The Government’s release of a consultation document on taxation issues associated with business-related research and development (R&D) reflects its determination to lift the lid on black hole expenditure, a somewhat colourful term for business costs that do not qualify for tax deductions.

As the Science and Innovation Minister, Steven Joyce, has noted, the current tax rules can deter businesses from investing in this area, largely because they may not be entitled to claim a deduction for all R&D expenditure.

The Government says it wants to shed light on the issue to create a level of certainty for businesses that doesn’t exist under the current regime. It is particularly interested in providing clarity to the businesses it labels as innovative and credits for driving New Zealand’s economic recovery and growth.

It will be interesting to see how businesses engage with this process. It could be assumed that those involved  with SMEs - which make up 97.2% of New Zealand businesses, employ 30.2% of all employees and are responsible for an estimated 27.8% of New Zealand’s Gross Domestic Product - do not lie awake at night stressing about their R&D spend.

But one might expect our larger businesses to be more engaged with the process.

Minister Joyce and his Cabinet colleague, Revenue Minister Todd McClay, want to build on the initiatives that featured in this year’s Budget and related to legal and administrative costs relating to patents and plant variety rights; costs of obtaining certain fixed life resource consents; the costs of abandoned resource consents; the costs of paying dividends (but not the dividends themselves); and certain costs of running a public company including annual listing and meeting fees.

These were a starting point for the Government; there is still some ground to cover before New Zealand businesses can enjoy the same tax advantages their Australian counterparts have enjoyed since 2005 when the Government increased the range of deductions available to businesses.

Business interest groups here have been lobbying for similar changes and the Government appears to be listening and interested in making changes.

Ministers Joyce and McClay are seeking specific feedback on depreciation of capitalised development expenditure, depreciation of software developed by businesses for their own use, and tax deductions for capitalised development expenditure that fails to produce a successful asset.

It’s this last point, in particular, that is worthy of attention. The Government is right when it says the current tax structure can curb enthusiasm for R&D and Minister Joyce should be seeking ways to stimulate R&D given his responsibility for the Science and Innovation portfolio.

But it’s Minister McClay’s revenue responsibilities that are the driving factor as the Government seeks to remedy a system that can create farcical situations with companies persisting with failing R&D projects simply to avoid a black hole expenditure situation.

Flushing out dead-end R&D projects would be one outcome of the changes proposed by the Government. Or, as the Government put it when it announced the release of the consultation document, addressing a situation which “can result in investors putting their money into less productive areas of the economy because of a perceived tax disadvantage with some research and development ventures”.

And, understandably, it is these productive areas of the economy that are attractive to the Government, which has been tinkering with the tax system since it came to power. So far, this tinkering has undeniably produced positive results. Revenue generated from taxes has increased and the Government tells us it is on track to returning the economy to a surplus.

Since the last election, the Government has promised to raise the level of innovation in New Zealand. The move to include innovation as a key platform of the Business Growth Agenda was a step in the right direction.

And it should be noted that businesses are investing in R&D – tax incentives or not. According to Statistics New Zealand, businesses spent $1.2 billion on R&D in 2012 – an increase of almost 25% since 2010.

But, as the Government appears to be acknowledging, until further changes are made to the tax system, R&D will continue to be driven largely by financial risk aversion. An interesting situation for a country that, generally, likes to think of itself as a risk taker.

Further enquiries, please contact:

Murray Brewer            
Grant Thornton New Zealand Partner, Tax
M +64 (0)9 308  2586