One of the big issues impacting claimants is uncertainty whether the current programme will remain as it is, or whether proposed changes will become law. To date, the Tax Laws Amendment (Research and Development) Bill 2010 and Income Tax Rates Amendment (Research and Development) Bill 2010 were reintroduced into the House of Representatives on 30 September, 2010.
While the bills incorporated the majority of the amendments suggested by the Senate Economics Legislation Committee (established due to concerns about the effect of the proposed legislative changes on the level of R&D activity conducted by Australian companies), many of the concerns raised by various industry groups and R&D consultants were not addressed and, as such, the current R&D tax credit provisions still contain concerning and R&D inhibiting provisions.
As the proposed legislation stands, if a quarry operator or business conducted R&D activities to overcome a specific technical issue (eg techniques to achieve specific fracture patterns in sandstone, techniques to dewater quarries within compressed timeframes, environmental related projects etc), unless the activities failed, there would be limited ability to make an R&D claim.
This proposed scheme is very different to the current R&D tax concession programme, which recognises that genuine R&D activities are commonly conducted within a commercial environment and need to be tested on a large scale in order to test if the R&D is successful.
Given the extensive delays since the bills were first introduced into Parliament (21 June, 2010), it is likely that with the passage of time, the retrospective application date of 1 July, 2010 cannot apply and, at a minimum, the commencement date will be pushed back to 1 July, 2011. This is even more likely, given the first sitting of the Senate was not until 8 February, 2011 and there have been further delays by independent senators who have voiced their concerns about the changes.
When the bills are finally debated in the Senate, additional amendments are likely to be introduced by independent Senators Nick Xenaphon and Stephen Fielding. They will aim to reduce the effect of the most significant and adverse aspects that the proposed changes will have on companies? abilities to claim genuine R&D activities.
These proposed changes will support some of the comments made by Senator Sophie Mirabella, the Shadow Minister for Innovation, Industry, Science and Research and the Opposition.
Participants in the quarry and extractive industries are advised to contact either industry associations or their local senator to clarify the adverse effect of the proposed changes on their ability to make R&D claims.
COMPLIANCE REVIEW FRAMEWORK
A significant proportion of companies that have lodged R&D claims have received correspondence from Innovation Australia (AusIndustry), requesting information under a programme to review prior year R&D claims. This is part of AusIndustry?s new R&D compliance continuum framework to review (and assess) more R&D claimants.
As part of the introduction of the proposed R&D tax credit, AusIndustry has been granted increased resources to perform an increased level of compliance activity.
AusIndustry was provided with additional funding to facilitate and introduce the new proposed R&D tax credit. However, due to the lengthy delays in having the new legislation approved, AusIndustry has allocated these additional funds to increase its R&D review and assessment compliance activities of the existing R&D tax concession programme.
According to AusIndustry officials, the new compliance continuum framework will involve four levels of review activity by AusIndustry?s State or Territory offices, including:
1. A registration review based on application information. There is no contact with the applicant at this stage. About 75 per cent of registration reviews progress to the next level.
2. A desk review. Applicants will most likely receive a request to provide a copy of the R&D plans as well as additional detailed information about the registered R&D activities. The level of detailed information required by AusIndustry has increased beyond the details that have traditionally been included in the R&D plans. This level of review creates a heavy focus on evidencing trial and experimentation activities, as well as explaining where the innovation and/or high levels of technical risk exist within the registered activities. About 45 per cent of desk reviews progress to the next level.
3. An activity review. As in the past, AusIndustry will undertake a site visit to discuss outstanding issues arising from the desk review process. Any unresolved issues progress to full statutory assessments.
4. A statutory assessment. This is an in-depth review of R&D activities, focusing on evidence held to substantiate claims. The decisions on eligibility are appealable and binding on the Commissioner of Taxation.
AusIndustry has confirmed that during the 2010?11 year, it will undertake registration reviews on 1200 companies with R&D expenditure of less than $10 million and will relate to R&D claims submitted for the 2008?09 income year.
Applicants will be selected for a review based on a variety of information, including registration information, past compliance activities and information provided by the Australian Taxation Office (ATO). This information is analysed by various risk filters, which include (but are not limited to):
? Significant variations in expenditure from year to year.
? R&D expenditure levels.
? First year applicants/first year offset applicants.
? Specific keywords in activity/project descriptions.
? Previous negative compliance activities.
In addition to this wide-ranging compliance programme, AusIndustry?s national office in Canberra is committed to conducting compliance assessments of 300 companies that have made R&D claims in excess of $10 million for the 2008?09 income year.
Based on past experience, any correspondence from AusIndustry with respect to any type of review should be treated seriously.
RECORD KEEPING REQUIREMENTS
AusIndustry recently won a case at the Administrative Appeals Tribunal concerning reasonable levels of documentation to support and substantiate an R&D claim.
In this specific case, while the applicant produced very little in the way of evidence and documentation to support the R&D claim (which primarily lead to an adverse finding against the claimant), AusIndustry used the case to emphasise the comments made by the tribunal members with respect to the level of documentation expected to be provided during a review of R&D claims, eg:
? Having contemporaneous documentation, outlining the activities conducted and how they meet the eligibility criteria.
? When addressing innovation and high levels of technical risk, outline what the company has done, what similar activities have been done before and how the current activities differ to what has been done before.
? Ensure that there is a backup system of all electronic files. Poor documentation controls impact negatively on any review/assessment.
? All hardcopy documents should be in a safe and accessible location. Copies of crucial documents should be made in case they are destroyed.
While the HZXD case1 represents an extreme case of an R&D tax claimant failing to generate any documentation, it provides an insight into what AusIndustry is currently focusing on in terms of substantiating an R&D claim.
TIGHTENING OF R&D ELIGIBILITY CRITERIA
With the continuing delays to the proposed R&D tax credit legislation, companies have been left with no choice but to prepare R&D claims on the basis of the existing R&D tax concession definitions, as detailed in the Income Tax Assessment Act 1936.
That said, while the current legislation and eligibility criteria being applied by Australian businesses has not as yet been amended, AusIndustry has sought to adopt elements of the proposed tax credit regime and embarked on a programme of increased compliance activity and focus, particularly on the levels of documentation held by applicants in relation to trials and experimental activities.
The increased focus on compliance and the level of documentation maintained by R&D claimants effectively means that there is a tightening of the eligibility criteria, without changes to the legislation itself. This includes more interaction between AusIndustry and the ATO when deciding whether an R&D claim should be subject to a review.
This tightening of the definition is evident by the queries raised within several AusIndustry reviews, whereby R&D claimants are being asked if any of the registered activities are ?business as usual? activities or toprovide evidence that ?innovation and novelty is on a worldwide basis?.
Neither term is included in the existing R&D tax concession legislation but is a concept of the proposed tax credit amendments. Companies need to be prepared for such queries as the debate about the introduction of the R&D tax credit drags on.
In addition, the historically strong emphasis placed by AusIndustry on the information contained within the R&D plan documentation appears to have taken a back seat in the eyes of its assessors.
Based on an analysis of a range of AusIndustry information requests from a number of States across Australia, as well as through discussions with AusIndustry representatives, it appears as if documentary evidenceis now the key to satisfying AusIndustry that the activities contain the requisite levels of innovation or technical risk. With this change in focus, BDO is working with clients to ensure claimants are in the best possible position to substantiate and defend their R&D claims.
REFERENCE/FURTHER READING:
1. See HZXD and Innovation Australia [2010] AATA 879. http://www.austlii.edu.au/au/cases/cth/AATA/2010/879.html