Constructive Payments

Not all invoices are paid in cash or equivalent arrangements. It is possible to apply a debt against another arrangement at the intended recipient’s direction, and as long as the recipient correctly accounts the invoiced amount as having been paid, then a constructive payment can be deemed to have occurred.

This commonly occurs within entity groups where there are multiple inter-company transactions occurring, and it can occur in the transfer of services (for example software development labour provided is paid by provision of a software licence to the development company to a value equivalent to the services provided – which could be for a different product in the R&D entities catalogue).

Whilst these transactions are eligible as long as they are treated correctly for accounting and tax purposes (the taxable supply is declared for both parties), they are troublesome in the case of payments to associates where the benefit is restricted to the year in which the invoice is paid, especially where the payment has been cleared by converting it to a loan.

This is a transaction that will result in very close ATO scrutiny (see their guidance on integrity rules here), because it can be used to commit fraud where the loan is never intended to be repaid, and the invoicing is only conducted to generate the R&DTI benefit.

A recent tribunal case involving a trust and its trustee (R&D costs incurred in the Trust, recharged to the Trustee, and then booked against a loan account) demonstrates that the ATO does not look favourably on these arrangements.

XQDX and Commissioner of Taxation [2021] AATA 4070

Even if the arrangement is not contrived, the documentation required to prove otherwise needs to be extremely comprehensive. We don’t advocate this model, especially for early stage start-ups that are likely to be light on legal advice and documentation.