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Two written warnings from the Australian Taxation Office over tax offsets for research and development expenditures reflect long-standing problems with the multi-billion dollar program that have left companies “bruised” and confused, tax professionals warn.
Some say the situation will lead to an uptick in litigation. Others suggest companies will shift research and development activities offshore, and there are widespread calls for a crackdown on inept and poorly regulated advisers that purport to be R&D tax specialists.
Commenting on the new ATO alerts, Kris Gale, chairman of R&D tax consultancy Michael Johnson Associates, told Bloomberg BNA Feb. 13 that they provided limited insight into the tax administrator’s thinking and there could be a “significant amount of litigation” as companies turn to the courts for clarity.
BDO tax partner Graham Wakeman agreed businesses were receiving insufficient guidance on how to make legitimate claims under the R&D tax incentive framework, Feb. 13, telling Bloomberg BNA a 2016 tribunal decision provided an early indication that the ball had already “started rolling” on the litigation front.
The research and development tax incentive provides a 38.5 percent tax offset for eligible R&D expenditure of up to A$100 million ($76.7 million) a year to businesses with revenue above A$20 million ($15.3 million).
Businesses with revenue below A$20 million receive a more generous 43.5 percent offset in the form of a cash refund.
In 2013-14, more than 13,700 entities spent A$19.5 billion ($15 million) on R&D, claiming total benefits of around A$3 billion ($2.3 billion), according to the ATO.
The program works on a self-assessment basis, with a federal agency known as AusIndustry managing the registration of R&D activities and vetting some, and the ATO performing the same functions for claims made for R&D expenditure.
An AusIndustry snapshot of how the program operates describes it as providing “generous, easy to access support for business innovation.”
However, the two new alerts, issued Feb. 9, show the ATO and AusIndustry are concerned some companies are playing fast and loose with the program, which the government had anticipated would cost significantly less.
Concerns identified in the general alert include claims made when “no R&D activities are being conducted at all,” or for activities that include a mix of eligible and non-eligible activities, or for activities that started as R&D but have transitioned into ordinary business actions.
The separate construction industry alert says expenditure on building or construction activities is expressly excluded from the program and warns that the ATO has identified contractual arrangements between builders and clients that result in clients lodging claims relating to ineligible expenditure.
The alerts specify that the ATO will contact companies about their R&D tax incentives claims if they are using advisers “who may apply high-risk practices.”
It will also scrutinize companies that claim a level of expenditure that is “high for the industry or stage of business” or if they register R&D activities using broad descriptions that don’t distinguish R&D from ordinary operational activities.
MJA’s Kris Gale said the alerts reflected a change in attitude by the government which, after initially strongly promoting the tax incentives regime, had now become concerned about its costs.
Program participation has come close to doubling over the last six years, he said, and that has also involved “a growth in claims of concern.”
However, the ATO alerts largely boil down to “you have to follow the law,” Gale said.
That’s of limited help to companies making claims that involve potentially contentious R&D activities, and if the ATO delivers a knock-back, “you can only go to the courts,” he said.
Gale said his company has detected within industries such as mining and construction, where the ATO has been more cautious about allowing claims, “a view that these matters are best resolved by the courts.”
Gale, who is a member of the national reference group on the R&D tax incentive that is jointly chaired by ATO and AusIndustry, said a key problem with the existing regime is that there are too many poorly skilled advisers assisting companies with their claims.
There is a “huge variability of service provision,” he said. “There are definitely people out there who are providing negligent and poor advice.”
The ATO alerts are partly designed to “scare the poor service providers straight,” said Gale, but he doubts that will work as few claims are checked.
That means most clients of the shonky providers are likely to receive their refunds “no questions asked,” he said.
Gale suggested it would be preferable for the ATO to instead work on clarifying the “areas of competence” that service providers need.
BDO’s Graham Wakeman agreed the alerts reflect concerns about the expense of the tax offsets program.
“The cost of the scheme is more than what they had anticipated,” he told Bloomberg BNA Feb. 13. “It is pushing up to about A$3 billion a year and I think it was budgeted at just over A$2 billion.”
Wakeman said “there is bad advice out there” and said it made sense for the ATO to pursue certain advisers and review their claims.
He agreed that an increase in litigation was likely as companies seek greater clarity, and noted that in January 2016 a pharmaceutical company won a dispute with AusIndustry over what constitutes eligible R&D ( JLSP v. Innovation Australia, AATA 23, 1/22/16).
Wakeman noted that a significant amount of litigation occurred in the 1990s under the previous R&D tax incentive regime, which was replaced in 2011.
“I think we are on the threshold of a similar kind of process to what we went through in the mid-1990s,” he said.
KPMG R&D incentives national partner David Gelb Feb. 14 told Bloomberg BNA it was “absolutely appropriate” that regulators pay close attention to the program, given the cost blow-out.
“What is important is that they get the balance right in terms of the targeting of their scrutiny,” he said.
Gelb noted that small companies and start-ups now account for between 60 percent and 70 percent of the entire program.
“That is the space where the costs have increased exponentially,” he said.
He agreed something must be done about the “burgeoning cottage industry” of poorly-skilled advisers that often target smaller companies.
“It’s an area which has not been regulated,” he said, adding that proper accreditation, training and auditing procedures should be introduced.
MJA’s Gale noted that since 2008 businesses have had to contend with the almost constant prospect of legislative changes or administrative review of R&D tax offset arrangements and Gelb agreed the uncertainty had taken its toll.
He noted that four different ministers have been responsible for the issue over the past several years, adding that the most recent program review—to which the government has yet to formally respond—could result in many large companies being denied access to R&D tax offsets.
Furthermore, “there are inconsistencies in terms of how the law is being interpreted by companies and the regulators,” he said.
“Industry at the moment is feeling very bruised when it comes to this matter,” he said.
Gelb isn’t sure that the end result will be more litigation, stating that “it depends on the facts of the case, the size of the claim and who you are as an organization.”
However, he cautioned that it could result in companies opting to shift R&D to countries where the “policy settings are more stable.”
The ATO prepared the new alerts in conjunction with the Department of Industry, Innovation and Science, which last month issued updated advice on common errors on R&D registration applications.
The department’s concerns included applications to register entire projects, rather than just the R&D components, and failing to designate a specific hypothesis that is being tested.
Industries “where mistakes are more common” included the mining industry, software development, construction and farming, the department said.
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"Taxpayer Alert TA 2017/3: Claiming the Research and Development Tax Incentive for ordinary business activities" is available at https://www.ato.gov.au/law/view/print?DocID=TPA%2FTA20173%2FNAT%2FATO%2F00001&PiT=99991231235958.
"Taxpayer Alert TA 2017/2: Claiming the Research and Development Tax Incentive for construction activities" is available at https://www.ato.gov.au/law/view/document?Mode=type&TOC=%2203%3ATPA%3A2017%3A%2300002%23TA%202017%2F2%20-%20Claiming%20the%20Research%20and%20Development%20Tax%20Incentive%20for%20construction%20activities%3B%22&DOCID=%22TPA%2FTA20172%2FNAT%2FATO%2F00001%22.
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