Eligibilty requirements (section LH 3)
2007 legislation covering eligibility requirements for research and development tax credits.
Eligibility requirements (section LH 3)
To claim the credit, the claimant must satisfy the requirements of subsection (1) which are listed below.
R&D must be related to the business of the claimant (paragraph (a))
A claimant must perform on its own behalf, or have another person perform on its behalf, R&D related to the claimant's business or intended business.
This means that there must be a connection or link between the R&D activity and the general area of the claimant's business. This requirement will generally be satisfied when the results of the activity (if successful) would have a direct and beneficial application in the claimant's business. Similarly, the requirement would be satisfied if the activity results in an extension of that business.
To show that the R&D relates to an intended business, the claimant must have a reasonable expectation, at the time that the activity is carried out, to exploit the results commercially in an extension of its business or in a new business if the R&D is successful.
In the case of industry research co-operatives, the R&D must be related to the business of an industry member. The requirements for industry research co-operatives and industry members are discussed below in relation to section LH 16.
Claimants must bear the risk, have control over the project and effectively own the results (paragraph (b) to (d))
Claimants must be able to show that they control the R&D activities, bear the financial risk associated with the project and effectively own the project results.
The tests in section LH 3(1)(b) to (d) are intended to ensure that the tax credit goes to the party making R&D investment decisions - that is, the party deciding what R&D should be undertaken to enhance its business activity. They aim to maximise the capture of spillover benefits.
If R&D activities are subcontracted, the rules act to prevent double dipping. The credit goes to the party commissioning the R&D, and not to someone who performs the R&D on behalf of the other person.
In some cases, no one will be eligible to claim a tax credit for the R&D activity carried out in New Zealand. This could happen if the activity is being carried out on behalf of an ineligible entity, or because no entity can demonstrate that it controls, bears the financial risk of, and effectively owns the results of the activity.
Parties to an unincorporated joint venture, or partners of a partnership (if the partnership consists of only eligible partners), can apply these tests as though the joint venture or partnership performed the R&D activity as an entity in its own right. See the discussion below on sections LH 3(3) and (4).
Controlling the R&D activity
Claimants must have control of the R&D activity. This means they must have the ability to:
- determine the R&D activities to be undertaken;
- decide on major changes of direction;
- stop an unproductive line of research;
- follow up on an unexpected result; and
- terminate the activities or project.
This may mean that the claimant exercises that control at the beginning of an arrangement and is bound by it for the duration of the work. For example, a provider may only undertake a programme of work if the party commissioning it agrees to bind itself to finance the whole programme. In these situations the claimant is not considered to have given away control, but made choices in the contract in advance. Even then, the claimant should be entitled to check that the programme is being carried out and require the researcher to act according to the arrangement.
If a business contracts another entity to carry out the R&D activity on its behalf, and that entity subcontracts that work to a third party, the R&D activity is still done on behalf of the original commissioning business, not on behalf of the intermediary contractor.
It is possible to exercise control decisions before a project begins. For example, before the work begins the parties could agree what R&D will be undertaken and what criteria should be used to determine whether a line of research is unproductive and should be terminated.
Where a major researcher determines a programme of research and actively seeks industry participants to fund the work, it may still be possible for the industry participants to meet the control requirements.
While the researcher may have independently formulated the R&D programme and control day-to-day management, it is subject to the agreement between the industry participants and the researcher. Essentially, the industry participants exercise joint control when they choose to participate and enter into the arrangement to fund the work programme.
A business's owners have the ultimate ability to control the activity by exercising their proprietary rights, but this does not undermine the demonstration of control of the activities by the business.
The claimant must bear the financial risk of the R&D activity.
If the R&D activity is outsourced, the claimant can be taken to be bearing the financial risk if it is required to pay for the activity to be carried out, regardless of the outcome of the activity. A party receiving payment for carrying out R&D regardless of the outcome of the activity is unlikely to be bearing the financial risk in relation to those funds.
"At risk" contracting is where the contractor works on the basis that its fee is not payable unless the R&D work succeeds. In this situation, the party contracting out the work would not be eligible for the tax credit. The contractor may be eligible for the tax credit if it meets the eligibility requirements in its own right.
Businesses may want to reduce the financial risk of undertaking R&D by finding another party to contribute to financing of the work. If they enter into an agreement to fund eligible R&D activity with another person, they may be eligible for the tax credit for their share of the expenditure. They are required to bear the financial risk in relation to their expenditure, not for all of the expenditure on the work.
The application of funds from donations to carry out R&D activities does not in itself mean that the claimant is not bearing the financial risk of carrying out the R&D activity. An expectation that the funds be applied for a particular purpose is not in itself fatal to the claim by the recipient that it bears the financial risk of doing the R&D.
Effective ownership of results
Effective ownership of the results of the R&D activity means that the claimant must have the ability to exploit the results for gain without further fee or payment. That is, the claimant must have gained the right to use the results of the activity in its business without incurring further costs. It does not require the claimant to formally own the intellectual property or results arising from the project.
While ownership can be shared, the claimant must retain sufficient rights to have reasonable commercial use of the results, commensurate with its contribution to the work.
Effectively owning the results does not require the claimant to own the intellectual property. Intellectual property such as copyright, a patent or a registered design, may not be available to protect the results.
It is also possible to have all the advantages of ownership without actually owning the intellectual property. The claimant may have the right to use a patent, to require the patent to be licensed, to restrict or direct further development based on the patent, all without further fee or payment, and not be the formal holder of the patent.
Some rights of ownership may be given to others without denying the effective ownership of the results. For example, a business having R&D carried out on its behalf might completely control commercial use of the results of that R&D (including further development of those results for commercial purposes), but allow the researcher exclusive scientific publication rights.
Similarly, actual use of particular results may only be possible in limited ways or for limited purposes, which means limited rights can amount to full effective ownership. For example, exclusive rights of commercial use and development for only a few years might amount to full ownership in a particularly fast-changing area.
A share in ownership of overall results may also amount to acceptable ownership. For example, if a business does R&D that builds on existing research results belonging to another person, the business may take a share of the overall results. The interest must match its contribution to the overall research.
If the R&D activity does not result in a product or patent, but results in new knowledge (perhaps published in a scientific paper), one way this requirement could be satisfied is if the business has been granted a preferential right to use the results of the activity. A preferential right could be access to unpublished results or early access to results.
Subsequent sale of the results does not change the effective ownership of the results at the time the eligible R&D was conducted. However, R&D carried out under an agreement that required the disposal of results or commercial rights for inadequate return will suggest less than effective ownership of the results.
It is possible that the R&D activity is unsuccessful and there are no exploitable results from it. This does not mean that the claimant does not effectively own the results of the activity.
Deductible expenditure or depreciation loss (paragraph (e))
The claimant must incur expenditure or depreciation that is of a type listed in Schedule 21, Part A and not a type listed in Part B. It must also be deductible in the year in which it is incurred. There are exceptions to the deductibility requirement for expenditure in deriving tax-exempt income, certain capital expenditure referred to in section LH 5(4) and deferred expenditure referred to in section LH 5(5).
For tax-exempt income, the requirement is that the expenditure or depreciation would be deductible if the person derived income other than tax-exempt income.
Partnership with entities excluded under section LH 1(2) (subsection 2)
R&D activities done in partnership with an entity referred to in section LH 1(2) are not eligible for a tax credit. Section LH 1(2) excludes anyone who is:
- a Crown Research Institute, a tertiary institution, or a District Health Board;
- associated with a Crown Research Institute, a tertiary institution, or a District Health Board; or
- controlled by one or more of these entities.
Partnerships (subsection 3)
Paragraph (a) makes it possible for the business tests and the minimum threshold to be applied at the partnership level even though individual partners will be claiming the tax credit in relation to R&D activities carried out on behalf of the partners.
The requirements for claimants to be in business in NewZealand (section LH 1(1)(a)), for their R&D activity to be related to either that business or an intended new business (subsection (1)(a)(i)), and the minimum threshold for eligible expenditure can be applied at a partnership level, with the partnership treated as the entity performing the R&D activities.
Partners will be taken to have met these requirements in relation to the R&D activity if the partnership (treated as the entity carrying out the R&D activities) would meet those requirements.
Paragraph (b) allows partnerships consisting of only eligible partners to apply the requirements to control the R&D activity, bear the financial risk of undertaking the work, and effectively own the results of the activity at the partnership level.
If the partnership, treated as an entity performing the R&D activities, meets those requirements, the partners will be treated as meeting those requirements.
Partners in partnership with partners who do not meet the requirements of section LH 1 must meet the control, risk, and ownership requirements in their own right. This is to prevent partnership structures being used to circumvent the requirements for eligibility.
The government will review these rules once the Limited Partnership Bill is enacted.
A and B have been in business for the whole year as partnership C. A and B have equal interests in the partnership.
- The firm carries out R&D and has eligible expenditure of $15,000. A has other eligible expenditure on R&D activities of $16,000. A can claim the concession in relation to $23,500 of expenditure. She meets the minimum threshold in her own right.
- The firm carries out R&D and has $22,000 of eligible expenditure. B has other eligible expenditure on R&D of $5,000. B can claim the concession in relation to $11,000 (her share of the firm's eligible expenditure). The firm has met the threshold, but B does not meet the threshold in her own right and therefore cannot claim the credit in relation to the other $5,000 of eligible expenditure.
- The firm carries out R&D and has eligible expenditure of $18,000. A has other eligible expenditure on R&D activities of $4,000. A is not eligible to claim the concession. Neither the firm nor A (in her own right) has met the minimum threshold.
Joint ventures (subsection 4)
Subsection 4 allows parties performing R&D as part of an unincorporated joint venture to apply the requirements to control the R&D activity, bear the financial risk of undertaking the work, and effectively own the results of the activity at the joint venture level.
If the joint venture, treated as an entity performing the R&D activities, meets those requirements, then the parties to the joint venture will be treated as meeting those requirements. While the financial risk can be shared between the parties, each party can only claim the tax credit in relation to their share of the expenditure for which they bear the financial risk.
Parties may establish a company to carry out R&D activities (incorporated joint venture). For the company to claim the credit it will need to show the R&D activities have been carried out on its own behalf and not on behalf of its shareholders. The company will be required to meet the requirements to control the activity, bear the financial risk of doing the work, and own the results. The fact that the shareholders may expect an indirect benefit through dividends does not mean the company is carrying out R&D activities on their behalf.