Substantiation for R&D Activities

6 June 2024

In brief

Given the approaching end of financial year, it’s timely for R&D Tax Incentive claimants to ensure their records meet AusIndustry and ATO expectations.

A review of AAT decisions on R&D Tax Incentive matters will reveal that a substantial proportion – perhaps the majority – have been decided principally on the existence (or absence) of evidence to support the R&D entity’s assertions. Published guidance from both AusIndustry and the ATO has consistently emphasised both regulators’ expectation that R&D entities create and maintain contemporaneous records that substantiate all elements of R&D Tax Incentive eligibility. When either regulator initiates a review, a request for such evidence is commonly in the earliest correspondence received by the R&D entity.

AusIndustry and the ATO are in the midst of their pilot program of joint reviews of R&D applications and claims, and both regulators also continue to independently review R&D claims. In this context, we explore the types of records that might satisfy a taxpayer’s obligations when making R&D Tax Incentive claims, in relation to each of the R&D activity eligibility requirements.

In detail

The records an R&D entity is obligated to retain fall into three categories:

1. The eligibility of the entity, and the offset to which the entity is entitled
2. The eligibility of the activities undertaken by the entity
3. The eligibility of the expenditure.

Each of these has specific requirements, so in this piece, we focus on what is required to evidence the eligibility of the activities. We note that the ATO has published record keeping guidance, which covers tax, superannuation and employer obligations, though it does not specifically address the unique requirements of the R&D Tax Incentive.

Substantiating R&D activities

Substantiation of R&D activity eligibility falls into two categories:

1. Evidence the activities took place
2. Evidence the activities were eligible

For both, it must be possible for an independent reviewer to link the evidence to the R&D activities as registered in the application form, and not just to a general program of R&D the company undertakes. Records should generally be created contemporaneously; that is, at the time the event is taking place.

Examples of records that may prove activities took place are:

• Evidence of the output of the R&D activities – for example, if the aim of the R&D activity was to make and test a prototype widget, and the widget has been made, there is physical evidence the activity took place, though proving the time period in which it was made may be an additional step
• Contractor or consultant contracts, reports and invoices, if an external party was engaged to do the work
• Photographs or videos of work taking place
• Emails, digital chats and whiteboards, showing interactions between employees
• Employee timesheets, with appropriate narrations.

Proving the activities were eligible R&D activities can be more challenging, because it requires proof not only that they happened, but proof about the nature of the activity. AusIndustry guidance instructs claimants to keep records proving all of the following:

1. The outcome couldn’t be known or determined in advance
2. The claimant conducted (or will conduct) a systematic progression of work, comprising hypothesis, experiment, observation, evaluation and logical conclusions
3. The purpose of each core activity was to generate new knowledge
4. The supporting activities had the required relationship with at least one core activity

AusIndustry has not been prescriptive about how claimants satisfy the above requirements, but has provided a number of examples of records. The table below lists the types of records that could meet the above four criteria.

The takeaway

To generate the necessary records to prove the eligibility of R&D activities, the supporting evidence and documentation should be collated as the R&D activity is being undertaken, or in some instances, before the R&D activity starts. This means claimants should incorporate into their R&D processes steps to prepare, capture and store records that prove that all R&D activity eligibility criteria are satisfied. While this may seem onerous, it is a requirement of program participation, and doing so means that claimants will be able to quickly and easily respond to and satisfy queries from either regulator. The right time for an R&D entity to review whether its evidence is adequate is before the end of the financial year for which it intends to lodge an R&D Tax Incentive claim.

If you would like to discuss any of these matters further or require assistance regarding your R&D records, please reach out to your PwC R&D contact.