The R&D Tax Incentive is supported by:
- Five (5) pieces of legislation specifically relating to ‘research and development’ (R&D)
- Two (2) pieces of legislation relating to taxation
The most important of these is the Tax Assessment Act, which is described below.
Tax Incentive legislation – how is R&D defined?
“R&D” is a bit of a loaded term at the best of times. Everybody thinks that they know what it means but consensus on a workable definition is difficult.
The R&D Tax Incentive program is governed by legislation, so the Government needed a ‘hard’ definition of R&D so that they could pin down the eligibility criteria. The definition they chose is based on the experimental or scientific method. Unfortunately, this definition of R&D is an awkward fit with a lot of R&D performed in Industry.
Partly the job of the R&D Tax Incentive consultant is to assist their clients in mapping their R&D activities onto the definition used by AusIndustry and to express their R&D activities in terminology consistent with the scientific method and the language used by AusIndustry.
Tax Assessment Act
Section 355-20 R&D activities of the Income Tax Assessment Act (ITA) specifies that “R&D activities are core R&D activities or supporting R&D activities”. Section 355-30 defines Supporting R&D activities as “are activities directly related to core R&D activities”. Hence, a successful RDTI application is reliant upon the eligibility of the core R&D activities.
Section 355-25 Core R&D activities states:
(1) Core R&D activities are experimental activities:
(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 are conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services).
For an application to be compliant and successful, it must fulfil the sum of (a) + (i) + (ii) + (b). AusIndustry’s review process is aimed at identifying compliance of the applicant’s R&D activities as presented in the application.
Although not mentioned above, to satisfy AusIndustry, there must be a technical gap (i.e. a problem), from which a hypothesis (theory or idea) is derived that can be tested with an experiment.
So, the legislative basis for the R&D Tax Incentive is relatively simple but therein lies the problem – it is open to interpretation.
AusIndustry has developed a series of guidelines (see Offset your R&D costs to help innovate and grow your business) which describe their interpretation of the legislation. For the Tech Abstract checklist on eligible R&D, please see Do you have eligible R&D?.
The AusIndustry interpretation tends to be quite prescriptive but does give a good overview of what AusIndustry is looking for.
Issues arise when claimants apply their own interpretation of the legislation or try to second-guess what AusIndustry means in their guidelines.
An experienced Tax Incentive Consultant should have a good understanding of the subtle nuances of the AusIndustry guidelines and how these guidelines are derived from the R&D Tax Incentive legislation. See “Using an R&D Tax Incentive Consultant”.