R&D Tax Incentive: How it Works
R&D Tax Incentive -
How it Works
government’s major incentive
for fuelling innovation.
Reading time 10 mins
Your guide to the R&D Tax Incentive.
The R&D Tax Incentive helps out thousands of Australian businesses striving for innovation, providing tax credits to help reduce the effective spend on R&D expenditure. The scheme has been out since the 1980s and is governed by an established compliance framework to help maintain integrity but also to facilitate reliable government support for businesses that are eligible.
We aim to guide you through the R&D Tax Incentive in a manner that straightforward as possible, providing examples and insights from our expert R&D Tax Consultants to help you better understand the scheme and achieve outcomes in line with best practice.
Read on for one of the most accessible guides to the R&D Tax Incentive:
- Introduction
- About the program
- The benefits
- How is it calculated
- Determining Eligibility
- R&D Expenses
- R&D Record Keeping
- Preparing the application
- The Fullstack Difference
- R&D Tax Incentive FAQs
- R&D Questionnaire
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.
A review of the dual agency administration model is currently being undertaken, with a view to simplifying administrative processes and identify opportunities to reduce duplication in the administration of the program.
What are the main benefits of the R&D Tax Incentive?
From 1 July 2021, the primary benefit for organisations is a tax offset equal to 18% plus the company tax rate. This applies 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 R&D 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.
Who uses the R&D Tax Incentive?
What is the R&D Tax Incentive calculated on?
- Eligible expenditure incurred on R&D activities
- Balancing adjustments on the above.
- Providing a predictable means of obtaining government support for their innovative venture; &
Impact on tax deductions
Where an amount is used towards the calculation of the offset the company cannot also apply the expenditure as a regular deduction when calculating its taxable income.
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 2019 financial year.
What is the cash benefit of the R&D Tax Incentive on their spend in FY2019?
HARDWARETECH CO
Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (27.5% tax rate)
R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax Offset (43.5%)
TAX CALCULATION
$0
$85,000
$20,000 (i.e $5k+15% of 100k)
$0
$0
$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
How much is the refund arising from the R&D Tax Incentive per the spend in the financial year?
DEV AGENCY CO
Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (25% tax rate)
R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax Offset (43.5%)
Cash Refund
$750,000
$450,000 (i.e. $400k+50k)
$200,000
$550,000 (i.e. $750k-$200k)
$137,500
$450,000
$195,750
$58,250
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 FY2019 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 FY2019?
BIO TECH CO
Assessable income
R&D expenses
Deductible expenses (non-R&D)
Taxable income
Tax liability (30% tax rate)
R&D Tax Incentive Calculation:
Eligible R&D expenditure
Refundable Tax Offset (38.5%)
Net Cash benefit
TAX CALCULATION
$23,000,000
$1,400,000
$20,000,000
$3,000,000 (i.e $23M – $20M)
$900,000
$1,400,000
$539,000
$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 via a Core R&D Activity
A company must have undertaken eligible R&D activities during the income year. Key to this is the identification of a Core R&D Activity that has been undertaken in the income year (or potentially to start in a future year).
ACore R&D Activityis an experimental activity:
a) whose outcome cannot be known or determined in advance on the basis of current knowledge, information or experience, but can only be determined by applying a systematic progression of work that:
i. is based on principles of established science; and
ii. proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
b) that was conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services).
Generally, when we discuss a Core R&D Activity, we break the above into three (3) components:
Experimental activities based on an area of established science:Is there experimentation required at a technological level? Can you identify the theories or concepts you are trying to prove and the experiments needed to test them?
This is to help demonstrate that the true innovation is at a technological level which will require experimentation to unlock new learnings.
Experimentation or testing to address hypotheses around commercial factors are not counted – i.e. market testing an existing product with a different B2B customer or different industry, or establishing consumer preferences in relation to a new product, process or service.
Unknown Outcomes–Was the outcome of the experiment(s) unknown, and unable to be determined in advance?
If you are developing algorithms or hardware, the outcome and the pathway to success should not be known, publicly available / easily accessible, or able to be easily derived by a competent professional without experimentation. For example, the development of a new app using a tech stack in a business-as-usual fashion would likely not qualify if there was no advancement of the state of the art at a technology level.
New Knowledge–Was a product/program developed to generate new technical knowledge or a new or improved product, process or service?
This requirement relates to establishing what the purpose of an activity was at the time it was conducted. Where the activity may have a dual purpose (i.e. to generate new technical knowledge as well as to produce a commercial service), you must carefully inspect the documentary evidence available to support that a significant purpose of conducting the activity was to generate new knowledge.
Can only claim activities conducted for you
The R&D activities need to be carried out for you, rather than say a corporate investor who owns and controls the IP of the venture, or a situation where you are contracted by another entity who pays for your efforts.
Factors to consider here are who:
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
Other Main Requirements
Australian R&D Expenditure
Generally, only the Australian expenses incurred in producing R&D activity will be eligible.
Overseas expenditure would only be potentially 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 Advance 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.
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 you wish to claim the cost of co-founders who contribute their expertise to an eligible R&D project you must ensure you pay them wages or consultant fees before 30 June. Payment in this instance would usually involve an actual cash transfer or payment.
Associated companies undertaking eligible R&D activities via way of contracted services should also be paid 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.
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 R&D Claim
As a self-assessment program, companies may be required to substantiate their claims if selected for a compliance review by AusIndustry or an audit by the ATO. Reviews and audits may be initiated based on a variety of factors including the quality of information provided in the R&D Application Form, company sector, underlying financial information such as quantum of R&D expenditure compared to sales revenue etc.
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 support that you cannot know or determine the outcome in advance, and you need to conduct an experiment(s) to verify that your concept is possible, the conduct of the actual progression of work and your hypothesis, and that you had a substantial purpose to generate new knowledge.
Records should also be generated to demonstrate that Supporting R&D Activities were directly related to eligible Core 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, detailing the hypotheses and the results of the scientific / technical experiments
- 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:
|
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:
- 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
- results of background research and scoping
- spreadsheets or templates 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
Software to help maintain R&D documentation
Cloud applications like Synnch might be able help you maintain R&D documentation on a regular & systematic basis.
Straightforward R&D Claim process
A high-level summary of Fullstack’s thorough but straightforward procedure for the R&D Tax Incentive is below:
Example 1 – Pre-Revenue Venture undertaking R&D
1 Week
Due Diligence
– Review of eligibility;
– Confidentiality Agreements;
– Determine projects & R&D activities;
– Review company struture,
IP arrangements & R&D expenditure
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 Rego. No. from AusIndustry;
– Prepare R&D schedule for inclusion in 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.
Registration of R&D Activities in the Application
Companies must register annually with AusIndustry before claiming expenditure with the ATO.
Registration involves submitting a the R&D Tax Incentive Application form through the R&D Tax Incentive customer portal.
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 relevant technical information about the eligible R&D activities comprising the company’s R&D program and 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, process or service, etc. From a business perspective, these projects are often made up of many different activities – admin, marketing, promotion, commercialisation, and of course, the development activities.
It is important to understand that the scope of Core and Supporting R&D Activities is not one-to-one with how most businesses would view a product development project for internal purposes. From an R&D Tax perspective, care must be taken to only include the relevant Core and Supporting R&D Activities in the claim.
Core R&D Activities
These are experimental activities pursuing new knowledge and technology which have not been done before that require an approach based on an area of established science that require development of hypotheses and experiments, observations and evaluations to address these.
These are conducted for the purpose of generating new knowledge or improved materials, products, devices, processes or services.
Supporting Activities
Supporting Activities are those that are directly related to a Core R&D Activity. These are those activities that are not experimental but are nonetheless required for a Core R&D Activity to be conducted.
Some examples include;
- Literature research supporting development of the hypothesis
- Project resourcing and management
- Manufacturing parts to be used as part of the experiment.
- Production activities where they are conducted for the dominant purpose (i.e. the main purpose) of supporting the Core R&D Activities.
- file notations and updated records to track the progress of an R&D activity.
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 for the purpose of internal administration
- Research into social sciences, arts and humanities
- 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 where the production goes beyond the minimum amount of items required for the experiments.
Example of R&D Project Scope
As an example, a significant project for Tesla could the development of Model X. This would likely constitute a number of discrete R&D Activities (or even mini projects), as well as activities which fall outside the scope of eligible R&D Activities.
From an R&D Tax Perspective, the projects could be (a) developing novel geo-sensitive auto-lock technology, (b) development of the improved battery system and (c) development of improved navigation technologies using machine learning. Depending on the complexity of each of these projects of these could have multiple Core R&D Activities relating to specific streams of experimentation.
Along with more generic Supporting R&D Activities such as background research, project management etc., it is likely that specific R&D Activities may be required for each project, for example the manufacture of prototype batteries used in testing, or data collection relating to road systems that is used to train and develop the machine learning models.
It is likely that the development of the overall finished Model X would include many activities that are part of the overall project (as viewed internally) but fall outside the scope of the R&D Tax Incentive because they do not deal with attempting to resolve technical uncertainties (e.g. the selection of the paint, design of the layout of the dashboard, etc.).
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.
An R&D Tax Incentive Schedule can then be prepared that includes the total expenses by category and the registration number.
The R&D Tax Schedule is then lodged as part of the company’s income tax return, with the refundable R&D Tax Incentive offset (if applicable) paid out after the return has been processed.
Why choose Fullstack for preparing the claim
7 main reasons to choose Fullstack for preparing your claim.
- An hourly approach –If you have tight documentation then you shouldn’t have pay extra. Our fees are generally 30% lower than the average R&D consulting firm on basis of our fair hourly approach.
- Based on your success– We only work with scenarios where we believe have a strong case for success and our fees are aligned with your own.
- Industry experience– Our consultants have been involved with the R&D Tax Incentive since its introduction and understand the landscape from a detailed perspective having gone through hundreds of different scenarios.
- Contribution to the community– We seek to improve the industry’s outcomes with government funding – and run multiple workshops, publish frequent articles and facilitate the popular group – Government Grants and Fundraising.
- Access to other grants– We share other grants opportunities to our community on a monthly basis from a state, industry and federal perspective so your can optimise every possible opportunity.
- All under one roof– Bundle your R&D Tax Incentive with our tax service to experience faster turnarounds with the processing of your claim (usually one week faster on average).
- Ongoing support –Our support doesn’t end with your claim – we check-in regularly with your team to help ensure information & projects are on-track to help ensure an straightforward process at 1 July.
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
“A very professional, knowledgeable and helpful team – highly recommended! They have made the process seamless for us.”
Heila Lessing – Managing Director, Capsolate
“Worked with Fullstack to complete a complex R&D Tax Incentive claim and found them knowledgeable, succinct and efficient.”
Brendan Nicholls – Valet Group
“I am impressed with your service and the speed and professionalism of Fullstack.”
Meow Ludo – Moth Diagnostics
“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 Incentive FAQs
What is the R&D tax incentive?
The R&D Tax Incentive provides a tax offset to companies to help offset some of the cost of pursuing eligible research and development activities.
If running at a loss, the R&D Tax incentive will generally provide a cash refund. Companies in profitable positions with no carried forward losses will receive the benefit as a reduction to tax payable.
How does the R&D tax credit work?
After engaging in R&D activities through the financial year, an R&D Tax Incentive application must be made to AusIndustry who will register the relevant R&D activities.
A special R&D schedule is then prepared and lodged as part of the company tax return which will be processed by the ATO and the benefits of the R&D Tax Incentive will be delivered through that process.
Is an R&D tax credit taxable income?
The R&D Tax Incentive is not taxable income. It must be reported on a cash basis on the Profit & Loss when received.
How much is the R&D Tax Incentive?
Starting from 1 July 2021, companies with under $20 million aggregated turnover will receive the refundable R&D tax offset equal to the corporate tax rate plus an 18.5% premium.
For example, if the company tax rate is 25%, the R&D Tax Offset rate would be 43.5%. This means that a company with losses greater than their R&D expenditure for the period would receive a cash refund of 43.5% of their R&D expenditure.
A profit making company would be unable to access any refunds and would instead reduce their tax payable by 18.5% of their eligible R&D expenditure.
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 quizhere.
