Company X is undertaking R&D activities to develop software to remotely manage household power consumption and production.

Assessing the eligibility for a notional R&D deduction of costs incurred on acquiring, or acquiring the right to use, technology, must be done on a case-by-case basis with reference to the purpose of the R&D activities that use the technology, and their relationship to the activities that developed the technology. While some circumstances will be relatively straightforward to assess, others will be more complex, and may justify seeking a finding from Industry Innovation and Science Australia.

The above examples are necessarily simple. In practice, it may be complex to determine if a specific technology acquisition – which under some circumstances may be at substantial cost – constitutes core technology. To obtain certainty about the notional deductibility of a specific technology expense, R&D entities may consider seeking a finding.

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b) the R&D activities were or are an extension, continuation, development or completion of the activities that produced that technology.

Under s 355-225(2) of the Income Tax Assessment Act 1997, a notional deduction under the R&D Tax Incentive program is not available for expenditure on the ‘core technology’ itself. The costs associated with further developing the core technology may still be eligible if the relevant criteria are met. Therefore, it is important that R&D claimants are aware of what constitutes ‘core technology’.

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Where technology has been purchased to enable experimentation to take place – as opposed to being the subject of further development – it can be eligible. Below we provide illustrative, simple examples.

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AusIndustry and the ATO provide limited guidance on the practical application of the core technology exclusion, notably in ‘Software-related activities and the R&D Tax Incentive’, published in April 2022, which provides an example of an eligible expense and of an excluded expense.

ii) to create new or improved materials, products, devices, processes, techniques or services to be based on that technology; or

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Company Y owns IP in the form of an AI-powered, automated software testing platform, to which it sells licences for use, in the form of monthly subscriptions.

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‘Core technology’ is technology that an R&D entity has acquired, or obtained the right to use, wholly or partially, for the purpose of one or more R&D activities conducted or to be conducted, where the purpose of those R&D activities is to further develop the technology. Additionally, if the R&D activities are an extension or completion of the activities that produced the technology, the technology is core technology. It is effectively an underlying or base technology that has been acquired to be developed further in one or more R&D activities by the R&D entity, as distinct from technology acquired as a tool to enable experimentation.

This definition is replicated in para 28E(2) of the Industry Research and Development Act 1986, which gives Industry Innovation and Science Australia the power to find that the technology is core technology for the R&D activities.

Company X determines that use of Company Y’s software could speed up its ability to both develop and deploy its software, and subsequently purchases a subscription. It uses Company Y’s software as a tool to aid development of its own software.

Expenditure on ‘core technology’ is expressly excluded from notional deduction under the R&D Tax Incentive. Such expenditure is defined in s 355-225(2) by reference to the purpose of the R&D activities and, alternatively, their connection to the activities that developed the core technology. Expenditure is incurred on core technology where:

Company A wants to develop technology to detect seismic activity underwater. It determines that the sensor developed by Company B could form a good basis from which to work. For $1m, Company A acquires the right to use the IP in Company B’s sensor, then works to extend its capability to detect seismic activity, to a depth of 5,000 metres. This additional work costs Company A $800,000.

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Company B is undertaking R&D activities to develop a sensor that can accurately detect seismic activity at an underwater depth of 3,000 metres.

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