The R&D Tax Incentive is now well into its fourth year of operation and has an R&D tax support pedigree stretching back into the 1980’s - the R&D Tax Incentive is not a new programme. It is very positive to see the strong majority of participants appropriately registering with the programme and going on to claim their tax offsets to support genuine R&D. However, despite the maturity of the programme AusIndustry still sees a small but worrying number of registrations and applications for finding that apply the law incorrectly. These registrations are prepared by both companies and registered tax practitioners.
AusIndustry administers its compliance assurance of the legislated eligibility requirements for R&D activities through a guidance led approach, publishing guidance on business.gov.au. Programme guidance is developed in consultation with stakeholders, such as the R&D Tax Incentive National Reference Group (NRG), and is designed to help companies participate in the programme with confidence that they understand how to be compliant with the legislation. AusIndustry expects that anyone who prepares registration applications and applications for finding is across its guidance and understands the requirements.
Registration applications that are incorrectly prepared run the risk of incurring an AusIndustry and/or ATO compliance review which puts an unwelcome impost on companies that just want to get on with business. A compliance review can result in some, or all, of the registered activities being determined to be ineligible.
Incorrectly written applications cost companies time and money, and are a reputation risk for registered tax practitioners.
Most companies and R&D tax practitioners understand and follow the legislation as it is explained in AusIndustry’s guidance.The interpretation and application errors we are seeing, which tend to fall into distinct categories, could be avoided if our guidance was followed when the applications were being prepared.
Failing to identify specific activities
The R&D Tax Incentive legislation requires that specific experimental activities must individually satisfy the requirements for eligibility for core R&D activities, and specific activities must individually satisfy the requirements for supporting R&D activities. Projects are generally composed of a number of specific activities and these specific activities must be self-assessed for eligibility under the programme.
AusIndustry is still seeing applications for entire projects – either as a claimed single R&D activity or as a collection of R&D activities that largely describe a whole project. It would be rare for all of the specific activities in a large or complex project to be eligible. See How should companies group R&D activities? (p1) and When could scaling-up involve eligible R&D activities? (p1) for further guidance.
An indication that activities are being incorrectly considered at the whole project level is where claimed hypotheses relate to entire projects rather than to specific R&D activities. Sometimes these whole of project claimed hypotheses are described as ‘overarching hypotheses’, and do not relate to an identifiable specific experiment. The legislation requires activities being registered as core R&D activities involve systematic experimental work with an experiment that tests a hypothesis. In other words, the sort of hypothesis required is one that is specific to a specific experiment, not the project as a whole. For example, see R&D Tax Incentive: A Guide to Interpretation (p7) and How should companies group R&D activities? (p1).
Failing to identify a technical knowledge gap
We still see too many registrations and applications for finding that do not identify the technical knowledge gap an experiment is seeking to bridge. This is a key requirement in the legislation and also cuts to the purpose the R&D Tax Incentive exists – to encourage industry to conduct R&D activities that might otherwise not be conducted because of the technical uncertainty of the outcomes. We also see too many registrations that identify an unknown outcome of an economic or commercial nature rather than a technical outcome, or identifying a technical knowledge gap that is only unknown because a standard test has yet to be applied (i.e. an ‘experiment’ that does not involve a hypothesis). The Administrative Appeals Tribunal in the Mount Owen case made clear that when considering whether an outcome cannot be known it is important to focus on the technical risk in the substance of the experiment itself, and not on the wider risks of the company’s operations, nor on aspects the activities were not designed to impact.
The legislation requires that eligible hypothesis-driven experiments are those that have an ‘outcome [that] cannot be known or determined in advance (Section 355-25(1)(a) of the Income Tax Assessment Act 1997). For adequate self-assessment a company needs to know what the specific technical knowledge gap is that it is trying to resolve. AusIndustry guidance is helpful in understanding this, see for example R&D Tax Incentive: A Guide to Interpretation (pp 6-8 and 10) and When could scaling-up involve eligible R&D activities? (p1).
AusIndustry’s guidance led approach helps companies to access the benefits of the R&D Tax Incentive with a minimum of risk. The errors identified above have often occurred because the parties concerned have either not read the guidance with enough care or have chosen not to follow it. Accordingly, I commend our guidance to all companies and advisors that are participating in the programme.
Industries/technologies where mistakes are more common
There are particular industries or technology areas where a concerning level of risk from eligibility mistakes have been seen: mining and resources; software development; construction; and broad acre farming.
In the mining and resources sectors, applications that encompass whole projects are occurring. We often see these errors in activities being registered to develop mining flowsheets.
In software development, we also see many whole of project claims. While software development lifecycles generally involve a systematic progression of work, they frequently do not involve experimental activities to resolve an unknown or undeterminable outcome. The outcome of an experiment in software development must be the resolution of a specific technical challenge, one that cannot be known or determined in advance by a competent professional/s in the relevant field/s. Whole of software project claims usually fail to address the eligibility of specific experimental activities and lead to compliance problems. AusIndustry’s R&D Tax Incentive: ICT Guidance (p3) is useful in understanding these requirements. AusIndustry is also developing additional guidance on software development activities to supplement the published guidance.
In the construction sector, whole of project claims and claims where technical uncertainty is resolved by applying existing knowledge are of concern. The ATO is particularly concerned where construction industry registration applications include expenditure that is explicitly excluded from the R&D tax offset under the legislation, as ‘expenditure incurred to acquire or construct a building or a part of a building’ (see section 355.225 of the Income Tax Assessment Act 1997).
We have seen a number of registrations from companies undertaking broad acre farming activities that are concerning. Risks lie in claims for the application of fertilisers and soil improvers which do not relate to R&D activities, but rather relate to business as usual farming activities across the whole or large part of their operations. AusIndustry and the ATO have now jointly released a Taxpayer Alert relating to this issue.
Top Tips for Avoiding Risky Claims
If you are preparing your own self-assessment, ensure that you have read and understand the relevant AusIndustry Guidance publications.
If you are uncertain you may contact AusIndustry for guidance, and you may apply for an Advance Finding if you need certainty about the eligibility of activities before making a claim.
If you are paying for professional advice, ask your adviser if their advice follows AusIndustry’s guidance.
R&D Tax Incentive