Software activities and the R&D Tax Incentive

12 March 2019

After much fanfare, AusIndustry has recently released guidance on R&D Tax Incentive claims for software developers.

Disappointingly, the long-awaited guidance lacks any new information which will help software developers self-assess R&D eligibility. The guidance is largely a rehash of previously published material and, unfortunately, does little to de-mystify the conjecture within the software community.

The guidance introduces — or more accurately, re-introduces — the Frascati Manual as a practical reference to assess software R&D eligibility. The Frascati Manual is published by the OECD as guidelines for collecting data on R&D. We have two points of concern with its introduction. Firstly, the Manual, while broadly helpful, was designed to standardise survey practices to collect R&D statistics. As such, it is a document written for statisticians to influence policy makers and its generic nature can overlook the nuances within activity-specific R&D. Secondly, by placing an over-reliance on the Manual’s definition of R&D (i.e. scientific and/or technological advance), and not the legislated definition with which eligibility is ultimately determined, only further disconnects the assessing body from the legislative process.

A contentious issue within the guidance, and what is likely to upset many software developers, is the blanket R&D exclusion of all business applications and information systems developed using known methods and computer architecture. This R&D exclusion is an extract from the Frascati Manual – 2015 Edition, [2.72]. The guidance, however, misleadingly references the exclusion without referencing its qualifying paragraph, below referenced.

2.72 Software-related activities of a routine nature are not to be considered R&D. Such activities include work on system-specific or program specific advances that were publicly available prior to the commencement of the work. Technical problems that have been overcome in previous projects on the same operating systems and computer architecture are also excluded. Routine computer and software maintenance are not included in R&D.

Examples of other software-related activities to be excluded from R&D are:

  • the development of business application software and information systems using known methods and existing software tools
  • [..]

When the exclusion is read in conjunction with its preceding qualifying paragraph, it clearly qualifies and limits the software-related R&D exclusion to known or routine software development, i.e. not the all-encompassing software R&D exclusion as implied within the guidance.

Furthermore, the inclusion of the 2015 version of the R&D software exclusion, 4 years after the R&D Tax Incentive bill came into effect, is also a contentious issue (as legislators could only have had access to the 2002 Manual at the time of drafting the bill). Yet, the sheer pace at which software technology advances, arguably, does excuse the Manual’s reference of the more recent 2015 version.

Regardless of the Manual’s inclusion, the Frascati Manual is not determinative of R&D eligibility within the Australian R&D Tax Incentive program. R&D eligibility will always be assessed against the definitions as defined in Subdivision 355-B of the Income Tax Assessment Act 1997 (ITAA 1997). The introduction of the Frascati Manual’s definition of R&D within the software guidance will only exacerbate the industry’s confusion, and, at a time when then industry is pleading for more assistance and clarification.

With that said, the guidance does prove useful in identifying the type of substantiation documents required to support software-based R&D applications. Acknowledging software developers aren’t the most formal of record keepers, the guidance encourages software claimants to make use of less formal records, such as: screenshots, instant messaging histories, task tracking, open source code searches (e.g. GitHub), tech blogs and forums. While this is a less onerous approach to substantiation, it should be cautioned that the documents required to support an R&D claim still need advanced planning and identification prior to the commencement of any R&D activity.

In summary, the published guidance material does clarify AusIndustry’s narrower position on software development. While we welcome the guidance, we continue to maintain that the R&D Tax Incentive program is ultimately governed by legislation.