Recent examples of ‘agile development’ from the R&D Tax Incentive administrator have brought uncertainty to the start-up sector. Taxpayers must be more vigilant than ever in how Software R&D claims are prepared.
What Is the R&D Tax Incentive?
The R&D Tax Incentive should be familiar for start-up businesses, given the broad definition of what constitutes eligible R&D (see below) and the cash refund opportunities. The benefit available depends on aggregated turnover and tax losses available however for small business with under $20million turnover, a 45% refundable benefit can potentially be cashed out. This means that if a pre-revenue company spends $100,000 on R&D, the company could receive a $45,000 cash refund.
To access this benefit, a company with a 30 June 2016 income year end must lodge their R&D Application to register their eligible R&D activities by 30 April 2017. In light of recent government activity, robust preparation of the R&D claim and obtaining the right advice is critical.
The relevance of software and the eligibility test
Software R&D claims are currently a hot topic, given the recent growth of software globally and the Turnbull Government’s National Innovation & Science Agenda. Brands such as Airtasker and Uber have become household names; furthermore, it is rumoured that in NSW over 2/3 of R&D claims are software related.
Interestingly, with some specific exceptions relating to software, the definition of eligible software R&D is the same as development of a new cancer curing drug. Broadly, for software R&D, there must be at least one activity satisfying the following:
- Systematic experimental process;
- Generates new knowledge/products/processes/technologies etc.;
- The outcome of the experiment is unknown.
Common R&D projects include the development of:
- New/improved architecture/codes for new functionality.
- New/improved algorithms to achieve specific outcomes (e.g. sort data sets).
- Software to automate previously manual services.
The ‘glove’ doesn’t fit
Having a uniform eligibility test is positive, as it does not discriminate based on industry. However, the negative of the ‘one size fits all’ is that it produces uncertainties where the definitions do not fit. Activities undertaken to develop new drugs can easily be applied to the tests. However, for software, particularly when agile development is used, determining the specific hypothesis can be difficult.
This ‘definitional conundrum’, and the lack of relevant eligibility examples and case law has created some uncertainty, which RSM’s specialist R&D Tax advisers aim to guide you through as we prepare the R&D claim.
Both the historic and recent releases by the AusIndustry/ATO show the lack of a clear answer or definitions on eligible software R&D. The released examples and guidance have evolved significantly over the past 5 years since the program commenced. In 2012, AusIndustry’s sample R&D Application Form comprised 2-3 sentences for each required field with broad application. Since 2012, AusIndustry guidance has undergone a process of ‘agile development’, with the most recent releases explicitly questioning the eligibility of a number of software activities.
In February 2017, the ATO/AusIndustry released 5 Taxpayer Alerts (“TA”). In the Software R&D TA, the administrator states that undesirable approaches to R&D claims will be targeted, such as claiming whole projects as an R&D activity. Whilst this position should be welcomed, the examples of ‘ineligible R&D’ in the TA has raised some claimant concerns that there will be significant tightening up on eligible R&D activities. This is a far cry from the broad three sentences in the original AusIndustry Sample Form. However, even the most recent position added uncertainty, as within a week the ATO issued an Addendum amending the position on the previous TA. This further demonstrates how broad the scope of (software) eligibility is and how it is critical to ensure a claimant clearly addresses the required eligibility criteria relevant to their specific activities.
What is the implication of the current landscape?
The historical uncertainties and the recent seemingly shift in position has mainly resulted from areas of concern regarding R&D tax advisers making significant errors and aggressive taxpayers, which is the exact issue now being addressed by the administrators. It is likely that we will see increased authority review in relation to the specified areas of concern (Software, Construction, and Agriculture) and therefore it is wise to ensure your claim fully addresses the eligibility criteria.
Concluding thoughts and a look to the future
With the release of the recent guidance and the concern of many claimants, it is critical to note that ultimately it is the job of the Australian Courts, to determine the legal meaning of legislation (e.g. what constitutes an “experiment”). To date, there has not been a Court decision on the statutory definitions of eligible R&D activities under the R&D Tax Incentive. There have been decisions in the Administrative Appeals Tribunal (”the AAT”) however it is important not to confuse this, as the AAT’s role is solely to decide on matters of fact and not law (e.g. documents to evidence an experiment, rather than the definition of “experiment”).
As a result of the uncertainties on definitions and increased reviews from the administrators, it is expected that test cases are on the horizon. Until such time, there is likely to be ongoing discussions and opinion regarding the definition of ‘eligible R&D’, particularly related to software. In the meantime, taxpayers must manage the definitional risk by catering to the administrator’s requirements on lodgement and substantiation. The only way to achieve this by engaging an established adviser with its finger on the pulse of the shifting landscape.
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