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Unpacking the Research and Development (R&D) Tax Incentive in Australia

The R&D Tax incentive or the Research and Development tax incentive is a self-assessed Australian Government assistance program. The aim of this program is to encourage companies to take up R&D (research and development) activities in Australia. R&D activities are considered too risky to undertake without the financial support provided by this program.

R&D has been helping Australian innovations for decades now, and it has been considered the best R&D incentive all around the world. Besides this, it remains under-utilised in numerous parts of the industry, especially among small companies.

Here, in this guide, we have gathered all the essential information about the R&D Tax Incentive to help you understand it and then use it to gain the maximum benefit.

Who can use the R&D Tax Incentive?

The creation of the R&D Tax Incentive had taken place with both the local businesses and new technology in mind for every sector. It also encourages multiple businesses from overseas (only if they satisfy certain criteria) to consider using this country as a hub for developing their R&D.

R&D Tax Incentive

Tens of thousands of businesses have availed the benefit all around the nation. Manufacturing businesses, scientific/technical businesses and the IT industry are the three major categories that have benefited the most from R&D Tax Incentive.

Overall, in order to take advantage of this self-assessment program, there are some conditions that you need to fulfil to become eligible.

Eligible entities

Who can claim the Research and development (R&D) Tax Incentive? Only an eligible entity is able to claim it. In simpler terms, it means that the individual must be an incorporated company; partnerships or even individuals aren’t eligible.

So if the company is incorporated in Australia, it is eligible. However, when it comes to companies incorporated overseas, things become a little complicated.

According to the Australian Taxation Office and AusIndustry, the following will be considered an R&D entity:

  • A corporate body that has been incorporated under an Australian law
  • A corporate body that has been incorporated under a foreign law but is an Australian resident for income tax purposes
  • A corporate body that has been incorporated under foreign law and is:
  1. A resident of a foreign country with which Australia has a DTA or double tax agreement, along with a definition of a permanent establishment and
  2. Running a business in Australia through the permanent establishment defined in the double tax agreement.

R&D Tax Incentive - Eligible Entities

Who are not eligible?

The following will not be eligible for the R&D Tax:

  • An individual
  • A corporate limited partnership
  • An exempt entity ( i.e., the whole income is exempt from income tax).

Who administers R&D tax incentives?

The following two jointly administer this initiative:

  • The Australian Taxation Office (ATO); and
  • AusIndustry (on behalf of Innovation & Science Australia

AusIndustry is responsible for overseeing the registration of the R&D activities. It also ensures that the activities comply with the law.

The Australian Taxation Office, on the other hand, is responsible for delivering the cash benefit through the details lodged in the entity’s tax return. The ATO may also check whether the R&D expenditure being claimed in the company’s tax return is eligible or not.

How does the R&D Tax Incentive work? (Tax Offset and Tax Refund)

This program works by providing a tax refund or a tax offset for the companies that are claiming eligible R&D expenditure.

To access the incentive, you must spend more than $20,000 on eligible R&D activities first and then claim a tax offset or tax refund for that expenditure. How can you claim a tax refund or offset from the ATO?

For this, you will have to register the R&D activities that your business is undertaking with the AusIndustry first. When you have received your registration number, claim the tax refund or tax offset from the ATO.

How much should you spend on R&D?

To claim under the R&D Tax Incentive, spending more than $20,000 on eligible R&D is required. When it comes to the maximum amount, you can claim $150 million (which used to be $100 million before 1 July 2021).

Do you have to register your R&D activities with AusIndustry every year?

Yes, you need to register with AusIndustry and the Australian Taxation Office for every year that you claim.

AusIndustry has a feature that lets you ‘roll over’ your application from one year to another. As a result, if you have any long-term R&D activity that spans multiple years, registering becomes easier.

How much is the R&D Tax Incentive?

From 1 July 2021, companies that have aggregated turnover of less than $20 million will get the refundable R&D tax offset, which will be equal to the corporate tax rate and with an additional 18.5% premium. For most of the companies, this percentage is 43.5%.

As a result, the entities that made a profit will have to pay less, and the ones that made a loss will receive a cash refund.

What about the entities with more than $20 Million aggregated turnover? Such entities are entitled to a non-refundable tax offset that reduces the tax liability, or they could carry forward to future periods. The percentage of tax offset for large entities ranges between 33.5% to 46.5%.

This rate will depend upon the proportion of the company’s R&D expenditure to the business expenditure and company corporate tax rate.

Who should consider the R&D Tax Incentive?

Thanks to the R&D Tax Incentive, the Australian government is providing financial support or subsidising R&D in Australia. So, if you are taking up R&D in the country, at least a few of the R&D activities will qualify for the incentive.

It is highly recommended that you claim the R&D tax incentive, as you can claim up to 43.3% of the money you have spent back from the government as a tax refund or tax credit.

Unlike other (Australian) government programs where you have to compete with other companies to take the benefits, this is not capped. Once you qualify, you will receive the benefit.

What R&D expenses can be claimed?

The amount you (or your company) can claim under the R&D Tax Incentive will be calculated on the eligible R&D expenditure. Here’s what can be claimed as per the category:

Australian Staff/Contractors

  • Salary expenditure for R&D activities only and the associated on-costs for the same employees (for instance, worker’s compensation, super, etc.)
  • Expenses incurred under contract to other parties.

Associated overheads and materials

  • Overheads involved in the R&D projects. It may include rent, subscriptions, telephone and internet, warehouse and office supplies, etc.
  • Expenses on materials used to develop a prototype.

R&D Tax Incentive - what can be claimed

Research service provider

  • Contract expenses incurred while using a Research Service Provider, like a university.

Payments to associates

If you want to claim the cost of co-founders who are contributing their expertise to the eligible R&D projects, make sure to pay them the consultant fees or wages before 30 June. Payment made for this purpose should involve an actual cash payment or transfer.

The same goes for the associated companies that are undertaking eligible R&D activities as contracted services.

What can be considered an associate for R&D purposes?

An associate is a term that is usually a shareholder or any entity associated with the shareholder through business or family ties.

Core Activities

What does a Core Activity in R&D Tax Incentive stand for? The applications of R&D incentives to the AusIndustry are written in terms of two activities: Core Activities and Supporting Activities. These types of activities are responsible for describing the actual technical completed in the claimed R&D.

The Core Activities are used to describe the experimental activities or work on which your application is based. The Supporting Activities, on the other hand, describe the other work (usually non-experimental work) required for the Core Activities to proceed.

Defining Core activities is notably difficult as the definition varies quite often. Here we have tried to explain this concept in a comprehensive language.

Definition by AusIndustry

As per the AusIndustry guide, a Core Activity is an activity that checks the following two conditions:

  • It is an activity whose outcome you cannot determine or know in advance based on the publicly available current knowledge, experience or information. The outcome can be known or determined only by applying a systematic progression of work, which must be based on principles of established science and also processed from hypothesis to experiment, then observation and evaluation and lastly, leads to logical conclusions.
  • It is an activity that is conducted for the sole purpose of generating new knowledge. The knowledge can be in the form of new or improved materials, devices, products, processes or services.

Although this definition can be used to evaluate a potential Core Activity, it is not really helpful. So, let’s understand this in simpler terms.

A Core Activity generally describes an experiment (or it can be a related series of experiments) that represents a logical progression of work with the aim of solving a specific technical problem or gap by generating the needed knowledge.

A logical progression of work is usually a connected or related series of experiments where the knowledge is improved gradually with each experiment.

R&D Tax Incentive - Core Activities & Supporting Activities

Excluded Core R&D Activities

Some specific activities cannot be considered Core R&D activities and are called excluded activities. Here’s a list of the excluded Core R&D Activities:

  • Market research: Activities conducted with the purpose of discovering (potential) consumers’ interest in the services or products;
  • Efficiency surveys or management studies: Investigating the effective or efficient conduct of the business or a part of it and investigating potential cost savings;
  • Prospecting, exploring or drilling: Activities concerned with searching for a resource and drilling for samples to analyse the deposit;
  • Research into social sciences or humanities: Activities in regards to Economics, Sociology, Psychology, Politics, History, Philosophy, Anthropology, theatre or other similar categories;
  • Complying with statutory standards or requirements: Activities undertaken by a company in order to meet a legislative requirement or an industry standard;
  • Patenting, licensing or other activities: Researching, preparing and filing applications for the registration of intellectual property;
  • Reproduction of a commercial product: It stands for the activities that take place with the purpose of recreating an already existing product or process;
  • Software development for use in internal administration: Developing software to be used for the day-to-day administration of a business and its functions.

Supporting R&D Activities

Activities that are not yet experimental and necessary for the experiment to occur may be registered. Supporting R&D activities is directly related to the core R&D activities.

These can be conducted at the same time when the Core R&D activity is being conducted, or these can be conducted after or before.

The supporting activity needs to be directly related to a Core R&D Activity or even more than one Core R&D activity. It must be in close, direct and relatively immediate relation with one or more components of the systematic progression of work, which is also relevant.

R&D – Record-Keeping

Since it is a self-assessment program, companies are required to provide evidence for the claims if the AusIndustry selects them for a compliance review or in case of an audit by the ATO. The reason behind the audits or reviews may depend on a couple of factors, for instance, the kind of information provided in the R&D application form, underlying financial information, etc.

Record Keeping for R&D Tax Incentive

As the program participant, you must satisfy the ATO or AusIndustry that you used reasonable methods for the identification and self-assessment of the eligible R&D activities. You shall also explain the ways you used to differentiate your expenditure on R&D activities and on non-R&D activities.

Activity-Based Record-Keeping

Activity-based records would support the idea that you can’t determine the outcome in advance. So, you will have to conduct experiments (or a single experiment) to verify that the concept is possible, the conduct of genuine progression of work and your hypothesis, and that there was a substantial purpose for you to generate new knowledge.

Records will also help in demonstrating that Supporting R&D Activities were/are directly related to the eligible Core R&D Activities. You may keep the following records for activity-based record keeping:

  • Business plans and approvals
  • Notes from meetings with the project staff and technical staff
  • Results of background research and scoping
  • Technical documents that were created at the time of activity (these should detail the hypotheses as well as the results of the technical or scientific experiments.
  • Updated records for tracking the progress of the R&D activity.

Along with these, you must keep a couple of other documents as well. A technical planning roadmap, which is similar to a business plan but is based on a technical perspective, helps you demonstrate the duration, reasons, approach and potential uncertainties.

You should also keep maintaining timesheets that will detail the necessary information.

Expenditure-Based Record-Keeping

As the name suggests, expenditure-based records are used to justify your expenditure claims for eligible R&D activities. You should keep:

  • General ledger entries, and also the invoices to verify the expense incurred on R&D activities (there should be enough detail to link the costs to the R&D activities.
  • Results of both background research and scoping
  • Templates or spreadsheets that will consolidate the eligible R&D costs into a format that will allow direct input of data into the ATO R&D Tax Incentive schedule
  • Financial documents and the record of expenditure that include the needed detail to link the expenses to the R&D activities.

Other documents that you can use to provide evidence

Here is a list of documents that you could be possibly asked for:

  • designs of experiments
  • project planning documents
  • records for the project development
  • project records and laboratory notebooks
  • design documents for source code and system architecture
  • progress reports and summary of project meetings
  • records of trial run
  • photographs and videos
  • test protocols, results and analysis of these results and conclusion
  • prototypes, samples, scrap or other artefacts
  • contracts
  • records of allocated resources for the project, such as asset usage logs

You do not have to do advanced research to access the R&D Tax Incentive, nor do you have to be a large-sized company. An average small business can qualify as long as it is doing something different or new.

If you are already developing interesting products or even plan to do so in the future, you might be eligible for this. All there’s left to do is check whether you fit the criteria of an R&D entity as set by the ATO.

Although submitting the R&D Tax Incentive application is a complex process and involves effort, the benefit you receive makes all the effort worth it. If the process becomes too stressful for you to handle on your own, you should reach out to a specialist.

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