The Labour-led Government recently released the Research and Development (R&D) Tax Incentive Discussion Document, which proposes a 12.5% R&D tax credit on eligible expenditure from 1 April 2019.
The Government believes R&D is key to building a better New Zealand through creating a diverse, sustainable and productive economy. R&D expenditure by businesses in New Zealand is currently 0.64% of GPD – compared with the OECD average of 1.65%. The Government aims to increase this to 2% of GDP over the next 10 years.
The proposed tax credit will apply to eligible R&D expenditure between $100,000 and $120 million, equating to a possible $15 million tax credit. All businesses, regardless of legal structure, will be eligible for the credit. So the key determinant for accessing the grant will be the definition of ‘eligible’ expenditure. Two approaches are being considered. The first based on the cost of labour directly incurred on R&D, and a second broader approach intended to capture both direct and indirect R&D costs.
The proposed definition of R&D necessitates the use of “scientific methods” and requires the resolving of “scientific or technological uncertainty”. Although the regime is intended to have a broad reach, the draft definition maybe narrow and could limit the scope of eligible R&D activities. For example, it may not encompass software/app development if it doesn’t involve traditional scientific methods, nor solve uncertainty (i.e. they are more targeted at a specific creation or result) or address a material problem.
There are also some taxpayers benefiting from the existing R&D tax credit regime that will lose out from the proposed change. Under the current regime, loss-making companies can cash-out a portion of their tax losses, providing valuable cash flow to start-up companies incurring losses in the early years of business. However, under the proposed new regime, the tax credit will not initially be refundable and the value of the tax credit will not crystallise until a business is in a tax paying position.
Furthermore, the Callaghan Innovation Growth Grants will be phased out over the next two years, with all grants ceasing on 31 March 2020. This is on the basis that the new tax incentive is funding “a similar type of activity and have a similar purpose”.
The combination of the above could have a detrimental impact on the cash flow of R&D start-ups who may not have access to bank funding or may not want to dilute equity through additional capital investment. However, the Government has indicated that it will introduce changes to support R&D businesses in tax loss positions from April 2020, so we will need to wait and see what these changes bring.