Don’t risk repaying your research and development incentive to the ATO
Your business has invested hours of time and thousands of dollars into researching and developing a new and innovative software solution – activities only made possible by accessing the Australian Government’s R&D Tax Incentive. Now imagine that these activities are investigated by AusIndustry or the ATO, and that your company is forced to repay the R&D tax rebate. Plus the possibility of a significant penalty!
For a growing number of frustrated small business owners and start-ups, this scenario is all too real. Recent attention around increased R&D Tax Incentive audit activity highlights just how hazardous claiming the R&D Tax Incentive can be. The software development industry is currently in the crosshairs of AusIndustry and the ATO, with some high-profile tech start-ups being forced to pay back their R&D claims.
The R&D Tax Incentive is a tricky landscape to navigate, and this is especially so for companies claiming for activities associated with software development. The process is complicated and there are a number of challenges to grapple with when deciding whether to claim for eligible activities.
If you’re a business owner or company leader faced with the difficult decision of whether to make a claim, you should ask yourself the following questions.
What are your eligible R&D activities?
The R&D Tax Incentive enables companies to claim for eligible activities. A common mistake is to claim for entire projects.
Eligible activities are either core R&D activities or supporting R&D activities.
What does this mean? Core R&D activities are activities that involve an experiment conducted for the purpose of generating new knowledge. This experiment must be carried out in a systematic and planned manner as we outline below.
Supporting R&D activities, on the other hand, are activities that have a direct, close and relatively immediate relationship with a core R&D activity.
Are your R&D activities generating new knowledge?
Claiming the R&D Tax Incentive is all about generating new knowledge. For R&D to take place, there must be a specific technical knowledge gap with an unknown solution. That means whatever problem your business is focusing on can’t be solved based on the information available in the public domain. Importantly, a solution which is highly complex but can ultimately be achieved by the right people following an established pathway is probably not R&D for tax purposes.
Are you using a scientific method?
Core R&D activities are experimental and follow the traditional scientific method of hypothesis, experiment, observations and conclusions. Ask yourself: what was my experiment? In the real world, you don’t have the time or budget to go and build five versions of the technology and test each of these. Commercially driven R&D usually follows an iterative approach. However, you might be testing each iteration throughout the experiment.
A good experiment is a systematic progression of work and has a control or baseline for comparing the relationship between the variables. It follows the format of hypothesis > experiment > observations > conclusions, and usually repeats this cycle until the company has established the new knowledge to move forward and commercialise or it abandons the experiment.
What’s your hypothesis?
To claim the R&D Tax Incentive, your experiment needs to be hypothesis-driven.
Think of your starting ideas, problems, theories or questions from a technical standpoint. The proposed answers and solutions are your hypotheses. Be sure to avoid business case or market research hypotheses, which are not eligible.
A good hypothesis for R&D is a statement that proposes a relationship between variables with measurable parameters. It can be ‘proven’ or ‘disproven’ based on the experimental results.
One example of a suitable hypothesis is: Newly designed and implemented search algorithms for listed commercial property will improve the speed of search results of the [multiple] data sets on Search Company Pty Ltd’s platform, reducing the average search time from 10.5 seconds to fewer than 3.0 seconds. A hypothesis like this might also further define the nature and structure of the new search algorithms.
What’s more, your hypothesis changes over time as a part of the research and development process. Record these changes and list multiple hypotheses in your R&D application.
Are your R&D documents in order?
It might not be the most glamorous aspect of developing an innovative new algorithm to take to market, but one of the most critical parts of claiming the R&D Tax Incentive is your contemporaneous R&D documentation. This will be scrutinised by AusIndustry.
Entire R&D claims can be declared ineligible if the company can’t support them with evidence. Being ‘agile’ is not accepted as an excuse for poor record keeping. There are no prescribed rules about what documentation you must keep, and every company is different. To claim the R&D Tax Incentive we recommend that your documentation:
- is made and maintained in real-time, on a weekly basis
- verifies how you assessed that the outcome could not be known in advance
- records planning, progress and results of your R&D activities
- verifies that an experiment took place and the experimental steps (NOT just the final source code)
- records staff and contractor time spent on R&D activities
- verifies the amount of expenditure incurred on activities and the relationship of the expenditure to the activities
- shows how expenditure was apportioned between eligible R&D activities and non-R&D activities
If your business is considering claiming the R&D Tax Incentive, registration of activities must be submitted by 30 April or 10 months after the income year in which the activities took place. You have up to two years to amend your tax return to include R&D eligible expenditure.
BlueRock’s specialist Grants & Incentives team can help you with the process. Get in touch to find out more.