Tax Incentives Available for Software Development

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.

Benefit:

  • 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.

Initial re­quire­ments:

  • 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.

Eligible ac­tiv­i­ties

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.

  1. 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.

  2. 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.

Supporting doc­u­men­ta­tion:

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.

General com­men­tary:

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.

Please note:

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.

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Yianni Stergou

Marketing en­thu­si­ast and FIFA ex­tra­or­di­naire

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