Federal Court decision: supporting R&D activities were conducted overseas

A recent Federal Court decision affirmed the Administrative Appeals Tribunal’s (AAT) decision that T.D.S. Biz Pty Ltd was not entitled to the research and development (R&D) tax offset for expenditure incurred on supporting R&D activities undertaken overseas. The company registered the R&D activities but did not disclose in the R&D Tax Incentive application form that some of these R&D activities were conducted in China, and no overseas finding had been obtained by the company in relation to these activities.

The Commissioner of Taxation had reduced the taxpayer’s refundable tax offset on the basis that the expenditure was not eligible, as it was incurred on overseas activities for which there was no overseas finding. A 50% administrative penalty was also imposed.

The taxpayer contended that the expenditure was eligible R&D expenditure on the basis that it was incurred on the acquisition of parts and components from China, which were used in undertaking the registered supporting activities conducted in Australia. The taxpayer asserted that the supporting activities were for the dominant purpose of supporting the core R&D activities, and as the supporting activities were undertaken in Australia, an overseas finding was not necessary.

The AAT found for the Commissioner on the basis that the expenditure did not consist of the mere supply of components but rather went beyond that, to activities undertaken overseas for which there was no overseas finding. It also upheld the 50% administrative penalty imposed by the Commissioner. 

The taxpayer appealed to the Federal Court. The Federal Court dismissed the taxpayer’s appeal on the basis that:

• The supporting R&D activities were conducted outside Australia, as these activities went beyond the mere supply of components. It followed that as the supporting activities were not covered by an Overseas Finding, the R&D expenditure incurred on those activities was not eligible to be claimed.
  
• There was no denial of procedural fairness in the approach taken by the AAT.

This decision may be relevant to R&D entities where their R&D activities utilise inputs sourced from overseas. The distinction between the supply of “off-the-shelf” components and the provision of services (such as design and manufacture) that result in components may not always be clear.

Key takeaways:

• It is important for claimants to understand the nature of the R&D expenditure (i.e. procurement of off-the-shelf components vs payment for services / R&D activity), especially if the expenditure is incurred to an overseas entity. The company should have contemporaneous documents to substantiate this, which can be in the form of invoices and written agreements.
• Plan in advance – where R&D activities are undertaken overseas, the associated costs can be included as eligible R&D expenditure only if specific conditions are met and a positive Overseas Finding is received. The finding application must be submitted before the end of the income year in which the overseas R&D activity is conducted.

Contact us if you would like to understand how this may impact on the eligibility of your R&D Tax Incentive claims, and what documentation you need to substantiate the positions you have taken.