Chapter 1 - Introduction
1.1 One of the major problems faced by small start-up companies undertaking research and development (R&D) is having uncertain cashflows or access to capital to fund further development.
1.2 These problems can be compounded by current tax settings, which require a tax loss to be carried forward and deducted against future taxable income. R&D-intensive start-up companies are particularly affected as:
- They expect to be in an ongoing tax-loss position over consecutive periods through the research and development phases.
- They do not have other sources of income to apply the tax loss against.
- The high-risk nature of R&D investment increases the risk of failure.
- In some cases, they do not realise any gain on the investment until they sell the R&D output.
1.3 Consequently, R&D-intensive start-up companies are unable to use their tax losses in a timely fashion, or in some cases, at all, increasing the cashflow problem.
1.4 Requiring taxpayers to carry losses forward is an essential integrity measure in the tax system to protect Government revenues from a number of risks. However, R&D-intensive start-up companies face a unique set of potential market failures and tax distortions that could be reduced by changing the treatment of some of their tax losses. As a possible solution, we suggest allowing R&D-intensive start-up companies to cash out their tax losses arising from qualifying R&D expenditure, instead of carrying these losses forward.
1.5 Allowing these companies to access their R&D tax losses early would help to reduce capital and cashflow constraints, and alleviate biases against R&D arising from current tax settings.
Summary of suggested changes
1.6 The suggested changes target R&D-intensive start-up companies. To be eligible, applicants would need to meet the following criteria:
- Company (and also group, if the company is part of a group) R&D expenditure on wages and salaries must be at least 20 percent of total expenditure on wages and salaries (the wage intensity threshold).
- The company (and also group, if the company is part of a group) must be in a tax-loss position for the applicable income year.
- The applicant must be a company resident in New Zealand. The company also cannot be a look-through company, listed company, qualifying company or special corporate entity.
1.7 The suggested R&D definition is based on the existing New Zealand equivalent to International Accounting Standard 38 (NZIAS 38), which is already used in the Income Tax Act 2007. It will be necessary, however, to exclude certain expenditure items and activities from the proposed R&D wage intensity threshold of 20 percent of the total group wage and salary expenditure and/or qualifying R&D expenditure, to ensure correct targeting and neutrality.
1.8 The amount of the loss that can be cashed out under the proposals will be the lesser of:
- 1.5 times the company’s eligible R&D salary and wage expenditure in the relevant year;
- total qualifying R&D expenditure in the relevant year; and
- total tax losses in the relevant year.
1.9 Initially, the suggested maximum cap on eligible losses that can be cashed out will be $500,000, which equates to a cashed-out loss of $140,000 at the company tax rate (28%). This cap would rise incrementally each year up to a maximum cap on eligible losses of $2 million. Increasing the cap gradually allows for greater control over any fiscal risk.
1.10 Loss recovery rules would be included to protect the neutrality and integrity of the suggested policy, while also minimising its fiscal risk. These rules would recover the value of the cashed-out loss when a taxpayer derives a return from the sale of:
- intellectual property from R&D the company has performed;
- some of the shares in the R&D company; or
- the R&D company itself (all of its shares).
How to make a submission
1.11 You are invited to make a submission on the proposed reforms and points raised in this issues paper. Submissions should be addressed to:
R&D tax losses proposal
C/- Deputy Commissioner, Policy and Strategy
Inland Revenue Department
PO Box 2198
Or email [email protected] with “R&D tax losses proposal” in the subject line. Electronic submissions are encouraged. The closing date for submissions is 30 August 2013.
1.12 Submissions should include a brief summary of major points and recommendations. They should also indicate whether it would be acceptable for officials to contact the authors to discuss the points raised, if required.
1.13 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their release. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.