The importance of Supporting Documentation in your R&D Tax Incentive claim

The first decision from the Administrative Appeals Tribunal (AAT) in relation to the R&D Tax Incentive was handed down last month (available here). The claim submitted by Docklands Science Park (DSP) for activities undertaken in their 2012-2013 income years was ultimately rejected after review, in main due to a lack of adequate documentation substantiating its R&D activities.

The emphasis on sufficient supporting documentation should come as no surprise – when introduced in 2011 the guidelines outlined for the Incentive heavily stressed the need for contemporaneous documentation detailing the creation of new knowledge, as well as the systematic progression of activities from hypothesis to experiment, observation, evaluation and conclusion. That is, clearly detailing the ‘scientific experimental method’.

The Docklands case is somewhat of an extreme example, in that, whilst not only failing to distinguish ‘core’ and ‘supporting’ activities, DSP also provided little evidence to suggest that the activities claimed had taken place at all. The AAT was eager to point out that simply registering activities as either core or supporting does not automatically make them so. Furthermore, DSP could not provide any evidence of a claimed $1.2million transaction, not an insignificant amount.

The R&D Tax Incentive is based on self-assessment. That is, it is the responsibility of the claimant (or a registered tax agent undertaking claim preparation on their behalf, such as NOAH) to determine the eligibility of the activities and associated costs to be claimed. To substantiate the claims, it is advised that supporting documentation be created concurrently whilst activities are undertaken i.e. not in retrospect – this a much more rigorous approach in capturing the correct data used when articulating the technical argument.

National Innovation and Science Agenda – What does it all mean?

The word innovation has most likely never been used so much in this country, in both political and general conversation, as it has in the last month. It’s safe to say that’s it the darling new buzzword. Finally.

And the cause of this shift? The National Innovation and Science Agenda (NISA). A $1.1. billion package, delivered through 24 new policies across 11 government portfolios.

As expected, responses have been mixed. Those focussed on numbers have commented that the $1.1 billion proposed is insufficient, when considering that the government spends around $10 billion a year on research funding already.

Numbers aside however, the obvious attempt to change cultural perceptions of innovation and ‘reduce the stigma associated with business failure’ is to be commended.

Unlike previous proposals from government the ‘Innovation Statement’ does present as a well thought-out and considered proposition, in contrast to the more haphazard approaches we’ve previously seen.

Here is what is proposed:

 

START-UPS AND EARLY STAGE VENTURES

It seems as though the government may finally address the deeply entrenched negative attitude towards failure in Australia.

20% non-refundable tax offsets will become available to early-stage, angel investors. VCs and other investors that have invested in a start-up for more than 3 years will be exempt from capital gains tax for 10 years. VC investments aimed at expanding existing start-ups will be eligible for a 10% tax rebate.

Furthermore, in an attempt to ‘reduce the stigma associated with business failure’, changes to bankrupty laws will see investors in a failed venture waiting only one year, as opposed to three, before being able to create a new start-up again.

 

SCIENCE AND RESEARCH

Addressing Australia’s deficiency in commercialising public research, a $200 million CSIRO innovation fund and BioMedical Translation Fund will support co-investments in new companies and start-ups developed by CSIRO itself or publicly-funded research agencies/universities.

Further working to encourage collaboration between industry and research, again with the aim to increasing commercialisation, $127 million over 4 years is being allocated to block grant funding. The difference here, is that now income from industry and ‘non-academic impact’ will hold as much weight as merit from research excellence.

$1.5 billion over 10 years will go to the National Collaborative Research Infrastructure Scheme, which explores projects such as ocean monitoring, medical research and advanced manufacturing.
$800 million over 10 years will also be allocated to two major scientific projects – the Australian Synchrotron and the Square Kilometre Array.

 

EDUCATION

Over $100 million will go towards not only encouraging students to study more STEM subjects, but also towards helping them ‘embrace the digital age and better prepare for the jobs of the future’.

Included in this is also an initiative to encourage more women to enroll in STEM subjects, with the ultimate aim of increasing female involvement in both startups and tech industries.

 

INTERNATIONAL TALENT AND VISION

Changes will be made to the 457 visa (Temporary Work – Skilled) system to attract more international talent to Australia and encourage international students to remain after graduating. STEM or ICT students will be fast-tracked for permanent residency.

$18 million will assist international expansion of Australian start-ups, with global ‘launching pads’ to be established in Silicon Valley, Tel Aviv and three other locations, to facilitate easier travel globally.

 

WHAT ELSE?

In a move requiring little to no funding, the government’s huge reserves of public data will be made increasing and more easily available. It is also proposed that the huge reserves will be made more ‘machine-readable’. Good news for big data–based businesses.

A link to the full National Innovation and Science Agenda can be found here.

What’s the deal with software development as R&D?

The number of companies reportedly making R&D Tax Incentive claims in Information and Communication Technology (ICT) is second only to those in the ‘Engineering’ field of research. One would expect that this number will only increase as uptake by SMEs and the tech Startup community continues to grow.

Recognising this, AusIndustry has issued Guidance Material for ICT that outlines, through commentary and case study, the government’s views on what will and won’t qualify for claim. ‘Algorithms’, ‘cloud computing’, ‘GUIs’ and ‘software modules’ all get a look over. Software development is also always a hot topic in AusIndustry forums and blog posts on the topic abound from every adviser imaginable, including the ‘Big 4’ through to smaller independents.

There’s lots of confusion.

Despite all this guidance, discussion and opinion there is still a lot of confusion as to exactly what software development activities will qualify for claim. To date, we’ve tended to resist putting our two cents worth out there and have preferred to offer tailored advice on a client by client basis. However, in our travels we continue to be asked for our views on software development and R&D tax, so perhaps the time is right to offer up some thoughts.

‘Guidance’ material is exactly that…guidance.

We acknowledge that the guidance material published by AusIndustry should be factored into any discussion on the eligibility of particular software development activities.  But we would qualify this by noting that it is, as the name suggests, “guidance” only that is intended to help address general questions of uncertainty and difficulty. It cannot be regarded as definitive.

 Not all software is created equal.

It seems much of the difficulty with ICT/software development is that it is an area of rapid transformation. Change is embraced and adapting to new technologies is the norm. It seems that innovative methods and techniques are introduced at such a rapid rate that what requires “R&D” one day is almost a routine activity the next. There is a danger when government (and advisers) buy into this popular perception too readily, for it can lead to setting themselves up as pseudo tech experts.

This danger is realised when they then become prescriptive about what qualifies and what doesn’t based purely on false assumptions. The number of times I’ve heard another adviser – with no background or expertise in the technology – pronounce that “the development of a phone app can’t be R&D because there are so many phone apps out there nowadays and so many tools available to help build them”.  Now, the development of that phone app at the end of the day might well not benchmark strongly for claim but the rationale can never be based on the fact that “there are so many of them out there now”. The same approach in respect of the cloud or mobility is equally ill conceived.

Then again, not all software is innovative.

On the other hand, another view might be that all software development is potentially eligible because the agile iterative software development methodology that is now an industry standard is inherently “experimental”. This approach is also flawed because it doesn’t pay sufficient regard to whether there were any precedents for the development and the extent to which any new knowledge was generated.

So, where does all this leave us?

Clearly, there is great potential to claim software development activities under R&D tax and the stats prove that a lot of such activity is indeed claimed. Guidance material from government can help provide a framework when qualifying such activities. Nevertheless, each development should be benchmarked against the legislative definition and treated on its merits, free from any assumptions that certain software development activities in particular areas cannot be “R&D” because they are now “old hat”.

Claimants (and their advisers) should always work from first principles and assess what activities have been conducted and the extent to which they can legitimately be described as “experimental” (remembering evidence of the journey from “hypothesis” to “test” to “analysis of results” to the drawing of a logical conclusion). And not forgetting the need to articulate a compelling argument that some “new knowledge” has been obtained from the exercise.

In this last respect, determining what is “new knowledge” and what is a relatively transparent extension of the “prior art” can be another contentious area. But that’s a topic perhaps best left for another post.

Better bottom line at tax time? Yes – if you’re careful…

BETTER BOTTOM LINE

With the financial year almost over and the budget offering incentives, many businesses will be talking to their accountants about all things tax related.

Questions might include:
– ‘What purchases should I make?’
– ‘Should I pre-pay rent?’
– ‘Am I going to make a profit or a loss?’

The answer to this last question will obviously inform whether the taxman is owed money or whether a refund is in the offing.

How your taxable position can change things.

In addition to all these bread and butter issues, more savvy business owners and accountants might also discuss R&D tax offsets. There are generous refunds on offer under the Federal Government’s R&D Tax Incentive program – up to 45% of eligible expenditure – but the level of refund very much depends on a company’s end-of-financial year taxable position. Hence the need for R&D to be factored into whole-of-business discussions before closing P&Ls.

What to be cautious of…

It is important that those inexperienced in R&D tax proceed with caution. There has been something of an explosion in R&D advisers and online solutions seeming to offer a fast track to claims and benefits. While it is true that the R&D tax program is relatively broad-based and can be self-assessed, activities must still be benchmarked against a legislative definition. Justification for a claim must also be defined and registered with government. Furthermore, it is not unusual for claims to be scrutinised by bureaucrats long after registration has been confirmed.

How to set your business up for sustainable R&D claims.

There is a lot to be said for spending a little more time upfront thinking about how best to characterise project activities and articulate the arguments justifying the “experimental” nature of what has been done. In other words, get the right advice, set your business up for sustainable claims going forward and don’t treat the whole exercise as easy money for little or no effort.

Things to consider when registering your R&D Tax Incentive claim:

• Don’t register broad based, generic or umbrella projects – that’s a sure way to attract a review from AusIndustry
• Articulate your hypothesis with an “If …then…” statement
• Make it clear that your new knowledge was not a transparent extension of the prior art

Some examples of things to consider on the cost side of your R&D claim:

• Startups – consider whether you paid yourself or how much should you pay yourself – considering other tax and super implications
• Has your business incurred R&D expenditure to an associate? If so, the expenditure must be paid prior to the end of the financial year in order to claim as an R&D tax offset in that year.
• and many more……..

Call us for a chat about maximising your benefits at tax time.

Budget 2015 – Any love for Innovation?

The 2015 Budget sees no hugely significant changes to innovation funding. The flagship R&D Tax Incentive remained untouched, whilst funding for various research initiatives was either slightly cut or slightly bolstered. The government’s focus is largely on SMEs in the latest budget – a step in the right direction some say, as innovative start-ups are included in this category, however the measures fall short of directly addressing innovation growth as Australia’s economy transforms into one that is knowledge-based.

As outlined by the latest Australian Innovation Systems Report (produced by the Office of the Chief Economist), Australian innovation is being hampered by a shortage of required skills and a lack of collaboration and innovation in management culture. Unfortunately, it does not seem that the latest Budget addresses these issues directly.

Impact on the R&D Tax Incentive

Though the last two years has seen the R&D Tax Incentive (Incentive) poked and prodded by various sides of the political spectrum, no additional changes were announced in the 2015 Budget handed down last Tuesday night.

Since February 2013, two major iterations to the program have been proposed – a 1.5% cut to the offset rates offered under the Incentive and removing access to the program for companies with a turnover of more than $20 billion per annum.

The 1.5% reduction was formally rejected by the Senate earlier this year, an outcome welcomed across all industries.

The proposal to restrict companies with turnovers of more than $20 billion from claiming under the Incentive was instead replaced by a $100 million cap on eligible expenditure, thanks to a deal struck with the Palmer United Party. These changes will be applied retrospectively from 1 July, 2014.

Impact on Innovation growth

Though the Incentive remained untouched, there was some movement in other areas of government innovation funding.

There were also numerous measures introduced to encourage the growth of SMEs, with a particular focus on start-ups for, some may say, the first time in any budget. These measures include:

  • Encouragement of crowd-funding through proposed easing of capital raising laws
  • Scrapping of Capital Gains Tax payments when changing company structures (i.e. to Pty Ltd)
  • Ability to immediately deduct fees associated with initial company set-up
  • Instant asset write-off for purchases up to $20,000 (if turnover is <$2 million)
  • Whilst these are not explicit innovation funding measures, it is hoped they will assist in extending the runway for smaller companies and start-ups that are at the core of Australia’s innovation growth.

The Entrepreneurs’ Infrastructure Programme (EIP), introduced in last year’s budget in a bid by the Government to provide more ‘practical’ assistance to businesses, saw a $27 million cut as a result of a slow start to the initiative. Our own research has shown that those eligible to participate in the EIP either don’t fully understand the ultimate benefits of the program or view the process involved as too daunting, complex and/or time consuming. Furthermore, Co-Operative Research Centres (CRC) – not-for-profit organisations supporting collaboration between researchers and industry – saw funding cut by $29.8 million.

Both the EIP and CRC cuts are an interesting move for a government that has seemingly been attempting to build a stronger bridge between innovation and commercialisation.

It’s not all slashing however – the National Collaborative Research Infrastructure Strategy (NCRIS) received an extra $150 million of funding for its researchers Australia-wide. Furthermore, the Australian Synchrotron – a world-class radiation research facility – was given an additional $13 million in funding.