New guidance for R&D tax incentives revealed: Here's what it all means

After much consultation, AusIndustry yesterday released its long-awaited guidance on R&D tax for software development.

We’ve been fielding a lot of fear, uncertainty and doubt queries about R&D tax from the startup community over the last six months or so. After all, the R&D tax incentive is the single biggest government program supporting Australian startups and it’s a major funding source.

So, what does the new guidance mean? Let’s break it down.

Firstly, who does the guidance apply to?

It applies to both software companies in their own right (like many startups), as well as the other companies that participate in software development.

At a glance, what does the guidance mean?

The bottom line is this: if you want to avoid kickback from AusIndustry reviewers of your software development R&D tax claim in future, you’ll need to do the following.

Take more time upfront to really consider if you’re eligible for it at a more detailed activity level. So rather than assuming you can claim it for an entire project, you’ll need to consider and frame activities as having an unknown outcome that you’re trying to test.
Keep detailed time-based records, as you are doing the work. Not retrospectively. You’ll need to do this for your own time, and work with any contractors to do it for theirs too. Broad percentages of project costs are not likely to be accepted.

These definitions aren’t necessarily new. However, by releasing this guidance, AusIndustry is sending a clear message that it’s going to be paying more attention to these things in particular.

If you want to learn more, including the full definitions of experiments, hypothesis and knowledge (and while you’re there, learn more about the Frascati Manual for R&D …) download the full guidance materials and a guide to common errors.

Some examples of R&D eligibility

The guidance provides some (caveated) examples to help you understand whether your software development will be eligible for the R&D tax incentive. These include:

Resolving conflicts within hardware or software (think integration);
Creating new or more efficient algorithms based on new techniques (including all machine learning); and
Creating new and original encryption or security techniques (this is a narrow example, but at least it’s good news for cyber security companies currently grappling with the AA Bill).

It also suggests doing a GitHub search or searching tech blogs and forums to help determine whether or not you’re developing new knowledge.

And some examples of what isn’t eligible

The guidance also provides some examples of what will not be eligible for R&D tax. These include:

Any software for internal business purposes (this has always been the case);
Customising a product for a particular use, unless during the process knowledge is added that significantly improves the base program (modifying open source software without new knowledge for a different application won’t cut it); and
‘Routine’ debugging and testing of existing systems and programs (unless this is done prior to the end of the experimental development process).

This last point is worth spelling out. If you’ve got an initial (eligible) development activity that ticks all the new knowledge, hypothesis and experimental boxes, and debugging is part of this, then it would count in that instance.

Once the system has been launched, any bug fixes will not be eligible, so if your developers are also doing some of this, you’ll need to identify their time on that and exclude it from your R&D claim.

Looking at the bigger picture

While there has been some news such as Airtasker having to pay the ATO back millions of dollars, we don’t believe there is a systematic problem with R&D tax being ‘over-claimed’.

There’s no fundamental change to the R&D tax laws with this new guidance, but its release makes it clear that software development is under the spotlight.

Why?

Is it to help the government balance its budget by dissuading software companies from claiming R&D tax?

Maybe.

Whatever is behind it, you’re going to need to pay more attention to defining and tracking R&D activities to support any R&D claims. But, it is still one of the best supports for cash-strapped startups, so it’s still worth the effort.

And don’t forget, you’ve got until April 30, 2019 to claim your 2017-18 R&D — if you’ve got your activities and timesheets ready.

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