With the financial year recently ticking over into FY2020/2021, the majority of innovators in New Zealand (those with year-end 31 March 2020) are able to begin lodging income tax returns and unlock the value from the newly introduced R&D Tax Incentive program.
As a reminder, the R&D Tax Incentive was introduced into law in mid-2019 to bring New Zealand in line with similar regimes in the Asia Pacific region and across the majority of OECD countries. With its ambitious goal of lifting the R&D spend as a percentage of GDP to 2% within 10 years, the generous cash benefit offered by the new program is 15% of eligible R&D expenditure.
The eligibility criteria and benefits are comparatively more generous than similar programs in the Asia Pacific region.
COVID-19 GOVERNMENT RESPONSE: IMPROVED REFUNDABILITY OF R&D CREDIT
As cash is often king during the innovation phases of a business’ lifecycle, one of the key policy decisions for the introduction of the new program was the limit on refundability of R&D tax credits. The initial refundability mechanism for year one of the R&D program required businesses to meet certain criteria and capped potential refunds to $255k.
This cautious approach was intended to allow the government to observe the cost to revenue from the new program in year one, and ultimately balance fiscal affordability with its benefits in encouraging greater R&D activity.
With COVID-19 sweeping the globe in the past quarter, the New Zealand government has proactively passed new legislation on 25 March 2020 which significantly increases the accessibility of R&D refunds for businesses. Introduced through the COVID-19 Response (Taxation and Social Assistance Urgent Measures) Act 2020, the refundability measures which had been intended to be in operation from year two of the program have been brought forward to the current income year.
Under the new rules for the FY19/20 year which has now passed, innovative businesses will now be able to choose one of two refundability mechanisms which maximises their cashflow.
These measures are:
Option One – Elect for the original limited refundability rules (capped at $255k)
A business may still elect for the original year one refundability mechanism if they choose to. Broadly, the key requirements are that:
- The entity must be a company.
- The entity is in a position of tax loss, or where the R&D credits exceeds income tax liability.
- The entity is not a listed company or associate of a listed company and does not derive exempt income or associate of a person who derives exempt income.
- Broadly, the entity is required to meet a 20% wage intensity test for R&D expenditure (i.e. at least 20% of wages are incurred on eligible R&D activities).
- The entity does not have any other outstanding tax liabilities.
Summary: In conclusion, this refund mechanism is targeted towards more early stage, high intensity R&D entities, with a limit of up to $255k refund (being $1.7m eligible R&D expenditure)
Option Two – Do not elect for Option One and Access Broader Refundability Regime
As the default option, entities undertaking eligible R&D activities will fall into the broader refundability regime. The key requirements and differences to Option One are:
- No company requirement (i.e. can be other types of eligible R&D entities).
- No general monetary-based refundability cap or wage-based rules (i.e. unlike Option One, there is no $255k refund cap or wage intensity test). Instead the refund is more broadly limited to “labour-related taxes” (PAYE, ESCT and FBT) paid either by:
o The R&D entity itself; and
o Companies by which the R&D entity is controlled, or those contained within the wholly-owned group.
- No refund cap for amounts paid to levy bodies or approved research providers.
Similar to Option One, the entity must be in a position of tax loss to access a refund.
Summary: In conclusion, the early introduction of this broader refundability mechanism will ensure more mature businesses, those which are not in a company structure and entities with lower R&D wage intensity will be able to access increased cashflow for their innovation.
ILLUSTRATIVE EXAMPLE – REFUNDABLE R&D TAX CREDITS
Innovation Co Limited, a New Zealand incorporated and owned company with a year end of 31 March, develops new steel products for the Asia Pacific market. During the 2019/20 income year:
- The business derived $30m of revenue.
- The business is in a tax loss position of $10m. This was largely due to a significant investment into a new R&D program which cost $10m during the 2019/20 income year.
- The business incurred a total of circa $16.5m of total labour costs (R&D and non-R&D staff) and paid circa $4m in labour-related taxes.
- The $10m R&D expenditure consists of salaries, contract costs and significant purchases of materials for experimentation with newly developed steel products in the factory. R&D wages comprises $2m of total R&D expenditure.
- R&D labour expenditure comprises approximately 12% of the company’s total labour expenditure in the year (i.e. less than the 20% required under the Limited Refundability rules).
- It is assumed all the R&D expenditure is eligible for the R&D Tax Incentive and not relating to excluded activities or expenditure.
- In April 2020, Innovation Co Limited lodges its Income Tax Return, along with the relevant R&D Supplementary Return.
If Original Limited Refundability Rules Applied: Under the original legislation for year one, Innovation Co Limited would fail the refundability test (e.g. as it fails the 20% wage intensity test, which requires at least 20% of total labour costs in the financial year to be R&D labour costs).
Under the new COVID-19 Measures: Under the new COVID-19 measures, Innovation Co Limited could potentially cash out its whole $1.5m of R&D tax credits (based on labour-related taxes paid, the refundability cap will be up to $4m). This will provide the business with crucial cashflow during the COVID-19 economic downturn. This ensures that Innovation Co Limited is able to retain more employees and continue parts of its R&D Tax program in the FY20/21 income year.
Where To Next?
If your business invested in R&D activities in the 2019/20 income year and would like to unlock the cashflow benefits from the recent COVID-19 measures and the existing refund mechanisms under the R&D Tax Incentive, please reach out to your RSM specialist to lodge your R&D claim.