The R&D notional deduction, explained

The R&D notional deduction sits at the heart of Australia's Research and Development Tax Incentive. For many business owners it is the concept that causes the most head-scratching. Yet understanding it is essential if your company undertakes eligible R&D and wants to claim the offset correctly. This guide was written by the team at GrantsMAX, an AI grant agent that helps Australian businesses discover what they may be eligible for and prepares evidence-backed packs for their accountant to review and lodge. It is general information only, not tax, financial or legal advice. You should always confirm your own position with a registered tax agent who can review your records and lodge your claim.

We will step through what the notional deduction is, how it differs from an ordinary deduction, what you need before you start, and a step-by-step process to work it out using ATO guidance. We will call out common pitfalls and offer pro tips so you can approach the calculation with confidence.

What is the R&D notional deduction?

The notional deduction is the starting point for calculating your R&D tax offset. Under the Income Tax Assessment Act 1997, the incentive does not give you a direct cash payment or a simple credit against tax paid. Instead, it lets you claim a tax offset equal to a proportion of a notional deduction, which is based on your eligible R&D expenditure.

According to the ATO Your notional deduction page, you work out your notional deduction by first determining a hypothetical business profit or loss before any deduction for R&D expenditure. Then you add back the R&D expenditure you want to claim as a deduction. The resulting amount is the notional deduction. This figure is used to work out the R&D tax offset you may be eligible for.

Key point: The notional deduction is not an actual expense you claim on your tax return. It is an input into the offset calculation. The offset then reduces the tax you need to pay (or, for certain entities, may generate a refundable offset).

Understanding this distinction is critical for compliance and for getting the numbers right. Later we explain exactly how the ATO instructs you to calculate it.

How notional deductions differ from ordinary deductions

Ordinary deductions under Australian tax law reduce your taxable income. You incur an expense, it meets the general deduction rules in section 8-1 of the ITAA 1997, and you deduct it in working out your taxable income. The R&D notional deduction does not work that way.

Ordinary deductions: the basics

• You spend money on a deductible item (e.g., salaries, materials, overheads).
• That amount is subtracted from your assessable income.
• You pay less tax because your taxable income is lower.
• The deduction directly reduces your tax liability at your company tax rate.

The notional deduction difference

• You start with your business profit or loss, before any deduction for R&D expenditure.
• You add back the R&D expenditure you have chosen to claim under the incentive (you cannot claim the same expenditure as both an ordinary deduction and an R&D notional deduction, claiming under the incentive replaces the ordinary deduction).
• This gives you a notional deduction amount.
• That notional deduction is then multiplied by the relevant offset rate (currently 43.5% for a refundable offset for eligible entities with aggregated turnover under $20 million, and 38.5% for a non-refundable offset for others; these rates are well established but you must verify them for the current income year with your tax agent).
• The result is your R&D tax offset, which directly reduces your tax payable, or may be refundable.

In short, an ordinary deduction lowers your taxable income; a notional deduction generates a tax offset that is a percentage of that notional amount. The ATO emphasises that you cannot double-dip: once you claim the R&D incentive on a dollar of expenditure, you do not claim an ordinary deduction for that same dollar.

Prerequisites: what you need before you start

Before you can calculate your notional deduction, you must have several things in place. Missing any one of them can lead to a rejected or delayed claim. We outline them below.

1. Eligible R&D activities registered with AusIndustry

You must be undertaking eligible R&D activities, as defined in the legislation. These are broadly divided into core and supporting activities. Core activities are experimental activities whose outcome cannot be known in advance and that are conducted for the purpose of generating new knowledge. Supporting activities are directly related to core activities. You must register these activities with AusIndustry annually, within 10 months of the end of your income year. If you have questions about whether your activities may be eligible, GrantsMAX's eligibility assessment analyses your business data and flags areas that a reviewer would scrutinise, so you can firm up evidence before your accountant lodges.

2. Eligible R&D expenditure

The ATO lists what can be included. Common categories are: salaries and wages of employees directly engaged in R&D, contract expenditure, consumables, depreciation on assets used for R&D, and a portion of overheads. For a full inventory, refer to the ATO website. GrantsMAX's AI application pack drafting pulls cost data directly from your Xero, MYOB or QuickBooks file and builds a cost structure that your accountant can review against the ATO's categories.

3. Contemporaneous records

The ATO expects you to keep records that show the link between the expenditure and the R&D activities. Timesheets, project notes, invoices, contracts, and emails are all relevant. An audit-ready evidence trail is not just nice to have; it is what the ATO will ask for if your claim is reviewed. GrantsMAX indexes your emails, invoices and timesheets and ties each cost line to its source, so your accountant can stand behind the pack.

4. A registered tax agent who will review and lodge

Only a registered tax agent can lodge the R&D tax incentive schedule with your tax return. You cannot lodge it yourself through myGov. GrantsMAX's workflow hands your pack to your accountant in a shared workspace. The accountant reviews, refines, and lodges, and you own the claim throughout. If you do not yet have an accountant comfortable with R&D claims, we can help you connect with one.

Step-by-step guide to calculating your R&D notional deduction

We now walk through the calculation steps as the ATO describes them. Use actual figures from your accounts and always have your tax agent check the final numbers.

Step 1: Calculate your notional business profit or loss before R&D

Take your accounting profit or loss from your financial statements (as reconciled for tax). Subtract any ordinary deductions you have already claimed that are unrelated to R&D. Do not include any deduction for the R&D expenditure you intend to claim under the incentive. The result is your notional business profit or loss. This is a hypothetical figure because, in reality, you might have already claimed an ordinary deduction for some R&D expenses; but for the purpose of the offset, you act as though you have not claimed them.

Step 2: Work out your R&D expenditure

Identify all eligible R&D expenditure for the income year. This includes:

• Salaries and contractor payments for R&D staff.
• Consumables directly used in R&D.
• Depreciation on plant and equipment used for R&D.
• An appropriate apportionment of overheads.
• Any payments to approved research institutes.

GrantsMAX's grant and R&D discovery engine maps your accounting data to these categories and flags potential gaps, so you do not miss expenditure that may be eligible.

Step 3: Determine your notional R&D deduction

Add the eligible R&D expenditure (from Step 2) to your notional business profit or loss (from Step 1). If you had a notional loss, the R&D expenditure increases that loss. This combined figure is your notional R&D deduction.

Pro tip: The ATO uses the term "notional deduction" because it is the deduction you would have been allowed if R&D expenditure were deductible in the ordinary way, but given the incentive rules, you replace the ordinary deduction with an offset. So the notional deduction is simply your R&D spend plus/minus your business profit before that spend.

An example helps. Suppose your business had a notional profit of $200,000 before any R&D deduction. You spent $150,000 on eligible R&D. Your notional deduction is $350,000. If your business was in a notional loss of $50,000 and you spent $150,000 on R&D, your notional deduction is $100,000 (a loss of $50,000 plus $150,000).

Step 4: Use the notional deduction to work out your tax offset

Multiply your notional deduction by the relevant offset rate. For an entity with aggregated turnover under $20 million (proposed to rise to $50 million under announced 2026 reforms), the refundable rate is 43.5%. For others, the non-refundable rate is 38.5%. You should verify the current rate with your accountant. The offset is applied against your tax payable; any refundable portion may be paid to you.

Using the first example above, a $350,000 notional deduction at 43.5% yields an offset of $152,250. This reduces tax payable and, if the offset is refundable, may generate a cash refund.

Your tax agent will complete the R&D schedule (usually via the ATO's online services) using these figures. The notional deduction itself does not appear on your tax return; only the resultant offset does.

Key considerations and compliance for notional deductions

The role of the registered tax agent

Because the R&D incentive is integrated with your company tax return, the notional deduction calculation must be reviewed and lodged by a registered tax agent. The Tax Practitioners Board (TPB) sets out the professional standards that apply. Your accountant is responsible for ensuring the numbers are accurate and that the claim complies with the law. GrantsMAX supports the accountant, not replaces them. It prepares an evidence-backed pack that the accountant can adopt, adjust, and ultimately lodge.

What the ATO expects in an audit

If the ATO selects your claim for review, they will ask for:

• Evidence that the activities were registered with AusIndustry.
• Proof that the expenditure is directly related to those registered activities.
• Contemporaneous records linking costs to activities.
• A clear calculation of the notional deduction.

Having a well-organised pack beforehand makes this process far less stressful. GrantsMAX's audit-ready evidence trail indexes every dollar to its source, so your accountant can respond quickly and accurately.

How GrantsMAX helps build an evidence trail

GrantsMAX connects read-only to your accounting software (Xero, MYOB, QuickBooks) and optionally to your Microsoft 365 or Google Workspace emails and documents. It drafts R&D activity narratives and a cost structure, then builds a supporting-evidence index. The entire pack is shared with your registered tax agent, who reviews, refines, and lodges. You own the claim from start to finish.

Common pitfalls and pro tips for notional deduction claims

Pitfall: Mixing up ordinary and notional deductions

Some businesses accidentally claim an ordinary deduction for R&D salaries in their tax return and an R&D offset on the same expenditure. This is not permitted. Once you elect to claim the incentive, you must not claim an ordinary deduction for that expenditure. The ATO will detect double-dipping and reverse the claim.

Warning: Always involve your tax agent early. They can help you ensure the same expense is treated consistently across your return and the R&D schedule.

Pro tip: Keep contemporaneous records

"Contemporaneous" means recorded at the time the work is done. The ATO places great weight on such evidence. Timesheets, lab notebooks, project meeting minutes and dated emails are gold. Do not attempt to reconstruct records months later; it weakens your claim. If your team uses Microsoft 365 or Google Workspace, GrantsMAX can index those communications automatically.

Pitfall: Claiming ineligible expenditure

Not every cost related to innovation qualifies. For example, marketing expenses, capital raising costs, and routine manufacturing are generally not eligible. The ATO publishes detailed guidance. Misclassification can lead to a reduced offset or an audit finding. GrantsMAX's eligibility assessment flags risk areas so you can double-check before your accountant lodges.

Pro tip: Review with your accountant early in the year

Do not wait until after year-end to discuss your R&D activities with your accountant. An early review can identify whether your activities need to be more clearly documented or whether you should register additional activities with AusIndustry. GrantsMAX for founders and CFOs helps you spot opportunities months before the deadline, giving your accountant time to refine the pack.

Pitfall: Assuming all R&D is eligible

The legislative definition of R&D is narrower than many assume. Simply being innovative does not automatically make the work eligible. You need a hypothesis-driven experimental process where the outcome is not known in advance. We cover this in our plain-English guide, What is the R&D Tax Incentive?. If you are unsure, speak to a registered tax agent who is familiar with AusIndustry's interpretation.

Pro tip: Use technology to cut preparation time

Traditional R&D consultants often charge a 10 to 20% success fee and can take weeks to produce a pack. GrantsMAX’s AI pack drafting reduces preparation time to hours, not weeks, and the flat subscription model keeps costs predictable. Because your data feeds the pack, the narratives are grounded in real transactions, not generic templates.

Summary and key takeaways

• The R&D notional deduction is a calculation step, not an actual tax deduction, used to work out your R&D tax offset.
• It is calculated by taking a notional business profit or loss before R&D, and adding back eligible R&D expenditure.
• It differs fundamentally from an ordinary deduction: it generates a tax offset instead of reducing taxable income.
• You must have eligible R&D activities registered with AusIndustry, eligible expenditure, and contemporaneous records before you can calculate the notional deduction.
• A registered tax agent must review and lodge the claim; you cannot self-lodge.
• The ATO’s guidance on notional deductions is clear, but the practical work of compiling evidence and linking costs to activities is where claims often fail. GrantsMAX streamlines this by connecting to your live data.
• The upcoming 2026 reform (proposed, not law) may lift the refundable-offset aggregate turnover threshold from $20 million to $50 million, potentially broadening the incentive’s reach.

Next steps: how GrantsMAX can help

If you run an Australian business that does genuine R&D, whether in software, manufacturing, biotech, agtech, clean energy or other fields, you may be eligible for the R&D Tax Incentive. The notional deduction is just one part of the puzzle, but getting it right matters. GrantsMAX is designed to make the process simpler, faster, and more affordable.

We connect read-only to your accounting data, discover government grants and R&D tax incentives you may be eligible for, and prepare a complete, evidence-backed pack. Your registered tax agent reviews, refines, and lodges, nothing leaves your accountant’s hands without approval. You own the claim, you keep the benefit, and you avoid the high success fees of legacy consultants.

Why GrantsMAX? Because government funding is real money you may be leaving on the table, and traditional R&D advisors are often too expensive or too slow for growing businesses. GrantsMAX for first-time claimants is built for companies that have never claimed before; for R&D-active startups, we draft narratives from your own data; and for manufacturers, we translate process improvement and new product development into defensible activity descriptions.

If you’re an accountant or bookkeeper, the accountant channel lets you white-label the same workflow across your client base, refreshing claims annually from their latest data.

Join the GrantsMAX waitlist today to see how your business could benefit from a simpler, accountant-led R&D claim process. Government funding is there for eligible companies, make sure you have a partner that prepares the pack and leaves the critical review and lodgement to your trusted tax professional.

This guide is general information and does not constitute tax, legal or financial advice. Always confirm your circumstances with a registered tax agent. Program rules, rates and thresholds may change; verify the current income year’s requirements on official websites.