Wage intensity criteria
Clauses 192 and 213
Issue: 100 percent of contractor R&D consideration should be included as total R&D labour expenditure
Submission
(KPMG)
Including only 66 percent of contractor R&D costs in the total R&D labour expenditure calculation (used for calculating wage intensity and the amount of the tax credit) should be reconsidered. It is acknowledged that this excludes non-labour and profit amounts from the contract cost, but these costs remain a genuine R&D cost to a business and the total amount should be taken into account in determining whether the proposal applies.
Comment
The 66 percent amount is intended to cover the wage component of the contracting cost, and provides a simple way of determining this amount. Contracting costs are likely to include a profit margin and, in certain cases, other costs like materials. These costs should not be included in the calculation to determine the R&D wage intensity.
The 66 percent amount is very similar to the UK equivalent, which allows 65 percent of contract staff costs as qualifying expenditure for their R&D tax incentives. It is also consistent with the multiplier used when calculating the amount of the tax credit.
Recommendation
That the submission be declined.
Issue: Work performed for below-market remuneration
Submission
(Deloitte)
The R&D wage intensity calculation may not be representative of the actual R&D intensity of the company when an employee (likely a shareholder-employee) works for below-market remuneration. This will detrimentally affect the level of the company’s R&D wage intensity. This could be remedied by deeming a shareholder-employee’s remuneration at market value for the purpose of calculating R&D wage intensity when the shareholder-employee has a significant ownership interest.
Comment
The situation described above would enable “sweat equity” to be included in R&D wage intensity calculations. We have excluded this from the wage intensity calculations because no expenditure has been incurred by the company at this point in time.
Deeming shareholder-employee’s remuneration at market value would create an opportunity for abuse. Remuneration may be inflated above market value to ensure the wage intensity criteria are met. Even though section GB 25 of the Income Tax Act protects against excessive remuneration to shareholders, directors or relatives in a close company, it is possible that inflation could occur at the margins.
It would also require an adjustment to total R&D labour expenditure to remove this deemed market value remuneration when calculating the amount that can be cashed out, as it would not be appropriate to cash out an amount of expenditure that has not been incurred. This would further increase the complexity of the calculation.
Recommendation
That the submission be declined.
Issue: Calculating total R&D labour expenditure when an employee’s role is only partly dedicated to R&D activities
Submission
(Deloitte)
Some employees will be splitting their time between R&D and non-R&D activities. The process for determining how the amount should be pro-rated has not been outlined by Inland Revenue. Inland Revenue should release guidance on the level of evidence they require to substantiate the time spent on carrying out R&D activities.
This amount can be pro-rated by basing it on the actual time spent on R&D, or estimating this. Calculating actual time spent on R&D can be complicated, with innovative start-ups unlikely to have sophisticated methods for recording time spent on R&D. In light of this, an estimation method is more appropriate.
Comment
Inland Revenue will communicate its expectations of taxpayer record-keeping for the purposes of pro-rating labour expenditure between R&D and non-R&D activities.
Inland Revenue is committed to lowering compliance costs to the extent this does not create opportunities for gaming or re-characterisation of expenditure. In this case, requiring only estimation can create a risk of non-R&D expenditure being characterised as R&D expenditure.
Recommendation
That the submission be noted.
Issue: Clarify meaning of “the part of the income year”
Submission
(New Zealand Law Society)
The phrase “or for the part of the income year for which the person exists if that is not the whole income year” in proposed section MX 3(1) should have the words “(the part of the income year)” following it to clarify the use of “the part of the income year” in the definitions of “total R&D labour expenditure” and “total labour expenditure” in that section.
Comment
Officials agree with this submission, and will make changes to this effect.
Recommendation
That the submission be accepted.
Issue: Clarify that the use of “acquiring” does not exclude contractor R&D consideration from being considered R&D material or R&D expenditure
Submission
(New Zealand Law Society)
The definitions of “contractor R&D consideration” and “R&D expenditure” exclude the provision of goods and services to the extent they relate to an activity described in proposed schedule 22 (Proscribed R&D activities). One of the proscribed activities is acquiring intellectual property or know-how. The definitions of “intellectual property” and “know-how” are sufficiently broad to make the application of the provisions uncertain. It is difficult to envisage what “R&D material” could be provided by a contractor that is not excluded by schedule 22 due to the use of the word “acquiring”. It should be made clear that the development of new intellectual property or know-how from carrying out R&D is not included within what is meant by “acquiring” for the purposes of the above definitions.
Comment
“Acquiring” refers to existing intellectual property or know-how already developed. When a company (Company A) provides R&D on behalf of another company (Company B) that Company B will retain the rights over, this should not be considered as acquiring intellectual property or know-how, and is valid R&D expenditure for company B only. On the other hand, if company A carries out R&D and claims the tax credit, and then sells the R&D asset to company B, expenditure incurred by company B on acquiring company A’s existing R&D asset should be excluded from cashing out R&D tax losses. Further guidance on this will be provided.
Recommendation
That the submission be noted.
Issue: Clarify references to “external contractor” in definitions of “R&D expenditure” and “R&D material”
Submission
(Matter raised by officials)
The use of “external contractor” in the definitions of “contractor R&D consideration” in proposed section MX 3 and “R&D material” in section YA 1 could be confusing as they refer to different parties of a respective contract.
Comment
It should be clarified which party is the contractor company (Company A above) that is doing R&D on behalf of the contracting company (Company B above).
Recommendation
That the submission be accepted.
Issue: Clarify who the user of R&D material is when providing a service of R&D to a third party
Submission
(New Zealand Law Society)
In the definition of “R&D material”, the user of the R&D in the contracting situation should be clarified. The words “by the recipient or, if the recipient is a member of a group of companies, by a member of the group” after “are used” has been suggested.
Comment
An addition similar to that suggested above would provide further clarity that when a company (Company A) performs R&D on behalf of another company (Company B), that provision of R&D by company A (or provision by another group member) is not considered “R&D material” for Company A for the purposes of cashing out R&D tax losses. Company B can consider this “R&D material” though.
Recommendation
That the submission be accepted, subject to officials’ comments.