Edited version of your private ruling

Authorisation Number: 1012568280702

Ruling

Subject: R&D activities

Edited version of your private ruling

Authorisation Number: 1012568280702

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Question 1

Is Company A eligible to claim the expenditure it has incurred in relation to the work it has undertaken under the R&D tax concession for the Estate Development on the basis that it has carried out the work on its own behalf, as required by subsection 73B(9) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Is Company A eligible to claim the expenditure it has incurred in relation to the work it has undertaken under the R&D tax concession for the Estate Development on the basis that when the expenditure was incurred, Company A was at risk in respect of the expenditure, as required by subsection 73CA(5) of the ITAA 1936?

Answer

No.

This ruling applies for the following period:

01/07/2010 - 30/06/2011

The scheme commences on:

01/07/2010

Relevant facts and circumstances

The Estate Development is a joint venture development between two entities.

Company X owns the land. Company X will retain legal title to the land.

The Company Y will pay Company Y 50% of the value of the land.

Company X and Company Y will own as tenants in common, shares corresponding to their interests in the land and the joint venture property (not consisting of land) and all personal property acquired in Estate Development's name.

The Agreement

The Agreement between Company X, the Company Y and Estate Development was established.

The Agreement details the Estate Development's authority.

Estate Development's financial obligations are detailed in the Agreement where they are not entitled to remuneration in respect of performance or observance of the Agreement.

Project Management and Exclusive Selling Agency Agreement

A Project Agreement was established.

The Estate Development is the "Appointor" and Company A is the "Manager".

Company A will manage the Project and have exclusive selling agency.

The Manager must ensure compliance with all obligations of the Appointor under the Contracts.

Company A is paid a Managers fee which is exclusive of some expenses

R&D expenses are exclusive of the Management Fee paid to Company A.

The Manager may invoice the Appointor with the expenses specified.

The Manager's duties are specified and must act with the due authority of the Committee.
The Committee is made up of stakeholder entities.

An Approved Program has been approved by the Committee and communicated to the manager.

Any Activities which are not included in an Approved Program must be approved by the Committee.

Expenditure outside budget is provided.

Company A will be annually assessed as manager to ensure that the actual costs do not differ from the approved budget by more than 15%.

Project management fees are specified.

Selling fees shall be paid upon the settlement of the Sale of each Lot at differing rates.

Regarding expenditure, nothing holds the Manager liable for the development works of the Project.

Conservation Agreement between a government department and Company A and Company X.

The Conservation Agreement relates to protection of an endangered species.

The purpose of the Conservation Agreement is to ensure its protection.

Company Y agrees to pay an amount to fund a habitat.

The Estate Development is named to undertake monitoring and surveying where the data will be communicated and used by the government departments.

COMPANY A

Company A is registered with AusIndustry.

Intellectual Property

Information regarding Intellectual Property (IP) of the R&D activities is not provided in any of the Agreements or Contracts provided. Formal ownership of the Intellectual Property is silent in the documents provided by Company A

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 73B

Income Tax Assessment Act 1936 Section 73CA

Income Tax Assessment Act 1936 Section 73D

Income Tax Assessment Act 1936 Subsection 73B(1)

Income Tax Assessment Act 1936 Subsection 73B(9)

Income Tax Assessment Act 1936 Subsection 73CA(5)

Reasons for decision

Question 1

Is Company A eligible to claim the expenditure it has incurred in relation to the work it has undertaken under the R&D tax concession for the Estate Development on the basis that it has carried out the work on its own behalf, as required by subsection 73B(9) of the ITAA 1936?

Detailed reasoning

Section 73B of the ITAA 1936 advises that expenditure incurred by an eligible company can qualify as research and development expenditure only if incurred in respect of R&D activities carried out by or on behalf of this company. For R&D activities to be carried out by or on behalf of a company, there must be a close and direct link between the company and the work undertaken.

Subsection 73B(1) of the ITAA 1936 defines research and development expenditure as;

…in relation to an eligible company in relation to a year of income, means expenditure…incurred by the company during the year of income, being;

(a) contracted expenditure of the company;

(b) salary expenditure of the company, being expenditure incurred on or after 1 July 1985; or

(c) other expenditure incurred on or after 1 July 1985 directly in respect of research and development activities carried on by or on behalf of the company on or after 1 July 1985;

9 …

Under subsection 73B(9) of the ITAA 1936, eligible companies generally cannot claim a deduction at the concessional rate in respect of expenditure incurred for the purpose of carrying on R&D activities on behalf of any other person. It is not necessary that the company be acting as agent of the other, the question is whether, in all circumstances, the R&D is to be carried out in substance for the other. This will be a question of fact in each case.

Subsection 73B(9) of the ITAA 1936, provides:

A deduction is not allowable under this section…in respect of expenditure incurred by an eligible company for the purpose of carrying on research and development activities on behalf of any other person, and expenditure of that kind shall be disregarded for the purposes of the application of this section … to a company.

The requirements outlined in subsections 73B(1) and 73B(9) of the ITAA 1936 (collectively referred to as the 'on own behalf' requirement) effectively prevent companies making double deductions in respect of the same R&D activities by restricting entitlement to the concessional deductions to the company that:

· bears the financial risk associated with a R&D project

· has control over the R&D project, and

· effectively owns the project results.

This is representative of the decision made in Bartercard Australia Pty Ltd v FC of T 2010 ATC 10-167, where the Commissioner's refusal to allow the taxpayer concessional treatment for its R&D expenditure pursuant to subsection 73B(9) was upheld because the state of the evidence left the AAT unable to find on whose behalf the R&D activities were undertaken.

Therefore, for Company A to claim any amount under section 73B of the ITAA 1936, the relevant R&D activities must be carried out by or on behalf of the company and not on behalf of any other person. To determine whether Company A is eligible for R&D expenditure it is necessary to examine how the above criteria apply to Company A's individual circumstances.

Financial Risk

Financial risk is linked to the undertaking of the R&D activities. Where R&D activities are carried out on behalf of a company, it would generally be expected that the company would bear the financial risk of the activities undertaken. A deduction would not necessarily be prevented in circumstances where a company does not bear the financial risk of an R&D project, but effectively owns the results and controls the conduct of the R&D project. The company should also demonstrate financial risk in respect of the R&D project. This would seem to require a chance or possibility of exposure to commercial loss or other risk.

Where an eligible company performs R&D under contract for another person and does not bear the financial risk and does not have any entitlement to the results of that R&D, that company would not be entitled to claim a deduction under section 73B of the ITAA 1936 for the expenditure incurred in fulfilling its obligations under the contract. In this case the eligible company is Company A. Company A has registered under 39J of the IR&D Act 1986.

R & D activities are not specified in the Project Agreement nor specified in the definition of Expenditure. However the definition of 'Expenditure' in the Schedule does encompass expenses provided it is approved by the Committee.

Where Company A conducts activities outside of what is detailed in the approved programs, it is required to consult the Committee. As R & D activities do not form part of the Projects Management and Selling duties then as per the requirements consultation is necessary.

If negotiations with the Committee and Company A result in R & D approval then expenditure for these activities can be paid for and reimbursed.

Company A is paid a management fee. Company A is also named as exclusive seller its entitlements resulting from sales are outlined. Depending on the Lot settlements, the selling fee may vary within 1%. However, it is clear from the financial arrangements between Company A and Estate Development, that in the event of a financial loss, it will be Estate Development that will happen to bear the bulk of the financial loss in the form of losing its share of the sales income as well as the payments made to Company A as management fees and expenses.

Company A does not incur the financial risk for the R & D expenses as it has these expenses are either reimbursed or paid for directly by the Appointor. Company A does not bear any financial risk as it does not outlay any finances for R & D which are not reimbursed.

Where an eligible company, incurs R&D expenditure which is reimbursed by another entity suggests the eligible company is not bearing the financial risk in relation to the associated R&D activities. If this company lacked effective ownership of the results flowing from the R&D activities in question, then subsection 73B(9) of the ITAA 1936 will apply. Whether or not a section 73B deduction would be allowable to the entity providing the reimbursement would depend on its circumstances, including whether or not it was registered, and whether or not it had effective ownership of the results.

R & D activities are not specified in the Agreements. Nor are they specified in the definitions of Expenditure. However the definition of 'Expenditure' in the Schedule includes expenses approved by the Committee.

Should the R&D activities be considered part of the approved programs; Company A is required to manage them in accordance with its role as manager.

Company A must act in compliance with all obligations of the Appointor under the Contracts.

Expenditure includes the payments to be made regarding R&D activities. The Estate Development therefore, is the responsible entity for payment of the expenses for the R&D activities.

Company A is also named as exclusive seller for the Project. Depending on the Lot settlement of the land, the selling fee may vary within 1%.

In a publicly obtained document; Company A is named as the party compelled to undertake monitoring and surveying in regards to conservation. Financial contributions are also stated in this document, however, it is the 'Company Ys' responsibility to contribute financially to a government department.

From the information provided it is evident that while Company A is responsible for the management of the Project, which includes R&D activities, however, they are not financing the operation. Estate Development as Appointor is providing finance for expenses which include R&D activities.

Therefore, for the reasons cited above, it is considered Company A does not meet the financial risk limb of subsection 73(9) of the ITAA 1936.

Control

A company seeking to claim an R&D concession in relation to particular research and development activities must be able to demonstrate an appropriate degree of control over the conduct of the activities.

The R&D Guidelines state that essential elements of control of the conduct of research and development activities are:

· The ability to choose the project of the R&D;

· The capacity to decide on major changes of direction in those activities;

· The ability to stop an unproductive line of research;

· The scope to follow up (or not) an unexpected result; and

· The power to end a project.

In applying these guidelines to Company A's situation it is evident that while Company A is the responsible party for maintenance and management of the R&D project, it is the Committee and/or Appointor that are the decision maker/s of the Project, which include the R&D activities.

From inception, to proceed with the Project it was necessary for the Participants to agree with the terms outlined by the government due to various conservation reasons. As part of the agreement, Estate Development has paid $ for research and development to investigate. In addition Company A was directed to monitor and survey which is also the subject of this Ruling. Therefore there was no choice as to what the R&D project would be.

The Agreement is clear on the authority given to Estate Development's responsibilities and authority. Specifically, it is stated that Company A is appointed as project manager and exclusive selling agency; pursuant to Agreement;

The management directions provided and are similar to those written into the Project Agreement. Company A's R&D responsibilities are not provided, however it is very clear that should any action or event occur contrary to the Agreements, Company A must consult with the Appointor and/or the Committee. It is only after consultation with these parties that further action may proceed where agreement is reached to do so. Company A is unable to make decisions as to alter the Project, change direction or cease R&D activities.

It is acknowledged that Company A has control to engage and vary personnel working on the project. Company A also has the day to day control of the R&D Activities and associated budgets. It is Company A's responsibility to develop and implement the necessary information systems and processes to fulfil the Agreement. However this is only under the specifics of the contract and does not have authority to alter, vary or change Project details.

The R&D project plan for Estate Development details Company A as the group who will be undertaking the R&D activities. Included in the plan are the key resources allocated to the project where a strong environmental innovation flavour is present.

It is considered that Estate Development controls the R&D activities that Company A has been contracted to provide. The project agreement has not set the parameters for the R&D to be undertaken, however it has specified the management and selling duties which Company A is bound to follow. It is clear that should any change to the Project occur, the Committee and/or the Appointor must be consulted. The manner in which the program is executed also supports the conclusion that the ultimate control is in the hands of the Committee and/or the Appointor.

Ownership

A company seeking to claim the R&D concession must have effective ownership of the results of those activities.

Ownership does not necessarily require that the company must be the proprietor of a piece of intellectual property in any formal sense. It is possible for the formal owner of any resulting intellectual property to hold it on such terms that the company has all the advantages of ownership.

The Intellectual Property (IP) of the R&D Activities are not discussed or mentioned in any of the Agreements, Contracts or documents provided or obtained. Formal ownership of the IP is unclear.

While R&D activities are not specified in the Agreement, Company A as manager is responsible for undertaking commercial exploitation including promotion, marketing and of the project which may include the findings of the R&D activities. The extent of the exploitation is not stated.

Under the Agreement, Company A is not restricted from providing similar services to other entities and therefore Company A is free to exploit the functionality of the R&D activities developed in the course of the Project.

Company A is tasked with monitoring and surveying by the government department. The Agreement states specific research that Company A must pursue which includes complementing existing research and sharing data collections and methods consistent with other work.

While ownership of the R&D activities or IP is silent in this Agreement, the R&D plan states that knowledge management strategies will ensure that information will be retained.

It is expected that Company A has developed its technical knowledge in the course of carrying out the activities and will be able to use the results from this project to deliver new or improved solutions to other developments. It is also acknowledged that there are other parties able to exploit the IP, however, in reality as Company A is in the business of estate development and is the most likely to exploit the R&D findings.

As a result of the R&D Activities, Company A may be able to apply its acquired knowledge to future projects. It is also evident that other groups will ensure a knowledge management system of acquired data. However, Company A boasts excellence in the development of residential communities, environment and urban renewal. It is reasonable, therefore, to conclude that Company A will perpetuate the R&D results to current and future developments.

From the information provided and sourced it is clear that there have been a number of parties interested in the R&D activities. Company A has been required to source information, build on existing research, as well as share their findings with third parties regarding the R&D. It is accepted that Company A will utilise their knowledge base in future endeavours regarding the results of the R&D activities and therefore it is accepted that Company A has effective ownership of the results.

Conclusion

There are many stakeholders in the establishment of the Estate Development Project. While Company A is the manager and seller of the Project, it is Estate Development that provides the financial input and controls the overall scheme. Company A is in the business of estate development albeit with a strong urban renewal and conservation flavor.

It is acknowledged that Company A contributes to the R & D activities, however, for the purpose of meeting the requirements outlined in subsection 73B(9) of the ITAA 1936 it is concluded that Company A does not meet the on behalf of requirements. As such Company A will be unable to claim the R&D tax concession for the Estate Development.

Question 2

Is Company A eligible to claim the expenditure it has incurred in relation to the work it has undertaken under the R&D tax concession for the Estate Development on the basis that when the expenditure was incurred, Company A was at risk in respect of the expenditure, as required by subsection 73CA(5) of the ITAA 1936?

Detailed Reasoning

Section 73CA of the ITAA 1936 generally applies to reduce the amount of the expenditure claimable to 100% if the Commissioner is satisfied that the expenditure was incurred at a time when the company was not 'at risk' in respect of whole or part of the expenditure. Lack of "risk" is fundamental to the operation of sections 73C and 73D of the ITAA 1936.

The terms of the section indicate that its object, broadly speaking, is to preclude an eligible company gaining the benefit of an uplifted deduction they might otherwise be entitled to under section 73B of the ITAA 1936, where the relevant underlying expenditure is reasonably likely to be reimbursed, recouped or recompensed in some way.

Section 73CA(1) of the ITAA 1936 states;

For the purposes of interpretation, this section is be read and construed as if it were part of section 73B.

This means section 73B of the ITAA 1936 has effect subject to section 73CA which is to be read and construed as if it was part of section 73B. Therefore, as it has been determined that Company A does not met the requirements of subsection 73B(9), subsection 73CA is not relevant and Company A cannot meet the requirements of subsection 73CA(5).