R&D tax offset - understanding affiliates and connected entities is key to getting your aggregated turnover calculation correct

12 November 2021

In brief

The concepts of aggregated turnover, connected entity and affiliate are important in determining the type of research and development (R&D) offset available to an R&D entity.  The determination of aggregated turnover can be a complex and time consuming exercise. Recently, the Australian Taxation Office (ATO) has issued four tax determinations to provide guidance to taxpayers when calculating their aggregated turnover.  

In detail

Relevance of aggregated turnover to the R&D tax offset

The type of R&D tax offset available to an R&D entity is determined by its annual aggregated turnover. If an R&D entity’s annual aggregated turnover is less than AUD 20 million, it is eligible for the refundable R&D tax offset, and if it is at AUD 20 million or more, it is eligible for the non-refundable R&D tax offset.

The term ‘aggregated turnover’ is defined in section 328-115 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) as the sum of the entity’s annual turnover and the annual turnover of any entities it is ‘connected with’ or that are its ‘affiliates’, less any specifically legislated excluded amounts. Therefore, in calculating an entity’s ‘aggregated turnover’ for an income year, it is necessary to determine which entities, if any, are ‘connected with’ or ‘affiliates’ of the R&D entity, calculate and then aggregated the annual turnover of those entities, and then determine whether or not the AUD 20 million threshold is exceeded. 

This article raises some of the issues to consider when determining aggregated turnover but it is not comprehensive. Additional information on the aggregated turnover concept, which is used as the threshold gateway to many other tax concessions, can also be found in this PwC Alert. This can be a complex question and if there is doubt, we recommend a thorough review.

‘Affiliate’

An affiliate, as defined in section 328-130 of the ITAA 1997, is ‘an individual or company that acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company’.

The ATO provides some limited guidance on when an affiliate relationship may exist, including examples. Indicators of an affiliate relationship tend to be less formal but are still fact-based, and may include:

• The existence of a close family relationship between the parties and
• The likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations.

It is important to note that the affiliate relationship is only relevant ‘in relation to the affairs of the business’. Therefore, a personal relationship - such as a familial one - may not necessarily create an affiliate relationship.

The definition of affiliate creates a circumstance where a relationship can be uni-directional - i.e. an entity can be your affiliate, because that entity acts in accordance with your directions or wishes, while you might not be that entity’s affiliate, because you do not act in accordance with the entity’s directions or wishes. It is also noteworthy that only an individual or company can be your affiliate. This means, broadly, that a trust can have affiliates, but it cannot be another entity’s affiliate. 

‘Connected with’

The definition of ‘connected with’ is provided by section 328-125 of the ITAA 1997. It focuses on the degree to which an entity controls or is subject to control by other entities (either directly or indirectly), as a result of shareholdings, voting rights and other means. 

If an entity is found to control, or to be controlled by, another entity, then the two entities are ‘connected with’ each other. If an entity is controlled by the same third party as another entity, then the entity is ‘connected with’ both the third party and the other entity.

For more types of entities (other than discretionary trusts), the relevant ‘control’ percentage for these purposes is 40 per cent, and it applies to any of the following:

• distributions of income
• distributions of capital, or
• if the entity is a company, the voting power.

• TD 2021/D2 regarding the application of the 'connected with' concept to partnerships, foreign hybrids and non-entity joint ventures
• TD 2021/D3 regarding the application of the 'connected with' concept to corporate limited partnerships, and
• TD 2021/D4 regarding the application of the public entity exception to the indirect control test.

Dealing with different accounting periods

As noted above, the aggregated turnover concept requires the R&D entity to identify entities connected with it and affiliates, and then calculate and aggregate the annual turnover of these entities. The ATO has recently provided guidance on determining aggregated turnover where a connected entity or an affiliate has a different accounting period to the R&D entity in Tax Determination TD 2021/7. The Tax Determination confirms that the annual turnover of each of these entities needs to be calculated relative to the 12-month period corresponding to the R&D entity’s income year. For example, if the R&D entity has an income year ending 30 June, the annual turnover of the connected entity(ies) and affiliate(s) will need to be calculated for the 12-month period from 1 July to 30 June, even though they may have a different accounting or tax period. This can add an additional layer of practical difficulty to the calculation of aggregated turnover, particularly in cases where the connected entities and affiliates are foreign entities that do not typically prepare accounts on a 30  June year end basis. 

The takeaway

An entity’s aggregated annual turnover is a key determinant of the benefit available under the R&D Tax Incentive, and this will remain with the new intensity rates taken effect for income years commencing on or after 1 July 2021. 

The absence of an immediate and direct link between two entities does not, by itself, mean that the two entities cannot be affiliates or are not connected with each other. Definitions of ‘affiliate’ and ‘connected with’ – which are fundamental to determining the aggregated turnover of any company – can be complex and warrant careful consideration by R&D Tax Incentive claimants and their advisers.