Private ruling: R&D Tax Incentive: Not at risk and conditions for R&D activities
Published: July 2012
Ruling period: The year ending 30 June 2012
Date scheme commenced: 1 June 2011

Ruling: Q1: Does section 355-405 of the Income Tax Assessment Act 1997 apply to Company A in respect of its participation (as a joint venturer) in a Joint Venture for the relevant income year? | A1: Yes. When Company A incurred expenditure on R&D activities in the relevant year, it could reasonably be expected to receive consideration as a direct or indirect result of the expenditure being incurred, regardless of the results of the R&D activities. | Q2: Does Company A satisfy the condition in section 355-210 of the Income Tax Assessment Act 1997 in respect of its participation (as a joint venturer) in a Joint Venture for the relevant year? | A2: No. In the year ending 30 June 2012, Company A's interest in the Tenement and the Joint Venture property is limited to 25%, while Company B's interest is 75%. Company B's 75% interest in the results of the R&D is considered evidence that the R&D is conducted, to a significant extent, for Company B and not for Company A.

Relevant facts and circumstances: Company B is an Australian company involved in mining. Some years ago, Company B applied for and was granted a Tenement. An independent valuation of the Tenement valued it at $Y dollars. Company B decided to joint venture the exploration and mining of the Tenement with Company A, its subsidiary. Companies A and B entered into a Sale Agreement under which Company A would acquire a 25% interest in the Tenement in consideration for issuing shares to Company B. The Sale Agreement was conditional on Company A raising a certain amount of money under an IPO and being admitted to the ASX. At the same time, Companies A and B also entered a Joint Venture (JV), which was subject to the satisfaction of the Sale Agreement. The Sale Agreement was satisfied. Accordingly, Company A left Company B's consolidated group and the JV was effected. Terms of the Joint Venture Agreement The purpose of the JV is stated to be to conduct exploration and mining within the Tenement. Company A is both the Manager and a participant in the JV. Companies A and B are the only participants to the JV Agreement. As at the commencement date, they held respective 'Interests' in the JV of: a) 25%; and b) 75%. 'Interest' is defined as the proportionate interest by which a participant is: a) obliged to contribute that percentage of Joint Venture Costs; b) entitled to receive in kind, and to dispose of for its own account, Minerals mined from the Tenement; c) the beneficial owner as a tenant in common of an undivided share in the Joint Venture Property; and d) entitled to all other rights, and obliged to pay or perform all other liabilities and obligations, accruing to or incurred by the Participants in or arising out of this agreement. 'Joint Venture Property' is defined as all property and assets of the Joint Venture from time to time including; a) the Tenement; b) the Mining Information; c) all fixtures, machinery, equipment and other property, tenements or rights of any description acquired with funds of the Joint Venture; and d) all Minerals derived by the Joint Venture prior to being taken by, or delivered to, the Participants. Under the terms of the JV, Company A can increase its interest in the Tenement by sole funding certain activities on the Tenement. That is, Company A can increase its interest by a further 30% by sole funding a certain amount of activities each year over four years, which in total would equal a 'threshold amount'. If Company A spends the full threshold amount, its interest in the Tenement would increase to 55%. Company A would then have the right to further increase its interest under a second sole funding period. Under the second sole funding period, Company A would need to deliver a feasibility study in bankable form. If finished successfully, Company A's interest in Tenement would increase from 55% to 80%. However, if Company A fails to spend the specified amount in the first two years of the first sole funding period, it must pay to Company B the difference between the amount it was supposed to spend and the amount it does spend. If it fails to do this, then Company B can acquire Company A's 25% interest for the sum of $Y. All JV activities must be carried out by the Manager on behalf of the participants in proportion to their respective interests, however for the avoidance of doubt, this does not apply during the sole funding period. The Manager is required to keep all participants advised of all 'Joint Venture activities' by submitting quarterly progress reports. The Manager must disclose to the participants any significant discovery of minerals on the Tenement immediately. The Manager must allow access to the participants so that they can inspect all mining information under its control. The Manager must allow access to the participants to inspect the Joint Venture Activities. During the Sole Funding Period, Company A, as joint venturer, has the exclusive rights to explore the Tenement and may determine the nature, timing and conduct of all exploration funded by it at its sole discretion. For the avoidance of doubt, the JV agreement stipulates that Company B has no obligation to contribute towards any Expenditure or other costs incurred in connection with the Joint Venture during the sole funding period. Post execution, a variation was made to the JV Agreement. It specified that during the sole funding period, Company A is entitled to count expenditure incurred solely in connection with Joint Venture Activities (which occurs after the sole funding period), as though such a reference includes expenditure in connection with exploration (which occurs during the sole funding period). At all times during the relevant year, Company A holds a 25% interest in the Tenement. Research and development activities During the relevant year, Company A undertakes activities which it considers to be 'R&D activities' as defined in section 355-20 of the ITAA 1997. Company A estimates that 100% of the amount it incurs on those 'R&D activities' in the relevant year will be applied against the sole funding threshold required under the JV Agreement. Company A has stated that it will apply for an advanced finding about the nature of its activities under section 28A of the Industry Research and Development Act (IR&D Act) prior to making any claim for a R&D tax offset. Company A has not yet applied for registration of those activities with X under section 27A of the IR&D Act for the year ending 30 June 2012.

Relevant legislative provisions: 355-20 of the Income Tax Assessment Act 1997 | 355-35 of the Income Tax Assessment Act 1997 | 355-100 of the Income Tax Assessment Act 1997 | 355-205 of the Income Tax Assessment Act 1997 | 355-210 of the Income Tax Assessment Act 1997 | 355-405 of the Income Tax Assessment Act 1997 | 28A of the Industry Research and Development Act 1986 | 27A of the Industry Research and Development Act 1986 | former 73B(1) of the Income Tax Assessment Act 1936 | former 73B(9) of the Income Tax Assessment Act 1936 | former 73CA of the Income Tax Assessment Act 1936

Reasons for decision: Detailed Reasoning - Detailed Reasoning: Subsection 355-205(1) of the ITAA 1997 provides that an R&D entity may deduct certain expenditure incurred on one or more R&D activities provided certain conditions are met. Relevantly, subsection 355-205(2) says the section has effect subject to (among other things) subdivision 355-F (integrity rules). Subdivision 355-F of the ITAA 1997 contains section 355-405 'Expenditure not at risk'. Broadly, expenditure that is not 'at risk' (for example if there is a guaranteed return under a financing arrangement or an indemnity), is not eligible for a notional R&D deduction but the ordinary deduction rules may apply. Specifically, section 355-405 provides: 355-405(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. 355-405(2) If: (a) when an *R&D entity incurs 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 less than the expenditure; the R&D entity cannot deduct under section 355-205 or 355-480 so much of the expenditure as is equal to the consideration. 355-405(3) For the purposes of paragraphs (1)(a) and (2)(a), have regard to: (a) anything that happened or existed before or at the time the expenditure is incurred; and (b) anything that is likely to happen or exist after that time. | Detailed Reasoning - Does subsection 355-405(1) or (2) apply to Company A's R&D expenditure in the year ending 30 June 2012?: For the Commissioner to be satisfied that all or a portion of Company A's R&D expenditure is not 'at risk', both elements of either subsection 355-405(1) or (2) must apply to Company A's R&D expenditure. | Detailed Reasoning - First element: The first element of subsections 355-405(1) and (2) will apply to Company A if, when it incurs the R&D expenditure, it 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; Consideration as a direct or indirect result of the R&D expenditure being incurred 'Consideration' is relevantly defined in the Australian Oxford dictionary as; 4. compensation; a payment or reward 5. (in a contractual agreement), anything given or promised or forborne by one party in exchange for the promise or undertaking of another. Company A entered a JV with Company B. Under the terms of the JV, Company A will acquire an additional 30% interest in the Tenement if it spends the threshold amount on the Tenement in the manner set out in the JV Agreement. Accordingly, Company A will receive consideration for its expenditure on the Tenement provided it incurs the threshold. Company A's expenditure on R&D will count towards the threshold required to be incurred in order for Company A to receive the consideration. Each dollar Company A spends on R&D satisfies a portion of its spending requirement under the JV agreement. If 100% of Company A's threshold amount is made up of R&D expenditure, then the incurrence of that R&D expenditure directly results in consideration for Company A (provided the threshold amount is reached). If a combination of R&D expenditure and miscellaneous expenditure make up the threshold amount required to be incurred for Company A to receive the consideration, then the incurrence of that R&D expenditure indirectly results in consideration for Company A (provided the threshold amount is reached). If Company A fails to meet the threshold amount, it will not receive any consideration from Company B. Therefore, it is necessary to consider whether Company A could reasonably be expected to receive consideration for its R&D expenditure at the time of its incurrence. When considering paragraph 355-405(1)(a), subsection 355-405(3) requires regard to be had to; (a) anything that happened or existed before or at the time the expenditure is incurred; and (b) anything that is likely to happen or exist after that time. Before the R&D expenditure was incurred, Company A held a public capital raising. Company A's only asset at this point in time was a 25% interest in the Tenement, and the right to acquire a further 30% (and then a further 25% etc), under the JV Agreement. The public offering was very successful and oversubscribed. On this basis, at the time of incurring the expenditure, past events made it reasonable to expect that Company A would reach the threshold amount necessary to receive consideration. However, Company A's agent has said that the exploration on the Tenement to date has not been overly fruitful, and has advised that Company A now thinks the Tenement is worth significantly less than originally thought. From an objective commercial perspective, Company A will continue to spend money on the Tenement while it considers there is a commensurate benefit to be achieved from the incurrence of that expenditure. If at any point prior to reaching the threshold amount Company A decides to discontinue spending on the Tenement, then there will be no reasonable expectation of receiving consideration for that expenditure. However, while Company A continues to incur the expenditure towards the threshold amount, it could reasonably be expected to receive consideration for that expenditure. | Detailed Reasoning - Consideration as a direct or indirect result of the R&D expenditure being incurred regardless of the results of the R&D activities: ATOID 2009/107 includes a discussion of the former 'at risk' provision under section 73CA of the ITAA 1936. It distinguishes between an arrangement where a company has a reasonable expectation of receiving consideration for R&D expenditure it has incurred because of its technical ability, and arrangements where a company has a reasonable expectation of receiving consideration because of the type of arrangement agreed between the parties. Relevantly, it says; The two critical elements of this provision for present purposes are that, for subsection 73CA(5) to apply, it must be the case that because of the matters specified in paragraphs 73CA(5)(a) and 73CA(B), ABC could reasonably have expected to receive an amount as a direct or indirect result of the expenditure being incurred. The Tax Office considers that the two paragraphs direct attention to the features of the relationship between the parties involved in the arrangements under which the expenditure is incurred. In this respect the paragraphs can extend to any combination of formal contracts, side arrangements, informal understandings, option and the like. But they do not extend to such matters as the technical, scientific or commercial prospects of the relevant R&D activities. Therefore the subsection is attracted if in any event, as a result of incurring the expenditure, some consideration could reasonably have been expected to be received because of the arrangement among those parties, even if, in particular, the expenditure fails to produce the intended technical result. In other words, the question is whether one can predict from the contractual arrangement itself, without regard to other matters of the type referred to above, that the incurrence of the expenditure will result in the receipt of consideration. For the company the subject of ATOID 2009/107, the Commissioner formed the opinion that section 73CA did not apply, because while one could have a reasonable expectation that the company would get a return from its expenditure under the terms of the contract, it was because of its technical confidence; it could not be said that that reasonable expectation was held because of the terms of the arrangement itself. When this reasoning is applied to Company A, the question becomes whether the Commissioner can make the prediction that Company A can, because of the terms of the contract with Company B, reasonably be expected to receive consideration as a result of incurring the R&D expenditure? The answer to this has to be 'yes'. The basis for the transfer of 30% interest under the JV agreement is the spending of the threshold amount on the Tenement, not the production of R&D results. If Company A spends the threshold amount and has some R&D success, it will receive consideration for that expenditure. If Company A spends the threshold amount and the R&D fails, it will still receive a 30% interest in Tenement because of the terms of the contract. Therefore, the Commissioner can make the prediction that Company A can, because of the terms of the contract with Company B, reasonably be expected to receive consideration from Company B as a result of incurring the expenditure. For the above reasons, the Commissioner is satisfied that paragraph 355-405(1)(a) and 355-405(2)(a) of the ITAA 1997 applies to Company A. However, both elements of section 355-405(1) or 355-405(2) must apply to a company before the Commissioner can be satisfied that its R&D expenditure is not 'at risk'. | Detailed Reasoning - Second element: Paragraph 355-405(1)(b) says that an R&D entity cannot deduct expenditure under section 355-205 or 355-480 if, when it incurs the expenditure, it received consideration or could reasonably be expected to receive consideration that is equal to or greater than the expenditure . Alternatively, paragraph 355-405(2)(b) provides that if, when the relevant expenditure is incurred, the consideration is less than the expenditure, the R&D entity cannot deduct so much of the R&D expenditure as is equal to the consideration. The consideration Company A will receive for spending the threshold amount on the Tenement is a 30% interest in that tenement. The dollar value of this interest is not identified in the JV Agreement or the Sale Agreement, however, for the purpose of paragraph 355-405(1)(b), the Commissioner must form an opinion as to the amount of consideration that Company A 'could reasonably have expected to receive'. The arrangement the subject of the JV Agreement is one that is commonly referred to as a 'farm out arrangement'. Relevantly, MT 2012/2 Miscellaneous taxes: application of the income tax and GST laws to deferred transfer farm-out arrangements (MT 2012/2) sets out the Commissioner's views on the application of the income tax and GST provisions upon entry into a deferred transfer farm-out arrangement. It describes these arrangements as follows: 4. Farm-out arrangements are common in the mining and petroleum industries. Broadly speaking, they are arrangements entered into for the purpose of facilitating exploration for the discovery of minerals and petroleum resources. 5. A typical arrangement provides for the owner of an interest in a mining tenement (the 'farmor') to transfer a percentage of that interest to another party (the 'farmee') if the farmee meets specified exploration commitments or contributes monetary payments. 7. Broadly, farm-out arrangements may be divided into two types referred to as 'immediate transfer' and 'deferred transfer' farm out arrangements. 8. Under a deferred transfer farm-out arrangement, the terms of the arrangement specify that the transfer of an interest in the mining tenement from the farmor to the farmee occurs only after the farmee has met all of the exploration commitments and any payment requirements to earn that interest (collectively referred to a the earn in requirements) with a specified period of time (the earn in period). The ruling is said to apply to a deferred transfer farm-out arrangement that has the following characteristics, summarised in table form in paragraph 13 of MR 2012/2: The farmor The farmee · Provides the farmee with a right (akin to an option) to acquire an interest in a mining tenement by satisfying the earn-in requirements over the earn-in period. · Provides the farmee with exclusive use and access rights (akin to a licence). · Transfers a percentage interest in the mining tenement to the farmee at the end of the earn-in period if the farmee exercises the right to acquire the interest in the mining tenement (and all necessary approvals are granted). This leaves the farmor with a reduced percentage interest in that mining tenement. · May also share mining information with the farmee. · Undertakes exploration commitments, which may be referrable to a period of time; an amount(s); a schedule of works; or a combination thereof. Under the terms of the agreement, the exploration commitments may to some extent be mandatory but most, if not all, of the exploration commitments will be at the discretion of the farmee. · May also make cash payments to the farmor. These payments may, or may not, be referrable to the exploration costs the farmor has incurred prior to entering into the deferred transfer farm-out arrangement. Payment(s) may also be made at the time of exercising the right to acquire, or upon transfer of, the interest in the mining tenement. · May also make cash payments to third parties to meet expenses incurred by the farmor thereby relieving the farmor from meeting those expenses. The farm-out arrangement between Company A and Company B appears to have all the characteristics of a deferred transfer agreement. Helpfully, the ruling sets out how to value interests that pass from the farmor to the farmee for income tax purposes. Relevantly, under the subheading of market valuation, MR 2012/2 states; | Detailed Reasoning - Market valuation: 35. If the parties are dealing with each other at arm's length, it is accepted that the market value of the exploration benefit provided by the farmee and any cash payments made to, or on behalf of, the farmor by the farmee is equal to the market value of the interest in the mining tenement and any other benefits that are provided by the farmor. 36. In the context of these arrangements, the relevant time for determining the market value of the interest in the mining tenement that is transferred by the farmor, and any other non-cash benefits, is at the time of entering into the farm-out agreement. 37. The market valuation must take into account all the facts and surrounding circumstances. The value of an exploration benefit provided by the farmee to the farmor does not necessarily equate with the amount to be spent by the farmee on exploration. Accordingly, the Commissioner must value the Tenement at its market value at the time of entering into the JV (farm out) agreement. The Tenement was independently valued just prior to the execution of the JV Agreement. Under the Sale Agreement, Company B sold a 25% interest in the Tenement to Company A in return for a number of shares. Those shares were ascribed a value such that the total consideration value of the 25% interest was $X dollars. If 25% of the Tenement had a market value of $X on the date the JV Agreement became effective, the Commissioner considers that the entire Tenement had a market value of $X at the time the parties entered the JV Agreement (4 x Ascribed value of shares = $X). This is within the range of the independent market valuation and demonstrates that the market value did not change between those dates. From this, the Commissioner can determine the market value of a 30% interest in the Tenement, valued at the time of entering the farm out agreement. 30% of $X = $Z, where $Z is marginally less than the threshold amount. In return for spending the threshold amount, Company A will therefore receive consideration to the value of $Z. The consideration Company A could reasonably be expected to receive is therefore less than the amount Company A is required spend to reach the threshold amount. Accordingly, paragraph 355-405(1)(b) does not apply to Company A, but subsection 355-504(2) does. Subsection 355-504(2) will prevent Company A from deducting so much of its R&D expenditure as is equal to the consideration it can reasonably expect to receive. | Detailed Reasoning - Conclusion: The Commissioner is satisfied that subsection 355-405(2) of the ITAA 1997 applies to Company A, and will prevent Company A from deducting any R&D expenditure it incurs up to $Z. If Company A spends in excess of $Z on R&D, then the difference between that amount and the threshold amount will be 'at risk'. Note, the Commissioner has not considered whether the 'at risk' provision applies to Company A once it has spent more than the threshold amount, as this will not occur in the relevant year. However, as the JV agreement specifies that once Company A has spent threshold amount there are ways for it to increase its interest in the Tenement further, the Commissioner considers that the same process as above would need to be considered in relation to whether sections 355-405(1) or (2) apply to that expenditure. | Detailed Reasoning - Question 2: Does Company A satisfy the condition in section 355-210 of the Income Tax Assessment Act 1997 in respect of its participation (as a joint venturer) in a Joint Venture for the relevant year? | Detailed Reasoning - Answer: No. In the year ending 30 June 2012, Company A's interest in the Tenement and the Joint Venture property is limited to 25%, while Company B's interest is 75%. Company B's 75% interest in the results of the R&D is considered evidence that the R&D is conducted, to a significant extent, for Company B and not for Company A. | Detailed Reasoning - Detailed Reasoning: Under section 355-100 of the ITAA 1997, an R&D entity will be entitled to a tax offset for an income year if it can deduct at least $20,000 for notional R&D expenditure under any or all of the following provisions: (a) section 355-205 (R&D expenditure); (b) section 355-305 (decline in value of R&D assets); (c) section 355-315 (balancing adjustment for R&D assets); (d) section 355-480 (earlier year associate R&D expenditure); (e) section 355-520 (decline in value of R&D partnership assets); (f) section 355-525 (balancing adjustment for R&D partnership assets); (g) section 355-580 (CRC contributions). Company A is an R&D entity within the meaning of subsection 355-35(1) ITAA 1997. Company A has advised that it estimates it will incur more than $20,000 on R&D expenditure for the relevant year. Therefore, Company A's entitlement to notional deductions is subject to the satisfaction of specific conditions for 'R&D activities' as set out in section 305-205. 1 It states: 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. We have been instructed by Company A to assume that it is registered under section 27A. Accordingly, the first requirement is satisfied. In respect of the second requirement, Company A will be able to deduct an amount for the relevant year if the activities for which it is registered are activities which meet the conditions covered by one or more of the paragraphs in subsection 355-210(1). For the purposes of this ruling, the relevant condition is that in paragraph 355-210(1)(a), which says that the section will apply to an R&D activity if: the R&D activity is conducted for the *R&D entity solely within Australia or an external Territory (condition contained in paragraph 355-210(1)(a)). However, the section is subject to the following exception; an R&D activity is not an activity to which this section applies if the activity is conducted, to a significant extent, for one or more other entities not covered by any paragraph of subsection (1). The Explanatory Memorandum to the Tax Laws Amendment (Research and Development) Bill 2010 (the EM), explains that section 355-210 retains a key rule from the previous law (the R&D tax concession) commonly known as the 'on own behalf rule'. 2 This rule is intended to limit eligibility for a notional R&D deduction to where an R&D entity is the major benefactor from the expenditure it incurs on R&D activities. In certain situations, the rule also prevents duplication of claims by different R&D entities. Under the former R&D tax concession, the 'on own behalf' provisions consisted of a positive test, (that contained in the definition of 'research and development expenditure' in former subsection 73B(1) of the ITAA 1936) and a negative test contained in subsection 73B(9). Subsection 73B(9) was only relevant where the eligible company could show its expenditure had been on activities that met the positive requirement in the subsection 73B(1) definition of 'research and development activities', i.e., that these activities have been carried on 'by or on its behalf'. Similarly, under the R&D tax incentive, the exclusion in subsection 355-210(2) will only be relevant to an R&D activity if it has first been determined that that R&D activity is covered by one of more of the paragraphs in subsection 355-210(1). Paragraph 355-210(1)(a) of the ITAA 1997 requires that the R&D activities are 'conducted for the R&D entity. 'For' in paragraph 355-210(1)(a) is followed by the definite article 'the', indicating specificity as opposed to the indefinite article 'an'. The Commissioner therefore interprets the use of 'for the R&D entity ' in this context as meaning that the R&D activities must be done for the particular R&D entity which is determining when notional deductions for R&D expenditure arise under section 355-205. From the information provided and the above assumptions, Company A is the only R&D entity which satisfies the registration requirement in subparagraph 355-205(1)(a)(i). Accordingly, the Commissioner considers that Company A is the R&D entity to consider in paragraph 355-210(1)(a). The Australian Oxford dictionary defines 'for' as having many different meanings, however most relevant to the context in paragraph 355-210(1)(a) is; for 1. in the interest or to the benefit of; The Commissioner considers that an R&D activity is conducted 'for', or 'in the interest of' the R&D entity who receives the benefit of the expenditure incurred on those R&D activities. However, the relevant R&D entity will be prevented from claiming a notional deduction for its expenditure on that R&D activity, if it was conducted, to a significant extent, for some other entity not covered by subsection 355-210(1). This is supported by the EM which says that determining who has the major benefit of the expenditure on R&D activities is tested by weighing up three key criteria. Namely, who: · 'effectively owns' the know-how, intellectual property or other similar results arising from the R&D entity's expenditure on the R&D activities; · has appropriate control over the conduct of the R&D activities; and · bears the financial burden of carrying out the R&D activities. In short, the question of whether an R&D activity is conducted for an R&D entity is a question of fact, determined by whether the activity is conducted in substance to provide the majority of knowledge benefits resulting from the activity, such as access to intellectual property, to this entity. 3.55 Whether an R&D entity has effective ownership involves reviewing all the circumstances surrounding the conduct of the relevant activities and the ownership and control of, and/or ability to utilise, the intellectual property or similar results obtained from the expenditure on the R&D activities. The three key criteria cited above are the same as those relevant to determining on whose behalf R&D activities were performed under former subsection 73B(9) of the ITAA 1936. These three indicators are set out in Taxation Rulings IT 2442 and 2451 (now withdrawn). | Detailed Reasoning - Effective Ownership: Objectively, it is considered that the 'interests' of a company performing R&D are served first and foremost by effectively owning the results obtained from carrying on the R&D activities in question. The Commissioner considers that effective ownership can generally be demonstrated by satisfying the criterion contained in paragraphs 6 to 8 of IT 2451. Just what will be 'effective ownership' of the results of the relevant R&D activities in a particular case will depend on the circumstances of each case. In this case, the aim of the R&D is to produce a commercially viable process for extraction and processing of minerals found on the Tenement. Therefore, the prospective beneficiaries of the results of the R&D activities are: · the owners of the process developed to enable extraction and mining of the minerals, · the owners of the minerals to be mined, and · the owners of any incidental intellectual property produced or obtained in the course of conducting the R&D activities. There is no specific section of the JV Agreement which refers directly to the ownership of any processes or intellectual property that may result from the performance of R&D activities. However, the definition of 'Interest' in the JV Agreement specifies who owns certain rights in general, and who will own any minerals that will be mined in the Tenement. It states that an 'Interest' is, the proportionate interest, expressed as a percentage, by which a Participant is, subject to the agreement: a) obliged to contribute that percentage of Joint Venture Costs; b) entitled to receive in kind, and to dispose of for its own account, Minerals mined from the CR Tenement; c) the beneficial owner as a tenant in common of an undivided share in the Joint Venture Property; and d) entitled to all other rights, and obliged to pay or perform all other liabilities and obligations, accruing to or incurred by the Participants in or arising out of this agreement. Paragraph (c) refers to 'Joint Venture Property', which is defined as; …all property and assets of the Joint Venture from time to time including; a) the Tenement; b) the Mining Information c) all fixtures, machinery, equipment and other property, tenements or rights of any description acquired with funds of the Joint Venture; and d) all Minerals derived by the Joint Venture prior to being taken by, or delivered to, the Participants. Immediately after execution of the JV Agreement and during the First Sole Funding Expenditure period, which includes the relevant year, Company A has a 25% interest in the Joint Venture, while Company B has a 75% interest. Paragraph (b) of the definition of 'Interest' directly refers to the entitlement to receive minerals mined from the Tenement, as does the definition of Joint Venture Property. Both definitions are consistent and state that ownership of the minerals to be mined from the Tenement are to be owned in proportion to an entity's 'Participating Interest'. That is, during the relevant year, Company A is to own 25% of any minerals mined from Tenement. Paragraph (d) of the definition of 'Interest' says that entitlement to 'all other right arising out of this agreement' is similarly to be owned in proportion to an entity's 'Interest'. In the absence of any specific clause dealing with intellectual property, the right to any intellectual property that may arise as a result of the R&D activities would be caught under this 'catch all' clause. Therefore during the relevant year, Company A owns 25% of the intellectual property resulting from the R&D activities. However, the fact that one party may have formal legal ownership of rights in relation to R&D results will not necessarily be decisive of who has 'effective ownership'. What needs to be examined is the practical reality of who can access those results, in what circumstances and on what terms. The JV Agreement says that during the sole funding period, Company A has the exclusive right to carry out exploration on the Tenement. For the avoidance of doubt, a clause says that Company B has no obligation to contribute to any expenditure or other costs incurred in connection with the Joint Venture during this period. However, nowhere does it state that the Sole Funding Period negates Company B's 75% Interest - although not required to contribute, Company B still has the benefit of a 75% Interest. In relation to accessing the results, the Manager's role is outlined in the JV Agreement. It is not clear whether these clauses only apply after the JV Final Commencement Date or whether it is applicable throughout the whole period of the Joint Venture. For example, some sub-clauses refer to the 'Committee' and 'Joint Venture Activities' which by definition only come into operation after the JV Final Commencement Date (which is when Company A has increased its Interest by 30%). However, a variation made to the JV Agreement says that wherever Schedule 2 refers to types of expenditure solely in connection with 'Joint Venture Activities', such a reference is deemed to include a reference to Expenditure in connection with Exploration, ie applicable during the Sole Funding Period. One clause expressly states that for the avoidance of doubt, certain subclauses do not apply during the Sole Funding Period, arguably indicating that other sub-clauses do apply during that period. Regardless, certain clauses do not include a specific time-frame for application and there is nothing to indicate that they do not apply during the relevant year. Respectively, they: · enable Participants to access and inspect all Mining Information under the control of the Manager, during normal working hours and by giving reasonable notice, and · require the Manager to disclose immediately to the Participants any significant discovery of Minerals on Tenement. These clauses ensure that both Participants have easy, ready and practical access to the results of the R&D activities during the relevant year. However, the Commissioner considers that it is Company B who receives the major benefit of those results, due to the proportionate size of its Participating Interest. In the relevant year, the factor concerning effective ownership supports the conclusion that the relevant R&D activities were conducted, to a significant extent, for Company B. | Detailed Reasoning - Controlling the conduct of the activities: Objectively, it is considered that the 'interests' of a company performing R&D are also served by having the ability to control and direct the course of the R&D activities. The Commissioner considers that paragraph 16 of IT 2451 which lists the essential elements of control are still relevant under the R&D tax incentive. 16. Essential elements of control of the conduct of R&D activities are the ability to choose the project of R&D; the capacity to decide on major changes of direction in those activities; the ability to stop an unproductive line of research; the scope to follow up (or not) an unexpected result; and, ultimately, the power to end a project. What these elements will involve depends necessarily on the circumstances of each case. During the relevant year, Company A must spend a minimum amount on 'Exploration', as defined in the JV Agreement. Company A is undertaking R&D activities under the generic banner of 'exploration', and as such, Company A is limited to performing R&D activities that are connected with the Tenement if its expenditure is to be counted towards the threshold amount. However, the Commissioner does not consider that such a general limitation would prevent Company A from having control of the R&D activities. The JV Agreement says that Company A has the exclusive right to carry out Exploration on the Tenement and that it may 'determine the nature, timing and conduct of all Exploration funded by it at its sole discretion'. The Commissioner accepts that Company A has the ability to choose the project of R&D, the capacity to decide on major changes of direction in those activities and the ability to stop an unproductive line of research. In the relevant year, the factor concerning control of the R&D activities supports the conclusion that the relevant R&D activities were conducted, to a significant extent, for Company A. | Detailed Reasoning - Financial risk: Who bears the financial risk of performing the R&D activities is also considered relevant because if a company outlays its own funds to get some R&D work performed, it gives rise to a prima facie presumption that that work is to be done for it, and not for any other party. However, this presumption must be examined having regard to all the relevant circumstances, including whether the R&D entity is receiving any consideration for its financial outlay. Whether or not Company A receives consideration for its expenditure on R&D activities in the relevant year has been examined fully in Issue 1, and will not be reproduced in full here. In summary, the terms of the JV Agreement (including its execution) demonstrate objectively that although Company A solely incurs the cost of performing the R&D activities in the relevant year, Company A receives consideration for its expenditure regardless of the results of the R&D activities, provided it reaches the threshold amount. Therefore, in the year ending 30 June 2012, the factor concerning who bears the financial risk of performing the R&D activities supports the conclusion that the relevant R&D activities were conducted, to a significant extent, for Company B. | Detailed Reasoning - Conclusion: The effect of paragraph 355-210(1)(a) of the ITAA 1997 is that an R&D entity is only entitled to a tax deduction for expenditure incurred in an income year in relation to R&D activities conducted for the R&D entity which registered those activities under section 27A of the IR&D Act. Further, subsection 355-210(2) provides that the R&D entity cannot deduct its expenditure on R&D activities if it conducts those activities to a significant extent for another entity not covered by any paragraph of subsection (1). Having regard to the indicators of financial risk, effective ownership and control of the R&D activities, the Commissioner considers that the relevant R&D activities are carried out, to a significant extent, for Company B during the income year ended 30 June 2012. Accordingly, Company A has no notional deduction for R&D expenditure under section 355-205 in the relevant year.

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