This is everything you’ve ever wanted (or not wanted) to know about the R&D tax incentive in Australia, we’re not kidding. This guide contains everything we know about this most excellent tax incentive, still, if you want to have a leisurely ride through the process and make sure you’re getting every penny you’re eligible for, it may be worth getting a specialist on your side. There are hundreds of companies specialising in helping you navigate these waters, and it’s clear why – the R&D tax credit is complicated, and there is lots of taxpayer money on the line. To help us verify our facilities, we partner with the best of Australia’s R&D providers. Feel free to chat with us if you’d like a no-obligation intro.

Australia has one of the most successful Research and Development (R&D) tax incentive frameworks in the world. Unfortunately, it seems that the number of companies applying to these schemes is meager, even though many are eligible to do so. It may be that you are eligible, even if you don’t think you’re conducting R&D. As always, it often pays to chat with a specialist to get a free assessment.

In this guide, we provide detailed information to make it clearer to companies when they can claim under the R&D tax relief schemes. We explain how Australia’s R&D tax relief framework operates and answer a range of frequently asked questions relating to it. Specifically, we:

  • Explain how R&D tax incentives work;
  • Identify the current R&D rates;
  • Identify the sorts of activities and projects that will qualify for R&D tax relief;
  • List the different expenses that can be claimed as R&D;
  • Explain the process for claiming R&D tax credits;
  • Explain how to produce the technical narrative to support an application for R&D tax credits;
  • Demonstrate how the R&D tax credit can be calculated;
  • Look at whether there is any template that can be used for the purpose of making this application;
  • Explain how governmental measures in response to COVID-19 affect R&D tax credits.

Introduction to R&D tax incentive in Australia

The R&D tax incentive is a business incentive programme managed by the Australian Government to support organisations to conduct R&D work that they may not have started or pursued otherwise. The scheme has been around in one form or another since the ’80s. The current research and development tax incentive replaced the old programme titled the R&D tax concession in 2011 and has been a constant since. At this point, it has become a major source of financing for innovative Australian companies.

To understand the scheme, let’s look at it from the top. The R&D tax incentive gives a company access to a percentage of their expenditure as either a cash benefit or a tax offset:

  • 38.5% of eligible spending for firms with an accumulated yearly turnover of $20 million or more. If the company’s tax debt is less than the tax credit, the remaining benefit is carried over to the next year and can be used to offset profits.
  • 43.5% of eligible expenditure for businesses with totaled yearly turnover under $20 million. If the tax credit amount calculated surpasses the company’s tax debt, the remaining difference is paid to the company in cash.

The scheme is managed jointly by the ATO and the Department of Industry, Innovation, and Science – AusIndustry, a branch of the Australian Government.

You will need to register your R&D activities with AusIndustry before you can claim any offset. This step ensures that the department understands that the expenditure you’ve claimed and the technology you’ve built are both eligible for the programme.

In recent years, regulation has become stricter around both eligible technology and claimable expenses. Companies need to provide thorough records of their process and comply with a set of complex demands to prove that their projects fit within the definition of R&D. We recommend you discuss your claim with a reputable advisor, especially if you will be seeking to finance your tax incentive. We are happy to recommend an advisor if the time is right for you to file a claim, you can chat to us here:

introduction to rd tax incentive in Australia

How does the R&D tax offset work?

As mentioned, R&D tax credits can be applied to either profit-making or loss-making companies to reduce the tax burden of the business. They can be taken either as a cash credit or a current or future tax offset.

For companies that make less than $20 Million in turnover, there are a few additional qualifying criteria.

The company needs to:

  • Be undertaking R&D activities that involve experimentation.
  • Spend over $20,000 on these activities in the relevant financial period.
  • Undertake these eligible activities in Australia.
  • Be defined as a company. Other forms like partnerships or trusts are not eligible.
how does the RD tax offset work

What kind of work will be eligible for R&D tax incentives?

In most cases, the R&D activities that are qualifying will need to have occurred in Australia – there are some exceptions to this, so be sure to check.

In the Australian Government’s guidelines explaining the R&D scheme, the definition is kept a little vague, so there is still some room for interpretation. Because the current scheme has been going on for over a decade now, advisors and qualifying companies have started to understand what the ATO’s intention is, and here are the main points:

Research and development activities need to meet a series of criteria to qualify for the R&D tax incentive. One of these criteria is that they must either be classified as core or supporting R&D activities.

Core R&D Activities

Core R&D activities are:

  • characterised by being experimental
  • activities whose outcome cannot be known before the activity is carried out, or predicted based on advance the current knowledge in the field of science. The outcome must only be determined by applying a systematic progression of work that is founded on the principles of science.
  • a progression that is characterised by moving from a hypothesis to an experiment, that includes observation and evaluation, and leads to conclusions based on the observed phenomena.
  • conducted with the intent of generating novel knowledge and insights. This includes many potential areas of inquiry: products, processes, services, materials, etc.

Supporting R&D Activities

A supporting R&D activity is one that is directly related to core R&D activities. This also applies to activities that have been undertaken primarily to support core R&D tasks.

This means that supporting R&D activities will need to be intrinsically tied to the core R&D activity in an important way or they will not be claimable.

This is called the “dominant purpose requirement” and applies to activities that produce goods and/or services or are at least tied directly into these processes. Supporting R&D activities can also be activities that are excluded from being core R&D activities but still serve to support a qualifying core activity.

What kind of work will not be eligible for R&D tax incentives?

According to section 355-25 of the Income Tax Assessment Act 1997, the following activities will not be considered core R&D :

  • Market research, testing & development, sales promotion.Routine testing and analysis of any of the following: materials, components, products, processes, soils, atmospheres, etc.
  • Activities that aim for the reproduction of a commercial product or service by copying any existing system or blueprint/plan.
  • Activities aimed at developing, customising or changing computer software that is primarily going to be used by the developer or affiliates of the developer.
  • Research in the area of social science, also in the arts or humanities.
  • Any commercial, administrative or legal activities that are tied into patents or licensing.
  • Prospecting, exploring or drilling for minerals or petroleum.
  • Management or efficiency studies.
  • Any activities in service of ensuring compliance with statutory requirements or regulations, like maintaining national standards or secondary standards.

What counts as R&D costs for the purposes of the tax incentive?

If you remember the definition we set out above, it’s clear that qualifying R&D may cover a wide range of different activities in different fields.

Some possibilities include:

  • Expenditure on research and development activities, including money paid to associates and potentially also expenditure on activities overseas. Activities conducted overseas can only be claimed if there is an advance finding from Innovation Australia associated with the project.
  • Expenditure to an RSP.
  • Expenditure on goods and materials that were transformed during the research process in order to create marketable products. AusIndustry gives the example of Feedstock expenditure.
  • The depreciation of assets that were used in the process of R&D (this includes R&D partnership assets)
  • Balancing adjustments for assets. This only applies to assets used for conducting R&D activities and this also includes R&D partnership assets.
  • Monetary contributions under the CRC programme.
what counts as RD costs

Which costs do not count for R&D tax incentives?

While, in some cases, it will be a judgement call, and it can be good to seek professional advice on whether an expense could be qualifying R&D, certain expenses will definitely not count.

This includes:

  • Expenditure on interest
  • Expenditure that can not be said to be at “risk”
  • Expenditure on core technology
  • Expenditure on real estate, be it the purchase of or constructing of a building or any part thereof
  • The expenditure included in the cost of an asset that is depreciating

What is an R&D Grant?

An R&D Grant is the same thing as the R&D tax incentive. It is a portion of your eligible expenditure on research and development that will either be paid out as a cash benefit or alternatively be offset from your tax burden. Sometimes it can also be carried forward to offset tax in the next year. Another name for the R&D grant is the R&D tax credit. The contents of this guide, therefore, applies to the R&D grant, as it is a synonym.


How does the R&D tax incentive work?

The R&D tax incentive is the same as the R&D tax offset and works as laid out above. Another name for the scheme is the R&D Grant.


How do I claim the R&D tax incentive?

Though if you are looking for R&D financing, we always recommend you work with a reputable R&D tax offset advisor, you can, of course, also self-file your tax credit application.

There are three essential elements:

  • Filling in your company tax return:
  • An explanation as to how your activities meet the requirements for claiming the tax credit. This is often referred to as a ‘Technical Narrative’;
  • Calculations to explain how you arrived at the final amount.
what is a RD grant

How do I keep appropriate records?

This is the tricky bit. Here you need to come up with a justification as to how your spending meets the R&D qualifying requirements. This involves careful record-keeping of your eligible R&D activities.

The ATO in collaboration with the Department of Industry, Innovation, and Science (AusIndustry), have developed a handy fact sheet that covers everything you need to know about the record-keeping requirements for the research and development tax offset. It includes all the relevant information about record keeping: which records need to be kept, what level of detail needs to be captured, and for how long. You can find it here.

Keeping accurate records of your eligible R&D activities will help you avoid a compliance or risk review if the authorities decide to analyse your claim a bit deeper.

keeping RDB appropriate records

Can I use an R&D tax incentive claim template?

We wouldn’t recommend it. The main factor in the application is your ability to keep records and assess which activities fall into the core and supporting R&D categories. This means there is generally a lot of variation in these applications. It can be a good idea to seek professional advice on whether you are eligible for R&D tax incentives and if you could benefit from R&D finance to access these funds early. Contact us to chat about options around R&D financing.


How is the R&D tax incentive calculated?

 

The R&D tax credit is applied slightly differently depending on whether the company is profitable or is making a loss or making more or less than 20 million in turnover. We consider the possibilities below:

Consider the following case of a company that had $100,000 of income, $50,000 of R&D expenditure incurred, and $50,000 of other deductible expenses:

Income: $100,000

Tax liability: 27.5%

R&D expenditure: $50,000

R&D tax incentive at 43.5% of $50,000: $21,750

Taxable income: $50,000 ($100,000 – $50,000 in other deductible expenses)

Tax: $13,750

R&D tax incentive – Tax owed = net cash benefit from R&D incentive is $8,000

What would the calculations look like if the SME made a $100,000 loss, still with $50,000 of R&D eligible expenditure $50,000 of other deductible expenses?

Income: $0

R&D expenditure: $50,000

R&D tax incentive at 43.5% of $50,000: $21,750

The net cash benefit from the entire R&D incentive is $21,750

What would this look like for a company above the $20M in turnover threshold?

Income: $25M

Tax liability: 30%

R&D expenditure: $2M

Non R&D deductible expenses: $22M

R&D tax incentive at 38.5% of $2,000,000: $770,000

Taxable income: $3M ($25M – $22M in other deductible expenses)

Tax before R&D incentive: $900,000

R&D tax incentive – Tax owed = net benefit from R&D incentive – a 770,000 reduction in tax, leading to a net tax bill of 130,000 instead of 900,000


How do the UK R&D tax credits contrast with the Australian scheme?

Businesses that are based in both the UK and Australia may wish to assess in which country it may be eligible to claim its R&D tax relief. Differences between the two frameworks include:

  • Administrative requirements. In Australia, a company must register for each year it wishes to claim the credit. Whereas in the UK, the company can simply claim its R&D tax relief in the course of its regular company tax return filing and can claim two years looking backward;
  • Australia uses a different definition of R&D which focuses on the testing of scientific hypotheses: it proceeds “from hypothesis to experiment, observation and evaluation, and leads to logical conclusions “, while the UK’s definition focuses on the overcoming of “technical uncertainty”.
  • Location. In the UK, R&D expenditure can be incurred anywhere. In Australia, the R&D must actually occur in the country in nearly all cases;
  • Standard of assessment of review. In Australia, a special governmental body called AusIndustry, determines which activities are eligible for relief. In contrast, in the UK, it is HMRC that reviews the documentation, and it likely has a less expert opinion on the activities;
  • In Australia, the minimum spend of $20,000 is required; The Australian scheme increases the tax offset from 30 percent (the Australian company tax rate) to 43.5 percent for businesses with an annual turnover of less than $20M. For companies larger than that, it is 38.5 percent. In the UK, for SMEs, the rate varies from 25% to 33% but is never above that level. For large companies, under the RDEC scheme, the rate is much lower, leading to a benefit of around 12%.
uk tax credits

What is the impact of COVID-19 on R&D tax incentives?

COVID-19 has had a small impact on R&D tax incentives in Australia. The main consequence of the pandemic is that it has postponed legislative changes related to the tax incentive. In recent years, the norms round eligibility have tightened and the scheduled changes would have kept up that direction, limiting the scope of the scheme and qualifying activities. At the moment, it seems to be business as usual for the Australian R&D tax incentive scheme, but things can change suddenly in this uncertain climate.

During this time, we especially recommend that you should seek professional advice on how to approach your application by talking to specialists that have recent experience with AusIndustry and their treatment of applications. Maneuvering through these uncertain times can be easier if you can rely on the experience of specialists.

Conclusion

The R&D tax incentive is an excellent source of funding for innovative companies that are on a growth path. However, there is a range of matters you need to consider before applying for this scheme including:

  • Does the activity of your business count as R&D according to the regulatory definition?
  • Which of your activities might be claimed as R&D and which are either ineligible or being carried out by another entity?
  • Assess which expenses, relating to your R&D can be claimed. Note, not all of them can be.
  • Work out your justification and explanation for R&D tax activities in the records that you will need to supply with your application;
  • Consider whether your access to any COVID-19 business support packages might affect your R&D tax situation;
  • Where you are eligible to apply in both countries, consider whether the UK’s R&D tax relief scheme might be more beneficial, or that you may potentially qualify for both.

We hope that you found this guide useful, and If you think you could benefit from professional R&D tax relief advice, don’t hesitate to chat with us.


Alexandra Kepka

Alex is a tech-focused funding expert, helping innovative companies grow through innovative funding through her work at Fundsquire. She also has a background in journalism, having written for outlets like Vice and many others in the past on topics ranging from philosophy to economics.

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