In this article, we will be going through the fundamentals of this tax incentive, and why all Australian companies and startups should seriously consider claiming the R&D tax incentive.
Always remember when looking at tax incentives that it does relate to the Australian taxation legislation and thus there are a number of elements that are important in terms of compliance under the Australian tax act.
When reading this guide, please understand that over time, the rules and regulations regularly change and evolve, so I encourage you to always refer to AusIndustry to be completely up-to-date with the current R&D tax incentive framework.
Fundamentals of the tax incentive
One of the fundamentals of R&D is to understand why a business would invest their capital in research and development. There are multiple reasons why it is sensible for businesses to invest in research and development.
These reasons may include;
- entering new markets;
- enhancing the value of the business;
- expanding the business, and;
- keeping ahead of the competition.
To this end the Australian government has created a tax incentive to encourage investment in commercial research and development.
This tax incentive is created because the government recognised the intrinsic risk associated with certain elements of R&D and thus there is a higher deductible allowance for those activities deemed to be eligible R&D.
It is important also to understand that it is an entitlement to claim the R&D tax incentive for eligible research and development activities, that is it is not a competitive grant scheme it is an entitlement however that entitlement is dependent upon you conforming with the rules and regulations as set out in the tax act.
One of the major advantages of the R&D tax incentive is the enhanced cash flow it can deliver to a business.
Tax incentive requirements
There are a number of requirements that you need to meet to be eligible to be claiming the R&D tax incentive. These are to be an eligible entity – for simplicity’s sake, that means that you are a proprietary limited company or a limited company registered within Australia, and you have to undertake eligible project activities and have eligible expenditure.
Finally you need to maintain appropriate records to justify both the project activities and the R&D expenditure.
Failure to comply with any of these requirements disqualifies you from claiming the R&D tax incentive. If you do claim the incentive and an audit occurs this can trigger penalties for invalid claims that may have been made.
When discussing maintaining records it’s important to understand that this is not designed to be onerous upon the business. Many of the records should be kept as a normal part of the day-to-day operations of any business anyway.
Benefits of the R&D tax incentive
What are the benefits that can flow to a business from the R&D tax incentive?
If you are a larger entity with a turnover of more than $20 million the R&D tax incentive is a non-refundable tax offset that is set at a premium, and linked to the intensity of the research and development activities within the organisation.
The government aims to encourage large and medium-sized companies to invest in R&D and provide a higher incentive where there is a higher level of R&D intensity; this tax incentive applies for expenditure up to $150m. These tax offsets apply to expenditure up to $150 million in an income year after which the incentive is reduced to the company tax rate.
For most people and companies claiming the R&D tax incentive, your turnover will probably be below $20 million. For those companies, there is a different set of rules with respect to the R&D tax incentive. For these smaller companies, the R&D tax offset is a refundable payment that means the company can be in tax loss and still receive a cash payment from the ATO for eligible research and development activities.
The level of the R&D tax incentive is set at 18.5% above the claimant’s company’s tax rate thus if your company tax rate is 26 % the value of the tax offset is 44.5% that is for every hundred dollars you spend on eligible R&D, you will will be refunded $44.50.
So for companies in the early stage of development investing in R&D, claiming the R&D tax incentive has a positive impact on the cash flow of the business. You should know that in the longer term that the refundable R&D tax offset does have an impact on the company’s franking credits.
You should discuss with your tax accountant the implications of franking credits for your specific business when claiming the R&D tax incentive.
Applying for the R&D tax incentive
Now let’s look at the administrative side of the R&D tax incentive. Two government departments are involved in the administration of the R&D tax incentive. AusIndustry is responsible for the registration of r d activities as well as the assessment of advanced findings and audit and review of research records.
AusIndustry emphasises that this is a self-assessment process. What this means is that you submit a registration form and this is assessed by the department however they do not do a detailed audit and you assert by signing the registration document and you declare by signing the registration document that you have the necessary records to validate your claimed R&D activities.
The Australian Tax Office is then responsible for processing the actual tax returns. They will assess the tax incentive schedule which is a record of the expenditure that you have claimed with respect to the R&D tax incentive. The ATO expects that you will be able to validate your expenditure through records such as time sheets and expenditure records within your chart of accounts.
They also administer two adjustments to the R&D tax incentive called the clawback adjustment and the feedstock adjustment.
If your expenditure is less than $20,000 in a single income year, then you are not eligible to claim that R&D expenditure except if those funds were expensed with a research service provider that is registered with the department. In that situation, you can claim smaller amounts of the R&D tax incentive.
AusIndustry maintains a list of registered research service providers that you can consult with.
In respect to timing when you register your eligible R&D activities you have 10 months from the end of your financial year to complete that registration.
What this means is that for a financial year that ends in June you have until the following April to complete your R&D tax incentive registration and submit to AusIndustry. That registration needs to be submitted prior to completing your tax return as the registration number provided by AusIndustry will need to be quoted in that tax return.
I would now like to mention advanced and overseas findings when discussing claiming the R&D tax incentive. AusIndustry allows companies to submit an application for an advance finding. An advance finding provides a level of comfort to companies that their R&D activities will be registered.
An advance finding, as the name implies, is submitted in the financial year of the first registration in which the activities listed in the advanced finding will apply and goes out for a period of up to three years.
This can be very useful if you have some level of concern about the eligibility of your activities and wish to gain a ruling that the project and activities are eligible. You may be seeking investment and wish to assure your investors that the money that they put into your company will be enhanced to the value of the R&D tax incentive.
An overseas finding is similar to an advanced finding indeed the same form is used for both advanced and overseas findings. The difference here is that if a company is wishing to claim expenditure for R&D activities conducted offshore they are required to submit an overseas finding within the first financial year of such expenditure.
If they wish to make a claim there are a number of rules regarding overseas expenditure. The overseas expenditure has to be related directly to Australian R&D activities and the level of expenditure on overseas activities cannot exceed the level of expenditure committed within Australia.
If you have any questions regarding overseas expenditure just strongly advise that you consult AusIndustry or your registered tax agent to get more specific guidance.
The registration process is a two-step process. First of all registration with AusIndustry and then submission of the company’s annual tax return. The company completes the R&D registration form and lodges that with AusIndustry.
They then process the application and subject to any queries or audit provide a letter with a registration number. That registration number is used by your tax accountant to complete the relevant schedule within the company tax return which is submitted to the ATO for processing.
There is some level of data validation between AusIndustry and the ATO to ensure that the information provided is consistent all things being well the ATO will then send to you your eligible tax incentive payment.
Claiming the R&D tax incentive is fantastic for businesses to improve their cash flow, and create documentation and systems around their research and development.
The entitlement to claim the R&D tax incentive for eligible research and development activities, that is it is not a competitive grant scheme it is an entitlement however that entitlement is dependent upon you conforming with the rules and regulations as set out in the tax act.