Don’t forget tax breaks for research and development

The tax law contains incentives for businesses to invest in research and development (R&D), but these incentives can be overlooked by many business owners. Some may not even know the tax concessions exist.

There is a new R&D Tax Incentive that applies to R&D activities and expenditure in income years commencing on or after July 1, 2011. It essentially provides a tax offset designed to encourage more companies to engage in R&D in Australia.

The R&D Tax Incentive has two core components:

• A 45% refundable tax offset (equivalent to a 150% tax deduction) to eligible entities with an aggregated turnover of less than $20 million per annum.
• A non-refundable 40% tax offset (equivalent to 133% tax deduction) to all other eligible entities.

AusIndustry manages the registration of R&D activities and conducts compliance reviews related to the eligibility of these activities. The ATO determines if the expenditure a business may claim in its tax return for R&D activities is eligible.

The new R&D tax incentive provides eligible entities with a tax offset for expenditure on eligible R&D activities and for the decline in value of depreciating assets used for eligible R&D activities. As noted above, the rate of the tax offset, and whether it is refundable, depends primarily on the aggregated turnover of the R&D entity.

Eligible R&D activities are categorised as either “core” or “supporting” R&D activities. Generally, only R&D activities undertaken in Australia qualify for the new R&D tax incentive. However, R&D activities conducted overseas also qualify in limited circumstances where the activities cannot be undertaken in Australia.

Under the legislation, 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, but can only be determined by applying a systematic progression of work that: (i) is based on principles of established science; and (ii) proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions; and
• that are conducted for the purpose of acquiring new knowledge (including knowledge or information concerning the creation of new or improved materials, products, devices, processes or services).

Activities need to satisfy all aspects of the definition of core R&D activities to be considered as core R&D. In essence, the definition recognises that a company needs new information and needs to do an experiment to discover that knowledge.

In assessing the eligibility of their activities against the definition, businesses need to consider the following questions:

• Was an experiment (or set of related experiments) carried out?
• Could the outcome of the experiment have been known or determined in advance?
• Did the experimental activities employ the scientific method?
• Was the purpose of the experiment to generate new knowledge?

Core R&D activities do not include things such as market research, market testing, management studies or efficiency surveys, research in social sciences, or the commercial, legal and administrative aspects of patenting or licensing.

As can be seen from the above very brief overview, the tests and conditions that need to be met in order to be eligible for the tax offset get a little complicated – this is tax law after all! The benefits of the tax concessions can be considerable, and it would be a shame if the complexity of the law surrounding the concessions was to put some businesses off. That’s why it’s worth checking with your accountant or adviser. Who knows, you could be conducting activities that qualify for the tax concession and you don’t know it.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.