R&D: Should you just worry about record keeping at the end of the Financial year?

Download R&D booklet - Azure Group R&D Experts-1

For our final blog post for the R&D month, we focus on best practice record-keeping that ensures a successful R&D claim that will stand up to rigorous audit activity.

DOWNLOAD R&D BOOKLET HERE

Just as the rest of the Australian income tax system, the R&D tax incentive operates on a system self-assessment by its applicants to substantiate its eligibility in accordance with the specific guidelines and requirements. However, unlike income tax, record keeping for the R&D tax incentive has a more methodical approach in that documentation used to substantiate the nature and occurrence of R&D activities must be kept throughout the different phases of the R&D project life.

#5 YOUR RECORD KEEPING PRACTICES MUST COMMENCE AT THE OUTSET OF YOUR EXPERIMENTAL ACTIVITIES

Just how in previous weeks we made it clear that the generation of new knowledge mustn’t be an afterthought but rather the purpose of R&D activities, your record keeping practices must commence at the outset of your experimental activities. In fact, records must be kept from before experimentation takes place to explain why an outcome is truly unknown. From there, records must highlight the new knowledge to be generated from an experiment and relevant observations and conclusions that arise from experimentation – this may sound familiar if you’ve been paying attention to our other blog posts this month! This is because your record keeping should be closely aligned to your systematic progression of work.

Failure to comply with the record keeping requirements regulated by AusIndustry will result in adverse consequences

As part of Tribunal decision in Tier Toys Limited and Commissioner of Taxation [2014] AATA 156, the R&D deductions and tax offset were denied due to the taxpayer being unable to produce adequate records and documentary evidence to demonstrate that the “[..] disputed expenditure was incurred directly in respect of its R&D activities […]”. 


What steps are involved to be compliance-ready and to avoid negative audit activity?

One of the main arguments in the Tribunal’s decision was that its records were not detailed enough to verify the nature, amount and relationship of the expenditure incurred on R&D activities. To meet the legislative definition for core R&D activities, you are required to demonstrate that the state of knowledge or technology which existed when R&D was conducted and that the knowledge you were seeking to attain was not already publicly available. Evidence can include literature reviews of scientific, technological or trade journals and patent searches.

The types of records will differ based on the nature and relevance to your business and R&D activities, and the judgement of a qualified R&D adviser will be invaluable here. Preliminary documentation could include a statement of work which provides the necessary requirements in the form of a defined project and pre-work objectives and milestones.

You will then need to retain documents detailing the experiments undertaken, results, analysis of results and subsequent changes implemented.

Similarly, your record keeping practices need to apply to your supporting activities to meet its legislative definition and how you applied the dominant purpose test. Commonly used evidence to demonstrate this are project records, records of trial runs, project meeting minutes, staff time sheets and tax invoices.


Below is an example of a meeting minutes undertaken to test trial prototypes of a product

With our early-stage clients we often see that a significant part of their R&D expenditure consists of employee salaries. It is rare that these employees will spend 100% of their time on R&D activities, and so their time must be apportioned appropriately. Although the type of records kept to record this apportionment can vary between industries this is often substantiated through timesheets.

Essential information to include in your payroll records are:

  • Names and salaries incurred/paid;
  • Period of employment of each employee in respect of R&D activities; and
  • Description of work and number of hours spent per R&D activity.


Below is a useful table to assist you with the types of records we recommend clients keep for their R&D claim:

Category for Eligibility Requirement

Examples of evidence

Outcome of experiments cannot be known in advance

  • Records of literature reviews
  • Email exchanges with industry experts
  • Details of questions posted on tech blogs

Experiments conducted for New Knowledge

  • Minutes of meetings where experiments were discussed 

Activities follow a systematic progression of work

  • Project scoping document
  • Records of each step in the experimental process, i.e. details of hypothesis, how it was tested, data from experiment, details if hypothesis was disproven or proven, results of experimentation.
  • Jira board (or similar project management tools)

Core Activities

  • Records to illustrate how expenditure for eligible activities were calculated
  • Records to illustrate what percentage of overhead costs were used for eligible R&D activities, e.g. employee timesheets
  • Contractor agreements for any parts of work undertaken by contractors

Supporting activities

  • Technical records to demonstrate how and why how the activity is directly related to core R&D activities
  • Where saleable goods are produced in an activity, there must be records to show that only sufficient numbers were produced (i.e. prototypes) for experiments and not for commercial output.
  • Production run and quality control sheets to identify which units were used for experiments and which were sold

Payroll

  • Timesheets with details on description of work undertaken
  • Diaries

Financial Report

  • Detailed invoices

 

THE BEST PRACTICES WE USE

Ultimately, record keeping means thorough and early planning, strong record keeping processes and robust business systems. The best practice that Azure Group follows is to assume that every claim will be audited, and we apply the same rigours to our clients that the ATO and AusIndustry would.

The principles we apply when we set up R&D record keeping systems for our clients are to:

  • Ensure you have internal system process and systems that allow for documentation requirements to be satisfied as part of the overall project planning and management process;
  • Identify and document your R&D projects and eligible activities at the time they are conducted;
  • Document your methods for evaluating projects and recording expenditure associated with eligible activities. The reasoning behind this is to demonstrate a clear understanding of how information has been derived. 


Why did we talk about R&D for the whole month?


We think it's important to demystify R&D and explain why now more than ever a careful focus on eligibility is key.

Over this month, we explored 5 misconceptions in a series of blogs, leaving you with a downloadable booklet to keep on hand when you are exploring R&D. We dived deeper into satisfying the different eligibility tests from this legislation using real-world examples to cut though the fog of confusion the market is having on eligible businesses.

DOWNLOAD R&D BOOKLET HERE

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Week 5 - RnD

 

What Small Businesses need to know about Tax in the 2020 Financial Year
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About Author

Michael Derin
Michael Derin

Michael Derin, Azure Group's Group Managing Partner has over 25 years experience as a qualified Chartered Accountant within the business and commercial sectors. Michael works across our Technology, Corporate Advisory and CFO operations, managing highly complex projects to success.

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