Ineligible expenditure (Schedule 21, Part B)

List of expenditure ineligible for research and development tax credits.

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.


ACo purchases an asset for $1 million which is used wholly in R&D for three years. Credits are claimed in relation to that depreciation. The adjusted tax value at the time of sale is $700,000. The asset is sold for $650,000. No credit is available for that $50,000 loss.

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.


ACo is an energy distribution company that is developing an innovative household meter. It instals the meters in 100 households before installing them more widely and plans a monitoring and testing programme over two months. Construction and installation of the test meters is an eligible support activity as the meters are mainly constructed and installed for the SIE R&D activities, and are required for and integral to them. However, if they are satisfactory, they will be left in place and used in ACo's normal business operations. The expenditure in constructing and installing the meters is treated by ACo as capital expenditure for tax and accounting. The materials and labour in constructing the meters are therefore not eligible for the credit as they are incurred. However, depreciation on the meters attracts the credit during the testing period.

One month after the trial begins, ACo finds that the meters are unsuitable. It removes and scraps them. The balance of the construction and installation cost of the meters are eligible for the credit at that stage.

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.


ACo contracts its sister company BCo to perform R&D services. BCo obtains all the services and property used to perform the R&D from third parties unassociated with the company (for example, employees and contractors). Unassociated T Co provides core technology to BCo to enable BCo to perform the services. BCo spends $30,000 on the core technology and incurs $50,000 eligible expenditure on performing the R&D services (salary of employees and depreciation on equipment). BCo charges ACo $100,000 for the services. ACo may claim the credit only on $50,000.

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).

Example 1

ACo sells computer equipment used in its R&D to associated BCo for its market value of $1,300. The equipment cost $2,000 and has a tax book value of $1,000. The $300 is not eligible for the credit in the hands of BCo.

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.

Example 1

ACo receives an R&D grant of $50,000 from the Foundation for Research Science and Technology. As a condition of the grant, ACo is required to contribute $100,000 of its own funds towards the project. The $150,000 is used to pay for R&D salaries and to purchase items consumed in the R&D. None of it is eligible expenditure.

As part of the R&D activity ACo spends a further $20,000 on items consumed in the R&D activity. This amount is eligible for the credit because neither the grant exclusion nor the required co-funding exclusion applies to it.

As a condition of the grant to ACo, BCo is required to fund $20,000 of salary expenditure on another R&D activity. A tax credit is not available to BCo for its expenditure of $20,000.



CCo receives a grant of $40,000 from a local authority for R&D activities. The total expenditure on the activity by CCo will be $120,000, consisting of $90,000 for the purchase of core technology and $30,000 of salary expenditure. The local authority has not stipulated that CCo should apply the funds to the purchase of core technology or to paying salaries. CCo can therefore apply the grant to the purchase of core technology and claim a tax credit in relation to the salary expenditure.

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.


ACo acquires a licence to use software in its R&D process. Depreciation on, or licence fees for, the software are not eligible.

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.