Demystifying Research and Development Tax Incentives in 2019
Over the past year Azure Group have heard some negative sentiment about the Research and Development Tax Incentive (R&D Incentive) – you may have seen the stories about Airtasker and CBA, or heard from your peers that the scheme is getting harder to access. Being an entitlement scheme rather than a competitive one, with a cash refund of up to 43.5% of eligible R&D expenses, the attraction to industry is obvious – as is the need for the Government to manage the program’s cost.
Related: Startups and Scaleups: R&D Tax Incentive FY2019 DEADLINE EXTENDED due to Coronavirusr&d claim software
For those businesses who seek out the right expert advice, have eligible R&D activities, and are good at record keeping the incentive is still accessible and as valuable as ever.
As trusted advisors to the Australian startup community we know the importance the incentive has in funding pre-revenue R&D and we are very pleased to say that we aren't seeing this sentiment reflected in practise. In fact, some recent cases have actually seen applicants overturn unfairly restrictive interpretations of eligible expenses and therefore broaden the pool of possible claims. r&d claim software
Why are we talking about it for the whole month of October?
Well we think it's important to demystify R&D and explain why now more than ever a careful focus on eligibility is key.
Over the month of October, we are going to explore 5 misconceptions in a series of blogs, leaving you with a DOWNLOADABLE BOOKELT to keep on hand when you are exploring R&D. We plan to dive 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.
#1 THE R&D INCENTIVE EXISTS TO REWARD AND ENCOURAGE INNOVATION r&d claim software
This is a misconception that goes to the core of industry uncertainty about the R&D incentive and is the focus of much R&D audit activity. The misconception is perfectly understandable – the body administering the scheme is Science and Innovation Australia and in its current form was part of then PM Turnbull’s “Innovation Agenda”. r&d claim software
However the word innovation doesn’t appear anywhere in the legislation and is not part of the test for eligible activities. In more recent ATO communication they specifically warn off confusing innovation with eligible R&D – in their words “innovation tends to encompass a broader range of activities that extend beyond experimental R&D activities and what is eligible under the program”. r&d claim software
So what activities are eligible for the incentive, if “innovation” isn’t the test?
The first test to meet is that the activities must be experimental and their outcome can’t be known in advance. But what does this mean in practise? The word “experimental” isn’t defined in the legislation, and therefore we look to the courts for their interpretation, in particular the recent case of Moreton Resources Limited v Innovation and Science Australia [2019] FCAFC 120 where it was covered in detail.
From Moreton Resources, the Tribunal at first instance rejected the taxpayer’s claim that their activities – relevantly here covering testing the application of Underground Coalseam Gas technologies at a particular site in Queensland – were truly experimental. The Tribunal compared the words of the Explanatory Memorandum to the R&D legislation where for eligible “the taxpayer needs new information (to solve a problem, develop a new product or improve a product) and needs to do an experiment to discover that knowledge” with their interpretation of Moreton Resource’s activities, which were “testing the application of existing technology at a particular site and nothing more”. r&d claim software
The blunt assessment of the Federal Court, in overturning the decision of the Tribunal in Moreton Resources, was “the words ‘experimental activities’…have very little, if any, work to do beyond reflecting the type of activities covered”. r&d claim software
The Court ultimately concluded that the Tribunal had misconstrued the words “experimental activities” as unduly restricting activities that otherwise could meet the tests in the paragraphs of the eligibility tests. More important is that the outcome of these activities “cannot be known or determined in advance on the basis of current knowledge…”.
The importance of this test is clear when you see the parallels to the scheme’s stated objective. According to the legislation it was created to encourage industry to undertake R&D by funding “activities that might otherwise not be conducted because of an uncertain return”. Experimental activities with an unknown outcome by their very nature involve an uncertain return. r&d claim software
An analogy used to explain known and unknown outcomes is that of measuring a piece of string. Measuring a piece of string with a ruler may be experimental, but the outcome of this activity could be known or determined in advance on the basis of current knowledge and is therefore not eligible for R&D incentives. r&d claim software
There is important difference here between an outcome that is not known compared to an outcome that can not be known. The standard, borrowed heavily from an OECD publication called the Frascati Manual, is what a competent professional in the field could have known without conducting an experiment.
For this reason, when we talk to clients about their eligibility for the R&D incentive our first questions are aimed at their senior technical staff not the finance team, and this is why our senior R&D team have a science and engineering background, not just finance. r&d claim software
The questions we ask aren’t outcome focused at all, but rather enhance our knowledge of the experimentation process - “what were your technical uncertainties when you began?”, “what failures did you experience along the way?”. This focus is key to filing an eligible R&D claim in 2019 and should be what your looking for when being asked questions by your own advisors.
Throughout the month of October we will delve further into qualifying for R&D incentives and the misconceptions that cloud these tests. Next week we discuss the next eligibility hurdle, that the outcome that can’t be known in advance must be determined by a scientific, systematic progression of work. We will then narrow our focus further still by examining the purpose of eligible R&D activities, which is the generation of new knowledge. Some activities are then explicitly excluded from R&D or considered business as usual. Last but not least we will talk about the importance of record keeping and share with you some of our practical templates that our clients use to track their R&D activities. r&d claim software
Keep your eyes peeled for Blog #2 to #5 and follow us on our socials.
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