It’s rare to have a new tax rule coming into effect before legislation has even been passed, but that’s how determined the Government is to put its new research and development (R&D) tax credit into place. As a small island nation at the bottom of the world, we know that our future economic power is not going to come from mass production or cheap labour. Instead, our best hope is great ideas well executed by local businesses using local resources. That’s why supporting R&D is such a cornerstone of strong economic policy; without it, we’re missing the opportunity to turn New Zealand into a hub of innovation.
In 2018 New Zealand spent 1.37% of GDP on R&D – considerably less than the OECD average of 2.4%. The Government aims to increase New Zealand’s R&D expenditure to 2% of GDP by 2028, acknowledging that R&D can benefit not only the company carrying it out, but also New Zealand’s wider economy and society.
How will the new tax credit work?
Draft legislation was released some months ago, so many will already be aware that the tax incentive will provide a 15% tax credit on R&D expenditure from the start of the 2019/2020 tax year, provided a business spends a minimum of $50,000 annually on R&D (there’s a cap of $120 million). The R&D tax credit will shortly replace the Callaghan Innovation administered Growth Grants, and should be comparatively more readily accessible to a wider range of businesses.
To claim the new tax credit, a business must have a core R&D activity. That means that an activity that has a goal of "creating new knowledge, new or improved processes, services or goods”. It must also use a systematic approach with a purpose of “resolving scientific or technological uncertainty”. The expenditure must also be of a qualifying type: this includes depreciation, buying goods or services to carry out R&D and paying R&D employees. Many businesses will already be undertaking R&D activities without necessarily flagging it as R&D or separating it out as a specific profit and loss item. The challenge will be ensuring that these are identified, recorded and that the qualifying nature of the activity and expenditure is well documented.
Who can claim?
It would of course be of little use to the enhancement of innovation and industry in New Zealand, if the credit was to be provided to businesses who are not spending on R&D in New Zealand, or for which the R&D is unlikely to benefit the country. The draft legislation therefore includes some very specific requirements about the ownership and control of the outcomes, as well as the types of activities and expenditure that will qualify as R&D.
IRD have recently fleshed these requirements out in an R&D tax credit guidance document, released in draft for consultation. The document provides some particularly useful commentary about ownership requirements of intellectual property and matters relating to ownership and control in situations where multiple parties are involved in the R&D activity. It also includes information about the relevance to the ‘ownership’ requirement where a R&D activity does not successfully conclude and there is no identifiable intangible asset resulting.
Where multiple parties are involved in the R&D activity, only the taxpayer who controls it is entitled to claim a credit. The focus on control is a way to ensure that only the ‘principal’ in relation to the R&D activity has a claim, and not agents or service providers also involved in the delivery of the R&D. This is to prevent multiple claims for the same activity and expenditure.
The IRD guidelines distinguish between a contractor who manages the day-to-day affairs of the R&D activity (not entitled to claim), and the ‘principal’ (entitled to claim) who should be entitled to check the work is being carried out in accordance with the terms of the contract, and should retain the right to start, stop or change the direction of the R&D activity. They emphasise that the contract with the R&D contractor should clearly identify the principal’s controlling rights.
For businesses interested in making R&D claims, IRD’s guidelines may suggest prompt action. Where relationships are not clearly set out in contracts with those conducting R&D activity, a claim may not be available.
The control requirement may be particularly large fishhook to a claim in situations where there are joint venture or similar cooperative type arrangements between multiple parties for the research and development activity. The guidelines clarify that the claimant must have the ‘sole right’ to start, stop and change the direction of core R&D activities.
Ownership and the right to use
A minimum level of taxable presence in New Zealand is required of the claimant (a fixed establishment is required), as well as various other conditions relating to the entity that will own the outcomes of the R&D.
A key requirement is that the results of the person’s R&D activities must be owned by the claimant or a member of the person’s corporate group that is situated in a jurisdiction with which New Zealand has a double tax agreement (DTA). The intention here is to balance the ongoing benefit to the New Zealand tax base in terms of the use of the knowledge, with allowing for New Zealand to become a ‘knowledge market’ for the provision of R&D to foreign companies.
In recognition of a wider set of rights models to R&D which may fall short of ownership, but from which the benefits of the incentivised R&D activity are likely to accrue to the New Zealand claimant entity – the ownership requirements are also satisfied where the claimant has the right to use the intellectual property resulting from the R&D activity for no further cost.
In terms of R&D development arrangements involving multiple parties – IRD have clarified that the right to use can be shared with others, available in limited ways, or available for limited purposes. This covers the myriad of contractual arrangements that third parties may choose to enter, that may allow for a New Zealand development of intellectual property which is intended for use both by the New Zealand entity and for their overseas partners.
R&D is risky by nature. Many ideas start and finish life as just that, ideas. Even where an idea makes it to the research phase, this phase may be short or long, simple or complex, and may produce new leads and development activities, or in many cases, come to a conclusion with no measurable benefit to the business other than the exclusion of one more possibility.
Sometimes nothing worthy of intellectual property protection will result. IRD have clarified in these cases that “ownership” of the results means that you must have the right to reuse the knowledge without further payment; failure to produce intellectual property does not mean the claimant will not satisfy the ownership requirement – a claim may still be available for the expenditure incurred.
Starting the process of documentation
Record keeping will be a major component of successfully claiming the tax credit. Building your documentation will be a journey that should start as soon as possible to answer the big questions: What R&D are you doing? How much of it is a qualifying activity? What expenditure is eligible? What can we include or exclude? How much of the work is taking place in New Zealand? Once your advisor has those answers, they can start to pull the R&D figures out of the general ledger and work out how to successfully keep records that will satisfy Inland Revenue.
Instead of being the domain of the finance department, claiming the R&D credit will require deeply specialised skills. Businesses from all industries are going to need to work hand-in-hand with accountants and CFOs to document R&D activities and investment.
We are optimistic that the new tax credit will provide a real cash injection into research and development across New Zealand’s economy, but an end-of-tax-year scramble to apply for an R&D tax credit simply will not meet the requirements. Contractual arrangements need to be in place, and records kept contemporaneously – businesses need to be recording R&D expenditure as it happens throughout the year.