Chapter 9 - Research and development loss cash-out

9.1 Research and development (R&D) start-up companies are able to receive a payment for up to 28 percent of their tax losses from R&D expenditure in any given year. We refer to losses in respect of which a refund has been received as “cashed-out losses”. These rules may not operate correctly when an R&D start-up company’s costs include ESS expenditure.

9.2 A cashed-out loss can be thought of as an interest-free loan from the Government, to be repaid from the taxpayer’s future income; it is intended to provide a cashflow timing benefit only. The rules focus on start-up companies engaging in intensive R&D, and are intended to reduce their exposure to market failures and tax distortions arising from the general tax treatment of losses.

9.3 Companies that qualify for the existing R&D loss cash-out may also be offering ESS to their employees and may qualify as a start-up company under the criteria considered in this issues paper.

9.4 When the R&D loss cash-out was introduced for the 2015–16 and later income years, expenditure on ESS was not explicitly deductible to employers and the R&D loss cash-out rules do not specifically cover ESS expenditure.

9.5 The interaction between the two sets of rules primarily arises in the definitions of “total labour expenditure” and “total R&D labour expenditure” in section MX 3(3). These definitions include salary or wages of the employee as well as other costs such as contractor R&D consideration and certain payments to shareholder-employees.

9.6 ESS costs are not included within the definition of salary or wages so will not currently be included in the definition of total labour expenditure or total R&D labour expenditure.

9.7 Where the costs of ESS are not yet deductible because the taxing point has been deferred, these costs should not be included in the R&D loss cash-out calculations.

9.8 If the taxing point has occurred so that ESS costs are deductible but these amounts are not included in salary or wages this could have two impacts on eligibility for or amount of the R&D loss cash-out:

  • Where ESS benefits are provided to employees who undertake R&D in a greater (lesser) proportion than other employees this will reduce (increase) the ability to meet the wage intensity criteria.
  • Where ESS benefits are provided to employees who undertake R&D these costs will not be included in the cap on the maximum R&D loss cash-out at 1.5 times the employer’s total R&D labour expenditure multiplied by the company tax rate.

Wage intensity criteria

9.9 The wage intensity criteria requires that R&D labour expenditure is at least 20 percent of total labour expenditure. The purpose of this restriction is to ensure the R&D loss cash-out is targeted at firms that undertake sufficient intensity of R&D as a proportion of their overall activities.

9.10 As the inclusion or exclusion of ESS will affect both the numerator and denominator there will be no effect on the wage intensity calculation if ESS are provided to employees conducting R&D or not conducting R&D in equal proportions to all other remuneration.

9.11 However, certain employees may receive a greater proportion of their remuneration via ESS than other employees in the same company. This would affect the company’s ability, either positively or negatively, to access the cash-out.

R&D loss tax credits

9.12 The amount of cash-out available to an eligible company is capped at the lower of a number of separate calculations; one of which is 1.5 times the total R&D labour expenditure multiplied by the company tax rate.

9.13 If costs of ESS are not included within the R&D labour amount then the amount of cash-out available may be lowered by up to 42 percent[8] of those ESS costs. As ESS is a deductible labour expense of the company, this does not seem appropriate.

Example 3: Current R&D treatment of ESS costs

Start-up Co has been established during the 2018–19 year to develop an innovative new product. In the 2018–19 year it has no sales but incurs $100,000 of cash wages, $200,000 of other cash deductible costs and provided shares to its employees which have been independently valued at $150,000. 90 percent of the cash costs meet the definition of “R&D expenditure” but only 40 percent of the ESS costs do as the majority are given to an employee who does not undertake R&D.

Start-up Co has made a tax loss of $450,000 for the 2018–19 year. Its wage intensity calculation is $90,000 ÷ $100,000 = 90% so it meets the wage intensity criteria for an R&D loss cash-out.

The maximum amount of the cash out for the 2018–19 year is the lesser of:

  • $1,100,000 x 28% = $308,000
  • Net loss for the year = $450,000 x 28% = $126,000
  • Total R&D expenditure = (($100,000 x 90%) + $200,000 + ($150,000 x 40%)) x 28% = $98,000
  • R&D labour expenditure = 1.5 x ($100,000 x 90%) x 28% = $37,800

Start-up Co is entitled to an R&D loss cash-out amount of $63,000

Proposal

9.14 To address both these issues officials propose that ESS costs, if they meet the other requirements, be specifically included within total labour expenditure and total R&D labour expenditure for the purposes of the R&D loss cash-out rules. This will allow companies entitled to the R&D loss cash-out to receive a tax refund under that scheme which may be able to be used to fund a substantial part of the employee’s tax liability on ESS benefits.

Example 4: Proposed R&D treatment of ESS costs

Using the same facts from example 3 Start-up Co applies the proposed changes to the R&D loss cash-out.

Start-up Co has made a tax loss of $450,000 for the 2018–19 year. Its wage intensity calculation is ($90,000 + $60,000) ÷ ($100,000 + $150,000) = 60% so it meets the wage intensity criteria for an R&D loss cash-out.

The maximum amount of the cash out for the 2018–19 year is the lesser of:

  • $1,100,000 x 28% = $308,000
  • Net loss for the year = $450,000 x 28% = $126,000
  • Total R&D expenditure = (($100,000 x 90%) + $200,000 + ($150,000 x 40%)) x 28% = $98,000
  • R&D labour expenditure = 1.5 x ($100,000 x 90% + $150,000 x 40%) x 28% = $63,000

Start-up Co is entitled to an R&D loss cash-out amount of $63,000

 

8 1.5 x 28%.