The Australian Taxation Office (ATO) this week released an addendum to the recently issued Taxpayer Alert TA 2017/5, which was jointly developed with the Department of Industry, Innovation and Science.
While the initial Taxpayer Alert about claiming software R&D under the R&D Tax Incentive gained negative public headlines and commentary regarding its implications on Australia’s software innovators, the addendum – has gone relatively unnoticed by the media. The addendum was released four days after the initial Taxpayer Alert, to ‘further clarify when routine testing steps in software development projects should not be claimed and when they may be eligible R&D activities’.
Whilst this change in interpretation should specifically appease those in the software industry, the addendum highlights that the application of the legislative definition of eligible R&D activity and expenditure should be taken on a case by case basis, and not as a ‘one size fits all’ approach.
Underlying issues to be addressed
The software Taxpayer Alert is one of a number of Alerts that focus on concerns the ATO and AusIndustry have identified regarding some activities and expenditure that have been claimed under the R&D Tax Incentive, which they believe do not meet the eligibility criteria as set out in the tax legislation.
The Alerts warn taxpayers against claiming what the ATO and AusIndustry deem to be ‘ordinary business’ activities or taking a ‘whole of project’ approach. Three of the Alerts give industry specific examples of activities that the ATO and AusIndustry would not generally believe to form part of an experimental ‘core’ activity. For example, the software Taxpayer Alert originally stated that activities such as bug testing, beta testing, and user acceptance testing would not be an eligible core activity. The addendum now clarifies that these activities can only be claimed as core R&D activities when they are being done as experiments that are resolving hypotheses about a specific technical issue.
The Taxpayer Alerts have also raised the issue of governance and reliance on advisers to assist with the compilation of an R&D Tax Incentive claim, particularly reliance on advisers that profit from ‘high risk practices’.
What does all this mean?
It’s easy to get lost in all the materials issued recently, but the underlying messages are that claimants should be comfortable that the activities and expenditure they are seeking to claim:
- Create new knowledge - in the form of new products, processes or services. This new knowledge could not be known in advance without undertaking experimentation
- Can be substantiated - supporting documentation to substantiate their intention to generate new knowledge, and the process undertaken to generate that new knowledge should be retained
It is important to remember the intent of the Incentive. The R&D Tax Incentive was designed to encourage more companies to engage in R&D, boost competitiveness and improve productivity across the Australian economy. Therefore, companies should not be overly concerned if they have not classified some of their activities directly in line with the Alerts or undertaken some experimental testing in an ‘ordinary business’ environment. Provided claimants can substantiate the activity was undertaken for the purpose of generating new knowledge through an experimental approach and the activities are not one of the excluded R&D activities, they should have eligible R&D activities that would comply with the R&D tax legislation.
What should claimants do?
Whilst there may be some inconsistencies between how the ATO and AusIndustry perceive the scope of an eligible R&D activity in comparison to industry, the release of these Taxpayer Alerts, combined with the few court case judgements under the R&D Tax Incentive, highlight that both regulators are aware that some claims are inconsistent with the eligibility criteria and cannot substantiate their eligibility.
The best advice is for claimants to understand and be comfortable that the eligibility of their R&D activities and expenditure included in their claim can be substantiated. They must also be aware of advisers that push the boundaries or who are not registered tax agents as the advice they provide could expose a claimant to unnecessary risk.
If you have any questions about how these Taxpayer Alerts or the recent addendum could apply to your R&D activity or existing claims under the R&D Tax Incentive, please connect with me.