Reading between the lines (of code???) - New guidance on software activities and the R&D Tax Incentive

The Department of Industry released some updated guidance on software activities and the R&D Tax Incentive in February 2019. There were 2 guidance documents released – a general guidance entitled Software Activities and the R&D Tax Incentive, and the Guide to Common Errors. This follows specific software guidance released in 2017 (ICT and the R&D Tax Incentive, and the ominously titled Getting Software Development R&D Tax Incentive claims right).

Having released guidance on software reasonably recently, you may wonder, what has led to the new guidance?

In a nutshell, there is (still) concern from AusIndustry and the ATO regarding R&D claims made on software development activities. Recent cases in the press (Commonwealth Bank, Airtasker etc) serve to highlight this (though it is more than likely that these reviews were commenced a good few years ago and we are now only hearing the conclusions). The following statement from the Software Activities and the R&D Tax Incentive document is revelatory:

‘You should only register activities if you feel confident with your assessment that what you are claiming is eligible and that you have the records to prove it.’

The same section warns companies that any non-compliance will mean paying back the money and possible compliance fines. The intent is clear – be aware (but not alarmed, provided you are confident in your assessment and have the records to prove it).  

Another interesting aspect of the guidance is that, compared to guidance issued under the old R&D Tax Concession, these documents tend to be a bit more general in nature. For example, guidance under the old R&D Tax Concession explicitly stated a method for calculating eligible overhead costs. While the regulatory authorities may be concerned over companies using prescriptive guidance to ‘game’ the system, this does come at the expense of certainty for legitimate claimants.

Having read through the guidance materials, here are my takeaways for companies making software development claims:

-          Expect continued scrutiny. The uptick of review activities will continue as AusIndustry and the ATO monitor claims to determine if the new guidance is being reflected in the quality of claims.

-          The Frascati Manual is still the go-to reference point for software R&D. This manual was referred to in the Guidance to the old R&D Tax Concession and was mentioned no less than 13 times in the latest guidance. In fact, the Frascati Manual is mentioned right at the beginning of the document. Consult this document when you’re assessing eligibility.

-          Activity vs project – it’s obvious that the authorities are continuing to see registrations based on projects rather than activities. This is tricky for software (do you consider a Sprint to be an activity, in which case there will be hundreds of activities in a year, or do you register at a more thematic Epic/Storyline level, in which case the technical information may be too abstracted from the actual activity), but the definition of R&D activities is based on activities, and so companies should consider how they structure their registrations.

-          Records – the guidance is also seeking to put a line in the sand in terms of record keeping. In short, no records, no R&D claim. Companies should start to track R&D regularly, including capturing both technical information as well as time spent by staff on R&D.

My last tip for companies who are seeking certainty is to consider an Advance Finding (which covers activities) and/or a Private Binding Ruling (which considers expenditure). This certainty is particularly important for companies where the Refundable R&D Tax Offset is critical to the company continuing to be a going concern. It may also become an issue for Directors and them discharging their fiduciary responsibilities (in which case certainty should become necessity). Having discussed Advance Findings with clients, one common concern that gets raised is whether a negative finding (or negative ruling) will open a Pandora’s box in the form of reviews of historic claims. In my experience I have not found this to be the case as both AusIndustry and the ATO have assessed these applications on their merits and in good faith, while also recognising the prudence of the taxpayer in seeking certainty over a sometimes-grey area of tax law (and not seek to penalise them for this).