specified in 1.1 Electro-mechanical design.

…

The supporting activity could not have been undertaken in Australia as the cost of fabrication of components would have been commercially prohibitive and the parts (motors, controllers, ADR compliant components, etc.) are not manufactured in Australia.

24. 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.

25. 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.

26. 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.

27. As for the administrative penalty, subsection 284-75(1) of schedule 1 to the TAA 1953 provides that a taxpayer is liable to an administrative penalty if the taxpayer makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under a taxation law; and the statement is false or misleading in a material particular, whether because of things in it or omitted from it.

28. Subsection 284-75(2) provides that a taxpayer is liable to an administrative penalty if the taxpayer makes a statement to the Commissioner and in the statement, the taxpayer treated an income tax law as applying to a matter or identical matters in a particular way that was not reasonably arguable; and item 4,5 or 6 of the table in subsection 284-90(1) of schedule 1 to the TAA 1953 applies to the taxpayer.

29. Subsection 284-75(6) of schedule 1 to the TAA 1953 does not preclude the applicant from being liable to an administrative penalty because the false nature of the statement resulted from recklessness as to the operation of a taxation law.

30. The applicant claimed tax offsets totalling $748,476.23 in its income tax return for the year ended 30 June 2018. This included a $701,855.95 tax offset for expenditure on supporting R&D activities conducted outside Australia without an overseas finding. The shortfall amount was $701,855.95. The applicant was not entitled to this claimed tax offset. Accordingly, the applicant is liable to an administrative penalty pursuant to subsection 284-75(1) of schedule 1 to the TAA 1953.

31. The applicant engaged an R&D consultant, Mr Jamie Collins, to assist with eligibility and registration requirements for the R&D tax offset and engaged a tax agent, Ms Debbie Kong, to prepare and lodge the applicant's income tax return for the year ended 30 June 2018 and R&D tax incentive schedule for the year ended 30 June 2018.

32. Despite this, no mention was made in the initial R&D Tax Incentive Registration Form for the year ending 30 June 2018, nor the variation request, that the supporting R&D activities were conducted overseas in China. 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.

33. 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. Particularly in respect of the applicant's R&D Tax Incentive Registration Variation Request for the year ended 30

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June 2018, as the applicant did not disclose the fact that its supporting R&D activities to produce prototype components had occurred outside Australia, and for claiming a tax offset in respect of its $1,613,462 expenditure on supporting R&D activities conducted outside Australia without an overseas finding.

34. I do not consider, on the available evidence and submission made by the applicant, that there are any circumstances which justify any remission in penalties.

35. Finally, I note that the applicant has raised a contention that the respondent should have referred the applicant's R&D Tax Incentive Application for the 2018 financial year to Industry Innovation and Science Australia for an examination of the applicant's R&D registration and a finding under section 27F of the IRDA 1986. The only finding that AusIndustry can make under section 27J is whether the applicant's registered activities are core or supporting R&D activities or not. As already stated, there is no dispute that the applicant's R&D activities conducted overseas are supporting R&D activities as per the variation request.

Decision

36. The decision under review is affirmed.