Last week, we explained that merely performing experimental activities doesn’t make them eligible for an R&D tax offset – the purpose of these activities must have been to generate new knowledge. This precludes accidental “eureka” moments from being eligible, and also those ‘business-as-usual’ activities that you would be performing regardless. This week we’ll look to examine why taking a ‘business as usual’, or similarly a ‘whole-farm’ approach to your R&D claim will leave you open to negative audit activity from Austrade and the ATO.
The regulators raised concerns in 2017 that companies were seeking to re-badge as R&D those activities that would otherwise be normal core business activities. As highlighted in last weeks blog, software companies claiming testing as R&D when the reality of software development is that testing is an essential part of business operations. However this is just as applicable to every other industry.
#4 WE CAN GET R&D INCENTIVE FOR 'BUSINESS AS USUAL'
The ATO expressed this concern in Tax Alert 2017-4 in relation to the agricultural sector, stating that the ‘whole-farm’ approach that businesses have adopted that include costs of the entire project will not constitute eligible R&D activities. The ruling underlined that adopting a ‘whole-farm’ approach suggests a limited degree of technical risk being undertaken and thereby de-emphasising the significant purpose of generating new knowledge. This point is echoed in the Tribunal decision of Rix’s Creek Pty Limited; Bloomfield Collieries Pty Limited and Innovation Australia  AATA 645, whereby the Tribunal found the company’s projects to be “[…]grossly excessive not only in extent but also in time”, failed to involve signs of innovation and in turn demonstrate high levelled technical risk. The Tribunal also found in all three projects that the company claimed to be “testing” in context for the industry, for example its excavator and explosives projects, did not meet the legislative criteria as it ultimately was found to be “conducted during the ordinary business of mining”, i.e. business-as-usual.
Does this mean that activities you may think are 'business as usual' are completely denied to claim for R&D?
Costs associated with your normal business operations can be claimed as a supporting activity, which as the term suggests are those activities that support core R&D activities to be undertaken. You must be able to demonstrate that the ‘prevailing or most influential purpose’ of these activities is to support an identified core activity.
Practical examples of supporting R&D activities may include:
- Design of predictive modelling software which inform the design of an eligible experimental activity (directly related);
- Transportation of materials for the purpose of experimental testing (directly related);
- Rent for employees directly involved in an eligible experimental activity (directly related);
- Production of prototype materials for experimental testing (dominant purpose).
In the above examples both the freight and rent must be apportioned on a reasonable basis to be captured as overhead costs. While there used to be clearer guidance on what constituted a reasonable basis, it has been withdrawn in favour of putting the onus on the preparer of the R&D claim to show that the basis is reasonable. That basis may change depending on the overhead cost – for example a reasonable basis for apportioning rent may be by calculating the floor space occupied by R&D-focused employees – workers compensation premiums instead on a portion of total payroll costs.
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 exploring 5 misconceptions in a series of blogs, leaving you with a downloadable booklet to keep on hand when you are exploring R&D. We 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.
Next week in our final blog post for R&D Month we discuss the importance of record keeping, with some tricks of the trade we’ve learned from actual audit activity.
Keep your eyes peeled for Blog #5 and R&D Booklet and follow us on socials.