R&D tax credits – our experience to date
Tax Alert - December 2016
By Ian Fay and Harriet Woods
With the new research and development (R&D) tax credit rules having been in effect since the start of the 2016 income year, a number of our clients have now been through the application process and are reaping the benefits provided by the regime’s cash flow injection. Given this we thought it was timely for an update as to how the initial implementation of the regime has been received as well as a few tips and tricks to look out for as 2016 tax returns are being prepared and the 2017 income year is underway.
In short, the R&D Tax Credit regime recognises that cash flow is a real problem for many New Zealand start-ups and operates to provide a ‘cash out’ of an entity’s R&D tax losses. The cashed out amount is then required to be repaid from the taxpayer’s future income and as such the benefit provided by the regime is solely a timing benefit, effectively being an interest free non-recourse loan.
Further information regarding the finer details of the regime can be found in the March 2016 tax alert article here or Inland Revenue’s special report here, however in general a taxpayer will be eligible for the cash out if they satisfy the following criteria.
- New Zealand tax resident company
- Tax loss position
- Must maintain ownership of intellectual property
- Must have a ‘wage intensity’ of at least 20% (calculated as total R&D labour expenditure ÷ total labour expenditure).
Overall the response to the regime has been relatively well received and is a benefit for some of our clients where cash is king.
However we have come across a number of issues which can be easily addressed with a bit of forward planning.
The R&D tax credit rules draw on accounting concepts from IAS 38: Intangible Assets. Most businesses applying for the R&D tax credit are not required to prepare financial statements under GAAP so instead prepare financial statements under Inland Revenue minimum financial reporting rules. Many businesses carrying out R&D, however, have already adopted IAS 38 as an accounting policy in order to: ensure deductibility of R&D expenditure that may otherwise be non-deductible; to defer deductions for R&D expenditure; or as a requirement of Callaghan Innovation R&D Growth Grants.
For those businesses that have not adopted IAS 38 previously, this may require changes to existing processes to identify R&D expenditure in accordance with the standard.
An important concept under IAS 38 is determining whether expenditure on R&D can be recognised as an asset. In order to be recognised as an asset the company must be able to demonstrate all of the following:
(a) The technical feasibility of completing the intangible asset so that it will be available for use or sale.
(b) Its intention to complete the intangible asset and use or sell it.
(c) Its ability to use or sell the intangible asset.
(d) How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
(e) The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
(f) Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
Only expenditure that doesn’t meet the threshold to be capitalised as an intangible asset qualifies for the R&D tax credit.
Many groups undertaking R&D will structure their operations so that the intellectual property (“IP”) is held by a separate group company from the one undertaking operations and employing staff – a structure that is often recommended for companies wanting to increase the protection of their IP from business risks.
However this becomes problematic in respect of the R&D Tax Credit rules as they only provide for an R&D Tax Credit where the company that makes the claim both owns the IP and employs the staff carrying out the R&D activities. Where a separate group company employs the staff carrying out the R&D neither the IP owning company nor the company employing the staff can make a claim.
In order to ensure this does not become an issue potential solutions include:
- Amending employment contracts so that the IP owning company is the employer of staff undertaking the IP, which exposes the IP owning company to employee liability risks; or
- Electing for the IP owning company and the employer company to form a consolidated income tax group.
Both of these solutions require forward planning.
Ministry of Business Innovation and Employment (MBIE) forms
Another thing to look out for is ensuring the R&D expense calculation submitted with MBIE in the activity statement and supplementary form matches the IR10 lodged with Inland Revenue.
Obtaining maximum value
The R&D tax credit is in effect an interest free loan. As such value can be maximised by ensuring tax returns and the R&D tax credit claim are filed as quickly as possible after year end. Our experience is that the tax credit is received between 3 – 10 weeks after the claim is made, depending on MBIE / Inland Revenue processing times.
If, after surrendering the tax loss, a company is going to be tax paying the benefit may be minimal. For the 2015-16 income year if the tax credit is received (for example 6 months after year end) this could be after the first instalment of provisional tax is due for the following year such that voluntary provisional tax payments may be advisable to reduce exposure to use of money interest. From 2016-17 onwards this will be a less significant issue as changes to the provisional tax rules should result in no exposure to use of money interest in the year following a tax loss. Even if the following year has a tax liability depending on timing of the tax credit being received there should be at least a full year’s use of the R&D tax credit before it is “repaid” through increased tax payments.
The R&D tax credit rules provide a potentially very valuable source of additional funding for companies undertaking R&D. With some careful planning, the R&D tax credit is reasonably simple to claim and the potential benefit is set to increase over coming years as the cap increases from $500,000 ($140,000 Tax Credit) for 2015-16 by $300,000 per year to a maximum of $2,000,000 for 2020-21.
December 2016 Tax Alert contents
- Timely revised guidance on deductibility of certain earthquake related costs
- Closely held companies bill reported back with significant changes
- Charitable change to the FBT rules? Depends on your facts
- Business tax simplification measures are a step closer
- Calculating “market rental value” on employee accommodation – guidance finally released
- R&D tax credits – our experience to date
- IR’s Operational Guidelines: Pre-Litigation Settlements
- What’s on the Tax Policy Agenda?
- A snapshot of recent developments