R&D Tax Incentive - How it Works

The essential guide about the government’s major incentive for fuelling innovation.
Reading time 10 mins

Your guide to the R&D Tax Incentive.

This government has been supporting Australian tech talent since the mid 1980s.

    The Research and Development (R&D) Tax Incentive encourages companies to engage in R&D benefiting Australia, by providing a tax offset for eligible R&D activities. It has two core components:

  • a refundable tax offset for certain eligible entities whose aggregated turnover is less than $20 million; or
  • a non-refundable tax offset for all other eligible entities.

Over 13,000 businesses nationally employ the benefit
with the lion’s share going to manufacturing (32%), scientific/technical (20%) and IT (17%).

Lowering the cost of R&D for innovative businesses.

Who uses the R&D Tax Incentive?

The R&D Tax Incentive has been helping fuel Australian innovation for decades.

The R&D Tax Incentive is an Australian Government initiative aimed at lowering the cost of pursing technological innovation for Australian businesses.

It was created with local businesses and new technology in mind for all sectors, spurring more companies to engage in more Australian based R&D and create economies for the future.

The R&D Tax Incentive encourages businesses from overseas to consider using Australia as a hub for developing their R&D.

Over 13,000 businesses nationally employ the benefit
with the lion’s share going to manufacturing (32%), scientific/technical (20%) and IT (17%).

It also delivers real cash savings with around $3 billion in benefits being facilitated in the 2017 financial year.

    The major aims of the incentive as stated by government include:

  • Boosting competitiveness and improving productivity across the Australian economy;
  • Encouraging industry to engage in new R&D activity;
  • Providing a predictable means of obtaining government support for their innovative venture; &
  • Providing an outlet for smaller and early stage ventures to recoup some of the costs in respect of their development activities.

Who delivers the R&D Tax Incentive?

    The initiative is jointly administered by:

  • AusIndustry (on behalf of Innovation & Science Australia); &
  • the Australian Tax Office (ATO).

AusIndustry oversees the registration of your R&D activities and helps ensure that they comply with the law.

The ATO delivers the cash benefit via details lodged in your entity’s tax return and may check if the R&D expenditure you are claiming in your company tax return is eligible.

What are the main benefits of the R&D Tax Incentive?

The primary benefit for organisations is a 43.5% tax offset where an entity has an aggregate turnover of less than $20 million per annum, (unless controlled by tax exempt entities).

These tax offsets reduce your company’s tax liability dollar for dollar.

The tax offset can also be refundable, so if it exceeds your tax liability you will receive a cash refund of the balance from the ATO.

Better access to the ESIC concessions

    • ESIC is a generous tax incentive to support investors of early stage innovation companies.

Of the many requirements is a 100 point test where R&D expenditure via R&D Tax Incentive help qualify a company for between 50 to 75 points of the test.

So asides from government support, an innovation company is more likely to get investor support as well.

What is the R&D Tax Incentive calculated on?

    A company is basically entitled to the offset calculated on the total of the below:

  • Eligible expenditure incurred on R&D activities
  • Depreciation on assets used in R&D activities (i.e. in-house software, physical assets).
  • Balancing adjustments on the above.

Impact on tax deductions
Where an amount is used towards the calculation of the offset the company cannot apply the expenditure as a deduction when calculating its taxable income.

Note: FY2019 changes for the R&D Tax Incentive

Also see this article for updates regarding details in FY2019 which primarily impact claims on the higher end of the scale.

R&D Tax Incentive Examples

Example 1 – Pre-Revenue Venture undertaking R&D

A hardware startup spends $100,000 in engaging various contractors to help build the prototype and several iterations (with 85% relating to R&D activities) & another $5,000 in setup and admin costs in the 2017 financial year.

What is the cash benefit of the R&D Tax Incentive on their spend in FY2017?

HARDWARETECH CO Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (27.5% tax rate)

TAX CALCULATION $0 (i.e $5+15% of 100k)
$85,000
$20,000(i.e $5+15% of 100k)
$0
$0

R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax offset(43.5%)

$85,000
$36,975

When the venture is making revenue, we receive a reduced cash refund because of tax liability on the income.
This often occurs where a company combines existing profit-making activities with R&D on new innovative technology.

Example 2 – Post Revenue Venture undertaking R&D
A software development agency turning over $750,000 in consulting fees (in the 2017 financial year) also spends $200,000 in developer’s wages (including on-costs) to develop new blockchain technology to potentially on-sell to businesses in the future. Their other expenses are $250,000 in overheads of which only $15,000 is associated to additional R&D expenses.How much is the benefit of their R&D Tax Incentive per the spend on R&D in FY2017?

DEV AGENCY CO  Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (27.5% tax rate)

TAX CALCULATION $750,000
$265,000
$235,000
$515,000(i.e $5+15% of 100k)
$141,625
R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax offset(43.5%)
$215,000
$39,525
Net Cash benefit
$48,100

For larger entities or groups we often have to consider the impact of aggregated group turnover into the equation.
If the aggregated turnover is over $20 million then the tax offset is non-refundable and can only serve to reduce a tax liability.

Example 3 – Large Group with >$20M turnover undertaking R&D
A listed bio-tech group with over 5 entities is wishing to claim over $1,400,000 spent in research. The group’s FY2017 turnover is $23M, and had $20M in non-R&D expenditure.

How much is the benefit of their R&D Tax Incentive per the spend on R&D in FY2017?

BIO TECH CO   
Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (30% tax rate)

TAX CALCULATION $23,000,000
$1,400,000
$20,000,000
$3,000,000(i.e $23M – $20M)
$900,000
R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax offset(38.5%)
$1,400,000
$539,000
Net Cash benefit
$361,000

Eligibility for the R&D Tax Incentive

There are a number of main criteria here which we will cover in detail.

Technological Innovation

A company must have undertaken eligible R&D activities during the income year.

Broadly, an eligible core R&D activity meets all of the following criteria around technological innovation:

Experimental – Is there experimentation required on a technological-based level?

It is important to note that the R&D will need to relate to technology based innovations not service based ones.

Experimentation around commercial factors are also not counted – i.e. market testing an existing product with a different B2B customer or different industry.

Unknown Outcomes – Was the outcome of the experiment(s) unknown, and unable to be determined in advance?

If we are developing algorithms or hardware, the outcome and the pathway to success should not really be known by a competent professional without experimentation.

Original – Was product/program created to create new technical knowledge or a new or improved product?

The requirement here is ‘state of the art’ – that is the technology unique? If already executed overseas, then further review is required.

Scientific Method – Can you identify the identical theories or concepts you are trying to prove & the experiments needed to test them?

This is to help demonstrate to others true innovation at the technological level which really require experimentation to unlock new learnings.

Other Main Requirements

Australian R&D Expenditure
Generally, only the Australian expenses incurred in producing R&D activity will be eligible.

Overseas expenditure could only potentially be eligible providing the facility, expertise or equipment was not already available in Australia. The process for claiming overseas R&D expenditure on this basis involves filing an additional Overseas Finding in advance of the main R&D Tax Incentive application.

Minimum $20,000 R&D Expenditure
Potential claimants must spend more than the minimum threshold of $20,000 which must be incurred in the space of a financial year.

Corporate Structure
Generally only companies are eligible for the benefit along with body corporates in the capacity of a trustee for a public trading trust.

Need to control the use and benefit of the IP
The R&D activities need to be carried out to build your own IP, rather than say a corporate investor who owns and controls the IP of the venture.

    Factors to consider here are whom:

  1. has effective ownership of results from the R&D activities
  2. has an appropriate degree of control over the R&D activities
  3. bears the financial burden or risk of conducting the R&D activities

What R&D expenses can be claimed?

The amount a company can claim under the R&D Tax Incentive is calculated on eligible R&D expenditure.

Australian Staff/Contractors

  • Salary expenditure (for R&D activities) and associated ‘on-costs’ for those employees such as super, worker’s compensation, etc.
  • Expenditure incurred under contract to other parties.

Associated Overheads & Materials

  • Overheads involved in the R&D project – this could include rent, warehouse or office supplies, subscriptions, telephone & internet, etc.
  • Expenditure on materials for developing a prototype.

Research Service Provider

  • Contract expenditure incurred using a Research Service Provider (such as a university).

Payments to Associates

Where co-founders also contribute their expertise to an eligible R&D project – be sure to pay them wages or consultant fees (involving actual cash payments and maintenance of timesheets for the efforts) before 30 June.

Associated companies undertaking the R&D expenditure via way of contracted services should ensure the amount is paid via cash before 30 June.

Who is an associate for the R&D purposes?

An associate in broad terms is generally a shareholder or any entities associated with that shareholder through family or business ties.

Broadly, an eligible core R&D activity meets all of the following criteria around technological innovation:

    Some examples of an associate include:

  • a partner of the company or a partnership in which the company is a partner
  • a trustee of a trust estate under which the company or associate benefits
  • another entity (including a natural person) that, acting alone or with another entity or entities, sufficiently influences the company
  • an entity (including a natural person) that, either alone or together with associates, holds a majority voting interest in the company
  • a second company that is sufficiently influenced by the company or the company’s associate
  • a second company in which more than 50% of the voting interest is held by the company or the company’s associate.

Substantiating a Claim

As part of the R&D Tax Incentive programme, companies are required to substantiate their claims if selected for a compliance review by AusIndustry or the ATO. Reviews are generally arbitrary in nature.

Programme participants are required to satisfy AusIndustry or the ATO that they used reasonable methods to identify and, self-assess eligible R&D activities, and differentiate between expenditure on R&D activities and expenditure on non-R&D activities.

Activity-based record keeping

Activity-based records should show that activities were actually carried out, and show how they are eligible core or supporting R&D activities.

    The type of records that might be kept for activity-based records include:

  • notes from meetings with project and technical staff
  • business plans and approvals
  • results of background research and scoping
  • technical documents created at the time of the activity, including the results of experimenting on the product, idea or service
  • file notations and updated records to track the progress of an R&D activity.

Some examples for how you could evidence your R&D activities are below:

A Technical Planning roadmap This provides written evidence you’ve done your homework and should include identified milestones, what you’re going to do, how you’re going to do it, potential uncertainties & pitfalls and why you can’t use “off the shelf” technology to resolve the problem. It’s similar to a business plan, except from a technical perspective.
Project Reviews on a progressive basis Upon completion of the development project (or ideally for every milestone), make note of how the actual process and outcomes reflected the roadmap. In the instance where issues arose not previously identified make note of unexpected problems, why they may have occurred and their resolution.
Timesheets This should be maintained by all technical staff and is as simple as detailing information under the following headings:

  • – Date
  • – Project Name
  • – Activity
  • – Time
  • – R&D related? (Y/N)
  • – R&D Project Name

Expenditure-Based Recordkeeping

Expenditure-based records should justify expenditure claims for eligible R&D activities and who conducted the R&D activities.

    • The type of records that might be kept for expenditure-based records include:
  • timesheets to verify the amount of time spent on R&D activities and who conducted the R&D activities
  • general ledger entries and invoices to verify the amount incurred on R&D activities and that include sufficient detail to link them to the R&D activities
  • spreadsheet or template that allows for eligible R&D costs to be consolidated into a format that allows for direct input into the ATO R&D Tax Incentive schedule
  • financial documents including records of expenditure that include sufficient detail to link them to the R&D activities.

Other documents which could be used to provide evidence

    A more comprehensive list of possible documentation includes:

  • project planning documents;
  • design of experiments;
  • project records and laboratory notebooks;
  • maintaining records of the project development such as JIRA/Trello;
  • design documents for system architecture and source code;
  • records of trial runs;
  • progress reports and minutes of project meetings;
  • test protocols, test results, analysis of test results and conclusions;
  • photographs and videos;
  • samples, prototypes, scrap or other artefacts;
  • contracts;
  • records of resources allocated to the project, e.g. asset usage logs.

Straightforward R&D Claim process

A high-level summary of Fullstack’s thorough but straightforward procedure for the R&D Tax Incentive is below:

R&D TAX INCENTIVE procedure

Due Diligence
– Review of eligibility;

– Confidentiality Agreements;

– Determine projects & R&D activities;

– Review company struture,
IP arrangements & R&D expenditure

1 Week

2-7 Weeks

Prepare Application
– In-depth interviews & R&D workshops.

– Liaison with development teams & external parties.

– Working with accounts for determining R&D spend on Y/E accounts.

– Internal reviews & lodgement with AusIndustry;

Finalise Tax Return
– Receive ID from AusIndustry;

– Prepare additional R&D schedule for company tax return

– Lodge tax return with ATO;

8-10 Weeks

Process & payment
– ATO processes tax return and pays out refund (if applicable).

Co-ordination
– Full liaison with AusIndustry, ATO & management throughout process.
– Ongoing R&D grant advisory.

We cannot guarantee eligibility or nor whether ATO or AusIndustry will approve your claim.
This document has been created for educational and promotional purposes only and does not constitute advice.
It does not take into account your individual or business needs. Before relying on this information, you should consider
your personal and business circumstances and seek professional advice as required.

Registration of R&D Activities in the Application

Companies must register annually with AusIndustry, before being able to claim expenditure with the ATO, under the R&D Tax Incentive application.

Registration involves submitting an online smart form called Application: Registration of R&D Activities.

This application must be lodged within ten months of the end of the income year in which the activities were conducted, with the annual deadline to submit generally being April 30.

    The application requires:

  1. Relevant technical information about the activities comprising the company’s R&D &
  2. financial information around the R&D expenditure.

Classifying your projects & activities

Your R&D efforts must also be classified as either core R&D activities or supporting R&D activities in the application.

Projects

A project is the overarching development of a new product, system or process. These projects are often made up of many different activities – admin, marketing, etc. with some classifying as core R&D activities as detailed below.

If we were to illustrate with an example; a project for Tesla could the development of Model X.

Core R&D Activities

These are experimental activities pursuing new knowledge, technology which has not been done before requiring a scientific approach utilising hypotheses to experiment, observe and evaluate the findings.

These are conducted for the purpose of generating new knowledge or improved materials, products, devices, processes or services.

Returning to our example; this could be Tesla developing novel geo-sensitive auto-lock technology for the Model X.

Supporting Activities

Basically most activities in support of the above core R&D activity which could include activities around the setup or conduct or review of the experiment.

    Some other examples;

  • Literature research on developing the hypothesis
  • Designing and producing tests to be used in the experiments,
  • Manufacturing some small parts to be used as part of the experiment.
  • Maintaining the hardware used in the R&D phase.

Excluded or Production activities

Certain activities are excluded from being eligible core activities but could function as eligible supporting activities in the right circumstances.

Examples of excluded core activities include:

  • Management studies
  • Market research, testing and development
  • Software development where used internally
  • Any activity related to the reproduction of a commercial product or process; by a physical examination of existing systems, detailed specifications, etc.

Production activities includes undertaking initial production runs of items.

With both excluded or production activities it is important that the primary purposes for these must be in support of the experimental activities.

Lodging the R&D Tax Incentive via a Tax Return

After the company has registered its R&D activities with AusIndustry it should receive a unique registration number.

A R&D Tax Incentive Schedule can then be prepared with the R&D expense calculations and the & registration number.

This is then lodged as part of the company’s income tax return & with the R&D Tax Incentive paid out after the return has been processed.

Note: before lodging a claim for the R&D Tax Incentive with the ATO, a company must have:

  • Established that it is an eligible R&D entity;
  • Self-assessed that its R&D activities and expenditure meet the requirements of the R&D Tax Incentive;

Why choose Fullstack for preparing the claim

As seasoned R&D Consultants & Chartered Accountants working on your claim, we have your long-term interests at heart and prepare high quality claims to optimise your outcomes.

We are passionate about local innovative technology and have a strong interest for putting original Australian IP on the map. As specialist advisors with in the tech ecosystem we are able to help you strategise for optimum outcomes and build the R&D into your forecasts.

We are keen to see you pass any arbitrary reviews with flying colours so reviews & procedures around retaining documentation is commonplace. Our team’s expertise is very well diversified with science, AusIndustry and big four environments all contributing to our thorough approach.

On occasion, we are also able to help facilitate forward payments of the R&D funds in advance.

For a commercial and thorough approach to the R&D check out our packages and chat to us today.

What Clients Say

“The Fullstack team were quick to engage for the R&D Tax Incentive and streamlined the whole exercise. In addition to guiding us through the daunting process & getting us the funds, Fullstack were able to allow our team to get back to doing what we do best.”
Edward Farrell – Director, Kemarto

“The Fullstack team has been absolutely great to work with – highly recommended.”
Tomo Hu – Director, Miriad Technologies

“Carefully guided us with the company accounting & extremely helpful with their R&D expertise as well. Highly recommend getting in touch for all startup accounting & R&D grant requirements.”
Mark Curry – Founder, Savvy Beverages

R&D Tax Questionnaire

Looking to claim the R&D Tax Incentive?

Want to check your eligibility on a high level?

Take our quick R&D questionnaire today – jump over to the quiz here.