R&D debacle: Will Aussie startups be dissuaded from taking advantage of tax incentive?

A crackdown on the government’s research and development (R&D) tax incentive scheme could deter early-stage startups from making claims altogether, to the detriment of innovation in Australia.

Earlier this week, the Australian Financial Review reported Australian startups including Airtasker have been ordered to repay millions in R&D tax incentives claimed in previous years.

According to the report, Airtasker’s claims from 2014 and 2015 have been audited and rejected, meaning the startup is faced with the possibility of repaying millions of dollars, as well as a 75% penalty.

The crackdown is largely in response to R&D claims for software development. In February 2017, the Australian Tax Office (ATO) and Innovation and Science Australia issued an alert announcing the tax office was reviewing the incentive, suggesting claims were being made on activities that were not eligible.

The alert specified the incentive should not be claimed for developing or upgrading software, using software to develop knowledge, or activities replacing manual work with software.

At the time, the ATO specified: “In order to be eligible, there must be an experiment or experiments being carried out for the purpose of generating new knowledge.

“The outcome of the experiments cannot be able to be known or determined in advance by a competent professional in the field.”

The ATO also expressed concern some companies may have been wrongly advised their activities constitute R&D activities.

It’s worth noting the Australian Financial Review report stresses Airtasker engaged a professional advisor for the claims in contention. The claims were also made long before the ATO’s alert was distributed.

The StartupAus Crossroads report 2018, also released last week, recommended amending the R&D tax incentive scheme to support more software claims.

Changes in the way the incentive is being operated is making it unreliable for software companies, the report said.

“While this uncertainty prevails, reviews of software claims by small companies should be halted.

“Clear language supporting software development claims needs to be added to the R&D tax incentive legislation, or a new program developed to support software R&D specifically,” the report said.

The report calls the R&D tax incentive the “single biggest government program supporting startups in Australia”, accounting for about $3 billion in federal government expenditure each year.

Of that, about $2 billion is spent on companies with less than $20 million in annual turnover.

Almost 90% of startups called the R&D tax incentive either “very important” or “critical”, the report said.

“For startups, who are intently focused on R&D, it’s a core part of business infrastructure.”

Critical risk for the ecosystem

Speaking to StartupSmart, StartupAus chief executive Alex McCauley says the political approach to startup and tech companies has shifted.

The view of software startups is “less rosy” than it has been in the past, he says.

R&D incentives are claimed and paid out, then audited later, rather than being assessed initially and approved or denied at the time of application.

Because of this, claims that were made in 2015, when “software companies could do no wrong” are being assessed in today’s climate when “the perception has changed”, McCauley says.

This is a “critical risk” for the startup ecosystem, he adds, but more problematically, it’s not “a reliable support program for software development”.

There’s “a real risk” early-stage companies will simply choose not to claim R&D rebates in light of the ATO’s apparent crackdown.

“We’re seeing a real shift here. It’s not a low-risk option any more.”

Speaking to StartupSmart, Evan Wong, co-founder of Checkbox, which has received the R&D tax incentive twice, says he isn’t too concerned at the moment.

“Because we’re so early in our journey, it’s not huge amounts of money,” he says.

However, the ATO knuckling down on past claims is “a concern”, as the incentive is “actually really enabling”, Wong says.

“If it’s under threat it will dramatically affect the industry,” he adds.

“There needs to be a balance struck,” Wong says, between not allowing people to “exploit the generosity” of the grant, but not dissuading founders from applying for it, either.

Gary Shapiro, co-managing director of Rimon Advisory, and an expert on government funding, tells StartupSmart while he can’t comment on any specific cases, it often comes down to record-keeping.

“If you’re going to be doing R&D and you want to claim the R&D tax incentive and get the benefit of it, then you need to make sure that you plan your R&D and treat it like a function of your business,” he says.

That means having “good, solid records to back up your R&D claims”.

For Shapiro’s part, he suspects the crackdown may have made startups more aware of the potential risks.

“I think that will have a knock-on effect, where some companies will opt not to claim because the risk outweighs the reward,” he says.

He advises startups to spend extra time making sure their claim is compliant, and — he reiterates — “keep good records”.

“Remove anything you think might not be R&D — that might be business-as-usual or software development as opposed to research and development.

“Just focus on the stuff that is definitely R&D and then keep records to show that you did that, and then you should be okay.”

R&D or not R&D?

Shapiro accepts for startups it can be difficult to focus on the minutiae of the business.

Founders are often moving fast, trying to get a product-to-market fit, and raising money, all while keeping their head above water.

“You’re trying to do a thousand things, and now on top of that you have to add in record-keeping processes around R&D,” Shapiro says.

That often lands in the “too-hard basket”, or at least at the bottom of the priority list.

“But, the bottom line is that if you want the benefits of the program — if you want the money — then you’ve got to do the compliance,” he says.

There are things that are definitely R&D, and things that are definitely not, he adds.

“It’s the piece in the middle where you have to try to navigate the guidelines and properly assess whether, according to legislation, that each individual activity you’re doing meets the requirement for R&D. And if it doesn’t, then don’t include it in your claim.”

However, startups are not exactly known for being risk-averse, and according to Wong, they have to weigh up the benefits of having some cash in the bank immediately with the risk of losing it later.

There’s always a chance they will never be audited at all, and when it comes to cash, “in the interim it’s often the best decision to go for it”, Wong says.

While he doesn’t believe the changes will dissentivise startups, he advises them to be careful, “because down the track, the cashflow can really kill you”.

He advises engaging with “a pretty reputable brand” to advise on the R&D incentive. Often, these brands will charge a percentage of the refund, rather than charging upfront, he adds.

However, Shapiro warns “at the end of the day, it’s the company’s responsibility to understand the legislation and make sure when they’re putting in a claim, that what they’re claiming for actually does meet the legislation.”

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