Kim Bigg
Hi everyone. Welcome to our next episode of Show Me The Perks. I’m your host, Kim Big, and today we’re diving into an area that could be incredibly beneficial for many Australian businesses, the R&D tax incentive. To help us unpack this topic, I’m joined by Mark Reuter, Senior R&D Indirect Tax Specialist at Perks. That’s a mouthful. With over 32 years of tax advisory experience, Mark has a broad range of and insights when it comes to R&D tax incentive and he’s here to help us understand how this program can benefit businesses across Australia. Mark, it’s a pleasure to have you here. Can you start by sharing a bit about your career journey and what has led you to specialise in research and development tax incentives?
Mark Reuter
Thanks, Kim. Great to be here. Thanks for having me on the podcast. I actually started working with companies doing R&D claims right back in the 1990s. At that time, there weren’t too many people around who had much knowledge about the incentive and there certainly weren’t a lot around that could actually help companies prepare R&D claims. I had a number of manufacturing clients and at that point, I was always interested in the technical aspects of what clients were doing and their product development. And so, working with clients on their R&D claims gave me a real view of a side of the business that I wouldn’t otherwise have had.
Kim Bigg
These were manufacturers in Adelaide?
Mark Reuter
Yeah, absolutely. I was basically working with some casting companies and other companies that were developing electronic products. And so was a really good intro to me for the R&D Tax Incentive. I think, you know, I always liked technical and scientific sort of issues. So was a really good area for me to get stuck into.
Kim Bigg
Tax, good way to get into technical things, but also from a tax perspective.
Mark Reuter
Yeah, I was working with, you know, I was working in the Tax Division of a big four firm for there. I started getting to iron D developed a client base Continued working there for about 30 years 12 of which I was a partner And, then I’m really pleased to be able to bring you know some of that capability Here to perks.
Kim Bigg
Yeah, and you’ve been with perks for near nearly six months now.
Mark Reuter
Yeah six months enjoying
Mark Reuter
Yeah, I’m really enjoying getting to know new people and getting into some new clients with different technologies
Kim Bigg
It’s really good to have you and you’ve very much rounded out our tax consulting specialist team by bringing some of this knowledge and expertise into that team. So we’ll get into it. you give us a R&D research and development? If I didn’t explain that acronym earlier, can you please give us the basics of what is the R&D tax incentive and why is it important for Australian businesses, both startup as well as mature existing businesses?
Mark Reuter
The R&D tax incentive is a federal government program that’s providing support for innovation. And it’s doing it through an incentive that is run through the income tax system. When companies actually make an R&D claim, they get an R&D tax credit. And that credit can either be refunded to the entities in cash or alternatively can be applied against their income tax. Either way, it’s providing them with an improved cash play position flow position.
I think one of the big things about the R&D tax incentive is that, unlike a lot of grant programs, it’s not competitive in nature. If you’re conducting eligible activities and you’re spending more than $20,000 a year, you can make an application and you can receive the benefit. So, it’s actually a really effective way where you can have a guaranteed return from making a claim under an incentive.
Kim Bigg
It’s obviously a return in cash or tax credit, which is pretty handy for some of those grants you got to apply and actually got to go and spend the money you first. like you say, you’re fighting with other small business startups to try to get a hold of the grant money. This one’s not the case. If you’re innovating and you pass the tests, anyone can retrieve it and you’re not fighting against someone else.
Mark Reuter
Yeah, that’s right. I mean, I’m not denigrating grant programs, but this is a way where you can have some assurance that, you know, if you’re doing eligible activities, you can get some cash back. I think one of the important things about the R&D tax incentive is that it’s not available to everybody. So generally speaking, you have to be a company in order to make a claim. There are some minor exceptions, but individuals, trusts, partnerships generally can’t make a claim. I think you asked the question about why it’s important for Australian businesses. And I think when you sort of look at a program, you’ve got to go back to say, what’s the program supposed to address? And in this case, it’s sort of a program that supports innovation and product development. And product developments are really difficult areas for companies because what you find is that through the process of developing products and innovation, there’s a lot of costs and there’s no immediate cash return to these entities. And so what you find is this huge cash drain and a lot of companies just don’t have the money to actually invest in that. Small companies in particular.
So a lot of small companies really struggle because a lot of them don’t have a revenue stream that they can divert into product development to fund ongoing products and development. And the problem that creates for them is they have this huge cashflow outlay and no way to do it. And this is why for startup companies in particular, that process where you’re going through product development and right through to commercialisation is often referred to as the valley of death. just, a lot of companies actually go under.
Kim Bigg
They can’t make it to the point of making a sale because it takes too long for the R&D to come through.
Mark Reuter
That’s, and that’s why getting cash from incentives like the R&D tax incentive can really help. But it’s not just small companies that have to make that decision. When you’re actually looking at larger companies, even every company has to make a decision between do I put my money into developing products and services that I can sell and get immediate revenue from? Or do I invest in product development which I won’t have immediate revenue from, but it can help extend the life of my products and give me future income. So, either way, whether you’re a large company or a small company, you can get a cashflow benefit that was really helpful under the R&D Tax Incentive.
Kim Bigg
And I’d note that you continue to mention companies. It’s obviously only available to companies. So it’s important to get your structure right before these small business entities start and make sure that they’re eligible in terms of how they structure and not set things up in a, you know, a discretionary trust or a partnership or some other arrangement and then not be eligible for R and D in the first place. very good. I’m going to move forward, sort of delve into a bit of discussion in a bit more detail here. So let’s say we have a lot of small and medium businesses that listen to this podcast. Some of them are clients of Perk, some of them are otherwise. Just want to get you to take me through imagining I was a, if there’s small and medium business owners out there who are listening and trying to wonder if the work that they do qualifies for R&D. So can you give us an indication of what sort of activities might they be doing, which would be eligible for R&D tax incentives?
Mark Reuter
Yeah, I think the first thing I would say to companies that are first time claimants and haven’t had much exposure to the R&D tax incentive is that you, don’t have to be wearing a lab coat and working in laboratory to be doing, know, or conducting an R&D activity that, you you can have a claim entitlement in relation to. The R&D tax incentive is meant to be a really broad-based incentive that applies across a lot of industries and to a lot of companies doing a lot of different things. It’s not meant to apply only to a narrow group of activities. When you’re looking at the R&D tax incentive,
Eligibility of activities really comes down to a couple of key definitions in the law. And one of them is the definition of what we call a core R&D activity. And in order to be a core R&D activity, you have a number of requirements. The first thing is that you need to be conducting an experimental activity that looks to test a hypothesis or a theory you have about how some new approach can achieve a particular outcome.
So, you need to have this experimental aspect to the activities you’re conducting. You also need to be able to show that when you’re looking at the outcomes of your experimental work, there’s a reason why you couldn’t predict those outcomes based on the existing knowledge that the industry has at the moment. You need to show that your experimental work relates to an established field of science. And you need to go through a process where you’re coming up with a hypothesis or a theory that you wanted to test by your experimental work.
You need to observe and get data from your experimental or trial type work, and you need to evaluate it and come up with logical conclusions. The last requirement that you have to show in order to have an eligible activity that’s a core R&D activity is your experimental work has to be done with the intention of developing new knowledge. And that can be a new knowledge in the form of new materials, devices, products, or processes, as well as just pure knowledge or information.
Kim Bigg
Fantastic. So it needs to be at least one core R&D activity and most of it’s coming from you have to have some experimental session to it. So you can’t just pick up someone else’s, you know, something out of America brings out some brand new scheme or a drone or something like that. And all of a sudden, you’re, you’re classifying purchasing drones or otherwise as R&D.
Mark Reuter
You’ve can’t to replicate other people’s R&D. And I think the other thing is that once you’ve identified that one core R&D activity, you get to claim not just the expenditure on the experimental aspect of work, but all the other things that are necessary for the conduct of that experimental work. And what that does is it means that it expands your claim into areas which are broader than just the conduct of that experimental process.
Kim Bigg
So you can start to get into some of the overheads and the electricity and the planning from the management crew and otherwise who might be helping them, helping them get their R&D activities underway. Yeah. Any misconceptions around R&D? I’ll probably just put one out there on the drones, but what is commonly, where do commonly people go wrong when thinking through R&D tax incentives?
Mark Reuter
I think one of the things that we’ve already talked about is that people actually look at product development and they tend to have the impression that if they’re not doing product development that they can’t make R&D claims. Whereas a lot of the times you’ll find that R&D can actually be done to resolve an existing problem in a production process or to improve aspects of production process that already exist. So, I think there’s a misconception about out there about what you have to be doing to make an R&D claim.
Kim Bigg
I think you’re right. think a lot of people think that they’re ineligible for R&D. They probably don’t think what they’re doing is actually R&D work relevant because they’re just fixing a problem in their business, and they think that it’s just fixing a problem. When in reality, if it’s a significant issue and they’re working through various experiments and hypothesis to work out how to fix it, then if it’s done the right way, there’s the potential that R&D incentives could apply.
I’ll jump on to the next section, financial benefits of R&D claims. So obviously, some of these people may be thinking, it’d be nice to get a tax incentive. To put it into some numbers and some percentages, can you give us a feel for for what people can expect if they’re trying to go down this path? And is it worth the effort?
Mark Reuter
Yeah, absolutely. I think, as a starting point, a lot of companies aren’t sure about what the outcome of an R&D claim might actually be for them. So, it’s a good point to clarify. There are two different forms of R&D credits that you can obtain through using the R&D tax incentive. And two factors determine which of those forms you get. And the two factors that you need to consider to work out the benefit you’re going to get are one, what the company’s level of aggregate turnover is. And in particular, whether they have aggregate turnover of $20 million or above, or whether they are below that threshold. And the second thing is to work out the benefit they’re going to receive, they also need to know what their likely tax position is going to be. So when we talk about aggregate turnover, what we’re talking about is the worldwide turnover of the entity, plus the turnover of entities that are taken to be connected with or affiliated with that R&D entity.
Kim Bigg
So if you’re over or under 20 million,I gather there’s more incentive offered to those who are under 20 mil.
Mark Reuter
Yeah, that’s right. So when you get when you’re under $20 million, what you get is you get a refundable version of the R&D tax credit. And it’s actually provided at a higher rate.
Kim Bigg
And if we were $10 million turnover, and you did 100 grand of eligible R&D $100,000 worth of eligible R&D, what would they expect?
Mark Reuter
If you had tax losses? Which you could use available to you and you did $100,000 of R&D work, you could potentially receive a credit of or a refund of $43,500. And I think it’s probably important just to talk a little bit more about each of those different types of credits. Yeah. So the when you actually have your aggregate turnover of less than $20 million, you get this refundable R&D tax credit. And it’s provided the rate of your tax rate plus 18 and half cents. So a 25 % rate taxpayer will get a 43.5 % R&D credit rate. And that’s refundable. So, if that entity has tax losses, they can actually, if that entity has tax losses, they can basically get the full value of that credit refunded back to them.
Kim Bigg
Does this come back as a refund when they lodge their tax return or does it back at some other through their bass or something like that?
Mark
It comes through the tax return lodgings process. So the whole incentive is administered through that income tax scheme.
Kim Bigg
It’s a federal government incentive, isn’t it? It’s not a state government.
Mark Reuter
That’s right. It’s federal incentive and you actually trigger the process for getting that money back by lodgement of your tax return with particular sections completed. And when you’re actually looking at the larger entities, though, it’s important to understand that what those entities get is they get a non-refundable tax credit. So if you’re in an entity with an aggregate turnover of $20 million or more, you get a non-refundable tax credit. So that’s a credit that can only be applied against an existing tax liability. And if your if your credit is greater than your tax liability in a year, it gets carried forward in much the same ways as tax losses get carried forward.
Kim Bigg
So you don’t lose it. you’re a $30 million turnover business and you have tax losses carried forward and you’re thinking, well, this isn’t going to kind of necessarily help me just having a tax offset. The answer is it will carry forward indefinitely for whenever it is that you do have a taxable profit and you’ll be able to use it at that point.
Mark Reuter
That’s right. And we talked about the fact that the rate that those larger entities get is a bit lower. So when you’re actually have that aggregate turnover of $20 million or above, what you get is a credit rate that’s equal to your tax rate plus 8.5%. So a 30 % rate taxpayer gets a 38.5 % credit. Now the other part to that is though, if your R&D expenditure actually exceeds 2 % of your total spend, you get an additional 8%. So in other words, on that part of expenditure that exceeds 2 % of your total spend, you’re actually getting support of 16.5 % plus your R&D plus your income tax rate.
Kim Bigg
So it goes to 46 and a half.
Mark Reuter
Yep. And the other thing people need to understand is that when you actually have our expenditure that you’re using to create an R in your tax credit, you don’t also get to deduct that expenditure.
Kim Bigg
So you’ve got rates of 43 and a half, 38 and a half, and 46 and a half. So you would say to me that you need some good quality tax expertise from Mark before trying to work out exactly how much you’re eligible for. As we’ve talked about a little bit earlier obviously these incentives are absolutely vital for some of these startup companies as well as mature businesses mind you particularly if you’re on less than 20 mil of turnover where you know these things can actually turn into cash physical cash that they can be using to help fund the next stage of their R&D or their product development. If I was a some of the people out listening
to this podcast might think, well, I’m just not sure how the process actually works. Is it difficult? Are there any issues that I should be watching out for? What would you say to those who are perhaps thinking, geez, I probably do have a few things that might qualify for this R&D, but I don’t really know where to get started. What would you say to those people?
Mark Reuter
Okay. I think it’s important to understand that the incentive is administered by two bodies. So there’s AusIndustry, which is part of the Department of Industry, Science and Resources. And they’re the entity that actually manage the eligibility of activities that people put into their claims. And then you have the Australian Taxation Office and they are generally responsible for making sure that the expenditure people put in claims is reasonable and appropriate under the law. The process that companies have to go through to make claims is again a two-step process with those two bodies. So, you have to in order to make an R&D claim, you have to make an annual application to register your R&D activities and that application has to be made within 10 months of the end of your financial year. And generally speaking, if you don’t lodge your application within that 10 month period, your claim’s gone. So it’s really important that entities understand that deadline. To make the claim, you put information into a web portal registration application that AusIndustry has set up.
The information that you put in relates to the technical nature of your projects and how it is shown to be eligible according to those activities and the eligibility criteria that we discussed a little while ago. In addition to talking about the technical nature of your projects, you’ve also got to provide an estimate of the expenditure that you’re intended to claim for each of the activities that you’re registering. Once you’ve finished actually completing that return on that web portal, you lodge it and AusIndustry issues you with a registration number.
Now the registration number is important because it actually sort of goes to integrate the registration of your claim with the process that you use with the ATO to get the money back. So generally speaking, a company that is making an R&D claim has to prepare a schedule. The schedule actually has to disclose different types of expenditure in prescribed categories and also provide a little bit of information that helps the ATO work out what type of incentive or what type of R&D credit they’re entitled to.
That with the AUS industry registration number that is provided once you register is inserted into that schedule. It goes into your tax return, you lodge your tax return, and that starts the process of you getting your funds back from the incentive.
Kim Bigg
Fantastic. So twostep process, AusIndustry and the ATO are the key players. ATO more of an administrative element to making sure everything lines up with AusIndustry, but I sense that the key part is feeding the right information into AusIndustry to make sure you have the right planning and hypothesis and otherwise needed to show the experimental nature and ultimately that will then, good information in is good information out and will strike a good claim. I’m just going to touch on a couple of examples before we then allow you to wrap things up and just summarise the best way to bring these things through and some other tips. So. I’m going to throw two examples out there. One of them, I’m going to call it an Adelaide food company and I’m going to imagine that they make
biscuits and chocolates for argument’s sake. And as everyone would know at the moment, there’s a lot of push on for new packaging and things like that. Maybe more environmentally friendly packaging, but it can’t be so environmentally friendly that it does something nasty to the food or doesn’t make it edible or the chocolates will melt or something along those lines. So, I mean, a lot of businesses would be working through these programs. Can you explain how an Adelaide food company might work through that?
you know, through the R&D lens.
Mark Reuter
Yeah. I think it’s a, one of the, one of the issues that you raised back there is a good example of how R&D can apply not just to new product development, but also to overcoming problems in your processes or problems that you have with existing products. Cause a lot of people overlook it and they actually just sort of focus on new product development. but R&D often, exists in overcoming existing manufacturing problems or making them more efficient. so really important to actually understand that.
Kim Bigg
So the process they might go through if they were trying if they had an existing process which needed to be tweaked, how would they, you know, thinking, well, I want to do this the right way. What would they be thinking at the beginning?
Mark Reuter
Okay, well, it all comes back to, you know, understanding what those eligibility criteria are. So, when I’m actually working with clients the first thing I do is look for the presence of those trialling and experimental activities. Because once you identify those types of activities, that’s the starting point for all of your core R&D activities. Once you’ve done that, you can draw down and find out what those other aspects like new knowledge development and uncertainties to outcome and the other eligibility criteria are also present.
Kim Bigg
And then you’d lead them along the right path to make sure they track it correctly and documented because that’s sometimes the thing that doesn’t happen is they, everyone loves to test things that I necessarily like to document.
Mark Reuter
And the thing about it is also that people shouldn’t just leave it till after the end of the year to start going back and retrospectively look at things. should actually look at it things a couple of times during the year to make sure they’re tracking expenses and things like Labor costs in particular as they go through the year.
Kim Bigg
Yeah, fantastic. So that’s a good example where an existing business and a lot of business owners would be out there spending most of their days solving problems, which is what they do for a living. But ultimately, you, some of these problems potentially could attract some R&D tax incentives if they’re done in the right way. And we’d encourage them to have a chat to Perks and Mark to see whether that might apply to them. I’m going to take a slightly different angle on an example now. And this is sort of a small…
startup, I’m going to call it mini tech, just to keep it blameless in case someone thinks I’m targeting a company out there and they ring us up afterwards and complain. So, I’m going to assume this is a startup medical company who might chase up, let’s call it vaccines or pills or otherwise, something to, you know, it could even be a protein type scenario. And they’re obviously trying various things to get the product right. What might be some of these small tech startup companies be thinking, because these ones would probably pass the smaller turnover test. If they’re startup, they’ve probably got turnover less than 20 mil. So, anything they can achieve through R&D is probably going to be a cash refund if they do it in the right way. How might they, if they were starting a business and they had a, this is on the more of the new product type scenario, what are they thinking when they’re thinking testing and documenting for R&D?
Mark Reuter
Wow. Okay. I think based on that sort of example, it’s a good, it’s a good example, because startup companies can often have cash that’s provided them to them by an equity investment. when companies have that cash and start to spend it, they don’t have revenue, but they have expenditure.
And if they’re a small company, you know, they generally, as you said, will have turnover of less than that $20 million negative turnover. So, they get a refundable version of the incentive. So, the R&D tax incentive actually works really well for companies like that because they have tax losses, the non-deductibility of their R&D expenditure doesn’t really worry them. It doesn’t create a tax liability. And what that means is the full value of that 43 and a half cent R&D credit can be refunded to them as cash, providing them with cashflow that they can use to continue their R&D activities. So, those are really good sorts of companies to look at and to get a benefit from the R&D tax incentive.
Kim Bigg
And they really rely on the R&D tax incentive a lot of the times because it extends their development period and allows them to continue on when they otherwise might have had to shrink their team or pause activities awaiting new funding from investors who probably increasingly get nervous as to whether there’s going to be a good outcome. So, it can be really helpful for those smaller businesses, I imagine.
Mark Reuter
A lot of startups really rely on the R&D tax incentive to get them through that period, know, that valley of death that we talked about earlier. Yeah. It’s critical for them.
Kim Bigg
If they can’t get through it, then they finish. So, okay, so onto a bit of a summation of today. Obviously, there’s quite a bit of information you’ve delivered there. Is there any, can you provide a few tips for assessing the eligibility of these R&Ds. you have a message for small or medium business owners out there or people who might be thinking about R&D, if you could run us through a few tips and common mistakes to avoid, that would be great.
Mark Reuter
Okay. The first thing that I think any person who’s looking to make an R&D claim for the first time should be mindful of is identify your R&D activities that you think you’re likely to claim first and make an estimate of the expenditure that you’ve got on those projects. By doing that, what you should be able to do is come up with an estimate of the benefit that you’re going to get from making an R&D claim. And I think you should know what you’re going to get back or be pretty close to know what you’re going to get back before you sort of engage in that process of actually making a claim. Know that it’s going to basically, you know, sort of if you’re going to go through the process of making a claim, which is not that difficult, particularly if you get a consultant to help you go through that process. But you do need to know that the value you’re to get back out is material enough to warrant making a claim. So that’s the first thing. I think the second thing is that some companies treat the annual registration application is like an administrative burden that they have to make. I would caution against that you really need to do a reasonably good job on your R&D registration application. If you don’t put know some effort into it and properly describe the activities you’re conducting, you can trigger a review. And it’s much more expensive to go through a review than it is to document your activities. And one more thing is, if you want to make an R&D claim, make sure you’re managing your intellectual property rights appropriately. Generally speaking, R&D claims are much more difficult to do if you’re not retaining the intellectual property that you’re developing as part of your activities. Make sure that your contracts with both your customers and your suppliers, as far as possible, you retain your IP in relation to those areas. Apart from the commercial issues, if you don’t retain your IP, it’s likely that you won’t be able to make an R&D claim.
Kim Bigg
Fantastic. And is there any sort of smaller aspects to R&D that businesses often miss?
Mark Reuter
I think one thing that businesses often are not aware of is that if you do get the refundable version of the incentive and you get cash paid out, it can affect your ability to frank future dividends. So in effect, the refund of the R&D tax credit applies like a negative tax payment or in a deferred negative tax payment in your franking account. And so, if you add in future periods want to actually start paying dividends, just be aware that receipt of that tax payment can affect your ability to frank.
Kim Bigg
Yep. So it may end up with unfranked dividends rather than franked dividends, which most of the business owners in Australia, I’m sure have had many discussions with their accounts and on. All right, I’ll just summarise as best I can and then perhaps you can add in a little bit as well. So, R&D tax incentives, this is really, coming at it from an innovation and an experimental and a new knowledge perspective. So there really needs to be those three items and a few others, which Mark talked about. These are tax incentives from the federal government. They are cash in some instances, if you have a turnover less than 20 mil. And there also can be a tax offset if you’re above. There are about three different rates. There’s probably more than that, to be perfectly honest, but there was three that we talked through today, which is the tax offset can be anything from
38.5 % to 43.5 to 46.5, depending on a few different factors. So important to get those things right. It’s two main industry bodies we deal with when it comes to R&D. It’s AUS industry and the ATO. And very important, as you mentioned just then, to get the information right and not treat it too much as an administrative item. Make sure that the information’s right in the first place, because it probably makes things harder if you end up getting a review.
And probably lastly, I’d just like to say, obviously, thank you to Mark for coming in and he can add some more comments as well. But I reckon there’d be a lot of small business owners out there who are, as Mark said, problem solvers. They’re solving issues and problems as they go. Probably not really thinking about R&D. R&D can sometimes be a forgotten sort of incentive that’s out there that people, when they’re busy in their daily lives and businesses, don’t think about immediately. So, if you’re If you’re one of those people out there thinking about that, please give us a call and we’d be happy to steer you in the right direction as to whether what you’re doing is R&D eligible or not.
Mark Reuter
Always happy to have a chat.
Kim Bigg
Yeah. Yeah. I think if anyone’s thinking about these things, if they can give Mark a call at Perks, I reckon he’d love to hear from you and talk through all the different machinations in R&D and product improvement and things like that. And what did you start with?
Mark Reuter
Product and process improvement as well as product development.
Kim Bigg
Yeah, that’s right. Exciting. So, all the good parts of accounting, think, all the exciting product development and R&D. So, thank you to everyone for listening again today. And thank you to Mark for telling us a little bit more about R&D to help our listeners out and thanks again until next time, we’ll have one more episode before the end of this 2024 calendar year. Thanks everyone.
