The ATO will be conducting these reviews in conjunction with AusIndustry.
Taxpayer Alert TA 2017/4 outlines the ATO’s concerns that taxpayers are claiming the R&D Tax Incentive with respect to agricultural activities that have the character of ordinary business activities, which are not eligible R&D activities.
Taxpayer Alert TA 2017/5 outlines the ATO’s concerns with regards to software development activities. The focus will be on whether experiments are being carried out for the purpose of generating new knowledge and ensuring that commercial risks are not being mistaken as technical risks.
In both alerts, the key areas of concern identified by the ATO are:
- Activities are being registered where they are not meeting eligibility requirements for the R&D Tax Incentive
- Expenditure forming part of the claim may not relate to eligible R&D activities
- Taxpayers may not be maintaining adequate levels of corporate governance (i.e. documentation to identify and support their R&D claim)
Software development activities
The process of developing, modifying or customising software often incorporates activities that meet the qualification criteria for the R&D Tax Incentive. The development process adopted is often systematic, iterative and almost always involves testing. However, this process must be directed towards the discovery of new knowledge whereby causal relationships between technical variables are tested in order to resolve an unknown outcome.
TA 2017/5 identifies some examples of software development activities that might not necessarily qualify as core R&D activities (on the basis that there is no development of new knowledge from this type of activity, but rather the application of existing knowledge) such as:
- Bug testing and beta testing
- System testing
- Requirements testing
- User acceptance testing
- Data mapping and data migration testing
- Testing the efficiency of different algorithms that are already known to work
- Testing websites in operation by measuring the number of hits
However, it is worth noting that these activities may qualify as supporting activities (which somewhat curiously is not stated in the Taxpayer Alert).
The ATO has also expressed concerns that taxpayers may not have adequate corporate governance in place with regard to the activities and expenditure being claimed for the R&D Tax Incentive. This includes the following:
- Having the correct processes and checks in place to prepare and maintain proper, detailed and contemporaneous records
- Having suitable accounting systems which segregate R&D expenses from other expenses
- Ensuring suitably qualified internal staff reviews of R&D applications prepared by external advisors to ensure that only eligible activities and expenditure are being claimed for the R&D Tax Incentive
What should you do now?
In light of the Taxpayer Alerts, R&D claimants should be encouraged to review their records to ensure that they can demonstrate, in the event of an ATO or AusIndustry review, that their activities and expenditure are eligible for the R&D Tax Incentive. Further, claimants may also wish to review their registrations to ensure that only eligible R&D activities have been registered and eligible R&D expenditure claimed.
We have included links to the Taxpayer Alerts here for your reference:
Pitcher Partners can assist if you have any concerns or uncertainty about the eligibility of your claim for the R&D Tax Incentive or if you require any assistance with regard to corporate governance objectives.