The report from the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) has confirmed what many in the industry have known for some time - the current administrative approach by AusIndustry and the ATO to the R&D Tax Incentive program is inconsistent with the objective of the program.
The findings align with BDO’s experience regarding the concerns of many small companies and particularly start-up business claimants. The report recognises the administrative deficiencies of the program have made it overly complex, with companies being misled as to the proper means of assessing R&D activity and expenditure eligibility, sometimes resulting in retrospective assessments dating back over several years.
The Ombudsman has highlighted the need for administrative clarity as to the legislative interpretation, particularly in the proper assessment of software development claims, along with the need for better education of AusIndustry and the ATO and the adoption of a more practical approach to their administrative role.
The release of this report comes at a crucial time for Australia’s innovation community. Australia's Business Expenditure on Research & Development (BERD), an important indicator of business commitment to generating value and new ideas, is decreasing annually. Despite some reports that BERD has fallen below 1% of GDP, on the last day of Parliament the Australian Federal Government tabled almost the same Bill that in February the Senate Economics Legislation Committee (SELC) had recommended should not proceed.
While the measures in this slightly revised bill will, in our opinion, stifle innovation and Business R&D in Australia, other jurisdictions are increasing the support of business R&D. For example, New Zealand has introduced a 15% R&D incentive program that as well as providing a greater tax incentive than Australia, does not impact on the franking account. The fact that the refundable offset impacts on future franking credits is something seemingly overlooked when treasury tries to calculate the true cost of the R&D Tax Incentive program.
In preparing the report, the Ombudsman listened to many key stakeholders of the R&D Tax Incentive program, including claimant companies, representatives from AusIndustry and the ATO, the Tax Practitioner’s Board (TPB), R&D Consultants (small, medium and large) and industry associations and academics in the field of innovation. It also analysed the R&D TI legislation, related policies, existing guidance material provided by AusIndustry and the ATO, as well as press articles.
One of the key findings in the report that aligns with our experience was the Ombudsman identified an overall ‘shift’ in how the R&DTI legislation had been interpreted over the last three to four years. This narrowing of focus has led to increased rejection of claims, which in previous years has been regarded as low risk, and has led to a backlog of claims undergoing the internal review and objection process or awaiting appeal in the Administrative Appeals Tribunal (AAT).
It was comforting that the report acknowledged that the Federal Courts decision in Moreton resources has a significant bearing on the statutory interpretation of the legislation underpinning the R&DTI and the use of other materials. Furthermore, it recommended the guidance material should be updated to reflect the Federal Court’s decision as to the legislative definitions of eligible R&D activity.
Another key finding was that AusIndustry’s software guidance should be reissued, either fully embracing the Frascati Manual (recognising that it is a conceptual guide and not a prescriptive list of eligible and ineligible activities) or abandoning all reference to it. This will help to align the program with a modern interpretation of R&D as it applies to software development, rather than choosing selective wording from the Frascati Manual to exclude certain activities.
Since approximately one-third of companies registered for the R&DTI are undertaking software development, and the recognition of the importance of this industry in numerous government reports such as ‘Australia 2030: Prosperity through Innovation, Innovation and Science Australia’, it is important for the government to support innovative software development in Australia.
Importantly the Small Business Ombudsman’s report recognises that the R&D Tax Incentive is an industry program, designed to incentivise companies to undertake potentially risky activities. To achieve this purpose of incentivisation, the Ombudsman recommends that the ATO and AusIndustry deliver a more transparent, customer-focused service including issuing joint guidance. Furthermore, their recommended changes in the approach to compliance will help companies gain surety in their R&D processes and give them greater opportunity to evidence their claim than current practices.
A proactive, professional, collaborative and proportionate approach to compliance activities will aid the faster and fairer resolution of compliance reviews. Conducting compliance examinations as closely as possible to the first year of registration of a project will help provide comfort that companies will not have several registrations revoked, with an exorbitant amount to be repaid accordingly. Adjusting expectations for documentation based on the size and complexity of the business and claim will ensure that the program is accessible, without excessive compliance costs, for small businesses and start-ups. It stated the ATO’s forthcoming guidance on record-keeping must take a nuanced approach in understanding that the resources available to large companies for maintaining contemporaneous documentation are vastly different from those available to small businesses and start-ups.
Although the report is primarily focused on the impact of the current approach by the regulators to small business, the recommended changes to the administration of the program will help to alleviate industry concerns about a crackdown on claimants, particularly in software development, and provide a fairer compliance environment more focused on consistency and education. In our opinion, many of these reforms should be implemented as soon as possible to provide companies with comfort in their investment decisions, and certainty on the administration of the program.