An update on the R&D Tax Incentive situation in Australia
The R&D tax incentive is a government initiative aimed at stimulating industry innovation and driving technological advancements. Through a self-assessment programme, the government supports entities by offsetting some of the associated costs of R&D activities.
While fintechs are well-positioned to take advantage of the scheme, recent high profile cases have highlighted both contradictions in the compliance environment as well as areas where tax law is being applied incorrectly. This has placed uncertainty on tech companies' (particularly software companies) eligibility to access the incentive.
While one of the main issues in the ATO’s audits of R&D activities has been the lack of contemporaneous documentation, the other issue has arisen from what constitutes core activities.
However, a recent ruling has given some clarity for tech companies on the latter.
The Moreton Case ruling and why it’s a win for fintechs
Following the ATO’s crackdown on claims on the R&D tax in Moreten Resources Limited was required to pay back millions in R&D tax benefits claimed for a pilot project that attempted to build an underground coal gasification facility in Queensland. While the government ruled in 2015 that this activity wasn’t eligible to claim the tax benefits, the Federal Court rejected this interpretation of the eligibility requirements ruling in Moreton’s favour that its activities were indeed eligible for claiming the tax incentive – stating that AusIndustry’s interpretation of the scheme’s eligibility requirements were too narrow.
This ruling is significant as it raises questions as to how these requirements should be best interpreted for all sectors, including the technology sector, and the need for clearer and more industry inclusive guidelines to best support innovation growth in Australia.
This landmark case may turn the tide when it comes to how the definitions for research and development activities should be interpreted in the context of technology and software companies.
While it’s yet to be seen how this ruling will affect tech companies, there are other areas where software companies have come unstuck. To avoid a costly audit, here are some of the key areas claimants should be aware of when it comes to assessing their R&D eligibility against the complex tax law.
Fintechs and eligible R&D activities - how do I know if my activities are eligible?
R&D depends on the nature of the software development and new functionality created.
The tax meaning of core activities is ‘experimental activities’ where:
- The outcome cannot be known or determined in advance. This means that there is a degree of technical uncertainty or risk in conducting the activity as the result is unknown and can only be determined a process that:
- Is based on principles of established science; and
- Proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions.
- The activity is conducted with the purpose of generating new knowledge. This includes new knowledge in the form of new or improved devices, products, materials, processes or services.
Supporting activities are activities directly related to ‘core’ R&D activities. If the supporting activity produces goods or services, is directly related to producing goods or services, or is an excluded activity, it must be done for the dominant purpose of supporting a core R&D activity.
Some examples of activities undertaken by tech companies include, the development of new operating systems or languages, the design of new search engines based on original technologies, the creation of new or more efficient algorithms, encryption and security techniques. For more information on these guidelines for software activities read our breakdown here.
In the context of fintechs, it is important to note that not all software development is considered eligible to receive the tax benefits.
Claimants should be asking themselves - was there technical uncertainty involved and/or was there any uncertainty resolved?
Consider a fintech that was in the process of developing a new payment system which included activities like:
- The development of app for trading international derivatives which offers very low latency trade executions
- Building the bespoke front and back end systems including algorithms to execute orders placed by investors
- Testing to ascertain latency and effectiveness of algorithms.
As these activities involve the development of new software with functionality and performance that requires an experiment, they would likely be eligible to claim the tax benefits.
Activities that software companies should avoid claiming which aren’t in the scope of the incentive include: claiming for whole projects, where only parts were core activity; Beta testing or system testing in the absence of a hypothesis and, customising existing platforms.
Lastly, a key factor for R&D is contemporaneous documentation – maintaining adequate records can’t be overstated. Not only does it document that the activities occurred, it’s also critical to the process - providing contact to the data and supporting the key issue of purpose.
If you’re considering using the tax incentive to support your R&D activities it is best to speak to an adviser who understands both the legislation, its application to fintechs and its interpretation in the technology sector.