Yes, in defined cases. Under s355-210(1)(c) and s355-220 ITAA 1997, an Australian subsidiary can claim for R&D it conducts solely in Australia for a connected or affiliated foreign company that is resident in a country with which Australia has a double tax agreement, under a written agreement between them. The foreign company can own the IP. R&D done overseas for the parent cannot be claimed.
A common setup for an overseas group is an Australian engineering or research team that works to the parent's roadmap, is paid by the parent and hands the results back to it. Under the general rule, that R&D is conducted for the parent, not the Australian company, so the Australian company could not claim. The RDTI has a specific exception for exactly this situation, and used properly it is one of the most useful provisions for foreign-owned subsidiaries.
This guide is part of our series on the R&D tax incentive for foreign-owned subsidiaries.
The general rule: R&D must be conducted for the claimant
Section 355-210 ITAA 1997 lists who an R&D activity can be conducted for. Activities that are conducted "to a significant extent" for anyone else do not count. To decide whose R&D it is, the ATO looks for the entity that gets the major benefit, weighing who effectively owns the results, who has appropriate control over the work and who bears the financial risk.
A subsidiary that is paid cost-plus, takes direction from the parent and assigns all IP to the parent would usually fail this test on its own. That is where the foreign-company exception comes in.
The exception: R&D for a foreign group company
Section 355-210(1)(c) allows a claim for R&D conducted for one or more foreign residents that are incorporated under a foreign law and resident in a country with which Australia has a double tax agreement, if the conditions in s355-220 are met:
- The activity is conducted solely in Australia. For a supporting activity, the core activity it supports must also be conducted solely in Australia and be registered or registrable.
- Each foreign resident is connected with or affiliated to the Australian company. A parent, a sister company or another group company controlled at 40% or more will usually qualify. An unrelated overseas customer will not.
- There is a written agreement that binds only the Australian company and each foreign resident, under which the Australian company conducts the R&D directly or through a subcontract.
- It is not a subcontract from an affiliated R&D entity (s355-220(2)).
The Australian company itself must be an R&D entity, which in practice means an Australian-incorporated company. The foreign company's country must have a comprehensive tax treaty with Australia. Most of Australia's major trading partners do, including the United States, United Kingdom, Japan, Singapore, India, China, Germany, France and New Zealand. Check your parent's country in our double tax agreements guide.
The ATO's example
The ATO uses the example of Company J, a UK company, and its wholly owned Australian subsidiary, Company K, based in Perth. Under an agreement, Company K conducts R&D solely for Company J's benefit. The consideration is at arm's length and is paid even if the R&D is not successful, and Company J is legally entitled to all the intellectual property. Because Company J is a UK resident, and the UK has a double tax agreement with Australia, Company K may be able to claim, provided the other requirements are met.
In other words: the parent can own the IP, and the subsidiary can be paid whatever the outcome, and the claim still stands.
Cost-plus arrangements and the at-risk rule
Normally, R&D spending is not claimable if the company will receive consideration regardless of the results (the "at-risk" rule in s355-405). That rule does not apply to R&D conducted for a foreign resident under s355-210(1)(c), which is why the ATO's example works. A cost-plus service agreement with a qualifying parent does not fail on that ground.
How the fees received are treated in other respects, for example under the rule for amounts received for the results of R&D (s355-410), should be reviewed for your specific agreement. The pricing of the arrangement must also satisfy Australia's transfer pricing rules. See intercompany agreements, IP and transfer pricing.
What the exception does not cover
- Overseas work. The exception requires the R&D to be conducted solely in Australia. The ATO says a subsidiary can only claim overseas expenses "if they were conducted for you, not for a foreign resident corporation". An overseas finding does not rescue work done for the parent.
- Parents in non-treaty countries. If the foreign company is not resident in a double tax agreement country, the exception is not available and the subsidiary must show the R&D is conducted for itself.
- Unrelated customers. Contract R&D for an unrelated foreign client does not fall within this exception.
- Arrangements the ATO has flagged. Taxpayer Alert TA 2023/5 targets arrangements where an Australian subsidiary claims for overseas R&D that is funded by and benefits a foreign related party. Keep the Australian claim to Australian work.
Checklist for the intercompany R&D agreement
- Signed before the work starts, and only between the Australian company and the foreign group companies it works for.
- Describes the R&D projects and says the work is performed in Australia.
- Sets an arm's length fee (commonly cost plus a mark-up) supported by transfer pricing analysis.
- States who owns the resulting IP.
- Identifies each foreign party's country of tax residence, with evidence such as a residency certificate.
- Is followed in practice: invoices, payments and project records should match the agreement.
The ATO's guidance on subsidiaries also looks for real substance in Australia: qualified staff, facilities, directors who make their own decisions, and a company that has not been set up just before year-end to catch a claim.
Frequently asked questions
Can a subsidiary claim R&D if the parent owns the IP?
Yes, if the work is done solely in Australia for a connected or affiliated foreign company resident in a double tax agreement country, under a written agreement. The ATO's own example has the UK parent owning all the IP.
Does the parent company have to be in a treaty country?
For this exception, yes. The foreign company must be resident in a country with which Australia has a double tax agreement. Without that, the Australian company must show the R&D is conducted for its own benefit.
Can we be paid cost-plus by the parent and still claim?
Yes. The rule that denies expenditure when you are paid regardless of the outcome does not apply to R&D conducted for a qualifying foreign resident. The fee still needs to be arm's length.
Can the subsidiary claim R&D its engineers do overseas for the parent?
No. Overseas R&D can only be claimed if it is conducted for the Australian company and covered by an overseas finding. Overseas work done for a foreign parent is not claimable.
This content is general information only and is not legal, financial or tax advice. Laws and regulations change often. For advice on your circumstances, speak to a qualified adviser.