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ATO to review R&D Tax Incentive for construction activities

The arrangements of certain building and construction industry participants that are claiming the R&D Tax Incentive are being reviewed by the ATO and AusIndustry.The arrangements under review concern R&D claimants who are involved in either:

Acquiring buildings or extensions

Alterations or improvements

Constructing, extending, altering or improving buildings.

The review applies for instances where some or all of the expenditure:

• Is incurred on building and construction activities, which are expressly excluded from being taken into account in calculating an R&D tax offset.
• Does not otherwise relate to the eligible R&D activities.

Concerns

While operators of some affected companies may believe or have been advised that their activities constitute eligible R&D activities, the concern is that:

• Activities may not fit within the stringent requirements of the laws that govern the R&D Tax Incentive.
• Expenditure claimed may not relate to eligible R&D activities or may be specifically excluded from the calculation of the R&D Tax Incentive.
• Taxpayers may not be applying adequate levels of governance and review to the registered activities and the claims made for the R&D Tax Incentive.

Observed Activities

 A number of cases have been observed where the acquirer and/or the builder of a building have registered construction activities with AusIndustry which are, or appear to be, ineligible for the R&D Tax Incentive.

Reasoning for ineligibility

• The activities are undertaken by the builder in the ordinary execution of the construction contract and are not undertaken for a significant purpose of generating new knowledge.
• Project management, environmental, commercial or economic risks are mistaken for technical risks.
• The activities are not experimental but rather involve solving issues by applying existing knowledge or methodologies and a suitably qualified and competent professional in the building and construction industry could have known or worked out the outcomes without conducting an experiment. For example, using and applying existing (even if they are quite new) building materials, designs, processes or modelling techniques to the local conditions or customer requirements.

Expenditure

It has also been observed that often some or all of the expenses included in the calculation of the R&D Tax Incentive claim are not correct. This is due to:

• The expenditure being significantly excluded from the R&D Tax Incentive, on the basis that it is incurred to acquire or construct
  • A building or part of a building
  • An extension, alteration or improvement to a building
• The expenditure included in the calculation of the R&D Tax Incentive is not for amounts that are incurred on eligible R&D activities; for example, production costs of products sold to the market in the ordinary course of business.
• Expenditure is being apportioned between R&D activities and ineligible ordinary business activities in an unreasonable manner. For example:
  • Expenditure is included as part of overall overhead expenses which does not relate to R&D activities; for example, advertising and sales expenses.
  • Overhead expenses are apportioned using a method that allocates an unreasonably large amount to R&D.
• The activities are conducted under contract for the acquirer or owner of the building and not for the builder itself, resulting in activities that are not conducted on the builder’s own behalf. Consequently, the expenditure incurred by the builder may not be at risk, as is required under the legislation.

Corporate Governance

It is expected that Companies distinguish eligible R&D activities from ineligible ordinary business activities at the time of registration and throughout the conduct of the activities. Proper, detailed and contemporaneous records must be kept to support the registration application and the claim for the R&D Tax Incentive.

A further concern is that some companies are not applying adequate levels of governance and review to the R&D activities that have been registered and to the claims that are subsequently made for the R&D Tax Incentive on their behalf. For example:

• Suitably qualified company officers or employees who understand the relevant activities failing to undertake reviews and approvals of the company’s R&D registration applications.
• Company management deferring responsibility for distinguishing ordinary business activities from R&D activities to external advisors, without checking whether the external advisors’ understanding of the eligible activities aligns with that of the company’s officers or employees.
• Accounting systems or records being kept which do not contemporaneously or adequately segregate R&D expenses from other expenses.

It has been observed that these practices can result in activities being registered as R&D activities and expenditures being claimed under the R&D Tax Incentive that should not be.

Actions taken by ATO

The ATO and AusIndustry are working together to alert taxpayers and their advisors to practices that may result in increased risk of registering ineligible activities and incorrectly claiming the R&D Tax Incentive.

We will be contacting companies directly to advise them of our concerns with their registered activities and/or their R&D Tax Incentive claims if:

• Advisors who may apply high-risk practices are involved in the preparation of the registration application and/or claim.
• The registration of R&D activities continues with the use of broad descriptions that fail to distinguish them from ordinary business activities.
• The level of expenditure claimed for the R&D Tax Incentive is high for the industry or stage of business.

Innovation and Science Australia will continue to issue findings to companies confirming whether activities qualify for the R&D Tax Incentive.

A Specific Issue Guidance product has been developed to assist companies engaged in the construction industry, and their accountants and advisors, to correctly identify and document eligible R&D activities in that industry. This product is available on www.business.gov.au

Actions to be taken by Claimers 

You should consider whether the following concerns apply to you. The onus is on the individual to ensure that your registration and claim for the R&D Tax Incentive is correct. It is encouraged that:

• Registration is reviewed to ensure that only eligible R&D activities are registered.
• Claims for the R&D Tax Incentive are correct and that claims are not being made on expenditure related to ineligible activities.
• Check that the records demonstrate the R&D activities being undertaken and support the associated R&D Tax Incentive claim.

If the following concerns apply, it is encouraged to:

• Phone ATO:  1800 177 006
• Seek independent professional advice.
• Ask the ATO for their view through a private ruling or apply for a Finding from Innovation and Science Australia.
• Apply to AusIndustry to amend or withdraw your registration or make a voluntary disclosure to the ATO or amend your tax return.

Penalties may apply if you have incorrectly claimed the R&D Tax Incentive but will be significantly reduced if you make a voluntary disclosure. Generally, the reduction is greater if you make the disclosure before we notify you of an examination of your tax affairs.

For more information about eligible R&D activities, what can be claimed under the R&D Tax Incentive and recordkeeping, refer to Research and development tax incentive

If you have any further questions, please contact one our R&D tax specialists.