How to respond to ATO compliance reviews

Do you need help with ATO compliance?

 Call us on 1300 658 508 to help.

Oh Crap!

Have you received an unexpected letter from the ATO regarding your R&D tax incentive claim?

First, don’t panic.

Let’s dive into understanding the purpose and response approach.

What is an ATO compliance review? 

Compliance letters are sent by the Australian Taxation Office (ATO) as a part of their routine process to verify the R&D tax incentive claims made by businesses.

Why do businesses receive ATO compliance letters? 

Though some reviews might be initiated randomly as part of routine checks, there are specific triggers or reasons that can lead to a closer look at a particular business’s claim.

Here are the top five reasons:

  1. High R&D costs versus total costs: When a company reports a disproportionately high amount of its spending dedicated to R&D compared to its total expenditures, it can stand out. Such anomalies may lead the ATO to probe deeper into the nature of the reported R&D activities and costs.
  2. Payments to associates: Transactions directing significant R&D funds towards associated or affiliated companies can draw scrutiny. The ATO will typically want to ensure that these transactions are genuine and reflect real R&D work rather than being avenues for shifting funds or inflating R&D claims.
  3. High ATO debt: If a business continually has a sizeable outstanding balance with the ATO, yet concurrently lodges substantial R&D claims, it might raise eyebrows. The ATO could perceive this as a strategic move by the company to expedite the clearance of its ATO debt without severely impacting its cash flow.
  4. History of Non-compliance: A company’s past interactions with the ATO matter. Those with previous compliance issues, be it related to R&D claims or other tax matters, are more likely to have their subsequent claims reviewed more thoroughly.
  5. Sector-specific Scrutiny: At times, the ATO might focus on specific sectors or industries, especially if they’ve observed patterns of non-compliance or discrepancies within those sectors. Companies operating in such targeted sectors may face a higher likelihood of reviews. Occasionally, the ATO directs its attention towards particular industries, especially if there have been noted trends of non-compliance or inconsistencies within those sectors. Industries like software development, the building industry, and agri-food have specific guidance due to their unique R&D challenges and nuances.

Wondering if your ATO compliance meets the mark? 

Send us a message to get an expert’s take.

ATO compliance letters

 

What should you do next?

When you receive a compliance letter from the ATO, it’s natural for a mix of emotions to set in—concern, confusion, maybe even a touch of anxiety.

Yet, the first steps you take can greatly impact the ease of your response process:

  1. Thorough Reading: As soon as you get the letter, allocate some quiet time to read it meticulously. Understand the specifics of what the ATO is seeking.
  2. Mark the Deadline: Identify the deadline for your response in the letter. This is a pivotal date. Record it prominently on your calendar and perhaps set multiple reminders to ensure you don’t miss it.
  3. Send an Acknowledgment: Before diving into any other actions, notify the ATO that you’ve received their letter. This establishes a line of communication and signals your intent to cooperate.
  4. Hold Off on Detailed Information: While you might be inclined to provide the ATO with immediate answers, it’s advisable to delay sending detailed information until you’ve sought expert advice.
  5. Consult with Your Accountant: Bring the letter to your accountant’s attention. Their insights on your financial statements and past tax returns can be instrumental in crafting a response.
  6. Engage an R&D Tax Consultant: Given the specialised nature of the R&D tax incentive, involving an R&D tax consultant can be invaluable. They’ll have a deeper understanding of the intricacies of the claims and can guide you through the response process.
  7. Consider a Tax Lawyer: If there’s ambiguity or complexity in your claim, or if the amount in question is substantial, think about consulting with a tax lawyer. Ensure you choose one with a strong track record in R&D claims.
  8. Formulate a Response Strategy: Once you’ve sought advice from the relevant professionals, start planning your response. This includes gathering necessary documentation, crafting a well-articulated reply, and determining a timeline to ensure you meet the ATO’s deadline.

What info does the ATO want?

Financial Statements (including the year prior for comparative figures)

  • a statement of comprehensive income with notes (also known as a statement of financial performance or profit and loss statement)
  • a statement of financial position with notes (also known as a balance sheet)

R&D Contract Expenditure

  • a breakdown of the amounts that comprise this expenditure
  • a list of the names and ABNs of the contractors that provided their services to your R&D activities, and the total amount charged by each contractor
  • details of the work that was conducted by each contractor during the income year
  • documents supporting the amount claimed, including: invoices, agreements and contracts

R&D Salary Expenditure

  • the name of the employee/s who contributed to your R&D activities
  • a description of the work they undertook during the year and how it relates to your R&D activities
  • a schedule showing how much was charged in relation to each employee for their contributions to your R&D activities, and ordinary business activities
  • an explanation of the basis used to allocate costs between R&D and ordinary business activities, and provide working papers that support your allocation
  • documentation supporting your claim including a sample of items such as diaries, time sheets, job sheets, and/or minutes of meetings

R&D Other Expenditure

  • a breakdown of the amounts that comprise this expenditure, including a description of the expenditure, and the dollar amount
  • the basis of any apportionment of costs between R&D and your ordinary business activities
  • documents supporting the total amount claimed as other R&D expenditure and the payment of this expenditure, including, but not limited to, invoices, contracts, agreements, receipts, bank statements and loan agreements.

R&D Paid to Associates Expenditure

  • the full names and ABNs of the associates you paid
  • the amount you paid to each associate
  • documents supporting the engagement of the associate to undertake the R&D work, including agreements and contracts
  • documents that demonstrate these amounts had been incurred and paid, including but not limited to, invoices, receipts, bank statements, loan agreements, and ledger accounts.

Want to ensure your R&D claim process is watertight?

 Call us at 1300 658 508 for a quick chat.

ATO compliance letters

Financial Statements   

Profit and Loss

This document provides a detailed overview of a company’s revenues, costs, and expenses over a specific period, typically a financial year. Here’s what they’d be interested in:

  • Revenues: All sources of income, including sales, grants, interest income, etc.
  • Costs and Expenses: This includes operational costs, cost of goods sold, administrative expenses, R&D expenditures, and more.
  • Net Profit or Loss: Essentially, revenues minus expenses.
  • Notes: These provide additional information about specific items in the statement, offering clarifications, breakdowns, or explanations. For instance, if there’s a significant spike in R&D expenses, the notes might offer a detailed breakdown or explain the reason for the spike.
  • Comparative Figures: By including the previous year’s numbers, the ATO can compare and look for significant changes or anomalies. If R&D expenses doubled from one year to the next, for example, they’d want to understand why.

Statement of Financial Position with Notes (also known as a Balance Sheet)

This document offers a snapshot of a company’s financial position at a specific point in time, detailing its assets, liabilities, and equity. Here’s a deeper look:

  • Assets: These are resources owned by the company that have economic value. This can range from cash, accounts receivable, inventory, to intellectual property and more.
  • Liabilities: These represent the company’s obligations, both short-term (like accounts payable or short-term loans) and long-term (like mortgages or long-term loans).
  • Equity: This reflects the ownership interest in the business and is the difference between assets and liabilities. It includes items like retained earnings and shares.
  • Notes: These are essential to understand the specifics behind certain items on the balance sheet. For instance, if there’s an intangible asset listed as “Patent,” a note might explain the nature of the patent, its acquisition cost, and any associated amortisation.
  • Comparative Figures: The ATO will look at the previous year’s numbers to identify any significant changes in assets, liabilities, or equity which might impact or be impacted by R&D activities.
By requesting these specific financial statements, the ATO aims to ensure that R&D claims align with the overall financial activities and position of the company, and that everything is above board.  
 

R&D Contract Expenditure

When the ATO asks for details about the R&D Contract Expenditure, they are probing into the specifics of external entities that the company has engaged for its R&D activities. By understanding the nature, value, and substantiation of these external engagements, the ATO can verify the genuineness and eligibility of these expenditures as R&D claims.

Breakdown of the Amounts that Comprise this Expenditure

Here, the ATO wants a detailed decomposition of the total expenditure figure claimed under R&D contracts.

This could include:

  • Different types of activities or projects for which contractors were hired.
  • The respective costs associated with each activity or project.
  • Any specific milestones or phases within a larger project and their associated costs.

This breakdown helps the ATO to understand how the total contract expenditure figure was arrived at and if each component aligns with eligible R&D activities.

List of Names and ABNs of the Contractors

This is a straightforward request for transparency:

  • The company needs to list every contractor they engaged for R&D activities.
  • Along with the name, the Australian Business Number (ABN) is crucial as it verifies the legitimacy of the contractor and ensures they are registered for business in Australia.
  • The total amount charged by each contractor gives the ATO an idea of the scale and value of work done by each entity.

Details of the Work Conducted by Each Contractor

The ATO requires a comprehensive description of the R&D activities each contractor undertook:

  • This can include the nature of the research, experiments, or developmental activities they were involved in.
  • The specific goals or objectives they were aiming to achieve.
  • Any challenges or uncertainties they were attempting to address or resolve.

By understanding the nature of the work, the ATO can assess whether the described activities genuinely qualify as R&D according to the set guidelines.

Supporting Documents:

These documents serve as evidence for the claimed expenditures:

  • Invoices: These provide a clear record of the amount charged by the contractor, the nature of services rendered, and the dates of service.
  • Agreements and Contracts: These are crucial as they detail the terms of engagement between the company and the contractor. They can provide insights into the scope of work, deliverables, payment terms, and other contractual specifics. This helps the ATO understand if the contract was genuinely for R&D activities and if the costs align with market rates.

Things to check:

  • What is owed – One extra thing I would examine is is how much is still owed to the contractor to make sure it doesnt fall under a ‘loan’ by the contractor

By requesting this detailed information on R&D Contract Expenditure, the ATO is ensuring that businesses aren’t inflating their R&D claims or including non-eligible activities under the guise of contracted services.

Ready to deep dive into the intricacies of R&D compliance?

 📅 Book a one-on-one meeting here

ATO compliance letters

R&D Salary Expenditure

Salaries are a major component of R&D expenditures for many companies.

The ATO wants to ensure that the amounts claimed under salaries are genuinely related to R&D activities, and not just general operational costs disguised under the R&D umbrella.

Here’s a deeper understanding of each requirement:

Name of the Employee/s who Contributed to R&D Activities:

This is straightforward but essential:

  • Listing the employees ensures transparency and offers a direct link between claimed expenses and specific individuals.
  • It allows the ATO to see who was involved in the R&D process and potentially validate their roles if needed.

Description of the Work They Undertook

Here, the ATO is seeking clarity on the nature of R&D activities:

  • What are their titles?
  • What specific tasks did each listed employee perform?
  • Were they involved in hypothesis testing, experiments, analysis, or any other R&D specific function?
  • How do these tasks relate to the broader R&D objectives of the company?

This helps the ATO determine if the work aligns with the definitions and criteria for R&D activities.

Schedule of Charges per Employee:

This component breaks down the financial aspect:

  • How much of each listed employee’s salary was attributed to R&D activities versus regular business operations?
  • It provides a clear financial distinction between general work and R&D-specific work for each employee.

Explanation of Cost Allocation:

Given that many employees might split their time between regular tasks and R&D activities:

  • How did the company decide what portion of their salary goes under R&D expenditure?
  • Was it based on hours spent, specific milestones achieved, or some other metric?

The working papers that support this allocation could include internal reports, task tracking tools, or project management breakdowns that show an employee’s involvement in R&D.

Supporting Documentation:

These documents validate the claims:

  • Diaries or Time Sheets: These can offer a day-by-day or hour-by-hour breakdown of an employee’s tasks, clearly showing time spent on R&D activities.
  • Job Sheets: These might provide a more task-oriented view, detailing specific R&D jobs or projects an employee worked on.
  • Minutes of Meetings: These can be useful, especially if they detail brainstorming sessions, progress reports, or discussions related to R&D challenges and solutions.

In essence, with the R&D Salary Expenditure section, the ATO wants to ensure that the claimed salary costs genuinely reflect work done towards research and development, and are not just a way to inflate R&D claims.

They’re seeking both quantitative (how much) and qualitative (what kind of work) clarity.

Do you need help with ATO compliance?

 Call us on 1300 658 508 to help.

ATO compliance letters

R&D Other Expenditure

This section encompasses all other costs associated with R&D activities that aren’t covered under contracts or salaries.

It’s a broad category, and the ATO is keen on ensuring that businesses don’t use this as a catch-all for non-specific or non-eligible expenses.

Breakdown of the Amounts:

Here, the ATO is looking for specifics:

  • What does each expense item or category represent? This could range from equipment used specifically for R&D, costs related to prototype materials, licensing fees for specific research tools, and more.
  • A clear description of the nature of each expense provides context. For instance, if a company claims costs for a software license, what role did that software play in the R&D process?
  • The dollar amount associated with each item or category gives the ATO a sense of scale and allows them to gauge if the expenses are in line with industry norms and R&D expectations.

Basis of Cost Apportionment:

Given that some expenditures might be shared between R&D and other business activities:

  • How did the company determine what portion of the expense is attributed to R&D?
  • Was it based on usage metrics, time allocations, project-specific costs, or some other methodology?

This distinction ensures that only the genuine R&D-related portion of an expense is claimed under the incentive.

Supporting Documentation:

These are the materials that substantiate the claimed expenses:

  • Invoices: These detail the vendor or service provider, the nature of the expense, the amount, and the date, ensuring the claimed costs were indeed incurred.
  • Contracts or Agreements: If there’s a longer-term engagement or a significant purchase, contracts offer a detailed view of terms, deliverables, and costs.
  • Receipts: For smaller or one-off expenses, receipts provide a direct record of the transaction.
  • Bank Statements: These can validate payments, especially if there’s a need to correlate expenses with specific bank transactions.
  • Loan Agreements: If the company took a loan specifically for R&D activities or equipment, these agreements can validate the nature and purpose of the loan.

By examining the R&D Other Expenditure section in detail, the ATO wants to ensure that every dollar claimed under this category has a direct and valid link to R&D activities.

They are keen on filtering out generic business expenses or any costs that might not fit the stringent criteria of R&D.

You are about to lose your R&D rebate!

We have seen it happen!

 Call 1300 658 508 to help.

ATO compliance letters

R&D Associate Expenditure

This is the main area the ATO examine because it is the easiest way to manufacture fake R&D expenses.

They want to make sure it has actually been paid.

The ATO scrutinises the expenditure related to associates carefully to ensure that the claims are legitimate and directly related to R&D work.

Here’s a more in-depth explanation of each requirement:

The Full Names and ABNs of the Associates You Paid:

This basic but crucial detail achieves two objectives:

  1. It establishes transparency by listing the associates involved, thereby giving the ATO the ability to cross-check the legitimacy of these entities.
  2. It offers a direct link between the expenses claimed and the associates, allowing the ATO to easily validate their roles if necessary.

The Amount You Paid to Each Associate:

Here, the ATO wants specificity:

  1. What is the total amount paid to each listed associate?
  2. Does this amount correspond to the scope and nature of the R&D activities they were involved in?

This helps the ATO assess if the costs are reasonable and aligned with the R&D objectives.

Documents Supporting the Engagement of the Associate:

In this section, the ATO is interested in formal documentation that outlines:

  1. What was the scope of work or service provided by each associate?
  2. What were the terms and conditions of their engagement, including payment terms?

This documentation can include contracts, agreements, and even formal emails that set out the terms of the engagement.

Supporting Documentation:

The focus here is on corroborating the claims:

  1. Invoices and Receipts: These provide direct evidence of payments made to each associate, clearly indicating the services rendered and their corresponding costs.
  2. Bank Statements: Financial statements showing transactions between your business and the associate can serve as an additional layer of proof that payments were actually made.
  3. Loan Agreements: If the associate was paid via a loan, documentation of this arrangement should be included. This provides context and justification for the expenditure.
  4. Ledger Accounts: Ledger entries can be a useful way to track the history and specifics of each payment made to an associate. These entries should correspond with other financial documents provided.
  5. Contracts and Agreements: These documents should outline the terms of engagement, the scope of work, and other contractual obligations. They help to verify that the associate was genuinely engaged for R&D work.
  6. Timesheets: Since associates in this context are not at arm’s length and should be treated similarly to employees, timesheets are critical

In summary, when it comes to the R&D Associate Expenditure section, the ATO aims to confirm that all expenditures related to associates are both relevant and justifiable within the context of R&D activities.

They seek quantitative (the amounts) and qualitative (the nature of engagement) information to validate these claims.

 

You have been warned!

 Call us on 1300 658 508 to help.

ATO compliance letters

 

How to respond to an ATO compliance letter?

Responding to the ATO in a structured and organised manner is not only courteous but also crucial to ensure a smooth and efficient review process. Here’s a suggested format for structuring your response:

Centralised Digital Storage

Use a cloud storage platform like Dropbox or Google Drive. This ensures that documents are easily accessible and can be shared without concerns over file sizes.

Logical Folder Structure

  • Main Folder:Name it with the Company’s Name and Financial Year (e.g., “Bulletpoint R&D 2022-2023”).
  • Sub-Folders: Create sub-folders for each major category they’ve asked for (e.g., “Financial Statements”, “R&D Contract Expenditure”, “R&D Salary Expenditure”, etc.).

Clear and Descriptive Filenames

Ensure each file’s name directly relates to what the ATO has requested. For instance, if they’ve asked for “a breakdown of the amounts that comprise this expenditure”, the file could be named “R&D Contract Expenditure Breakdown.xlsx”.

Use Editable and Common File Formats

  • For data that may need calculations or analysis, spreadsheets (Excel or Google Sheets) are preferred over PDFs.
  • However, for scanned receipts, contracts, or agreements, PDFs are appropriate.
  • Ensure the files don’t have editing restrictions unless necessary.

Include an Index or Guide

Within your main folder, have an introductory document (e.g., “Index” or “Guide to Submitted Documents”). This document should:

  • List all the files and a brief description.
  • Provide a sequence in which they should be reviewed, if necessary.

Annotation and Notes

If certain files or data points need clarification, consider including a separate ‘Notes’ section in the document or an accompanying ‘ReadMe’ file.

Keep a Backup

Always keep a backup of everything you send. This is vital if there are any disputes or if you need to refer back to what was submitted.

While it might feel frustrating or adversarial, always approach the situation with a mindset of collaboration.

The goal is to present a clear, honest, and easily verifiable case to the ATO.

The onus is on you to prove their claim’s validity, so making the ATO’s verification process easier can be in your best interest.

By following this structured and transparent approach, you not only make the ATO’s job easier but also demonstrate a commitment to honesty and thoroughness, which can only benefit your claim.

Wondering if your ATO compliance meets the mark? 

Send us a message to get an expert’s take.

ATO compliance letters

What are the big red flags the ATO looks for?

Responding to an ATO inquiry on your R&D claims can be a meticulous process. It’s a dance between providing just the right amount of information and ensuring every piece of data paints a consistent picture.

While you want to come across as transparent and organised, there are pitfalls you must avoid.

These pitfalls, often appearing as red flags to the ATO, can trigger increased scrutiny and potentially complicate your claim process. Here are five such red flags and how best to avoid them:

  1. Disorganised Documentation: Avoiding clarity can be your downfall. Whether it’s a maze-like structure of digital folders or a stack of unsorted physical papers, disorganisation can immediately cast doubts on the authenticity and reliability of your claims. Whenever you’re sending information, be it digitally or in hard copy, ensure it’s structured in a logical, easy-to-follow manner. For physical copies, tools like binders, tabs, and dividers can be instrumental.
  2. Information Overload and Vagueness: There’s a balance to be struck between clarity and overload. Flooding the ATO with excessive or redundant data, hoping they won’t scrutinise everything closely, can backfire. On the flip side, offering too vague or brief explanations can lead to further questions or suspicions. It’s always best to be specific, detailed, and stick to the point, providing only what’s necessary and relevant.
  3. Unwarranted Delays: While everyone can face unforeseen challenges, consistently dragging your feet or postponing your response can signal evasion or unpreparedness. If you genuinely need more time to gather all necessary documents or ensure everything is in order, it’s wiser to request an extension early in the process. This shows proactiveness and respect for the ATO’s procedures.
  4. Bypassing Professionals: R&D claims and their associated processes can be intricate. Deciding to go solo, bypassing your accountant or R&D consultant, can lead to inadvertent mistakes or omissions. We are equipped with the expertise and experience to guide you, ensuring your responses align with the ATO’s expectations and avoid potential pitfalls.
  5. Inconsistencies and Over-disclosure: Every piece of data, every narrative, and every figure you submit must be consistent across all documents. Even unintentional discrepancies can raise flags about the authenticity of your claims. While you want to be transparent, oversharing or providing unsolicited information can open up more avenues for unnecessary scrutiny.

FAQ

These letters can be triggered by various factors, such as substantial R&D claims relative to company size, frequent claim alterations, or inconsistencies in submitted data.

The ATO usually provides a specific date in their letter. It’s typically 28 or 30 days from the date of the letter, but it’s vital to refer to your specific notice.

Yes, in certain circumstances, the ATO might grant extensions. It’s crucial to request this well in advance of the original deadline.

Ignoring the letter can lead to delays in processing your R&D claim, additional scrutiny, or even denial of your claim.

This can range from financial statements and contracts to specific breakdowns of R&D expenditures and supporting documents like invoices or receipts.

Generally, clear and legible copies are acceptable, but it’s always good to check the specific instructions in the compliance letter.

Organising documents logically, using folders and clear filenames, and providing digital versions where possible can streamline the ATO’s review process.

Yes, based on the documents you provide, the ATO might require further clarification or additional documentation.

Not necessarily. The ATO periodically reviews claims to ensure the integrity of the R&D tax incentive program.

Ensuring that your claims are accurate, consistent, and backed by comprehensive documentation can reduce the likelihood of future reviews.

The ATO will review the provided information. They may then release your refund, request additional information, or adjust your claim based on their findings.

The ATO has dedicated teams, often with specialised knowledge of the R&D tax incentive, to review the documentation and assess compliance.

Outcomes can range from approval and release of your claimed incentive, a request for more information, adjustments to your claim, or a denial of the claimed amounts.

You have the right to object to the ATO’s decision. This can be done by lodging a formal objection, and in some cases, you may seek independent review or appeal the decision.

While each review is specific to the claim year in question, if discrepancies are found, the ATO might decide to review previous years’ claims.

Yes, if the ATO determines that there was intentional disregard or recklessness in your claim, penalties might be imposed.

Being proactive, organised, and transparent in your response, and seeking expert guidance can streamline the review process.

An adjustment to a current year’s claim doesn’t automatically affect future claims, but consistent discrepancies might result in increased scrutiny in subsequent years.

Yes, the ATO encourages voluntary disclosures of discrepancies. Doing so can lead to reduced penalties if there were any inadvertent mistakes.

Engaging professionals, especially those experienced with R&D tax incentives, can be invaluable. They can guide you through the process, ensure compliance, and advocate on your behalf if necessary.

 

Myths and Misconceptions

Many businesses believe that these reviews are rare or completely random, thinking they can fly under the radar. In reality, the ATO targets specific sectors and looks for red flags in claims.

Some businesses think they can sort things out if they’re selected for a review, but lack of documentation or evidence can make it very difficult to substantiate claims later on.

The belief that one can go it alone without specialised R&D tax advice is a common misconception. Navigating ATO compliance reviews can be complex and seeking expert advice is often beneficial.

Simply being selected for a review doesn’t imply wrongdoing. However, it does mean you should take the process seriously and prepare accordingly.

Some small businesses think they’re too small to be noticed by the ATO. However, businesses of all sizes can be selected for compliance reviews, especially if they exhibit certain red flags.

What is the #1 grant for start-ups?

12,000+ companies access the R&D tax incentive per year that yields a CASH REBATE of up to 43.5%.
This might be perfect your start up.
Do you want to know more?

Scroll to Top
R&D Top 10 Consultant Tips

Top 10 Consultant Tips to Maximise the R&D Tax Incentive