Ineligible expenditure (Schedule 21, Part B)

The following expenditure is ineligible:

• interest;
• loss on sale or write-off of depreciable assets (except in one situation);
• profits on R&D services and property provided by an associate;
• amounts in excess of market value for leasing property of an associate;
• depreciation attributable to the time an asset is not used in R&D
• certain depreciation deductions on assets acquired from an associate;
• the cost of feedstock other than the net cost referred to in Part A, clause 8;
• the cost of acquiring core technology (technology used as a basis for further R&D);
• in-house software development costs exceeding $3 million (unless the cap is increased by Ministerial waiver);
• expenditure funded from a government grant or any required co-funding;
• donations;
• professional fees in determining whether the person, activities or expenditure are eligible;
• the cost of acquiring intangible assets; and
• expenditure of an industry research co-operative funded by an ineligible person.

Some of this expenditure (for example, professional fees and donations) would not be eligible in any event, as it would not fall within the list of eligible expenditure in Part A. It has been inserted to make the provisions as clear as possible, and to avoid doubt.

Interest (clause 1)

Expenditure incurred under a financial arrangement - essentially, interest - in financing R&D activities is not eligible.

Depreciation loss on disposal or write-off of assets (clause 2)

To reduce compliance costs, there is no clawback of credits when depreciable property used in R&D is sold for more than its adjusted tax value. There is generally a corresponding restriction in relation to a loss on disposal of depreciable assets and the write-off when depreciable items are no longer used (sections EE 11(3) to (5) and EE 39). No credit is available in relation to this loss or write-off.

End-result assets to be used for commercial purposes

As noted earlier, the cost of assets that are the object of the R&D (such as prototypes) do not attract the credit when they are incurred unless their sole intended use is in R&D. If they are to be used in commercial activity, either simultaneously or subsequently to their R&D use, and if the construction of the asset is an R&D activity, the credit may be claimed in relation to depreciation on the asset for the time it is used in R&D.

If the asset is a failure and is written off, the credit can be claimed for the balance of the costs provided the conditions in Part B, clause 2, paragraphs (a) to (c) and Part A, clause 2 are met. In particular, the asset must be wholly or mainly used in the R&D activities and not used after they end, and development costs must not be eligible for the credit in the year they are incurred.

R&D services and property purchased from an associate (clause 3)

When R&D is outsourced to an associate of the claimant, or property used in R&D is acquired from an associate, the credit cannot be claimed for any profit margin of the associate in supplying the services or property. The credit is payable on the lesser of the amount paid to the associate (eligible under Part A, clause 9) and the eligible expenditure of the associate incurred in a third-party transaction.

Property leased from an associate (clause 4)

When property is leased directly or indirectly from an associate at more than market value, the excess over market value is not eligible for the credit.

Depreciation in excess of time asset used in R&D (clause 5)

This is the apportionment rule for depreciation on assets used in performing R&D. (See the explanation of Part A, clause 2.)

Depreciation deduction on property purchased from associate (clause 6)

Because there is no clawback of credits when depreciable property used in R&D is sold for more than its tax book value, a rule is required to prevent associated entities claiming credits twice for depreciation. Clause 6 therefore provides that when depreciable property is sold to an associate for a price in excess of the vendor's tax book value, the excess over the vendor's tax book value does not attract the credit in the hands of the purchaser. This rule is required even if the sale price is less than the vendor's cost (that is, it is required even though there are restrictions on the associated purchaser's ability to deduct depreciation under section EE 40).

Feedstock expenditure in excess of net expenditure (clause 7)

This excludes all feedstock expenditure in excess of the sale proceeds or market value of the end product.

While not in current legislation, consideration is being given to restriction of the credit when other property developed in the R&D process is sold.

Core technology (clause 8)

Core technology is technology which is used as a basis for further R&D. It may be intellectual property or a tangible asset such as a prototype. Core technology that is acquired or leased from another person is ineligible for the credit. The definition is in substance the same as it is in Australia.

Cap on certain in-house software development (clause 9)

This is discussed under sections LH 9 to LH 13 and LH 17 at the end of this report.

Grants and required co-funding (clauses 10, 11, 12)

Expenditure funded by a grant from a public authority or local authority or from funds required as a condition of the grant (co-funding) by the public or local authority is ineligible for the tax credit. This is because the R&D project is already subsidised by government.

The rule applies when the co-funding is required from the recipient of the grant or from another party.

"Public authority" and "local authority" are defined in section YA 1 of the Income Tax Act 2007.

Donations (clause 13)

Making donations towards the R&D of others is not eligible. In Australia, making of donations is excluded as an activity.

Professional fees in determining eligibility (clause 14)

Fees paid to accountants, lawyers, scientists and others in determining whether claimants, activities and expenditure are eligible and calculating the amount of the claim are not eligible for the credit. This includes payments paid to Inland Revenue for a determination under section 91AAP of the Tax Administration Act 1994.

Cost of acquiring intangible assets (clause 15)

The credit is not available for the cost of purchasing, leasing or obtaining the right to use intangible assets. Expenditure on intangibles can be by way of royalties or a lump sum capital cost.

The extent to which they can be included in eligible expenditure requires careful consideration as such assets tend to be the focus of tax avoidance schemes. This policy work will be done once the R&D credit is in effect.

The paragraph does not exclude the cost of creating intangible assets from R&D.

Certain expenditure of an industry research co-operative (clause 16)

Clause 16 provides that expenditure of an industry research co-operative that is sourced from funds contributed by a person who does not have a business in New Zealand or who is ineligible under section LH 1(2) is not eligible expenditure of the co-operative. This is to prevent co-operatives being used to circumvent the requirements for eligibility.

Industry research co-operatives are discussed in more detail in relation to section LH 16.