R&D Tax Incentive – Loans from Directors

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What Are Director Loans in R&D Claims?

A director loan occurs when a company borrows money from its directors or shareholders instead of securing financing from a bank or external lender. Many businesses use director loans to fund R&D activities, assuming these costs qualify under the R&D Tax Incentive.

However, the ATO applies strict rules when assessing R&D claims that involve related-party financing. If the loan does not meet the ‘at risk’ rule, the ATO may deny or significantly reduce your claim.

Why Director Loans Might Not Qualify for the R&D Tax Incentive?

The ‘at risk’ rule prevents businesses from claiming R&D expenditure where the financial risk is limited or eliminated. If a director loan is structured in a way that removes true financial risk, the ATO considers it ineligible.

Director loans can be flagged if they include:

Non-recourse loans – If repayment of the loan depends on the success of the R&D, the claim could be disqualified.
Forgiven loans – If a director or related entity forgives the loan, the expenditure is not truly at risk.
Circular funding arrangements – If funds are loaned with an expectation that they will return to the lender in some form, the ATO may disqualify the R&D claim.
R&D assets transferred to the lender – If intellectual property or developed assets revert to the lender in the event of default, the loaned funds were not genuinely at risk.

Common Red Flags in Director Loans

Non-recourse loans

A non-recourse loan is where the repayment depends entirely on the success of the R&D project. That means if the project fails, the company isn’t required to pay back the loan. The ATO sees this as a major red flag because there’s no real financial risk involved. If you only have to pay back the loan when things go well, it’s not truly at risk, and the claim could be denied. To stay compliant, loans should have genuine repayment terms, regardless of the R&D outcome.

Forgiven loans

If a director or related party lends money and then later decides to forgive the loan, the ATO won’t consider the expenditure as truly at risk. Essentially, if the company was never actually required to pay back the money, the loan wasn’t a real liability. This kind of arrangement can lead to the ATO rejecting R&D claims, as the funding wasn’t at true financial risk in the first place. Ensuring clear repayment terms from the outset is key to avoiding this issue.

Circular funding arrangements

Circular funding is when loaned funds end up back in the lender’s hands, either directly or indirectly. This can happen through complex financial arrangements where the money flows back to the lender in a way that nullifies any real financial risk. The ATO closely examines these structures, and if they suspect that the loan was just moving money around without actual risk, they will likely disallow the claim. Loans should have a clear financial structure where the company is genuinely obligated to repay the borrowed funds.

R&D assets transferred to the lender

If a company takes out a loan for R&D and later defaults, handing over intellectual property (IP) or assets to the lender as repayment, the ATO may view this as a risk-free arrangement. Essentially, the lender gets the benefit of the R&D without ever actually taking on any financial uncertainty. If assets developed through the R&D process automatically revert to the lender, the ATO might consider the loan as not truly at risk, making the claim invalid. To avoid this, businesses should ensure loan agreements don’t include automatic asset transfers in the event of non-payment.

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Why This Matters for Your Business

The ATO is increasingly scrutinising related-party transactions. If your R&D claim includes costs funded by a director loan, you need to ensure compliance to avoid:

Claim Reductions or Rejections – The ATO may disallow your R&D expenditure.
ATO Audits and Reviews – Non-compliant loans may trigger a full review of your R&D claim, leading to delays, adjustments, or penalties.
Cash Flow Disruptions – If you rely on the R&D rebate, a rejected claim can impact financial stability.

Real-World Example: ATO Ruling on Related-Party Non-Recourse Loans

A case outlined in ATO ruling TR 2021/5 provides a clear example of how these arrangements can lead to a denied R&D claim.

How the Case Unfolded

Little P, an Australian subsidiary of the multinational company Peradventure, borrowed $10 million from its parent company to fund software R&D. On paper, this seemed like a straightforward loan agreement, with terms requiring repayment over a set period. However, when closely examined, Little P lacked the financial independence needed to repay the loan without additional support from Peradventure.

As the R&D project progressed, it became clear that Little P would not be able to make its repayments. Eventually, the company defaulted, and as outlined in the agreement, all R&D assets, including intellectual property and research findings, were handed over to Peradventure. The loan was ultimately written off.

The ATO’s Decision

After reviewing the arrangement, the ATO ruled that the loan did not meet the ‘at risk’ requirement. Their reasoning was simple:

There was no realistic expectation that Little P would ever repay the loan.
The intellectual property and R&D outcomes were always going to revert to Peradventure, meaning the financial risk was essentially eliminated.
The loan functioned more as a mechanism to shift funds within the corporate group rather than a legitimate financial obligation.

Because the funds were not truly at risk, the ATO denied the entire $10 million R&D claim. This case serves as a clear warning—if an R&D loan is structured in a way that removes genuine financial risk, it will likely be rejected.

Read the full ATO ruling here.

How to Ensure Your R&D Loan Stays Compliant

If you’re funding R&D through a director loan, it’s essential to ensure compliance with ATO requirements to protect your R&D claim.

To avoid issues, consider the following:

Ensure the loan is at genuine financial risk – The company must be obligated to repay the loan, regardless of the outcome of the R&D project.
Structure loans properly – The loan should be documented with commercial terms, including a repayment schedule and an arm’s length interest rate.
Avoid circular or forgiven loans – Loans that lack real risk or that are repaid in a circular fashion may be flagged as ineligible.
Keep detailed documentation – Maintain full records of loan agreements, repayments, and how the funds were used in R&D activities.
Seek professional advice – Engaging experts in R&D tax compliance helps safeguard your claim and maximise your benefits.

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Don’t Let Compliance Risks Jeopardise Your R&D Claim

Example 1 – Structuring a $200,000 Director Loan for ATO Compliance

If you’re providing a $200,000 loan to your company to fund R&D activities, the ATO will closely scrutinise whether the funds are genuinely at risk. If the loan is structured informally or lacks evidence of real financial risk, your company’s R&D Tax Incentive claim could be denied.

To ensure the loan holds up under ATO review, it must be structured as a legitimate commercial debt, similar to what an independent lender would provide. Here’s how to set it up correctly:

Legally Binding Loan Agreement– The $200,000 loan must be documented in a written loan agreement that details the loan amount, repayment schedule, and commercial interest rate. The contract must clearly state that the loan must be repaid in full, regardless of the success of the R&D activities.
Commercial Interest Rate – The loan should carry a market-based interest rate, ensuring it’s not provided at a concessional rate that could indicate an artificial arrangement. A 6% annual interest rate is reasonable, aligning with standard business lending rates. If the interest rate is too low or missing, the ATO could argue that the loan was not a real financial liability.
Fixed Repayment Terms– The company must make structured repayments of $3,500 per month for five years. The repayments must be regular and not deferred indefinitely, as this would suggest the loan is not truly at risk.
Repayments From Business Revenue – The repayments must come from company earnings rather than new loans or fresh director contributions. If repayments come from another director loan, the ATO could disqualify the claim by arguing that the funds are being recycled rather than truly at risk.
Security Over Company Assets– To strengthen the loan’s legitimacy, the director may secure the loan against company assets. If the company defaults, the director should have a legal right to recover funds, similar to how a bank would.

Example 2 – Managing Circular Payments: Director Loans and Associate Salaries

One common issue arises when a director injects funds into the company, but the company is also paying a salary to the director or an associate. If not structured correctly, the ATO may argue this is circular funding, where money flows back to the lender instead of being truly at risk.

To avoid issues, the company must demonstrate clear separation between R&D salary payments and director loan repayments. Here’s how to set it up correctly:

Separate Salary and Loan Accounts – Ensure that salary payments to the director or an associate are made from a separate company account and not directly from loaned funds. This prevents the ATO from arguing that the loan funds are being indirectly returned to the director.
Repayments From Company Revenue, Not Loaned Funds – The company must repay the director loan using operational revenue rather than funds from new director contributions. If repayments come from fresh loans, the ATO may disqualify the R&D claim by arguing that the funds are not truly at risk.
Use a Delayed Loan Repayment Structure – Instead of repaying the director loan immediately, allow the company to first generate revenue before commencing repayments. This prevents repayments from overlapping with R&D salary payments, reducing the risk of circular funding concerns.
Ensure Salary Payments Are Reasonable and Justified – If a director or an associate is receiving a salary, ensure that it aligns with market rates for their role in the R&D project. Excessive salaries could raise ATO concerns about artificial arrangements.
Document the Source of All Payments – Keep clear records of where loan repayments and salary payments originate. This should include bank statements, payroll records, and financial statements showing that the company is repaying the loan using genuine business earnings, not recycling funds.

Example 3 – Startup Needing $200K Per Year While Paying an Associate Director

A common scenario occurs when a startup needs $200,000 per year to fund R&D activities but is also paying an associate director a salary of $100,000 per year. If not structured carefully, the ATO may question whether the director loan is truly at risk or if it is being cycled back through salary payments.

To ensure compliance and pass ATO scrutiny, the startup should consider structuring funding through equity instead of loans and rethink salary arrangements. Here’s how to make it work:

Issue New Shares Instead of a Loan – Instead of loaning $200,000 to the company each year, the director or investor subscribes for new shares. This ensures the funds remain in the business and eliminates concerns that the money will be repaid in a circular manner.
No Guaranteed Buyback – The investment must be at genuine financial risk, meaning there can’t be a pre-arranged share buyback or a director agreement to return the funds later.
Use Preference Shares for Controlled Returns – If the director wants some level of financial return, issuing preference shares with dividends (instead of debt) allows for controlled payments without breaching ATO loan risk rules.

By using an equity investment instead of a loan, the startup ensures that the funds are permanently at risk, avoids circular payment concerns, and strengthens its R&D Tax Incentive claim.

For startups where the director or an associate is also receiving a salary, the ATO will closely examine whether funds are being cycled back to the director. Here’s how to avoid this issue:

Defer Salary Until the Business Generates Revenue – Instead of drawing a $100,000 salary from company funds, the associate director could delay taking a salary until the business has a sustainable revenue stream.
Take Compensation as Equity Instead – Rather than salary payments, the associate director could be issued shares in the company to reflect their contribution. This reduces the risk of the ATO seeing director-funded salaries as circular funding.
Use a Lower Salary with Performance-Based Payments – If the associate director must take a salary, keeping it at a modest level (e.g., $50,000 instead of $100,000) and structuring additional compensation as future bonuses or dividends once the company is profitable can help strengthen the R&D claim.

An ATO assessor reviewing this case would likely raise concerns if:

The director is injecting $200,000 per year but immediately taking $100,000 back as salary, making the financial risk questionable
The loan agreement lacks clear repayment terms or repayments are made from fresh director contributions rather than business revenue.
The company lacks evidence of independent business operations, relying solely on director-funded salaries.

By restructuring funding through equity instead of loans and reducing or deferring salaries, the startup can strengthen its R&D Tax Incentive claim and avoid ATO scrutiny over circular payments.

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