How to meet the rules and minimise risk
Since late 2018, one of the biggest talking points in the Australian startup community has been the perceived ‘crackdown’ on software R&D tax incentive claims.
Seemingly overnight, the key government incentive for encouraging technical advancements has become a question mark for the very companies driving Australia’s innovation.
The facts: how did we get here?
Given the importance of the R&D tax incentive to the tech sector, dispelling some of the myths that have come about following this issue will allow Australian companies to align their businesses to continue to legitimately access incentive benefits.
Jack Qi, Director of Tax Services at William Buck says one myth is the idea that the R&D rules have changed.
“Whilst the Government has been exploring ways to improve the program’s effectiveness through policy reviews and proposed new law, the fundamental concepts applying to startups have not changed since 2011,” says Jack.
“What we are seeing is Government efforts to ensure the integrity of the program. Software is not the first industry to come under the microscope. “The mining industry bore the brunt of audits some years back. Then it was construction industry’s turn in the limelight. And now, software companies are discovering the value of a well-planned R&D documentation strategy,” says Jack.
Agile methodology Vs the ‘Frascati Manual’, and adapting to the climate
So, why have some software companies on the cutting edge of innovation found it difficult to support their R&D claims?
Jack says it comes down to how R&D is defined.
“Government assessors point to the Frascati Manual as the benchmark, a document which originates from the 1960’s – well before the emergence of modern software development methodologies. This definition has a focus on the process of hypothesis, experimentation, observation and logical conclusions.”
“Its disconnect with the modern Agile methodology, which emphasises functional software over comprehensive documentation, is the single biggest contributor to the woes of software companies at the centre of recent headlines.”
But unless the Government decides to create a carve-out in the tax law for software, adapting to the current landscape is a non-negotiable requirement.
“Treat the rules seriously, however archaic or irrelevant they may seem from a software perspective,” says Jack.
“Imagine you are pitching to a potential investor. This particular investor, being the Government, demands that you meet certain milestones before you can receive the funds – worth hundreds of thousands of dollars. If you want the funds, you have to meet those milestones. Do it with real diligence. This is the mentality shift needed going forward.”
Practical tips: Realtime documentation is key
To demonstrate your eligibility in the event of an audit or review, you must ensure that the following records are kept prior to R&D claim lodgement:
Weekly test reports
- Customise your records or existing Atlassian/Trello/Asana per the Frascati Manual
- Start with a hypothesis around a new knowledge and technical uncertainty –> experimentation –> evaluation –> logical conclusions that prove/disprove the hypothesis
Weekly or ideally daily labour tracking for R&D employees
- Allocated per Core/Supporting R&D activity
R&D Contractor agreements and invoices
- Include their names, timesheets and amount of expenses allocated per Core/Supporting R&D activity
- Code repositories, GANTT charts, records of research (including screenshots for internet-based search research).
AusIndustry guidance: red flags to watch for
Earlier this year, AusIndustry released guidance to assist companies that are claiming the R&D tax incentive on software development activities. This provided claimants with a valuable insight into what AusIndustry considers eligible and ineligible Core R&D activities (note: it is still possible for the ineligible activities to be Supporting activities).
Activities regarded as ineligible as Core R&D activities include:
- Software-related development activities of a routine nature
- Solutions to technical problems that have been overcome in previous projects that have the same technical characteristics (e.g. the same operating systems or architecture)
- Development of business application software and information systems using known methods and existing software tools
- Adding user functionality to existing application programs
- Routine debugging of existing systems and programs, unless this is done prior to the end of the experimental development process.
Activities regarded as probably ineligible as Core R&D activities include:
- bug testing
- beta testing
- user acceptance testing
- system testing
- requirements 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
- routine computer and software maintenance
- converting any existing computerised or manual record-keeping system to a new system
- any kind of data manipulation
- any automated reporting system
In many cases, the above items can vary when interpreting eligibility with regard to context and the nature of the specific R&D activity. Reach out to an R&D Tax Incentive specialist if additional specific advice is required.