R&D tax credits – latest developments and key considerations
Tax Alert - July 2020
By Simon Taylor, Brendan Ng and Denver Ingram
The Research and Development (“R&D”) tax credit regime has been up and running for over a year now, with many taxpayers getting themselves in a position to complete and file their first returns. During this time the Government has been amending the regime to ensure it is fit for purpose, including introducing broader refundability of the tax credit, particularly for those taxpayers who are in losses (read more about refundability). This is particularly useful for any taxpayers who need access to a cash benefit now, not a tax credit they can carry forward into the future.
The Government has also proposed other clarifications, with the latest changes coming in the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill (“the June Bill”), which was introduced to Parliament on 4 June 2020. The June Bill proposes a number of amendments that impact the R&D tax credit regime, the most noteworthy of which introduces a change that will allow more capitalised R&D to be eligible, potentially significantly increasing the amount of R&D qualifying under the regime.
We discuss these most recent proposals below, followed by some key considerations and frequently asked questions that we’ve observed in our time working through the R&D tax credit regime.
Proposed changes to note
Tangible depreciable property – more employee costs are eligible
This proposal makes more capitalised expenditure on employee costs eligible for the R&D tax credit, if it is related to a core R&D activity. Previously employee costs capitalised into tangible fixed assets were ineligible (unless they fell within the prototype exemption covered below). This meant that many R&D activities that would have otherwise been eligible were excluded simply because they had been undertaken in a capital project. This change is welcome as it removes a bias against valid R&D activity in capital projects.
The proposed change is backdated to the commencement of the R&D tax credit regime i.e. from the start of the 2019/20 income year.
In our view the capitalised employee cost inclusion should be extended to contractor costs as well, as there should be no difference between the insourced and outsourced labour. Currently, eligible outsourced R&D can only be claimed if it has not been capitalised, and to the extent it relates to eligible R&D activities. In practice, outsourcing often occurs and it is common to find that outsourced costs relate to the most challenging / specialised aspects of R&D projects (e.g. design engineering).
Prototypes – clarification of eligibility
Further clarity has been provided in relation to the ‘prototype exception’, to ensure that expenditure on prototypes is only eligible where it is intended that the prototype is to be used solely in R&D throughout its lifetime, and where the creation of the item involves a core R&D activity. This means that upon a future change in use of an R&D prototype to a commercial use, it will be essential that the taxpayer can evidence that the property was originally intended to be used solely for R&D. We accordingly recommend that records of this intention be kept in respect of all R&D prototypes.
Mining development activities – specific exclusions
Currently, activities relating to prospecting, exploring, or drilling for minerals, petroleum, natural gas, or geothermal energy are already excluded from the regime. The June Bill proposes to extend this to explicitly exclude development activities as well (for example, developing land for the purposes of mining). There are also new exclusions for decommissioning expenditure and expenditure on land remediation.
The key point here is that the exclusions are intended to only target the broad development phase itself. If, however, there is R&D within any of these phases, this may still qualify. We have been working with both Inland Revenue and taxpayers on how these rules should practically apply in this sector and have a team of experts with first-hand experience in this area. If you are in an industry specified in one of these exclusions, please come and talk to us as you may still have R&D which will still be eligible.
Definition of eligible R&D expenditure
Currently, the regime provides a 15% tax credit for eligible expenditure incurred on eligible R&D activities.
The Bill proposes a new definition which would require expenditure to be:
• required for conducting an R&D activity;
• integral to conducting an R&D activity; and
• directly related to conducting an R&D activity.
This is worded as a clarification of the existing definition and as such it also has retrospective effect to the start of the 2019/20 income year. The emphasis on finding a close link between the cost and the R&D activity highlights Inland Revenue’s concern that expenses remotely linked to R&D activities may make their way in to claims.
Satisfying the new criteria (if enacted) will be much easier to achieve where good records are kept explaining why expenses relate to the R&D activity and meet the three tests above. Read more about the basic documentation requirements.
The June Bill includes a number of other changes including:
- proposed amendments to the schedule of excluded expenditure;
- bringing forward the due date for submitting a criteria and methodologies application (relevant to larger R&D performers using the significant performer regime for the 2020/21 year onwards); and
- a positive amendment to extend the time bar period for consideration of requests made by claimants to increase their R&D tax credit claim after the initial claim has been filed.
Key considerations and frequently asked questions
With the 2019/20 tax year over for most taxpayers, income tax returns and R&D supplementary returns can now be filed and the R&D tax credit (or refund) accessed. We have been assisting businesses to prepare their claims throughout the year and are now seeing the first wave of R&D supplementary returns prepared for filing. From this experience, below are the answers to some frequently asked questions and key considerations.
With the impact of COVID-19, I’m constrained on cash – can the R&D tax credit regime help me?
The R&D tax credit is now able to be refunded for taxpayers in losses which creates a potential cashflow benefit available to businesses right now. We have found that the current economic climate has meant that many entities are now keen to understand the potential tax refund available from claiming under the R&D tax credit regime and want to progress their claims.
I heard that the Government has an R&D loan scheme?
The Government has recognised the value of R&D to New Zealand by introducing a R&D Loan Scheme to encourage R&D performing businesses to continue with their R&D activity post COVID-19. The loan will be up to $400,000 to spend on R&D activities (with interest of 3% applying only if the loan is not repaid in the first 12 months), and the loan will only be provided where it can be proven that a business’ ability to finance their R&D activity has been impacted by COVID-19. If you think you qualify for the loan, please talk to us so we can work through your options, as if you qualify for the loan scheme it is likely that the R&D tax credit regime will be able to provide further benefits for you.
Is R&D just people in a laboratory in white coats?
While there is a lot of ‘traditional’ R&D activity going on, New Zealand is an innovative country with a history of leading the world in new developments across a broad range of industries and skillsets. In particular, a large number of the taxpayers we are working with are in the technology sector, and our team has valuable experience in this area. The R&D tax credit regime applies broadly, and many of the taxpayers we work with do not consider themselves to be R&D organisations.
How can I find out if I am undertaking an eligible R&D activity?
Deloitte has a team of R&D experts who have experience across a broad range of industries. If you would like to discuss how the R&D tax credit regime could benefit your business, please don’t hesitate to contact our specialist R&D team or your usual Deloitte advisor.
July 2020 Tax Alert contents
- R&D tax credits – latest developments and key considerations