R&D in software is no different from the R&D in engineering or product development because the R&D is comprised of the experiments that test the efficacy of the hypothesis. The R&D is made up of the core activities that test whether the hypothesis is proven to be correct or incorrect, along with the directly related supporting activities needed to be done to help test this hypothesis.
What software costs are typically eligible R&D expenditure?
As discussed in our last blog entry, the R&D in software is no different from the R&D in engineering or product development because the R&D is comprised of the experiments that test the efficacy of the hypothesis. The R&D is made up of the core activities that test whether the hypothesis is proven to be correct or incorrect, along with the directly related supporting activities needed to be done to help test this hypothesis.
This means that the hypothesis cannot just be along the lines of “We can develop a new big data/social media/cloud app….”. It must be addressing a question as to what makes the software different from what is known or reasonably available.
This will limit the software development costs to just those costs incurred on the activities that answer, or support being able to answer, the questions about the aspects of the project that have been identified as containing technical uncertainty.
Once this limit is identified by an appropriately targeted hypothesis, then the claimable costs are typically made up of the following:
- Labour to design, create and test the code’s performance against the hypothesis. This will include the costs of Australian coders and also overseas coders where an approved overseas finding is in place. These may be employees, contract employees or external contractors so long as what is created is owned by the R&D entity and the process is managed and controlled by that entity. This cost needs to be apportioned to include only those costs diectly related to the core and supporting R&D aspects of the development. The costs need to be split appropriately to exclude post-R&D support costs from R&D support costs during phases such as implementation trials.
- Software engineer and technical project manager costs directly associated with the management of the R&D aspects of the overall development project.
- Direct overheads incurred to enable the labour to conduct the R&D activities. Note: where the work is carried out by external contractors who work primarily offsite, then this overhead cost is typically included in the contract rate charged.
- Depreciation of capital equipment (e.g. computers, servers, networking equipment, office equipment etc.) to the extent it is used in the R&D activity.
What software costs are routinely excluded?
Expenditure on the creation of new software may not qualify as eligible R&D expenditure for two main reasons:
- The expenditure is directly incurred on experimental core R&D activities to develop new or improved software that is primarily for internal use by the R&D entity (or one or more of its associates) for business administration purposes. That is, it is not for customers or not for purposes other than administration of the business aspects of the group. Internal business administration R&D is specifically excluded by s355-25 in the 1997 Income Tax Assessment Act. This excludes software produced for use in enterprise resource planning, payroll, accounts payable/receivable and the like. It does not exclude software created for customers or for customers to interact with the R&D entity nor software to automate processes and the like.
- It is increasingly common for software coding to be undertaken overseas. This can be as a result of a direct decision of the R&D entity or by a contracted software company assisting the R&D entity choosing to meet its contractual obligations by conducting the R&D activities outside Australia.
These overseas costs cannot be claimed unless they are covered by an overseas finding. This finding must be applied for through AusIndustry during the first year in which eligible R&D expenditure is to be claimed. It will not be granted unless it meets strict criteria including that the majority of the expenditure over the whole expected life of the activities must be expected to be incurred in Australia. Normally, there must be a significant expertise or access to facilities not reasonably available in Australia before any finding will be allowed. Saving time and money will not be accepted as a justification for granting an overseas finding.
In the next blog entry, we will look at the issue of what to do if the software expenditure has been or is intended to be capitalised.
We warn you that it gets pretty technical so consume at your own peril!