What is an associate payment?
Are associate payments eligible for the R&D tax incentive?
For these expenses to be eligible for the R&D Tax Incentive, the payment must be made to the associate entity within the same income year the expenditure is incurred.
Who is an associate?
Under Australian tax law, an associate can refer to several types of relationships. It could be:
- Relatives: This includes spouses, children, parents, brothers, and sisters.
- Partner entities: This includes partners in a partnership and their spouses and children.
- Trustee-Beneficiary relationships: A trustee of a trust and any beneficiaries of the trust are considered associates.
- Companies and their directors or shareholders: A company and its directors or shareholders can be considered associates.
- Companies within the same group: Companies within the same group, i.e., a parent company and its subsidiary, are also typically considered associates.
- Act: Any person or entity that acts, or could reasonably be expected to act, according to the directions or wishes of the taxpayer or their associates.
In the context of the R&D Tax Incentive, an associate entity is usually a related company or individual who is conducting the R&D activities on behalf of the main entity or is involved in the R&D process in some way.
What are the rules around associate payments?
Payments to associates are a complex area of the R&D tax incentive legislation, and there are several rules that you need to consider:
- Actual Payment: The legislation requires an R&D entity to actually pay the amount to the associate within the same income year the expenditure is incurred for the expenditure to be eligible for the R&D tax incentive. It means that a commitment to pay (or constructive payment) alone is not sufficient, and an actual cash flow must occur.
- Eligible R&D Activities: The expenditure must relate to eligible R&D activities as defined under Australian law. It includes core R&D activities, which are experimental activities whose outcome cannot be known or determined in advance, and supporting R&D activities, which are directly related to the core R&D activities.
- Arms-Length Terms: The amount paid to the associate for the R&D activities must be in accordance with the “arm’s length” principle. This means that the payment terms should be similar to what would have been agreed upon if the transaction was between independent parties in similar circumstances.
- No Double-Dipping: The R&D entity cannot claim the R&D tax incentive for any amount that has been allowed as a deduction under any other provision of the income tax legislation.
- R&D Registration: The R&D activities must be registered with the Department of Industry, Science, Energy, and Resources before the R&D entity can claim the tax incentive.
These are general rules, and the specific circumstances of each case can significantly impact the eligibility for the tax incentive. It is strongly recommended to seek professional advice when dealing with payments to associates under the R&D tax incentive.
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Why do we care about associates?
The associate rules under the R&D tax incentive are primarily in place to ensure the integrity of the incentive and to prevent potential abuses of the system. There are two main concerns the rules address:
- Preventing Artificial Inflation of Claims: In the absence of clear rules around payment timing, companies could potentially manipulate the timing of contracts and payments to artificially inflate their eligible R&D expenditure in a given income year.
- Preventing ‘Round-Tripping’ of Funds: The rules aim to stop ’round-tripping,’ a process where a company makes a payment to an associated entity, which then returns the funds to the original company. The company could then potentially claim the R&D tax incentive on this expenditure, even though no actual R&D has occurred.
By requiring actual payment to associates within the same income year that expenditure is incurred, the rules aim to ensure that only legitimate R&D expenditure is claimed under the incentive. Moreover, the regulations help maintain the incentive’s credibility, ensuring its sustainability for supporting genuine R&D activities over the long term.
Will a journal entry suffice?
Under the R&D tax incentive scheme, the general rule is that merely incurring an expense (i.e., making a journal entry) is not sufficient for eligibility when it comes to associate payments. The legislation requires the actual payment to be made to the associate within the same income year as when the expenditure is incurred. This rule stands to ensure that legitimate R&D expenditure is being claimed and to mitigate risks of inflated R&D claims where no actual payment occurs.
So, even if you’ve recorded an expense in your books as a journal entry or as a loan to an associate, the R&D tax incentive claim can only be made when the actual cash payment has been made to the associate entity within the same income year. It’s advisable to consult with a tax professional or an R&D tax incentive consultant to fully understand these specific rules and ensure compliance.
Can I work around it with a two way loan agreement?
A two-way loan agreement involves a mutual commitment between two parties (entities) to lend and repay money. In the context of the R&D tax incentive, this could be an arrangement between an R&D entity and its associate (another entity).
In general, for expenditure incurred by an associate entity on behalf of the R&D entity to be eligible for the R&D tax incentive, the legislation requires the R&D entity to make an actual payment to the associate within the same income year that the expenditure is incurred. This is true even in the context of a two-way loan agreement.
Here’s an illustrative scenario:
Company A (the R&D entity) and Company B (an associate of Company A) enter into a two-way loan agreement. Company B incurs R&D expenditure on behalf of Company A and makes a payment to a third party for R&D services.
To make this R&D expenditure eligible for the R&D tax incentive:
- Company A must make an actual payment to Company B within the same income year that the expenditure was incurred, not just record a loan in their books.
- If the loan from Company A to Company B (to cover the R&D expenditure) is not repaid in the same income year, then the R&D expenditure would not be eligible for the R&D tax incentive in that year.
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Is the two way loan agreement the same for non-associates?
Two-way loan agreements between non-associate entities follow similar financial principles but are treated differently under the R&D tax incentive legislation. Here is an illustrative scenario:
Company A (R&D entity) and Company B (non-associate) enter into a two-way loan agreement. Company B incurs R&D expenditure on behalf of Company A and makes a payment to a third party for R&D services. The handling of this R&D expenditure for R&D tax incentive purposes would differ from the associate scenario:
Under R&D tax incentive rules, when the expenditure is incurred to non-associates, the ‘incurred’ date of the expenditure is recognised when the service is provided, not when the payment is made. This implies that even if Company A doesn’t make the actual payment to Company B within the same income year, the R&D expenditure may still be eligible for the R&D tax incentive, based on when the R&D service was provided.
The two-way loan agreement between Company A and Company B, in this case, is treated like any commercial loan agreement, where the terms of the agreement (e.g., interest rates, repayment schedule) are determined according to market conditions. These terms would not typically impact the eligibility of the R&D expenditure for the R&D tax incentive.
As always, it’s important to consult with a tax professional or an experienced R&D tax consultant for accurate advice, as the interpretation of the R&D tax legislation can be complex and subject to change.
Can I get an R&D loan to finance my associate payments?
In theory, an R&D loan could be used to provide funds for associate payments. It’s essentially a way to finance your R&D activities and manage cash flow, especially if you’re a startup or a small-to-medium enterprise.
Here’s how it could work:
- You apply for an R&D loan based on a future R&D tax claim. Lenders specialised in R&D financing can provide this type of loan based on the anticipated value of your R&D tax incentive.
- You receive the loan and use it to fund your R&D activities, including making associate payments within the same income year as the R&D expenditure.
- When you receive your R&D tax incentive from the government, you use it to repay the R&D loan.
However, it’s important to remember that taking on debt, including an R&D loan, has inherent risks. Always seek advice from a financial advisor or an R&D tax consultant before proceeding with this or any other significant financial decision.
Ineligible associate payments
Here are three examples of ineligible associate payments under the R&D tax incentive:
- Payment Not Made Within the Same Income Year: Company A incurs an expense in June 2023 due to an agreement for R&D services with an associated entity, Company B. However, Company A only pays Company B in January 2024. This payment would be ineligible for the R&D tax incentive in the 2023 income year because the actual payment to the associate did not occur within the same income year that the expense was incurred.
- Ineligible R&D Activities: Company A makes a payment to its associate, Company B, for activities that are supposedly for R&D. However, on review, the activities do not meet the eligibility criteria as defined by Australian R&D tax legislation. In this case, the expenditure would be ineligible for the R&D tax incentive.
- Round-Tripping of Funds: Company A pays an associate, Company B, for R&D services. Company B then returns the funds back to Company A without performing any R&D activities. This is an example of ’round-tripping’ of funds, which is explicitly considered ineligible under the R&D tax incentive.
Remember that these are simplified examples and the eligibility of R&D expenditure can be complex, with various factors at play. It is always advised to seek advice from a tax professional or an experienced R&D tax consultant.
What does at arms length refer to for associate payments?
The “arm’s length” principle is a fundamental element of Australia’s tax law. It stipulates that the conditions of the commercial or financial relations between associated entities should not differ from those that would be made between independent entities in comparable circumstances, undertaking comparable transactions.
In the context of the R&D Tax Incentive, this means that any expenditure incurred to an associate for R&D activities must reflect a price that independent entities would have agreed upon for the same transaction.
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What will the ATO do if they regard the payments at not arms length?
Where the arm’s length principle is not met, the Australian Taxation Office (ATO) may adjust the amount of the expenditure to reflect what would have been the arm’s length amount. This can result in a reduction of the R&D tax offset that the entity can claim.
In making these adjustments, the ATO takes into account various factors, including the nature of the R&D activities, the level of risk assumed by each party, the skills and expertise of the parties, the market conditions, and any other relevant factors.
Therefore, businesses must carefully document and substantiate their R&D transactions with associated entities, and ensure they are conducted at arm’s length. This can be particularly challenging, so businesses are often advised to seek professional advice in this area.
An example of a Non-arms length associate payment?
Company A engages Company B to perform certain R&D activities on its behalf. As part of the agreement, Company A will pay Company B a sum of $1,000,000 for the R&D services.
However, the market rate for such R&D services performed by an independent company (Company C, which is not an associate of Company A) is typically $600,000. In this scenario, despite the commercial agreement between Company A and Company B, the payment does not meet the “arm’s length” condition because it significantly exceeds the amount that would be payable in a comparable transaction between independent parties.
Therefore, if Company A claims the full $1,000,000 as eligible R&D expenditure, it may face scrutiny from the Australian Taxation Office (ATO), which may adjust the expenditure to the arm’s length amount of $600,000, reducing the R&D tax offset that Company A can claim.
How does the ATO know what are associate payments for the R&D tax incentive?
When a company lodges its income tax return, it should also complete an R&D Tax Incentive Schedule. This schedule details the R&D activities conducted during the income year and the associated expenditure incurred.
For associate payments, there are specific labels within the R&D Tax Incentive Schedule where these amounts should be reported:
- Label G: This label is where a company discloses the total amount of R&D expenditure to associates. This includes both actual payments made to associates and also amounts incurred but not yet paid (i.e., a liability to pay exists).
- Label H: This label discloses the amount of R&D expenditure to associates that has been paid during the income year. If the company has made a choice under the income tax law to only claim an R&D tax offset for amounts paid to associates, this is where those amounts would be disclosed.
Note that when reporting associate payments, you need to ensure that the expenditure is at arm’s length and that it is for eligible R&D activities. It’s also important to note that, under the R&D tax incentive, an R&D entity can only claim an R&D tax offset for amounts paid to associates if they are actually paid within the income year.
As the rules surrounding R&D tax incentives and associate payments are complex, it’s recommended that companies consult with a tax advisor or specialist to ensure correct reporting and compliance with the law.
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Are employees associates?
In the context of the R&D Tax Incentive, employees are generally not considered to be “associates” unless they fall under the specific criteria outlined in the income tax law. According to Section 318 of the Income Tax Assessment Act 1936, an associate can include a partner, trustee, company, or beneficiary, as well as family members of an individual or company.
Therefore, while employees can be considered associates if they are, for example, a spouse, parent, child, or sibling of the entity or if they hold a significant control over the entity (like a major shareholder), they are not typically considered associates merely by virtue of their employment status.
However, payments made to employees for their R&D activities can be included as eligible expenditure under the R&D Tax Incentive. This includes salary, wages, and other benefits provided to the employee in return for conducting R&D activities.
As always, these matters can be complex and case-specific. It is recommended to seek advice from a tax professional or legal advisor for a detailed understanding of your unique situation.
How do you identify if employees are associates?
The identification of employees as associates for the purposes of the R&D Tax Incentive is determined based on the guidelines laid out in Section 318 of the Income Tax Assessment Act 1936. Generally, employees are not considered associates merely by virtue of their employment status. However, they may be regarded as associates in the following scenarios:
- Family relationships: An employee may be an associate if they are a close family member (like a spouse, parent, child, or sibling) of the individual or the controlling individuals of the company.
- Significant control or influence: If an employee, in addition to their employment, holds a significant control or influence over the company, such as through a substantial shareholding, directorship, or partnership, they may be considered an associate.
- Trustees and Beneficiaries: If an employee is a trustee of a trust that the entity is a beneficiary of, or if the employee is a beneficiary of a trust that the entity is a trustee of, the employee could be considered an associate.
It’s important to note that the determination of whether an employee is an associate can be a complex process and will depend on individual circumstances. It’s recommended to seek advice from a tax professional or legal advisor to ensure compliance with the R&D Tax Incentive regulations.
The ATO looks at associate payments
A key area of focus in this compliance work is around payments to associates. This is due to the potential risks associated with these payments, including artificial inflation of R&D claims or the round-tripping of funds. To mitigate these risks, the ATO has implemented stringent regulations that require payments to associates to be made in the same income year that they are claimed.
The ATO uses sophisticated data matching techniques to identify and investigate potentially ineligible claims. If a company is found to be non-compliant, they may be required to repay the tax offset received, with penalties and interest charges potentially also applied.
To help companies understand their obligations, the ATO provides clear guidelines on its website and through its advice and guidance products. It also works closely with AusIndustry, which manages the registration of R&D activities, to ensure a coordinated approach to compliance.
For companies, maintaining compliance with these regulations is essential. This not only involves ensuring that all R&D claims are valid, but also that payments to associates are made in accordance with the rules. Engaging with a professional R&D tax consultant or tax advisor can be a prudent step to ensure that all requirements are being met.
How does the ATO know?
When a company lodges its tax return and claims the R&D tax incentive, the ATO matches the data against other parts of the tax return, such as the financials of related companies, to ensure that the information aligns. This includes scrutinising associate payments, which are a known area of risk in the R&D tax incentive.
If an R&D entity reports expenditure paid to an associate for R&D services, the ATO cross-checks this information with the associate’s reported income to verify that the payments were indeed made in the correct income year and that they align with the associate’s reported income.
This data matching process helps the ATO in identifying instances where companies might be artificially inflating their R&D expenditure through payments to associates, or where there might be a round-tripping of funds between associated entities where no genuine R&D activity is conducted.
It underscores the importance of accurate reporting and compliance with the rules of the R&D tax incentive scheme, especially in relation to associate payments. Businesses are therefore encouraged to seek professional guidance to ensure their R&D claims, including associate payments, are correctly reported and substantiated.
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Associates should keep good timesheets
Everyone who works on R&D should keep good timesheets but this is more so for associates. If you have employees who are considered associates in the context of the R&D Tax Incentive scheme, it’s important to be aware that their work on R&D activities should be appropriately recorded and substantiated.
The ATO scrutinises timesheets and job descriptions of associates involved in R&D activities to ensure the veracity of claims made under the R&D Tax Incentive scheme.
Timesheets provide quantifiable evidence of the hours associates have dedicated towards R&D activities, and job descriptions offer context regarding the nature of the work done, ensuring it falls within the scope of eligible R&D.
Both these elements help the ATO validate that the claimed R&D expenses are legitimate, directly related to R&D activities, and in compliance with the scheme’s rules and regulations. This thorough examination is part of the ATO’s responsibility to maintain the integrity of the R&D Tax Incentive scheme and ensure that it is utilised appropriately and fairly by entities undertaking genuine R&D work.
Associate Payment Checklist
Here’s a comprehensive checklist that R&D entities can use to ensure compliance with associate payments for the R&D Tax Incentive:
- Identify All Associates: Ensure that all associates involved in R&D activities have been identified. This includes employees, contractors, or entities with a controlling interest.
- Document R&D Activities: Keep meticulous records of the R&D activities conducted by each associate. This includes the nature of the work, the duration, and the results.
- Validate Arm’s Length Transactions: If associates are contractors, validate that the payment terms and conditions of the contract reflect an arm’s length transaction. This means that the payments are consistent with what would have been agreed upon had the parties been independent and dealing at arm’s length.
- Maintain Contractor Agreements: Maintain up-to-date and legally compliant contractor agreements. These agreements should clearly state the nature of the work, the remuneration, and the relation to the R&D activities.
- Keep Timesheets for Employees: For employees who are associates and involved in R&D work, maintain detailed timesheets. These should record the time spent on R&D activities and align with their job descriptions.
- Ensure Timely Payments: Make sure payments to associates are made within the same income year as when the R&D activities were carried out. This is crucial for these expenses to be eligible for the R&D tax incentive.
- Review Compliance Regularly: Regularly review your compliance with the associate payment rules as part of your overall R&D tax incentive governance. This ensures ongoing adherence to the legislation and can help identify any potential issues early.
Remember, the above checklist is a guide and does not replace the need for professional advice tailored to your specific circumstances. It is always recommended to consult with a professional R&D tax consultant or tax professional to fully understand your obligations and entitlements under the R&D Tax Incentive scheme.
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Frequently Asked Questions
Payments to associates refer to expenditures made to entities that have a close connection to the R&D entity, such as related companies, directors, or family members.
To ensure the integrity of the R&D Tax Incentive, it’s essential to confirm that payments to associates are for genuine R&D activities and are not artificially inflated.
For R&D tax purposes, a payment to an associate is only deductible when the amount is actually paid, not when it’s incurred.
The term “associate” is broadly defined and can include entities like relatives, partners, trustees of a trust estate where you or your associate benefit, or companies that control or are controlled by you.
It’s crucial to maintain proper documentation, like contracts, invoices, and proof of payment, to substantiate payments to associates for R&D activities.
Payments to overseas associates for R&D activities may be eligible, but they are subject to specific conditions and might require an Overseas Finding.
If the payment isn’t made within the income year, the expenditure might not be eligible for the R&D Tax Incentive for that year.
Payments to associate contractors for R&D services are subject to the same “at-risk” rule and need to be paid to claim the R&D Tax Incentive.
No, a mere promise to pay or a loan does not constitute an actual payment for the R&D Tax Incentive’s purposes.
The “at-risk” rule requires entities to bear the financial risk related to their R&D activities, ensuring that payments to associates are genuine and not a way to inflate R&D claims without bearing the actual economic risk.
It’s essential to resolve disputes promptly and maintain documentation of all communications and resolutions.
Yes, associates can contribute to R&D activities. However, payments made to them for such activities should be well-documented and substantiated.
Yes, it’s crucial that payments reflect the market value of the services or goods provided to ensure the integrity of the R&D claim.
Maintaining detailed records, contracts specifying the R&D work, timesheets, and evidence of actual payment can help substantiate the claim.
No, dividends or director fees are not considered genuine R&D expenditures and cannot be claimed under the R&D Tax Incentive.
Failing to substantiate payments can result in denied claims, penalties, and interest charges from the ATO.
Payments to associates, like other R&D expenditures, can be eligible for the R&D tax offset. The applicable rate will depend on the company’s aggregated turnover and other factors.
Yes, as long as the payment relates to the R&D activities conducted in a prior year, but it can only be claimed in the year the payment is made.
Only actual payments made to associates within the income year are eligible for the R&D Tax Incentive.
Companies can consult the ATO’s guidance or engage experts, like those at Bulletpoint, familiar with the intricacies of the R&D Tax Incentive process.