The feedstock rule in the R&D Tax Incentive, explained

The Research and Development Tax Incentive (R&D Tax Incentive) can deliver meaningful support to Australian businesses that are doing genuine R&D-from software startups refining a new algorithm to manufacturers testing a novel process on the factory floor. But many claims hit a snag when the R&D activity produces something of value that is then sold or used commercially. That is where the feedstock adjustment comes in.

If your R&D project churns out a saleable product, even a by‑product, you may need to adjust your notional R&D deductions to reflect the value of what emerged from the experiment. The Australian Taxation Office (ATO) publishes detailed guidance on feedstock adjustments, setting out when the rule bites and how to apply it. The rule is meant to keep the incentive squarely focused on the cost of genuine experimentation, not on subsidising ordinary production. Yet it consistently trips up manufacturers and process‑oriented businesses that thought they were claiming correctly.

This article steps through what a feedstock adjustment is, when it applies, how to work through a simple calculation (with a plain‑English example), and the record‑keeping evidence the ATO expects. It is general information only-not tax, financial, or legal advice. Always confirm your position with a registered tax agent who can review your specific circumstances and the latest rules for the current income year.

Before you start: Prerequisites

Before unpacking the feedstock rule, you should have a solid grounding in how the R&D Tax Incentive itself operates. In brief, the program-jointly administered by the ATO and AusIndustry (through the Department of Industry, Science and Resources)-offers eligible companies a tax offset for expenditure on eligible R&D activities. The core idea is to encourage innovation by reducing the after‑tax cost of experimenting with new or improved products, processes, or software. You can read a plain‑English overview in our What is the R&D Tax Incentive? guide.

To work through feedstock issues sensibly, you will also need:

• A clear understanding of which of your business activities are registered as R&D activities with AusIndustry-both core R&D activities and supporting activities.
• A breakdown of the direct costs incurred in carrying out those activities (often pulled from your accounting system).
• Records of any physical output, product, or saleable by‑product that emerged from the R&D process.

If you are not yet confident you have identified your eligible R&D correctly, start by examining your accounting data against the program’s definitions. GrantsMAX is designed to help businesses discover the grants and R&D tax incentives they may be eligible for by reading their own Xero, MYOB, or QuickBooks data and flagging candidate activities. From there, you can see what you may be entitled to, ranked by fit, before a registered tax agent ever reviews the claim.

Step 1: Grasp the core concept of a feedstock adjustment

What the legislation says

Under the Industry Research and Development Act 1986, when an R&D activity produces a tangible output that is either sold, applied to the entity’s own use, or incorporated into another product that is sold, the notional R&D deductions must be reduced. The legal framework-and the ATO’s interpretation-centers on the idea that the incentive should subsidise the cost of experimentation, not the cost of making a saleable good.

The ATO’s feedstock adjustment guidance explains that if the output from your R&D is something you can derive revenue from (or use yourself as if you had bought it), you need to add an amount back into your assessable income. This adjustment effectively claws back the benefit you would otherwise receive for the input costs that went into creating that valuable output.

You may hear people say “feedstock expenditure.” The term refers to the costs of raw materials, intermediates, or other inputs that go into the R&D process and end up embodied in something you can sell or use. The adjustment, then, is the mechanism that removes the double benefit: you cannot claim a tax offset for expenses that you later recoup through sales.

Why the rule exists

Imagine a metal fabricator experimenting with a new alloy. If the trial run produces 10 tonnes of saleable alloy and the business claims a full R&D tax offset on all the input materials, it would effectively be getting a discount on the raw material cost of ordinary inventory, while also collecting sale revenue. That is not the policy intent. The feedstock rule aligns the tax treatment with what would have happened if the R&D activity had been treated as ordinary production: you would have deducted the cost of materials from your sales revenue anyway.

This is not a penalty-it just ensures the program remains targeted at the incremental cost of experimentation. Firms like Grant Thornton Australia and BDO Australia have published practical walk‑throughs that emphasise early identification of feedstock flows. Their advice often notes that missing a feedstock adjustment at claim time can lead to ATO compliance activity later.

Step 2: Identify when your activities produce a feedstock output

Examples of feedstock in different industries

Feedstock outputs are not limited to finished goods. They can include:

• Scrap, offcuts, or by‑product that is sold, even for cents on the dollar.
• Intermediate outputs that become an input to another process in your own factory.
• Samples or prototypes provided to a customer for evaluation, if the customer pays for them.
• Excess material from a trial batch that you sell into the regular market.

For instance, a food manufacturer running pilot batches of a new recipe might end up with several pallets of product that meet commercial specification. Those pallets, if sold, trigger a feedstock adjustment on the ingredients and packaging used in the trial. Similarly, a clean‑energy business testing a new battery module may produce functional units that are sold to early adopters-those units are feedstock.

The rule commonly catches manufacturers because factory‑floor experiments often yield physical outputs that are unavoidable. A PwC Australia commentary on feedstock adjustments points out that even businesses with robust R&D programs can overlook the value of trial production when the output is small relative to regular output. However, the ATO takes a principled view: if the output has value, the adjustment applies.

What is not feedstock

Not every output from an R&D activity is feedstock. For example:

• Waste that is genuinely discarded at no value (e.g., a contaminated batch that must be disposed of at cost) may not be feedstock because there is no sale or beneficial use.
• Data, knowledge, or software that is not sold or licensed separately might fall outside the feedstock rules, though other parts of the tax law may apply.
• If a prototype is destroyed during testing and has no scrap value, feedstock treatment is unlikely.

Determining whether something is feedstock often turns on whether the entity would have had to acquire an equivalent item in the ordinary course of business. The ATO’s guidance is the best starting point for this analysis.

Step 3: Work through a simple feedstock adjustment calculation

A manufacturing example

Let’s walk through a simplified example, attributing the principles to the ATO’s published methodology. Always verify the current rates and thresholds for your income year with a registered tax agent, as rules can change.

Suppose a company, Oztek Innovations, is developing a new lightweight composite panel for the construction industry. It registers a core R&D activity with AusIndustry: experimental development of a composite panel with reduced weight and maintained structural strength. During the year, the R&D team runs a series of trial production runs using raw materials costing $80,000 in total (fibre, resin, additives). The trials produce 1,000 square metres of composite panel that meets specification and is subsequently sold to a building company for $50 per square metre, generating $50,000 in revenue.

At first glance, Oztek might think it can claim R&D expenditure of $80,000 for the raw materials. But because the output was sold, a feedstock adjustment is required.

The ATO’s feedstock adjustment formula essentially asks: what was the value of the feedstock output? Typically, you take the market value of the output (or the notional cost if it had been purchased). In this case, the simplest measure is the sale price of $50,000. The adjustment is then the lesser of:

• The notional R&D deductions incurred on the inputs that became the feedstock output (here, $80,000), and
• The feedstock output amount (here, $50,000).

So Oztek must include a $50,000 feedstock adjustment (reducing its notional deductions from $80,000 to $30,000). In effect, the R&D tax offset is only available on the $30,000 of input cost that genuinely represented the excess cost of experimentation over and above the recoverable value.

This example is deliberately straightforward. Real‑life scenarios can get hairy-e.g., when only a portion of input becomes saleable product, or when the output is not sold but used internally. In those cases, you allocate costs on a reasonable basis, and the ATO expects documentation of your methodology.

How the adjustment changes your R&D tax offset

The feedstock adjustment reduces your notional R&D deductions, which in turn reduces the size of the R&D tax offset you can claim. For an entity with an aggregated turnover under $20 million (or under $50 million once the proposed 2026 reform is legislated-see our note below), the refundable R&D tax offset is generally calculated as the company tax rate plus a premium on the adjusted notional deductions. A smaller notional deduction means a smaller offset.

For entities above the threshold, the offset is non‑refundable, and a feedstock adjustment can similarly reduce the tax benefit. Exactly how the offset mechanics work depends on your turnover, your company tax rate, and the specific R&D intensity of your business. GrantsMAX for growing companies discusses how the landscape shifts as your turnover changes, including the announced proposal to lift the refundable‑offset turnover threshold to $50M. But until such changes are enacted, you must apply the current law.

Pro tip: Do not wait until you are preparing the tax return to discover that you have sold an R&D output. If you plan a trial or pilot run, document upfront whether any saleable output is expected, and ask your accountant to model the feedstock adjustment early. This avoids surprises and lets you decide whether to claim R&D for the trial at all.

Step 4: Keep records that support your feedstock treatment

Evidence the ATO expects

The ATO and AusIndustry are clear: eligibility for the R&D Tax Incentive is self‑assessed, but you must be able to substantiate your claim if reviewed. For feedstock adjustments, the ATO typically wants evidence of:

• The nature and quantity of the R&D activity that produced the output.
• The direct materials, energy, and other inputs that went into that activity.
• The fate of the output-if sold, sale invoices; if used internally, a record of the transfer and its notional market value.
• The calculation of the feedstock adjustment amount, including the method used to split shared costs between the R&D run and normal production.

In the Oztek example above, you would keep trial run batch records, purchase invoices for the raw materials, a log of the trial’s execution, and the sale invoice for the 1,000 m² of composite sold. You would also keep a working paper explaining why $50,000 was chosen as the feedstock output amount (i.e., the actual sale price) and how you concluded that the $80,000 input cost was fully attributable to the feedstock output.

Using accounting data to build an audit trail

This is where having your accounting system in good order really helps. If your cost data sits in Xero, MYOB, or QuickBooks, you can often trace the purchased materials directly to the job or project code. A platform like GrantsMAX reads that data, drafts an activity narrative and cost structure, and builds a supporting‑evidence index that ties each cost line to a source document. The result is an audit‑ready evidence trail that your registered tax agent can stand behind if the claim is reviewed.

Of course, the platform does not lodge the claim-your registered tax agent does-but it dramatically reduces the manual work of compiling and referencing records.

Warning: If you pool costs from a general ledger without tagging which costs went into the R&D batch, you risk either underestimating or overestimating the feedstock adjustment. Over‑claiming can lead to an adverse ATO finding and penalties. The ATO’s feedstock adjustment page stresses that you must be able to demonstrate a reasonable basis for your allocation.

Step 5: Avoid common factory‑floor pitfalls

Why manufacturers are often tripped up

Manufacturers-whether in metal fabrication, food processing, chemical blending, or plastic moulding-run into the feedstock rule more often than software developers because their R&D almost always consumes physical inputs and yields physical outputs. A few recurring traps include:

• Not recognising trial output as feedstock. A production engineer might treat a trial batch as “just an experiment” and dispose of it as waste, but if the business later sells the output, the ATO will look at that sale.
• Undervaluing internal use. If the R&D output is used in your own factory-say, a new component is incorporated into a machine that you operate-the ATO may treat it as if you had purchased an equivalent item. Even though no cash changes hands, a feedstock adjustment may still apply.
• Forgetting the small stuff. Scrap metal swarf, offcuts, or spent chemicals that are collected and sold to a recycler can still be feedstock. Even a modest revenue stream can trigger an adjustment.
• Assuming the whole batch qualifies. If a trial run produces 10% scrap that is truly valueless, you may be able to exclude that portion from feedstock. But you must be able to justify the split.

KPMG Australia’s insight page on feedstock adjustments notes that the rule can create unexpected compliance work for businesses that trial new manufacturing processes at scale, because the larger the trial, the more likely a saleable output emerges.

What to watch when you scale up

As you scale up your R&D-moving from lab bench to pilot plant, for example-the amount of input material grows, and so does the potential feedstock adjustment. If the trial is successful, you may end up selling the entire pilot output and effectively have no net R&D deduction for materials. That is not necessarily a problem; it just means the incentive supported the labour, overhead, and other qualifying costs of the experiment, not the material that found a paying customer.

For businesses that are considering GrantsMAX for first‑time claimants, getting the feedstock treatment right in year one sets a clean precedent. When you roll the claim over each year, the platform refreshes claims from your latest data (as described on the Annual Refresh & Accountant Channel page), so the feedstock calculation stays current.

Pro tips and warnings throughout the process

• Pro tip: Even if you think a feedstock adjustment will wipe out most of your material deduction, the R&D Tax Incentive can still be valuable. You may still claim the offset on qualifying labour, consumables that do not become feedstock, and certain overhead allocations. Run the numbers before abandoning a claim.
• Warning: Do not try to “price away” the feedstock problem by selling the output at an artificially low price to a related party. The ATO will benchmark the value at market value or the cost you would have paid if you had not produced it yourself.
• Pro tip: Talk to your registered tax agent early. They can advise on whether a feedstock adjustment applies and help you decide if the R&D activity is worth registering. GrantsMAX does not provide tax advice, but it can prepare a complete, evidence‑backed application pack from your accounting data that your accountant can then review and lodge. This division of work-described in our Governance and trust overview-keeps you in control of your claim.
• Warning: The feedstock rules can intersect with other R&D compliance points, such as the requirement to register activities with AusIndustry within 10 months of year‑end. Missing that registration deadline eliminates any ability to claim, regardless of how carefully you prepared the feedstock calculation. The Eligibility Assessment & Risk Flags feature in GrantsMAX helps you catch such timing risks before they become missed deadlines.

Summary and key takeaways

1. The feedstock adjustment exists to ensure the R&D Tax Incentive does not subsidise the cost of saleable outputs. If your R&D activity produces something of value that you sell or use, you must adjust your notional R&D deductions.
2. The adjustment is generally the lesser of the notional R&D input cost that went into the feedstock output, and the value of that output (market price or notional cost). The ATO’s guidance on feedstock adjustments is the authoritative starting point.
3. Manufacturers are frequently tripped up because factory‑floor experiments almost always yield physical outputs. Every scrap sale, internal transfer, or trial batch with commercial value can trigger an adjustment.
4. Good record‑keeping is essential. You need to trace which inputs went into the R&D activity, what came out, the fate of the output, and the basis for your adjustment calculation.
5. GrantsMAX can help you assemble the evidence‑backed pack-pulling data from your accounting system and indexing it to activity narratives-but the claim is always reviewed and lodged by your registered tax agent. You own the claim and the responsibility.

Understanding the feedstock rule upfront protects you from a costly ATO review and ensures your R&D claim reflects the genuine net cost of experimentation. If you want a clearer picture of what your business may be eligible for, including how feedstock might affect your numbers, join the GrantsMAX waitlist and be among the first to use the AI agent when it opens.