R&D expenditure
Clauses 213, 217 and schedule 1
Issue: Specific and relevant guidance should be provided on defined terms and excluded activities
Submission
(Chartered Accountants Australia and New Zealand, PwC)
Inland Revenue should issue specific and relevant guidance on the definition of “research and development”, “excluded activities” and “expenditure” with commercially relevant examples to help minimise compliance costs and provide greater certainty. An example would be clinical trials or software development, for which expenditure goes through a number of stages. Industry-specific guidance would also be useful. Some of the terms in schedule 22 are too broad or open to interpretation.
Comment
Inland Revenue will publish appropriate guidance on its website soon after the legislation is enacted. Special attention will be paid to clinical trials and software development because these are areas where it is more difficult to determine when the activity ceases to be R&D.
Inland Revenue will have access to expertise from Callaghan Innovation to advise on the eligibility of R&D activities. This service should enable R&D performers to discuss their R&D activities with experts.
The exclusions listed in schedule 22 are similar to the exclusions used for Callaghan Innovation’s business R&D grants and Statistics New Zealand / OECD guidance on how to measure R&D for statistical purposes (the Frascati Manual). For this reason many R&D performers will already be familiar with these exclusions, which should reduce overall compliance costs.
Recommendation
That the submission be noted.
Issue: Certain expenditure undertaken overseas should not be excluded
Submission
(Chartered Accountants Australia and New Zealand, EY)
It may not be appropriate to exclude all R&D expenditure undertaken overseas. Some testing is integral to the product’s development. For example, products that require approval by the US Food and Drug Administration must be tested and approved in the US. Research on product packaging may also be required to be undertaken in the target overseas country itself because of legislative requirements. This could be done by exempting expenditure that is integral to product development.
Comment
The measure is targeted at R&D performed in New Zealand as this R&D is likely to generate higher benefits for the New Zealand economy than R&D conducted offshore. It is simpler to maintain an exclusion for overseas expenditure than create an exemption to the exclusion when the expenditure is integral to product development. Some of this expenditure may also be excluded by another item; item 11, for example, excludes expenditure on activities involved in complying with statutory requirements or standards.
Recommendation
That the submission be declined.
Issue: Finance leases should not be excluded from the definition of “R&D expenditure”
Submission
(Deloitte)
Taxpayers who enter into operating leases will have an advantage over taxpayers who enter into finance leases. This difference should be removed so that all leases are treated equally as R&D expenditure.
Comment
Finance leases more closely resemble debt instruments, such as a loan, than an ordinary lease. The proposed rules do not allow interest deductions to be cashed out as these are funding costs, rather than R&D costs. This includes the interest component of finance leases. The tax treatment is therefore the same regardless of whether a finance or operating lease is used.
Recommendation
That the submission be declined.
Issue: The definition of “R&D expenditure” should include capitalised expenditure
Submission
(KPMG)
Eligible “R&D expenditure”, as defined in section YA 1, excludes expenditure for which no deduction is available. This means that any “R&D expenditure” must be directly deductible. Capital expenditure will be excluded despite the company incurring real costs – for example, salary and wage expenditure. The intent behind this exclusion of capital expenditure should be clarified.
Comment
The intention is to cash out R&D tax losses that arise from expenditure on R&D. Capital expenditure does not generate losses, and therefore is excluded from the definition of “R&D expenditure”. This ensures that the amount calculated for the cash-out using “R&D expenditure” in proposed section MX 4(1)(h) does not include capital expenditure.
To clarify a further issue, it is possible that “total R&D labour expenditure”, used to calculate the tax credit amount in proposed section MX 4(1)(i), could include capital expenditure.[1] If this occurs, we expect that the amount calculated in section MX 4(1)(h) based on “R&D expenditure”, which does not include capital expenditure, will be lower than the amount calculated in section MX 4(1)(i). Consequently, it is unlikely capital expenditure will not contribute to the tax credit.
We do not wish to add further complexity to the definition of “total R&D labour expenditure” by requiring taxpayers to remove capital expenditure from the eligibility calculation when calculating the tax credit.
Recommendation
That the submission be declined.
Issue: Interactions with section EJ 23 (Deferred deductions arising from expenditure on R&D)
Submission
(Deloitte)
Section EJ 23 allows taxpayers to defer deductions until the taxpayer derives taxable income from the corresponding R&D. It is possible that the drafting of this section and the “R&D expenditure” definition could enable this deferred expenditure to be cashed out in an income year after the expenditure was incurred.
Comment
This is not the policy intent. Only R&D expenditure incurred in that income year should be eligible for a tax credit. Officials will make the necessary changes to ensure that this situation cannot arise.
Recommendation
That the submission be accepted.
Issue: References to disestablished business R&D grants
Submission
(EY)
Section CX 47(4) references to “technology development grant” and “technology transfer voucher” should be removed or replaced by more appropriate descriptions of the current grants. These grants have special tax treatment because of a timing issue where the grant is derived in a later income year than that in which the related expenditure is incurred, and a deduction is denied by section DF 1 (this matches the treatment of government grants as excluded income). This situation could arise in any situation, not just for business R&D. Consequently, references to the superseded grants should be removed. If it must be retained, the terminology should be updated to reflect the current grants that the section should apply to.
Comment
The reference to this section will be removed from the definition of “R&D expenditure”. The taxpayer’s treatment of the government grant as either “excluded income” under section CX 47 or “income” will provide the correct result for the purposes of the R&D tax loss credit.
Officials will look to update section CX 47(4) when possible.
Recommendation
That the submission be accepted, subject to officials’ comments.
[1] This will likely take place when the asset recognition criteria in the relevant accounting standard (NZIAS 38) is met for the R&D asset.