Amount of tax credit (section LH 4)

Research and development and the amount of tax credit, being 15 percent of 'eligible expenditure'.

The amount of the tax credit is 15 percent of "eligible expenditure". This is the amount of expenditure or depreciation that is listed in Schedule 21, Part A, not excluded under Part B, and deductible in the year after making adjustments as required under sections LH 5 and LH 6.

Adjustments in calculating "eligible expenditure" (section LH 5)

Expenditure added back under timing rules (subsection (2))

Expenditure that is added back as income under subpart CH for tax purposes generally is also added back for the purpose of calculating the credit. This applies also to expenditure that would be added back under that subpart if the R&D expenditure was not deferred under section EJ 23 or if the claimant did not derive only exempt income

Example 1

In March 2009, ACo incurs $100,000 of eligible expenditure on R&D services to be provided by a Crown Research Institute. The services have not been performed by the end of ACo's income year. The amount of the unexpired portion calculated under section EA 3 is therefore $100,000, which is income of ACo in the 2008-09 year under section CH 2. The amount that is eligible for the credit in that year is therefore $0 ($100,000 deductible eligible expenditure less $100,000 added back as income). The services are provided in May 2009 so the $100,000 becomes deductible in the 2009-10 income year. The $100,000 is therefore eligible for the credit in the 2009-10 income year.

 

Example 2

BCo is owned by B, who is a shareholder/employee of the company. B is engaged as an employee conducting R&D. In March 2009, BCo accrues a liability for B's salary but has not paid it out by the last date for filing its return of income as provided in section EA 4(3). The salary is therefore added back as income under section CH 3(2) and is not eligible for the credit in the 2008-09 year. The salary is paid out in the 2009-10 year and therefore becomes eligible for the credit in that year.

Under section LH 3(3), there is an exception to the requirement to add back certain expenditure for the purposes of calculating the amount eligible for the credit. This is for stock to which section CH 1 applies if it is feedstock under clause 8 of Schedule 21, Part A that has been processed or transformed in the R&D. If expenditure on stock has been incurred but the stock has not yet been processed or transformed in the R&D activities, the adjustment applies.

Example

In February 2009, ACo buys or manufactures $100,000 of trading stock which it intends to process or transform in R&D. It is still on hand and has not been processed or transformed in the R&D activity at 31 March 2009. The value of the closing stock is therefore added back as income in the 2008-09 year. This add-back also applies for the purpose of calculating the credit. The opening value of the stock ($100,000) is then deducted in the 2009-10 year. In April 2009, the trading stock is processed or transformed in the R&D activity. The stock is still on hand at 31 March 2010 but there is no add-back of the value of the stock for the purposes of the credit.

Under clause 8 Schedule 21, Part A, if the market value of the stock is $30,000, only $70,000 will be eligible for the credit and it will be eligible in the 2009-10 year.

Certain capital expenditure (subsection (4))

An exception to the rule that expenditure be deductible in the year it is incurred is available for certain capital expenditure that is not deductible under section DB 34. The intention is that the rule applies to expenditure that would be deductible but for the capital limitation. While not in the current legislation, this provision is proposed to be modified so that it only applies to expenditure that would be deductible if not for the capital limitation.

Eligible capital expenditure incurred in seeking to create or improve a depreciable intangible asset that is developed as the object of the R&D activities attracts the credit when it is incurred.

Example

ACo has $100,000 R&D salary expenditure in developing software which is intangible depreciable property. The expenditure falls into three categories. Some is revenue expenditure and some is expenditure that is expensed for accounting and is immediately deductible for tax under section DB 34. Both those categories of expenditure therefore satisfy section LH 3(1)(e) and the credit applies in the year the expenditure is incurred. The third category is development expenditure that is capitalised for tax and accounting. Section LH 5(4) applies to this and it attracts the credit in the year in which it is incurred.

Capital expenditure incurred in seeking to construct or improve adepreciable tangible asset that is developed as the object of the R&D activities (such as a trial model or preliminary version) attracts the credit when it is incurred only when its sole intended use is in the R&D process of that business.

Example

In the 2008-09 year, ACo incurs eligible salary and materials costs in constructing a preliminary version of a product that it intends to add to its range of trading stock. The sole purpose of the prototype is its use in the R&D process in developing a model for the trading stock. It treats these costs as capital costs for accounting and tax. The expenditure attracts the credit in that year. Depreciation on facilitative assets used in the construction of the prototype also attracts the credit in that year.

Capital expenditure in seeking to construct or improve a trial model or prototype that is not solely to be used in the R&D process does not attract the credit as it is incurred and is discussed in the section on depreciation of assets used in R&D (Schedule 21, Part A, clause 2).

Consideration is being given to limiting the credit under this provision in circumstances where the property is subsequently used for non-R&D purposes.

Deduction deferred under section EJ 23 (subsection (5))

Eligible expenditure is calculated as if deferral of a deduction under section EJ 23 were not allowed. If a business elects to defer a deduction for R&D expenditure under section EJ 23, the expenditure is therefore eligible for the credit in the year in which the expenditure is incurred, and not the year in which the deduction is taken. For the purposes of calculating the credit, the expenditure is still subject to the add-back rules in subpart CH (by virtue of the words "or would apply" in section LH 5(2)).

Example 1

ACo is owned by A, who is a shareholder/employee of the company. A is engaged as an employee in conducting R&D. In March 2009, ACo pays a salary to A but elects to defer a deduction for this expenditure under section EJ 23. The expenditure is eligible for the credit in the 2008-09 year.

Example 2

BCo is owned by B, who is a shareholder/employee of the company. B is engaged as an employee in conducting R&D. In March 2009, BCo accrues a liability for B's salary but has not paid it out by the last date for filing its return of income as provided in section EA 4(3). BCo elects to defer a deduction for the expenditure under section EJ 23. For the purposes of calculating the credit only, there is an assumed add-back of the salary under section CH 3(2) and the salary is not eligible for the credit in the 2008-09 year.

Expenditure on overseas R&D (section LH 6)

Expenditure on R&D activities carried out overseas is not eligible for the tax credit unless it is part of a project based in New Zealand, and meets the definition of overseas eligible expenditure.

Subsection (1) excludes expenditure or an amount of depreciation loss on R&D performed overseas unless it is part of a R&D project. "Research and development project" is defined in subsection 4. (See discussion below.)

Subsection (2) excludes expenditure or an amount of depreciation loss on R&D performed outside New Zealand as part of a R&D project, unless it is overseas eligible expenditure.

A "research and development project" is defined in subsection (4) and means a process:

  • consisting of co-ordinated R&D activities controlled by the business;
  • having start and finish dates;
  • undertaken collectively to achieve a specified objective within constraints of time, cost and other resources;
  • for which the business bears the financial risk and effectively owns the results, if any; and
  • for which the business incurs on R&D activities performed in New Zealand more than half of the total amount of expenditure and depreciation loss that would be eligible expenditure under section LH 4 in the absence of subsection (2).

For an R&D project to exist, more than half of the expenditure that would be eligible under section LH 4 must be incurred on R&D activities performed in New Zealand. If that is not the case, then the expenditure incurred on activities performed outside New Zealand will not be eligible for the credit. However, the expenditure incurred in New Zealand will still be eligible.

"Overseas eligible expenditure" is defined in subsection(5). The expenditure must be:

  • expenditure that would be eligible under section LH 4 (in the absence of a restriction on overseas R&D);
  • incurred on R&D performed outside New Zealand in or after the 2008-09 income year; and
  • limited to 10 percent of the total eligible expenditure incurred in New Zealand in or after the 2008-09 year as part of the same R&D project.

The 10 percent rule applies over the life of the project. Therefore, eligible expenditure incurred on R&D activities performed overseas can be carried forward until sufficient local eligible expenditure is incurred on the same project. Similarly, the eligible overseas expenditure can be incurred in years subsequent to years in which the eligible local expenditure is incurred.

"New Zealand" is defined in section YA 1.

Example 1

Company A performs eligible R&D activities. The activities are carried out over three years, starting in the 2008-09 income year. Some of the activity is carried out in New Zealand, and some is done in Australia.

In the first year, the company spends $100,000 on eligible expenditure in New Zealand and $15,000 on eligible expenditure in Australia. The company is entitled to claim the tax credit in relation to $110,000 of expenditure. This is made up of $100,000 of local expenditure + $10,000 Australian expenditure. The remaining $5,000 of Australian expenditure has to be carried forward until there is sufficient eligible local expenditure to claim the credit.

In the second year of the project, the company spends $100,000 on eligible expenditure in New Zealand and $2,000 on eligible expenditure in Australia. The company is entitled to claim the tax credit in relation to $107,000 of expenditure, made up of $100,000 local expenditure + $5,000 Australian expenditure carried forward from the previous year + $2,000 Australian expenditure from the current year.

In the third year, the company has no eligible expenditure in New Zealand and $40,000 of eligible expenditure in Australia. The company is entitled to claim the tax credit in relation to $3,000 of expenditure, made up of $3,000 of Australian expenditure, for which sufficient local expenditure was incurred in the previous year and the resulting entitlement carried over to this year.

 

Example 2

Company B performs R&D activities which are carried out over three years, starting in the 2007-08 income year. Some of the activity is carried out in New Zealand, and some is done in Brazil.

In the 2007-08 year, the company spends $100,000 in New Zealand and $15,000 in Brazil. The company is not entitled to claim the tax credit in relation to any of expenditure because the R&D is done before the credit is in effect.

In the second year, the company spends $100,000 on eligible expenditure in New Zealand and $15,000 on eligible expenditure in Brazil on the same R&D project. The company is entitled to claim the tax credit for $110,000 of expenditure, made up of $100,000 local expenditure + $10,000 Brazilian expenditure.

In the third year, the company spends $20,000 on eligible expenditure in New Zealand and $200,000 on eligible expenditure on the same project in Brazil. The company is entitled to claim the tax credit in relation to the $20,000 of New Zealand expenditure for that year.

However, the project no longer comes within the definition of an R&D project (because more eligible expenditure has being incurred in Brazil than in New Zealand in or after the 2008-09 income year) and therefore the company must revise its tax credit claim for the previous year and pay back the credit for the Brazilian expenditure incurred in that year.