R&D Tax Incentive Regime – Where are we at?
Tax Alert - October 2020
By Aaron Thorn, Simon Taylor and Brendan Ng
The Research and Development tax incentive (RDTI) regime has been in place for over a year now, and as with any new regime, we are starting to see how the rules are being applied in practice, and whether they are in line with expectations.
This article covers some of the practical applications for software, developments to be aware of and what to do next. Other proposed changes to the regime and the answers to some frequently asked questions are covered in our July 2020 article.
Where are we at with software R&D?
The application of the R&D tax incentive regime to software has received some media attention, with the Minister of Research, Science and Innovation Megan Woods recently stating:
Software is an essential part of the innovation ecosystem and we expect it will be strongly represented in the R&D activity that receives the RDTI. A number of very promising RDTI applications relating to software R&D have been submitted.
When it comes to software, it is important to remember that the definition of R&D is the same no matter what the underlying activity is. This means that the same requirements around a scientific or technological uncertainty, systematic activity, and new or improved knowledge, process, product or service must be met, identified and articulated in order to be eligible.
The key step is to assess your organisation’s activities against the legal criteria, and Inland Revenue’s R&D guidance, with particular reference to the sections on software in the guidance. The guidance provides a comprehensive interpretation of this relatively new legislation, and its content is followed very closely by Inland Revenue when reviewing claims.
Whilst many software claims have already been prepared, a number of businesses are still receiving Callaghan Innovation Growth Grants, and are assessing the impact of the transition to the RDTI. For all potential software claimants, the key focus areas in assessing eligibility are the learnings gained from the R&D activity, and the technical risks overcome in the development programme. Questions to ask include: What new technical knowledge has resulted from the activity? What was uncertain in how or whether the technical objectives could be met, and why?
The software development process typically requires a systematic approach, involving testing, in order to develop new products or services. It is important in tracking eligible activities to apply the above criteria early in the process, identifying the scientific or technologically uncertain aspects of the design, development and testing undertaken.
The R&D support for software development is undeniably different under the RDTI compared with Growth Grants (as admitted by the Government) however despite some public concerns, the Minister has confirmed that she is aware of and expects that further software will be able to access the RDTI - it is accordingly essential to focus on the RDTI eligibility requirements to get the claim right, with a focus on identification of the eligible aspects.
Inland Revenue’s guidance begins with an overview of the policy intent of the regime, with an expectation that it will lower the cost to businesses in performing R&D, to help transform the New Zealand economy into a high-skill, knowledge-based and productive economy. A tax credit was chosen as the method to provide a subsidy because of the wide reach of the tax system, with the ability for claimants to access support based on predefined rules. This was expressed by the Minister, in the comments quoted above, when referring to her expectations of the regime. It is clearly contemplated that software development can receive funding under the RDTI, with the key to a successful claim being an accurate focus on how activities meet the eligibility criteria.
What else should I be aware of?
For R&D claims in the 2020-21 income tax year onwards, organisations must get their R&D activities approved by the Commissioner before they will be eligible for the R&D tax credit. This is known as ‘general approval’ and is mandatory for organisations wishing to claim. Under general approval organisations gain certainty from the Commissioner (in advance of submitting their R&D supplementary return) that their activities meet the definition of an R&D activity, with this approval being binding on the Commissioner. General approval can be granted for an activity for up to 3 years.
To obtain general approval of an activity an organisation must provide to the Commissioner information about the project and details of the activities proposed to be undertaken. This means organisations will need to prepare write ups describing their R&D activity and how it meets the requirements of the legislation (i.e. what the scientific or technological uncertainty is, whether a systematic process has been undertaken and what the intended new knowledge, or new and improved process, product or service is).
General approval applications must usually be received by the 7th day of the 2nd month following the end of your income year (i.e. a 31 March balance date must submit its general approval applications by 7 May, and a 31 December balance date must submit its general approval applications by 7 February 2021). This is a very short timeframe after year-end, combined with financial reporting and audit commitments, so the timing for completion of applications should be planned carefully – early applications are consistent with Inland Revenue’s expectations around contemporaneous supporting documentation.
However, in response to the disruption caused by COVID-19, the Commissioner has extended the deadline by which a general approval application must be submitted, to the 7th day of the fifth month after the end of the first income year (i.e. a 31 March 2021 balance date must submit its general approval applications by 7 August 2021).
This deadline variation only applies to the 2020-21 income tax year and where “the planning or conduct of eligible research and development or the ability to appropriately obtain necessary information, seek advice and formulate an application… on time has been materially delayed or disrupted by the COVID-19 outbreak and its effects.” At this stage it is unclear what evidence is required to show that such disruption has occurred, but it will be worth considering what documentation your organisation has to substantiate any delays.
Other notable changes to the regime, already covered in previous Tax Alert articles, include favourable changes to the refundability criteria and eligibility of expenditure on tangible fixed assets.
For easy reference, set out below are some key milestones to be aware of:
- Enrol in R&D tax credit regime – before filing a claim a taxpayer must enrol for the regime in myIR to access the supplementary return (and application form for general approval).
- Apply for general approval (2020-21 income year onwards) – this must be done by the 7th day of the 2nd month following the end of the income year in which the R&D activity was undertaken (or, as noted above in relation to COVID-19, by the 7th day of the 5th month in certain circumstances).
- Significant performer regime (2020-21 income year onwards) – organisations expecting to incur more than $2 million of eligible R&D expenditure in an income year may opt out of the general approval regime (i.e. they will not be required to get project-by-project approval) and make an application under the significant performer regime by the 7th day of the 2nd month after the end of their income year. These organisations will also need to apply for approval of their criteria and methodologies (CAM) for determining whether R&D activities and expenditure are eligible. Some points to note:
- When making a significant performer notification, CAM approval must be sought which involves a very detailed presentation of the procedures used to identify and track R&D, and sufficient time should allocated to this process to ensure the information required by Inland Revenue is provided to them.
- Applicants under the significant performer regime may still choose to seek general approval for selected projects – for example, for those where upfront certainty of their eligibility status is desired. This should be considered because CAM approval is not binding on the Commissioner.
- The choice of pre-approval mechanism requires careful consideration, because there is no fall-back ability to apply for general approval if a CAM application is denied after the deadline for applying for general approval has expired. Significant performer applicants should submit their CAM applications as early as possible to allow for the review period – this is partly why a change to the CAM application date has been proposed for the 2021-22 income year, bringing the deadline forward to six months before the end of the applicant’s income year.
- Prepare and file income tax return – this must be done by your organisation’s usual due date and will include an entry for the amount of the R&D tax credit to be claimed.
- Prepare and file R&D supplementary return – this must be filed within 30 days after the due date of the income tax return.
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.
October 2020 Tax Alert contents
- R&D Tax Incentive Regime – Where are we at?