Are you claiming your R&D?

Don’t miss out: it’s now easier to claim Research and Development (R&D) activities than ever before, as Alan Johnson reports.

There was a time when trying to claim money back from the government for any R&D work was like pulling teeth, and many manufacturers didn’t bother claiming. However, in the recent years the change of name from a R&D tax concession to a R&D tax incentive has heralded major changes in attitude.

Basically, the R&D tax incentive is a broad-based, market-driven assistance scheme for all industries, and provides a targeted tax offset to encourage more companies to engage in R&D activities.

The program, according to the blurb, aims to boost competitiveness and improve productivity across the Australian economy, encourage industry to conduct R&D, provide business with more predictable, less complex support, and improve the incentive for smaller firms to engage in R&D.

Hank Sciberras, R&D tax partner with Deloitte, explained that the program’s name change from tax concession to tax incentive, which took place in 2011, heralded a new era and included many significant changes, including becoming a tax credit program and making it much easier for companies to claim a tax incentive for their R&D activities.

“The Australian Tax Office (ATO) and AusIndustry have always administered the R&D program, but now they work a lot closer together, especially with larger claims.

“Essentially, AusIndustry manages the registration of a company’s R&D activities and may check that they comply with the law, while the ATO may check if the R&D expenditure a company is claiming in its company tax return is eligible.”

Sciberras said the first thing manufacturers should remember when claiming an R&D tax incentive is that the scheme should only be used on inputs evaluated to help a company with its R&D investment decision making.

“But once a manufacturer has decided the tax incentive program works for them, it is usual it will be useful for them for a reasonable period of time, especially if the company has a continuous improvement mindset on R&D and innovation in the manufacturing industry,” Sciberras told Manufacturers’ Monthly.

He said the key to successful financial returns from the program is for companies to get their systems in place at the very beginning of the project.

“The problem is many companies believe the tax incentive is a given, something they are entitled to and don’t have to do much work for. However, the truth is, companies do have to monitor their activities fairly closely.

For manufacturers, Sciberras said there are a couple of areas where they need to pay close attention.

“For example, where companies conduct some R&D activities in line with production activities, they must make sure they have the right systems in place to capture their R&D activities appropriately.

“Companies need to show at what point of time they were using the production line and the purpose for using it for R&D activities. In the R&D tax law there is a purpose test requirement regarding production settings.

“Often, companies need to show what was the purpose of running the production line at a certain point. Is it used for just pumping out product, or is it to do R&D activities?”

Sciberras said to prove adherence to the test requirement, having a trial authorisation request to use the production floor is always useful.

“Plus having the appropriate stage gate to show where a company is in the R&D process, and showing production is still in a R&D setting, rather than a production setting, is also useful.”

Sciberras said there are also tests around clawing back some benefits where companies actually sell outputs of their R&D.

“In a production sense again, manufacturers must be cognisant if they are making new products and claiming R&D on these new products that they are able to sell.

“There is a calculation that has to be done to claw back some of the benefit that companies may have gained from a R&D tax incentive.

“This where I would count on manufacturers to be on top of this particular aspect of the law, because there was a change in September this year on the Government’s Omnibus bill about a R&D tax saving measure.”

In the measure, the R&D rate came down from 40 per cent to 38.5 per cent for clawback adjustment mechanisms in what is known as feedstock positions where companies are actually making a product as part of their R&D process.

“That clawback mechanism looks at a 10 per cent clawback.”

Sciberras said it is quite a complex change, but the key message for companies claiming a tax incentive for products manufactured during trial runs, and sold, is to be very careful about how they capture that expenditure and look closely at to whether or not they received a benefit from doing that work.

“Of course if that product never makes it into production, the work involved is still claimable.”

As Sciberras explained, the definition of R&D stands regardless of the success or failure of the product or process.

“The key elements of eligible R&D are that companies have to engage in experimental activity, and at a time of undertaking that activity they have to demonstrate they could not have known the outcome of that activity when they were doing it.

“And it must be a true experimental activity where companies have to articulate their hypothesis, their experiment and talk about their observations and logical conclusions.

“That’s a fairly well worn scientific definition of what R&D is and is very different from the R&D tax concession where we really focused on the high levels of technical risk,” Sciberras explained.

Claiming

Sciberras said since the changes in 2011, the system has got far easier for manufacturers to claim a tax incentive for their R&D operations.

“So for companies who think they are going to be eligible for R&D, which they usually will for a reasonable period of time, it is important to set themselves up correctly right at the earliest stages of the project. That will serve them well.”

Before starting on the project, Sciberras said companies should document what the current state of the art is in that particular area.

“This is always useful with a R&D claim, because companies have to prove what they don’t know before undertaking the R&D. That is a requirement.”

He said companies should also have documents around the level of any experiments that they will do, then setting up a fairly formal process outlining what those steps they are going to undertake to overcome those unknowns, in an experimental sense.

“What is the hypothesis of overcoming the company’s knowledge gap, and what experiments or tests does it need to run to get its new product or process effectively validated?

“The documentation needs to have the depth in order to meet all legal requirements. This lack of appropriate documentation is one of the most common mistakes manufacturers make.”

He said it’s not the lack of general documentation, but the lack of appropriate documentation.

At the same time, Sciberras scoffs at the idea of manufacturers not claiming for what they can.

“It’s normally the other way around with manufacturers claiming for things they can’t. They normally do their homework well, and don’t leave any stones unturned.

“Where they do fall down occasionally is not engaging with their advisor around those models to begin with,” Sciberras said.

Using advisors

Sciberras believes the relationship between manufacturers and their tax advisors has changed in recent times.

“More and more companies are looking at tax advisors for advice on their systems.

“The traditional relationship between a company and its tax advisor regarding R&D tax has been one of a claim preparation to comply.

“Now we are seeing a shift from that to a more of an advisory relationship which extends to setting up the systems and testing the integrity of the systems that manufacturers might have rather than simply having a compliance/tax return type of approach.

“I think this shift is quite significant, because the refundable R&D tax incentive is experiencing significant growth.

Sciberras pointed out that it is the number one flagship program for the federal government and expects it to remain that way.

“Offering a 43.5 per cent refundable offset is very generous by global standards and is a very effective method to get manufacturers to invest, as the 43.5 per cent comes as a cash flow benefit.

“At a benefit level it is OK, but at a cash flow perspective, it is probably one of the better ones in the world,” Sciberras said.

Top tips

Sciberras has three top tips for R&D activities being conducted in a manufacturing environment:

  1. Companies conducting R&D activities should ensure that their documentation to substantiate their R&D activities contemporaneously is in order prior to making an R&D claim
  2. When conducting R&D activities in a manufacturing environment be clear around what activities are being conducted for the purpose of research and development versus another purpose and whether the trial size (as an example a manufacturer may consider the use of appropriate trial authorisation requests for the R&D team to control the production floor for discrete periods of time).
  3. When conducting R&D in an environment where the R&D activities produce a marketable product or products applied to the companies own use, companies should be aware that feedstock adjustments to assessable income may need to be considered.

Possible changes

Late in September, industry minister Greg Hunt released the R&D Tax Incentive Review report and called for business, industry and research community to have their say.

The review, which was completed in April, was performed to “identify opportunities to improve the effectiveness and integrity of the R&D Tax Incentive, including by sharpening its focus on encouraging additional R&D spending”.

The recommendations are:

  1. Retain the current definition of eligible activities and expenses under the law, but develop new guidance, including plain English summaries, case studies and public rulings, to give greater clarity to the scope of eligible activities and expenses.
  2. Introduce a collaboration premium of up to 20% for the non-refundable tax offset to provide additional support for the collaborative element of R&D expenditures undertaken with publicly funded research organisations. The premium would also apply to the cost of employing new STEM PhD or equivalent graduates in their first three years of employment. If an R&D intensity threshold is introduced (see #4), companies falling below the threshold should still be able to access both elements of the collaboration premium.
  3. Introduce a cap in the order of $2m on the annual cash refund payable under the R&D Tax Incentive, with remaining offsets to be treated as a non-refundable tax offset carried forward for use against future taxable income.
  4. Introduce an intensity threshold in the order of 1-to-2% for recipients of the non-refundable component of the R&D Tax Incentive, such that only R&D expenditure in excess of the threshold attracts a benefit.
  5. If an R&D intensity threshold is introduced, increase the expenditure threshold to $200m so that large R&D-intensive companies retain an incentive to increase R&D in Australia.
  6. That the government investigate options for improving the administration of the R&D Tax Incentive (e.g. adopting a single application process; developing a single programme database; reviewing the two-agency delivery model; and streamlining compliance review and findings processes) and additional resourcing that may be required to implement such enhancements. To improve transparency, the Government should also publish the names of companies claiming the R&D Tax Incentive and the amounts of R&D expenditure claimed.

The government is seeking comment until October 28. Click here to contribute.

Deloitte

03 9671 7000 

www2.deloitte.com/au