Are your clients carrying out research and development activities behind your back?
You might be surprised to discover that many SMEs conduct their research and development activities in total secrecy. That’s because they’ve been scared off by blogs and articles warning about confidentiality and protecting intellectual property. In some cases, clients can take this a bit too far, and they may not even tell you, their accountant, what they’re up to. This is crazy stuff! These ‘sneaky’ clients may be missing out on some serious government incentives.
By keeping you in the dark, these SME clients won’t be getting the proper professional advice they need to know on how their operations should be structured to take full advantage of their R&D activities. Research and Development is part of the Income Tax Act and your eligible clients should be claiming their Research and Development Offset.
Let your clients know that you can help them if they’re thinking about any research and development projects.
You don’t have to be a scientist or an engineer to advise your clients on the “due diligence documentation” needed to claim the offset. In fact, it is better that you’re not! This is the time they need you as their accountant. Research and Development presents opportunities for small and medium-sized accountancy firms to offer valuable Business Advisory Services to clients and prospects.
Ask yourself. What advice should I be giving my SME businesses that have told me they are going to undertake research activities?
Well, here are some suggestions:
- Tell them that to claim the Research and Development Rebate, the entity that conducts the research activities has to be a company; and
- Companies turning over less than $20m a year can get a refundable Research and Development Tax Offset equating to their applicable corporate tax rate plus a premium of 18.5%.
In short, that means most companies with turnovers under $20m could receive a tax offset of 43.5%.
This refundable component is highly prized by entrepreneurs and researchers. Many of them want their Research and Development registration and the company’s tax return to be lodged in July or August. This way, they can receive the potential cash refund, even if they are trading at a loss.
The government is so serious about R&D that it’s instructed the Australian Taxation Office to ensure that these refunds are paid within 30 days of the company lodging its income tax return.
- For eligible companies with turnovers over $20m, the non-refundable Research and Development Tax Offset is the company’s corporate tax rate plus an incremental premium.
This incremental premium is based on the company’s research and development intensity. The intensity is a percentage of the company’s eligible research and development expenditure as a proportion of the company’s total expenditure for the year.
All eligible R&D expenditure, up to a 2% research and development intensity, will receive a non-refundable Research and Development Tax Offset equal to the company’s corporate tax rate plus 8.5% premium.
Eligible research and development expenditure above 2% research and development intensity will receive a non-refundable research and development tax offset of the company’s corporate tax rate plus 16.5% premium.
- Your clients need to set up a formal approach to their research and development activities before they start work on any projects. ESS BIZTOOLS has developed a special form (BAS5505) to help streamline this process. We’ve called it ‘Planning a Research and Development Project’ and it is available to our subscribers.
- To claim the offset, your client’s company must undertake the research activities in a systematic way, and their costs must exceed $20,000 within the financial year.
- This systematic process requires initial pre-planning to define what their “idea” is.
- One of the first steps is to carry out realistic research to see whether someone else, anywhere in the world, has already documented solutions to that idea. If they have, then it’s game over. The Australian government isn’t going to pay an Australian business to reinvent a process that has already been invented and published.
- Documentation must be kept detailing the checks that were made to discover any prior research. This is known as “prior art” research. These “checks” could include details of professional literature that your client has read, or extensive internet searches, to establish that no satisfactory solution has yet been found. The company will have to explain in its AusIndustry application what sources were investigated, what information was found and why a competent professional could not have known or determined the outcome in advance. It’s best for them to keep all this documented as the research is done.
If the checks were conducted on the Internet it’s a good idea to print out the information that identifies why this idea is still an unsolved problem.
It’s also a good idea to make sure your client understands that Research and Development Incentive applications are submitted on a “self-assessment basis”.
This means that while AusIndustry and the Australian Taxation Office might accept the original documentation as lodged, they can still take follow-up action over the next four years.
Your client’s company must create and retain written records that support the research and development claim being made.
Company directors need to remember that those researchers who worked on an R&D project may not even be employed by the company, or in Australia, at the time when the government comes knocking.
So, it’s essential that appropriate supporting documentation is prepared and filed during the R&D phase. By doing this, the company can easily defend its position on its research and development expenditure claim.
- When an idea has been researched and appears to be unique, your client will then need to make a decision whether they want to start a research and development project.
At this early stage, we recommend a small team be appointed to undertake preliminary investigations. Their report can then be presented to the directors, so the Board can decide whether it is worthwhile committing to a full-scale research and development project.
- There are two components to eligible research and development:
- Core research and development activities; and
- Support for the core research and development activities.
- It is important to identify those “core activities” that are proposed to be undertaken. There must be at least one core activity in each research and development project. The outcome of that core activity cannot be known or determined in advance on the basis of current knowledge, information or experience. That’s the whole point behind the incentive to research and develop it.
- The core activity or activities can only be determined by applying a systematic progression of work that:
- is based on principles of established science;
- proceeds from an hypothesis to experiment, observation and evaluation, leading to logical conclusions; and
- is conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services).
In determining the eligibility of “core research and development” activities companies need to consider the following questions:
- Was an experiment (or set of related experiments) carried out?
- Could the outcome of the experiment be known or determined in advance?
- Did the experimental activities employ a scientific method?
- This new knowledge cannot be known or determined in advance based on current knowledge, information or experience, but can only be determined by applying a “systematic progression of work”.
- Our strong recommendation is that a company’s system should have the R&D team prepare a project plan, clearly identifying all of the key information. The Project Plan should then be submitted to the company’s Board of Directors for approval.
- This Project Plan should identify the “core research and development activities.” Key amongst these being the hypothesis (or hypotheses) on which the R&D will be conducted.
The “hypothesis” is a statement that can be proven right or wrong by conducting various experiments.
Any hypothesis statements must be recorded in writing as part of the company’s documentation.
The hypothesis needs to be a “positive statement” of a belief that through subsequent experimentation by the company will be either proven or disproven.
If the hypothesis is disproven this doesn’t affect the company’s ability to claim the cost of the research and development activities. The Government understands that there is always going to be a lot of “trial and error” involved in research and development processes. The key is for the company’s officers to make sure they keep appropriate records regardless of whether the project was a success.
- Part of the company’s approval process should be a budget, detailing estimated costs specifically for the project.
- Our suggestion is that when the submission is made to the board, a Directors’ Minute is prepared. This should identify that the directors have fully considered the proposal to undertake specific research and development activities. The Minute should also note that the plan and the associated budget have been approved.
- Once the board approval has been given the R&D team could then be assembled. In some instances, this may involve hiring full-time researchers. For smaller SMEs, it may involve recruiting team members who have been asked to spend part of their time working on a research and development project.
- Each project should be given a project number and detailed records must be kept of all activities and experiments conducted for that project. All the costs incurred, including in-house team members’ time, should be recorded as a cost of undertaking the project
The company is required to submit a “Research and Development Tax Incentive Application” each year. This is normally by 30 April which is ten (10) months after the end of the financial year. The application is submitted to AusIndustry.
- In the application, each project should be clearly described and a project reference number allocated.
The key sections in the registration document relate to the following:
- the objectives of the project;
- the expected amount to be spent over the life of the project, which can run over more than one financial year;
- the hypothesis (or hypotheses) for the project, including details of the background research;
- the new knowledge that the core activity was intended to produce;
- how the company determined that the outcome could not be known in advance?
- what research the company undertook to determine that the idea had not already been solved anywhere in the world. The application needs to include details of those investigations; and finally
- what was the experiment and how did it test the hypothesis?
The company needs to ensure details are provided of the experiments that were undertaken to test the hypothesis or hypotheses. The response should be a summary of the hypothesis and then details of the tests that were performed.
When completing the AusIndustry application, your R&D clients will need to be able to answer these questions:
- What conclusions have you reached from the experiments that were conducted?
- What evidence did the company keep about this core activity?
They will be required to comment on the evidence that they’ve prepared and retained relative to the experiments.
For each project, the company must supply details of any supporting activities that relate to a core activity, for which they want to claim the Research and Development Incentive Rebate.
The application requires them to:
- briefly describe the supporting activity that has been conducted for a core activity.
- explain how this supporting activity directly supports the core activities?
- detail the estimated expenditure for this supporting activity during the year?
AusIndustry will review the information contained within the Research and Development Tax Incentive application.
If they are satisfied with the information, they’ll advise your client’s company and provide a reference number. That reference number needs to be included in the company’s tax return to claim the benefit.
This reference number is particularly important if the company is trading at a loss. In this case, the company’s directors may wish to receive a cash payment from the Australian Taxation Office up to the value of the company’s tax loss, subject to it being below the calculation of the Research and Development Tax Incentive Rebate amount.
This is why, for companies with turnovers under $20m, the scheme is referred to as a “Refundable Research And Development Tax Incentive Rebate”.
At this point, you may be totally confused with information overload? At first glance, the Research and Development Tax Incentive Rebate does appear very complicated, but it doesn’t have to be. Thousands of SMEs participate in this program each year.
Here at ESS BIZTOOLS, we’ve developed a package that simplifies the whole process for both you, the accountant, and your clients.
The forms and proforma documents are included to help you give informed advise to your clients on the scheme and to make their record-keeping compliant and relatively simple.
Small and medium-sized accounting firms, like yours, have found by utilising the ESS BIZTOOLS Research and Development package that they have a complete resource that helps them to offer professional Business Advisory Services to their clients.
Want to know more? Please visit www.essbiztools.com.au for a review of the accountancy packages offered under our ESS BIZTOOLS banner.
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