Payments to Associates

The definition of an associate is as per section 318 of the Income Tax Assessment Act 1936. 

The ATO provides some examples of an associate of a company:

  • a partner of the company or a partnership in which the company is a partner
  • a trustee of a trust estate under which the company or associate benefits
  • another entity (including a natural person) that, acting alone or with another entity or entities, sufficiently influences the company
  • an entity (including a natural person) that, either alone or together with associates, holds a majority voting interest in the company
  • a second company that is sufficiently influenced by the company or the company’s associate
  • a second company in which a majority voting interest is held by the company or the company’s associate.

A majority voting interest means the ability to cast, or to control the casting of, more than 50% of the maximum number of votes that may be exercised at a general meeting of the company.

These are similar but not exactly the same as the connected entity definitions that are considered when calculating aggregated turnover.

Payments made to an associate must be declared in the year that they are incurred (the year when the corresponding eligible activities occurred), but they are excluded from the calculation of the R&DTI offset, until they are paid by the company.

That includes items such as Director salaries, Invoices for services from other companies in the ‘group’, rent paid to a holding company for property occupied, and Contractor Invoices from significant shareholders. All these arrangements are common for small businesses, and it is also common in pre-commercial situations that these payments cannot be satisfied because the company has no income and they are held as a debt, or categorised as a loan.

Ensure that you tell of us of all arrangements with entities that might be classified as an associate (and note that transactions with associates are also declared elsewhere within the company tax return, so a mismatch in treatments in the R&D schedule will be noticed).

These expenditures must be at arm’s length (at an appropriate market rate), so mark-ups cannot be included as R&D expenditure.

The R&D schedule does have the facility to record these ‘carry forward’ amounts so that they can generate an R&DTI offset in future years (even after the R&D activities have ceased). If you are transferring R&D service providers, ensure that prior year schedules are retained so that the new agent can include these amounts.

If carried forward, the amounts are still deducted from your normal expenditure (changing the taxable position of the tax return) in the year incurred. 

In some cases commercial arms-length loan arrangements can be set up which can be considered to be a constructive payment and the law allows these payments to be claimed, however the ATO is very wary of these arrangements and will ask for considerable documentation proof to show that the transactions are being correctly treated for tax purposes. Their position is that most if not all such arrangements are not eligible (see their guidance here). Whilst ATO guidance does not overrule the law itself, challenging a judgement in court would be extremely costly so we recommend all payments to associates are clean and clear (meaning a payment from a bank account to a connected entity) and do not immediately reappear as an investment or loan to be recycled against further invoices to that same entity.

These arrangements increase the likelihood of an audit by the ATO, and can cause it to be a very protracted experience.