The Australian Tax Office has warned business operators and advisers that it is ramping up its efforts to target the misuse of research and development tax incentives, and it will pursue those deliberately exploiting the tax breaks in court.

The ATO says it is particularly concerned about businesses in the building and construction industry, where it says an increasing number of operators are attempting to claim excluded expenditure as R&D expenses.

The R&D Tax Incentive program allows Australian companies to claim tax offsets for their research and development activities, with the incentive particularly important for early-stage ventures and startups.

According to the ATO, more than 13,700 business entities spent $19.5 billion on R&D activities in the 2013-14 financial year, and claimed tax benefits of approximately $3 billion.

ATO deputy commissioner Michael Cranston said in a statement the ATO is undertaking a range of compliance activities to identify businesses and advisers that are incorrectly including ordinary business activities in their claims for the R&D tax offset.

“While most do the right thing, we are seeing some businesses in these industries and their advisers improperly applying for the tax incentive where the activities and expenditure claimed don’t match with legislative requirements,” Cranston said.

“For example, we have seen an increase in claims for ordinary business activity expenses, or for large parts of projects that do not correspond to the scale or scope of experimental activities.

“Ordinary business activities are not generally carried out with a purpose of generating new knowledge. We often see issues including claims that encompass whole of projects (where project, management, environmental and commercial risks are mistaken for technical risks) and where the activities use existing knowledge and expertise.”

As part of “early warning” to business, the ATO and the Department of Industry, Innovation and Science have published a range of alerts and other materials about making R&D Tax Incentive claims, including information for businesses that are unsure of their position or that may have made a mistake in their claims.

However, Cranston says the ATO “will take legal action against those who wilfully misuse the R&D Tax Incentive”.

Tax offset a source of confusion

David McKellar from Allied Business Accountants told SmartCompany this morning the R&D Tax Incentive program is complex and a source of confusion for many business owners who may not fully understand what they can claim or what the limitations are.

“The situations that have led to this new compliance activity are a combination of misunderstanding, misinformation and at times overly enthusiastic claimants attempting to push the envelope and increase their claims,” McKellar says.

“Broadly speaking, the incentives are available on expenses related to R&D activities. To be eligible the activities need to be genuine research and development conducted for the purpose of generating new knowledge for products, [or] services.

“The trap many fall into, is that they may conduct R&D activities in relation to a ‘component’ of a new product or service, but seek to claim the incentives in relation to the development of the product or project as a whole, not just the one component of that product.”

But McKellar says professional advisers or consultants who make big promises to business owners are also contributing to the problem.

“It is often the case that businesses engage an R&D consultant for advice and to prepare the claim. Whilst it is advisable to seek appropriate advice, it has created an industry of consultants that are essentially out there ‘selling’ the incentives and promising to deliver big results,” he says.

The scope of the R&D Tax Incentive is likely to come under further scrutiny this year, after the federal government last year proposed reducing the rate of the tax offset from 45% to 38.5% for businesses with an annual turnover of less than $20 million, and from 40% to 38.5% for larger operations.

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In September 2016, a review into the overall incentives scheme was released for public consultation, after being completed earlier in the year by Innovation Australia chair Bill Ferris, chief scientist Dr Alan Finkel and secretary to the treasury John Fraser.

The six recommendations made in the report focused on the “sustainability” of the R&D program. These include placing a cap on the annual cash refund available through the incentives scheme at $2 million, while doubling the eligible R&D expenditure threshold from $100 million to $200 million.

The government is expected to respond to the report in coming months as part of the “second wave” of its national innovation agenda.