The R&D regime, effective 1 July 2011, is designed to encourage R&D activities by companies with the ultimate objective of enhancing the competitiveness and productivity of the Australian economy.
The ATO has launched R&D tax incentive customer portal for companies to manage their applications for the R&D tax incentive. Companies can submit applications on the portal by 5 July 2021.
To be eligible for the incentive, a company must satisfy certain conditions.
- It must be an R&D entity. An R&D entity is a corporation that satisfies any of the following criteria:
- it is incorporated under Australian law;
- it is incorporated under a foreign law but is resident in Australia for income tax purposes; or
- it is incorporated under foreign law and is resident in a country with which Australia has a double tax agreement and carrying on a business in Australia through a permanent establishment as defined in that agreement.
- Special rules apply in cases involving consolidated groups (e.g. permitting the head of the group to register and claim the incentive for the entire group) and R&D partnerships (e.g. permitting the partners in a partnership to claim the incentive in lieu of the partnership itself); and
- The company must incur notional deductions of at least AUD 20,000 on eligible R&D activities.
Specifically excluded from entitlement to the incentives are individuals, corporate limited partnerships, fully tax-exempt entities, and trusts (other than a company functioning as a trustee of a public trading trust).
The R&D activities covered are primarily those undertaken in Australia, although those undertaken abroad may also qualify if they meet specific criteria laid down in the Industry Research and Development Act 1986.
The activities covered include "core" R&D activities (i.e. consisting of experimental activities whose outcome is not known in advance but can only be established through a scientific process or experimentation, observation, and evaluation) or activities directly related to the core activity or that are conducted for the dominant purpose of supporting the core activity.
Expenses that qualify for the incentive include those in respect of the decrease in the value of assets used for conducting the R&D activities. However, expenditure incurred on certain items that are deductible under the normal deduction provisions, including interest, cost of a depreciating asset, core technology and the acquisition or construction of a building, and expenditure that is not at risk (such as expenditure that is fully or partially reimbursed), do not qualify for purposes of the incentive.
The ATO issued guidance (TD 2021/9) which provides the conditions for the applicability of the ‘at-risk’ rule (i.e. expenditure that is not at risk) to job keeper payments received by R&D entities:
- For paid employees who are wholly or partly engaged in R&D activities; and
- Under business participation entitlement.
The guidance details the conditions when the ‘at-risk rule’ is triggered and the R&D expenditure cannot be notionally deducted either fully or partially due to the job keeper payment received by the R&D entity. The portion of the R&D expenditure that cannot be notionally deducted does not give rise to an R&D tax offset. No additional income tax is payable under the R&D clawback rules for that portion of the job keeper payments received by the R&D entity which triggers the at-risk rule.
The tax incentives provided under the R&D program depend on whether the eligible company is controlled by an income tax-exempt entity (where control is defined with reference to a holding of 50% or more of the voting power in the qualified company or entitlement to 50% or more of the income or capital distributions of the qualified company), and are as follows:
- For a company with an aggregated turnover of less than AUD 20 million per annum, which is not controlled by a tax-exempt entity, an incentive by way of 43.5% refundable tax offset is granted. Effective 1 July 2021, the tax offset rate will be 18.5 percentage points above the company’s corporate tax rate without any cap on annual cash refunds; and
- For all other qualified companies, a 38.5% non-refundable tax offset is granted. Effective 1 July 2021, larger companies (i.e. with turnover equal to or exceeding AUD 20 million) will be entitled to a tax offset equal to 8.5 percentage points above the company’s corporate tax rate for initial R&D expenditure up to 2% R&D intensity, and 16.5 percentage points above the company’s corporate tax rate for R&D expenditure above 2% R&D intensity. R&D intensity is computed as notional R&D deductions of the R&D entity divided by the R&D expenditure.
For income years starting on or after 1 July 2014, the amount of eligible R&D expenditure for which the above offsets can be claimed is capped at AUD 100 million, with the offset for expenditure exceeding the cap equal to the applicable company tax rate. Effective 1 July 2021, the cap on eligible R&D expenditure will be increased to AUD 150 million per annum. Unused non-refundable offsets may be carried forward for deduction in subsequent years.
To be eligible for the full offset, the total notional deductions of a qualified entity for the relevant income year must be at least AUD 20,000. For deductions less than this amount, the offset is limited to certain expenses (e.g. those incurred to a non-related Research Service Provider (RSP) for services within a field of research for which the RSP is registered, and those incurred as a monetary contribution under the Co-operative Research Centre (CRC) program).
Additional provisions govern the application of the incentive, including adjustments required to account for recoupments from the government, the application of marketable products from the R&D activities to the company's own use, and the manner in which claims for the incentive (which is administered on a self-assessment basis) should be made and record-keeping requirements.
The Australian Taxation Office (ATO), issues tax alerts from time-to-time clarifying the position on ineligible claims of R&D incentive. Some of the key clarifications issued are as follows:
- In respect of agricultural activities: Expenditures incurred in arrangements that exhibit some or all of the following features, will be under review by the ATO and may not be eligible for R&D tax incentive:
- an agricultural business is being carried on, often by an entity that is not eligible for the R& D Incentive, for example, a family trust;
- the operators of the agricultural business are approached by a promoter/R&D consultant advising that the farming activities that are being carried on are eligible for the R&D tax incentive;
- where necessary, a new special purpose R&D company may be incorporated in order that the activities are conducted by an entity that is able to claim the R&D tax offset;
- a company registers one or more activities for the R&D tax incentive;
- the registered activities involve the application of farm products or practices across all or a significant part of a farm or farms;
- some or all of the registered activities have the character of ordinary farming activities whose main purpose is the production of crops; and
- the company claims the R&D tax incentive for expenditure that is not on eligible R&D activities.
- In respect of software development activities: Expenditures incurred in arrangements that exhibit some or all of the following features, will be under review by the ATO and may not be eligible for R&D tax incentive:
- the company claims the R&D tax incentive for expenditure that is not on eligible R&D activities;
- a company undertakes a software development project that involves one or more of the following activities:
- developing new software;
- modifying, customizing, or upgrading existing software; and
- acquiring and modifying off-the-shelf software.
- the software development project includes one or more of the following:
- undertaking activities that use existing software development knowledge and expertise to achieve the required technical outcomes;
- undertaking activities that involve business risk rather than technical uncertainty;
- undertaking activities to replace manual work processes using software technologies that are available in the market and adapted to the requirements of the company; and
- using existing software technologies as they were intended to be used. Some or all of the registered R&D activities are broadly described and non-specific. For example, they may describe project objectives or business and system requirements that the company is seeking to design and implement.
- the company includes the whole, or a large proportion, of their expenditure on the software development project in the calculation of their R&D tax incentive claim.
- In respect of construction activities involving either acquiring buildings, or extensions, alterations or improvements thereto (the acquirer); or whose business it is to construct, extend, alter or improve buildings (the builder): Expenditures incurred in arrangements that exhibit some or all of the following features, will be under review by the ATO and may not be eligible for R&D tax incentive:
- a contract is entered into between the acquirer and the builder to construct, extend, alter or improve a building or buildings (construction);
- the contract is a standard construction contract and is not for the provision of R&D services and does not specify that R&D will be carried out by the builder;
- the acquirer or the builder registers one or more activities associated with the construction of the building for the R&D tax incentive, identifying the structure or construction techniques as purportedly involving untested or novel elements;
- some or all of the activities registered are broadly described and non-specific. For example, whole construction projects may be registered rather than the specific activities which are being undertaken;
- some or all of the registered activities are ordinary construction activities that are directed to fulfilling the requirements of the building or construction contract, or relate to expenditure that is expressly excluded from being taken into account in calculating an R&D tax incentive;
- frequently, the expenditure which is incurred relates to construction methods or techniques that are already known within the building industry, or involve the mere adaptation or integration of existing technology; and
- the acquirer or the builder claims the R&D tax incentive for expenditure that is not on eligible R&D activities, or for expenditure that is expressly excluded.
- In respect of ordinary business activities: Expenditures incurred in arrangements that exhibit some or all of the following features, will be under review by the ATO and may not be eligible for R&D tax incentive:
- a company registers one or more activities for the R&D tax incentive;
- some or all of the activities registered are broadly described and non-specific. For example, projects may be registered instead of the specific activities undertaken;
- some or all of the activities registered are ordinary business activities that are not eligible for the R&D tax incentive;
- some or all of the activities were undertaken in the course of their ordinary business activities and recharacterized as R&D activities at a later time; and
- the company claims the R&D tax incentive for expenditure that is not an eligible R&D activity.
The above clarifications from the tax authorities note that the companies are expected to distinguish eligible R&D activities from ineligible ordinary business activities at the time of registration and throughout the conduct of the activities. Proper, detailed, and contemporaneous records must be kept, to support the registration application and the claim for the R&D tax incentive. The onus is on the taxpayer to ensure that the registration and claim for the R&D tax incentive are correct. Penalties may apply if the incentive is incorrectly claimed, however, such penalties could be reduced significantly if voluntarily disclosed.