Edited version of private advice

Authorisation Number: 1012598758337

Ruling

Question 1

Has Entity A incurred expenditure on R&D activities for the purposes of section 355-205 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of invoices issued by Entity B as trustee for the Family Trust during the income year ended 30 June 2013?

Answer

No.

Question 2

Is Entity A an associate of Entity B for the purposes of section 318 of the Income Tax Assessment Act 1936 (ITAA 1936) where Entity B acts in the capacity of trustee for the Family Trust?

Answer

Yes.

Question 3

Is Entity A an associate of Entity C for the purposes of section 318 of the ITAA 1936?

Answer

Yes.

Question 4

Is Entity A an associate of DE Partnership for the purposes of section 318 of the ITAA 1936?

Answer

Yes.

This ruling applies for the following period:

Income tax year ended 30 June 2013.

The scheme commences on:

1 July 2012.

Relevant facts and circumstances

Entity A has registered R&D activities under section 27A of the Industry Research & Development Act 1986 (IR&DA 1986).

Entity A has a commercial understanding whereby supporting R&D activities are undertaken on its behalf by Entity B as trustee of the Family Trust. The commercial understanding is not formally expressed in writing in any trade or commercial agreement but has existed since 2XXX. The only parties to the commercial understanding are Entity A and the Family Trust. The commercial understanding would only come to an end if the commercial activity of both or either of the parties were to change.

The Family Trust can invoice Entity A under the commercial understanding as soon as work is performed and completed. Family Trust will usually close work order jobs the month following the month when the work was completed.

Due to common ownership, Entity A is under no obligation to pay invoices issued under the commercial understanding by the Family Trust. All invoices are recorded on the relevant debtor and creditor accounts which are transferred to the inter-entity loan accounts at the end of each financial year.

Entity A has the option under the commercial understanding, if it has sufficient funds available, to pay invoices issued under the commercial understanding by the Family Trust. However, the Family Trust has never called for payment from Entity A.

The Family Trust is established by a deed titled Family Trust Deed and is appropriately dated.

Entity D holds 80% of the issued shares in Entity A.

Entity D and their spouse exercise control over all of the relevant entities referred to in the questions stated above.

Relevant legislative provisions

Income Tax Assessment Act 1936 51(1)

Income Tax Assessment Act 1936 318(1)

Income Tax Assessment Act 1936 318(1)(e)(ii)(A)

Income Tax Assessment Act 1936 318(2)

Income Tax Assessment Act 1936 318(2)(d)(i)(A)

Income Tax Assessment Act 1936 318(2)(f)

Income Tax Assessment Act 1936 318(3)

Income Tax Assessment Act 1936 318(3)(a)

Income Tax Assessment Act 1936 318(3)(b)

Income Tax Assessment Act 1936 318(4)

Income Tax Assessment Act 1936 318(4)(a)

Income Tax Assessment Act 1936 318(4)(b)

Income Tax Assessment Act 1936 318(6)(b)

Income Tax Assessment Act 1936 318(6)(c)

Income Tax Assessment Act 1997 8-1

Income Tax Assessment Act 1997 355-20

Income Tax Assessment Act 1997 355-205.

Reasons for decision

Question 1

Section 355-205 of the ITAA 1997 relevantly states that:

(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

(b) if the expenditure is incurred to the R&D entity's associate -- is paid to that associate during the present year.

The word 'incurred' in section 355-205 of the ITAA 1997 is not defined within the ITAA 1997. The word 'incurred' in section 355-205 of the ITAA 1997 has the same meaning as that ascribed to the word 'incurred' in section 8-1 of the ITAA 1997.

Taxation Ruling TR 97/7 Income Tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7) sets out in detail the view of the Commissioner of Taxation on whether an outgoing is 'incurred' for the purposes of section 8-1 of the ITAA 1997. TR 97/7 provides that a taxpayer incurs an outgoing at the time that they owe a present money debt that they cannot escape. In incurring an outgoing a taxpayer need not actually have paid any money provided that the taxpayer is definitively committed in the year of income. A loss or outgoing may be incurred even though it remains unpaid provided that the taxpayer is 'completely subjected' to the loss or outgoing. That is, it must be a presently existing liability to pay a pecuniary sum, even though the liability may be defeasible by others and even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation. Whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise.

The High Court of Australia considered the meaning of 'incurred' in section 51(1) of the Income ITAA 1936 which was the predecessor to section 8-1 of the ITAA 1997 in a number of decisions, including: Commissioner of Taxation (Cth) v James Flood Pty Ltd (1953) 88 CLR 492, Nilsen Development Laboratories Pty Ltd v Commissioner of Taxation (Cth) (1981) 144 CLR 616 and Coles Myer Finance Ltd v Commissioner of Taxation (1993) 176 CLR 640.

Furthermore, the meaning of 'incurred' in section 8-1 of the ITAA 1997 has been considered in a number of decisions, including: Malouf v Federal Commissioner of Taxation (2009) 174 FCR 581, Commissioner of Taxation (Cth) v CityLink Melbourne Ltd (2006) 228 CLR 1 and Transurban City Link Ltd v Commissioner of Taxation (2004) 135 FCR 356.

The meaning of 'incurred' in the R&D context has been considered in recent times by the Administrative Appeals Tribunal in a number of decisions, including: Outbound Logistics Pty Ltd v Federal Commissioner of Taxation [2012] AATA 899, Hadrian Fraval Nominees Pty Ltd v Federal Commissioner of Taxation [2013] AATA 127, Ozone Manufacturing Pty Ltd v Federal Commissioner of Taxation [2013] AATA 420, Vision Intelligence Pty Ltd and Commissioner of Taxation [2013] AATA 527 and Desalination Technology Pty Ltd v Federal Commissioner of Taxation [2013] AATA 846.

The Commissioner is not satisfied that Entity A would owe a present money debt that they cannot escape or have a presently existing liability to pay a pecuniary sum as a result of any invoice issued under the commercial understanding with the Family Trust. The Commissioner is therefore not satisfied that Entity A would incur an amount as a result of invoices issued to it by the Family Trust under the commercial understanding for the purposes of section 355-205 of the ITAA 1997.

The conclusion that any invoice issued by the Family Trust under the commercial understanding would not result in Entity A incurring an amount is not dependent upon any assessment as to whether or not the amount invoiced arose in relation to R&D activities as defined in section 355-20 of the ITAA 1997.

In the event the Commissioner were satisfied that any invoice issued by the Family Trust under the commercial understanding could result in Entity A incurring an amount, then it would be necessary to determine whether any amount arose in relation to R&D activities before concluding that it was incurred for the purposes of section 355-205 of the ITAA 1997.

Question 2

Whether an entity is an associate of a trustee is determined by subsection 318(3) of the ITAA 1936 which relevantly states:

(3) For the purposes of this Part, the following are associates of a trustee (in this subsection called the primary entity):

(a) any entity that benefits under the trust;

(b) if a natural person benefits under the trust--any entity that, if the natural person were the primary entity, would be an associate of that natural person because of subsection (1) or because of this subsection;

(c) if a company is an associate of the primary entity because of paragraph (a) or (b) of this subsection--any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or because of this subsection.

Clause X of the Family Trust Deed provides that the beneficiaries of the Family Trust include Entity D. As Entity D benefits under the Family Trust he is an associate of the Family Trust due to the operation of paragraph 318(3)(a) of the ITAA 1936.

Paragraph 318(3)(b) of the ITAA 1936 operates where a natural person benefits under a trust so that any other entity which would be an associate of that natural person due to the operation of subsection 318(1) of the ITAA 1936 is also an associate of the trust for the purposes of subsection 318(3) of the ITAA 1936.

Subsection 318(1) of the ITAA 1936 relevantly states:

(1) For the purposes of this Part, the following are associates of an entity (in this subsection called the primary entity) that is a natural person (otherwise than in the capacity of trustee):

(a) a relative of the primary entity;

(b) a partner of the primary entity or a partnership in which the primary entity is a partner;

(c) if a partner of the primary entity is a natural person otherwise than in the capacity of trustee-the spouse or a child of that partner;

(d) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

(e) a company where:

(i) the company is sufficiently influenced by:

(A) the primary entity; or

(B) another entity that is an associate of the primary entity because of another paragraph of this subsection; or

(C) another company that is an associate of the primary entity because of another application of this paragraph; or

(D) 2 or more entities covered by the preceding sub-subparagraphs; or

(ii) a majority voting interest in the company is held by:

(E) the primary entity; or

(F) the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the preceding paragraphs of this subsection; or

(G) the primary entity and the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and because of the preceding paragraphs of this subsection.

Whether an entity holds a majority voting interest in a company is determined by paragraph 318(6)(c) of the ITAA 1936 which relevantly states:

(a) an entity or entities hold a majority voting interest in a company if the entity or entities are in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

Entity D holds a majority voting interest in Entity A which satisfies the requirements of paragraph 318(6)(c) of the ITAA 1936. Entity A is therefore an associate of Entity D due to the operation of sub-subparagraph 318(1)(e)(ii)(A) of the ITAA 1936.

Entity A is an associate of Entity B as trustee of the Family Trust due to the operation of paragraph 318(3)(b) of the ITAA 1936.

Question 3

Whether an entity is an associate of a company is determined by subsection 318(2) of the ITAA 1936 which relevantly states:

(2) For the purposes of this Part, the following are associates of a company (in this subsection called the primary entity):

…

(b) another entity (in this paragraph called the controlling entity) where:

(i) the primary entity is sufficiently influenced by:

(A) the controlling entity; or

(B) the controlling entity and another entity or entities; or

(ii) a majority voting interest in the primary entity is held by:

(A) the controlling entity; or

(B) the controlling entity and the entities that, if the controlling entity were the primary entity, would be associates of the controlling entity because of subsection (1), because of subparagraph (i) of this paragraph, because of another paragraph of this subsection or because of subsection (3);

…

(a) any other entity that, if a third entity that is an associate of the primary entity because of paragraph (d) of this subsection were the primary entity, would be an associate of that third entity because of subsection (1), because of another paragraph of this subsection or because of subsection (3).

Whether a company is sufficiently influenced by an entity or entities is determined by paragraph 318(6)(b) ITAA 1936 which relevantly states:

(b) a company is sufficiently influenced by an entity or entities if the company, or its directors, are 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 entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); and

Entity C is sufficiently influenced by Entity D as the company is accustomed or might reasonably be expected to act in accordance with his directions, instructions or wishes. As Entity C is sufficiently influenced by Entity D he is an associate of Entity C due to the operation of sub-subparagraph 318(2)(d)(i)(A) of the ITAA 1936.

As explained above, whether an entity holds a majority voting interest in a company is determined by paragraph 318(6)(c) of the ITAA 1936 which relevantly states:

(c) an entity or entities hold a majority voting interest in a company if the entity or entities are in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

As also explained above, Entity D holds a majority voting interest in Entity A which satisfies the requirements of paragraph 318(6)(c) of the ITAA 1936. Entity A is therefore an associate of Entity D due to the operation of sub-subparagraph 318(1)(e)(ii)(A) of the ITAA 1936.

Entity A is an associate of Entity C due to the operation of paragraph 318(2)(f) of the ITAA 1936.

Question 4

Whether an entity is an associate of a partnership is determined by subsection 318(4) of the ITAA 1936 which relevantly states:

(4) For the purposes of this Part, the following are associates of a partnership (in this subsection called the primary entity):

(a) a partner in the partnership;

(b) if a partner in the partnership is a natural person-any entity that, if that natural person were the primary entity, would be an associate of that natural person because of subsection (1) or (3);

(c) if a partner in the partnership is a company-any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or (3).

As Entity D is a partner in the partnership of DE Partnership he is an associate of the DE Partnership due to the operation of paragraph 318(4)(a) of the ITAA 1936.

Paragraph 318(4)(b) of the ITAA 1936 operates where a natural person is a partner in a partnership so that any other entity which would be an associate of that natural person due to the operation of subsection 318(1) of the ITAA 1936 is also an associate of the partnership for the purposes of subsection 318(4) of the ITAA 1936.

As explained above, whether an entity holds a majority voting interest in a company is determined by paragraph 318(6)(c) of the ITAA 1936 which relevantly states:

(c) an entity or entities hold a majority voting interest in a company if the entity or entities are in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

As also explained above, Entity D holds a majority voting interest in Entity A which satisfies the requirements of paragraph 318(6)(c) of the ITAA 1936. Entity A is therefore an associate of Entity D due to the operation of sub-subparagraph 318(1)(e)(ii)(A) of the ITAA 1936.

Entity A is therefore an associate of DE Partnership due to the operation of paragraph 318(4)(b) of the ITAA 1936.