R&D Tax Incentive in Manufacturing

Manufacturing Case Study

Apex, like many other Australian manufacturers, is struggling to maintain its competitiveness in the global market place. The Asia-Pacific region is spearheading global growth in chemical manufacturing, led by a rising demand for sophisticated raw materials and products among the region’s processors. Attracted by the region’s burgeoning market and low cost base, many Australian manufacturers are now looking to relocate their manufacturing operations to Asia.

In the face of this aggressive regional competition and offshoring, Apex determined that it needed to undertake a significant operational restructure. Rather than abandon manufacturing in Australia altogether, Apex decided rationalise its operations, closing the older and less efficient sites and consolidating its production in one or two “super sites”.

Naturally this rationalization presented a number of human resource challenges but it also raised significant technical issues associated with the transfer of product manufacture from disparate sites to one (or two) main sites. The issue stemmed from the fact that every site was different in terms of the nature and configuration of its production equipment which, in turn, informed critical process parameters such as the size of the reaction, heating and cooling regimes and materials handling. Changes in these parameters brought about by the relocation of the point of manufacture had the potential to flow through to undesirable changes in product quality and performance characteristics in the hands of the end-user.

Despite careful planning, Apex invariably found that in some cases it had to go back to formulation in order to achieve the same product quality as was being delivered prior to the relocation.

Apex was uncertain whether its endeavours in this regard would attract R&D tax entitlements, especially given that the products that had been successfully manufactured at other sites previously and were not “new”. Further, it was not transparent where the boundaries should be drawn between core and supporting R&D activities and the more commercially orientated activities that had to be undertaken as part of the wider organisational restructure.

Core R&D activities

NOAH worked with Apex to help the company understand that – notwithstanding the fact the products at the end of the day were not new – reformulation of the product chemistry to address changes in batch size and all that is associated with that change (i.e. reaction temperature, agitation rates, cooling regimes etc) still constituted “an experiment”. That is to say that propositions had to be put forward as to how the quantities, rates and points of addition of the chemical constituents would need to be changed in conjunction with other changes to reaction temperatures, pressures and mixing protocols to keep products within specification in the different processing environment(s).

Some of this reformulation occurred in the laboratory before being scaled up to production. Apex could understand how the lab work might qualify as core experimental R&D activity but was less clear about the scale up activities.

NOAH worked with Apex to help the company understand how a number of the production batch trials could be claimed as part of the suite of experimental activity. This characterisation of the scale up activity was considered legitimate on the basis that proving a formulation in the lab does not necessarily mean that the performance of the formulation will translate to a larger reaction size and under operational conditions that are more variable and unpredictable than those encountered under controlled conditions.

New knowledge

The project work thus generated new insights about the inter-relationship between the different chemical constituents and process parameters and their effect on product performance variables such as viscosity, stability, UV resistance, and opacity and adhesion performance. This new knowledge represented more than a simple progression from what was already known regarding the product chemistry or previous manufacturing processes because it was not transparent and did not simply present itself because of the skills and experience of Apex personnel.

Supporting activities

Apex conducted a range of other activities in support of the project including an assessment of the state of the art, literature reviews, discussions with suppliers and project management more generally.

NOAH advised Apex to claim these activities as directly related supporting activities because of the close and immediate relationship between the activities and the conduct of the core R&D.

What documentation did Apex need to keep?

Apex generates a range of different types of project documentation through the ordinary course of doing its work, including business cases, lab diary sheets and production related batch sheets. Some of this information addresses technical issues relevant to R&D tax claims but, for the most part, it represents what might be called “business-as-usual” documentation.

NOAH advised Apex that such documentation would not be sufficient to support an R&D tax claim in the context of an AusIndustry Audit. NOAH thus worked with Apex to develop a new “R&D” template that could be used to record information on R&D batch trials, including dates, product specification, quantifies, processing protocols and outcomes. Again, on NOAH’s advice, the protocol for R&D batches was brought into alignment with Apex’s broader Total Product Quality (TPC) regime which stipulated that until three (3) successful production trials the product (or process change) would not be regarded as having been commercialised.