ATO R&D advice is a bombshell

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James Riley

The Australian Taxation Office’s just-published alert aimed at companies seeking R&D tax benefits for software development activity has landed among high-growth startups like a bombshell.

The advice is confusing and appears to run directly counter to the way in which the scheme has been applied to software activity since it was last given an overhaul in 2011.

And the alert has been published at a time when the industry is still waiting for the Commonwealth to formally respond to the landmark Ferris, Finkel and Fraser Review of the R&D Tax Incentive that was handed to government last April.

The result is a rising-tide of anxiety among those startups and scale-ups that have software at the core of their business.

Industry Minister Arthur Sinodinos’ office has sought to quell concerns. A spokesman for the Senator said the ‘nothing has changed’ and that the taxpayer alert was aimed at merely clarifying compliant and non-compliant activities. The legislation has not changed, he said.

But rightly or wrongly, that’s not the message being heard by software-based businesses.

It is impossible to read the taxpayer alert targeting software and not see a clear resetting of the boundaries of what’s eligible and what’s not. In the case of software, the alert clearly and significantly tightens what is claimable.

The ATO and the Department of Industry, Innovation and Science last week published four alerts related to the R&D tax incentive shceme, including one focused on software-based companies. It is likely to publish one more in the next week.

ATO deputy commissioner Michael Cranston said at the time that tax office acknowledged the vast majority of people “are doing the right thing” and was focused instead on a “small number of people who are deliberately trying to exploit the system.”

The immediate problem is that the wording of the alert means that in the software sector at least, the ATO appears to be signalling that the majority of claims will no longer be eligible.

As background, the government is understood to have been looking closely at the ballooning cost of the scheme. The R&D Tax Incentive makes up about one-third of the $9 billion annual government investment innovations (and is the fastest growing.)

The Review of the R&D Tax Incentive by Innovation and Science Australia chairman Bill Ferris, the Australian Chief Scientist Dr Alan Finkel, and the Secretary of the Treasury John Fraser acknowledges the growing cost of the program, and sets out through its six recommendations to find ways to improve the integrity and effectiveness of the scheme.

And this is where things seem to come unstuck, and where the advice from the ATO and AusIndustry seems to get ahead of itself.

The Ferris/Finkel/Fraser (FFF) review recommended keeping the existing language for definitions of R&D, but said new ‘plain english’ guidance, case studies and rulings should be produced to give greater clarity to the scope of eligible activities.

The concern here is that the ATO/AusIndustry has produced advice ahead of an official Australian Government response to the FFF review. Sure it might be in plain English, but by tightening eligibility criteria for software companies, seems at odds with other FFF recommendations.

You could be forgiven for wondering out loud about the process.

One the one hand, three of Australia’s most senior and respected voices – the FFF’s – conduct a detailed review of the scheme and after a lengthy consultation with stakeholders, make formal recommendations to government (to which it gets no response.)

And on the other hand, you have a unilateral and substantial re-working of the scheme via a single government agency (ie through the ATO’s taxpayer alerts).

I am surely not the only person in Australia wondering where the instructions came from to issue this advice. Because from the outside at least, it looks like the political agenda and the bureaucracy are working at cross-purposes.

Startup advocacy group StartupAus says the ATO/AusIndustry advice had taken the sector surprise and had caused genuine concern.

The advice “looks like a significant narrowing of the way the scheme operates,” said StartupAus CEO Alex McCauley. “It runs counter to the way the scheme has run over the past several years at least.”

“And given the R&D Incentive is the biggest single support for startups in the government’s innovation agenda, we are obviously very concerned.”

If the changes are about tightening a ballooning investment in the scheme, Mr McCauley said the apparently sweeping changes to the way software development is treated among startups and SMEs seems poorly targeted – given it has been so effective in helping the startup sector grow in this country.

And if the tightening of the interpretations are actually aimed at hobbling the so-called “success fee” industry that has grown around the R&D Tax Incentives, then it’s a sledgehammer being used to crack a nut, he said.

“It’s StartupAus’ number one ask to make the R&D Tax Incentive scheme better. And this is absolutely the wrong direction to take it.”

One of the problems for software companies is in the definitions. At the time the scheme was originally created, its focus was very much on the research end of R&D because it talks of a requirement for ‘new knowledge’. It has evolved over time.

For startups and scaleups with software development at the core of their job-creating enterprises, the ATO alert on software is going to make life much, much harder. That is the reality.

Really, it’s a pretty shoddy way to deliver such dramatic changes to a sector. Where’s the consultation? Where’s the political argument?

Do you know more? Contact James Riley via Email.

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