Federal court affirms rules for overseas R&D activities

The Federal Court judgement in T.D.S Biz Pty Ltd v Commissioner of Taxation, handed down on 29 June 2023, has affirmed the rules for Australian companies conducting R&D activities overseas and upheld previous decisions by the Commissioner of Taxation and the Administrative Appeals Tribunal.

The decision has implications for companies procuring equipment and components from overseas to be used in Australian experimental core activities, and emphasises the importance of providing accurate information in R&D applications. Learn more details about the case and findings below.

Background to the TDS Biz case

The applicant, T.D.S Biz Pty Ltd (TDS Biz), designed and developed an electric tricycle prototype and registered R&D activities in the 2018 income tax year. The Commissioner of Taxation undertook a review of the R&D Tax Incentive claim and supporting documentation, identifying three invoices totalling AUD $1,613,462.00, relating to activities conducted in China, which were not covered by an overseas finding. The Commissioner subsequently issued an amended notice of assessment - which excluded the three invoices - and a shortfall administrative penalty of 50 per cent on the amounts.

TDS Biz received a successful variation request from Industry Innovation and Science Australia that effectively registered a new supporting activity - ‘design, development and fabrication and/or supply of components’ - for the 2018 year, as the grounds to support an objection to the amended notice of assessment. However, the Commissioner issued a decision advising the objection was disallowed.

TDS Biz appealed the decision in the Administrative Appeals Tribunal (AAT), but the tribunal affirmed the decision on the basis that the supporting activities were conducted overseas and not covered by an overseas finding. The tribunal also affirmed the administrative penalty, as TDS Biz did not disclose in the variation request or registration form that it’s supporting R&D activities to produce prototype components had occurred outside Australia.

Details of the case and outcome

TDS Biz brought the following two grounds of appeal to the Federal Court:

  • The applicant had been denied procedural fairness and not afforded a reasonable opportunity to present its case, with no legal representation, with the only submissions made by the external R&D consultant, and with no witnesses for the applicant called or examined
  • The tribunal had erred in the construction and application of the R&D provisions that entitle notional deductions for R&D expenditure on R&D activities conducted for the R&D entity solely within Australia, in relation to the applicant’s purchase of the components from China.

The Federal Court chose to address the second ground of appeal first, in order to provide context to the assertion of procedural fairness. TDS Biz contended it did not require an overseas finding because it did not undertake any R&D activities outside Australia, pointing to the distinction between the core R&D activities carried out in Australia, and the purchase of parts and components outside of Australia - which it described as not being R&D activities at all.

The Federal Court took the view that only expenditure on core or supporting R&D activities could form the basis of claiming R&D tax offsets, and could extend to activities that produce goods or services, or to activities directly related to producing goods or services, provided they are undertaken for the dominant purpose of supporting core R&D activities. Referring to the legislative conditions for R&D tax offset eligibility, the Federal Court noted the requirement that activities must be conducted for the R&D entity solely within Australia, unless the claimant entity has an overseas finding. The Federal Court found that TDS Biz was therefore not entitled to a tax offset for the expenditure on supporting R&D activities carried out on its behalf in China.

In relation to the denial of procedural fairness, the Federal Court said there was no evidence (or submissions) that "could possibly have changed" the conclusion by the AAT that TDS Biz did not have the necessary overseas finding that would entitle them to claim the R&D tax offset for the supporting activity. In the words of the court, the objections and AAT review application were "doomed to fail”.

The Federal Court also affirmed the decision of the AAT to disallow the objection to a notice of assessment of shortfall penalty, imposing a 50 per cent administrative penalty on the basis that TDS Biz failed to refer to the overseas nature of the supporting activity in and from China.

BDO comment

While the Federal Court decision provides an expansive view on what constitutes a supporting activity, the decision may be of concern to companies procuring equipment and components from overseas to be used in Australian experimental core activities. The decision affirms that applicants conducting activities overseas are only entitled to claim R&D tax offsets on expenditure incurred on overseas activities under an approved overseas finding. As such, applicants that purchase equipment and components that are not ‘off the shelf’ should seek early advice on the structuring and eligibility of R&D activities and expenditure for claim purposes.

TDS Biz’s failure to disclose that certain elements of the activities had been conducted overseas allowed the Commissioner to deny the tax offset and impose the 50 per cent administrative penalty. This decision demonstrates the Commissioner can deny expenses on activities approved by Industry and Innovation and Science Australia, and the importance of accurately describing activity information in the R&D application,  ensuring  claims comply with the legislation.  

We can help determine whether your organisation’s activities meet the legislative requirements to access the R&D Tax Incentive. Our team also has significant experience in advising on eligibility and preparation of overseas findings. Contact us for advice in relation to your R&D Tax Incentive claim.