ATO to crack down on businesses misusing R&D tax breaks

The Australian Tax Office has warned business operators and advisers that it is ramping up its efforts to target the misuse of research and development tax incentives, and it will pursue those deliberately exploiting the tax breaks in court.

The ATO says it is particularly concerned about businesses in the building and construction industry, where it says an increasing number of operators are attempting to claim excluded expenditure as R&D expenses.

The R&D Tax Incentive program allows Australian companies to claim tax offsets for their research and development activities, with the incentive particularly important for early-stage ventures and startups.

According to the ATO, more than 13,700 business entities spent $19.5 billion on R&D activities in the 2013-14 financial year, and claimed tax benefits of approximately $3 billion.

ATO deputy commissioner Michael Cranston said in a statement the ATO is undertaking a range of compliance activities to identify businesses and advisers that are incorrectly including ordinary business activities in their claims for the R&D tax offset.

“While most do the right thing, we are seeing some businesses in these industries and their advisers improperly applying for the tax incentive where the activities and expenditure claimed don’t match with legislative requirements,” Cranston said.

“For example, we have seen an increase in claims for ordinary business activity expenses, or for large parts of projects that do not correspond to the scale or scope of experimental activities.

“Ordinary business activities are not generally carried out with a purpose of generating new knowledge. We often see issues including claims that encompass whole of projects (where project, management, environmental and commercial risks are mistaken for technical risks) and where the activities use existing knowledge and expertise.”

As part of “early warning” to business, the ATO and the Department of Industry, Innovation and Science have published a range of alerts and other materials about making R&D Tax Incentive claims, including information for businesses that are unsure of their position or that may have made a mistake in their claims.

However, Cranston says the ATO “will take legal action against those who wilfully misuse the R&D Tax Incentive”.

Tax offset a source of confusion

David McKellar from Allied Business Accountants told SmartCompany this morning the R&D Tax Incentive program is complex and a source of confusion for many business owners who may not fully understand what they can claim or what the limitations are.

“The situations that have led to this new compliance activity are a combination of misunderstanding, misinformation and at times overly enthusiastic claimants attempting to push the envelope and increase their claims,” McKellar says.

“Broadly speaking, the incentives are available on expenses related to R&D activities. To be eligible the activities need to be genuine research and development conducted for the purpose of generating new knowledge for products, [or] services.

“The trap many fall into, is that they may conduct R&D activities in relation to a ‘component’ of a new product or service, but seek to claim the incentives in relation to the development of the product or project as a whole, not just the one component of that product.”

But McKellar says professional advisers or consultants who make big promises to business owners are also contributing to the problem.

“It is often the case that businesses engage an R&D consultant for advice and to prepare the claim. Whilst it is advisable to seek appropriate advice, it has created an industry of consultants that are essentially out there ‘selling’ the incentives and promising to deliver big results,” he says.

The scope of the R&D Tax Incentive has recently undergone some changes, with legislation passed in September 2016 changing the rates of the tax offset for companies. The rate of the tax offset for businesses with annual turnover of less than $20 million has been reduced from 45% to 43.5%, while the rate of the non-refundable tax offset for larger entities is now 38.5%.

The reduced rates apply to income years starting on or after July 1, 2016.

In September 2016, a review into the overall incentives scheme was released for public consultation, after being completed earlier in the year by Innovation Australia chair Bill Ferris, chief scientist Dr Alan Finkel and secretary to the treasury John Fraser.

The six recommendations made in the report focused on the “sustainability” of the R&D program. These include placing a cap on the annual cash refund available through the incentives scheme at $2 million, while doubling the eligible R&D expenditure threshold from $100 million to $200 million.

*This article was updated on February 16, 2017. 

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Braden, QLD
Braden, QLD
3 years ago

David’s assertion that the programme ‘has created an industry of consultants.. promising to deliver big result’ is incredibly offensive to a number of specialists within the field.

The R&D Tax Incentive falls under the Income Tax Assessment Act 1997, and like all other areas of tax law, taxpayers engage specialists within the field to provide taxation advice, just like David’s own clients.

The R&D Tax Advisers role is to help taxpayers self assess whether their activities meet the definition of eligible activities under the tax law. A respectable adviser will have specialists with industry experience that understand both how R&D operates within the their industry as well as a strong grasp of the law.

If an adviser is telling you ‘all your activities are eligible’ run away. A good adviser will help you assess each of your activities individually, and help to separate R&D form business-as-usual activities.

At the moment a good R&D adviser is invaluable as it is not the taxpayers, but AusIndustry (the body who assesses the eligibility of R&D activities) who are pushing the boundaries. A clear example of where AusIndustry has stepped away from the legal definition in recent guidance is what is referred to as ‘uncertainty of outcome’.

Under the law “Core R&D activities are experimental activities whose outcome cannot be known or determined in advance on the basis of current knowledge…” [ITAA1997 355.25(1)(a)]. The ‘outcome’ can only be determinable by undertaking an experiment.

However, in recent guidance AusIndustry has stopped using the terms ‘known or determined’, and now opt for ‘known or predicted’. While subtle, AusIndustry’s interpretation significantly impacts the application of the law, and effectively rules out a number of activities. Any industry specialist, whether a scientist, engineer or software developer, should be able to ‘predict’ an outcome at the outset of the project.

In-fact it’s a key requirement under the law. Under 355.25(1)(a)(ii) – the experimental activity must proceed from ‘hypothesis to experiment, observation and evaluation, and leads to logical conclusions’. A hypothesis is a specific type of prediction that involves the supposition of a result based on existing knowledge and the parameters of an experiment.

There is a distinct difference between a competent professional having the ability to ‘predict’ and the ability to ‘determine’ the outcome of an activity prior to undertaking the experiment. This is but one of the many diversions from the law in recent AusIndustry guidance.

One of the key goals of the ‘Review of the R&D Tax Incentive’ was to reduce the cost of compliance for taxpayers. However, the further that AusIndustry diverts from the law, the more misinformation there is, and the more compliance costs that will arise.

Taxpayers, particularly those in the start-up sector, are susceptible to AusIndustry’s interpretations as they do not have the resources to participate in the extensive compliance process. They are instead more likely to withdraw their claim.

The Review found that for the most part, the definitions under the law are acceptable and align with the definitions outlined in the Frascati Manual, the basis for most of the R&D Tax Credits in OECD countries. It also found that a majority of taxpayers that participate in the programme are following the law.

AusIndustry’s choice to complicate these definitions further is contrary to not only to the Review, but what is broadly accepted as eligible R&D activities worldwide.

As a taxpayer I’d much prefer to see my tax dollars go to Australia’s innovators, rather than supporting a compliance process where the activities are no longer assessed against the law, but are instead assess against AusIndustry’s interpretation of the law.

J
J
3 years ago

*… from 45% to 43.5% for businesses with an annual turnover of less than $20 million.
Also, the reduced rates apply to financial years from 1 July 2016.