1 Is entity A entitled to notionally deduct the licence fee that it settled during the 20XX-XX financial year?
1 Yes Question 2 Where the answer to question 1 is yes, will entity A's notional deduction entitlement for the 20XX-XX financial year be modified by either: a) the prepayment rules contained in section 82KZM of the Income Tax Assessment Act 1936 , or b) the 'expenditure not at risk' rule contained in section 355-405 of the Income Tax Assessment Act 1997 ? Answer 2 No This ruling applies for the following: Year ending 30 June 20XX The scheme commenced on: Year beginning 1 July 20XX
1. Entity A is an R&D entity under section 355-35 of the Income Tax Assessment Act 1997 (ITAA 1997). 2. The R&D activities of the Entity A have been registered under section 27A of the Industry Research and Development Act 1986. 3. Entity A and the Entity B are not associates for the purposes of section 318 of the Income Tax Assessment Act 1936 (ITAA 1936)1936. 4. Entity A is a 'small business entity' as defined by section 328-110 of the ITAA 1997. 5. On XX Month 20XX entity A entered into a perpetual license agreement with entity B for the use of entity B's intellectual property. 6. On the XX Month 20XX Entity B entered into a perpetual licence agreement with Entity A for the use of its intellectual property. 7. Each licence agreement stipulates that a licence fee is payable and determines a provisional consideration sum. 8. On the XX Month 20XX entity A recorded a payable invoice equal to the provisional consideration payable to Entity B and receivable invoice equal to the provisional consideration payable by entity B in its accounts.
9. Entity A uses the intellectual property licensed by entity exclusively in the delivery of its registered R&D activities. 10. Before to entering into the above licence arrangements, Entity A and Entity B considered offsetting obligations to the extent either party could not pay amounts owing via cash. 11. On XX Month 20XX Entity A recognised a set-off in relation to the invoice payable and invoice receivable (plus GST) in its accounts. 12. Later Entity A received a third party valuation for its intellectual property increasing the consideration payable by Entity B. 13. Later Entity B received a third party valuation for its intellectual property increasing the consideration payable by Entity A. 14. On XX Month 20XX Entity A recognised an increased receivable invoice in their accounts to reflect the license fee amendment in accordance with the valuation. 15. On XX Month 20XX Entity A recognised an increased payable invoice in their accounts to reflect the license fee amendment in accordance with the valuation. 16. On XX Month 20XX Entity A recognised two cash payments from Entity B in satisfaction of the license fee amendment.
17. On XX Month 20XX Entity A recognised a cash payment to entity B in satisfaction of the license fee amendment
Section 82KZM of the Income Tax Assessment Act 1936 Subsection 82KZL(1) of the Income Tax Assessment Act 1936 Section 8-1 of the Income Tax Assessment Act 1997 Section 318 of the Income Tax Assessment Act 1936 Section 355-405 of the Income Tax Assessment Act 1997 Section 355-35 of the Income Tax Assessment Act 1997 Section 355-205 of the Income Tax Assessment Act 1997 Section 328-110 of the Income Tax Assessment Act 1997
Question 1 Is entity A entitled to notionally deduct the licence fee that it settled during the 20XX-XX financial year? Summary Entity A is entitled to notionally deduct the license fee incurred to Entity B under Division 355 of the ITAA 1997 for 20XX-XX. Detailed reasoning Background - Incurrence - section 8-1 ITAA 1997 Section 8-1 of the ITAA 1997 provides that you can deduct from your assessable income any loss or outgoing to the extent that it is 'incurred' in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. While the term 'incurred' is not defined in the legislation, Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7) sets out the Commissioner's view on whether a loss or outgoing is incurred for the purposes of section 8-1 of the ITAA 1997. The meaning of the term 'incurred' in relation to R&D expenditure is the same as its meaning in relation to section 8-1 of the ITAA 1997. [1]
Accordingly, the same principles set out in TR 97/7 are applicable to determining whether an amount has been incurred for R&D purposes. You 'incur' an outgoing at the time you owe a present money debt that you cannot escape, as set out in paragraph 5 of TR 97/7. Further, paragraph 6(e) of TR 97/7 explains that where a liability to pay is not presently existing, the expense is incurred when the money is paid. Background - Incurred on - 355-205 ITAA 1997 An R&D entity's entitlement to a notional deduction is determined under section 355-205 of the ITAA 1997, which provides: (1) An R&D entity can deduct for an income year (the present year) expenditure it incurs during that year to the extent that the expenditure: (a) is incurred on one or more R&D activities: (i) for which the R&D entity is registered under section 27A of the Industry Research and Development Act 1986 for an income year; and (ii) that are activities to which section 355-210 (conditions for R&D activities) applies; and (b) if the expenditure is incurred to the R&D entity's associate - is paid to that associate during the present year.
To qualify for a notional deduction under section 355-205 of the ITAA 1997, an R&D entity must incur expenditure on one or more registered R&D activities. Background - non-monetary obligations The Commissioner has expressed views on the provision of goods or services in exchange for other goods or services without reference to money in IT 2668 Income tax: barter and countertrade transactions (IT 2688). Principles derived from this publication indicate that barter and countertrade transactions do give rise to allowable deductions to the extent that the goods or services exchanged reflect a commercial value. Application to your circumstances Incurrence, non-monetary obligations and incurred-on
The existence of a presently existing liability is determined on the fact of the case, and especially by reference to the terms of the contract or agreement entered into. Entity A, in entering into a licence agreement on XX Month 20XX has a liability to pay Entity B. Further, Entity A and Entity B in exchanging use of their respective intellectual property, subject to independent valuations, have entered into a transaction that gives rise to the same tax consequences as any other countertrade or barter trade. Therefore, Entity A's liability under the licence agreement is considered relevantly incurred for the purposes of section 8-1 of the ITAA 1997. Entity A uses the intellectual property that it licenses from Entity B exclusively in the delivery of its core R&D activities. As such, the expense that has been incurred is considered to have been incurred on Entity A's registered R&D activities for the purposes of section 355-205 of the ITAA 1997 and therefore notionally deductible to Entity A. Issue 2 Income Tax - Notional Deductibility - Prepayments - At-Risk Rule Question 2
Where the answer to question 1 is yes, will Entity A's notional deduction entitlement for FY24 be modified by either: a) the prepayment rules contained in section 82KZM of the Income Tax Assessment Act 1936 ; or b) the 'expenditure not at risk' rule contained in section 355-405 of the Income Tax Assessment Act 1997 (ITAA 1997)? Summary Entity A's notional deduction of the licence fee incurred to Entity B will not be modified by section 82KZM of the ITAA 1936 or the expenditure not at risk rule in section 355-405 of the ITAA 1936. Detailed reasoning Prepayment Rules Application of 82KZM of the ITAA 1936 to deductions under section 355-205 of the ITAA 1997 requires satisfaction of the following: • expenditure is incurred under an agreement entered into after 25 May 1988 • the company is a small business entity as defined by section 328-110 of the ITAA 1997 • the company has not chosen to apply section 82KZMD of the ITAA 1936 • the expenditure is not excluded expenditure as defined by section 82KZL(1) of the ITAA 1936 • the eligible service period is longer than 12 months.
In relation to the determination of the eligible service period the Commissioner has expressed his views in the context of television program licences in IT 2646 Income tax: television program licences (IT 2646). Under these licence arrangements the granting of the right to use the program is done only once at the commencement of the agreement. Similar reasoning would apply to a perpetual licence for intellectual property in that the granting of the right to use the license is only done once at the commencement of the agreement. Expenditure not at risk rule Section 355-405 of the ITAA 1997 precludes the notional deductibility of expenditure where it is deemed not to be at risk. Section 355-405 of the ITAA 1997 states that: (1) An R&D entity cannot deduct expenditure under section 355-205 or 355-480 if: a) when it incurs the 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; and b) that consideration is equal to or greater than the expenditure.
Further, Taxation Ruling 2021/5 Income tax: research and development tax offsets - the 'at risk' rule (TR 2021/5) establishes the Commissioner's view on section 355-405 of the ITAA 1997. In this ruling, the Commissioner adopts a broad interpretation of the meaning of consideration including the provision non-monetary benefits. Further, the Commissioner makes clear the consideration reasonable expected to be received is that which objective can be concluded as being concluded as being received or receivable as a direct or indirect result of having incurred that R&D expenditure. Application to your circumstances Prepayment Rules Under the licence arrangement between Entity A and Entity B, Entity B granting of the right to use its intellectual property to Entity A is only done once at the commencement of the agreement. As such the eligible service period requirement is not met and 82KZM of the ITAA 1936 does not apply to the arrangement. Expenditure not at risk rule
While the provision of the right to use Entity B's intellectual property, as non-monetary benefit, falls within the scope of the meaning of consideration. However, the consideration received by Entity A was for the provision of its intellectual property rather than for having incurred the R&D expenditure. As such section 355-405 of the ITAA 1997 does not apply to the arrangement. > [1] Commissioner of Taxation v. Desalination Technology Pty Ltd [2015] FCAFC 96