The impact of Covid19 could mean that the last thing many businesses are considering is spending money on R&D. Others could be seeing this as a great time to seize an opportunity. Their time horizon may by now or when the Corona fog lifts. Whatever the timeframe, what follows is a brief overview of what those businesses need to carefully think about before claiming the incentive.
The R&D incentive is designed to be “a targeted, generous and easy to access entitlement program that helps businesses offset some of the costs of doing R&D.” Sounds good. There are a few hurdles for a business to get over before the incentive is made available. To qualify for the incentive, in tax speak, Section 335-25 of the ITAA informs us that “Core R&D activities are experimental activities: (a) whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience.” What does this all mean?
To qualify for the incentive a new product or process should be the intended outcome of the research and development activity. A business cannot utilise knowledge that it already has and look to apply that knowledge to improve a process or product. It is not simply trying to make something work better. The research and development activity must be designed to be more than an improvement, it must be looking to create something new, something that has not existed before. Undertaking geology, safety, operational, production, economic and other commercial risks which in themselves do not demonstrate technical risk therefore do not qualify for the incentive. It must be an improvement that advances technology. New knowledge.
R&D concepts are difficult to appreciate
Distinguishing an activity that seeks a new outcome from what is already known by a business is not always an easy. Another difficult concept to appreciate is that a firm trying to produce new knowledge through R&D activity may not always be successful – an uncertain outcome. A risk must be accepted. Normally a business, particularly one operating in the Australian marketplace, would not spend money on an activity with no certain outcome.
Why would a business undertake the expenditure of considerable time, effort and money and not produce a profitable outcome? At one level this idea does not make sense. The process of developing a new product or process and making it available to others has a high level of risk associated with it. The R&D required to develop this new thing is risky. It is important to remember that the R&D incentive is provided by the government because of that risk. Governments around the world look to support R&D and Australia’s tax incentive is highly rated.
How to secure the incentive
A key to success is to take a scientific basis and approach to your activity. Incidentally, this is also a key to successful R&D irrespective of any tax outcome. The Oxford dictionary defines research as the careful study of a subject in order to learn new facts or information about it. In the context of this discussion this study requires a business to have a sound scientific basis for R&D expenditure. As we have already said a business undertaking R&D must be prepared to take the risk that the research may not produce a successful business outcome. The legislation clearly says that the “outcome cannot be known “. The risk of R&D. From that perspective common sense to say that when an organisation begins an activity whose outcome is unknown, they need to be careful in how they do it.
Scientifically speaking this is a hypothesis. I was once asked “Do you need to employ people in white coats to obtain the incentive?” Not necessarily, but the activity does need to be based on scientific principles and adopt a systematic approach leading to a logical conclusion. The scientific approach also enables the knowledge to be built upon. It does this by having documented information available to others. Interestingly, the documented evidence is vital for the assessment of a claim for the incentive by the ATO and Innovation and Science Australia. More on their role later.
The ATO has, as usual, produced some sound instructional material on how to access the incentive. A good place to start from. As we said earlier there are many parts of the legislation and R&D concepts that are difficult to interpret. If an organisation misinterprets a critical requirement it can prove costly. In many areas of the complex legislation the legal system is the best source of interpretation. In this instance the Courts have provided clarification in defining key aspects of the legislation. As should be clear this article is not about explaining all the elements of the R&D incentive. But a couple of examples from the Courts are helpful to shed light on the complexity of the incentive.
The Moreton Resources Ltd. case has clarified some elements of the incentive – activities versus activity. This has helped by supplying some clarification to a contentious issue of what constituted a core research activity and how and where that activity takes place. Another important case, Mt Owen, gave definition to the concept of new knowledge. Importantly for readers the need to have evidence of what they have undertaken was emphasised in this case. A good advisor would know their way around these cases and be able to relate the findings to a business’s circumstances.
The R&D incentive application process
The process of applying for the incentive is also important to understand. While the claim proceeds through the ATO initially, Innovation and Science Australia reviews the claim for eligibility. This will often be a rigorous and time-consuming process. While this can be very frustrating as well as costly it is something that a business needs to factor into their planning.
R&D specialist advisors
As was mentioned earlier a good advisor is valuable in helping with your incentive claim. DTC suggests businesses be wary of advisors that suggest Research and Development tax advantages are readily and easily available by using their services. This is because those same advisors may be setting the business up to deal with ATO/ISA concerns. Nice work if you can get it – clip the ticket on the way in (recommending that a client claim the incentive) and clip again on the way out (advise them when the ISA and the ATO have a problem with the claim). Be cautious in your use of an expert in this specialised area. A reputable expert can significantly develop and support your claim; perhaps work through your normal tax advisor if you take this step.
Steps to consider
While the ATO supplies good sound guidance on claim eligibility there are clearly a few hurdles to overcome before the offset or refund is granted. For example, ensure that your evidence (documented) supports your approach. Make sure that your intent to create something new is clearly stated and that the evidence developed throughout the process is aligned to the intent. If you are not sure about research it or have it researched on your behalf.
Our suggestion is to consider the tips and traps we have mentioned, then carefully plan what a business needs to do to access the incentive. Do this very early in the R&D journey. Another way of saying this is as a business contemplates undertaking their R&D activity at that same time it should consider the incentive. We have been keen to point out that there are no walk up starts. The incentive is not just given away because a business is labelling an activity R&D and the government is so keen it will back anything. Similarly a business trying to retrofit its activity to access the incentive will be more than likely be disappointed. The claimant should also be aware that the claiming process itself may be an expensive and time-consuming exercise which is not always met with success.
So – the R&D incentive
The R&D incentive supports Australian businesses intending to invest in new technology. It is necessary that at the same time there is constraint in granting tax incentives to businesses that are not undertaking a legitimate research and development activity. Those responsible for managing the availability of the incentive, the ATO and ISA, are charged with supporting the legitimate claims. This article us intended to provide things to consider so that a business can make a successful claim for the R&D incentive.
Research and Development – take considered advantage of the Incentive
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