Time is running out for many companies to finalise their claims for this year's research and development (R&D) tax concessions. Despite potential benefits equivalent to 125% and even 175% of qualifying expenses, a surprisingly high number of companies appear not to take full advantage of the concession. In many cases, tax advisers suggest, claims can be boosted if chief financial officers and their tax managers improve communications with their business units, engineers and production managers.
What needs to be communicated is exactly what constitutes R&D for tax purposes. Alun Needham, a principal with Ernst & Young's indirect taxes and incentives practice, says there is often confusion surrounding the terms "innovation" and "high levels of technical risk" that the R&D activities need to display (see panel, page 57). "There is an undue focus on the innovative side of the equation, which is the harder of the two criteria, rather than looking for technical risk. There is a wrong perception that you need to be wearing a white lab coat to be doing R&D," Needham says. "Look not at what you're attempting to achieve, but at what you have to do to overcome the technical challenge. While the outcome might be a new or improved product or process, if the approach is systematic, investigative and experimental, then you're likely to have identified the required high levels of technical risk."
The director of research and development and government incentives at PricewaterhouseCoopers, Sandra Mason, says making the effort can be rewarding. "The 125% concession means every dollar of a qualifying claim generates 7.5¢ in benefits over and above the usual tax deduction [30¢ in $1]," she says. "CFOs should look at what permanent difference this will make to their bottom line, and incorporate R&D-specific questions into their strategic planning process."
Engineers often take the view that developing new products for market was the only R&D work they were undertaking. "Some items are as simple as making sure the technical team have set themselves objectives to improve or diversify their processes. I've seen missed claims totalling $2 million at one client, including increasing throughput of production lines, and changing a single product line to produce five different products for the first time," Mason says.
Needham warns against lack of communication from the finance team to the rest of the organisation. "It's a classic quandary. Engineers putting forward a business case for a particular project are highly unlikely to play up the technical risks involved, yet that's exactly what the tax people want to hear," he says.
Getting paperwork spot-on is crucial. Tax concessions are claimed in annual tax returns, but a company claiming the R&D tax concession must also lodge an application for registration of R&D activities with AusIndustry within 10 months of its financial year ending. Most Australian companies have a June 30 balance date, so April 30 is a crucial date on many CFOs' compliance calendars.
Tax concessions are jointly monitored by the Industry Research and Development Board, through AusIndustry, and by the Australian Taxation Office (ATO), and one of the biggest mistakes CFOs can make is not having documentation in place - not just for compliance, but from a project management point of view.
Needham says: "Non-awareness of your R&D qualifying expenditure is not only costly in terms of missed opportunities and audit risk, it also calls into question your ability to realise the full commercial value of the R&D results."
By design, there is no time limit on when the ATO and AusIndustry can audit R&D claims, unlike other areas. Needham says: "This brings due diligence risks, for example, where a takeover target has large R&D tax concession claims for projects that have not been reviewed by AusIndustry."
Several traps exist for inexperienced players. Needham explains: "Totalling labour costs can be quite challenging, as can maintaining records to a level the ATO finds acceptable. When it comes to tracking indirect costs, such as overheads and salary on-costs and other expenses from running production-scale trials, many companies struggle, or fail to claim the correct amounts."
Ali Noroozi, tax counsel for the Institute of Chartered Accountants in Australia, says subsidiaries of multinational companies need to show they are carrying on R&D on their own behalf. "Look at who bears the financial risk, who controls the project, who has the right to exploit the results. You need to show that what is put in is commensurate with what you get out," he says.
Tax concession claims can create more administration costs than CFOs and tax managers imagine. For example, a $150-million brewery upgrade with a new waste-water plant highlighted shortcomings in how R&D was managed at Foster's Group. The company now has an innovative approach to its R&D administration, making each business unit responsible for all its R&D costs, including tax administration expenses, in return for extra tax benefits.
Peter Filipovic, taxation manager at Foster's, says: "We're not a big [R&D tax deduction] claimer in relative terms, with annual claims normally under $5 million over the past three years. It's more about how the process is being managed."
Previously, Foster's business units did not receive benefits for time and effort put into substantiating the cost of work done. "Although the corporate tax group runs the R&D tax concession claims, we need the technical knowledge of people running the projects. Until now, however, they've had no incentive to work with us in a pro-active way," Filipovic says.
"Our proposal is to give the R&D tax concession back to the business units by letting it appear on the business units' Ebit [earnings before interest and tax] lines, which is what they get measured on. This won't necessarily make it easier for them to meet performance targets, but it incentivises them to help my tax team evaluate R&D tax claims, while still promoting innovation. All costs surrounding the R&D tax concession and all the benefits can be properly considered," Filipovic says.
Foster's R&D concession claim recently increased to $10 million, which, according to Filipovic, reflects a new large project. "The brewery upgrade was going ahead anyway. We were just tick-tacking on to that process. It's not about increasing claims by any particular amount, it's about changing how our process is managed," he says.
For companies that have not documented R&D claims properly, it may well be too late. Now is the time to start planning to get the most from next year's spending. Needham says: "Lodging an R&D application once is not enough. Companies also need to follow through with the application process each year."
The R&D tax concession
What you need to know The research and development (R&D) tax concession is administered jointly by the Industry Research and Development Board (IRDB), through AusIndustry, and the Australian Taxation Office. The concession is claimed by companies in their tax returns, but annual registration of R&D activities with the IRDB is a prerequisite for claims.
The concession allows Australian companies to deduct up to 125% of eligible spending incurred on R&D activities from assessable income. A 175% tax concession is also available where R&D expenditure is increased above a base level from the previous three years.
Applications for registration must be lodged annually within 10 months of the end of the company's financial year. Eligible activities must be systematic, investigative and experimental activities that display the following characteristics:
* Involving innovation (an appreciable element of novelty); or
* Carrying high levels of technical risk, where the result is not known or determined in advance on the basis of existing knowledge or experience, and the uncertainty can be removed only by applying scientific methods; and
* Being carried on for the purpose of acquiring new knowledge or creating new or improved materials, products, devices, processes or services; or
* Supporting activities directly related to undertaking the core activities mentioned above.