Commissioner of Taxation v Desalination Technology Pty Limited
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 1159 of 2014)
Judgment date: 3 July 2015
Date published: 7 December 2015

Summary of decision:
Whether the taxpayer 'incurred' research and development (R&D) expenditure for the purposes of subsection 73B(14) of the Income Tax Assessment Act 1936 (ITAA 1936), and as such whether it was entitled to claim an R&D offset, in circumstances where the taxpayer's obligation to make the invoiced payment was subject to certain contingencies affecting the existence of that obligation.

Overview of facts:
The taxpayer is a member of a group of companies involved in R&D activities. Mr D has been a director of the taxpayer since June 2007. Mr K was a director from incorporation in June 2007 until January 2008 (and since then he has been an alternate director, but at all relevant times he has been the accountant and tax agent for the taxpayer). | The taxpayer (Desalination Technologies Pty Ltd) and Innovative Design Technologies Group Pty Ltd (IDTG) were both associated with Mr D and Mr K. | The taxpayer entered into an agreement with IDTG to provide services relating to the taxpayer's R&D activities. The agreement was for IDTG 'to act as a project manager for all research and development projects and to coordinate the use of labour and equipment for the various projects'. | The R&D work itself was carried out by Mr D and others as employees of Davey Technology Pty Ltd, a company established by Mr D. The workers recorded the number of hours they spent undertaking R&D activities. The value of the time they charged became the basis of the fee invoiced by IDTG to the taxpayer, generally on a monthly basis. | During the relevant year, IDTG issued monthly invoices totalling $1,065,625 to the taxpayer. Of the total amount invoiced, the taxpayer paid $149,964. The balance of $915,661 was debited to an inter-company loan account between IDTG and the taxpayer, and the account remained unpaid. Payment of amounts debited to the inter-company loan account was subject to two conditions: 'the first, that the taxpayer receive funds from investors, lenders or other sources; and second, that even if it has the funds, the taxpayer considers it "prudent" to make a payment to IDTG'. | In its income tax return for the year ended 30 June 2009, the taxpayer claimed an R&D tax offset in respect of the R&D expenditure of $968,750. The amount claimed by the taxpayer as a tax offset was $363,281. [1] Of that amount the Commissioner allowed a tax offset of $56,236, relating to the paid amount of $149,964. | Issues decided by the court | There were two issues before the Full Federal Court. The first issue was whether the Commissioner's appeal to the Tribunal was competent. The second issue was whether the taxpayer had incurred the relevant R&D expenditure, notwithstanding the conditions attaching to the come and go loan account. | The issue of competency was considered and dismissed. | The Court held that since the taxpayer and IDTG agreed that the invoices received were not to be treated as trade creditors, but to be treated as 'fully paid at the date it is rendered' and 'charged to a come and go loan account', no obligation of the taxpayer to IDTG came into existence on the rendering of each invoice because of the contigencies attaching to the come and go loan account. Even if some obligation did come into existence, it was so infected by those contingencies that it was not open to the Tribunal to conclude that the taxpayer was definitively committed to the obligation. | The Court found that there was no evidence that IDTG financed the R&D work by lending the invoiced amount to the taxpayer.

Issues decided:
There were two issues before the Full Federal Court. The first issue was whether the Commissioner's appeal to the Tribunal was competent. The second issue was whether the taxpayer had incurred the relevant R&D expenditure, notwithstanding the conditions attaching to the come and go loan account. The issue of competency was considered and dismissed. The Court held that since the taxpayer and IDTG agreed that the invoices received were not to be treated as trade creditors, but to be treated as 'fully paid at the date it is rendered' and 'charged to a come and go loan account', no obligation of the taxpayer to IDTG came into existence on the rendering of each invoice because of the contigencies attaching to the come and go loan account. Even if some obligation did come into existence, it was so infected by those contingencies that it was not open to the Tribunal to conclude that the taxpayer was definitively committed to the obligation. The Court found that there was no evidence that IDTG financed the R&D work by lending the invoiced amount to the taxpayer.

ATO view of decision:
The Commissioner considers the Court's application of the law to the facts to be uncontroversial and correct. | The decision of the Court affirms earlier case law which established that for an amount to be incurred, a taxpayer must be definitively committed to the payment. | The Commissioner does not accept that such contrived invoicing arrangements satisfy the requirements of either the now repealed section 73B of the ITAA 1936 or the current section 355-205 of the Income Tax Assessment Act 1997. The invoiced amounts under these arrangements are neither incurred by the taxpayer nor are the payments definitively committed to by the taxpayer. | In its comments in obiter, the Court stated that where a creditor lent money to the taxpayer, even subject to the two contingencies as to repayment, and the taxpayer paid the invoices from the loan proceeds, there would be no doubt that the invoices had been paid and the expenditure 'incurred'. Where the lender is the provider of the R&D services (the counterparty), the Commissioner would also consider whether the funds received by the counterparty in respect of the R&D services are characterised as income, and if so, whether the income has been derived by the counterparty for the relevant period: see for example the judgment of Edmonds J in Business and Research Management Ltd (in Liq) v FCT [2008] FCA 1652. | The application of the general anti-avoidance provisions in Part IVA of the ITAA 1936 was not at issue before the Court in this matter, nor was there any finding of the Court in relation to its application. The Commissioner's view is that the provisions of Part IVA may apply where R&D expenditure is incurred under a similarly contrived invoicing arrangement. The Commissioner may seek to apply Part IVA to similar claims in these circumstances. | The Commissioner will disallow R&D claims in similar circumstances where the amounts have not been incurred or where the Commissioner determines that Part IVA applies to otherwise disallow the claim. | Taxpayers should take this opportunity to review their R&D claims for arrangements of a kind described here and to make voluntary disclosures to the Commissioner, where appropriate. A voluntary disclosure can result in a significant reduction in penalties that would otherwise apply where these claims are disallowed by the Commissioner.

Administrative treatment:

Legislative references: Income Tax Assessment Act 1936 73B 73I 73J Income Tax Assessment Act 1997 8-1 355-205 Administrative Appeals Tribunal Act 1975 44
Case references: Belton v General Motors-Holden's Ltd (No 1) (1984) 55 ALR 142 58 ALJR 352 Birdseye v Australian Securities and Investments Commission [2003] FCA 232 Brookton Co-operative Society Limited v Commissioner of Taxation [1981] HCA 28 (1981) 11 ATR 880 81 ATC 4346 Business and Research Management Ltd (in Liq) v FCT [2008] FCA 1652 (2008) 74 ATR 525 2008 ATC 20-065 Coles Myer Finance Ltd v Commissioner of Taxation [1993] HCA 29 (1993) 25 ATR 95 93 ATC 4214 Commissioner of Taxation v CityLink Melbourne Ltd [2006] HCA 35 (2006) 62 ATR 648 2006 ATC 4404 Haritos v Commissioner of Taxation [2015] FCAFC 92 2015 ATC 20-513 Hope v The Council of the City of Bathurst [1980] HCA 16 Manzi & Ors v Smith & Anor [1975] HCA 35 New Zealand Flax Investments Limited v Federal Commissioner of Taxation (1938) 61 CLR 179 (1938) 5 ATD 36 (1938) 1 AITR 366 Price Street Professional Centre Pty Ltd v Commissioner of Taxation [2007] FCAFC 154 2007 ATC 5044 (2007) 67 ATR 544 TNT Skypak International (Aust) Pty Ltd v Federal Commissioner of Taxation [1988] FCA 198 (1988) 19 ATR 1067 88 ATC 4279 Vetter v Lake Macquarie City Council [2001] HCA 12