R&D Tax Incentive – Core Technology Expenditure

What is Core Technology Expenditure?

Core technology expenditure refers to costs incurred when acquiring, developing, or adapting technology essential to your R&D activities.  

Why is it important for your R&D claim?

Understanding core technology expenditure can have a big impact on your R&D tax incentive claim. If you incorrectly classify your costs or miss out on what you can claim, you could be leaving significant savings on the table. On the flip side, claiming too much could trigger a review or audit, so it’s essential to get it right.  

Core Activities vs Core Technology: Understanding the Difference

It’s easy to confuse core activities with core technology, but they’re distinct components of the R&D tax incentive.

Core activities are the experimental processes you undertake during your R&D. They are the actual research and development work that involves innovation and technical risk, forming the heart of your project. Core activities must meet specific eligibility criteria to qualify under the R&D tax incentive. You can find a detailed explanation of core activities here.

Core technology refers to the equipment, software, or systems essential to your core R&D activities. While core activities are the experimental processes themselves, core technology is what supports or enables those activities. For example, if you’re conducting research into AI, your core activity might be developing a new algorithm, while the core technology could be the advanced computing systems you use to run and test that algorithm.

The key difference:

• Core activities – The experimental work itself, the innovation.
• Core technology – The tools and technology supporting that work.

What does lesgislation say about R&D tax claims for core technology?

Let’s say a company, TechInnovate Pty Ltd, is developing an innovative AI-powered platform for healthcare data analysis. To support this project, they purchase an advanced software package from another company that serves as the foundation for their R&D work. The software is considered core technology and costs $500,000.

Application of R&D Tax Incentive:

1. Core Technology Expenditure – The $500,000 spent on acquiring this pre-existing software cannot be claimed under the R&D tax incentive as a notional deduction. According to Section 355-225(1) and Section 355-205(2) of the Income Tax Assessment Act 1997, core technology expenditure is excluded from R&D tax claims because the software is used as a foundation for further development.

2. Depreciation Deduction –  Since the software is a depreciating asset, the company can still claim a depreciation deduction under Division 40 for the decline in value of the software over time. The depreciation would be calculated based on the effective life of the software and how much of it is used for R&D activities. If the software has an effective life of five years, for instance, they can claim depreciation for its R&D-related usage each year over that period.

Breakdown:

• The $500,000 acquisition cost cannot be claimed under the R&D tax incentive.
• However, annual depreciation on the software (e.g., $100,000 per year over five years) can be claimed under standard tax provisions if it’s used in the R&D project.

This illustrates how the acquisition of core technology, in this case a software package, is ineligible for the R&D tax incentive itself, but can still be partially recovered through depreciation claims.

The Absolute Vision Technologies Pty Ltd v Innovation and Science Australia case offers important lessons for companies looking to claim the R&D tax incentive. In this 2022 decision, the AAT found that Absolute Vision Technologies (AVT) had failed to demonstrate that its activities met the requirements for core R&D activities.

AVT’s project involved modifying an enterprise resource planning (ERP) system to create a real-time freight and manufacturing scheduling system. The company argued that the work was eligible for the R&D tax incentive, as it required substantial technical modifications. However, the AAT disagreed.

The tribunal ruled that the work undertaken by AVT did not meet the key criteria for R&D. Specifically, the activities lacked the uncertainty and experimental nature required under the Income Tax Assessment Act 1997. While AVT’s work was technically challenging, it was considered adaptation of existing technology, rather than an experiment involving a hypothesis that was tested through systematic progression. This distinction is crucial for anyone claiming the R&D tax incentive.

In other words, simply improving or customising a pre-existing system does not qualify as core R&D. The R&D tax incentive is designed to reward activities that generate new knowledge through experimentation, where the outcome is uncertain. AVT’s work, while valuable, was seen as more of an enhancement to existing technology, rather than genuine R&D.

This case is a good reminder that modifying or adapting core technology may not meet the threshold for eligibility. If you are unsure whether your activities qualify, it’s important to get advice from an expert who understands the complexities of the R&D tax incentive.

At Bulletpoint, we have successfully guided many businesses through the claim process, ensuring their applications are accurate and compliant.

In PKWK v Innovation and Science Australia (2021), the AAT reviewed the eligibility of activities for the R&D tax incentive, particularly in relation to the generation of new knowledge. PKWK was developing a waste-to-energy technology and claimed that its work constituted core R&D activities.

The case focused on whether the activities conducted by PKWK were sufficiently experimental to qualify for the R&D tax incentive. The AAT examined whether the work was undertaken to address a specific hypothesis and whether the outcome could not be known in advance. PKWK claimed that their work involved systematic experimentation, but the tribunal found otherwise.

The tribunal ruled that PKWK’s activities, while technical, did not meet the necessary experimental criteria under the R&D tax legislation. The activities lacked a clearly defined hypothesis and instead appeared to be more focused on implementing and adapting existing processes. The tribunal noted that there was no evidence of fundamental uncertainty in the processes being tested, which is a critical requirement for core R&D activities under the legislation.

The AAT decision highlighted a common issue where companies mistakenly believe that technically challenging work automatically qualifies for the R&D tax incentive. However, the work must involve an element of genuine experimentation and uncertainty. In PKWK’s case, the AAT determined that the company had not sufficiently demonstrated that the outcomes of its activities were unknown or that they followed a scientific method of hypothesis testing.

This case serves as an important reminder that core technology development or implementation of pre-existing systems may not be enough to qualify as core R&D. To meet the legislative requirements, there needs to be a systematic progression of work with outcomes that are not known or determined in advance.

If you’re navigating similar questions about the eligibility of your R&D activities, seeking expert advice can help ensure your claim meets the necessary criteria. At Bulletpoint, we have extensive experience helping businesses accurately classify their activities for the R&D tax incentive.