R&D Tax Incentive

What is the incentive?

The R&D Tax Incentive is a tax offset, the rate of which has been coupled to corporate tax rates since 1 July 2021. 

The R&D Tax Incentive currently provides the following offsets:

• eligible R&D entities with aggregated turnover of less than $20 million are entitled to a refundable tax offset that is fixed at 18.5 per cent above the corporate tax rate
• the non-refundable offset for eligible R&D entities with aggregated turnover of $20 million or more, is equal to the corporate tax rate plus 8.5 per cent for R&D expenditure between 0 and 2 per cent R&D intensity, and 16.5 per cent for any expenditure above 2 per cent R&D intensity. R&D intensity refers to the percentage of the entity’s total expense that is considered to be R&D expenditure.

The aggregated turnover is the sum of the company’s annual turnover and the annual turnover of the company’s ‘connected’ and ‘affiliate’ companies around the world.

Control is a key factor for ‘connection’ – if either company controls the other, or both are controlled by the same third-party companies, they would be considered to be connected.

There is a looser threshold for ‘affiliation’ – any entity (other than a trust) that acts or could reasonably be expected to act in accordance with the company’s directions or wishes is considered to be ‘affiliated’.

The application of the tests for ‘connected’ and ‘affiliates’ can be challenging.

Where the tax offset exceeds the entity’s liability, the balance may be refunded or carried forward to be used in future income years.

Eligible R&D activities must be registered with IISA within 10 months of the income year in which they were carried on. The IISA registration number and relevant expenditures are lodged with the ATO as part of the income tax return for the year in which the expenses occurred.

Who is eligible?

A corporation that is any of the following may be an eligible R&D entity:

• incorporated under Australian law
• incorporated overseas but an Australian resident for income tax purposes
• incorporated under foreign law and both:
  • a resident of a country with a double tax agreement with Australia that includes a definition of ‘Permanent Establishment'
  • carrying on a business in Australia through a Permanent Establishment as defined in the double tax agreement.

A consequence is that trusts, and some types of companies are not eligible.

If a company is a subsidiary member of a tax consolidated group, the R&D Tax Incentive applies to the consolidated group as if the head company is conducting all R&D activities, and only the head company should register for and claim the R&D Tax Incentive for the whole group.

What activities are R&D activities?

The value of the tax offset available under the incentive is based on the expenditure on R&D activities. These activities include “core R&D activities” and “supporting R&D activities”.

Core R&D activities are experimental activities whose outcome:

• cannot be known or determined in advance on the basis of current knowledge, information or experience
• can only be determined by applying a systematic progression of work that is based on principles of established science and proceeds from hypothesis to experiment, observation and evaluation 
• leads to logical conclusions and that are conducted for the purpose of generating new knowledge.

Supporting R&D activities are those activities which are ‘directly related’ to a core R&D activity.

Some activities are specifically excluded from being core R&D activities. However the activities could still be considered supporting R&D activities provided their dominant purpose is to support core R&D activities.

The decision tree sets out the key legislative requirements for activities to be either eligible core or supporting R&D activities.

R&D must generally be carried out in Australia to be eligible for the offset.

There are additional requirements that attach to overseas activities. For example, in order to be eligible, an overseas R&D activity must:

• be scientifically linked to an Australian core R&D activity
• not be able to be conducted in Australia
• have a lower anticipated expenditure than the anticipated expenditure for related Australian R&D activities.

Deductions

It may be possible to deduct expenses associated with R&D activities that are not linked closely enough to be considered supporting R&D activities – this could be expenditure such as consumables and software costs. 

To deduct under the general deduction provisions, the expenditure must be both relevant and incidental to the production of assessable income, and not of a capital nature.

Additionally, there are separate deduction provisions for R&D deductions under section 73A of the Income Tax Assessment Act 1936, including for payments to approved research institute for related scientific research.

Additional ATO requirements

There are various additional measures surrounding the R&D offset, including:

• expenditure that is ‘not at risk’ (i.e. protected because consideration will be received irrespective of the result of the R&D activity) will not be deductible
• a ‘clawback adjustment’ will be applicable to the extent that government grants have been used to fund claimed R&D activities
• if R&D activities produce marketable products that are used or sold in the business a ‘feedstock adjustment’ may apply.

Record keeping

A core reason for failure of R&D claims is inadequate documentation to substantiate that the legal requirements to claim the R&D Tax Incentive have been met. Records should be kept of all claimed activities, and the connections between related expenditure and the substantive activity.