Tax Incentives Available for Software Development
Building a software application indicates that a business is ready to scale up and grow to the next level. As you might expect, this is exactly the sort of market stimulation the government thrives from. Given that’s the case, let’s take a look at some of the tax incentives available to help businesses justify the investment on software development.
This article looks primarily at two initiatives: the R&D tax incentive as well as software depreciation/the instant asset write off. There are a number of grants also available to businesses considering development, however this article is focused on tax incentives once the investment has already been made.
R&D Tax Incentive (R&DTI)
The R&D tax incentive is an initiative that encourages Australian companies to dive deeper into the unknown and as we like to say at WorkingMouse, discover new boundaries.
- You may be eligible to receive between 8.5% and 43% of the expenses on R&D activities back.
- These percentages depend on the company revenue and profitability.
- Spend $20,000 or more on eligible activities (or go through a registered Research Service Provider).
- The R&D activities have taken place within Australia (there are some exceptions to this).
- Operate as a company.
It’s good that we still have you, because this is where it can get a little more complicated.
First things ﬁrst, eligibility is not done on a project basis. Rather, eligibility is determined on a per activity basis. So let’s say you’re building a ﬁsh recognition app, where there is an element of machine learning along with pretty basic front end. The activities around creating a machine learning model that can accurately predict a ﬁsh species may be eligible activities, whereas building the front end of the app which includes creating a user account and a login screen may not be eligible.
R&D activities have two key criteria they have to satisfy. They must meet all criteria in order to be eligible to claim.
Conducting experimental activities
The outcome of the experimental activities cannot be known or worked out before the experiment is carried out based on the knowledge or experience of a competent professional.
You won’t be eligible if a simple Google search would have given you an answer before the experiment started.
Generating new knowledge
The knowledge generated must be new. It can’t have been available or reasonably accessible to the public at the time the R&D activities were conducted.
Businesses are expected to do a thorough search to ensure the knowledge doesn’t already exist or is not publicly available, and to keep records of their search.
The Government has noted that while you can’t absolutely prove that the knowledge you need doesn’t already exist, you are expected to make reasonable attempts to ﬁnd out. For example, undertaking a search of major open-source code repositories (such as GitHub) and/or tech blogs, consult with your professional network and ask questions on tech forums.
How to write a hypothesis
One of the core elements of the R&D tax incentive is to create a hypothesis in order to discover new boundaries. If you’re like me, it’s been a long time since Year 12 Chemistry and writing a hypothesis doesn’t come naturally. So there are a few frameworks that we recommend based on our previous submissions.
Framework 1: How might we statement
A how might we statement should be the backbone of any software project. Good products solve problems, so it’s important to articulate and document the problem. That statement then becomes the framework for your hypothesis.
Let’s go back to the earlier ﬁshing example. An example of that as a problem statement is; how might we create a user friendly way to identify ﬁsh species in real time.
That problem statement can then be broken down on a per activity basis (remember, we’re focused on the activity not on the project). How might we create an accurate machine learning model that will identify a ﬁsh species in real time? Based on the results of that activity, you may have a systematic progression to a future activity: how might we improve the accuracy of a machine learning model to better identify ﬁsh species?
Framework 2: Scientiﬁc approach
The scientiﬁc approach asks for a bit more information. It sets up your project as an experiment. This is what you believe, what you’ll do and this is how you’ll know that you’ve succeeded.
The name of this test is ______________________ (test name)
It will begin on //__ and ﬁnish on //__ (test dates)
It will cost ______________________ (resources & money)
We believe that ______________________ (the solution) ______________________ (to these people) will result in ______________________ (this outcome)
We will do this by ____________________________________________
We will know we are successful when
What’s not eligible under the R&DTI
There are some activities that have been classiﬁed by the Government as ineligible as core R&D activities. What this means is that on their own, they aren’t R&D activities, however they may be supporting activities.
Developing, modifying or customising software for the dominant purpose of use for your company’s internal administration is not a core R&D activity. Some other examples given include user acceptance testing, requirements testing, routine computer and software maintenance, any kind of data manipulation.
When applying for the R&D tax incentive it is critical to have supporting documentation for your claim. Here are some examples that may provide clarity when proving your activities meet the criteria.
In order to show that the outcome was unknown in advance of the experiment you may want to show:
- Screenshots of questions posted on tech blogs,
- Literature reviews,
- Conversations with industry experts.
To show that the purpose is for generating new knowledge you may want to show:
- Team discussions,
- Board meeting minutes,
- Hypothesis documentation
To show that it follows a systematic progression of experimental work:
- GANTT project management charts,
- Records of each step,
- Progression or gates that demonstrate systematic progress.
Expenditure is linked to an eligible activity:
- Invoices from an agency,
- Scoping documents.
What are the next steps?
The answer depends on what stage of the process you’re at. If you’re yet to commence the R&D activities, then the next step is to setup your experiment. Keep records and documentation to save yourself the headache of looking for everything retrospectively.
If you’re like many and are either currently undertaking the R&D activities or have already completed them then your next steps differ slightly.
Start compiling all your supporting documentation. It’s also important that you consult a professional before lodging your claim — there are R&DTI specialists that are well versed in lodging these claims.
Don’t wait too long. You need to apply to register your R&D activities within 10 months of the end of the income year where they took place. If you undertook R&D activities in the 2020-21 ﬁnancial year, you have until the April 2022 to lodge your claim.
The R&D Tax Incentive Schedule instructions are available here.
The R&DTI has evolved over time, with many suggesting that it’s become stricter and more ambiguous with regards to its application to the software development industry.
This is a bit of a problem given that 80 percent of the tax incentive claims are from small and medium enterprises, with 48 percent coming from the software development industry.
The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell said in a submission to the Federal Government’s Financial Technology Inquiry that the current system is unsuitable for software development in its current form.
“The R&D Tax Incentive eligibility requirements need to be changed so that it is clear and simple to claim tax incentives under the existing scheme,” Carnell said.
“Alternatively a dedicated software development incentive should be created to promote investment and growth in the sector.”
Should the Government be doing more to promote advances in technology above and beyond the R&DTI? The incentive itself is good, the issue lies in the restrictive application of it. Every time a business decides to invest in software development, they’re investing in their growth. Scaling up and competing on the global stage is no easy feat. Shouldn’t that type of investment be rewarded to promote more home-grown success stories like Atlassian?
There are a number of grants available in the space, but again they are competitive and have difﬁcult eligibility requirements. It’s easy to see why experts have been calling for more initiatives to promote growth in the tech sector.
Keep in mind that businesses will soon be able to access the R&DTI through a new digital platform. Deloitte was awarded a $1.1 million contract in July 2020 to build a new customer portal for the scheme.
What happens when you’re not able to claim your expenses under the R&DTI? All hope may not be lost.
Depreciation/Instant asset write off
First thing to note with the depreciation rules/instant asset write off is that we’re not talking about off-the-shelf systems that you license. As the ATO website puts it: in-house software is computer software, or the right to use computer software that you acquire, develop or have someone else develop for your business use.
This won’t apply to your Adobe licenses, or your Hubspot license — this is for software that you’ve built for your internal use.
There are three ways you can depreciate the cost of the software application.
- Business costs,
- Software development pools,
- Disposal of in-house software.
We won’t go into depth about these techniques, that’s a question for your accountant. What we will say however is that the instant asset write off amount was increased to $150,000 as a way of stimulating the economy during COVID19.
That may inﬂuence your decision on which method you choose to depreciate the cost of the application. The previous ﬁgure of $30,000 was significantly smaller than the cost of building a software application.
Pros and cons vs R&DTI
The biggest con is that it’s a deduction whereas the R&DTI is an offset. Where you may receive all the expenses incurred on R&D under the R&DTI, you’re only likely to receive a beneﬁt of about 30% under depreciation/instant asset write off.
On the ﬂip side, it’s a far easier threshold to meet. As long as you’re developing software for in-house use, you’re likely to be eligible.
Put bluntly, not every application or project will generate new knowledge. The R&DTI should be your ﬁrst priority but understand that you may need to fall back to a simple asset depreciation.
This article should not be construed as legal or ﬁnancial advice. This should give you an introductory understanding of some of the incentives available before you seek further professional advice.