Issue
Is an eligible company able to choose the research and development tax offset under section 73I of the Income Tax Assessment Act 1936 (ITAA 1936), where an exempt entity is the registered holder of all the shares in the company, but those shares are beneficially owned by an individual who is not an exempt entity?
Decision
Yes. The eligible company can choose the research and development tax offset under section 73I of the ITAA 1936 and will not be prevented from doing so because of the exception in subsection 73J(2) of the ITAA 1936.
Facts
The company is an 'eligible company' as defined in subsection 73B(1) of the ITAA 1936.
The company satisfies the conditions of eligibility to choose the tax offset under subsection 73J(1) of the ITAA 1936.
An exempt entity is the registered holder of all the shares in the company, and hence, the legal owner of those shares. The shares carry the right to exercise 100% of the voting power in the company, and the right to receive all distributions of income and capital.
The shares are 'interests' for the purposes of subsection 73J(2) of the ITAA 1936.
The exempt entity holds these interests on trust for an individual, who is not an exempt entity. Under this trust the individual is beneficially entitled to all income and capital distributions, and entitled to have the voting power in the company exercised as they direct.
The exempt entity, although the legal owner of the interests, cannot enjoy the benefits of them in any way, or dispose of them for its own benefit.
Reasons for Decision
An eligible company is able to choose a research and development tax offset under section 73I of the ITAA 1936 rather than a deduction. However, to choose the tax offset, the company must satisfy certain conditions under subsection 73J(1) of the ITAA 1936. Even though those conditions may be met, subsection 73J(2) of the ITAA 1936 excludes certain eligible companies from claiming the tax offset.
Under subsection 73J(2) of the ITAA 1936, an eligible company is not able to choose the tax offset for a relevant year of income if an exempt entity, the affiliates of an exempt entity, an exempt entity together with its affiliates, or two or more exempt entities, at any time during the year, legally or beneficially own, or have the right to acquire, the legal or beneficial ownership of:
interests in the company that carry between them the right to exercise or control the exercise of, at least 25% of the voting power in the company; or
interests in the company that carry between them the right to receive at least 25% of any distribution of income or capital by the company.
The exempt entity is the registered holder and legal owner of all of the shares in the company. However, the person who beneficially owns all of these shares is not an exempt entity. The question of whether subsection 73J(2) of the ITAA 1936 applies in such a case requires an examination of the purpose and context of the subsection.
The proper construction of subsection 73J(2) of the ITAA 1936 is determined by having regard to the context of the provision and the issue ( CIC Insurance Ltd v. Bankstown Football Club Ltd (1995) 187 CLR 384 at 408).
The broad purpose of the research and development tax offset is to provide a tax concession to eligible small companies, by enabling them to 'cash out' their otherwise deductible research and development expenditure (refer to paragraphs 5.4 and 5.5 of the Explanatory Memorandum to the Taxation Laws Amendment (Research and Development) Bill 2001).
However, some of these small companies may be owned by exempt entities, such as universities or other tax exempt research bodies. These not only receive the benefit of being tax exempt, but may also receive other forms of government support.
The purpose of subsection 73J(2) of the ITAA 1936 in this context, is to prevent such exempt entities from benefiting from ownership of an eligible company that might otherwise be able to cash out its research and development expenditure.
This does not explain though why subsection 73J(2) of the ITAA 1936 refers to the exempt entity either legally or beneficially owning the relevant interests, in contrast, for example, to the grouping rules in section 152-30 of the Income Tax Assessment Act 1997 , which refer only to beneficial ownership.
The explanation can be found in circumstances where it has been held that it is not possible to identify a beneficial owner (see for example Linter Textiles Australia Ltd (in liq) v. FC of T [2003] FCAFC 63; 2003 ATC 4458; (2003) 52 ATR 502, and the situation referred to in Taxation Determination TD 2000/27). Tests of control or ownership which refer only to beneficial ownership may therefore fail to operate appropriately in such cases.
It cannot be concluded therefore from this context, that subsection 73J(2) of the ITAA 1936 was intended to operate where both a legal owner and a separate beneficial owner can be identified. In such a case there would be no point denying the legal owner the benefit of the eligible company being able to choose the research and development tax offset, as it would be the beneficial owner only who could enjoy any benefit from this.
The relevant purpose of subsection 73J(2) of the ITAA 1936 then is to prevent an eligible company from being able to choose the tax offset if an exempt entity legally owns sufficient interests in the company, of the type in question, and there is no beneficial owner who can be identified. In such a case it will be the exempt entity as the legal owner who would, but for the subsection, be able to benefit. The better construction of the subsection is one that promotes this purpose (section 15AA of the Acts Interpretation Act 1901 (Cth)).
The beneficial owner of the relevant interests in the company can be identified and they are not an exempt entity. Therefore, the exception in subsection 73J(2) of the ITAA 1936 does not apply.
Accordingly, the company can choose the research and development tax offset under section 73I of the ITAA 1936.