• Helping you to get it right

    The ATO and AusIndustry (on behalf of Innovation and Science Australia) jointly administer the Research and Development (R&D) tax incentive.

    AusIndustry administers registration and compliance of R&D activities. We are responsible for expenditure claimed in the tax return on eligible R&D activities.

    The R&D tax incentive is a self-assessment programme, which means the responsibility for compliance rests with the taxpayer.

    The ATO and AusIndustry undertake complementary risk assessment and compliance work.

    AusIndustry's compliance work focuses on the eligibility of R&D activities while our compliance work focuses on the R&D tax offsets allowable in respect of those activities.

    As a result of the risk assessment and compliance work of both ATO and AusIndustry have identified a number of areas of concern.

    Four industries have being identified with significant number of companies making claims that have issues. The industries are:

    • agriculture
    • building and construction
    • mining
    • software development.

    The remaining areas of concern are not restricted to companies in particular industries:

    • ordinary activities vs eligible R&D activities
    • apportionment of overheads
    • payments to associates
    • record keeping
    • R&D consultants
    • fraud.

    Industry specific areas of concern

    Agriculture

    The ATO and AusIndustry have observed issues with R&D tax incentives claims made by companies in agricultural industries where:

    • No R&D activities are being conducted.
    • The activities form part (or all) the entity's ordinary business activities.
    • The activities involve the application of established products and existing methodologies that a competent professional could have worked out the outcome without conducting an experiment.
    • The activities address a commercial rather than a technical risk.
    • The scale of R&D activities is disproportionate with the scale of any data collection, observation and evaluation.
    • The method employed to apportion overhead expenses allocates an unreasonably large amount to R&D.
    • It is uncertain whether the activities are being conducted by the company on its own behalf or for the entity carrying on the agricultural business.
    • It is uncertain whether amounts billed to related parties are paid.

    See also:

    Building and construction

    The ATO and AusIndustry have observed issues with R&D tax incentive claims made by companies in the building and construction industries, including:

    • Whole of project claims where the technical uncertainty is resolved by applying existing knowledge.
    • R&D claims where activities involve untested or novel elements where in effect they relate to fulfil the building and construction contract.
    • Expenditure that is subject to the building exclusion.
    • R&D consultants advising clients they are eligible to make a R&D claim as their activity is unique.

    See also:

    • TA 2017/2 Claiming the Research and Development tax incentive for construction activities

    Mining

    The ATO and AusIndustry have observed issues with R&D tax incentive claims made by mining companies where:

    • The scope of the R&D activities in the context of extracting minerals is not clearly identified and why it is R&D, where activities in R&D projects are too broad there is an increased risk of over-claim of costs.
    • Activities relating to modelling of mines are not R&D unless it is associated with a physical experiment. A feasibility study does not necessarily mean that R&D has or will occur.
    • Claimants need to explain the technical challenges and how they overcome them using simple terminology.
    • Exploration activities are specifically excluded from being a core R&D activity.

    Software development

    The ATO and AusIndustry have observed issues with R&D tax incentives claims by companies in the information technology and software development industries where:

    • R&D claims made on whole of project basis not considering each of the activities and applying the relevant legislation to determine which activities are R&D activities.
    • The software experiments are not clearly articulated in the R&D registration forms.
    • Technical uncertainties are not clearly identified.
    • Expenditure is incurred in acquiring, or acquiring the right to use, technology that cannot be claimed as a notional deduction.
    • Expenditure is being apportioned between R&D activities and ineligible activities in an unreasonable manner.

    See also:

    • TA 2017/5 Claiming the Research and Development tax incentive for software development activities

    Ordinary business activities vs eligible R&D activities

    ATO and AusIndustry have observed issues to R&D tax incentive claims that include expenditure relating to ordinary business activities and are not eligible R&D activities where:

    • No R&D activities have been undertaken.
    • The registered activities include a mixture of eligible R&D activities and ineligible ordinary business activities.
    • The R&D activities being carried out have transitioned into ordinary business activities.
    • The R&D activities are not concerned with the generation of new knowledge.
    • The R&D activities do not involve the application of the scientific method (proving or disproving a hypothesis through experiments).
    • The R&D activities address commercial being rather than technical risks.

    See also:

    • TA 2017/3 Claiming the Research and Development tax incentive for the ordinary business activities

    Apportionment of overheads

    Apportionment methodologies may be used in some instances, but the company can only claim notional deductions under the R&D tax incentive to the extent that the expenditure has been incurred on eligible R&D activities. For example, it may be appropriate to use R&D salary over total staff to apportion personnel costs but not for utilities.

    It commonly observed that the appointment methodologies used by claimants can result in an unreasonable apportionment of overhead expenses to R&D activities over non-R&D activities.

    The company must use a reasonable basis of apportionment which must reflect the extent to which the expenditure has been incurred on R&D activities where:

    • There is no single apportionment method that can be used to apportion expenditure between R&D and ordinary business activities on a fair and reasonable basis.
    • The appropriate methodology to apportion an expense depends on the nature of the expense.
    • The company should document the methodology adopted and the rationale for that methodology.

    Payment to associates

    The ATO has observed R&D tax incentive claims that include notional deductions claimed in relation to expenditure incurred to associates where the amount has not be paid. Notional deductions can only be claimed in relation to expenditure incurred to associates of the company where the amount has also been paid.

    See also:

    Record keeping

    It is a requirement that companies maintain contemporaneous records to support their R&D claims. This view is supported by AAT Cases (Tier Toys and Ozone Manufacturing) where contemporaneous records were not maintained so the taxpayer could not demonstrate that the expenditure was anything more than normal business expenses.

    The taxpayer’s business records must be sufficient to verify the amount of the expenditure incurred on R&D activities, the nature of the R&D activities and the relationship of the expenditure to the activities.

    Self-assessment requires evidence that substantiates that each and every part of the legislative requirements are met. A taxpayer cannot succeed in establishing those requirements in the absence of detailed documentation recording the process of each activity as it develops.

    The taxpayer has the responsibility to ensure that reasonable methods have been used to differentiate between expenditure on eligible R&D activities and other activities.

    Documents created after the fact will generally not be adequate on their own without some contemporaneous records (that is, records of activities at the time they were conducted).

    See also:

    R&D consultants

    Tax agents and R&D consultants have an important role to play as intermediaries in providing advice to taxpayer in relation to the R&D tax incentive. However, we have concerns how the R&D tax incentive is being advised to taxpayers.

    The ATO and AusIndustry have concerns with some of the practices of tax agents and consultants, including:

    • 'Cold calling' of taxpayers and advising them that their business activities are eligible R&D activities.
    • The use of late registrations to amend claims to access the R&D refundable offset to provide funding for companies in financial difficulties.
    • The charging of excessive commissions which are a large percentage of the refundable R&D tax offset.
    • A registered activity that relates to the 'whole of the project' rather than a specific activity.
    • Registered tax agents, including R&D consultants, advising companies to make incorrect R&D tax incentive claims – these may be referred to the Tax Practitioners Board to consider whether there has been a breach of the Tax Agent Services Act 2009.
    • Promoter penalty laws may also apply under Division 290 of Schedule 1 to the Taxation Administration Act 1953 for promoters of schemes to access the R&D tax incentive for ineligible activities.

    Fraud

    While most taxpayers and advisors generally 'do the right thing' the ATO and AusIndustry are working closely to identify taxpayers and advisors that may be involved in aggressive R&D arrangements. We are taking a coordinated approach to address these behaviours to ensure the integrity of the R&D tax incentive programme.

    These arrangements:

    • are inconsistent with the requirements of the R&D regime
    • may have feature of tax avoidance
    • may be fraudulent.

    See also:

    Last modified: 28 Apr 2017QC 24614