Research and development

The R&D tax credit will lead to more investment in the New Zealand technology sector and aligns New Zealand with other leading technology nations. (New Zealand Technology Industry Association)

A well designed and administered R&D tax credit regime, in combination with other measures, has the potential to achieve the Government’s goal of incentivizing R&D in New Zealand to drive innovation, productivity, and economic growth. (EY)

A successful R&D tax credit regime will benefit all New Zealanders, by helping to increase productivity, enhance skills and knowledge, and potentially attract new activity to New Zealand. (Corporate Taxpayers Group, Deloitte)

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Long-term sustainability is important

Submission

(EY)

The R&D tax credit regime needs to be sustainable from a fiscal and cost management perspective, which includes compliance costs on claimants and administrative costs for Government.

The submitter supports measures that aim to maintain the regime’s sustainability over time. We support the broad direction of the tax reforms in the Bill because simplifications in administration are positive for the tax system as a whole.

Comment

Officials welcome the support and agree that sustainability is important. The R&D tax credit rules already contain a number of integrity measures. The proposed refundability cap is also aimed at ensuring the sustainability of the regime.

The systems and processes for claiming the credit have been designed so that wherever possible compliance and administrative costs are minimized while still ensuring the continued integrity and sustainability of the regime.

Recommendation

That the submission be noted.

Issue: Support for stakeholder engagement on proposals before Bill introduced

Submission

(Corporate Taxpayers Group, Deloitte)

Submitters appreciated the consultation undertaken prior to the introduction of the Bill, as it means that we have already had the chance to provide feedback on the R&D proposals in the Bill. It has been a constructive process and we have found it particularly useful to understand officials’ specific concerns behind the proposals. This understanding has helped us address these concerns directly and to work with officials to find solutions.

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

REFUNDABILITY

(Clause 101 (proposed new sections LA 5(4B), (5B) and (5C)))

Issue: Support for broader refundability

Submission

(EY, Corporate Taxpayers Group, Deloitte, NZRise, Chartered Accountants Australia and New Zealand, New Zealand Technology Industry Association, PwC, KPMG, Pharmaceutical Solutions)

Support broader refundability because it is a necessary incentive for firms in loss, or with insufficient tax to pay, to participate in the regime and increase their R&D activity. It will also help the Government reach its goal of increasing New Zealand R&D expenditure to two percent of GDP over the next ten years.

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Support for refundability cap

Submission

(EY, KPMG)

Support having the cap. (EY, KPMG)

While some businesses may not be able to receive refunds of all their R&D tax credits because of the cap, the cap is nevertheless a reasonable approach to ensure the integrity of the regime is maintained. (EY)

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Changing the name of the cap

Submission

(Matter raised by officials)

The name of the cap should change from “payroll-tax based cap” to “refundability cap”. The references to “payroll” in the components of the formula for the cap should, where appropriate, just refer to “tax” (and not refer to payroll).

Comment

Officials recommend the name of the cap be changed from “payroll-tax based cap” to “refundability cap” because the current name may cause confusion. Changing the name to “refundability cap” better reflects that the cap applies to R&D tax credit refunds and is made up of the total PAYE, ESCT and FBT paid by a claimant[2] in a given income year.

The same changes should be made to the components of the formula, so that instead of referring to “payroll” they just refer to “tax”. That is, the relevant components of the formula should be “own tax”, “other wholly-owned tax”, and “other controller tax”.

Recommendation

That the submission be accepted.

Issue: Contractors and sweat equity

Submission

(Chartered Accountants Australia and New Zealand, PwC)

A payroll tax-based cap is not appropriate, because start-up businesses often use sweat equity or contractors (and do not opt into voluntary withholding) instead of hiring employees. These businesses may not pay payroll taxes. (Chartered Accountants Australia and New Zealand, PwC)

A cap is unnecessary because:

the credit is largely only available for work performed in New Zealand. (Chartered Accountants Australia and New Zealand)
there are sufficient integrity measures in place to prevent fraud, such as in-year approval. (PwC)

If the Government is not willing to remove the cap, then a solution would be to extend it to include the tax effect of contractor payments not already subject to schedular tax. (Chartered Accountants Australia and New Zealand)

Comment

The Bill seeks to broaden access to refundable research and development (R&D) tax credits so that more businesses with insufficient tax liability are able to access support for their R&D expenditure sooner. Without refundable R&D tax credits, firms in a tax loss position or with insufficient income tax liability would be unable to benefit from R&D tax credits for some time, which would reduce the incentive for these firms to perform additional R&D.

The provisions introduced by the Taxation (Research and Development Tax Credits) Act 2019 earlier this year currently allow some businesses to have their R&D tax credits refunded. The rules that currently apply to refundable tax credits, including the corporate eligibility and wage intensity tests, significantly constrain the number of firms that can access this part of the scheme. The value of the tax credits that can be refunded is also capped at $255,000, although any unused credits can be carried forward.

The objective of the R&D tax credit is to support as much genuine R&D as possible while maintaining the integrity of the tax system. This objective has informed the design of the broader refundability rules proposed in the Bill.

The Bill proposes to replace the current refundability rules with a single measure which would cap the maximum amount of R&D tax credits paid out to the total amount of PAYE, fringe benefit tax (FBT), and employer superannuation contribution tax (ESCT) paid in the same income year by the claimant business. PAYE includes schedular payments deducted from contractors’ pay. The cap would apply at the group level. That is, the cap can include amounts of PAYE, FBT, and ESCT paid by firms the claimant is controlled by, and firms in the same wholly-owned corporate group as the claimant (subject to a double dipping rule, which prevents the same amount of tax counting towards more than one claimant’s cap). The cap would not apply to credits claimed by levy bodies, or that relate to eligible R&D expenditure on approved research providers.

The proposal would take effect for the R&D tax credit regime from the 2020–21 income year (“year 2”).

Officials consider a refundability cap necessary to ensure the continued integrity and sustainability of the R&D tax credit regime. It is widely recognised that paying refunds through the tax system increases the risks of fraud. This has been the experience of overseas jurisdictions that offer refundable tax credits, as well as other parts of the New Zealand tax system (such as GST refunds). To counter this risk, all countries that offer refundable tax credits have put in place additional integrity measures. It is common to limit the amount of refund with reference to tax paid by a claimant business.

For example, the UK initially had a payroll-type cap on refundability but removed it. After this they experienced large amounts of R&D tax credit fraud. The UK is now looking to reinstate their cap – earlier this year HM Treasury and HM Revenue & Customs released a consultation document Preventing abuse of the R&D tax relief for SMEs.[3]

New Zealand officials discussed our proposal to broaden refundability from year two of the regime with UK officials. UK officials recommended that we introduce the proposed style of refundability cap because it is an effective and efficient deterrent of fraud, and because it is more difficult to introduce a cap once a regime has had uncapped refundability.

Officials considered and discarded other options to manage the increased risks of fraud associated with refundable tax credits including:

allowing chartered accountants or lawyers to certify that a claimant has a tangible economic presence in New Zealand instead of imposing a refundability cap; and
a minimum threshold below which claims would be automatically approved.

It was considered that these options could increase complexity and compliance costs as well as administrative costs. In addition, they did not fully address risks associated with refundability. The proposal to limit refunds by the amount of labour-related taxes paid by a business provides a measure of tangible economic presence. This ensures that refunds are only paid to businesses undertaking genuine R&D in New Zealand. The proposed cap is easy for businesses to calculate, thereby providing them with certainty about their claim. It is also simple for Inland Revenue to administer, thereby reducing administrative costs so that effort can be focussed on assessing claims.

Officials acknowledge the cap may mean some R&D performers do not fully benefit from the tax credit. Modelling of the potential impact among current Callaghan Innovation Project Grant recipients indicates the number of affected firms will be small. Chartered Accountants Australia and New Zealand has suggested the cap include the tax effect of contractor payments. This would impose an additional administrative and compliance burden for both Inland Revenue and businesses. The burden associated with calculating the tax effect of payments to potentially multiple contractors per claim, and cross-checking this against the amount claimed by each business, is significantly greater than that imposed by the cap as currently proposed.

With respect to the point about sweat equity, officials note that this is not eligible for the R&D tax credit because the credit is based on actual expenditure incurred. For the same reason, that it would be difficult to verify, officials do not support its inclusion in the cap. Therefore, it would not be appropriate to include it in the calculation.

The R&D tax credit will provide substantial support for businesses’ R&D, but it is not the only measure available to support businesses to increase their investment in R&D. Businesses that may not be eligible for the credit because they spend less than $50,000 a year on R&D (so do not satisfy the minimum threshold), or who are in a tax loss position but have no employees (and therefore cannot access refundable tax credits) may be eligible for R&D grants provided by Callaghan Innovation. This includes the following grants:

Getting Started Grant: provides a grant for forty percent of eligible expenditure up to $5,000.
Project Grant: provides a grant for forty percent of eligible expenditure up to $800,000, and then twenty percent after that.

The Callaghan Innovation grants not only offer higher rates of co-funding than the tax credit, but also provide businesses with wrap around support. This includes access to advisory services and Callaghan Innovation’s research and technical experts. MBIE has commenced a review of the wider funding landscape to ensure that these other forms of support complement the R&D tax credit.

Officials will also ensure the refundability cap is reviewed as part of the five-yearly evaluation of the R&D tax credit regime.

Recommendation

That the submission be declined.

Issue: Cashing out non-refundable year one credits in year two

Submission

(Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand)

The refundability of non-refundable credits carried forward from year one of the regime to year two needs to be clarified. (Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand)

If the proposed new refundability cap (based on payroll taxes) applies to credits carried forward from year one to year two, then year one payroll taxes should be included when calculating the cap on refunding credits carried forward from year one. (Corporate Taxpayers Group, Deloitte)

Comment

If a claimant in loss (or with insufficient income tax payable to use up its R&D tax credits) cannot refund all of its R&D tax credits in year one, then the claimant can carry forward its non-refundable credits to year two of the R&D tax credit regime. The policy intent is for these year one credits to then be refundable in year two, provided the total number of credits in year two (including any year two credits) does not exceed the total PAYE, ESCT and FBT paid for year two.

Officials agree, however, that allowing PAYE, ESCT, and FBT paid in year one[4] to be taken into account in year two when determining the refundability of year one credits brought forward to year two is sensible. Allowing year one taxes paid to be taken into account in year two would allow claimants to benefit from the scheme more in the first two years of the regime. It is in line with the regime’s goal of incentivizing R&D activity. Officials recommend that this rule apply for year two only. That is, in year three, only year three PAYE, ESCT, and FBT paid will be included in the year three refundability cap, even if non-refundable credits are brought forward from prior years.

Officials recommend that guidance is published on how the proposed new rules would apply to credits brought forward from year one.

Recommendation

That the submission be accepted, subject to officials’ comments.

WIDER R&D SUPPORT MECHANISMS

Issue: Wider R&D funding landscape

Submission

(EY, Corporate Taxpayers Group, Deloitte, NZRise, Pharmaceutical Solutions, New Zealand Technology Industry Association, PwC)

The R&D Tax Incentive must be considered in combination with a wider package of initiatives to drive innovation in New Zealand. Together, these measures have the potential to help drive innovation, productivity, and economic growth. (EY, Corporate Taxpayers Group, Deloitte)

The definition of R&D in the R&D tax credit rules excludes virtually all commercial software development. Growth Grants are ceasing soon, so will no longer be available to support software R&D. (NZRise, New Zealand Technology Industry Association)

Other initiatives in the package could better target areas of the economy that do not necessarily fit easily into the R&D tax credit regime, including:

Software development. (Corporate Taxpayers Group, Deloitte, New Zealand Technology Industry Association)
The digital economy. (Corporate Taxpayers Group, Deloitte)
Start-ups and small-medium sized businesses. (New Zealand Technology Industry Association)
Charities. (PwC)
Clinical trials undertaken by global businesses in New Zealand. (Pharmaceutical Solutions)

The Government should continue to engage with the industry and undertake a broad education campaign to ensure businesses are aware of the range of options available beyond tax credits. The Bill presents the Government with an opportunity to:

make it easier to identify the various grants and other support mechanisms (like the tax credit) that are available to encourage and support firms making investments in R&D;
grow innovative new businesses; and
clearly demonstrate to innovative firms how each piece of Government support for R&D is interlinked (in a manner similar to Hong Kong). (New Zealand Technology Industry Association)

Comment

MBIE has commenced a review of the wider funding landscape, to ensure that other forms of support such as Callaghan Innovation grants complement the R&D Tax Incentive.[5]

Officials recognise that education is critical to increasing business awareness, especially amongst small-medium sized enterprises. Callaghan Innovation has received additional funding to deliver an education and engagement programme to raise awareness of the tax credit and support high quality applications. Callaghan Innovation is New Zealand’s innovation agency, and one of its core functions is to educate businesses about the benefits that R&D creates for businesses. Callaghan Innovation also supports businesses who wish to increase their investment in R&D.

Officials note that online guidance is available, which addresses the eligibility of software development. The guidance provides examples of software development expenditure that may be eligible for the credit.[6]

Recommendation

That the submission be noted.

Issue: Tax barriers to innovative activity

Submission

(Corporate Taxpayers Group, Deloitte)

There are existing barriers to innovation in the tax system. These issues include the deductibility of feasibility and black hole expenditure, and the tax loss carry-forward rules. Addressing these issues would help encourage innovative activity in New Zealand.

Comment

Officials recognise that these issues may present barriers to innovative activity, and that addressing them would help encourage innovative activity in New Zealand. These issues are on the Government’s tax policy work programme.

Recommendation

That the submission be noted.

TAX-EXEMPT ENTITY EXCLUSION

(Clauses 106 and 107 (proposed new sections LY 3(2)(f) and LY 8(2B))

Issue: Entities that derive small amounts of exempt income should be eligible

Submission

(EY, Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand, KPMG)

The proposed exclusion may apply more broadly than intended because it extends to all entities that receive any exempt income (other than from dividends). As currently drafted, the exclusion prevents some businesses from claiming the credit, even though they only receive small amounts of exempt income and otherwise sit within the tax system. This is inconsistent with the policy intent. (EY, Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand, KPMG)

There are various provisions under which otherwise taxpaying entities or individuals may receive exempt income. Receiving income that is exempt under such provisions should not make a potential claimant ineligible. These sections include:

CW 1: Forestry companies established by the Crown, Māori owners, and holding companies acquiring land with standing timber from founders. (Corporate Taxpayers Group, Deloitte)
CW 1B: Treaty of Waitangi claim settlements – rights to take timber. (Corporate Taxpayers Group, Deloitte)
CW 2: Forestry encouragement agreements. (Corporate Taxpayers Group, Deloitte)
CW 3: Forestry companies and Māori investment companies. (Corporate Taxpayers Group, Deloitte)
CW 26: Jurors’ and witnesses’ fees. (KPMG)
CW 27: Certain income derived by transitional residents. (KPMG)
CW 28: Pensions. (KPMG)
CW 34: Compensation payments. (KPMG)
CW 53: Distributions from complying trusts. (Corporate Taxpayers Group, Deloitte, KPMG)
CW 55: Māori authority distributions. (KPMG)
CW 55BAB: Rebates of fees paid by FIFs. (Corporate Taxpayers Group, Deloitte)
CW 55B: Amounts of exempt income from partners. (Corporate Taxpayers Group, Deloitte, KPMG)
CW 58: Disposal of companies’ own shares. (Corporate Taxpayers Group, Deloitte, KPMG)
CW 59C: Life reinsurance outside New Zealand. (Corporate Taxpayers Group, Deloitte)

There needs to be flexibility for the Commissioner to disregard the tax-exempt entity exclusion where the exclusion would prevent businesses that are not the target of this reform from claiming the credit. (EY)

A more targeted approach should be taken to appropriately exclude specific entities. (Corporate Taxpayers Group, Deloitte, KPMG)

Prefer a more targeted approach to excluding exempt income entities. An alternative rule is excluding “a person whose main source of income is exempt income”. (KPMG)

Comment

Officials agree that the legislation as currently drafted has some overreach, so does not satisfy the policy intent. The policy intent is for businesses that receive exempt income (such as lines company dividends) but otherwise pay tax to be eligible for the credit.

Officials recommend the legislation is amended so that the exempt entity exclusion is more targeted, rather than being a blanket exclusion that prevents any recipients of exempt income from receiving the credit. Officials prefer this targeted approach which provides more certainty to business and reduces both compliance and administrative costs.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Rationale for tax-exempt entity exclusion acknowledged

Submission

(EY)

The submitter acknowledges the rationale for making tax-exempt entities (such as charities) ineligible for refundability and from the R&D tax credit as a whole.

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Eligibility of charities

Submission

(Deloitte, KPMG)

Some organisations, such as social enterprises, have eligible R&D activities but are tax exempt. It would be useful to review the tax exempt exclusion to ensure these organisations are not disadvantaged from participating in R&D. (Deloitte)

Charities should be eligible for the R&D tax credit and refundability. The fact that they are not “income” taxpayers does not alter the logic for their entitlement to the credit. The R&D tax credit is delivered through the tax system because it is agnostic to activities and businesses. Any changes to the eligibility of charities should be subject to the full Generic Tax Policy Process and public consultation, with changes applicable only from the 2021–22 income year onwards. Bypassing this wider consultation raises serious questions about the process followed for such a fundamental change to the scope of the R&D tax credit regime. (KPMG)

Comment

Throughout the policy development process of the R&D tax credit officials have signalled that it was uncertain whether charities and other social enterprises would be eligible for the R&D tax credit.

The Taxation (Research and Development Tax Credits) Act 2019 introduced provisions that allow charities to claim the R&D tax credit in year one of the regime, but does not provide charities with any way to cash-out their credits. This makes the credits effectively unusable for charities because they do not pay income tax (and non-refundable credits can only be used to offset a claimant’s income tax payable, with any remaining credits able to be carried forward to the next income year only if shareholder continuity requirements are satisfied). This means that while charities can claim the credit in year one, they cannot benefit from the credit unless changes are made to the refundability rules for charities.

Officials engaged with charities and other tax-exempt entities at various workshops early this year, where the current eligibility of these entities for the credit was expressly discussed. Officials made it clear to participants that the eligibility of charities for the credit from year two of the regime was under consideration, and that it was possible they would not continue to be eligible for the regime (and that they may never be able to cash out any credits claimed in year one).

Charities do not pay income tax and receive additional Governmental support in the form of GST concessions, an exemption from FBT, and the donor tax credit regime. Tax-exempt entities such as charities sit outside the tax system, so it is not appropriate for them to also benefit from incentives provided from within the tax system. This approach was reflected in the initial uncertainty of charities’ eligibility, which has been communicated by officials to tax-exempt entities.

The proposed new tax-exempt entity exclusion does not extend to associates or entities controlled by a tax-exempt entity. This means that from year two of the regime, tax exempt enterprises will be able to continue accessing the credit through their wholly or partially-owned subsidiaries, provided they do not register these subsidiaries as charities.

Recommendation

That the submission be declined.

Issue: Credits carried forward by excluded entities and definition of levy body researcher

Submission

(Chartered Accountants Australia and New Zealand)

Support the amendment to section LY 8, which ensures that tax-exempt entities ineligible from year two will not be able to carry forward their year one R&D tax credits. Also support the proposed definition of levy body researcher in section YA 1.

Comment

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Eligibility of Māori enterprises

Submission

(Deloitte)

The tax-exempt entity exclusion highlights the challenges faced by some Māori enterprises that may have eligible R&D activities but be tax exempt. It would be useful to review the credit to ensure Māori enterprises are not disadvantaged from participating in R&D because of a lack of legal recognition of organisations using business models to address social and environmental issues.

Comment

Officials understand that there is some concern that Māori enterprises may be ineligible for the credit because they are charitable or may have charitable entities within their group structure.

Officials have already reviewed the proposed tax-exempt entity exclusion to ensure it does not prevent Māori enterprises from accessing the credit. This review included discussions regarding the proposed exclusion with both internal and external experts on Māori enterprises, charities, and subpart CW of the Income Tax Act 2007.

Under section CW 42 of the Income Tax Act 2007, income derived by a tax charity is tax exempt. “Tax charity” is defined to include registered charities and unregistered charities that carry on business for (or for the benefit of) a registered charity.

From 1 April 2020, a new tax provision is coming into force which means an entity will only be able to use the section CW 42 tax exemption if the entity is a registered charity. This is the case even where the entity is wholly owned by a registered charity. This means that entities owned by charitable, tax-exempt Māori enterprises will soon have the flexibility to choose whether the CW 42 tax exemption will apply to them.

The proposed new tax-exempt entity exclusion does not extend to associates or entities controlled by a tax-exempt entity. This means that from year two of the regime, tax exempt enterprises will be able to continue accessing the credit through their wholly- or partially-owned subsidiaries, provided they do not register these subsidiaries as charities.[7]

Recommendation

That the submission be noted.

ADMINISTRATION

Clauses 105, 122, 123, 128, 145 (sections LY 1, 46, 108, 113E, and 138E)

Issue: Timeframe for completing disputes process

Submission

(EY, Chartered Accountants Australia and New Zealand)

Support the amendment about the timeframe for completing the disputes process.

Comment

The proposed amendments to sections 108(1E) and 113E of the Tax Administration Act 1994 will allow the Commissioner to adjust a person’s R&D tax credit claim upwards if the person has initiated the disputes process through issuing a notice of proposed adjustment (NOPA) before the earlier of:

four months of filing their income tax return; or
a year after their income tax return due date.

The legislation currently requires a person to complete the disputes process within a year of their income tax return due date. The policy intent is for the person to initiate the process within the earlier of their income tax return due date or four months of filing the return, but not for the person to have to complete the disputes process within this timeframe. Therefore, the proposed amendments would ensure the legislation satisfies the policy intent.

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Challenging the Commissioner’s decisions

Submission

(EY, Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand)

Support the amendment about challenging the Commissioner’s decisions. (EY, Chartered Accountants Australia and New Zealand)

There should be transparency as to why an application might be declined in respect of applications to exceed the $120 million cap. Officials should work closely with an organisation to determine whether the Commissioner might apply her discretion. (Corporate Taxpayers Group, Deloitte)

Comment

The Bill proposes an amendment to prevent a person from challenging the Commissioner’s decisions regarding the pilot approval scheme and exceeding the $120 million eligible expenditure cap. The amendment brings these parts of the R&D tax credit regime into line with other Commissioner decisions regarding R&D, such as whether an entity can be an approved research provider, the in-year approval of activities that will apply from year two, and whether an entity can be an R&D certifier. This amendment does not prevent a person from applying for judicial review of the Commissioner’s decision.

Officials welcome the support for this amendment and agree that there should be transparency regarding why an application to exceed the $120 million cap might be declined. Officials recommend that guidance be published on the process involved in applying the exceed the $120 million cap, so that potential applicants understand what is required and can prepare their applications accordingly. As with other parts of the R&D tax credit regime that involve the Commissioner exercising discretion, officials will contact each applicant before their application is declined. They will also provide applicants with the opportunity to supply additional information in support of their applications, before they are declined, if appropriate.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Allocating credits to joint venture members

Submission

(EY, Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand,

We support the amendment regarding allocating credits to joint venture members. (EY, Corporate Taxpayers Group, Deloitte, Chartered Accountants Australia and New Zealand)

The amendment ensures the rules are in line with how joint ventures operate in practice. (Corporate Taxpayers Group, Deloitte)

Comment

The Bill proposes an amendment to correct the allocation of R&D tax credits claimed for R&D activities performed by joint ventures, so that these credits are allocated in accordance with members’ interests in the joint venture (rather than members’ interests in the income of the joint venture, which is impractical for joint ventures that do not derive income).

Officials welcome the support.

Recommendation

That the submission be noted.

Issue: Cost of claiming credits

Submission

(New Zealand Technology Association, Red Crater Software)

Concerned that the R&D tax credit claims process may have excessive compliance costs for businesses. (New Zealand Technology Association, Red Crater Software)

The administrative and compliance costs of the R&D tax credit currently outweigh its value. Instead of the current R&D tax credit claims process, it would be faster and easier if a representative worked through only the most necessary information required one-on-one with us, either in person or on the phone. (Red Crater Software)

Since in-year payments are not available under the R&D tax credit but are available under the existing Callaghan Innovation grants regimes, businesses are more likely to perceive that the credit has high compliance costs. (New Zealand Technology Association)

Comment

Officials recognise that there will be compliance costs associated with claiming the R&D tax credit, but compliance costs need to be balanced against the need for integrity and sustainability. The credit has been designed with various integrity measures to help ensure the credit’s sustainability. Some of these measures mean claimants will be required to provide the Government with information as part of the claims process.

The intent is that claimants should only be required to provide information they would generate as part of their usual business processes wherever possible. This may involve claimants assembling the information required to make an R&D tax credit claim but should not require the creation of new information just to satisfy the requirements of the R&D tax credit regime.

Recommendation

That the submission be noted, subject to officials’ comments.

ENTITY ELIGIBILITY CRITERIA

(Clause 106 (section LY 3))

Issue: Tertiary education organisation exclusion

Submission

(Matter raised by officials)

The legislation should be amended so that it is clear that foreign tertiary education organisations are ineligible for the credit, regardless of whether they are registered in New Zealand.

Comment

The legislation as currently enacted should exclude foreign tertiary education organisations but officials agree that it should be amended so that it is clear they are ineligible. This exclusion should include the organisations themselves, entities they are directly or indirectly controlled by, and entities they are associated with. This amendment would apply from year one of the regime (so from the 2019–20 income year), so that it can be incorporated into the processing and administration of year one claims.

Recommendation

That the submission be accepted.

Issue: Fixed establishment and in-business requirement

Submission

(Pharmaceutical Solutions)

The general entity eligibility criteria for the credit are too narrow, so make it harder to qualify for the credit when compared with the Australian R&D tax credit regime. The Australian regime only requires foreign claimants to have at least one resident director and allows a business to be eligible even if it only has a virtual presence. This is an easy requirement to meet.

On the other hand, the New Zealand regime requires foreign claimants to have a fixed establishment and operate a substantial business in New Zealand. This currently does not occur with clinical trials, which means that many foreign companies that run clinical trials in New Zealand will not be able to access the credit.

The credit should be available to foreign businesses with no fixed establishment or substantial business in New Zealand, because the R&D these businesses do in New Zealand through clinical trials provides the same benefits and spill-over effects to New Zealand. Clinical trials are considered the backbone of R&D in the life sciences industry.

Comment

Officials have met with and discussed New Zealand’s R&D tax credit regime with officials from other jurisdictions as part of the policy development process. The New Zealand regime has been designed with integrity and sustainability in mind, taking into account issues that have arisen in other jurisdictions.

Officials consider the fixed establishment and in-business requirements necessary to help ensure the continued integrity and sustainability of the regime. Removing these requirements would potentially enable claimants with little presence in, or connection with, New Zealand to claim the credit.

Claimants with no fixed establishment in New Zealand are unlikely to pay income tax in New Zealand, so would need to receive refundable credits to derive any benefit from the R&D tax credit regime. Refunding credits to such claimants is particularly risky because the claimants’ lack of New Zealand presence would make it difficult to ensure any overpaid refundable credits are paid back to the Commissioner (for example, if a fraudulent or excessive claim is made that is later reassessed downwards).

Officials note that there are benefits to clinical trials being undertaken in New Zealand but consider that support might be better targeted through other mechanisms such as grants.

Recommendation

That the submission be declined.

Issue: Excluding Growth Grant recipients

Submission

(Corporate Taxpayers Group, Deloitte)

The inclusion of an association test means that shareholders in a company that receives a Growth Grant are ineligible for the R&D tax credit regime for the remaining duration of the Growth Grant scheme. There are enough measures within the R&D tax credit rules already to prevent double dipping – this additional exclusion is unnecessary.

The exclusion creates a significant area of ineligibility that was not previously included when the Taxation (Research and Development Tax Credits) Act 2019 was first introduced, nor was it submitted on or covered in the officials’ report on that legislation.

We prefer removing the association rule to a grandfathering approach (which officials have previously indicated to the Corporate Taxpayers Group is their preference, should a change be made), because a grandfathering rule would be unnecessarily complex.

It does not make sense for eligible R&D undertaken by an entity to become ineligible when it later makes a separate investment into an entity which receives a Growth Grant. This change prevents access to capital needed by innovative firms, because it discourages recipients of R&D tax credits from investing in Growth Grant recipients as doing so means they can no longer access R&D tax credits. This may limit the extent to which companies are prepared to invest in Growth Grant recipients and the growth of Growth Grant recipients.

An announcement or other action should be taken to provide comfort to affected taxpayers that this rule will be amended, before the Select Committee reports back on the Bill. This will enable affected businesses to know whether they will be eligible for the regime, and if so, whether they should be keeping records of their R&D to meet the requirements.

It is not practical for these businesses to have to wait until Select Committee reports back to find out whether they will be eligible because:

the regime already applies for affected businesses in the Corporate Taxpayers Group;
a significant amount of work is required to bring businesses up to speed with the R&D tax credit rules; and
the credit has contemporaneous documentation requirements.

Comment

A person cannot currently claim the credit if they:

(i) receive a Callaghan Innovation Growth Grant;

(ii) are directly or indirectly controlled by a Growth Grant recipient; or

(iii) are associated with a Growth Grant recipient.

The Taxation (Research and Development Tax Credits) Bill as introduced only contained the rule in (i) above, with rules (ii) and (ii) introduced at Select Committee.

These two additional limbs were introduced to prevent Growth Grant recipients from artificially structuring so that they could claim both the credit and the Growth Grant at the same time. The policy intent is that a person can only claim either the credit or the Growth Grant, because the credit is intended to replace the Growth Grant regime.

Officials acknowledge that adding limbs (ii) and (iii) to the Growth Grants exclusion at the Select Committee stage may have had effects beyond what was intended by the Government. Some businesses may have entered into arrangements in reliance on the Growth Grants exclusion in the Taxation (Research and Development Tax Credits) Bill as introduced, prior to the Select Committee report back on 3 April 2019.

While officials recognise that a grandfathering approach involves more complexity than removing the association rule altogether, officials consider the association rule necessary to prevent businesses deliberately structuring themselves so that they can claim both the credit and the Growth Grant. Therefore, officials recommend:

that the rule in the Taxation (Research and Development Tax Credits) Bill as introduced (just limb (i) above) apply before the date the Select Committee reported back, so that businesses who entered into arrangements in reliance on the rule in the Taxation (Research and Development Tax Credits) Bill as introduced can still access the credit; and
that the rule that is currently in place (which includes all three limbs above) apply from the date Select Committee reported back, to ensure businesses cannot structure themselves to get around the Growth Grant exclusion (and claim both the credit and the Growth Grant).

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Callaghan Innovation ineligible for the R&D tax credit

Submission

(Matter raised by officials)

Callaghan Innovation should not be eligible for the R&D tax credit. Nor should entities directly or indirectly controlled by Callaghan Innovation, or associated with Callaghan Innovation be eligible.

Comment

Callaghan Innovation is a Government agency and is helping Inland Revenue administer the R&D tax credit regime. For the avoidance of doubt, officials recommend a new provision that ensures Callaghan Innovation, entities it controls, and any of its associates cannot claim the R&D tax credit. This amendment would apply from year one of the R&D tax credit regime (the 2019–20 income year), so that it can be incorporated into the processing and administration of year one claims.

Recommendation

That the submission be accepted.

IN-YEAR APPROVAL

(Clause 127 (schedule 21, sections 68CB, 68CC, and 124ZI))

Issue: R&D certifier approvals and applications

Submission

(EY, Chartered Accountants Australia and New Zealand, PwC)

Support the amendments about R&D certifier approvals and applications. (EY, Chartered Accountants Australia and New Zealand, PwC)

There should be a clear process or framework for those businesses potentially affected by the revocation of their R&D certifier, noting that those businesses would have been responsible and compliant. Therefore, they should not be adversely impacted. (PwC)

Comment

Officials welcome the support. Officials agree that there should be a clear process or framework for businesses potentially affected by an R&D certifier’s status being revoked. Officials recommend that guidance be published on this issue.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: General approval binds the Commissioner

Submission

(Matter raised by officials)

General approval should be binding on the Commissioner.

Comment

Binding approval will provide businesses with the certainty that their activities are eligible earlier in the claims process. However, general approval is not currently legally binding on the Commissioner. Therefore, it is possible for the Commissioner to change her view as to whether an activity is a core or supporting activity, even if it has been approved as part of the general approval process. This is contrary to the policy intent, which is for general approval to be binding on the Commissioner.

Officials recommend the legislation be amended so that general approval is binding on the Commissioner. This amendment would apply from year one of the R&D tax credit regime (the 2019–20 income year) for the general approval pilot, and from year two of the R&D tax credit regime for general approval once it is rolled out for all customers (from the 2020–21 income year), so that it can be incorporated into the processing of relevant year one claims and the administration of the tax credit from year two.

Recommendation

That the submission be accepted.

Issue: Clarifying the scope of general approval in relation to supporting activities

Submission

(Matter raised by officials)

Schedule 21, part B does not currently specify that supporting activities are ineligible if they have not been approved. It should be amended to clarify this.

Comment

Various amendments were made to the Taxation (Research and Development Tax Credits) Bill in response to submissions made to the Select Committee earlier this year. This included an amendment to the scope of general approval. In the Taxation (Research and Development Tax Credits) Bill as introduced, general approval only applied to core activities.

At the Select Committee stage, the proposed legislation was amended following submissions requesting general approval be extended to cover supporting activities as well. This was to provide businesses with added certainty that their R&D would be eligible for the credit. A clause equivalent to schedule 21, part A, clause 24 should have been added into schedule 21, part B at the time these other changes were made.

Officials recommend that a clause be added into schedule 21, part B to clarify that supporting activities are ineligible if they have not been approved. This amendment would apply from year two of the R&D tax credit regime (the 2020–21 income year), so that it can be incorporated into the administration of the tax credit once in-year approval is rolled out in year two.

Recommendation

That the submission be accepted.

Issue: Criteria and methodologies approval mandatory for significant performers

Submission

(Matter raised by officials)

Criteria and methodologies approval (CAM) should be mandatory for businesses that choose to opt out of the general approval regime.

Comment

From year two of the R&D tax credit regime, all businesses will be required to obtain general approval or, if they qualify, opt into the significant performer regime. A business can be eligible for the significant performer regime if it reasonably expects to have more than $2 million of eligible R&D expenditure for the relevant income year. The significant performer regime is intended to provide large R&D performers with an alternative to the general approval regime, because the compliance and administrative costs associated with obtaining general approval for large amounts of R&D activities may outweigh the benefit of the R&D tax credit for these businesses.

It is recognized, however, that businesses who spend significant amounts on R&D will still want certainty regarding their R&D tax credit claims. This led to the creation of the CAM regime, which is optional for businesses in the significant performer regime. Businesses in the significant performer regime can apply for CAM if they want to obtain approval from Inland Revenue that their R&D systems and processes are appropriate for determining the eligibility of R&D activities and expenditure.

Without general approval or CAM, businesses in the significant performer regime have no way of knowing for certain whether their activities or expenditure are eligible until they file their income tax and R&D supplementary returns.

At recent meetings with the Research and Development Advisory Group (RDAG)[8] and other key external stakeholders, officials were advised that CAM should be mandatory for significant performers. This was for these reasons:

Businesses who opt out of general approval (which is mandatory for businesses that are not in the significant performer regime) but do not have CAM will have no certainty that their R&D will be eligible for the incentive.[9] This is because they will not have general approval and will not have CAM. It is expected that most businesses in the significant performer regime who are legitimately performing R&D will want CAM because of this.
Some stakeholders had always thought CAM would be mandatory and were surprised to discover it was optional.
Businesses in the significant performer regime are required to obtain R&D certificates from R&D certifiers that they have complied with the R&D tax credit rules. Providing an R&D certificate to a business with no CAM involves significantly more work for a certifier, because the certifier would have to:

(i) Identify the systems and processes the business has in place;

(ii) determine whether these systems and processes would enable compliance with the R&D tax credit rules; and

(iii) test samples of the business’s claim to determine whether they satisfy the R&D tax credit rules.

On the other hand, if a business has CAM, (i) and (ii) above will have been completed by the R&D core team working with the business as part of the CAM process. Only (iii) would need to be completed by a certifier, who would also be tasked with checking whether the business has complied with their CAM.[10] Therefore, the cost obtaining an R&D certificate is expected to be comparatively greater for non-CAM significant performers.

R&D advisors have indicated that they are comfortable certifying whether businesses have complied with the requirements of their CAM, but that they may not be willing to certify much beyond this because of the risk associated with erroneously providing an R&D certificate to a business who has not complied with the rules.[11] This means it may be difficult to find certifiers willing to provide R&D certificates to non-CAM businesses in the significant performer regime.
Businesses in the significant performer regime who do not have CAM will not have early engagement with officials, which means that more scrutiny will have to be applied later in the claims process. This is not ideal for businesses, because if they have reduced their provisional tax payments expecting to receive a certain amount of R&D tax credits for a given year, the reassessment of their R&D tax credit claim could lead to the imposition of penalties and interest.

Officials agree with the points raised by stakeholders. Officials recommend that CAM is amended so that it is mandatory for businesses that opt into the significant performer regime. Officials also recommend that additional guidance is published on CAM and the R&D certifier process. This amendment would apply from year two of the R&D tax credit regime (the 2020–21 income year), so that it can be incorporated into the administration of the tax credit once in-year approval is rolled out in year two of the regime.

Recommendation

That the submission be accepted.

OTHER R&D SUBMISSIONS

(Clause 113(5) (schedule 21B, sections LY 2, YA 1 and 124ZH))

Issue: Eligibility of software

Submission

(NZRise, New Zealand Technology Industry Association)

The definition of R&D may exclude a lot of software R&D. It does not incorporate a novelty or innovation test, which currently enables some software R&D to be eligible for the Callaghan Innovation Growth Grant. (NZRise, New Zealand Technology Industry Association)

Further consideration should be given to the definition of eligible R&D for software R&D. As it stands, Australia may offer a more favourable environment for software R&D, so this creates the risk of exporting companies shifting their R&D from New Zealand to Australia. (NZRise)

New Zealand’s definition expressly excludes elements of the Frascati definition, such as experimental development and activities. Most other jurisdictions use the Frascati definition of R&D. (New Zealand Technology Industry Association)

Comment

In developing the tax credit and associated policies, such as the transitional arrangements for Callaghan Innovation Growth Grant recipients, the Government has wanted to minimise any disruption to R&D performers. In switching from one scheme to another, however, it is not possible to guarantee that all firms will get the same support as they did with the Growth Grant. There are inherent differences between a tax credit and a grant.

Some firms may be entitled to less money under the R&D tax credit, while other firms may be entitled to more than they would have received under the Growth Grant. Overall, the Government considers that the settings within the tax credit will mean that a greater amount of support to a larger number of R&D performers will be provided.

Officials consider that the current definition adequately incentivises software development. Widening the definition, such as by introducing a novelty test, would create an easier test and may let in activities of the kind that the Government does not wish to incentivise. Officials have already made changes to the definition from what was originally proposed in the discussion document by dropping the requirement that the R&D is conducted using a scientific method, in order to better accommodate software development. By introducing a novelty test, a claimant could qualify where they have created something “new”, without it necessarily incorporating the degree of difficulty and risk required by the uncertainty concept (that is, being “hard”).

New Zealand’s R&D activity definition is based on the Frascati definition of R&D. The Frascati manual provides that for an activity to be an R&D activity, it has to be novel, creative, uncertain, systematic, and transferrable/reproducible. All five of these criteria have to be satisfied.[12] Similar to Frascati, New Zealand’s core activity definition requires the use of a systematic approach, an intention to create new knowledge or things, and the resolution of uncertainty.

The New Zealand definition is comparable with definitions used by other jurisdictions including Australia and Canada. Other jurisdictions with a similar R&D activity definition to the one proposed in New Zealand support a considerable amount of software related R&D. Officials expect this outcome in New Zealand, but the credit will not support all software development activities.[13]

Recommendation

That the submission be declined.

Issue: Approved research providers

Submission

(Matter raised by officials)

To be eligible to become an approved research provider, an entity must be capable of performing core R&D activities.

Comment

Under the legislation as currently enacted, an entity can technically apply to become an approved research provider for the R&D tax credit regime if it performs core or supporting activities in New Zealand. Officials are concerned that this is too easy a threshold to meet, as a supporting activity just has to be inextricably linked to a core activity without necessarily involving any scientific or technological uncertainty in its own right.

There are benefits associated with being an approved research provider. There is a special rule for expenditure on approved research providers in relation to the proposed new refundability cap. Businesses can also claim expenditure on an approved research provider despite being under the $50,000 minimum threshold. These benefits may make the approved research provider regime an attractive way of getting around the cap or the minimum threshold.

Officials therefore recommend that to be eligible to become an approved research provider an entity must at a minimum be able to perform core activities on behalf of R&D tax credit claimants. This amendment would apply from year one of the R&D tax credit regime (the 2019–20 income year), so that it can incorporated into the processing and administration of year one claims.

Recommendation

That the submission be accepted.

Issue: Internal software development expenditure

Submission

(EY, Chartered Accountants Australia and New Zealand, Deloitte)

Support the amendment to the definition of internal software development. (EY, Chartered Accountants Australia and New Zealand)

It would be useful to update the R&D tax credit guidance to include some examples of affected expenditure for clarity. (Deloitte)

Comment

The Bill proposes an amendment to clarify the definition of internal software development expenditure, to make it clear what expenditure is subject to the $25 million internal software development expenditure cap.

Officials welcome the support for this amendment. Officials also recommend updating the guidance to include examples of affected expenditure for clarity.

Recommendation

That the submission be accepted.

Issue: Eligibility of expenditure on creating depreciable tangible property

Submission

(Corporate Taxpayers Group, Deloitte)

R&D expenditure that contributes towards the cost of depreciable tangible property should be eligible for the R&D tax credit because it is true R&D expenditure. The R&D regime is intended to incentivise R&D expenditure in New Zealand, but many organisations are finding this exclusion a significant barrier to their entry into the regime. We want to continue working with officials to develop an appropriate rule.

Comment

R&D expenditure that contributes towards the cost of creating depreciable tangible property is currently ineligible for the R&D tax credit. The rationale for this exclusion is the fiscal risk associated with R&D claimed in relation to creating large assets such as bridges and dams. Despite the exclusion, the cost of creating prototypes can be eligible, as can the depreciation associated with using an asset in subsequent eligible R&D.

Officials look forward to continuing to work with the Corporate Taxpayers Group, Deloitte and other stakeholders on this issue.

Recommendation

That the submission be noted.

[1] Pharmaceutical Solutions’ submission is supported by Julie Jones (President of the New Zealand Association of Clinical Research), Brandon Capital and the Medical Research Commercialisation Fund (MRCF), Edward Watson (CEO of Middlemore Clinical Trials), Barney Montgomery (CEO of Optimal Clinical Trials), Richard Stubbs (CEO of P3 Research), and Mike Williams and Simon Carson (CEOs of Pacific Clinical Research Network).

[2] Grouping rules may also apply to allow a claimant to include amounts of tax paid by a member(s) of their wholly-owned corporate group, and/or an entity that controls the claimant, in certain circumstances.

[3] Available at https://www.gov.uk/government/consultations/preventing-abuse-of-the-rd-tax-relief-for-smes

[4] Also taking into account any taxes paid that qualify through the proposed new refundability grouping rules. These allow PAYE, ESCT, and FBT paid by members of a claimant’s wholly-owned corporate group, or by entities that control the claimant, to be included in the cap in some circumstances.

[5] For more information on Callaghan Innovation grants, refer to the section of this report on contractors and sweat equity.

[6] Note that there is also a specific section of this report regarding submissions on the eligibility of software for the R&D tax credit.

[7] Although note that similar to other potential claimants of the credit, Māori enterprises would still need to ensure that they or their subsidiaries seeking to claim the credit do not receive tax-exempt income under any of the other provisions in subpart CW of the Income Tax Act 2007 that come within the proposed new tax exempt entity exclusion.

[8] RDAG is made up of representatives from PwC, Deloitte, KPMG, EY, BDO, Fisher and Paykel Healthcare, and Barkers of Geraldine. Officials discussed this issue with RDAG in late August and with other stakeholders in early September.

[9] Although note that significant performers do have the option of obtaining general approval for some of their activities, even if they have opted into the significant performer regime.

[10] The exact requirements of the CAM process and what will be required of R&D certifiers is still being developed. It is expected that part of checking compliance with CAM will involve looking at samples of activities and expenditure, but that this process would be lighter and significantly more straightforward for businesses with CAM (compared with businesses that do not have CAM). Officials will continue to develop the CAM process to ensure it provides certainty to businesses while still reducing the administrative and compliance costs that would otherwise be associated with these businesses obtaining general approval.

[11] An R&D certifier can have its certifier status revoked in a number of different circumstances, including when the certifier provides a certificate to a business who is later found to have committed tax evasion in relation to R&D tax credits. After having certifier status revoked, a firm cannot reapply for R&D certifier status for two years. The Bill contains proposals to extend the circumstances in which the Commissioner can revoke certifier status, so that certifier status can be revoked where a certificate has been provided to a business who has entered into a tax avoidance arrangement for R&D tax credits, or where allowing the certifier to retain their certifier status would adversely affect the integrity of the tax system.

[12] Frascati Manual 2015: Guidelines for collecting and reporting data on research and development, OECD, page 45.

[13] Officials note that online guidance is available which addresses the eligibility of software development. The guidance provides examples of software development expenditure that may be eligible for the credit.