ATO guidance on Commissioner’s discretion regarding ‘control’: impact on R&D Tax Incentive claimants

In brief

The Australian Taxation Office (ATO) issued Taxation Determination TD 2023/5 which provides guidance on how the Commissioner of Taxation may exercise discretion in determining whether one entity is controlled by another. This is relevant for a range of tax measures, including the research and development (R&D) incentive, that are based on the calculation of an entity’s aggregated turnover. In the R&D context, the aggregated turnover of a claimant will determine whether the entity is entitled to the refundable R&D tax offset which is widely used by start-ups and early-stage companies in Australia’s innovation ecosystem. 

In detail

The ATO’s release recently of TD 2023/5, which provides guidance on the Commissioner’s discretion in section 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997), has potential relevance for companies accessing the refundable R&D tax offset. 

The R&D tax incentive applies in the following ways:  

1. A refundable tax offset for R&D entities with aggregated turnover of less than $20 million, or 
2. A non-refundable tax offset for R&D entities with an aggregated turnover of $20 million or more. 

An R&D entity’s ‘aggregated turnover’ is calculated with reference to its annual turnover and the annual turnover of other entities, if any, that are ‘connected with’ or an ‘affiliate’ of the R&D entity.  ‘Connected with’ is based on the concept of control, as defined in section 328-125 of the ITAA 1997.  Accordingly, the concept of control is an important factor for determining whether the R&D entity can access the refundable R&D tax offset. 

For companies, control can be established by having rights to at least 40 per cent of the distribution of income, capital, or voting power. 

Where an entity has a control percentage of the R&D entity of between 40 per cent and no more than 50 per cent, and this does not reflect the actual relationship between the R&D entity and the other entity, the tax law gives the Commissioner the discretion to treat the entity as not being controlled by the other entity. However, TD 2023/5 emphasises that section 328-125(6) of the ITAA 1997 requires the Commissioner to positively conclude that there is actual control of the R&D entity by a third entity or entities. It is not sufficient to merely show that the R&D entity is not actually controlled by the entity that owns more than 40 per cent but less than 50 per cent. 

TD 2023/5 provides guidance on the following specific issues relating to the concept of ‘control’, which the ATO has had to consider in administering the Commissioner's discretion: 

• Requests for the Commissioner’s discretion to be exercised where a third entity has sole or primary responsibility for day-to-day management of the affairs of the entity, but holds relatively insignificant or no interests in the income or capital of the entity, or in shares carrying voting rights, and 
• Applicants suggesting that their control percentage interests of between 40 and 50 per cent should be disregarded because the remaining holders of interests in the entity will together necessarily control the entity, irrespective of their number or relationship to each other. 

According to TD 2023/5, the nature of control relevant to the Commissioner's discretion is control over the matters typically associated with ownership of a business entity, such as entitlements to income and capital, and participation in decision-making on key matters affecting the entity’s constitution, funding, structure and management. The latter would ordinarily include matters such as: 

• Decision-making on the composition and oversight of the management team 
• Amending the entity’s constituent documents 
• Deciding on capital and entity restructuring proposals, the issue of new ownership interests or winding up, and 
• Authorising significant changes in the direction of the entity’s business operations.

Control over the day-to-day management of the entity’s affairs, while not irrelevant, does not of itself constitute sufficient control to warrant the exercise of the Commissioner’s discretion. 

TD 2023/5 is not intended to cover all possible situations where the Commissioner’s discretion may be relevant and does not provide a definitive answer on the concept of control. The Commissioner's conclusion on control in each case will depend on ‘the specific facts and circumstances, and may require further consultation, or evidence from the entities involved’. 

The Determination contains several examples and is potentially a useful resource for business entities that are considering applying for the R&D tax incentive, or that are uncertain about which entities need to factor into their aggregated turnover calculation. It provides some clarity and transparency on how the Commissioner approaches the concept of control, and what factors are considered. However, it is not a substitute for seeking professional advice or contacting the ATO for more guidance on the application of the control tests and the Commissioner’s discretion. 

The takeaway 

This latest ATO guidance highlights the need for care when assessing which entities should be considered when calculating an R&D entity’s aggregated turnover, and thus its entitlement to the refundable R&D tax offset. Where the control percentage is between 40 per cent but less than 50 per cent, it may be appropriate to seek the Commissioner’s discretion, if it appears that the R&D entity could be controlled by another entity, as defined in the law. If you wish to discuss this in further detail, please contact us.