ATO guidance on R&D “at risk rule” finalised

7 February 2022

In brief

If an entity conducting research and development (R&D) or its associate receives, or expects to receive, consideration as a direct or indirect result of incurring expenditure on R&D activities, its notional R&D deductions are reduced as a result of the ‘at risk’ rule. The ‘at risk’ rule applicable under the R&D Tax Incentive law compares consideration with R&D expenditure and the effect may be to deny or reduce expenditure that can be claimed for purposes of calculating the R&D tax offset. The Australian Taxation Office (ATO) has now finalised its guidance on the wider application of the ‘at risk’ rule as well as in relation to JobKeeper payments.

In detail

On 22 December 2021, the ATO released the following final guidance on the application of the ‘at risk’ rule in relation to R&D Tax Incentive:

• TD 2021/9 - sets out the ATO’s position on the application of the rule to JobKeeper payments
• TR 2021/5 - provides guidance on determining whether in general terms the ‘at risk’ rule is triggered in respect of R&D expenditure. 

The JobKeeper Payment scheme created (among many other things) a requirement that R&D entities contemplate how it affected R&D Tax Incentive claims, when R&D employees were the subject of JobKeeper payments. The ATO’s preliminary view, set out in draft taxation determination TD 2020/D1, indicated that it expected claimants to treat JobKeeper payments received for R&D salary expenditure as ‘expenditure not at risk’ (in accordance with section 355-405 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)) and not treat the payment as a government grant. This view has continued in the ATO’s final position, set out in TD 2021/9. 

This means that where an R&D entity received JobKeeper payments and incurred wages expenditure on R&D activities, the portion of JobKeeper that relates to the R&D activities cannot be claimed as a notional deduction. Specifically, if an R&D entity received a JobKeeper payment:

• for its paid employees, the ‘at risk’ rule is triggered. Accordingly, the entity cannot notionally deduct the portion of its wage expenditure incurred on R&D activities that attracted the JobKeeper payment; or
• for an eligible business participant - i.e. an individual who is actively engaged in the operation of the business and is not an employee, such as a director or shareholder, where there is no wage condition to be satisfied for entitlement - the ‘at risk’ rule is not triggered. The entity is, therefore, not prevented from notionally deducting expenditure for having received a JobKeeper payment in relation to an eligible business participant.

The ATO has also finalised its guidance on the wider application of the ‘at risk’ rule. TR 2021/5 provides guidance on determining whether the ‘at risk’ rule is triggered in respect of R&D expenditure. The ‘at risk’ rule under section 355-405 of the ITAA 1997 compares consideration with R&D expenditure and may deny or reduce expenditure that can be claimed for the R&D tax offset. There are a number of examples provided in the Ruling.

To paraphrase section 355-405 of the ITAA 1997:

‘...(a) when an R&D entity incurs expenditure, the R&D entity or its associate had received, or could reasonably be expected to receive, consideration:

(i) as a direct or indirect result of the expenditure being incurred; and

(ii) regardless of the results of the activities on which the expenditure is incurred…’

Broadly, if the above conditions are satisfied, the R&D entity must reduce its R&D expenditure by the amount of the consideration. If the consideration is greater than the R&D expenditure, the R&D entity is prevented from deducting the expenditure.

Some key points that all potential R&D claimants should note from TR 2021/5 when  contemplating R&D claims are:

• Both the ‘nexus to expenditure’ test and the ‘regardless of results’ test must be satisfied for the ‘at risk’ provision to be triggered. 
• ‘Consideration’ is not confined to money and includes non-monetary benefits.
• The ‘at risk’ rule applies where a reasonable expectation of receiving consideration exists. The ‘reasonable expectation’ does not need to be in the form of a binding contract.
• The fact that consideration may also be received as a result of something other than the expenditure being incurred does not alter the conclusion that the consideration is received as a result of that expenditure being incurred. However, in order for there to be a ‘nexus to expenditure’, the R&D entity (or its associate) must have received, or have a reasonable expectation to receive, consideration at the time of incurring the expenditure.
• The ‘regardless of results’ test could be satisfied where consideration is received, or could reasonably be expected to be received, where the consideration depends only on:
  • incurring the expenditure 
  • conducting the activities on which the expenditure is incurred; or
  • supplying an effective ownership interest in the outcomes of the R&D activities, whatever those outcomes may be.

The takeaway

This latest, final ATO guidance highlights that there are a number of issues to take into account when assessing whether any ‘consideration’ an R&D entity has received, or will receive, affects its R&D notional deductions. Such assessments should be made when the R&D entity incurs the expenditure and also reviewed when preparing R&D claims. If you wish to discuss this in further detail, please reach out to one of our R&D Tax Incentive team members.