Monday 8 April 2019

Taxation (Research and Development Tax Credits) Bill about to go before Parliament for its second reading

The Taxation (Research and Development Tax Credits) Bill (Bill), which implements the New Zealand Government’s R&D tax scheme (Scheme), passed its first reading on 1 November 2018. The Finance and Expenditure Committee released its report on the Bill last week.

After a transition period, the Scheme will replace the Callaghan Innovation Growth Grant. The Scheme, once it is in place, will apply from 1 April 2019. Businesses who wish to be able to claim the tax credits for FY19/20 should start keeping records of eligible R&D expenditure now, even though the Scheme is not yet in place.

Below we summarise the key features of the Scheme, as well as the changes recommended by the Select Committee, and our comments.

Summary of the Scheme

The Scheme provides a 15% tax credit on eligible expenditure (up to a maximum of $120 million of R&D expenditure each year or a $18 million tax credit, although businesses can apply to have a higher cap approved). There is a minimum R&D expenditure threshold of $50,000 per year to be eligible for the tax credit.

For at least FY19/20, the tax credit may be given as a refund up to a total of $255,000. Beyond that, the credit is non-refundable, but may be carried forward into future years, providing continuity requirements are met. The Government is still to finalise how the Scheme will operate in FY20/21 and beyond.

Definition of R&D activities

R&D is defined as core R&D activities and supporting R&D activities. Broadly speaking, a core R&D activity is one that:

  • is conducted using a systematic approach
  • has a material purpose of creating new knowledge, or new or improved processes, services, or goods; and
  • has a material purpose of resolving scientific or technological uncertainty.

A supporting R&D activity is one that has the only or main purpose of, is required for, and integral to, conducting a person’s core R&D activity.

Select Committee changes

The Select Committee has recommended a number of changes, but they are mostly small changes around how the Scheme works. Some of those changes include:

  • making it easier for joint ventures to claim tax credits
  • making it clear that subsidiaries of overseas entities can claim credits for qualifying activities undertaken in New Zealand
  • increasing the cap on eligible internal software development expenditure (as mentioned below)
  • excluding expenditure on software development for the purpose of internal administration or the purpose of integrating existing and new software platforms from the tax credit
  • making it clear that principals and contractors cannot both claim the tax credit for the same expenditure.

Internal software development expenditure

Some internal software development expenditure is eligible for the tax credit. To qualify:

  • the expenditure must be related to developing software for the purpose of providing services;
  • the main reason why recipients use the services must be the services themselves, not the use of that person’s computer technology or software;
  • the software development must not be for the main purpose of internal administration of the person’s business;
  • the software development must not be for the main purpose of disposing of the software to a third party;
  • the software must not be an integral part of goods that the person disposes of in the ordinary course of business.

Internal software development expenditure can be claimed up to a cap of $25 million (this was increased from $3 million by the Select Committee).

It is good to see that some internal software development costs are eligible for the tax credits, as this was potentially a gap in the Scheme. However, the eligible internal software development costs are quite narrow. Businesses will have to spend significant time and effort to keep good records in order to be able to claim any tax credits for software development costs.

Impact on start-ups

The use of a tax credit, as opposed to a grant, may disadvantage start-ups, who do not have taxable income to set the tax credit off against. A portion of the tax credit is refundable, so start-ups will receive that cash in hand to use to grow their business. However, the refundable amount is a relatively small portion of the available tax credit, and could still leave start-ups with large tax losses, but little funding to actually drive R&D.

If the Government wished to drive more R&D at a start-up level, it could consider having a higher refundable amount, particularly for businesses that are loss-making.