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The R&D Tax Incentive Program in Australia

12/04/20 | 8 MIN READ

Exploring the advantages of doing research and development in Australia.

The Australian Federal Government’s R&D Tax Incentive Program, arguably one of the most generous tax incentives globally, is surprisingly easily available to both Australian technology companies and similar overseas establishments that have a presence in Australia.

The incentive offers generous tax offsets to companies undertaking R&D activities in Australia. In addition, pre-approved overseas R&D activities (and associated expenditures) are also eligible.

First, let’s understand the program and how it operates. Then, we’ll explore how the Program can be of significant benefit to overseas companies that undertake some or all of their R&D in Australia. Finally, we’ll examine the requirements for setting up a ‘permanent establishment’ in Australia – where a Double Tax Agreement (DTA) with Australia is necessary for overseas companies to access the incentive (there are approximately 45 such DTAs in place).

 

Administration of the Australian Federal Government’s R&D Tax Incentive Program

The program is jointly administered by AusIndustry (a division within the Department of Industry, Science, Energy and Resources) and the Australian Taxation Office (ATO). AusIndustry is tasked with assessing the ‘technical/scientific’ eligibility of the R&D activities; while the ATO manages the eligibility of the R&D expenditure that is being claimed by a company (through that company’s tax return).

Each organization has fairly stringent compliance requirements in assessing the eligibility of R&D activities and expenditure. This is essential for maintaining the integrity of the program, as it offers generous tax benefits for a wide range of R&D activity types and a fairly wide scope of R&D expenditure.

 

Eligibility Criteria for the Australian Federal Government’s R&D Tax Incentive Program

1. Company

In order for a company to claim the R&D Tax Incentive, that company must be a body corporate registered in Australia, or be a permanent establishment of an overseas company registered in Australia (where Double Tax Agreements are in place between the two countries).

2. Activities

Eligible R&D activities are broadly defined as those activities that a company will undertake outside their normal scope of business activities. These activities are undertaken for the purpose of generating new knowledge (typically in the form of new or improved materials, products, devices, processes, or services).

At the time these (core or experimental) activities are undertaken, their outcome could not be known or determined in advance based on current knowledge, information, or experience. The outcome of such activities can only be determined by applying the scientific principles of systematic experimental methodology to acquire new knowledge.

In addition to these core/experimental activities, there are other ‘associated’ activities that are necessarily undertaken to support the experimental activities. These supporting activities must be directly related to the core/experimental activities, or undertaken for the dominant purpose of supporting those.

In respect of compliance, AusIndustry has the expectation that companies maintain contemporaneous records that can substantiate the undertaking of such R&D activities. These may be in the form of project briefs, test reports, publications, lab books, correspondence of a technical nature, photographs, scientific/technical board meeting minutes. Such evidence may be called upon during compliance reviews or audits.

3. Expenditures

There are a number of categories of R&D expenditures that may be deemed eligible. These must be necessarily segregated from the ‘business-as-usual’ (or commercial) expenditure incurred on ‘non-R&D’ activities, as these expenditures are subject to the higher tax offset percentages (see later).

The broad categories of eligible R&D expenditure include:

  • Salaries / Wages: This is tracked as staff time spent on eligible R&D activities (as opposed to ‘business-as-usual’ activities).
  • Contractors or Consultants: These may be Universities, Research Organizations, Clinical Research Organizations (CROs), Pathology Laboratories, Clinical Manufacturing Organizations (CMOs), specialist external Scientific or Technical Consultants, Testing Facilities, and the like.
  • Materials: Oftentimes, raw materials are required for the R&D activities, and these may include biological materials, chemicals, prototype components.
  • Eligible Overhead Expenditure: These are the items of expenditure that a company incurs in enabling the operation of the business while undertaking R&D activities. These costs usually have to have the dominant purpose of supporting (or being crucial to) the R&D activities. Examples are utilities, rent, repairs & maintenance, security, R&D travel, staff technical training, specific state and federal taxes.
  • Depreciation: The decline in value for equipment or assets that are used for the R&D activities may be claimed at the higher R&D tax offset rate – to the extent that those assets are used in the R&D activities.

As with AusIndustry, the ATO has the expectation that claimant companies maintain adequate contemporaneous evidence of R&D expenditure, and how these are associated with the relevant R&D activities. These may be in the form of staff time-tracking, contracts, invoices, and appropriate apportionment methodologies (usually for eligible overheads), and may be called upon during compliance reviews or audits.

 

Benefits of the Australian R&D Tax Incentive

The R&D Tax Incentive offers two categories of tax offsets:

  1. For eligible companies with an aggregated (global) turnover of greater than $20M AUD in any one financial year, there is a non-refundable 38.5% tax offset. This typically equates to a tax offset (reduction in tax liability) of between 8.5% - 11% (depending on the specific company tax rate).

    For example, if a R&D company incurs $1,000,000 AUD in eligible R&D expenditure, that company can get a reduction in their tax liability (i.e., tax payable) of between $85,000 and $110,000 AUD. If a company is in tax losses, the non-refundable offsets are carried forward to future tax years, when they can be used to offset future tax liabilities.

  2. For eligible companies with an aggregated turnover of less than $20M AUD in one financial year, there is a refundable 43.5% tax offset. This typically equates to a refundable tax offset of between 13.5% and 16% (depending on the specific company tax rate).

    For example, if a R&D company incurs $1,000,000 in eligible R&D expenditure, AND that company is in tax losses (as many early-stage start-ups are), that company can get a $435,000 (cash) refund through their lodged tax return. If a company is profitable, an accountant is able to more accurately assess the quantum of refundable offsets or reduction in tax liability.

There is a cap of $100M AUD on R&D expenditure that can be subject to the relevant R&D Tax offset. Any amounts beyond that figure are subject to normal corporate tax rates.

This program then becomes very attractive to those in the Life Science sector, usually on account of the not-insignificant amounts necessary for the various phases of clinical trials (see Australia’s expertise in this regard later on).

 

Additional Benefits of the Australian R&D Tax Incentive

Foreign-Owned R&D

In order to attract Overseas talent to collaborate with Australia, the R&D Tax Incentive Program offers a unique incentive to companies based overseas.

Companies from countries with a Double Tax Agreement (DTA) with Australia can, with relative ease, set up a permanent establishment in Australia. The presence of any (overseas) company staff is optional, as the minimum legal requirement for such a company in Australia is for an Australian permanent resident or citizen to be appointed as a local Non-Executive Director. Australian professional services companies can assist in day-to-day business administrative roles, while R&D activities themselves may be contractually outsourced to Australian Consultants or Contractors (refer to earlier descriptions of these).

The process is best described with the aid of the following illustration:

Screenshot (5)

  • Step 1: The Overseas company establishes a permanent establishment (subsidiary or parent company) in Australia.
  • Step 2: The Overseas company formally contracts the related Australian company to undertake R&D activities on behalf of the Overseas company. The Overseas company may choose to fund the Australian R&D activities.
  • Step 3: The Australian company undertakes the R&D activities in Australia.
  • Step 4: The Australian entity sends the results of the R&D activities (IP) to the Overseas company, who then owns that IP. The Overseas company may choose to reimburse the Australian company for the IP.
  • Step 3A: If the Australian company does not have the relevant Scientific capability of Research/Technical personnel, they may opt to contract the R&D out to an Australian Contractor or Consultant.
  • Step 3B: In this case, the Australian company must own the results of the R&D (IP), and then ultimately send that to the Overseas company (Step 4).

In the above scenario, the Australian entity is eligible to claim the relevant R&D Tax offset for all R&D expenditures incurred in Australia.

In the case where the Australian company is reimbursed by the related overseas company, the Australian company can still claim the R&D Tax Incentive, as it meets the three major eligibility criteria (see Eligibility above).

 

Overseas R&D Activities

Quite often, Australian companies undertaking R&D projects come to the conclusion that specific aspects of their R&D project cannot be undertaken in Australia.

Following investigations, such a company establishes that the expertise required for their R&D projects simply do not exist, or are not immediately available to them in Australia.

This expertise may encompass such things as:

  • Access to expert knowledge (researchers, scientists),
  • Access to specialized equipment (unique engineering or technical machinery,
  • Access to specific living organisms (population groups [for clinical trials]; quarantine issues [viruses, plant material]; natural habitats), and/or
  • Access to geological features (soil, oil spills, rare/toxic chemicals)

In these instances, the company can apply to AusIndustry for an Overseas Finding, wherein the company puts forward a substantiated case as to the reasons why certain aspects of their R&D projects have to be undertaken overseas and not in Australia. These reasons are based on the 4 criteria listed above.

Once approved, the Finding allows such companies to claim the costs of those overseas activities as part of their R&D Tax Incentive claim and enjoy the higher tax offset benefit for those offshore activities.

An Australian company, related to an overseas company, can therefore undertake certain aspects of their R&D projects overseas, and claim the costs of the (approved) overseas activities as part of their R&D Tax Incentive claim.

This is true even if the Australian IP is being sent to the related overseas company – via the Foreign-Owned R&D provisions.

 

Regulatory Benefits

Australia’s equivalent of the FDA is theTherapeutic Goods Administration (TGA). The TGA has introduced a range of new prescription medicine application pathways that utilize overseas evaluations and accelerate market access. 

A well-respected regulatory advisory company, BrandwoodCKC, has estimated that US companies can save up to 60% of their Development and Clinical Trial costs by undertaking these in Australia. Furthermore, they’ve suggested that getting approval for some FDA-equivalent approvals and registration requirements takes a few weeks in Australia as opposed to many months in the USA.

Clinical Trials in Australia:
  1. Accepted in the USA as Early Feasibility Data.

  2. Accepted in Europe for the CE Mark Applications.

  3. International recognition for quality research (substantiation studies).

  4. Australia has more than 40 globally researchers, PIs, dedicated and purpose-built facilities, and associated support staff.

Human Research Ethics Committee and Governance:
  1. Approval ~ 4-12 weeks.

  2. Patients enrolled.

  3. Data generated.

The TGA has a pre-submission process with the same level of professionalism as that of the FDA.

 

Timing

The Australian tax/financial year operates from July to June of the following year. However, many American (& other) companies in Australia can apply for a Substituted Accounting Period – to align with that of the overseas entity. The AusIndustry application for Local R&D activities must be lodged within 10 months after the end of a specific financial year. That is, for the financial year ended 30 June 2020, eligible companies have 10 months - until 30 April 2021 – within which to prepare and lodge their AusIndustry applications.

During this time, the company – using records maintained throughout the year – calculates the eligible R&D expenditure amounts. These are forwarded to the company accountants, who incorporate these amounts in the company’s tax return. There is usually a short turnaround period, after which the Australian Taxation Office processes any R&D Tax refunds owing to the company. These tax refunds are deemed non-assessable income, and may be used by the company as they deem appropriate.

Many start-ups use these funds to further their R&D, employ new staff, or pay their founders.

 

Case Studies

  1. A multi-national pharmaceutical company, based in the USA, has an Australian subsidiary. The US parent company formally contracts the Australian subsidiary to undertake R&D for the parent company. The Australian subsidiary undertakes the R&D work in Australia, and sends the resulting IP to the US parent company. The Australian company claims the R&D Tax Incentive, AND is reimbursed by the US parent.

  2. A US-based MedTech company establishes a company in Australia. Through a successful Overseas Finding, the Australian entity is able to claim eligible R&D costs incurred BOTH in Australia and the USA. The amount refunded to the company via the tax return is in the millions of dollars.

Conclusion

On October 6, 2020, the Australian Treasurer announced in the 2020-21 Budget, that the rate of the refundable tax offset will be increased to 46% from July 1, 2021 onwards. This is an increase in 2.5% from the current refundable tax rate. This is a remarkable commitment to encouraging R&D, and in particular, to provide tangible incentives for SMEs to continue making technological advances. Larger companies (with an aggregated [global] turnover of more than $20M AUD are also in line to receive significantly higher (8.5% more) non-refundable tax offsets. The program is one of the most generous in the world and covers a wide range of activities and expenditure items.

The regulatory bodies have fairly simple and straightforward compliance requirements in the form of records and evidence that the R&D Tax claimants need to maintain on a contemporaneous basis.

It is also well known that many Life Science companies use the Australia’s TGA regulatory compliance framework to ‘springboard’ their developments for more efficient and faster FDA approvals in the USA. This is due in part to the FDA recognizing TGA approvals and registrations as being equivalent and meeting the strict requirements.

There are a number of overseas companies that are currently making use of this program (including the Foreign-Owned and Overseas Finding provisions) and their refundable tax offsets have often been in the millions of AUD. However, any overseas company wishing to explore the options outlined above needs to carefully consider the various issues that will impact such a decision. The trusted advice of relevant business professionals should be sought to confirm the feasibility of proceeding with some of the suggestions mentioned here.

This information presented in this article is provided by Dr. Pavel Reddy, Managing Director of Clearpoint Ventures  based in Melbourne, Australia.  As Dr. Reddy has said himself, he is "a scientist first and R&D tax advisor second.”  He is genuinely interested in seeing tech startups succeed and has created a consultancy and a network of partnerships to help US companies set up in Australia as well as helping Australian companies get into the US market.

The information presented is meant to provide a high-level overview of the salient points of the program. For more detailed information, please review:

Australian Research and Development Tax Incentive

Australian Government - Australian Taxation Office

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