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When technology companies rely on the Research and Development Tax Incentive (RDTI) to support ongoing innovation, the last thing they want to deal with is a claim review undertaken by one of the regulators for not having articulated their activities in the best light.
The Department of Industry, Science and Resources (DISR) – which administers the incentive (along with the ATO who focus on the eligibility of the expenditure) – conducts regular compliance reviews to weed out ineligible claims. It’s therefore prudent to get RDTI claims right from the outset because if DISR was to conduct a review, a company may need to pay back benefits received with interest and possible penalties applied if activities are found by DISR to be ineligible.
Having supported clients with their RDTI claims since the incentive was first introduced in 2011 (and earlier with the R&D Tax Concession), I’ve been fortunate to never have a client I’ve managed selected for a review of their activities over the past two decades. I have however assisted companies (that either self-claimed or used other advisors) through the review process, demonstrating to DISR that what was first perceived as ineligible business as usual software activities do in fact meet the criteria.
In my experience, there's one simple tip that companies can implement to reduce the chances of a negative claim review:
Demonstrating experimentation, not development
Software (and often engineering) companies in particular often face scrutiny in RDTI claim reviews, due to the way they define and articulate their development activities. This issue was spotlighted several years ago when the DISR drew a firm line between what counts as eligible and what doesn’t, with a number of companies having to repay RDTI benefits for former claims that didn’t make the cut.
For those that rely heavily on the RDTI to fund continued research and development, knowing how to describe their R&D activities to communicate to the regulators how the activities meet the eligibility criteria is essential.
For this, they must understand:
- the intent of the legislation
- what constitutes eligible activities
- how to frame and describe those activities
Even the most experienced RDTI advisors can get it wrong – failing to clearly explain how the company’s R&D fits the definition of an ‘experimental activity’ that meets the legislative definition of R&D rather than a ‘development’.
It requires substantiating that your activities follow a process of setting a specific and measurable hypothesis, and testing that the hypothesis is consistent with scientific principles.
Articulating eligible core activities
Core activities are essentially experimental activities that are based on principles of established science. They follow a systematic progression of work from hypothesis to experiment, observation, and evaluation which lead to logical conclusions being formed. They are undertaken to overcome technical uncertainty, and therefore the outcome of the activities cannot be known in advance and they must intentionally develop new knowledge in the process.
A key challenge for tech companies is understanding how to articulate that the core activities are experimental. It’s not trial and error that is done haphazardly, but rather (in our opinion) a systematic approach involving testing a specific and measurable hypothesis – ideally by altering independent variables, one of which could be a control, and observing the results.
For software, those variables that are tested might include changes to the software architecture, algorithm, or similar. The dependent variable is the outcome being measured, such as improvements in performance, latency, scalability, and so on. In engineering-based projects, it could involve testing different designs or materials used in a device, product, widget, etc.
What companies should avoid doing, especially in a software context where it seems to be more of an issue than other industries, is to describe what their software does or what they hoped to build (although it is good for context when describing the commercial objective).
The focus of the R&D activities should be to describe the technical process implemented to achieve the intended commercial outcome. Consider: what are the technical outcomes required to enable the commercial outcome? Then, describe the experimental process to achieve that technical outcome.
The legislation requires you to demonstrate that your development involved a genuine experimental activity to solve a technical problem where the outcome wasn’t known in advance. This could be the make or break of whether you have articulated your activities in the best light, to align them with the requirement of the tax legislation.
Invest in aligning your activity descriptions with the requirements of the legislation R&D activity descriptions are usually meticulously crafted. We spend hours understanding how our clients’ R&D activities align with the RDTI criteria and forming an appropriate narrative for a claim based on the facts that we’ve been provided by our clients.
This is not to say our clients can’t write accurate descriptions. However, even the most educated scientists and engineers can and do often get it wrong – especially when they haven’t read the tax law. What R&D is in a colloquial sense is different to R&D as defined by tax law, so it’s important for claimants to understand that.
Before you embark on your next RDTI claim, consider the time and cost associated with having a claim reviewed and possibly rejected, which could trigger reviews of the past four years’ worth of claims. As a huge potential liability, it’s worth investing in the right expertise to get it done properly from the start, which will also create a solid foundation from which to prepare future claims.
If you need help, reach out to our experienced RDTI team. We’ve worked with many tech and software companies, and helped them overcome common pitfalls that can lead to a negative review.
We’ll work closely with your team to uncover the real substance of your R&D activities, and build a claim that stands up to scrutiny.
FOR MORE INFORMATION
For more information about how RSM can assist with your next RDTI claim, contact your local RSM office.
