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The importance of Supporting Documentation in your R&D Tax Incentive claim

The first decision from the Administrative Appeals Tribunal (AAT) in relation to the R&D Tax Incentive was handed down last month (available here). The claim submitted by Docklands Science Park (DSP) for activities undertaken in their 2012-2013 income years was ultimately rejected after review, in main due to a lack of adequate documentation substantiating its R&D activities.

The emphasis on sufficient supporting documentation should come as no surprise – when introduced in 2011 the guidelines outlined for the Incentive heavily stressed the need for contemporaneous documentation detailing the creation of new knowledge, as well as the systematic progression of activities from hypothesis to experiment, observation, evaluation and conclusion. That is, clearly detailing the ‘scientific experimental method’.

The Docklands case is somewhat of an extreme example, in that, whilst not only failing to distinguish ‘core’ and ‘supporting’ activities, DSP also provided little evidence to suggest that the activities claimed had taken place at all. The AAT was eager to point out that simply registering activities as either core or supporting does not automatically make them so. Furthermore, DSP could not provide any evidence of a claimed $1.2million transaction, not an insignificant amount.

The R&D Tax Incentive is based on self-assessment. That is, it is the responsibility of the claimant (or a registered tax agent undertaking claim preparation on their behalf, such as NOAH) to determine the eligibility of the activities and associated costs to be claimed. To substantiate the claims, it is advised that supporting documentation be created concurrently whilst activities are undertaken i.e. not in retrospect – this a much more rigorous approach in capturing the correct data used when articulating the technical argument.

National Innovation and Science Agenda – What does it all mean?

The word innovation has most likely never been used so much in this country, in both political and general conversation, as it has in the last month. It’s safe to say that’s it the darling new buzzword. Finally.

And the cause of this shift? The National Innovation and Science Agenda (NISA). A $1.1. billion package, delivered through 24 new policies across 11 government portfolios.

As expected, responses have been mixed. Those focussed on numbers have commented that the $1.1 billion proposed is insufficient, when considering that the government spends around $10 billion a year on research funding already.

Numbers aside however, the obvious attempt to change cultural perceptions of innovation and ‘reduce the stigma associated with business failure’ is to be commended.

Unlike previous proposals from government the ‘Innovation Statement’ does present as a well thought-out and considered proposition, in contrast to the more haphazard approaches we’ve previously seen.

Here is what is proposed:

 

START-UPS AND EARLY STAGE VENTURES

It seems as though the government may finally address the deeply entrenched negative attitude towards failure in Australia.

20% non-refundable tax offsets will become available to early-stage, angel investors. VCs and other investors that have invested in a start-up for more than 3 years will be exempt from capital gains tax for 10 years. VC investments aimed at expanding existing start-ups will be eligible for a 10% tax rebate.

Furthermore, in an attempt to ‘reduce the stigma associated with business failure’, changes to bankrupty laws will see investors in a failed venture waiting only one year, as opposed to three, before being able to create a new start-up again.

 

SCIENCE AND RESEARCH

Addressing Australia’s deficiency in commercialising public research, a $200 million CSIRO innovation fund and BioMedical Translation Fund will support co-investments in new companies and start-ups developed by CSIRO itself or publicly-funded research agencies/universities.

Further working to encourage collaboration between industry and research, again with the aim to increasing commercialisation, $127 million over 4 years is being allocated to block grant funding. The difference here, is that now income from industry and ‘non-academic impact’ will hold as much weight as merit from research excellence.

$1.5 billion over 10 years will go to the National Collaborative Research Infrastructure Scheme, which explores projects such as ocean monitoring, medical research and advanced manufacturing.
$800 million over 10 years will also be allocated to two major scientific projects – the Australian Synchrotron and the Square Kilometre Array.

 

EDUCATION

Over $100 million will go towards not only encouraging students to study more STEM subjects, but also towards helping them ‘embrace the digital age and better prepare for the jobs of the future’.

Included in this is also an initiative to encourage more women to enroll in STEM subjects, with the ultimate aim of increasing female involvement in both startups and tech industries.

 

INTERNATIONAL TALENT AND VISION

Changes will be made to the 457 visa (Temporary Work – Skilled) system to attract more international talent to Australia and encourage international students to remain after graduating. STEM or ICT students will be fast-tracked for permanent residency.

$18 million will assist international expansion of Australian start-ups, with global ‘launching pads’ to be established in Silicon Valley, Tel Aviv and three other locations, to facilitate easier travel globally.

 

WHAT ELSE?

In a move requiring little to no funding, the government’s huge reserves of public data will be made increasing and more easily available. It is also proposed that the huge reserves will be made more ‘machine-readable’. Good news for big data–based businesses.

A link to the full National Innovation and Science Agenda can be found here.

What’s the deal with claiming software development as R&D?

The number of companies reportedly making R&D Tax Incentive claims in Information and Communication Technology (ICT) is second only to those in the ‘Engineering’ field of research. One would expect that this number will only increase as uptake by SMEs and the tech Startup community continues to grow.

Recognising this, AusIndustry has issued Guidance Material for ICT that outlines, through commentary and case study, the government’s views on what will and won’t qualify for claim. ‘Algorithms’, ‘cloud computing’, ‘GUIs’ and ‘software modules’ all get a look over. Software development is also always a hot topic in AusIndustry forums and blog posts on the topic abound from every adviser imaginable, including the ‘Big 4’ through to smaller independents.

There’s lots of confusion.

Despite all this guidance, discussion and opinion there is still a lot of confusion as to exactly what software development activities will qualify for claim. To date, we’ve tended to resist putting our two cents worth out there and have preferred to offer tailored advice on a client by client basis. However, in our travels we continue to be asked for our views on software development and R&D tax, so perhaps the time is right to offer up some thoughts.

‘Guidance’ material is exactly that…guidance.

We acknowledge that the guidance material published by AusIndustry should be factored into any discussion on the eligibility of particular software development activities.  But we would qualify this by noting that it is, as the name suggests, “guidance” only that is intended to help address general questions of uncertainty and difficulty. It cannot be regarded as definitive.

Not all software is created equal.

It seems much of the difficulty with ICT/software development is that it is an area of rapid transformation. Change is embraced and adapting to new technologies is the norm. It seems that innovative methods and techniques are introduced at such a rapid rate that what requires “R&D” one day is almost a routine activity the next. There is a danger when government (and advisers) buy into this popular perception too readily, for it can lead to setting themselves up as pseudo tech experts.

This danger is realised when they then become prescriptive about what qualifies and what doesn’t based purely on false assumptions. The number of times I’ve heard another adviser – with no background or expertise in the technology – pronounce that “the development of a phone app can’t be R&D because there are so many phone apps out there nowadays and so many tools available to help build them”.  Now, the development of that phone app at the end of the day might well not benchmark strongly for claim but the rationale can never be based on the fact that “there are so many of them out there now”. The same approach in respect of the cloud or mobility is equally ill conceived.

Then again, not all software is innovative.

On the other hand, another view might be that all software development is potentially eligible because the agile iterative software development methodology that is now an industry standard is inherently “experimental”. This approach is also flawed because it doesn’t pay sufficient regard to whether there were any precedents for the development and the extent to which any new knowledge was generated.

So, where does all this leave us?

Clearly, there is great potential to claim software development activities under R&D tax and the stats prove that a lot of such activity is indeed claimed. Guidance material from government can help provide a framework when qualifying such activities. Nevertheless, each development should be benchmarked against the legislative definition and treated on its merits, free from any assumptions that certain software development activities in particular areas cannot be “R&D” because they are now “old hat”.

Claimants (and their advisers) should always work from first principles and assess what activities have been conducted and the extent to which they can legitimately be described as “experimental” (remembering evidence of the journey from “hypothesis” to “test” to “analysis of results” to the drawing of a logical conclusion). And not forgetting the need to articulate a compelling argument that some “new knowledge” has been obtained from the exercise.

In this last respect, determining what is “new knowledge” and what is a relatively transparent extension of the “prior art” can be another contentious area. But that’s a topic perhaps best left for another post.

The Funding Conundrum – bridging the ‘Valley of Death’ beyond grants and VC funding

The ‘Valley of Death’ is used to describe that period in the development of a new product or service when a significant increase in investment is required to realise the vision, making the risk of failure a very real proposition despite the potential future returns. Typically, companies peering over the precipice will look to either Grant funding or Venture Capital as a means of safely getting to the other side. There are, however, other options.

Governments at all levels and persuasions love to talk up the importance of “Innovation” and want to perceive themselves as supportive of such activities. It’s true that both State and Federal Governments offer a wide range of funding grants including, at a state-level, ‘Innovate NSW’, ‘Technology Innovation Fund’ and the ‘Minimum Viable Product Program’.

The issue with these State-based programs is that the monies on offer are modest, giving the new ventures little runway.

At the Federal level, the flagship grant program is the ‘Entrepreneurs Infrastructure Programme’ (EIP), with three strings to its bow:

  1. Business Management (a mix of expert advice and small grants)
  2. Research Connections (help for small business seeking to collaborate with the research sector)
  3. Accelerating Commercialisation (co-funded grants up to $1M to commercialise novel products, processes and services but not to conduct R&D).

Indeed, some companies do receive support and go on to commercialise their ideas. What companies – and startups in particular – should remember however, is that these government grant programs are highly competitive and hugely bureaucratic.

The project seeking funding must not only benchmark strongly against specific merit criteria but must also out-rank other projects from other businesses. Furthermore, the larger licks of grant money come with the catch that the applicant must stump up matching funding (see point 3 above). Moreover, the challenge of dealing with the respective government bureaucracy during the grant application process cannot be under-estimated, especially with no guarantee of a successful outcome.

The investment of time required to draft a compelling grant application is not insignificant, meaning companies need to carefully consider whether their business would not benefit more from using this time to

Indeed, in the grant space, the Age of Entitlement is well and truly over, if it ever existed in the first place.

In relation to private sector VC funding, as we all know, it can be hard to secure in Australia. Yes, there are a number of Accelerators, Incubators, Angels, Mentor Networks and Early Stage Funds that are currently operating. The problem is that these all differ in terms of their strategy, selection criteria, what they put in and what they take in return. As a result, working through the options and determining which, if any, represent a realistic potential funding stream is no easy task.

Which leaves us with the Federal Government’s R&D Tax Incentive. Often overlooked by SMEs at first instance because it offers “refundable tax offsets” and not a “grant”, the end-result is in many cases the same – cash into the business when the business has no revenue and is in cash burn.

The real beauty of the program is that it operates by self-assessment and is – wait for it – an entitlement! This means that if you have a reasonably compelling argument for believing that your activities satisfy the eligibility criteria, you are entitled to the benefit. No “ifs, buts or maybes”, no benchmarking against other projects conducted by other companies and no need to find matching funding, Access to the benefit is also much easier and straightforward that any self-respecting grant application process – an annual registration form is lodged with AusIndustry and a R&D Tax Schedule included with the company tax return.

So if you’re a startup with some exciting tech but in the proverbial cash burn and wondering where the next injection of funds might come from, think beyond venture capital and grants and instead explore rebates and offsets under R&D Tax Incentive. They just might be the way you can bridge the gap between discovery and application.

Better bottom line at tax time? Yes – if you’re careful…

With the financial year almost over and the budget offering incentives, many businesses will be talking to their accountants about all things tax related.

Questions might include:
– ‘What purchases should I make?’
– ‘Should I pre-pay rent?’
– ‘Am I going to make a profit or a loss?’

The answer to this last question will obviously inform whether the taxman is owed money or whether a refund is in the offing.

 

How your taxable position can change things.

In addition to all these bread and butter issues, more savvy business owners and accountants might also discuss R&D tax offsets. There are generous refunds on offer under the Federal Government’s R&D Tax Incentive program – up to 45% of eligible expenditure – but the level of refund very much depends on a company’s end-of-financial year taxable position. Hence the need for R&D to be factored into whole-of-business discussions before closing P&Ls.

 

What to be cautious of…

It is important that those inexperienced in R&D tax proceed with caution. There has been something of an explosion in R&D advisers and online solutions seeming to offer a fast track to claims and benefits. While it is true that the R&D tax program is relatively broad-based and can be self-assessed, activities must still be benchmarked against a legislative definition. Justification for a claim must also be defined and registered with government. Furthermore, it is not unusual for claims to be scrutinised by bureaucrats long after registration has been confirmed.

 

How to set your business up for sustainable R&D claims.

There is a lot to be said for spending a little more time upfront thinking about how best to characterise project activities and articulate the arguments justifying the “experimental” nature of what has been done. In other words, get the right advice, set your business up for sustainable claims going forward and don’t treat the whole exercise as easy money for little or no effort.

 

Things to consider when registering your R&D Tax Incentive claim:

• Don’t register broad based, generic or umbrella projects – that’s a sure way to attract a review from AusIndustry
• Articulate your hypothesis with an “If …then…” statement
• Make it clear that your new knowledge was not a transparent extension of the prior art

 

Some examples of things to consider on the cost side of your R&D claim:

• Startups – consider whether you paid yourself or how much should you pay yourself – considering other tax and super implications
• Has your business incurred R&D expenditure to an associate? If so, the expenditure must be paid prior to the end of the financial year in order to claim as an R&D tax offset in that year.
• and many more……..

Call us for a chat about maximising your benefits at tax time.

Can’t argue with statistics – Why innovation needs more funding

Budget 2015 – Any love for Innovation?

The 2015 Budget sees no hugely significant changes to innovation funding.  The flagship R&D Tax Incentive remained untouched, whilst funding for various research initiatives was either slightly cut or slightly bolstered. The government’s focus is largely on SMEs in the latest budget – a step in the right direction some say, as innovative start-ups are included in this category, however the measures fall short of directly addressing innovation growth as Australia’s economy transforms into one that is knowledge-based.

As outlined by the latest Australian Innovation Systems Report (produced by the Office of the Chief Economist), Australian innovation is being hampered by a shortage of required skills and a lack of collaboration and innovation in management culture. Unfortunately, it does not seem that the latest Budget addresses these issues directly.

 

Impact on the R&D Tax Incentive

Though the last two years has seen the R&D Tax Incentive (Incentive) poked and prodded by various sides of the political spectrum, no additional changes were announced in the 2015 Budget handed down last Tuesday night.

Since February 2013, two major iterations to the program have been proposed – a 1.5% cut to the offset rates offered under the Incentive and removing access to the program for companies with a turnover of more than $20 billion per annum.

The 1.5% reduction was formally rejected by the Senate earlier this year, an outcome welcomed across all industries.

The proposal to restrict companies with turnovers of more than $20 billion from claiming under the Incentive was instead replaced by a $100 million cap on eligible expenditure, thanks to a deal struck with the Palmer United Party. These changes will be applied retrospectively from 1 July, 2014.

 

Impact on Innovation growth

Though the Incentive remained untouched, there was some movement in other areas of government innovation funding.

There were also numerous measures introduced to encourage the growth of SMEs, with a particular focus on start-ups for, some may say, the first time in any budget. These measures include:

  • Encouragement of crowd-funding through proposed easing of capital raising laws
  • Scrapping of Capital Gains Tax payments when changing company structures (i.e. to Pty Ltd)
  • Ability to immediately deduct fees associated with initial company set-up
  • Instant asset write-off for purchases up to $20,000 (if turnover is <$2 million)

Whilst these are not explicit innovation funding measures, it is hoped they will assist in extending the runway for smaller companies and start-ups that are at the core of Australia’s innovation growth.

The Entrepreneurs’ Infrastructure Programme (EIP), introduced in last year’s budget in a bid by the Government to provide more ‘practical’ assistance to businesses, saw a $27 million cut as a result of a slow start to the initiative.  Our own research has shown that those eligible to participate in the EIP either don’t fully understand the ultimate benefits of the program or view the process involved as too daunting, complex and/or time consuming. Furthermore, Co-Operative Research Centres (CRC) – not-for-profit organisations supporting collaboration between researchers and industry – saw funding cut by $29.8 million.

Both the EIP and CRC cuts are an interesting move for a government that has seemingly been attempting to build a stronger bridge between innovation and commercialisation.

It’s not all slashing however – the National Collaborative Research Infrastructure Strategy (NCRIS) received an extra $150 million of funding for its researchers Australia-wide. Furthermore, the Australian Synchrotron – a world-class radiation research facility – was given an additional $13 million in funding.

What does Australia’s performance in Innovation look like?

The Australia Innovation System Report is compiled annually by the Office of the Chief Economist and explores quantitative and qualitative data gathered on innovators and their activities in Australia. Activities with direct relation to innovation are also examined, such as research and development, skills development and capital investment.

The Report provides some very interesting statistics on businesses that innovate, making it all the more important that businesses maximise their access to government innovation funding such as the R&D Tax Incentive.

According to the 2014 study, across all business sizes and sectors, innovative businesses are:

  • 31% more likely to increase income and 46% more likely to report increased profitability
  • Twice as likely to export and five times more likely to increase the number of export markets targeted
  • Twice as likely to report increased productivity, employment and training
  • 3 times more likely to increase investment in ICT
  • 3 times more likely to increase the range of goods and services offered

In terms of Australia’s performance in innovation, the 2014 Report gave us both good and bad news. The good news is that Australia’s SMEs perform extremely well in the innovation stakes by OECD standards. Furthermore, manufacturing, information services, media and telecommunications, wholesale trade and professional, scientific and technical services perform well above the national average.

It seems however that the good news stops there. Despite their good performance, the vast majority of SMEs do not undertake export activities. As a result, we see only domestic implications, with little impact on Australia’s presence on the global stage.

Those companies that do export, with larger roles globally, unfortunately did not fare as well as their small-medium counterparts. It seems that large Australian businesses are ‘not innovation leaders by international standards’. Furthermore, it seems that Australian businesses of all sizes have a lot of improving to do when it comes to introducing innovations that are ‘new to market’. Unfortunately, on a global scale our performance is rather dismal, affecting the diversity of our export capabilities and general competitive potential. In fact, the report found that Australia has one of the least diverse export profiles amongst OECD countries.

In fact, the report indicated an overall decline in ‘new to market’ product innovation in Australia over the last decade, stating quite frankly that ‘Australia is primarily a nation of adopters and modifiers operating behind the innovation frontier’. With a positive association between business sales and ‘new to market’ innovation, as well as evidence that those successful in ‘new to market’ initiatives are up to eight times more likely to export than those that are unsuccessful, this news is of distinct concern.

Clearly, Australian industry needs to up its game in the innovation stakes. If finances are the issue, programs such as the aforementioned R&D Tax Incentive assist businesses in accessing cash rebates and tax offsets to fund innovative activities. However, the report points to a shortage of required skills and a deficiency of innovation and collaboration in management culture.

If Australia is to move away from a resource-based economy towards one that is increasingly knowledge-based, these issues need to be addressed swiftly and explicitly.

Entrepreneurs’ Infrastructure Programme – Part 3

3. Accelerating Commercialisation (commenced 1 November 2014)

The third and final element of the Entrepreneurs Infrastructure Programme (EIP), Accelerating Commercialisation (AC), aims to help SMEs and commercialisation offices to commercialise novel products, processes and/or services.

There are two main stages to the AC application process which tie to the two main components of the stream:

Stage 1 – Expression of Interest

Companies that pass this initial review are added to the ‘Accelerating Commercialisation Portfolio’. This database of businesses will be accessible to investors, industry experts, supply chains, ‘strategic corporations’ and Commercialisation Advisors who can provide feedback and guidance.

Stage 2 – Competitive Application for co-funding and further support/exposure

If an application is successful, companies can receive co-funding for eligible projects and expenditure. Up to $1 million over two years for companies and $250,000 for research organisations is available.

Businesses applying for grant funding are assessed against the following criteria:

i.       Need for funding

ii.        Market opportunity

iii.        Value proposition

iv.        Execution plan

v.        Management capability

vi.        National benefits

The ‘Need for Funding’ criteria arguably holds the most weight – businesses must demonstrate that they have exhausted all efforts to fully fund their project yet still have the ability to co-fund their project.

Access to the Expert Network is also provided to those that pass Stage 2. This network can potentially provide business connections, funding opportunities and promotional events.

Eligible projects must be shown to aim to achieve at least one of the following:

–       Complete development of a novel product, process or service

–       Prove commercial viability of a novel product, process or service

–       Make the first sales of a novel product, process or service in Australia or overseas

–       Drive the businesses towards commercialisation of its novel product, process or service

In other words you cannot seek funding if:

–       You cannot demonstrate the commercial viability of your product, process or service

–       You have already made sales and are looking to scale or conduct marketing activities

–       You are looking to develop further versions of your product

–       You are not looking to ultimately commercialise your product, process or service i.e. your project is for
internal business use only

–       Your project is still in a fundamental R&D stage with a low likelihood of the finished product
being commercialised

Note:

i)     The business must demonstrate that they are able to equally match the funding being sought through sources besides other government funding schemes

ii)     A project can take place over a two year period but no longer

iii)    Businesses applying only for inclusion in the Portfolio will not be assessed on ‘need for funding

iv)   Although the AC stream is open to businesses in all industries, priority will be given for those operating in Advanced Manufacturing; Food and Agribusiness; Medical Technologies and Pharmaceuticals; Mining Equipment, Technology and Services; Oil, Gas and Energy Resources; or Enabling Technologies of these sectors.

Eligibility

To be eligible to access the services offered under the Accelerating Commercialisation stream, businesses must:

–       Be a registered business/corporation

Note: applicants can be individuals, partnerships or trustees BUT must agree that at the time of submitting an application that they will form a non-tax exempt corporation before signing a funding agreement if granted

–       Be registered for GST

–       Not be tax-exempt

–       Have not exceeded an annual group turnover of $20mil for each of the 3 years preceding the application

–       Have a novel product, process or service they wish to commercialise and trade to customers external to
the state or territory of the Applicant’s place of business

–       Have ownership, access to, or the beneficial use of, any IP that is the subject of, or is necessary to carry
out the eligible project

Entrepreneurs’ Infrastructure Programme – Part 2

2. Research Connections (commenced 1 September 2014)

The objective of Research Connections, the second element of the Entrepreneurs’ Infrastructure Programme, is to foster collaboration between businesses and the research sector for the purpose of commercial gain.

The programme will provide eligible businesses with a ‘Facilitator’, tasked with identifying any ‘knowledge-related issues and/or opportunities’ within the business. In a nutshell, this element is looking to identify any business ideas with commercial potential that need research to develop them, to identify any knowledge gaps that are holding the growth of the business back and to facilitate businesses’ access to the research sector and other sources of relevant expertise.

The programme aims to achieve this through:

1. A ‘Business Research Needs Assessment’, followed by

2. One-on-One access to a Facilitator who will:

o    Identify knowledge/related issues and/or opportunities

o    Identify critical research areas in need of improvement

o    Identify research opportunities into new or existing markets

o    Provide connection to relevant sources of expertise, knowledge and advice

o    Accommodate collaboration with the research sector

3. A ‘matched funding’ grant is also available for up to $50,000 over 12 months. This reimbursed funding must be applied for and only be used to:

–       Engage a ‘Publicly Funded Research Organisation’ to undertake research activities for the business

–       Engage a ‘Researcher’ to develop a new idea that holds commercial potential

–       Access research infrastructure

–       Access anything else that may be determined the ‘Business Research Needs Assessment’

Note:

i)     The total cost of the Research Connections project must be funded by the business before claiming the Grant.

ii)   The business must demonstrate that they were unable to access funding from other means i.e. state governments, other schemes

iii)  The project must be of ‘commercial relevance’ to the business and must be directly related to outcomes resulting from ‘Facilitator’ access

 

Eligibility

 To be eligible to access the services offered under the Research Connections stream, businesses must:

–       Be a registered business/corporation

–       Be registered for GST

–       Not be tax-exempt

–       Have operated in Australia and filed business activity statements for at least 3 years

–       Be financially solvent

–       Have an annual turnover or operating expenditure thresholds between $1.5 million – $100 million

–  Be operating in the following industries: Advanced Manufacturing; Food and Agribusiness; Medical Technologies and Pharmaceuticals; Mining Equipment, Technology and Services; Oil, Gas and Energy Resources; or Enabling Technologies of these sectors, or demonstrate the business has the ability to operate in one of these industries in the future