The Government has now released draft legislation prescribing how its R&D tax credit will operate. The key incentive is the introduction of a 15% R&D tax credit (increased from 12.5% in the draft proposals) applying to maximum expenditure of $120m, equating to a potential tax credit of $18m. Businesses can apply to exceed this expenditure cap if they can demonstrate NZ will derive a substantial net benefit from the R&D. The minimum R&D expenditure threshold has also been decreased to $50,000 per annum, from the original amount of $100,000, which will help smaller businesses access the regime.

As originally proposed, the new tax credit was to be non-refundable. During the consultation period requests were made for the new scheme to include a refund mechanism for early stage R&D intensive companies that commonly experience tax losses during their early years. The resultant cash flow problems can threaten their existence. The Government recognised that such firms are vital to innovation and the development of a diversified economy. Hence, for the first year of the new regime (1 April 2019 – 31 March 2020) the Government will allow tax credits to be refunded based on the limits prescribed within the existing tax-loss cash-out scheme, i.e. businesses can receive refunds providing at least 20% of their labour cost is R&D related, to a maximum eligible spend of $1.7m. At the new tax credit rate of 15%, this will provide a maximum refund of $255,000. For context, approximately only 350 businesses currently benefit under the current scheme. The Government recognise this is only an interim solution so they will continue to review the new regime, with revised rules for refunds expected from 1 April 2020.

A further welcome change is a widening of the definition of ‘eligible R&D expenditure’. The initial Discussion Paper contained a narrow definition requiring the use of ‘scientific methods’. There was concern that this would preclude tech sector businesses from accessing the regime, as the development of computer software or phone apps is not commonly based on ‘scientific methods’. This has been addressed, with the revised definition based on the use of a ‘systematic approach’.

The tax credit claims will be submitted alongside income tax returns. However, from the 2020/21 year, businesses will be required to attain pre-approval of their eligible R&D expenditure, which will be binding on IRD, providing businesses the ability to confidently forecast their future tax positions.

The changes to the regime reflect the Government’s commitment to raise NZ’s R&D expenditure to 2% of GDP over the next ten years, whilst making the regime accessible to a wider range of businesses.

The loss offset (and subvention payment) mechanism allows a ‘profit’ company to reduce its taxable income by utilising the tax losses of a ‘loss company’. The mechanism is a great tool that is commonly used.

Before a loss offset can be made, the following key requirements must be satisfied:

• The loss company must have maintained shareholder continuity of 49% from the time the loss was incurred, until the time it is utilised.
• The two companies must have maintained shareholder commonality of at least 66% during the period in which the losses were incurred and the profits derived (against which the losses will be offset).
• The loss company must carry on a business through a fixed establishment in New Zealand and cannot be a dual resident company.
• The amount of the loss offset cannot exceed the taxable income of the profit company.

As with most tax issues, the devil is in the detail, and prescribed legislation exists to govern the use of the loss offset mechanism. To assist taxpayer’s with ensuring the rules are correctly applied, Inland Revenue has recently issued an updated standard practice statement (SPS) setting out its view on how the legislation is to be interpreted.

The new statement is useful because it clarifies an ambiguous matter that had existed after a previous statement made by Inland Revenue. In previous guidance, Inland Revenue had advised that it is possible to complete a subvention payment by way of journal. However, no detail was provided on what the form of those journals should be to ensure they were technically correct. The problem lies in the fact the legislation requires the profit company to bear the loss of the loss company; this ordinarily occurs through the physical payment of cash. However, it is not possible for a profit company to bear another companies loss, solely by way of journal.

Inland Revenue have now advised that journals can be used if they cause a genuine crediting in a payee’s account or off-set of a pre-existing obligation. For example, if the profit company had previously loaned cash to the loss company and the two companies agreed that the profit company will make a subvention payment to the loss company, that could be completed by journal. The journals would reflect that the loan is eliminated, allowing the loss company to keep the cash.

The SPS also covers a number of other scenarios such as:

• how to make a valid election,
• part period loss offsets due to a change in shareholding,
• the effect of amended assessments, and
• late elections.

Reference to the SPS is recommended if any of the above situations are encountered.

The update is a timely reminder to ensure the rules are applied correctly, especially for those who might be thinking about transferring some losses this coming tax year.

It is important for individuals to correctly determine their residency status for tax purposes, as a New Zealand tax resident is taxed on their ‘worldwide income’.

A person is considered to be a New Zealand resident for tax purposes if they have been physically present in New Zealand for more than 183 days in any 12-month period or if they have a ‘permanent place of abode’ (PPOA) in New Zealand. A person ceases to be a tax resident if they are physically absent from New Zealand for 325 days in any 12-month period. However, if a  person maintains a PPOA throughout the period they are absent from New Zealand, they are still considered a New Zealand tax resident.

A recent Taxation Review Authority decision has highlighted the importance of these residency rules, and in particular, the breadth of a PPOA. The taxpayer, a sea captain, had an interest in his employer’s superannuation fund, and in foreign investment unit trusts owned by him, which were all sold by August 2008.

The taxpayer was accused by Inland Revenue (IRD) of maintaining a PPOA in the income tax years ended 31 March 2005 to 31 March 2009 (inclusive), and was therefore liable to pay New Zealand income tax on his interest in the unit trusts and any deemed income under the Foreign Investment Fund (FIF) rules.

The taxpayer had been a mariner all his adult life, and under the terms of his employment, spent approximately eight months a year at sea. The taxpayer’s wife typically accompanied him at sea. In 1998 he became a trustee and beneficiary of a trust which owned a property in New Zealand. The taxpayer returned to this house at least twice a year in the years from 1998 until October 2014, when the property was sold. The TRA found this property to be a PPOA for the taxpayer, supported by the following facts:

• The property was not rented when the taxpayer was absent from New Zealand – friends and family were able to stay on occasion but otherwise the property was available for use by the taxpayer and his wife.
• During the tax years in dispute, the taxpayer, on average, spent three and a half months in New Zealand, with credit card statements for these periods showing daily use in the suburb where the property is situated.
• The taxpayer’s salary was used to meet the trust’s loan obligations, pay insurances, utilities and other expenses.
• Vehicles belonging to the taxpayer, his wife, and the trust were registered to the property during the years in dispute.
• A SKY subscription was maintained for the taxpayer’s use when at the property.
• The address was used for mail, including mail related to the trust’s rental properties.
• When not at sea, the taxpayer’s payslips were sent to the property.
• The taxpayer was registered on the Electoral Roll in 2008 at this address.

As a result, the TRA upheld the Commissioner’s reassessments for each of the 2005-2009 income tax years, to tax the taxpayer’s interest in the unit trusts and any deemed FIF income from the superannuation fund. Adding to the cost, a shortfall penalty for taking an unacceptable tax position was charged, calculated at 10% of the tax shortfall.