The eligibility of software development activities under the R&D Tax Incentive is under scrutiny by both AusIndustry and the Australian Taxation Office (ATO).
To apply to register R&D activities, a company needs to consider each of the activities it has conducted and assess which of these are:
- eligible core R&D activities;
- eligible supporting R&D activities; and
- ineligible activities that cannot be registered with the R&D Tax Incentive.
Core R&D activities
These are activities that involve an experiment that is conducted in a systematic and planned manner. They will be designed around a specifically targeted problem statement (hypothesis) that proposes a relationship between variables which would be proven right or wrong by observing and evaluating the results after conducting the experiment.
Testing activities that are not eligible experiments include:
- bug testing;
- system testing;
- data mapping and data migration testing; and
- testing websites in operation by measuring the number of hits.
Examples of where a core R&D activity may be identified in software development could include experiments necessary to develop and test new or improved algorithms such as those needed for:
- predictive modelling;
- interrogating large data sets; and
- functionality in firmware.
Using existing knowledge, information or experience to determine outcomes is not eligible e.g. developing customised solutions from an existing commercial software package).
Supporting R&D activities
These are activities that have a direct, close and relatively immediate relationship with a core R&D activity. These may include:
- setting up test beds;
- coding algorithms that will be used in an experiment; and
- collating a data sample that will be used in an experiment.
ATO taxpayer alert
The ATO recently released a Taxpayer Alert (TA 2017/5) to alert companies that the ATO and AusIndustry are reviewing expenditure included in software development projects that are not eligible R&D activities.
Companies undertaking software development projects sometimes assume or assert that software development activities are by their nature, eligible R&D activities. While a project may involve some experimental activities, that does not qualify the entire project as an eligible R&D activity.
The ATO’s concerns
The ATO is concerned that operators of some companies may believe (or have been advised) that their activities are innovative or constitute eligible R&D activities, in particular:
- activities may not fit the stringent requirements of the laws that govern the R&D Tax Incentive;
- expenditure claimed may not relate to eligible R&D activities; and
- they are not applying adequate levels of governance and review of the registered activities and the claims made for the R&D Tax Incentive.
What is the ATO Doing?
The ATO along with AusIndustry are working together to alert companies that may incorrectly claim the R&D tax incentive by including non-eligible R&D activities in their software development pools. The ATO will contact the companies directly if:
- Advisors who may apply high risk practices are involved in the preparation of the registration application and/or claim.
- The registration of R&D activities continues with the use of broad descriptions that fail to distinguish them from ordinary business activities.
- The level of expenditure claimed for the R&D tax incentive is high for the industry or stage of business
AusIndustry will continue to issue Findings to companies confirming whether their activities qualify for the R&D Tax Incentive.
What should companies be doing?
1. Review registration and expenditure
Companies registered for R&D Tax Incentive will need to review their registration and ensure that they are registering only eligible R&D activities and not claiming expenditure related to ineligible ordinary business activities.
2. Contemporaneous documentation and record-keeping
Companies that do not have contemporaneous evidence that an activity was conducted to meet all the eligibility criteria will have their claims disallowed. This is a basic step in any company’s self-assessment of eligibility.
The Administrative Appeals Tribunal (AAT) has consistently ruled that R&D activities claimed without evidence that substantiated eligibility are not eligible. Documentation and records must demonstrate all eligibility requirements are met.