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It's only R&D if you keep detailed records

dETAILED RECORD-KEEPING

As foreshadowed by the Tax Payer Alerts issued early last year (see blog post), the last 12 months has seen an intensive focus by both of the regulators (AusIndustry and the ATO) on R&D Incentive claims.

THE KEY FOCUS IS ON:

  • 'whole of project' claims which may include activities that are not eligible,

  • substantiation at a very granular level (i.e. activity breakdown supported by directly referenceable timesheets or task management systems), and

  • the merit of the R&D activities (level of 'complexity' and 'novelty' requiring experimentation).

An 'activity' needs to be linked to experimentation (development, test iterations) to address a unique technical problem that cannot be proven by reference to existing information.

The scope of the R&D activity is linked to the research and enablement of the experiment/s and the development/test iterations to the point the technical problem is resolved.

A very high percentage of R&D expenses to total company operations implies an aggressive 'whole of project' rather than R&D activity based claim. This may trigger a review with a high burden of proof.

The quality of the information in the AusIndustry Registration Form (rationale as to the new scientific knowledge sought by each core R&D activity, number of experiments, specific details of results and observations) is initially desk reviewed and if flags are present, this may also trigger a review.

In our experience

THE ATO IS INCREASINGLY DETAILED:

  • is very focused on substantiation of:

    • staff/contractor time and other costs

    • details of experiments focused on results, observations, evaluations and conclusions

  • starts by requesting detailed information of the experiments and results, company financials, funding sources, R&D costs, link to the R&D activities, and evidence to substantiate this

    • for example, if a developer is 100% involved in R&D activities, the expectation is that his activity could be cross referenced to a daily/hourly level. In a similar fashion involvement by a CEO is a key risk area for most claimants.

Once information is submitted, the request is either cleared with no further action, or a meeting ensues to bridge gaps in information before proceeding to a detailed audit (which may span years).

The meeting is very detailed and involves lines of questioning as to the company background, nature and location of the R&D activities, and gaps in evidence to support the claim.

EXPECT TO BE ABLE TO EVIDENCE TIME ON R&D TO AN HOURLY LEVEL

AUSINDUSTRY:

  • is increasingly applying a superficial review to information in the AusIndustry Registration Form

  • ignoring sound rationale and terminology in software development/computer science,

SEEKING A VERY ACADEMIC/SCIENTIFIC FORMAT BASED ON A DISCRETE FALSIFIABLE HYPOTHESIS, RESULTS, OBSERVATIONS, AND CONCLUSIONS

  • in a similar fashion to the ATO, starts by requesting a detailed written response to substantiate the R&D activities and evidence to support this

  • if concerns/questions remain, a site visit to meet key technical staff and better understand the nature of the R&D activities

  • may engage a industry specialist to provide an opinion in the late stages of a review/audit

With the R&D Incentive refunding 43.5% of expenses, and reviews/adjustments being retrospective, a company could face a considerable liability from any dismissed claims or adjustments. For example, not understanding the complex definition of 'aggregated turnover' being under $20m may result in a company that has received $600k in refunds over 2 years needing to pay this back plus interest and potential penalties.

Another key issue (especially for software companies) is that assessors often do not have a technical background and may struggle to understand the nature of the R&D activities in any information provided.

MANY COMPANIES CONTINUE TO IGNORE THE BURDEN OF PROOF REQUIRED, AND DO NOT UNDERSTAND WHAT DOES AND DOES NOT QUALIFY.

In our next blog post we will discuss a pragmatic approach to documenting details of R&D activities and associated effort.

Tim Florea