Article by Ms Anne-Marie Perret, Advisor to high growth companies, Board Member & Investor
This article is the second of three on the factors and changes in the innovation system post the National Innovation and Science Agenda, particularly in relation to tax issues, and the impact on CRCs. The first article focused on how to leverage the R&D tax incentive to encourage collaboration with industry. This second article will focus on the R&D tax incentive implications for CRC’s spinning out IP into a corporate entity.
The R&D Tax Incentive program offers two core components:
- a 43.5% to eligible entities with an aggregated turnover of less than $20 million per annum for expenditure on eligible research and development activities, unless the entity is controlled by tax exempt entities (ie 50% or greater). Where the company is in losses or the amount of the offset exceeds the amount of the tax that the company would have had to pay in the income year of the claim then the excess is refundable.
- a 38.5% to all other eligible entities (including those controlled by tax exempt entities) for expenditure on eligible research and development activities. Unused offsets may be carried forward for use in future years.
The assumptions implicit in this article are that the:
- IP is spun out into an eligible R&D entity, being a company that is a tax paying entity; and
- R&D entity will be undertaking eligible R&D activities.
Aggregate Turnover Test
Aggregated turnover is the sum of the annual turnover for all of the R&D entity, any entity connected with the R&D entity and any entity affiliated with the R&D entity (Connected Entity Rules). Any dealings between these entities are excluded.
Under the R&D Tax Incentive legislation to be eligible for the 43.5% refundable tax offset a company must have an aggregate turnover over of less than $20 million. Companies with an aggregate turnover of greater than $20 million are eligible for the 38.5% non-refundable tax offset. In order to calculate the aggregate turnover consideration has to be given, not only to the company’s turnover but also, to the turnover of associated entities. Where an entity has a 40% or greater shareholding in the R&D entity, the other entity’s turnover must be aggregated with that of the R&D entity to calculate turnover. The potential application of the aggregated turnover rules is illustrated in the following examples:
- One shareholder owns more than 40% of shares in the R&D entity, therefore that shareholder’s turnover would need to be aggregated with the R&D entity’s to determine whether the R&D entity breached the $20million turnover threshold.
- There are several unrelated shareholders each with an individual holding of less than 40% each in the R&D entity but a together their combined shareholding is greater than 40% in the R&D entity. As long as all parties are unrelated, their turnovers will not need to be aggregated with the R&D entity’s. Therefore, as long as the R&D entity’s turnover remains less than $20 million, the R&D entity will not breach the $20 million threshold.
- There are several potentially related parties with shareholdings in the R&D entity that individually are less than a 40% ownership but if combined will result in a shareholding of greater than 40% in the R&D entity. These parties may be required to aggregate their turnover with the R&D entity depending upon the degree of affiliation or connection between these related parties (Connected Entity rules).
Tax Exempt Entity ownership
Where an R&D entity is controlled 50% or greater by tax-exempt entities, being one or more tax-exempt entities, the entity fails the threshold test for the 43.5% tax credit. That is, regardless of turnover, the R&D entity is only entitled to claim the 38.5% tax credit. To work out whether one or more exempt entities control your R&D entity, you must apply the Connected Entity rules, but adopt 50% as the control percentage, instead of 40%.
Likely Scenario for new R&D entity
At the time of incorporation the R&D entity is 100% owned by the CRC, the Tax Exempt Entity Ownership rules will apply and thus the entity will be eligible for the 38.5% non-refundable tax credit as the entity will have no income at this stage this tax credit will be carried forward as a loss.
When further investment is obtained it will be important to examine the impact of the shareholdings and new structure to determine entity’s position against both the Aggregated Turnover rules and the Tax Exempt Ownership Rules.
If and when the shareholdings of the tax exempt entity shareholders fall below 50% stipulated by the Tax Exempt Entity ownership rules, the R&D entity may become eligible for the 43.5% refundable tax credit as long the Aggregated Turnover Rules do not apply to the tax paying shareholders to keep the entity above the $20 million threshold.
If the R&D entity is eligible for the 43.5% refundable tax credit and has an eligible expenditure on R&D activities, the R&D entity would receive a tax credit, to the extent that R&D entity is in losses, as a refund from the ATO after lodgment of its income tax return. By way of example if the R&D entity spends $1 million on eligible expenditure, the tax credit will be $435,000, if the R&D’s entity’s losses exceed this amount the $435,000 will be received from the ATO as a refund.
The different impact arising from the refundable versus the non-refundable tax credit is just one consideration to take into account when determining the best approach to the establishment, in terms of both structure and timing, of an entity to commercialise the CRC’s IP.