R&D Tax Incentive: Do I qualify? What can I claim? How does it work?

The R&D tax incentive (RDTI) is a major source of funding for startups and SMEs. It’s an Australian government program, used by more than 10,000 companies each year. All up, it provides more than $1 billion of support for research and development activities annually.

The RDTI is reasonably simple in theory but not so much in practice. You might have seen it in the media over the last few years too, as proposed government changes have proven unpopular with many. Here, we’ll explain how the RDTI works and what you need to know if you’re considering claiming it.

How does the R&D tax incentive work?

Essentially, the RDTI can provide up to 43.5% of your annual R&D costs back through the tax process. 

Let’s start with the admin side. The program is run by the Australian Taxation Office (ATO) and AusIndustry. It’s based on self-assessment, which means you need to decide if you’re eligible before applying. For many this means seeking advice from an RDTI service, especially with recent uncertainty around eligibility and some headlines about companies having to pay R&D refunds back.

Applying for the RDTI involves two steps:

1. Describing your R&D project/s and activities in an application lodged with AusIndustry within 10 months of the end of your financial year. It will typically be approved within a few weeks but might be scrutinised by reviewers then or later. Once approved, you’ll receive a registration number from AusIndustry via email (this doesn’t mean your claim is guaranteed – it just means you can submit it).

2. Summarising your eligible expenses in an R&D tax incentive schedule. Include your registration number and lodge the schedule with your annual company tax return.

How much can you claim?

For the 2019-20 and 2020-21 income years:

• Startups and SMEs (companies with aggregated annual turnover below $20 million) can apply for 43.5% of eligible R&D costs; and
• Larger companies (annual turnover above $20 million) can apply for 38.5% of eligible costs.

Generally, you must claim at least $20,000 of eligible annual expenses, and there is currently a $100 million cap on claims.

The ATO has a calculator for estimating your benefit and producing your R&D tax schedule.

How do you get the money?

This can depend on your tax position. For example, if your annual turnover is under $20 million, in 2020-21:

• If you have enough tax losses, you can receive a 43.5% cash refund from the ATO typically four to eight weeks after lodging your tax return (with R&D schedule); or
• If you’re in a tax payable position, your R&D claim will reduce the tax you would otherwise be paying by 16% (43.5% minus the company tax rate of 27.5%)

Both the ATO and AusIndustry have  examples on their websites.

Is your business eligible?

You should consider applying for the RDTI if you:

• Are a company developing (or planning to develop) a unique, non-trivial software, hardware, engineered or manufactured product, process or service;
• Can describe these developments as a series of experiments with unknown outcomes from which you have learned along the way; and
• Have spent at least $20,000 on eligible R&D expenses in the last financial year, or have:
  • made a monetary contribution to a CRC under the Cooperative Research Centres (CRC) Program; or
  • engaged a registered Research Service Provider (RSP) to do R&D on your behalf.

Are your R&D costs eligible?

You know the saying, the devil is in the detail? Well, eligible costs and recordkeeping is where the RDTI gets a bit hellish. 

In summary:

• R&D costs need to be tied to either ‘core R&D activities’ or ‘supporting R&D activities’;
• You need to be conducting or planning at least one ‘core R&D activity’, which means:
  • The outcome can’t have been known or determined in advance;
  • It is carried out in a scientific way, with the aim of generating new knowledge; and
  • It is experimental and based on the principles of established science (moving from hypothesis to experiment, observation and evaluation, and leading to logical conclusions).

It’s important the problem you’re trying to solve through R&D is technical, not commercial in nature. Usually, R&D is required for testing if something is even possible, rather than simply testing if your customers would use it.

AusIndustry has more on eligibility here and so does the ATO here.

A quick guide to eligible expenses

Yes

• Salaries of staff involved in R&D
• Contractors involved in R&D and working inside Australia
• Costs of equipment and operations related to R&D
• Other direct costs such as R&D related travel
• Some indirect costs such as rent and utilities
• Depreciation of assets used for R&D
• Feedstock expenditure incurred on R&D activities (though there are some issues around this, as the ATO explains)

No

• Salaries of staff not involved in R&D
• Contractors not involved in R&D or working outside Australia
• Costs of equipment and operations not related to R&D
• Company establishment and related fees
• Interest, legal and accounting costs
• Entertainment, marketing or advertising costs

What records should you keep?

Even if your R&D is eligible, you still need to keep the following records that can prove it:

• How was it determined that you were generating new knowledge?
• Who was involved and to what extent?
• How did you differentiate between eligible activity costs and broader project expenditures?
• Did you document your hypothesis and the experimental methods carried out?
• Are these records retrievable and understandable (by someone without technical knowledge of your industry and technology)?
• Were they created at the time the activities were carried out?

Record keeping is also essential to help you avoid future pain from an AusIndustry review or an ATO audit.

The number one rule about recordkeeping is actually more about planning: take time upfront to really consider if your project is eligible at a detailed activity level. Rather than assuming you can claim an entire project, you’ll need to consider only activities that have an unknown outcome that you’re trying to test.

Golden rules of recordkeeping

• Keep detailed time-based records as you are doing the R&D work, not retrospectively;
• AusIndustry talks about contemporaneous records for R&D activities, which means ‘in real time’. It’s a good idea to set a reminder to check in with your recordkeeping efforts a few times a year to make sure you’re on top of it;
• You need to show how you identified and tracked eligible R&D activities (as well as the basis on which those records have been used to determine the associated R&D spend);
• You’ll need to do this for your employees’ time, and work with any contractors to do it for theirs too. Broad percentages of project costs are not likely to be acceptable. Make sure you have any underlying payroll details or copies of external contractor services you’ve used for R&D; and
• Including ineligible activities has led to whole claims being rejected, even if there were eligible elements in the projects

Remember, once you receive your registration number from AusIndustry, it doesn’t mean your claim is approved or guaranteed. It simply means you can submit it.

Read more about RDTI record keeping on the AusIndustry and ATO websites.

Common RDTI records

• Staff time sheets (even if you don’t keep them normally, they’re worth it for RDTI claims)
• Notes from team meetings relating to the R&D project
• Business plans, information memorandums, investor pitch decks
• Collections of materials from background research and scoping
• Technical documents, including testing results
• Notes and updated records tracking the progress of your R&D project

What about overseas-based companies or activities?

Overseas companies (incorporated in another country) can claim the RDTI if their resident country has a double tax agreement with Australia and they are carrying out business here through a ‘permanent establishment’. This is definitely one for the RDTI savvy accountants.

If you’ve carried out R&D activities overseas, it’s possible to claim up to half the total cost. You need to have a positive Advance/Overseas Finding, which is basically a full registration that gets reviewed immediately. You need to apply for this before the end of the financial year in which the activities began.

What about partnerships and joint ventures?

Only companies can apply for the RDTI. However, if your company is in a joint venture or partnership, each company within that joint venture or partnership can apply on their own, for their portion of the R&D expenditure.

What about R&D contracted in or out?

The law is set up to prevent companies from claiming R&D expenditure incurred on behalf of other entities, and to prevent claim duplication.

This can be a bit tricky sometimes. You can determine the extent that your company carried out the R&D activities by considering who:

• ‘effectively owns’ the know-how, intellectual property or other similar results arising from your company’s expenditure on the R&D activities;
• has appropriate control over the way the R&D activities are conducted; and
• bears the financial burden of carrying out the R&D activities.

Sometimes, shareholders contract R&D services into their own company. You might be able to claim such ‘expenditure to associates’ in some circumstances, as the ATO explains here.

So, is that it?

It’s also worth knowing that there’s been a lot of FUD (fear, uncertainty and doubt) about the RDTI over the last few years. In particular, the government considered reducing the broad-based nature of the program. 

In good news from the 2020-21 federal budget, that didn’t happen, although there were some subsequent RDTI reforms that will affect the tax offset available to companies. 

Overall, this was mainly also good news, but there are continued calls from the startup sector and others to redesign the RDTI to make it simpler to access. Watch this space.

Where can you learn more?

To learn more about eligible registrations, including the definitions of ‘experiment’, ‘hypothesis’ and ‘new knowledge’, download the guides and resources and other key documents from the AusIndustry website. The site also has sector guides that illustrate eligible core and supporting R&D activities through hypothetical customer stories, and more.

To learn more about eligible claims, including the required steps to claiming, go to the ATO website.