R&D tax credits – an ever evolving regime, even before first returns are filed
Tax Alert - February 2020
By Aaron Thorn, Simon Taylor and Emma Faulknor
More changes to the research & development (“R&D”) tax credit regime were announced prior to Christmas, when the Taxation (Kiwisaver, Student Loans, and Remedial Matters) Bill (“the Bill”) was reported back to Parliament. The changes predominantly affect entities that earn exempt income and those who will be seeking a refund of the tax credit.
In overview, the R&D tax credit regime provides a 15% tax credit for eligible expenditure incurred on qualifying R&D activities undertaken in the 2019/20 and later tax years. The R&D regime was legislated for in May 2019 through the Taxation (Research and Development Tax Credits) Act 2019. In June 2019 amendments to the regime were first proposed in the Bill. We provided an explanation of the changes proposed when the Bill was first introduced in our July 2019 Tax Alert (available here).
The changes announced in the original Bill were mainly to extend the refundability of the tax credit to a broader range of recipients, in recognition that the regime was of little use to many businesses in a tax loss position.
The changes proposed in the original Bill included:
- Extension of the refundability provisions from year two of the regime (the 2020/21 tax year), so that the R&D tax credit is refundable to the extent of payroll taxes paid in that year;
- Exclude all entities that earn exempt income (except exempt income from wholly owned groups or foreign company dividends) from the regime.
Exempt income exclusion
The initial proposal in the Bill was to change the refundability rules from year two and to exclude entities who derive exempt income from being an R&D tax credit claimant altogether. This proposal would have resulted in significant overreach as many taxpayers may earn small amounts of tax exempt income.
The Finance and Expenditure Committee has recognised that organisations receiving small amounts of exempt income would be unfairly excluded from the regime. The Bill as reported back therefore contains changes so that only entities that derive the following types of exempt income will be excluded from being claimants:
- Business and non-business income derived by charities;
- Income related to public and local authorities;
- Local and regional promotion bodies;
- Income derived by a tertiary education institution or subsidiary.
A charity may have subsidiaries that are eligible for the R&D tax credit provided the subsidiary is not a registered charity.
Charities that claim in year one but have excess R&D tax credits will forfeit the excess R&D tax credits and will be unable to carry forward the tax credits to year two. Other entities can still carry forward R&D tax credits, provided the shareholder continuity requirements are met.
The rationale for excluding charities from the regime is due to the benefit they already receive under the tax system, such as the exemptions from income tax, the donor tax credit regime and other GST and FBT concessions.
Once enacted the above proposals would apply from the 2020/21 tax year.
In the reported back Bill, the Finance and Expenditure Committee has changed the name of the refund cap calculation from “payroll-tax based cap” to “refundability cap”. The refund of the tax credit will continue to be based on Fringe Benefit Tax (FBT), Employer Superannuation Contribution Tax (ESCT) and Pay As You Earn (PAYE) paid but in response to submissions the reported back Bill also proposes a one-time concession to allow year one payroll taxes to also be included when determining what can be refunded in year two (i.e. to allow any 2019/20 R&D tax credit carried forward to be refunded if there has been sufficient payroll taxes paid).
We note that the calculation still largely remains the same, which means that the regime remains unfavourable for organisations, such as start-ups, that use contractors instead of hiring employees and do not pay payroll taxes. Unfortunately it seems unlikely that this will be reviewed before the five-yearly evaluation of the regime.
Considerations for year two
There are already claimants (including a number with December balance dates) who have now entered year two of the regime. Although the regime has always required contemporaneous documentation to be maintained, from year two the process for applying for the R&D tax credit includes a pre-approval process.
The two approval regimes are a general approval regime, and, for claimants with more than $2 million of eligible R&D expenditure, the significant performer regime. These regimes are explained further in our July 2019 Tax Alert referenced above.
Pre-approval deadlines under both regimes are the seventh day of the second month after the end of the income year, but claims can be submitted throughout the year. The changes in respect of these regimes proposed in the Bill as reported back are:
- General approval is binding on the Commissioner, and
- Significant performers must obtain criteria and methodologies approval (this was previously optional).
It is important that businesses implement systems to gather information to obtain approvals throughout the year, so they are ready by the approval deadlines.
What to do next?
As a reminder, we recommend talking to those responsible for R&D in your business to gauge the level of eligible activity occurring. Deloitte is happy to assist with this stage and our R&D experts have experience with a wide range of technical activities and industries.
If you do have an eligible R&D activity, then you will also need to check your documentation processes to see whether adequate records are in place to track eligible projects and expenditure.
If the above sounds like it might apply to you, please contact one of us, or your usual Deloitte advisor.
February 2020 Tax Alert contents
- Purchase price allocation: Using a sledgehammer to crack a chestnut
- R&D tax credits – an ever evolving regime, even before first returns are filed
- Are you aware of changes to the taxation of telecommunication and travel allowances?
- Happy New Year – a taxpayer (pyrrhic) victory, and a refresher on Parliamentary sovereignty
- Snapshot of Recent Developments