Understanding payments to associates

18 June 2024

Introduction 

Many businesses have links to, or relationships with, individuals, companies and other types of entities that meet the definition of ‘associates’. In circumstances where eligible R&D costs are being incurred to third parties in these categories, it is important for claimants and their advisors to be aware of the payments to associates rules, in section 355-480 of the Income Tax Assessment Act 1997 (ITAA 1997). 

This article explains the meaning of an associate and highlights some of the key issues of which R&D tax incentive claimants should be aware. A key point is that R&D expenditure incurred to associates should ideally be paid by the end of the financial year. 

What is an associate? 

The definition of an associate, as outlined in section 318 of the Income Tax Assessment Act 1936 (ITAA 1936), generally applies to an entity that, by reason of family or business connections, might appropriately be described as an associate of a company. Examples include:

• A partner of the company or the partnership in which the company is a partner
• Another entity that, either acting alone or with one or more other entities, sufficiently influences the company
• Another entity that, either individually or in combination with one or more associates, holds the majority of the voting power in the company
• A second company that is sufficiently influenced by the first company or by the first company’s associate
• A second company in which the majority of the voting power is held by the first company or by the first company’s associate. 
  

Some of the above connections are of an indirect nature, highlighting the need for appropriate care to be taken when identifying potential associates of a company. 

The phrase “sufficiently influenced” is addressed in subsection 318(6)(b) of the ITAA 1936: "a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities." 

How must payments to associates be treated? 

In a given financial year, it is acceptable to claim a notional R&D deduction for costs incurred to associates on eligible R&D activities as long as those costs do not exceed market value and have actually been paid during the year. If the costs are not paid during the year, R&D entities can either: 

• Claim a deduction under normal income tax provisions, forgoing a notional R&D deduction, or
• Don't claim a deduction under normal income tax provisions noting that the relevant amount will need to be added back at Label D of the Income Tax Return in the year the amount is incurred, then claim a notional R&D deduction in a subsequent year, when payment is made.

There are pros and cons to be considered when making the choice. By choosing the first option, R&D entities forgo the benefit that would arise from claiming an R&D notional deduction for that year and all future years. Choosing the second option may increase your company’s assessable income and tax liability for the year in which the amount was incurred (but not actually paid), but gives access to the R&D offset for that amount in a subsequent year when the amount is actually paid. The increase in your company’s assessable income and tax liability is effectively reversed in the year in which the R&D offset is actually claimed, being the year when the amount is paid.

Once the choice is made, it cannot be reversed through an amended Income Tax Return.