New ATO Guidance on Australian R&D Subsidiaries: What It Means for Foreign-Owned Biotechs
Author: Matthew McLean
For foreign life sciences companies considering Australia as an R&D location, the pull of the RDTI’s 43.5% headline rate for R&D expenditure can be significant. But the devil is often in the detail. Things like the aggregated turnover test, and whether the R&D is conducted on behalf of an Australian or foreign entity, can be determinative of whether an Australian subsidiary is eligible for the full refundable rate, a materially smaller refund, or a non-refundable tax offset it may never actually benefit from.
The ATO has been explicit that it has concerns about Australian subsidiaries incorrectly assessing that activities are conducted for themselves and claiming the 43.5% RDTI rate on that basis, when in substance the activities are conducted for a foreign parent. This question falls back to one of the program’s key legislative principles, that an entity may only access an R&D Tax Offset for expenditure on activities that were conducted for that entity.
Despite this being a longstanding principle, the weighting of the three factors used to demonstrate that the test is satisfied (effective ownership of the results, control over the activities, and who bears the financial risk) is more subjective. In recent years, this subjectivity has created an environment of heightened compliance risk for Australian subsidiaries of foreign biotech companies and, anecdotally, the ATO has been particularly active in reviewing and denying claims that don't meet its expectations.
Last week, the ATO provided some more clarity about what those expectations are in the form of updated guidance. The guidance sets out some more factors it considers when determining who R&D activities are conducted for in the context of foreign-owned Australian R&D subsidiaries.
What the ATO is looking at
The new guidance adds some further colour to how the ATO considers the three factors weighed when determining who the R&D is conducted for.
Effective ownership of the results
Points to the subsidiary: it's paid in full, at arm's length, for anything it later provides the parent out of the R&D results, and it can genuinely commercialise those results independently of its arrangements with the parent.
Points to the foreign parent: the agreement explicitly gives it ownership; only the parent can benefit from or commercialise the results, whether formally or in practice; it holds the primary right, from the outset, to exploit and manage whatever the subsidiary develops.
Control over the activities
Points to the subsidiary: its people (employees, contractors, or advisers) aren't under the parent's direction, control, or influence in relation to the specific R&D being conducted. Ordinary parent company governance and oversight doesn't count as control here.
Points to the foreign parent: it has direct control or decision-making authority over the activities, beyond what an arm's length customer would ordinarily exercise. This counts whether or not it's written into the agreement, since control exercised in practice is enough. A subsidiary effectively operating as a research service provider for the parent is a strong indicator this factor sits with the parent.
Financial risk
Points to the subsidiary: the R&D is genuinely funded with money that belongs to it (i.e. business revenue or a third-party loan) and any financial support from the parent is arm's length, provided as working capital rather than earmarked to fund the R&D itself, with repayment obligations that aren't conditional on the R&D succeeding, both in the agreement and in practice.
Points to the foreign parent: it's covering the subsidiary's R&D costs, including any cost overruns, or paying a non-arm's length price for products or services later provided out of the results, calculated to cover the cost of the R&D.
What the ATO is seeing
The ATO is explicit that it has concerns about subsidiaries incorrectly assessing that activities are conducted for themselves and claiming on that basis, and that it regularly reviews claims, including years after the offset has already been paid out.
It says it looks particularly closely at subsidiaries with no physical presence in Australia, no substantial business activity, directors acting under the direction of the foreign parent, no qualified employees able to conduct or supervise the R&D, or incorporation shortly before the end of the income year.
If a claim is found to be ineligible, the consequence isn't just a lower future refund. It's shortfall tax on the difference, potentially penalties, and, because these reviews can land years after the refund was received, a liability that can surface well after the cash has been spent.
Unfortunately, this sits in direct tension with how the RDTI is still sometimes pitched to the global market. The version where a foreign company sets up an Australian subsidiary, appoints a resident director to sign the incorporation paperwork, and claims a 43.5% offset. Some government bodies, CROs, and other advisers promote this simplified version because it's clearly very attractive. This guidance, read alongside TA 2023/5, is the ATO being explicit that it isn't that simple.
Aggregated turnover
The guidance additionally restates is that if the subsidiary is connected with the foreign parent (which is usually the case), the parent's global turnover counts toward the aggregated turnover test.
This means, a subsidiary can look like a small, pre-revenue entity in isolation and still fall outside the AUD 20 million refundable offset threshold once the group's revenue is included. This is why the revenue check needs to be the first question before any conversation about structure, IP or funding. Things like interest on a capital raise, grant income and/or contract services in the hand of the foreign parent can contribute to this turnover cap.
What this means in practice
Having a subsidiary genuinely conducting R&D on its own behalf (real ownership, real control, and real financial risk, reflected in substance and not just in agreements) is what unlocks the full RDTI benefit. Where the R&D is genuinely for the foreign parent, the refundable R&D tax offset remains available for Australian activity conducted under the right conditions, albeit at a lower net benefit.
If you're establishing or reviewing an Australian R&D subsidiary structure, get in touch to talk through how this applies to your circumstances.