For a foreign-owned subsidiary, the R&D claim depends on who owns the IP, who controls the work and who bears the risk. Payments to associates count only when paid, are capped at market value, and group profit margins are removed. Sign an arm's length intercompany agreement before work starts.
For a foreign-owned subsidiary, the paperwork between the Australian company and the rest of the group often decides the R&D claim. It shows whose R&D it is, whether the subsidiary can claim at all, how much of its spending counts, and whether the ATO will accept the pricing. This guide covers the three decisions to make before the work starts. It is part of our series on the R&D tax incentive for foreign-owned subsidiaries.
Decision 1: who owns the IP?
The ATO decides whose R&D it is by asking who gets the major benefit, looking at ownership of the results, control of the work and financial risk. There are three workable models, and one that fails.
| Model | How it works | R&D claim |
|---|---|---|
| Australian company owns the IP | The subsidiary funds the work (from equity or a group loan), directs it and owns the results. It may license the IP to the group. | Claims as its own R&D. The simplest position. |
| Contract R&D for a treaty-country parent | The subsidiary performs R&D in Australia under a written agreement with a connected foreign company in a double tax agreement country, usually for a cost-plus fee. The parent owns the IP. | Claimable under s355-210(1)(c) if the s355-220 conditions are met. See R&D for a foreign parent. |
| Shared or staged ownership | For example, the subsidiary owns IP it develops for the Australian market, and specific projects are done under contract for the parent. | Possible, but each project needs clear terms and records. |
| Parent in a non-treaty country owns and directs everything | The subsidiary is a cost centre for a parent that is not in a treaty country. | Generally not claimable, because the R&D is conducted for the parent. |
Decision 2: how is the subsidiary paid, and at what price?
Most service arrangements pay the subsidiary its costs plus a mark-up. Three things to get right:
- Arm's length pricing. Cross-border dealings between group companies must be priced at arm's length under Australia's transfer pricing rules (Subdivision 815-B ITAA 1997). The mark-up should be supported by a benchmarking analysis and documented.
- The at-risk rule. Spending is normally not claimable where the company is paid regardless of the R&D outcome (s355-405). That rule does not apply to R&D conducted for a qualifying foreign resident under s355-210(1)(c), so a cost-plus fee from a treaty-country parent does not fail on that ground. Where the subsidiary is claiming its own R&D, it must not be guaranteed recovery of the costs by someone else.
- Taxable profit to use the offset. A cost-plus subsidiary of a large group has taxable profit, which it needs to absorb a non-refundable offset. Price too low and the offset may simply carry forward.
Decision 3: what does the subsidiary pay the group?
When the Australian company pays other group members for staff, services, software or materials used in the R&D, special rules limit what it can claim:
- Paid, not just incurred. Amounts owed to an associate are notional deductions only in the year they are actually paid (s355-205 and s355-480). An intercompany payable left open at year-end is not claimable until paid. The ATO accepts constructive payment, such as a genuine set-off, but it must be real.
- Market value cap. Spending with an associate, or not at arm's length, is limited to market value (s355-400).
- Group mark-ups are removed. Where a connected or affiliated entity supplies goods or services for the R&D, the claim is reduced by the profit margin that entity made (s355-415). A recharge from the parent at cost plus 10% is claimable at cost.
The ATO's Taxpayer Alert TA 2023/4 covers R&D delivered through associated entities, and TA 2023/5 covers overseas R&D funded by and benefiting foreign related parties. Both are worth reading before you design a group arrangement.
Document it before the work starts
- Sign the intercompany R&D or service agreement before the projects begin. The ATO says records that are backdated are not appropriate.
- Match invoices, payments and timesheets to the agreement.
- Keep a transfer pricing file supporting the mark-up.
- Record each project's hypothesis, experiments and results as the work happens, not at year-end.
- Keep records for five years, in English.
We draft and review intercompany R&D agreements for foreign-owned subsidiaries as part of our R&D tax incentive service, and handle the company's tax returns and bookkeeping so the numbers match the agreement.
Frequently asked questions
Should the Australian subsidiary or the parent own the IP from R&D?
Either can work. If the subsidiary owns the IP, it claims the R&D as its own. If a parent in a double tax agreement country owns it, the subsidiary can still claim under the foreign-company exception with a written agreement. If a non-treaty parent owns and directs everything, the subsidiary generally cannot claim.
Can we claim the full recharge from our parent company?
Only up to the parent's cost. Where a connected entity supplies goods or services for the R&D, its profit margin is removed, spending is capped at market value, and amounts owed are counted only when paid.
Does transfer pricing apply to R&D service agreements?
Yes. Cross-border dealings between group companies must be priced at arm's length under Australia's transfer pricing rules. The R&D rules are an extra layer, not a replacement.
Can we sign the intercompany agreement after year-end?
You should not rely on that. The ATO says backdated records are not appropriate, and a written agreement is a condition of the foreign-company exception. Sign it before the work starts.
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.