RSM flags common RDTI pitfalls for foreign companies

The process to claim Australia’s R&D tax incentive (RDTI) can be complex, RSM said, and incorrect documentation can jeopardise valid RDTI claims from foreign-owned companies.

“Incorrectly setting up the documentation and substance to the business, or incorrect characterisation of the R&D claim when the relevant integrity rules are not satisfied could permanently jeopardise an otherwise eligible R&D claim,” RSM warned.

The Australian government introduced the R&D tax incentive in order to boost the commercialisation of innovation in Australia, and attract R&D activities onshore to Australia.

In a discussion paper, the government noted that Australia had lower R&D intensity than other OECD countries. Australia’s gross R&D expenditure was 1.66 per cent of GDP in 2021–22, compared to the OECD average of 2.9 per cent. The report noted that this was an impediment to Australia’s productivity growth.

The Australian government has provided two distinct claim pathways for Australian owned (AORD) and foreign owned (FORD) entities.

Under the FORD pathway, a foreign claim for the RDTI offset must occur within an Australian company income tax return and ensure the Australian entity carrying out R&D gains commensurate benefits for conducting that R&D, RSM said.

As the Australian entity would absorb some of the R&D tax offset, the FORD pathway would reduce the refund available to the foreign entity.

When an inbound foreign company has established a longer-term investment in Australia with an Australian company, they may be able to access the AORD pathway and thus avoid reducing its RDTI refund.

This approach would require the Australian entity to be funded appropriately for the long-term, RSM said. The AORD pathway would have the added benefit of enabling expenditures incurred on linked overseas activities to be included in the RDTI claim.

The ATO assesses RDTI claims by foreign-owned companies primarily using the ‘by or for’ test, RSM explained. The test poses two key questions - for whom the R&D activities are being conducted, and are the activities being conducted for more than one entity.

In order to claim the RDTI, firms would have to adhere to both ‘positive limb’ requirements - that R&D activities were being conducted by, or for, an eligible entity - as well as ‘negative limb’ requirements that ensure that R&D activities were not being conducted for the significant benefit of multiple entities.

The two limbs do not represent a tiebreaker test. RSM warned that firms commonly made the error of overlooking the ‘negative limb’ requirements, rendering otherwise eligible claims unsuccessful.

When assessing who the R&D was being conducted ‘for,’ the ATO would consider which firm would be the major beneficiary of the resulting economic property, which would have the day-to-day strategic control over R&D activities, and which firm would be the major benefactor taking on the financial risk.

For foreign-own firms looking to claim the RDTI through the AORD pathway, RSM highlighted that regulators would investigate the substance of their economic operations in Australia in order to assess firms’ eligibility.

“The ATO stated that arrangements may in practice have a legal form that is inconsistent with the actual commercial substance of the arrangement between the entities, especially where there is little independent economic substance in Australia,” RSM said.

For successful AORD claims, RSM added that firms would have to demonstrate long-term equity funding in Australia and the presence of strategic decision-makers on the ground.

“Inbound R&D claimants must ensure that all RDTI claims substantially align with a realistic global analysis of activities, including the transfer pricing positions, and functional DEMPE analysis,” RSM said.

“Typically, successful claims would require a team of corporate tax, R&D advisers and transfer pricing experts working together given the complexity and uncertainties of this area.”