Definition of R&D activities (section LH 7)

Only R&D activities as defined in section LH 7 are eligible for the tax credit.

The definitions of "research" and "development" in section DB 35, which apply to allow tax deductibility to follow accounting treatment, remain and have been updated. As the tax treatment is so closely linked to accounting, the accounting definitions have been retained for that purpose only and are not relevant for the credit.

The legislation defines research and development activities as:

• systematic, investigative and experimental activities (SIE) that are performed for the purposes of acquiring new knowledge or creating new or improved materials, products, devices, processes or services and that:
  • are intended to advance science or technology through the resolution of scientific or technological uncertainty; or
  • involve an appreciable element of novelty.
• other activities that are wholly or mainly for the purpose of, required for, and integral to, the carrying on of the activities in paragraph (a).

The definition is not limited to basic research and is expected to apply to a wide range of development activities in a variety of industries. However, routine business activities directed at improving efficiency that do not seek to advance science or technology, or that do not involve an appreciable element of novelty, are not eligible.

The definition draws on elements of the R&D definitions in the United Kingdom, Ireland, Canada and Australia. It is most similar to the Australian definition, which has advantages for businesses operating on both sides of the Tasman and also for Inland Revenue, which will be required to implement the credit within a short timeframe. In particular, it is expected that application of the "appreciable element of novelty" limb will draw on Australian experience.

Activities described in paragraph (a) are SIE activities and activities in paragraph (b) are support activities. This is relevant in relation to the excluded activities in Schedule 21, Part C.

The creation of new or improved production equipment and machinery is included in paragraph (a) as new or improved products.

R&D need not be successful to qualify for the credit.

There is legislative clarification of the meaning of some of the terms used in the definition. Further elaboration on the definition is included in guidelines.

Systematic, investigative and experimental activities (subsection (2))

Claimants must demonstrate that the R&D process followed a planned, logical progression of work involving hypothesis, experiment, observation and evaluation.

Scientific or technological uncertainty (subsection (3))

This exists when knowledge of whether something is scientifically or technologically possible, or how to achieve it in practice, is not publicly available or deducible by a competent professional working in the field. This definition, and the definition of "technology" are derived from the United Kingdom's R&D definition.

Novelty (subsection (4))

For activities to be "novel" there must be some development of the technology or a new use of existing technology. To establish whether something is new, it should be compared with what is already available in the public arena on a reasonably accessible world-wide basis at the time in that technology.

The "appreciable element of novelty" limb is drawn from the Australian R&D definition and the statutory clarification discussed in the paragraph above is based on the explanation of that term in the Australian R&D Guide (Part B, page 16). The provisions should be very similar in scope. In particular, "appreciable" means meaningful or significant in the context of the activities undertaken.

Technology (subsection (5))

For the purposes of the R&D definition, "technology" is the practical application of scientific principles and knowledge.

Simultaneous R&D

Under the definition, R&D qualifies if it is done by two firms simultaneously and independently doing the same innovative work or when work has already been done, but this is not public knowledge because it is a trade secret, and another firm repeats the work.

Improvements to existing products/processes

Incremental development and improvements to existing products or processes can qualify as R&D. However, the improvement sought would have to involve an appreciable element of novelty or attempt to advance science or technology. It therefore should be more than routine upgrading.

Support activities (paragraph (b) of R&D definition)

Supporting activities that are wholly or mainly for the purpose of, required for, and integral to the carrying on of SIE activities referred to in paragraph (a), but which in themselves are not systematic, investigative and experimental, are eligible R&D. Support activities are eligible only if there is a SIE activity, though the support activities need not occur in the same income year as the SIE activity.

The requirement that activities be wholly or mainly for the purpose of SIE R&D is intended to exclude the following types of activity:

• construction of an asset with an innovative component when the main purpose of construction is sale of the asset or use for commercial purposes; and
• activities carried out simultaneously for routine business purposes and R&D if R&D is not the main purpose. For example, if a business collects data mainly for its routine business operations but also uses it as an input to R&D, it is not an eligible support activity.

"Required for" means that the supporting activity must be only to the degree necessary to support the project. For example, if a drilling company is developing an innovative piece of drilling equipment that can be adequately tested using computer simulation, drilling is not "required for" the SIE R&D activity. If drilling is required to test the equipment, only drilling that is the minimum necessary qualifies.

"Integral to" means that such activities must be part of an R&D project (rather than indirect supporting activities such as cleaning and administration, which are dealt with as expenditure on overheads).

Examples of support activities that could be eligible include scientific or technological planning activities, mathematical analysis or modelling used to analyse the results of the experiments and routine data collection.