Recomazing Blog

How to overcome common R&D Tax Incentive mistakes

[fa icon="calendar"] 20-Sep-2017 14:51:37 / by Freya Hunter

Freya Hunter

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If you’re unsure if the R&D Tax incentive is something you should apply for, or if you’re keen to apply but just don’t know where to start, then this guide is for you! We’ve been talking to the best in the biz when it comes to successfully applying for the R&D Tax Incentive, bringing you the do’s and don’ts on how you can secure a nice cash injection.


A big thank you to our resident R&D experts Jessica Olivier, Principal R&D Tax Services at RSM and Cameron Reid, Senior Manager Research & Development at Ernst & Young for their valuable insights and tips! We are extremely grateful we could tap into these clever and experienced experts to find out how to best navigate R&D Tax Incentive waters.

 

This whopper of a guide is split into five sections:

  1. Part 1: RSM defines the R&D Tax incentive and how it works
  2. Part 2: EY explains the process of applying
  3. Part 3: RSM explain how to maximise claim and minimise risk
  4. Part 4: We take you through applicant common mistakes 
  5. Part 5: We provide some tips on tracking R&D activities and expenditure
  6. Part 6: RSM provides a hypothetical case study and bring the process to life

So without further ado, let’s hand it over to Jessica Olivier, Principal of the Tax Services division at RSM. Jess is a very experienced providing specialist R&D tax incentive compliance and consulting services. Since 2006, she has specialised in R&D Tax & government incentives and assisted a broad range of industries to identify R&D opportunities and access the R&D Tax benefits, including start-up innovators, SMEs and large multinational corporations.

 

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Part 1: What is the R&D Tax Incentive and how does it work? 

The R&D Tax Incentive is a good option for some startups due to the cash refund opportunities and the broad-based nature of the program. The cash benefit available depends on aggregated turnover and tax losses available, however for small business with under $20million turnover, a 43.5% refundable tax credit can potentially be cashed out for income years starting on or after 1 July 2016. This means that if a pre-revenue company spends $100,000 on R&D, the company could receive a $43,500 cash refund.

The procedure to access the R&D Tax Incentive is two-fold, being:

  1. Lodge the Application for Registration of Eligible R&D Activities with AusIndustry within 10 months of income year-end.
  2. Complete R&D Tax Schedule within the usual tax return timeframes to claim the notional R&D deductions.

As an example, to access the R&D benefit, a company with a 30 June 2017 income year-end must lodge their R&D Application to register their eligible R&D activities by 30 April 2018, and then lodge the R&D Tax Schedule in line with their income tax return (either initially or within the relevant amendment period, generally being 2 or 4 years).

 

Up next is Cameron Reid, a Senior Manager within Ernst & Young Australia’s Business Tax Advisory Services team. Cameron regularly assists companies from various industries to access the R&D Tax Incentive and other government grants. Cameron is going to walk us through a step by step process on how to apply for the grant.

 

Part 2: The R&D Tax Incentive: Step-by-step guide for accessing the program

 

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Accessing the R&D Tax Incentive can provide critical financial support to companies to grow and develop their products and services. In some instances, companies can access a cash refund via a refundable R&D tax offset. Before submitting an R&D Tax Incentive claim, please refer to additional guidance provided by the program regulators, AusIndustry and the Australian Taxation Office (ATO), or seek specialist advice.

 

1. Assess eligibility of your company to claim the R&D tax incentive.

Broadly, a company may be eligible for the R&D Tax Incentive for an income year if it is a company incorporated in Australia, is an Australian tax resident or has a permanent establishment in Australia.

The following entities are not eligible for an R&D tax offset:

  •       Individuals
  •       Corporate limited partnerships
  •       Tax-exempt entities
  •       Trusts (with the exception of a public trading trust with a corporate trustee)

There are also special rules applied to consolidated groups and R&D partnerships.

 

2. Identify eligible core and supporting R&D activities.

A company must have undertaken eligible R&D activities in Australia during the income year (some overseas R&D activities may also be claimed by obtaining an overseas advanced finding). Under the R&D Tax Incentive, eligible R&D activities are either core R&D activities or supporting R&D activities.

In order to claim the R&D Tax Incentive, a company must have undertaken a core R&D activity. Broadly, an eligible core R&D activity meets all of the following criteria:

  • The activity is experimental; that is, it aims to test a hypothesis or idea through a systematic scientific process.
  • The outcome of the experiment is unknown; that is, the outcome cannot be determined in advance on the basis of publicly available knowledge, information or experience.
  • The activity is undertaken for the purpose of generating new knowledge. This includes new knowledge in the form of new or improved materials, products, devices, processes or services.
  • The activities are conducted ‘for’ the R&D entity. A company is generally only entitled to a tax offset for R&D activities conducted for itself and not for another entity.

 

Certain activities are excluded from being core R&D activities such as (not exhaustive):

  • Market research, market testing or market development, or sales promotion (including consumer surveys).
  • Management studies or efficiency surveys.
  • Research in social sciences, arts or humanities.
  • Activities associated with complying with statutory requirements or standards, including one or more of the following:

o   maintaining national standards;

o   calibrating secondary standards;

o   routine testing and analysis of materials, components, products, processes, soils, atmospheres and other things.

  • Any activity related to the reproduction of a commercial product or process:

o   by a physical examination of an existing system; or

o   from plans, blueprints, detailed specifications or publicly available information.

  • Developing, modifying or customising computer software for the dominant purpose of use by the R&D entity (or any connected or affiliated entity) for their internal administration (including the internal administration of their business functions).

These excluded activities and activities that do not meet the core R&D activity criteria may be considered as supporting R&D activities in certain circumstances. Generally, supporting R&D activities must be directly related or undertaken for the dominant purpose of supporting a core R&D activity.

 

3. Identify eligible expenditure incurred or assets used on the registered R&D activities

To claim the R&D Tax Incentive the company’s total notional deductions for the income year must be greater than $20,000 (unless the expenditure is incurred to an RSP or is a monetary contribution to a CRC under the CRC program).

Only expenditure that is eligible for the R&D Tax Incentive and that is incurred in an income year on registered core and supporting R&D activities can be claimed. R&D expenditure you incur may align to these broad categories:

  • Contract expenditure you incur to an RSP
  • Expenditure you incur under contract to other parties
  • Salary expenditure for people employed by your company
  • Other R&D expenditure (e.g. overhead and administrative costs, tools, consumables, etc.)
  • R&D expenditure paid to your associate in your claim year, unless already claimed under another provision in the year the amount was incurred.
  • The decline in value of asses used for conducting R&D activities.

Certain types of expenditure are ineligible for the R&D Tax Incentive such as:

  • Amounts unrelated to core and supporting R&D activities (e.g. advertising, company establishment fees, donations, staff amenities, entertainment expenses, distribution/selling expenses, etc.)
  • Expenditure on overseas activities (unless an advance finding has been granted)
  • Interest expenditure (within the meaning of interest in the withholding tax rules)
  • Expenditure that is not at risk 
  • Core technology expenditure
  • Expenditure included in the cost of a depreciating asset (decline in value notional deductions may apply)

Other integrity measures and expenditure rules apply that must be considered. Please refer to the R&D tax legislation and ATO guidance for further information.

 

4. Ensure the company has maintained sufficient supporting documentation to evidence the R&D activities

If you are planning on accessing the R&D Tax Incentive, you must meet the compliance requirements set forth by the program.

There has been a strong uptake of R&D benefits under the R&D Tax Incentive since its introduction in 2012, and the number of companies registering R&D claims has increased significantly. As a result, we have seen an amplified focus by the program’s regulators, AusIndustry and the ATO, on R&D claims. The regulators are taking a firm approach to any R&D claims that are not appropriately substantiated.

AusIndustry and the ATO state in their information sheet that companies must keep adequate records to demonstrate that:

  • They carried out eligible R&D activities (i.e. core and supporting R&D activities).
  • They incurred eligible expenditure in relation to those activities.
  • Their R&D activities and expenditure met all other legislative requirements under the program.

Examples of documents required to substantiate activities and expenditure include:

  • The results of a literature analysis or searches outside the company regarding the current state of knowledge or state of the art for the core R&D activity. This could include a broad range of information from suppliers, research organisations, industry articles, blogs, wikis, etc.
  •  Project reports (including, evidence the purpose of undertaking activities, the experiments undertaken, the outcomes of the experiments, the dates of the activities)
  • Contractual agreements (if engaging other parties to conduct R&D activities)
  • Invoices detailing activities undertaken
  • Timesheets detailing who has conducted the R&D activities, the effort on the activities and the dates on which activities are undertaken.

Recomazing has recommendations on some great tools that many of our clients use to effectively substantiate their R&D activities and expenditure. Please review some of the tools and recommendations within the following categories:

  •       Productivity and Organisation (including, collaboration, task management and time tracking)
  •       Finance (including expense management, invoicing)

 

5. Register your R&D projects and activities

An R&D entity must lodge an application to register its activities with AusIndustry within 10 months after the company’s financial year-end. For example, if your financial year ends on 30 June, the R&D application must be lodged by 30 April the following year. The approved application form can be downloaded from the business.gov.au website.

Once AusIndustry processes the application form, the company should receive a notice of registration (including a registration number).

 

6. Lodge the ATO R&D schedule with the company’s income tax return

To claim the R&D tax offset, the company must lodge the ATO R&D Schedule (including the registration number) with the company income tax return. The ATO R&D Schedule includes the total amount of your notional R&D deductions and the amount of R&D tax offset claimable.

The R&D tax offset is calculated by multiplying the total notional R&D deduction amount by either 43.5% or 38.5% (depending on which R&D tax offset rate applies). For income years starting on or after 1 July 2016, for R&D expenditure up to $100 million in an income year, companies can access a:

  1.     43.5% refundable tax offset if they have an annual aggregate turnover of less than $20 million.
  2.     38.5% non-refundable tax offset for all other eligible companies.

The refundable tax offset is available to companies that are not controlled by income tax exempt entities.

Eligibility for the 43.5% refundable tax offset or the 38.5% non-refundable tax offset depends on the company’s aggregated turnover. Broadly, aggregated turnover is the combined annual turnover of all affiliated and connected entities of the company in an income year.

 

7. Receive cash or tax offset

The company should receive the R&D benefit once the tax return is processed by the ATO.

 

So now Cameron from EY has guided you through the process on how to apply, Jess from RSM will give you some pointers on how to make the most of your claim.

 

Part 3: Things to Consider To Maximise Your Claim Whilst Minimising Risk

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Given the relative ease of accessing the R&D Tax program and the crucial role the cash refund plays in helping startups through the ‘valley of death’ and beyond, the topic of claiming R&D should be a top priority for any entrepreneur. Missing out on this much-needed cash whilst your competitors are accessing it could prove to be fatal for your business. Also, businesses and entrepreneurs should remember the context in which the R&D program is run and manage the risks accordingly.

The R&D Tax Incentive isn’t your typical grant program, the risk of not receiving the cash does not generally arise at the initial lodgement phase. As part of a self-assessment regime, cash will usually be accessible for the company upfront, however, the registration can be subjected to review at a later date. To ensure that the company does not need to repay large amounts of cash for non-compliance further down the track (which could be more detrimental to a business whilst it is gaining traction), some key things entrepreneurs and start-up businesses should remember are:

1. Claiming R&D

If your new venture or business involves technological or scientific innovation and you undertook experiments (rather than purchasing off the shelf solutions), chances are that at least some of your expenses will be eligible for the R&D Tax Incentive. The R&D Tax Incentive is accessible for all industries and does not discriminate.

2. Apply the law

Rather than going off gut feel, the R&D Tax Incentive is governed by specific and prescriptive law which should be applied limb by limb and at activity level. The company should attempt to do this either with or without an R&D Tax Adviser. There is a raft of AusIndustry and ATO guidance material which your adviser should be able to point you to. Whilst having an adviser is comforting, the company should always read all guidance materials itself to ensure that it is up to date with the compliance landscape.

3. Getting advice

get good advice and get it early. Remember that good R&D Tax advice should involve a balance between the ‘good news story’ and cash benefit, how the company’s activities fit into the program, getting into the details in the year-end registrations to provide relevant and targeted information to the authorities, and practical steps to managing risks and the documentation process. Any general advice which promises large benefits for minimal work, or other stories which sound too good to be true, probably are just that.

Check out some of the advisors with recos on Recomazing here.

 

4. Document your activities and costs and set up an appropriate process

Contemporaneous documentation for both eligible R&D activities and eligible R&D expenditure is a necessary requirement under the tax law, and specific documentation for each activity and how eligibility is met should be maintained. Where start-ups have not implemented a detailed documentation process, this should be considered to support any R&D claims. Having a good R&D adviser will ensure that an appropriate yet simple documentation system is setup to manage the risks of claiming R&D.


Next up, let's have a look at the most common mistake applicants make when applying for the incentive.

 

Part 4: So what are the common mistakes faced by applicants?

 

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Common Mistakes to avoid with the R&D Application Form 


Mistake 1: Poorly Defined Objectives.
  • The objectives of the projects and activities are described quite broadly and do not provide specific technical details of the R&D activities undertaken.

Mistake 2: Business Objectives instead of Technical Objectives.
  • The objectives of the projects and activities describe business objectives as opposed to technical details.

Mistake 3: Ineligible Activities
  • Some or all of the activities registered are ordinary business activities that are not eligible for the R&D Tax Incentive.

Mistake 4: Activities retrospectively fit into R&D activities

  • Some or all of the activities registered were undertaken in the course of ordinary business activities and recharacterised as R&D activities at a later time.

Mistake 5: New knowledge is generic and unspecific

  • The description of new knowledge intended to be generated through experimentation is generic and unspecific, i.e. the innovative aspects of each of the core activities registered and how the innovations are different to similar products in the worldwide market are not adequately stated.

Mistake 6: Core activities not provided post experimentation

  • Specific details alluding to how the outcomes of the core activities could not have been known or determined in advance of experimentation are not provided, i.e the specific reasons why such activities aren't routine for a competent professional in the field aren’t provided.

Mistake 7: Lacking systematic work progression

  • The core activities registered do not comprise a systematic progression of work that is based on the principles of established science and proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions.

MIstake 8: Generic hypothesis

  • The hypotheses (if provided) are generic and do not comprise specific, measurable parameters being tested as part of experimentation.

 

Common Mistakes to avoid with calculation of R&D expenditure 

 

Mistake 1: Salary expenditure is calculated in an unreasonable manner.

As an example, a singular R&D apportionment percentage is often applied to the salaries and wages of all employees within the payroll, regardless of their roles or functions within the organisation. 

 

Mistake 2: No consideration given to contract expenditure relating to R&D activities

No consideration is given to whether contract expenditure incurred to other entities relates to R&D activities performed ‘for’ the claimant entity. The ‘for’ test requires the claimant to demonstrate, on balance, that it:

    • effectively owns the know-how, intellectual property or other similar results arising from expenditure on the R&D activities;
    • has appropriate control over the way the R&D activities are conducted; and
    • bears the financial burden of carrying out the R&D activities.

 

Mistake 3: Expenditure assigned unreasonably

Expenditure is apportioned between R&D activities and ineligible business activities in an unreasonable manner, i.e overhead expenses are apportioned using a method that allocates an unreasonably large amount to R&D.

 

Mistake 4: Ineligible expenditure

Expenditure included as overheads in respect of incurrence on eligible R&D activities comprises ineligible expenditure, such as, but not limited to advertising, donations and rent paid for premises that are not used in R&D activities.

 

Mistake 5: Incorrect calculation of R&D depreciation

R&D depreciation is calculated through the application of a singular percentage apportionment from the Profit & Loss statement, instead of consideration being applied as to the use of each asset within the Fixed Asset Register for undertaking R&D activities.

 

Mistake 6: Incorrect calculation of direct expenditure

Direct expenditure included in the claim includes costs incurred on goods or materials materials that were subject to ‘processing’ or ‘transformation’, without consideration as to the application of feedstock provisions.

 

Mistake 7: Lack of specific allocation of core R&D expenditure

Eligible R&D Expenditure is not specifically allocated to core and supporting activities.

 

Common Mistakes to avoid with Corporate Governance

Mistake 1: Lack of proper company records kept

Companies do not maintain proper, detailed and contemporaneous records to support the registration application and the claim for the R&D Tax Incentive.

 

Mistake 2: Not enough evidence provided to prove R&D activity and claims

Companies are not able to provide contemporaneous documentary evidence that substantiates the direct link between the registered R&D activities and the expenditure claimed in the event of an ATO and/or Ausindustry review.

 

So now you're familiar with the do's and don't of applying for the R&D grant, let's see how to best track your R&D actvities and expenditure.

 

Part 5: Tips on how to track R&D activities and expenditure

 

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To ensure an ability to both make and then (in the event of a review) support an R&D Incentive claim, the business should keep the program front of mind from project inception and document:

The objective 

What are you seeking to achieve (technically and commercially)?

Examples:

      • Business case
      • Management briefing – slide deck
      • Project plan 
      • Records from emails, etc.

 The state of the art

What is currently out there?

Examples:

The invention

What are you doing differently?

Examples:

      • Patent, Innovation Patent, Registered Design
      • Awards or ‘innovation’ recognition from external parties

The challenge

Why is it going to be difficult?

Example:

      • Internal and third-party comments on technical challenge

The test

How will you test the product/service/process?

Examples:

      • Test plans indicating the scope of testing (e.g. both ‘control’ and ‘test’ environments) and the knowledge sought
      • Test results and outcomes

The cost (i.e. R&D Expenditure)

What can effort (and therefore cost) be attributed to the R&D activities?

Examples:

      • Timesheets or diaries recording effort on R&D versus non-R&D
      • Monthly summaries of team R&D effort (e.g. %, days, weeks, etc. per activity)
      • Contracts and invoices from consultants – is it clear what has been worked on is R&D? If not – perhaps request a quick summary from the consultant

 

If you’re still a little unsure of how to go about the grant, Jessica from RSM have provided a hypothetical case below as an example to help you wrap your head around the process. 

 

Part 6: The myths, facts and examples

Case Study: Bob’s Gift Marketplace

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Before we get started, please remember, this case study is for information only. This case study is not formal guidance and should not be used to inform the self-assessment of your own R&D activities.

 

Bob’s Gift Marketplace Pty Ltd


Bob’s Gift Marketplace Pty Ltd was founded by Bob and two friends and starting on 1 July 2016. Bob’s previous work experience was as an Artificial Intelligence (AI) code designer with Google for 15 years, whilst Bob’s two friends are experienced Retail Executives.


Bob’s Gift Marketplace Pty Ltd obtains seed funding from family and friends during September 2016. Between July and September 2016, Bob and his two friends spend all their time sourcing funding and designing the initial concept for Bob’s Gift Marketplace Pty Ltd. Bob’s Gift Marketplace will attempt to partner with e-Commerce companies to automatically select, purchase and deliver gifts.


The technology being developed is a world first AI based algorithm which involves a user installing the Application on their mobile device, the algorithm then scans all interactions with a person for whom the user is wishing to purchase a gift for (e.g. instant messaging, WhatsApp, Facebook, Twitter). The user then manually inserts the occasion for the gift. Using the background interaction data collected, and the occasion, the algorithms generates a shortlist of gifts based on the interaction between the user and the gift recipient, and the occasion. Supporting codes will then automatically search each e-Commerce Partner’s stock to identify the ideal gift based on current discounts, percentage match with the algorithm and various other variables. If selected by the user when setting up the account, the support codes will automatically pay and order the gift to be delivered to the recipient’s home address. The platform expects to launch on 1 July 2018.


What constitutes eligible R&D activities


Myths and common mistakes

Companies assessing all their activities as being innovative and ‘R&D’, therefore self-assessing its activities as being eligible for the R&D Tax Incentive.


The Hypothetical Example for the Myth Approach

Bob and his friends are assured by their accountant that he has experience preparing R&D claims and that all of the work up to product launch is eligible R&D. The accountant does not advise the co-founders of any documentation requirements.

Bob’s accountant spends some time researching background papers prepared by Bob and then meets with the co-founders for one hour.

Based on these notes, Bob’s accountants registers all of the businesses’ activities for the year as one eligible core R&D activity, being design and development of the new platform. To elaborate on some of the work done, Bob’s accountant describes various business activities undertaken to date, including engaging in funding discussions, setting up the website and setting up the business.

Bob’s accountant prepares a high-level description of the innovations being developed and lodges the R&D Application Form. The R&D Application Form does not specifically address any technical hypotheses from a software engineering perspective, or any experiments which were set up and its results.


The Fact

What constitutes eligible R&D activities are prescriptively defined in the Tax Act. All of the provisions of the Tax Act must be applied against a company’s activities to determine whether all of the criteria is met. Similar to other ‘activities’ governed by tax law, a robust process of statutory application must be undertaken, rather than a process of ‘gut-feel’ around whether activities are R&D.


The Hypothetical Example for the Fact Approach

Whilst the algorithms developed by the company in this example are highly likely to be eligible, the company needs to ensure:

  • The company activities are broken down between eligible R&D design and experimentation, general funding related activities, and any other activities (potentially general software development using known methods and not relating to the new algorithms.

  • The company is able to understand the documentation process to contemporaneously track the shifts in the development and the experimental outcomes, along with the time spent by the co-founders and other staff on each activity. If required, appropriate advice should be sought from a qualified R&D Tax professional on the types of documentation/templates which should be implemented.

  • The R&D Application Form adequately describes the innovations from an activity level, rather than at a broad project level. Each identified activity must be registered in a manner which addresses every limb of the R&D Tax eligibility criteria. One example of a core R&D activity in this example would be the development of the initial algorithm. For example*:

  • The hypothesis: Could relate to how the algorithm is written to be able to generate the intended measurable output which the company expects, being the ability to automatically scan any mobile device, use fuzzy logic to match a gift recipient’s data within a mobile device and through any social media platforms, and then correctly generate the best gift for that person.

  • The technical knowledge gap: Rather than explaining that no algorithms exist which is able to achieve this output, the company would need to elaborate on why a competent professional such as Bob cannot predict the outcome of the algorithm without undertaking any experiments. It may be that the algorithm contains more variables than ever proven previously, or that the ability to scan the memory within a mobile device as well as social media platforms requires support codes which do not exist.

  • The experiments and the new knowledge: The experiments could be that Bob set up a ‘control’ environment where real people were used to manually generate the gift that person would most want out of a selection of 100 gifts. The algorithm which is newly written is then run against that same gift recipient multiple times to determine whether a hypothesised level of accuracy has been achieved. Out of 50 test cases run, the algorithm successfully predicted the top gift 18 times. The algorithm was then re-written and re-tested. The new knowledge generated would then be new algorithms and support codes which are able to extract, combine and manipulate social media and communications data for a gift recipient to accurately predict the gift that person would want.

*NB – remember this is only one of a number of activities the company undertakes. The next algorithms to automatically extract gift data from partner databases will require a similar assessment and documentation process.


Types of ‘innovation’


Myths and common mistakes

Myth 1 – Any innovation will automatically be eligible under the R&D Tax Incentive.

Myth 2 – My company does not undertake traditional ‘R&D’ activities, or my company is not in a traditional industry for R&D and therefore will not be eligible.


The Fact

Again, all of the provisions must be applied against the company’s activities. For example, one of the criteria for core R&D activities is that the innovation must be based on established science.

Some company innovations may be around bringing about a new service, or new technique, however, if this does not generate new knowledge from a scientific perspective, the activity may not be an eligible core R&D activity.

Conversely, the R&D Tax legislation is broad-based and not discriminatory against industry. R&D activities will be eligible as long as the criteria set out in the law is met.


High-level grouping of ‘R&D’


Myths and common mistakes

Myth 1 – Where the company’s technology contains elements of scientific innovation, all the activities in relation to bringing the innovation to market are eligible.

Myth 2 – Assessing the eligibility criteria as set out in the law requires application at the project level.


The Fact

Some aspects of a company’s work may be eligible ‘R&D activities’ as defined in the tax law, however, identification of these activities require a detailed process of pre-planning, documentation, collation of results and confirmation of eligibility at the end of the income year.

R&D activity eligibility should never be assessed at a project level, as the law for eligible core R&D activities requires identification of a hypothesis premised on scientific principles, which is then subjected to a systematic process of an identifiable or pre-planned experiment (also subject to other limbs of the test).

A business developing a new product or a new process can rarely be a single activity which satisfies this, as it is difficult to identify a precise hypothesis without breaking down the development into more detailed activities.



Calculating R&D expenditure


Myths and common mistakes

All time and costs broadly spent in relation to identified R&D activities is eligible based on the amount spent in the year.


The Hypothetical Example for the Myth Approach

Bob’s accountant reviews the Profit and Loss Statement at the end of the year and determines that all of the expenses to date have been on R&D and therefore eligible.

OR

Bob’s accountant reviews the Profit and Loss Statement at the end of the year and removes the company establishment fees and other commercially related accounts. Bob’s accountant generally estimates that 90% of time spent by the co-founders is eligible and includes 90% of payments to the co-founders in the R&D claim.


The Fact

There are rules contained within the Tax Law which prescribes how R&D expenditure is to be calculated, including modifications for depreciation on hardware and the portion to be claimed for R&D. There is also a series of ATO publications which provides guidance. Broad-based apportionments or estimates of time or cost will rarely be accepted as being sufficient.


The Hypothetical Example for the Fact Approach

Specific General Ledger analysis needs to be undertaken to identify transactions which actually relate to either the core, or supporting R&D activities, and the quantum.

Further, the company by this stage should have implemented a time-based tracking system. If this is not yet implemented, any historical exercise should not rely on broad estimates. Rather, the company would need to evaluate existing evidence (e.g. diary entries, calendars etc.) to determine actual hours spent on the registered R&D activities.

Specific attention must also be paid to certain categories of costs. For example, costs included in low-value pools cannot be claimed for R&D. Costs on tangible depreciating hardware must also be excluded, with the eligible tax depreciation portion included only.


Documents and record keeping


Myths and common mistakes

General business records will be able to provide a ‘feel’ that the company’s activities are eligible R&D and this will be sufficient to prove that the company is undertaking R&D. The business will be able to explain why its developments are eligible R&D if the administrators require this.

The company should not have to be burdened into preparing documentation in excess of the usual business documents to evidence its R&D activities.


The Hypothetical Example for the Myth Approach

Bob’s accountant does not undertake any additional steps to either implement documentation processes/systems, or review existing documentation to determine whether sufficient evidence exists to support the activities registered with AusIndustry, or the costs included in the R&D Tax Schedule.

Bob’s accountant advises the company that in the event of a review, general investor documents and day to day emails will be sufficient.


The Fact

The consequences of being part of the tax system are two-fold:

  1. The onus is on the taxpayer to prove that the activities meet the eligibility criteria.
  2. The onus is on the taxpayer to provide contemporaneous evidence to support the activities it undertakes.

General business documents with no attention directed towards the R&D eligibility criteria will rarely be sufficient in itself to prove that the activities undertaken by the company satisfied the eligibility criteria.

General documents which are not contemporaneously prepared and which do not benchmark the activities against the specific eligibility criteria on an ‘activity’ basis will rarely be sufficient.

Whilst the R&D Tax Incentive does not explicitly require additional documentation to be kept, in most industries the company will need to undertake some contemporaneous planning activity and implement certain review and documentation processes to be able to generate the required documentation.


The Hypothetical Example for the Fact Approach

At the outset, the company should evaluate whether a documentation process should be implemented. A qualified and experienced R&D adviser should at this stage assist the company to implement real-time systems (whether extremely basic such as spreadsheets and experimental records, or adoption of technology) to ensure that adequate records are captured.

Period reviews of documentation which is available, and the processes of documentation, should be undertaken between the company and the R&D adviser.


Use of technology for record keeping


Myths and common mistakes

Using technology to track R&D will automatically ensure the correct information is captured and therefore satisfy the eligibility criteria.

The Hypothetical Example for the Myth Approach

In the second year of its development, the company grows and purchases licences for a JIRA system. The company is now confident that JIRA will capture all tasks, including those relevant for the R&D Tax Incentive.

Bob consults his accountant and is advised that in the event of a review, the JIRA records can be submitted as evidence of ‘R&D’.


The Fact

Common Project Management tools are available for purchase or licensing, with some specifically targeted towards the R&D Tax Incentive.


Common tools for software start-ups include:

 

Companies should remember that simply using technology or some other process/system for recording time, cost, or details of activities, does not in itself mean the activities will satisfy the eligibility criteria.

Technology and documentation systems is a step in the right direction, however not the whole picture. The actual information collected by these systems must still be sorted against each of the eligibility criteria on a contemporaneous basis to serve the purpose the systems are actually used for. Simply providing an information dump will unlikely satisfy the administrators.


The Hypothetical Example for the Fact Approach

JIRA extracts, or other technology-based project tracking systems, do not in themselves provide sufficient evidence.

The company should meet with the R&D Tax adviser to review records for a selected period and assess any problem areas where records may be insufficient. Together, the company and its adviser should then develop strategies to fill these gaps.


Reliance on advisers

Myths and common mistakes

A company which uses an R&D Tax adviser will mitigate risk and optimise the amount claimed.


The Hypothetical Example for the Myth Approach

Having engaged Bob’s accountant who has prepared other R&D Tax claims for similar technology companies, the company is confident that the R&D claim is robust and defensible in the event of a review. The company will also put forward that it has prepared the R&D claims in good faith by using a registered tax agent.

 

The Fact

R&D Tax advisers, like advisers in other areas of tax and corporate life, vary in skill, expertise and experience. Engaging an R&D Tax adviser does not guarantee that your claim is maximised, or that your risk is managed appropriately.

If possible, you should always seek a second opinion on your R&D activities at least periodically. Most R&D advisers would be happy to provide this service free of charge.


The Hypothetical Example for the Fact Approach

The company should investigate whether the R&D Tax adviser actually specialises in the area and their level of expertise. Whilst there are many R&D service providers, many of these providers are not specialists in R&D Tax. The company should also review any recent guidance from AusIndustry and/or the ATO and the law, and review the R&D claim documents carefully to ensure that it is comfortable that the detailed tests in the law are being applied.

The company ideally would provide the R&D claim documents to an independent adviser for review every 2-3 years. These services can usually be sought at no cost in the first instance.


Time and tasks required to ensure a robust R&D claim is prepared


Myths and common mistakes

The real work is at the year-end compliance step, and value-add from the adviser comes at the compliance step.


The Hypothetical Example for the Myth Approach

Bob and the co-founders are happy that Bob’s accountant is able to only take up one hour of their time at the end of each year. The R&D claim is then prepared without any additional input and lodged. Bob and the co-founders have not yet encountered any issues with reviews.


The Fact

Whilst the year-end compliance paperwork is a large part of the ‘labour’ component of preparing an R&D claim, managing the risks of any claimed activities and maximising the claim happens throughout the year.

The real value-add from a good R&D Tax adviser will involve both the year-end paperwork process, and assisting you to contemporaneously document your R&D activities, implement appropriate systems (whether simple systems such as Excel spreadsheets, or investing in more complex systems) and keep you updated on developments in the compliance landscape.


The Hypothetical Example for the Fact Approach

Reviews from the authorities are broadly arbitrary in nature unless there are major errors in either R&D benefit claimed, or the preparation of the compliance documentation. Poorly prepared R&D Applications may not be reviewed for a number of years.

The only way for a company to truly protect itself is to maintain dialogue with an experienced R&D Tax Adviser periodically, ensure that the documentation processes which are in place are current and in line with the expectations of the administrators. Failure to implement a robust process will expose the company to a time-consuming task in the event of a review. If no contemporaneous documentation is available in such an event, the company would likely need to repay significant amounts of cash.


When is an R&D claim really ‘Approved’?


Myths and common mistakes

Once AusIndustry provides the Notice of Registration and/or the ATO processes the tax offsets, the R&D claim is approved.


The Hypothetical Example for the Myth Approach

When the company receives the Notice of Registration from AusIndustry each year, and when the ATO processes the refund, the company determines that it is another successful year of obtaining the ‘grant’.


The Fact

The compliance process falls within the self-assessment regime. Preliminarily, provided no obvious information is missing and there are no stand-out risk flags, AusIndustry and the ATO should approve any R&D claims which are submitted.

However, as with all tax matters, the authorities have the right to undertake detailed review or audit activities. If a company is submitting R&D claims without adequate documentation and processes, there is a substantial risk that cash received today must be repaid back at a later date.


The Hypothetical Example for the Fact Approach

A company will only truly be deemed to have undertaken eligible R&D activities, and claimed eligible R&D expenditure if its activities and supporting documentation is reviewed by both AusIndustry and the ATO for that year, and a positive outcome is achieved.

Reviews by AusIndustry and the ATO are both sporadic and generally arbitrary in nature (although proper registration of eligible R&D activities will reduce the initial risk of review somewhat). The only way to truly protect the cash which has been provided by the government through the R&D program is to ensure that the company’s governance processes are robust and that a detailed process of identification and registration of eligible R&D activities and expenditure is undertaken with an experienced R&D Tax adviser on a periodic basis.

 


So there you have it, everything you ever needed to know about the R&D Tax incentive and how to apply in the best way possible. I’d like to thank Cameron Reid at EY and Jessica Olivier from RSM for giving up their time to contribute to this extremely helpful post!

Do you have any R&D tips to include?

Topics: EY, Cameron Reid, Jessica Olivier, Grants, R&D, RSM

Freya Hunter

Written by Freya Hunter

Is the Conversation Party Starter @Recomazing, communications guardian, community manager, resident social media geek and office DJ.

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