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What is the R&D Tax Incentive?
The Research and Development (R&D) Tax Incentive is a government initiative designed to encourage businesses to invest in innovation. It offers tax benefits to companies that engage in qualified R&D activities, with the aim of fostering technological advancement and economic growth.
What is the R&D Rebate?
The R&D rebate is a tax offset for eligible R&D activities. The rebate rate depends on the profitability of the entity. For profitable entities, the rebate is calculated at 18.5%, while loss-making entities can claim a rebate of 43.5%. This rebate is aimed to lessen the financial burden and risk associated with investing in R&D activities.
Should You Set up a Separate Entity to House All Your R&D Costs?
A common question that arises is whether or not to set up a separate entity specifically for R&D activities. From an R&D rebate perspective, the answer is generally no. While creating a separate entity might be beneficial for intellectual property protection, it doesn’t necessarily provide additional tax benefits.
The reason is that you are essentially moving costs from one existing entity to another. The existing entity, now with reduced R&D costs, will show higher profits and thus attract more tax. From a group perspective, the overall tax benefit remains the same.
Worked Example with Detailed Explanation
Current Structure: Single Entity
In this scenario, Company 1 has an R&D expenditure of $100,000 and makes no profit.
R&D Costs: $100,000
Tax Deduction: $100,000 * 25% (Tax Rate) = $25,000
R&D Rebate: $100,000 * 43.5% = $43,500
Net R&D Rebate after Tax Deduction: $43,500 (Gross Rebate) – $25,000 (Tax Deduction) = $18,500
Overall Net Benefit: $18,500
The R&D costs are tax-deductible, which means that $25,000 would be subtracted from the company’s taxable income. Since the company makes no profit, this translates to zero tax payable.
The R&D rebate is 43.5% for loss-making entities, which equates to $43,500. However, the $25,000 tax deduction from the R&D costs should be considered. The net R&D rebate after accounting for the tax deduction becomes $18,500.
Proposed Structure: Two Separate Entities
In this scenario, Company 1 shows a profit of $100,000 with zero R&D costs, while Company 2 has R&D costs of $100,000 but makes no profit.
R&D Costs: $0
Tax Payable: $100,000 * 25% = $25,000
R&D Costs: $100,000
Tax Deduction: $100,000 * 25% = $25,000
R&D Rebate: $100,000 * 43.5% = $43,500
Net R&D Rebate after Tax Deduction: $43,500 – $25,000 = $18,500
Net Benefit across the two entities: $18,500 (Net R&D Rebate of Company 2) – $25,000 (Tax Payable of Company 1) = -$6,500
However, if you view them collectively, the net benefit of having two separate companies would still equate to $18,500 when you consider just the R&D rebate for Company 2. The only difference is that now Company 1 has to pay tax on its profits, which is $25,000.
In both examples, the net R&D rebate after accounting for the tax deduction is $18,500, underscoring that from an R&D rebate perspective, setting up a separate entity does not provide additional tax advantages.
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Why Do Companies Set Up a Separate R&D Entity Anyway?
While setting up a separate entity specifically for R&D activities may not always maximise your R&D tax rebate, there are strategic reasons businesses choose to go this route. Here are some of the most common:
Creating a separate R&D entity can help isolate and protect intellectual property (IP). For instance, if your main business revolves around retail but you’re developing proprietary software, housing that software in a separate entity can protect it from any financial or legal issues that may affect your retail operations.
Example: A health tech company develops a novel diagnostic algorithm. By placing this IP in a separate entity, it becomes easier to license, sell, or enforce rights, without affecting the main company’s operations.
Companies may plan to spin off the R&D entity into an entirely separate business in the future.
Example: A transport company develops vehicle tracking software that has wider applications beyond just their core business. By keeping this software in a separate R&D entity, the company can later white-label it to competitors or even spin it off into a full-fledged software company.
Different investors may be interested in the technology or innovation coming out of the R&D entity but may not want to get involved with the trading side of the original business. A separate R&D entity makes it easier to bring in technology-focused investors.
Need for Cash
Innovation often requires a significant infusion of cash. A separate R&D entity can make it easier to attract investment without affecting the financial structure or valuation of the primary business.
While not a corporate partnership in the traditional sense, a separate R&D entity can also facilitate strategic collaborations with other companies.
Example: A fintech startup and a legacy bank might both see the potential in a new blockchain technology. By contributing their IP to a separate, jointly-owned R&D entity, each can share in the R&D costs and later, the profits, without having to merge their main businesses.
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Key Considerations for Transferring Costs
If you’re planning to establish a separate entity for R&D activities regardless of the rebate complexities, it’s often with strategic aims like altering ownership structures or preparing for a spin-off. However, this move comes with specific intricacies you should consider, particularly in relation to transferring R&D costs between entities.
Eligibility After Establishment
Firstly, remember that only costs incurred post-establishment of the new entity are eligible for the R&D rebate. If the initial entity bears R&D costs intending to transfer them later, these expenses won’t qualify for the rebate in the new entity. Ensure all eligible costs are properly incurred and accounted for by the new entity after its establishment.
Actual Payments Versus Loans to Associates
Transferring costs between your original company and the new R&D entity can bring about eligibility issues if not managed correctly. Specifically, costs must be actually paid by the new entity to be eligible. Payments to associates, such as a loan agreement between your existing company and the new R&D entity, don’t qualify for the R&D rebate. This issue is particularly relevant when considering payments to related companies, where a cash basis rather than an accrual basis is essential for rebate eligibility.
Cash Basis Over Accrual for Payments to Associates
In the case of payments to associates like related companies, thinking on a cash basis is crucial. While accrual accounting might indicate that an expense has been “incurred,” for R&D rebate purposes, what’s important is the actual cash transaction between the entities. Implied or constructive payments are not sufficient in this case; the transaction must be finalised in cash terms to qualify for the rebate.
Navigating the Complexities: Why Choose Bulletpoint?
Embarking on the journey of setting up a separate R&D entity comes with a labyrinth of intricacies and challenges. While the benefits of IP protection, investor attraction, and future growth opportunities are enticing, the complexities around R&D rebates and tax implications can be daunting.
You don’t have to go it alone.
At Bulletpoint, we’re not just consultants; we’re experts in R&D tax incentives with a decade of experience. Our track record speaks for itself with over 500 successful R&D lodgements and a history of successful defences against both ATO and AusIndustry reviews and audits. But don’t just take our word for it; we’re proud to have an average rating of 4.8 stars from over 250 Google reviews.
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If you’re grappling with the decision of whether to set up a separate R&D entity, now is the time to seek expert advice.
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Don’t leave your R&D tax incentive benefits to chance. Choose Bulletpoint. We’re ready to guide you with a blend of professionalism and personality, ensuring your experience with us is not just successful, but enlightening.
The 43.5% R&D rebate is a tax incentive for loss-making entities to encourage research and development activities in Australia.
Setting up a separate entity doesn’t automatically improve your eligibility for the 43.5% R&D rebate, but it can align with other business strategies.
No, only costs incurred post-establishment of the new entity are eligible for the rebate.
Think about timing, eligibility requirements, and the actual payment of costs to ensure you maximise your R&D rebate.
For payments to associates like related companies, the rebate is calculated on a cash basis.
No, loans to associates are not eligible; only actual payments qualify.
No, the 43.5% R&D rebate is specifically for loss-making entities; profitable companies can claim an 18.5% rebate.
No, setting up a separate entity is not necessary for claiming the rebate and can complicate the process.
The most common mistake is transferring costs incurred by the existing entity to the new one, which are not eligible for the rebate.
Myths and Misconceptions
Fact: Creating a separate entity doesn’t automatically make you eligible for a higher rebate. The calculation is the same whether the R&D is performed in a single or multiple entities.
Fact: Only eligible costs incurred by the separate R&D entity after its establishment can be claimed for the R&D rebate.
Fact: Inter-company loans don’t count. For payments to associates like related companies, the rebate is calculated on a cash basis, not accrual.
Fact: The same strict eligibility criteria apply, whether you’re a single entity or a group of companies.
Fact: There is no one-size-fits-all strategy; setting up a separate entity may align with broader business goals but not necessarily offer R&D tax benefits.
Fact: While a separate entity can offer IP protection, this doesn’t impact the R&D rebate you’re eligible for.
Fact: Eligibility is based on the type of R&D activities, not where they are housed. Costs must meet specific criteria to be eligible.
Fact: Only costs incurred after the establishment of the new entity can be considered for the R&D tax incentive.
Fact: The separate R&D entity must be actively engaged in eligible R&D activities, not just serve as a holding company for costs.
Fact: While it can serve broader business strategies, it can also introduce complexities around eligibility and claiming of the R&D rebate.