Australia's 3rd Largest Economy

R&D Tax Incentive Landmines And How To Steer Clear Of Them

30-Apr-2024 12:39 | Cassidy Lau (Administrator)

By Jack Qi

This article was first published in Startup Daily

(Note: the following are general observations only and do not constitute tax advice)

News of Macquarie Bank writing off its $46m investment into software company Plutora brought to light the devastating impact that denied Research and Development (R&D) tax incentive claims can have on a startup. Whilst the exact circumstances of Plutora’s situation is not known to members of the general public, articles in the news quote the founder as attributing the recent disruption to Plutora’s operations as having been triggered by the Australian Taxation Office unexpectedly denying the refundability of the company’s past R&D tax incentive claims.

The point of contention

At first glance, the apparent trigger for the ATO challenging Plutora’s prior year R&D tax incentives is not actually to do with the merits of its R&D activities. It seems that it has to do with a little understood tax concept called ‘aggregated turnover’, and whether Plutora’s figure was less than $20m.

Essentially, the tax rules say that only companies with revenues of less than $20m are entitled to the refundable version of the R&D tax incentive. For other companies, their R&D incentive is non-refundable i.e. its only use to the company is reducing its tax liabilities, which is cold comfort for loss-making tech startups who don’t have a tax liability in the first place.

Whilst it is usually fairly easy for a startup to determine whether its revenues are less than $20m, this issue gets much murkier for companies with major shareholders who either have significant revenues themselves or own significant stakes in other companies with significant revenues.

Without getting overly technical, the aggregation of revenues occurs where there is a common 40 % direct or indirect ownership interest. Making this issue even more tricky is the fact that ownership interest in this context could mean dividend rights, capital rights or voting rights. So, it is theoretically possible for a startup to have multiple related parties whose revenues are aggregated together with the startup.

A rule of thumb for startup founders and CFOs is that whenever a shareholder’s interest reaches 40 %– and this includes the founder – tax advice should be sought on how the shareholder’s revenues and other investments affect the startup’s R&D tax incentive.

Why is tax even relevant?

“Startups usually make losses, so why is tax even relevant to the R&D claim?” I hear you say. The reason why tax has a profound impact here lies in the name, the R&D tax incentive. The relevant rules are mostly found in the Tax Act, which means a company’s tax affairs affect its R&D rebate, and its R&D rebate affects its tax. Put simply, a startup should never consider the R&D tax incentive in isolation whilst ignoring tax issues.

Other common pitfalls

‘Aggregated turnover’ is joined by a lengthy list of other common landmines when a startup makes an R&D tax incentive claim. Here are a handful of common ones, in no particular order:

  • For R&D expenses incurred to related parties, an R&D rebate only arises if the expenses have been paid before the end of the financial year as opposed to merely being owed to the related entity

  • R&D expenses already reimbursed by another government grant, such as the Accelerating Commercialisation grant that was recently rebranded to the Industry Growth Fund, and the MVP Grant, cannot be claimed again for the R&D tax incentive

  • Where a startup’s development work is done by an Australian contractor, but the actual work is performed overseas, there this generally no eligibility for the R&D tax incentive unless an ’Overseas Finding’ is obtained before the end of the financial year. Such findings are generally very difficult to obtain for software development work. Unfortunately, many startups do not ask their contract developer the right questions and get caught out

  • Where a startup has a group of companies, if the companies are not structured correctly for tax purposes then R&D eligibility will suffer

  • Poor substantiation of expenses is one of the most common reasons for R&D claims being struck down. In an ATO review or audit, you can be assured that the ATO will ask for timesheets for the wages component of the R&D expenses. Remember, timesheets are ‘Boring but important.’

In addition to the ATO, startups must also satisfy the requirements of AusIndustry, the government body that assesses the R&D claim from a technical/scientific perspective. AusIndustry has the power to direct the ATO to deny R&D claims where it finds any of the following common deficiencies:

  • The R&D hypothesis is weak or too general

  • The R&D is focused on something commercial in nature as opposed to technical, for example, if the R&D is on whether your customer will like your product, it could easily be rejected by AusIndustry

  • The R&D ’Core activity’ is focused on marketing, mining, social sciences, reverse engineering or complying with statutory standards. You may think ‘None of these apply to me’, but as an example, last year we were asked to help a fintech company whose self-prepared R&D claim got denied by AusIndustry because instead of focussing on software development the claim was focused on financial market behaviour and therefore economics, which is a social science that is not eligible.

Quality is key

A common misconception is that once a startup receives the R&D incentive in its bank account, it must all be okay. It then comes as a rude shock to learn that the ATO generally has 4 years, and sometimes more, to challenge an R&D claim. There is no secret to avoiding all this trouble, take the time and prepare the best R&D claim that you can, don’t be afraid to ask uncomfortable questions and make doubly sure that your R&D advisor understands your tax.

If you believe your company may need help with the R&D tax incentive, now is the time to speak to your local William Buck tax specialist.

Find out more

Powered by Wild Apricot Membership Software