R&D Tax Incentive Bill introduced to Parliament
Tax Alert - November 2018
By Aaron Thorn
Following on from the Government’s announcement at the beginning of October 2018, the Taxation (Research and Development Tax Credits) Bill (the “R&D Bill”) has been introduced to Parliament, and contains the Government’s proposals for the research and development (“R&D”) tax incentive scheme that will be available from the 2019/20 income year.
The R&D Bill and its accompanying Commentary mirror the Government’s previous announcement and provide detail on the proposed regime. This includes some more detail on filing requirements, documentation required, provisional tax and what activities and expenditure are eligible / ineligible. There are also a number of helpful flowcharts at the back of the Commentary to help users understand how the rules work.
We covered the key details of the R&D tax credit regime in our earlier Tax Alert article following the announcement in early October 2018. We set out below some of the extra information in the R&D Bill and the Commentary.
Further details from the R&D Tax Bill: What expenditure will give you an R&D tax credit?
Excluded activities: Excluded activities will be listed in new Schedule 21 Part A and B of the Income Tax Act 2007 (ITA). The Commentary provide examples of excluded activities (and when some of these activities may be supporting activities). Excluded activities include such things as maintaining or making minor improvements to software, market research, commercial, legal or administrative aspects of patenting, licensing and similar activities, quality control and testing, and preproduction activities such as tooling up.
Eligible / ineligible expenditure:
New Schedule 21B Part A lists the categories of expenditure and loss that are eligible for R&D tax credits, while Part B lists the categories that are not eligible. Section LY 5(1) defines eligible expenditure as being available for the credit “to the extent” the expenditure or loss is incurred on a R&D activity. However R&D activities performed in the course of commercial production are only claimable to the extent the costs (including energy costs) exceed the market value of the production outputs.
Ineligible expenditure includes the cost of acquiring technology that is used as a basis for further R&D activities and expenditure to commercialise the results of an R&D activity.
“Business-as-usual” commercial production costs (except labour costs) are excluded from the credit, being expenditure on R&D activities performed in the course of commercial production that would have been incurred in the absence of the R&D activities. The policy here is clear however we foresee that this restriction may be quite problematic in practice in terms of being able to identify the line of demarcation.
- Contracted R&D: Where R&D expenditure is contracted out, an R&D tax credit may be claimed, however the total R&D expenditure for calculating this portion of the tax credit is reduced by 20%. The theory behind this is that the person contracting out their R&D activity shouldn’t get a credit for the profit margin of the person carrying out the R&D, and a 20% margin has been assumed for simplicity.
- Approved research providers: Although there is a minimum spend of $50,000 before an R&D tax credit is available, this doesn’t apply if the business uses an approved research provider to carry out the R&D. This is to ensure that the R&D tax credit is available to even the smallest of businesses.
- Software development:
- Expenditure on internal software development is subject to a $3million cap, but is excluded altogether where this relates to the ordinary internal administrative functions of a business (i.e. for the purpose of using the resultant software to perform common internal business functions such as payroll, HR, accounting, invoicing, inventory, human resources, executive or management information and enterprise resource planning). The cap groups a person’s expenditure with internal software development already claimed by associated parties.
- Internal software development expenditure is defined as expenditure for the purpose of the internal administration of a person / associate’s business; or providing services to customers, unless the main reason the customers use the services is to use the software or technology developed by the person. If the software is developed for sale or license, however, it will not be categorised as “internal software development”.
- General software development expenditure is not subject to the $3million cap.
- Nexus: A person’s R&D does not need to relate to their New Zealand business – it is sufficient that the person carries on business in New Zealand through a fixed establishment.
- Support activities: Support activities are those that are only or mainly (75% of the supporting activity) for the purpose of, required for, and integral to a core activity.
What will happen to my refund?
- Refunds / carry-forward: When a person has more R&D tax credits than their income tax liability, their R&D tax credits are refunded up to a maximum of $255,000 provided the person meets certain criteria (i.e. the R&D tax loss cash-out regime in subpart MX of the ITA, and in particular the 20% R&D labour intensity test). R&D tax credits that are not refunded are carried forward, subject to the same continuity rules as apply to losses in the ITA.
- Provisional tax: The R&D tax credit is proposed to allow a person to reduce their future provisional tax liability by taking expected R&D tax credits into account in calculating their RIT. Taxpayers who wish to benefit from R&D tax credits via reduced tax payments in the current year may use the estimation method for paying their provisional tax.
How do I apply for my tax credit?
- To claim an R&D tax credit the business has to file an R&D supplementary return within 30 days of filing their tax return for the relevant income year. In addition, from the second year of the scheme businesses will have to obtain general approval for their R&D core activities shortly after the end of the income year (the seventh day of the second month after balance date). Without this general approval an R&D tax credit cannot be claimed.
- An R&D tax credit claim, once filed, can only be amended once. A request to amend the claim must be made within two years of the date on which a person’s income tax return is due for the relevant income year.
- To prevent people retrospectively reclassifying expenditure as R&D a person cannot apply for R&D tax credits if they have not filed the income tax return for the relevant income year (containing their R&D tax credit claim) within one year of the due date for the income tax return.
- Record keeping:
- Taxpayers must keep sufficient records to support their R&D claim (and hold these for seven years after the end of the income year to which the records relate). The claim must be based on records which were prepared contemporaneously with the R&D activities and which identify the creator and date of creation, not records which are backdated or created at year end.
- The type of evidence required will include project documentation (such as log sheets, project plans and test results), as well as minutes of meetings, internal reports, receipts and contracts. The Commentary provides further detail on the records that will need to be kept in relation to R&D activity and R&D expenditure, and it is expected that there will be further detail on this in the guidance to be released.
- Significant performers regime (Year 2): Persons with more than $2million of eligible expenditure in an income year have the ability to opt out of the general approval process and into the significant performer regime. Expenditure can be grouped together to meet this threshold for partners in partnership and companies in the same group of companies.
- Publication of claim details: It is proposed that the Commissioner will publish the name of each person and their eligible R&D expenditure amount in dollar bands, two years after the end of the tax year to which an R&D tax credit claim relates.
What should you do now?
The new R&D tax incentive regime is coming soon, so now is the time to get prepared. Documentation and processes should be in place to enable your business to identify eligible projects and expenditure as soon as the rules are in place. Contemporaneous documentation that addresses the R&D credit eligibility criteria will become very important, as will the ability to separate eligible and non-eligible expenditure.
If you think there any issues with the rules, please get in touch with us about making a submission on the R&D Tax Bill. At this stage it is unclear when submissions will be due, however we understand that submissions are likely to be due around the end of January 2019.
If you would like to make a submission or need any help in understanding the new rules, please contact our National R&D Leader Aaron Thorn, or your usual Deloitte advisor.