As the economy shifts more and more toward rewarding innovation, the types of financing that companies can access have followed this trend as well.
Both through the government and the private sector, a wide variety of support mechanisms and funding schemes have popped up. This means that entrepreneurs aren’t limited to having to sell equity or bootstrapping growth any longer. A new form of financing that is specifically geared at supporting innovative companies is the R&D loan, alternatively called R&D finance.
The purpose of R&D financing, as a form of finance, is to help smooth out the timeline of how R&D tax incentives get paid. So, in this post, we want to give you information on the factors that go into a lender’s decision to offer R&D financing solutions.
But first, it makes sense to look at the normal timeline for R&D payouts and why it makes sense to finance a future R&D claim.
How are R&D tax incentives paid?
R&D tax incentives are paid after the claim has been created and filed together with the tax return within 10 months of the end of the company’s income year.
The main issue with the payout is that even though the funding is reliable, it is very slow to materialise. This is understandable, the ATO has cultivated a careful and considered approach to handing out taxpayer money. For a company on a steep growth path, though, this slow and steady pace can seem glacial at times.
A lot of founders end up spending months waiting for the payment to come through and it isn’t always a predictable schedule. Though the typical timeline between filing and receiving funding is 8 to 10 weeks, but can vary wildly, especially if the company becomes the subject of an audit. This uncertainty can be bridged with products like R&D finance.
What is R&D tax incentive finance?
R&D finance is a form of funding that allows a company to make use of its R&D tax incentive early, in the form of a loan.
The way it works: The lender uses the estimated future tax credit as collateral for an affordable loan, typically starting up to 9 months before the tax credit is expected.
Why it works: The R&D tax credit is a reliable scheme that the ATO has been running for over two decades, representing one of the most predictable receivables that a company can have. This is all, of course, conditional on the quality of the claim that the lender is evaluating, and working with a great advisor can yield dividends here.
The main condition for accessing R&D lending is, of course, qualifying for the R&D tax incentive.
“The R&D tax incentive is a reliable scheme that the ATO has been running for decades, representing one of the most predictable receivables that a company can have.”
What qualifies for R&D tax credits?
The three main qualification criteria for a company to be eligible for RD financing are:
- Eligible to pay corporation tax in Australia.
- Has carried out at least one qualifying core r&d activity.
- Has spent over $20.000 on said activities within the financial year.
As the first condition is easy to figure out, that leads us to the next two qualifications for RD financing which are: technology and spending.
What technology qualifies for the tax incentive claim?
The ATO has set broad criteria for the types of activities it considers qualifying for the R&D finance solution. This means that independent of the sector, companies could be investing in qualifying activities.
The main question an AO inspector seeks to answer (and wants you to have answered in your claim) is “Is the company attempting to resolve scientific or technological problems that are based on principles of established science and proceed from hypothesis to experiment, observation and evaluation, and lead to logical conclusions?”.
This could mean anything from the creation of a new piece of software that resolves a problem that was not easily resolved by a competent professional to creating a new manufacturing sub-process that saves time and resources.
The key is to create something that is a technological innovation rather than simply a market innovation. This can be tricky to understand, as the type of technology, however complex or filled with buzzwords, isn’t always important.
Take something cutting-edge like neural networks – if a company takes an existing neural net technology and brings it into a new market, say, neural networks for pet food distribution, this would not in itself be bridging technical uncertainty. But if the company works to integrate this neural net into other, unrelated technologies and creates more software in the process, that software would most probably be qualifying, just as if the company built its own neural net-based algorithm.
What types of spending qualify for R&D credits?
Though interpreting the technology can be quite a nuanced exercise, seeing what spending qualifies for R&D finance is more clear cut.
Costs that can be claimed include:
- expenditure on core and supporting R&D activities
- the decline in value of assets used in R&D activities and balancing adjustments for their value
However, under the R&D grant programme you cannot claim:
- interest expenditure
- expenditure that is not at risk through the experimental nature of R&D
- expenditure on pre-existing core technology
- expenditure included in the cost of a depreciating asset
- expenditure incurred to acquire or build real estate.
Are there any other things to consider when applying for R&D loans?
If you can claim R&D tax incentives grant program, you’ve fulfilled the baseline criteria for R&D finance. If that’s a given, there are a few more details to consider when applying for a R&D finance loan.
Profit or Loss-making
A company that is looking to get an advance on their R&D grant program funding will need to be receiving a cash benefit from the ATO, which will act as the collateral and repayment mechanism for the loan. If the company is not receiving this benefit and is only getting an offset on their tax burden, there is no asset to be financed. As most of the companies who receive a cash tax credit are loss-making, this is an important factor for lenders as well.
Tax debt
One of the main factors a lender will look at is tax debt when an applicant is applying for R&D finance solutions. If the company has significant debt outstanding to the ATO, this will preferentially be extinguished through the R&D tax incentive. What this means is that if you owe money to the ATO, they will keep your R&D tax incentive payments to fulfill your obligations. This is the case even if a payment plan is in place.
Other debt and charges
If the company has multiple charges and is burdened with a lot of pre-existing debt, it becomes harder to arrange suitable security for the new debt facility. For most companies that are claiming R&D and incurring a loss, this won’t be an issue, as debt finance is typically unavailable at this stage.
Overall company health
R&D lending is ideal for companies that are on a growth path and want to use this type of funding to put fuel on an already existing fire. If the company does not have a coherent plan for the future and solid documentation that backs this up, it will be hard to make the case to a lender that the company should be funded with R&D financing solutions.
Conclusion
To sum up, the main condition to be able to apply for R&D finance solutions is, as you would have expected, eligibility for the R&D tax incentive. Outside of that, you should be aware if you are going to be incurring a profit or a loss at the end of the financial year. A potential RD finance lender will also look at other debt you have on the balance sheet, especially if it is owed to the ATO, and at other charges. The last but not least important factor is the trajectory of your company. If the company will use the funds to accelerate on its upward path and not to plug existing holes in its plan, getting funding is all but a certainty. Let us know in the comment if you have any questions about how R&D finance works, or if you have any experience that you’d like to share.
