R&D tax incentive
A useful tool for infrastructure projects
Construction and Infrastructure projects carry many technological obstacles, such as challenging ground conditions, extreme environments or being confronted with something unexpected; all of which can result in smart solutions being developed to overcome them.
Fortunately, if used and understood properly, R&D tax incentives can help mitigate the financial risks linked to these uncertainties. In a nutshell, the R&D tax incentive allows for a 15% tax credit on eligible R&D expenditure.
The incentive has the goal to promote innovation and the development of new solutions by increasing the total amount of R&D performed in New Zealand from 1.3% to 2% of the gross domestic product (GDP) by 2028. To meet this goal, there needs to be a significant increase in the amount of business R&D performed in New Zealand.
The construction industry accounts for 6.4% of New Zealand’s GDP (as of 2018). Considering that many developments in the sector constitute complex and challenging projects, it stands to reason that a significant proportion of business-performed R&D should be coming from this industry.
Furthermore, the NZ government recently announced a $3 billion investment to fund infrastructure projects and an additional $1.1 billion for improvements to transport. These will undoubtedly translate into a significant increase in activity, and therefore R&D, in the sector. One perspective might be, that if a modern transport infrastructure project doesn’t qualify for any R&D credits – then the technological solutions developed for the project might not be forward looking enough.
However, in order for the construction and infrastructure industry to fully benefit from this incentive, the approach and understanding to R&D incentive claims needs to change. The current industry approach to performing R&D tends to be retrospective – determining lessons learnt after the project has finished. In order for companies to fully benefit from this incentive, this approach needs to be revised. The benefit is worthwhile as it could be a material contributor to the business case and model. If R&D is considered at the start of the project, it may then be accounted for during the project. This allows for the financial benefit from R&D activities to be included within the cash flow modelling and the budget of an individual project from the outset. An alternative approach would be to invest the R&D tax credit in internal innovations that would create the competitive edge on future R&D projects. Consequently, construction firms can then make their pricing more competitive, or even consider a project that might not have otherwise appeared profitable. Given that the contribution could be fifteen cents back from every eligible dollar spent, this could give claimants a significant edge over the competition.
For existing projects, the R&D credit might potentially be a windfall (or equity buffer) against modelled expectations. The challenge for projects underway, is that they need to be alive to the opportunity and look to implement a level of R&D credit governance and compliance that isn’t programmed into the project.
For many, using R&D tax incentives in this way is a completely new way of thinking. An important part of it consists simply of educating staff to think differently and approaching the tender process from a new perspective. Of course, understanding the rules, recording requirements and what constitutes R&D is vital for this process to be a success. Below are some examples of R&D within this industry:
- Advances in engineering to develop new or unique materials;
- Design and build of specialist machinery, or modification of existing equipment;
- Complex modifications of existing construction methods or designs to overcome technical challenges, such as challenging ground conditions or tight movement tolerances;
- Innovation regarding environmentally friendly processes, such as significant reduction of waste.
Beyond this, it is a case of identifying the areas that are likely to qualify for R&D tax credits up-front, then ensuring these activities and the related expenditure are tracked throughout the life cycle of the project. A seemingly straightforward project could be hiding a host of challenges, forcing plans to change and on-the-job redesigns. These innovations should be tracked and recorded as they happen to ensure that businesses are capturing every eligible activity that occurs.
Risks associated with calculations of claims that have not yet been approved can be mitigated through the pre-approval process.
After the first claim year, claimants will be required to obtain pre-approval for R&D activities or tracking systems. If activities are pre-approved, this can provide certainty to companies by ensuring the R&D activity is eligible for the tax credits before companies incur significant expenditure on the R&D. If the R&D project is expected to take longer than a year, general approval can be obtained for activities for up to three years. Due to the size of most infrastructure projects, there is a high chance that the R&D will span multiple years. Therefore, if the activity is approved and all costs associated to it are recorded, this can give companies some certainty of a 15% tax credit for future years.
It is important to note that not all expenditure is eligible for this incentive with the most relevant exclusion being expenditure on capitalised tangible fixed assets. However, a recently proposed change will allow employee costs that have been capitalised to be eligible for R&D tax credits, if it is related to eligible R&D activities. This reiterates the needs to fully understand and plan up front what the cost of R&D will be to the business to maximise the benefit from this incentive.
Properly used, Inland Revenue’s R&D tax incentives can be a powerful and strategic tool enabling more competitive pricing and bolder business decisions. But the impact of rethinking R&D incentives does not stop at a company level. The construction industry as a whole faces a turbulent post-COVID-19 environment. Tight margins and challenging projects will become the norm in this new climate. By factoring-in R&D tax incentives across the board, businesses can take on more complex projects, keeping the industry moving forward.