It is time to start thinking like an accountant if you truly want to maximise the organisational bang for buck on IT investments.
If you're a typical CIO, you may be failing to appreciate the vital role you could be playing in developing business strategies to achieve optimal tax outcomes. Then again, if your organisation is typical of most Australian companies, says KPMG national partner Innovation and Technology Incentives, David Gelb, even your accountants may be continuing to ignore the possibility of getting substantial R&D tax concessions on software developments and other IT projects.
Gelb has been working with many CIOs in the past few years developing business strategies to achieve optimal tax outcomes. He has also advised many CIOs on federal government incentives on innovation, such as the R&D Tax Concession and the 175 per cent Premium (Incremental) R&D Tax Concession. In doing so he has identified eligible R&D expenditure ranging from $1 million to $5 million, which has resulted in effective "cash refunds" of between $90,000 and $450,000 after-tax dollars. But he says too many companies are failing to take advantage of a potential government windfall.
"We have been involved with many major projects and have identified these as eligible R&D projects," Gelb says. "In my experience, many CIOs are not aware of the tax consequences of their IT investments, in particular R&D tax concessions and the tax treatment of software development."
Gelb says the failure of many Australian companies to take advantage of the R&D tax concessions in place for the past 17 years can be blamed on lack of appreciation and understanding of what eligible R&D is for the purpose of income tax legislation. There have been preconceived notions that in order to qualify a software development needs to be a world first. That is not necessarily the case, he says. There has also been a tendency to associate R&D with white coats, test tubes and laboratories, rather than with software and hardware and networking innovations.
"My message to CIOs is that with last year's government innovation package, Backing Australia's Ability, there is now a very clear program available, which is well understood, because it effectively harnesses a large part of the existing infrastructure that has some 17 years of history and certainty of interpretation," Gelb says.
Instant Deductions
In the normal course of events, software developments, whether in-house or purchased off-the-shelf, are required to be capitalised and amortised over two-and-a-half years. This tax treatment provides a long drag on the after-tax cash flow and Net Present Value (NPV) calculations.
The benefit of the R&D Tax Concession is that IT spending can be deducted immediately at 125 per cent for tax purposes, rather than having to be amortised. This can make many IT projects more attractive from a financial return perspective.
In other words, under the normal tax rules a company spending $100,000 on a software development amortises that amount over two-and-a-half years and therefore staggers its tax deductions. But if the $100,000 investment is eligible for an R&D tax claim, the organisation gets a $125,000 tax deduction that it can claim in the year in which it incurred the costs rather than over two-and-a-half years. The catch, if there is one, is that projects involving the development of computer software must satisfy a requirement known as multiple sale, meaning the company must intend to sell or license the resultant software to two or more non-associates of that company. Gelb says while this is an important point to note before organisations apply for concessions, it is likely to prove a barrier to far fewer companies than it might have in the pre-Internet days, when up-line licensing of software development was much more rare.
Better still, from July 1, pursuant to the new rules that were enunciated last year, companies may be entitled to claim 175 per cent income tax deduction to the extent that their current year R&D expenditure exceeds the average of their R&D expenditure in the preceding three years. To qualify for the 175 per cent incremental R&D tax deduction, a company is required to demonstrate that it in fact has a three-year history of making R&D claims.
As a consequence, Gelb says, companies that have not previously taken advantage of the R&D Tax Concession should consider lodging an R&D claim for the June 30, 2001 financial year, to at least establish the first year of their three-year registration history. Such claims must be lodged by April 30, 2002. "There is a window of opportunity there. If they do something very, very quickly at least they can get something up and running," he says. "It all depends on the profile. Some companies might never have lodged, others might have lodged one year; but for most of them it is something they can do immediately."
Investigations Worthwhile
The new R&D concessions are defined in the R&D tax concessions Tax Laws (Research and Development) Amendment Bill passed on September 27, 2001. The Bill implemented the new R&D Tax Concession program originally announced on January 29, 2001 in the government's innovation statement, Backing Australia's Ability.
To qualify for eligibility an R&D activity must exhibit innovation and/or technical risk/uncertainty of outcome. Most major IT projects will involve not only one of those requirements, but both, Gelb says. And even where entire projects do not qualify for concessions, parts of them may. While he says it is extremely difficult to generalise, CIOs should at least investigate the eligibility of major IT projects.
Companies may also be eligible to claim the costs of supporting activities, provided they can demonstrate a nexus between the supporting activity and the core activity involving innovation or technical risk. This means routine activities such as attending training programs or an overseas conference to obtain relevant knowledge for input into an Australian R&D project can qualify for the concessions deduction. There is no cap on the concession.
From July 1, 2002, a small company rebate also entitles company groups with a turnover of less than $5 million and R&D expenditure annually of less than $1 million to take their R&D tax benefit by way of a cash grant rather than the R&D tax deduction. This will be of particular benefit to IT start-ups, which often do not become tax payable for many years and therefore in the past have seen little value in claiming R&D tax deductions that might only increase carry-forward losses.
Organisations "absolutely ought to be taking advantage" of any of the concessions they can qualify for, Gelb says. But in order to do so, they must be aware of their eligibility up front. All too often, organisations wait until after projects are completed before considering whether they are eligible for any kind of a rebate. That comes far too late in the piece, he says.
"There are many ways and strategies for maximising entitlements at the outset of the project. What one would normally like to see in the perfect world is the individuals involved in the business case or project plan seriously evaluating whether they can get a government concession or incentive in respect of their proposed investment."
Gelb says CIOs should never leave such matters for year-end accounting consideration because typically accounting is concerned with looking back after the event and seeing what claims might be available in relation to amounts that have already been expended.
"There are numerous planning opportunities whereby proactive thinking and planning at the outset of a project is likely to result in a far greater opportunity for maximising entitlements. Besides, the accountant might not necessarily appreciate the intricacies of a project and might regard it as a fairly routine project rather than one involving research and development. They would be relying on the IT people to say: Â'This one really is an innovative project', or Â'We are taking a major risk in this area'.
"Of course there is a delicate balance in that if a project involves technical risk often the IT person doesn't want to highlight the risk. It may be the CFO who will sign off on the [project] funding, and if the CIO highlights the risk, the CFO may be reluctant to approve it." In such cases it is up to individual CIOs to balance the two competing claims in their own minds, Gelb says.
CIOs also need to be mindful of who owns the intellectual property arising from the software project or development project. There are regulations in place precluding two companies from making an R&D claim with regard to the same project. As a rule, it is the company that owns the intellectual property and bears the financial risk of the development that should make the R&D claim. However, should that organisation not be in a position to maximise its entitlements because, for instance, it is in a tax loss situation, it may wish to use the entitlements as part of its negotiation with an external party such as a vendor or contractor.
"Maybe you can use it as a bargaining tool in terms of the overall commercial negotiation," Gelb says. "In other words, recognising that there is an incentive one party can get they should all sit down together and work out the best way of structuring the project arrangement." vA MineStar Is BornQueensland IT solutions provider Mincom Limited developed its MineStar operational mining system with the help of a $5.23 million Commonwealth government R&D Start Grant with Premium.
Mincom is confident its new MineStar system, developed in association with Caterpillar Incorporated, represents a breakthrough in the analysis and optimisation of mining productivity and will have a significant impact on the industry's ability to maximise its asset utilisation. MineStar focuses on capturing data generated from all major mining equipment used in the mining operation and transmitting it via a wireless communications network to the mine site office in real time. By then integrating this raw data with the core business systems the system can generate more effective and efficient management processes.
Emphasis on research and development has been crucial to Mincom's growth and the R&D Tax Concession has allowed the company to undertake a variety of projects that have been successfully commercialised. In fact, project director Andrew Lingard insists without the Commonwealth government assistance the MineStar project could not have proceeded in its current form.
"The AusIndustry R&D Grant enabled Mincom to comprehensively explore the potentially innovative aspects of the project, both functionally and technically, without exposing them to unnecessary and unwarranted levels of risk. The fundamental advantage provided by grants such as this is that the level of innovation can be maximised while containing the associated risks. They give companies the capability to bolster their product development budgets in areas of innovative research."
Premium Position
AusIndustry says access to the 175 per cent Premium will be determined on the basis of annual R&D expenditure rather than annual R&D intensity or percentage of turnover spent (as announced on January 29, 2001). The calculations are based on the increase in R&D expenditure. There is no expenditure hurdle to qualify and no "cap" or upper limit restricting the amount the company can claim.
AusIndustry calculates the base R&D expenditure on which the Premium will apply as a three-year rolling average of eligible R&D expenditure by adding up the eligible R&D expenditure for the last three years and dividing by three. It says all eligible R&D expenditure above that average will be eligible for the Premium.
To qualify, companies must have been registered under the 125 per cent R&D Tax Concession for the three immediately previous years or else have received grants for R&D projects under the R&D Start program. A company also qualifies if a group member qualifies.
AusIndustry says the 175 per cent Premium does not include investments on R&D plant, pilot plant, plant leasing, contracted plant, core technology, R&D-related interest and items not eligible for the general R&D Tax Concession. It says these amounts must also be excluded in calculating the base expenditure for the previous three years.
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