By Tim Benbow & David Snell*
Thousands of businesses can claim an estimated $1 billion over the next three years under the long-awaited research and development (R & D) tax incentives, announced on Wednesday by Prime Minister Jacinda Ardern and Research, Science and Innovation Minister Megan Woods.
This is a bold package.
A well-designed R&D tax incentive could boost productivity, create high-skilled jobs and attract economic activity to our shores.
Preliminary proposals released in April were perhaps too conservative. I applaud the Government for acting on feedback to make some big design improvements.
The result is a generous R&D tax incentive, which should keep everyone happy (except perhaps for a fiscally conservative Treasury).
The vital statistics
Business expressed four big concerns on Woods’ preliminary paper – a 12.5% incentive was too low, refundability was essential for loss-making businesses, existing Callaghan Growth Grant recipients would be worse off, and software was potentially excluded from a too narrow definition of R&D. The Government’s acted on all the major concerns.
| Feature | Decision |
| Rate | 15% of eligible R&D expenditure |
| Application date | 2019/2020 income year |
| Eligible expenditure | $50,000 - $120 million of expenditure per year qualifies (some exceptions apply) |
| Refundability | Yes to a maximum of $255,000, if a business qualifies for the existing R&D loss cash-out |
| Qualifying expenditure | R&D activity definition requires scientific or technological advancement of products, processes or knowledge |
| Callaghan Growth Grants | Continue until 31 March 2021 |
| Overseas R&D expenditure | Up to 10% allowed |
| Expenditure for overseas affiliate | Local R&D qualifies |
| State-owned enterprises | Qualify for R&D incentive |
| No double dipping | Cannot claim Growth Grant and Tax Incentive in the same year |
Woods looks to be seeking to ensure no business is worse off, and that many will be significantly better off. Can this more generous design stay in balance with fiscal reality?
Compliance crucial
Today’s announcement is light on the application and compliance requirements. How will Inland Revenue police claims?
With taxpayers progressively entering the program from now, Government needs to explain the compliance process quickly.
Otherwise businesses which believe they comply could progress blindly for nine months or more. The key question: what type of evidence needs to be created and retained?
A potential high compliance burden is a significant unresolved concern. A burdensome compliance framework will reduce take-up. Conversely, a too relaxed set of rules will lead to low value claims, program costs blowout and scale-back of the R&D tax incentive in three or four years at most. Our last R&D tax incentive lasted only a single year before repeal.
Woods has delivered an industry agnostic definition of R&D. This aligns with the policy intent of making the program broadly accessible, especially for software R&D. The open definition brings with it the potential for overly broad claims. I’d like to see comprehensive guidelines and exclusions to prevent pseudo-science from being claimed, especially covering the IT and manufacturing sectors. These guidelines and exclusions will be key in determining which projects do and don’t qualify and will hopefully prevent protracted disputes as are commonplace in Australia.
Let’s hope this time we have a sustainable balance.
With a generous incentive rate and broad definition of qualifying R&D, I expect a high compliance bar.
Refundability (at least in part)
Refundability from day one is the most material shift from the Government’s original programme proposal. But a business can access cash only if it qualifies for the existing R&D loss cash out program. To be eligible for this, business needs to:
- Have current year tax losses
- Spend at least 20% of total business salary on R&D activities
- Not have shares listed on a recognised exchange
This is a big win for the subset of businesses which qualify as they’ll receive up to 43 cents per dollar in R&D funding. For qualifying R&D expenditure at the maximum of $1.7 million the combined refund of 28 cents from the existing R&D loss cash out program/ plus another 15 cents per dollar from the R&D tax incentive has a cash flow effect of over $700,000.
It looks like the R&D loss cash out expenditure caps will equally apply to the R&D tax incentive. Secondly, since a business will be accessing two similar but non-identical programs, compliance efforts may be duplicated and onerous.
New Zealand attractive
Multinationals will locate high value R&D activities wherever the business case stacks up. Access to markets, the availability of skilled scientists and engineers, intellectual property law and other regulations are all factors.
Even so, tax matters.
Woods’ globally competitive R&D tax incentive package looks attractive, in particular compared to Australia.
The Australian Government tabled legislation only two weeks ago to reduce its R&D tax incentive for the majority of large businesses to just 4% (the benefit is up to 13.5% for certain businesses). I’m seeing business already considering whether to relocate certain R&D to New Zealand.
Prepare now
This new funding could be available within days (from the start of an entity’s 2019/20 income year, for some businesses that could be as early as 1 October 2018.)
Businesses need to prepare now or risk sleep-walking past the potentially transformative R&D tax incentive.
Preparation takes two forms – modelling the potential impact of R&D incentive/growth grant options, and setting up the right systems for record-keeping.
On modelling, every business I’ve worked with has been different.
Businesses without growth grants can begin preparing for the programme immediately.
Businesses with growth grants need to determine which program will give them the better outcome and the best time to transition. The right choice will depend on each business’s:
- Balance date and income year
- Tax paying/loss position
- Total R&D expenditure
- Overseas activities
- Activity and expense eligibility under each programme – not everything qualifying for a growth grant will qualify for the new R&D incentive and vice versa, and
- Capitalisation of development expenses.
On record-keeping, preparation of evidentiary documents in real time is key. This sounds simple, but getting processes right before a business enters the programme should minimise the compliance pain.
*David Snell is EY NZ Tax Policy Lead; Tim Benbow is EY National R & D Lead.
13 Comments
I am not sure if you are correct on that NZ does not put a considerable amount of input into innovation (despite the obvious fact that NZ is obsessed with real estate). As per global innovation index, NZ ranks 16th in the world in amount of input toward innovative economy, however it has a terrible Innovation Efficiency Ratio (i.e. for a unit of input how much innovative output is produced). It ranks 59 in the world.
While I am not saying that it is not a good idea to allocate even more resources into innovation, the issue is we are not getting a value for money we invest. That may indicate a lack of strategy (or opportunity) for NZ economy as a whole.
It seems the problem is underutilization of innovation inputs, not the loss of value in the process. For example, despite featuring at rank 14 in tertiary enrollment, our poor performance in % of STEM graduates puts us at 61st in the world.
We are 45th in the world at capital formation, 42nd in local competition, 109th at FDI net inflows and 35th in research talent in business enterprise. We are 74th in ICT exports % of total trade and 38th in imports, meaning we neither produce nor consume enough of these services. Looks to me that we have the inputs needed to innovate but our businesses, government and workers lack the direction or initiative to produce the required outcome.
Hopefully, this initiative gets us moving in the right direction.
I was 47 before first visiting NZ (a 5 day holiday). Now I'm a patriotic Kiwi. In the thirty years of working in Europe, USA and the Pacific I met many New Zealanders - they were invariably hard working, good-natured, pragmatic, competant and often imaginative and creative. I was surprised to discover NZ is not the same as the talented people who leave it. There is an emigration problem. Kiwi risk takers prefer to take their risks overseas. It will take more than govt R&D tax refunds to change us.
I didn't say we don't put money into innovation, I just said it's better that we encourage productive innovation rather than encouraging primarily unproductive investment. In the same way we'd likely see much more investment in business if we dropped company income tax and increased land value tax.
The open definition brings with it the potential for overly broad claims. I’d like to see comprehensive guidelines and exclusions to prevent pseudo-science from being claimed, especially covering the IT and manufacturing sectors. These guidelines and exclusions will be key in determining which projects do and don’t qualify and will hopefully prevent protracted disputes as are commonplace in Australia.
The potential for re-description of existing expenditure is very high. Given the vagueness of the objective - "scientific or technological advancement of products, processes or knowledge" - it will be very tempting to chuck a wrapper around something that already exists but which is either not selling or is sitting on the shelf as being of dubious value, proclaim that it 'advances' something, and Pass Go.
The fact that Oz is full of contested R&D definitions should be a red flag here: the compliance alone could take a couple of FTE staffers to keep on top of.
But, glass half full, it may well help to sell a swag of new administrative software to keep track of it all....
At the lower end, R&D may only be a company working out how to make a product, rather than spending a large amount of money they don't have to buy someone else's method from overseas. A cost which could be beyond the company and would have meant the technology was beyond reach.
A case in point; some years ago i worked as R&D manager for a company manufacturing fibreglass products. They were putting a Resin Transfer Moulding process in place. Some of the equipment had to be purchased, but the moulds were another aspect. We could have spent millions getting someone else to teach us with no guarantees, but what happened was a bit of local effort and trial and error. It mostly worked out well in the end. There were still wrinkles to be worked out when I left, but most consistency and quality issues had been resolved. The cost was still research and development but a lot less than could have been spent.
Sounds complicated a great win for the accountants with high compliance requirements and with all of these types of policies open to rort. Simply cut the company tax rate and allow full capital expensing within the first year of capital purchase. This would increase incentives for business to invest in capital (accelerating productivity growth).NZ businesses need to start investing capital into technology big time.
Accounting for R&D is complicated and subject to a significant level of interpretation (which only benefits large firms who can employ best accountants and by virtue of being active in many fields have the necessary foundation for classifying expenses (that they might have otherwise differently classified) into R&D). So i totally agree with your comment.
Full capital expensing will boost gross capital formation numbers in the economy but are more likely to benefit larger, capital-rich companies. Smaller businesses and startups tend to be more conservative with their asset purchases at initial stages of growth, so prefer to lease and share and depend on intellectual capital to generate revenue.
Also, the way I see it, such a regime will increase our reliance on foreign capital (remember, we incur current account deficits) to fund capital assets import (tangible and intangible). It could improve our economy in the long run but the conditions aren't exactly ideal for either importing goods or borrowing capital from overseas in the face of plunging NZD, FED rate hikes.
An intended benefit of the R&D tax credit is to reduce dependence on hi-tech imports by domestically developing, hopefully, export-generating IP.
That's just my opinion. What do you guys think?
I don't understand the issues here. Why not just expense your R&D costs as incurred? My own experience with these sorts of schemes is they absorb a lot of senior management effort that would be better spent elsewhere. It looks like an ad hoc scheme that will be very inefficient and end up funding a lot of uneconomic research, but such is the nature of R&D anyway. Is tax the answer? Are there other more powerful but less obvious factors at work here?
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.