Research and development tax credits
2007 tax rules which provide a tax credit for NZ businesses that perform research and development, or commission others to perform it for them in New Zealand.
Sections LA 6(1)(db), LH 1 to LH 17, OB 4(3)(eb), OB7C, OK 2(3)(cb), OK 4B, OP 5(2)(bb), OP 7(3)(fb), OP 11B, YA 1, YB 2 to YB 4, YB 7, YB 9 to YB 11, YB 13 to YB 18, YB 20(2)(ob) and Schedule 21 of the Income Tax Act 2007; sections 3(1), 22(2) and (7), 33A(2), 43A(2), 68D and 68E, 91AAP, 91C(4), 108(1B), 108B(3)(d), 113(1), 113D, 141(7C) and (7D) of the Tax Administration Act 1994
New tax rules have been introduced, which provide a tax credit for New Zealand businesses that perform R&D on their own behalf, or that commission others to perform R&D for them, provided the R&D is performed predominantly in New Zealand. The definition of R&D is in line with comparable jurisdictions where it has proved to be sustainable. The new tax credit applies not just to "white-coat" research, but to the development of new or improved products or processes in a variety of industries.
R&D expenditure that is eligible for the credit includes the cost of employee remuneration, training and travel of employees conducting R&D, depreciation of tangible property, consumables, certain overheads and payments to entities conducting R&D on behalf of the claimant.
The credit applies at the rate of 15 percent of eligible expenditure in a year, and is claimed in the annual income tax return, offsetting the tax liability of the claimant. Surplus credits are refundable. This means that businesses that have a tax loss or have only tax-exempt income receive the credits in cash.
The government first raised the option of introducing an R&D tax credit in the Business Tax Review discussion document, released in July 2006. This was followed by an issues paper in November 2006 which proposed general eligibility criteria, a definition of R&D and a list of eligible expenditure. The government announced the introduction of the credit as part of the Business Tax Reform package in Budget 2007.
R&D tax incentives are common overseas with a body of international evidence suggesting that tax incentives are effective at encouraging business R&D. The rationale for them is that there is under-investment by businesses in R&D because the investing firm does not capture all of the benefits of the investment. There are likely to be spill-over benefits to New Zealand when businesses invest in R&D and providing an R&D tax credit will encourage firms to invest more in R&D.
Eligibility for the credit (sections LH 1 to LH 3 and LH 7 of the Income Tax Act 2007)
To be eligible, a claimant must be in business in New Zealand. Non-residents must be in business in New Zealand through a fixed establishment in New Zealand. The expenditure for which a claim is made must relate to that business or an intended business of the claimant. An exception to the requirement to be in business exists for industry research co-operatives which have special rules.
Crown Research Institutes, tertiary institutions, District Health Boards, their associates, and entities under the control of any combination of them, are not eligible for the credit. R&D performed by a business in partnership with these entities is also ineligible.
Claimants must bear the financial risk associated with the R&D project, have control over the work and effectively own the project results. When R&D is outsourced, this distinguishes the person who commissions the R&D (who is eligible for the credit) from the person who merely performs the R&D on behalf of someone else. The performer is not eligible for the credit - the incentive is provided to the party making the R&D investment decisions.
The claimant must also spend at least $20,000 of eligible expenditure in the year a claim is made unless the R&D services are purchased from an unassociated listed research provider. These are entities that perform research for others on a commercial basis.
The business must conduct R&D activities as these are defined in section LH 7. They must be systematic, investigative and experimental activities that either seek to advance science or technology through the resolution of scientific or technological uncertainty or that involve an appreciable element of novelty. In either case, the activities must be directed at acquiring new knowledge or creating new or improved products or processes. These are "SIE" (systematic, investigative and experimental) R&D activities. Certain activities are excluded, as they are in other jurisdictions, generally to delineate more clearly the boundary between innovative and routine activity.
Activities that support SIE activities, but that are not systematic, investigative and experimental in themselves, are eligible if they are wholly or mainly for the purpose of the SIE activities and are required for, and integral to, them.
Rate of credit (section LH 4)
The credit applies at the rate of 15 percent of eligible expenditure.
Eligible expenditure (sections LH 3(1)(e), LH 5, LH 6, LH 8, Schedule 21)
Expenditure is eligible only if it is of a type listed in Schedule 21, Part A and not listed in Part B. The expenditure must also generally be deductible in the year it is incurred, although there are exceptions from this requirement for certain expenditure.
Eligible expenditure includes the cost of employee remuneration, training and travel, depreciation of tangible assets used in conducting R&D, certain overhead costs, consumables and payments to third parties for R&D performed on behalf of the claimant.
Ineligible expenditure is listed in Schedule 21, Part B. The main items are interest, loss on sale or write-off of depreciable property, the cost of acquiring core technology (technology used as a basis for further R&D), expenditure funded from a government grant or the required co-funding, expenditure on intangible assets and professional fees in determining eligibility.
Expenditure on R&D done overseas is not eligible unless it is part of a project based in New Zealand. The amount of overseas eligible expenditure available for the tax credit is limited to 10 percent of the eligible expenditure incurred on the project in New Zealand.
Cap on internal software development (sections LH 9 to LH 13, LH 17)
There is a cap of $3 million on eligible expenditure when the R&D activity is "internal software development". Internal software development includes the development of software without the main purpose of sale to non-associates, as well as the development of software which is used in administration of the claimant's business or to provide its customers with services other than the use of its computer technology or software. The cap applies whether the activity is a SIE activity or a support activity. The level of the cap can be increased by the Minister of Finance when it is in the national interest. Claimants under common control that undertake internal software development will be required to calculate their expenditure as a group and to allocate the cap between members.
Administrative procedures (sections OB 4(3)(eb), OB 7C, OK 2(3)(cb), OK 4B, OP 5(2)(bb), OP 7(3)(fb), OP 11B of the Income Tax Act 2007; sections 3(1), 22(2) and (7), 33A(2), 43A(2), 68D and 68E, 91AAP, 91C(4), 108(1B), 108B(3)(d), 113(1), 113D, 141(7C) and (7D) of the Tax Administration Act 1994)
Businesses will claim the tax credit in an income tax return. They will work out their liability for tax in the normal way, and then subtract the amount of the credit. When the amount of the credit exceeds the tax liability, the balance is used to reduce other tax liabilities, or is refundable in cash.
The credit will reduce residual income tax, which will reduce provisional tax liability, allowing businesses that pay provisional tax to receive the benefit of the credit closer to the time they incur R&D expenditure. This reduction will be immediate for people who estimate provisional tax, but delayed for people who use the "uplift" method for calculating provisional tax.
Companies and Maori authorities will receive a credit in their imputation credit accounts for an income tax liability that is satisfied by way of the credit.
To be eligible for the credit, a business must provide - in addition to the income tax return - a detailed statement of R&D activities and expenditure. This is collected for administrative and evaluation purposes.
From a date to be appointed by the Governor-General by Order in Council (but no later than 1 April 2010), a potential claimant will be able to apply to the Commissioner to determine whether an activity is R&D, whether a person is eligible for the credit, and whether expenditure is eligible for the credit. Binding rulings are not available on these matters.
There are a number of other minor and consequential amendments to the Tax Administration Act 1994 relating to the new tax credit.
The credit will apply from the 2008-09 income year.
Unless otherwise indicated, examples assume a standard income year and section references are to the Income Tax Act 2007.
Who can claim the credit (section LH 1)
In business in New Zealand (subsection (1))
To be eligible, a claimant must carry on business in New Zealand. Non-residents must carry on business in New Zealand through a fixed establishment.
This requires activities to be a profession, trade, manufacture or undertaking with an intention to make a pecuniary profit. All types of New Zealand businesses are eligible, whether incorporated or not, including businesses that earn only exempt income.
In the case of partnerships, the business test is applied at the partnership level, rather than to individual partners. (See discussion below on section LH 3(3)(a).)
An exception exists for industry research co-operatives which do not need to be in business. However, there is a requirement that the members of the co-operative be in business. That requirement is discussed further below in relation to section LH 3 and other requirements in relation to the co-operatives are discussed below in relation to section LH 16.
Crown Research Institutes, tertiary institutions and District Health Boards (subsection (2))
Crown Research Institutes, tertiary institutions, District Health Boards, and their associates, and entities controlled by any combination of those entities, are not eligible for the credit. These entities are defined in section YA 1 through cross-references to their enabling Acts. Crown Research Institutes are defined in section 12 of the Crown Research Institutes Act 1992. A tertiary institution is a body established under section 162 of the Education Act 1989. A District Health Board is a board established under section 19 of the New Zealand Public Health and Disability Act 2000.
Association is determined using the 1988 version provisions (section YB 20(2)(ob)). However, the tripartite test does not apply for the purpose of determining who is associated under section LH 1(2) (section YB 4(3B)). R&D performed by a person in partnership with one of these entities is also not eligible. (See discussion below on section LH 3(2).)
ACo is 25 percent owned by a Crown Research Institute, 26 percent owned by a trust whose beneficiary is a tertiary institution, and 49 percent is owned by a private firm, BCo. ACo is not an eligible person.
BCo purchases 5 percent of the shares from the trust and thereby takes a controlling share in ACo which it later sells to a tertiary institution. ACo is an eligible person for the period that BCo has a controlling interest
Entitlement to the credit (section LH 2)
Section LH 2(2) provides for the tax credit and section LH 2(1) sets out the broad requirements for entitlement to the credit.
To claim the credit, a claimant must, for a year or part-year:
- be an eligible person under section LH 1(1) - that is, carry on business in New Zealand;
- meet the requirements in section LH 3 - in essence, do R&D related to the business, have the requisite control of the R&D project and effective ownership of the results and incur eligible expenditure or depreciation on the R&D that is tax deductible in the year;
- perform the R&D activities on its own behalf and not on behalf of another person;
- incur $20,000 or more (or a pro-rated amount) of eligible expenditure or depreciation unless the R&D is outsourced to an unassociated listed research provider; and
- file a detailed R&D statement in relation to that year by a due date (new sections 68D or 68E of the Tax Administration Act 1994).
The amount of the credit is set out in section LH 4 at 15 percent of "eligible expenditure".
Minimum expenditure threshold (subsections (3) and (4))
A claimant must have eligible expenditure (as calculated under section LH 4) of at least $20,000 to qualify for the credit. This is pro-rated when a person is eligible under section LH 1(1) for part of a year only (for example, when the person carries on business for part of a year only).
An exception to the minimum threshold exists if the R&D services are outsourced to an unassociated listed research provider.
If a provider is delisted, payments under an arrangement entered into when the provider was still listed are not subject to the minimum threshold. This is to ensure that the claimant will not be subject to the minimum threshold if the provider is delisted subsequent to the parties agreeing on the arrangement for services. The claimant and the provider must not have been associated at the time the arrangement was entered into.
The requirements to be a listed research provider are set out in section LH 15.
A partnership can meet the minimum expenditure threshold for R&D activities carried out by the partnership and the individual partners claim credits in relation to their share of the expenditure. (See discussion below on section LH 3(2).)
In 2010, ACo incurs $10,000 of eligible expenditure on R&D performed inhouse. This is not eligible for the credit.
In 2010, BCo spends $10,000 contracting an unassociated listed research provider to do its R&D. The part of the $10,000 that is eligible expenditure will not be subject to the minimum threshold.
In 2010, CCo spends $100,000 on eligible expenditure undertaking its own R&D. This expenditure exceeds the minimum threshold.
Expenditure treated as incurred in a year (subsection (5))
Expenditure that is deductible in a year but added back as income under the timing rules in Part CH at the end of the year is not eligible for the credit in that year. It becomes eligible for the credit in a subsequent year when it ceases to be added back. Because the expenditure is not actually incurred in that subsequent year, it needs to be treated as incurred in that year to satisfy the provisions listed. This applies to the opening value of trading stock, unexpired amounts of expenditure under section DB 50 and unpaid employment income under section DB 51.
It applies also to overseas eligible expenditure that is incurred in one year and is eligible for the credit in a subsequent year (subsection (5)(d)).
Treatment of credits (subsection (6))
The credit is applied to satisfy a claimant's tax liability for as far as the credit extends. Surplus credits are applied, in turn, to satisfy an income tax or provisional tax liability that is payable in relation to other years, or any amount due and payable under an Inland Revenue Act (such as GST, or PAYE). Any excess credits are refunded.