By Alan Baghdasarayan | Senior Manager, R&D Services
Innovation is good for the economy. It keeps Australia competitive in the global market, and it drives new companies, new jobs and brings new talent to our shores. Because of this, the government incentivises Australian companies with cash refunds for genuine R&D expenditure through the R&D Tax Incentive program.
And, the refunds are generous. For companies with a turnover under $20 million, it could deliver a cash refund of up to 43.5 percent of eligible R&D expenditure. So if your SME company claims $100,000 on R&D and you’re in start-up mode, you could expect a $43,500 cash refund to appear in your bank account. Not bad. For those with a turnover more than $20 million, the benefit is still significant, an 8.5% permanent after-tax benefit.
Make no mistake, though; the Australian Taxation Office (ATO) and AusIndustry, the two regulatory bodies, aren’t too fond of cutting cheques—especially for hundreds of thousands of dollars. In fact, they’re tightening requirements to ensure no one claims the incentives unlawfully by auditing R&D claims years after the refund has been paid, something we absolutely support to preserve the integrity of the program.
How long do you need to keep R&D records?
According to the recent ruling in Tier Toys v. Commissioner of Taxation, ATO agents have a few years to come back and review an organisation’s R&D activities (and verify that they actually occurred.)
With this ruling in place, it’s more important than ever to keep solid, real-time R&D records if you plan on claiming the R&D Tax Incentive. This ensures that you properly comply with the program’s requirements in the event of an audit, and, in turn, maximises the cash refund for your company. In order to be compliant, you must:
a) Prove that your company conducted eligible R&D activities during the relevant financial year;
b) Provide detailed evidence of the R&D costs incurred; and
c) Show that the costs incurred directly relate to the R&D activities.
While this may seem relatively straight forward, trying to prove specific R&D cost and activity linkages retrospectively can be futile.
Think about it: If an ATO agent shows up at your door asking for company records from year’s back, could you quickly find and draw all of the necessary connections within your data?
Record keeping: The R&D key
If you’re claiming an R&D Tax Incentive, there needs to be a thorough and detailed paper trail in place—one that outlines the exact costs you incurred and the specific R&D activities that led to those costs.
You also need to prove that the costs were incurred during the financial year you filed for the incentive, so time and date stamps are crucial.
The best way to achieve this type of detailed documentation is with a daily, systematic and real-time approach to recordkeeping—an approach that records every R&D-related activity that your organisation takes part in. Here’s what that should look like:
1. Provide specific and detailed descriptions.
Specificity is vital in R&D recordkeeping. Whether you plan on claiming an entire employee’s salary as R&D or just a few software programs they used as research, there needs to be a detailed description of how those costs were used for R&D.
If you’re claiming contractor wages or employee salaries, you’ll need a job description and employment contract that outlines the specific R&D activities the hire is and has been responsible for that financial year. Ensure that the job description contains keywords that will help your claim. A title such as “Software Developer” may be too broad, and it will come down to the ATO agent’s discretion at the time of review.
If it’s a contractor, you’ll need a contract agreement in place that outlines the project’s initiatives and invoices that define clearly what tasks the contractor executed. So, instead of accepting an invoice for “consulting fees,” ask your contractor to specify the R&D activities they performed in detail on the invoice.
The golden standard is timesheets and calendar entries, because they can help point to specific dates and times when R&D activities were performed.
In some cases, emails may serve as substantiation of R&D activities, as long as they pertain to the status of an R&D project or related task, so be careful not to purge any old messages until you’re sure they’re not relevant.
Remember, all records for payments must take place within the relevant financial year.
2. Back it up.
You need to keep your documentation for at least four years—ideally more, so invest in some sort of system that can back up and safeguard your records. A cloud-based solution is likely best, as it won’t be vulnerable to outages and hardware problems.
Be sure to back up all types of records—especially human resources documents, emails, old calendars and time cards, etc. You should also keep historical records of employee job descriptions, even if the employee has left the company, as well as how those change over the years.
3. Use the right tools to track systematic progression.
The right cloud-based software tools can help you create a veritable R&D wiki to document your activities, control versions and shows the systematic progression of new knowledge generation across your organisation. This level of documentation can actually safeguard your data, as well as boost visibility and accessibility for your teams.
Set up reliable internal controls to manage and track day-to-day costs and activities. We recommend Xero for expenses and cost-code tracking, and Google Drive, Dropbox, Jira and GitHub for project tracking, time stamps and version control. All are cloud or web-based and allow for multiple users.
4. Show the test results from your activities.
You want to show that your R&D activities have led to some sort of result, too—that there was an initial knowledge gap and a systematic progression toward closing that gap. Test reports, business case and market analysis reports, design specs, clinical trials and quality control tests can all serve as proof of finding and developing results. For example, if Uber was to claim R&D expenditure for its app, it’s not as simple as providing the go-to-market or advertising plan. Uber must prove that its technology did not exist in the industry prior. This may involve showing that the company looked for off-the-shelf solutions first, and present a business case that looks at current vs new technology.
5. Link R&D costs to activities by providing context.
Any costs directly or indirectly incurred through R&D can qualify for the tax incentive, but you’ll need to link those costs back to a specific activity that your organisation engaged in. Be clear and show the accurate numbers, too—things like percentages claimed, ledgers, invoices, etc.
Utilities and rental costs, for example, can be claimed for R&D purposes—but only a percentage of them (equal to the percentage of R&D work done in the office). You’ll also need to keep invoices and bills from rental and utility providers to document those costs. A bank statement with direct debit expenses won’t cut it.
You also have the option to claim travel and accommodation expenses, if someone on your team is collaborating with other locations on R&D or attending an industry-specific conference. But, again, you’ll need to link those expenses back to the specific R&D activity being performed.
Worth the time
All this detailed documentation may seem like a hassle but, believe us, it’s well worth the investment. False claims, or claims that can’t be substantiated, can backfire big time and you may have to pay hefty penalties.
Want help ensuring your R&D incentive claim goes off without a hitch? Let our R&D Tax Incentive advisers guide the way.