Research and development

• Refundability and new tax exempt entity exclusion
• Timeframe for completing disputes process
• Declining R&D certifier applications
• Revoking R&D certifier approvals
• Challenging the Commissioner’s decisions
• Allocating credits to joint venture members
• Internal software development expenditure

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REFUNDABILITY AND NEW TAX EXEMPT ENTITY EXCLUSION

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(Clauses 101, 106, 107 and 113(6), (9), (10) and (13))

Summary of proposed amendment

The Bill proposes an amendment to make refundable R&D tax credits available to more firms. It is proposed that the existing corporate eligibility criteria, wage intensity test, and $255,000 cap be removed and replaced with a payroll-tax based cap. It is also proposed that entities that derive tax exempt income (other than levy bodies, and claimants that only receive exempt income from certain intercompany and foreign dividends) be ineligible for the R&D tax credit.

Application date

The proposed amendment would apply from a business’s 2020–21 income year. The proposed amendment in clause 107 would apply from the 2019–20 income year.

Key features

Proposed new refundability rules

It is proposed that the existing limited refundability rules be replaced with new rules that make refundable R&D tax credits available to more firms from the 2020–21 income year (year two of the R&D tax credit regime). This means the new rules would apply from the start of each business’s 2020–21 income year, so would apply from 1 April 2020 for standard balance date taxpayers. These credits would be available for claimants in a tax loss position, or with insufficient income tax liability to utilise all of their R&D tax credits in the relevant income year.

Table 1 compares the current limited refundability rules with the proposed new refundability rules.

Table 1: Current and proposed refundability rules

Area	Existing rules 2019–20 income year	Proposed new rules 2020–21 income year
Eligibility criteria	Must satisfy the corporate eligibility criteria (section MX 2) – this includes a requirement that claimants must be companies, cannot be listed, and cannot be considered a tax resident of another jurisdiction under a double tax agreement	No corporate eligibility criteria.
	Must satisfy the wage intensity criteria (section MX 3) – this requires twenty percent of a firm’s labour costs to be on R&D labour	No wage intensity criteria.
Exempt income exclusion	Must not derive exempt income or be associated with a person who derives exempt income (unless the exempt income is from intercompany or foreign dividends under section CW 9 or 10).	Must not derive exempt income (unless the exempt income is from intercompany or foreign dividends under section CW 9 or 10, or the claimant is a levy body researcher) – note that this is an exclusion from the R&D tax credit regime, not just from refundability.
Cap	$255,000.	The total payroll taxes (PAYE, FBT, and ESCT) paid by the claimant (exceptions and grouping rules apply).
Outstanding tax	Must not have an outstanding tax liability.	Must not have an outstanding tax liability.

There would be two exceptions to the payroll tax-based cap. The cap would not apply to R&D tax credits:

• derived from eligible R&D expenditure on approved research providers; or
• claimed by levy body researchers (a levy body researcher is an industry organisation to which a levy is payable under New Zealand statute, such as the Commodity Levies Act 1990).

Grouping rules would apply to allow certain companies to allocate their payroll taxes to other companies they control or that sit within the same wholly-owned group.

Similar to the existing refundability rules, any non-refundable R&D tax credits may be carried forward to the next income year provided the shareholder continuity requirements in section LY 8 are met.

Proposed new exclusion for tax exempt entities

Tax exempt entities, other than firms that receive exempt income from dividends under section CW 9 or 10, (“excluded tax exempt entities”) are ineligible for year one refundability. Given that, the Government has decided these organisations should not be eligible for refunds of their tax credits in year two.

It is proposed that these excluded tax-exempt entities will also be completely ineligible for the R&D tax credit regime from the 2020–21 income year (year two of the R&D tax credit regime), except where the claimant is a levy body researcher.

Any R&D tax credits received by tax exempt entities in year one cannot be carried forward to year two. These credits will be extinguished from the beginning of year two.

Background

The Taxation (Research and Development Tax Credits) Act 2019 introduced an R&D tax incentive regime from the 2019–20 income year. The R&D tax incentive was developed under tight timeframes, so there was insufficient time to resolve some associated issues before the legislation was enacted. These included the eligibility of tax-exempt entities, and refundability for firms in loss or with insufficient income tax liability to use all of their R&D tax credits in the relevant income year.

Eligibility for the credit

A firm must first be eligible for the R&D tax credit more generally before it can be eligible for refundable R&D tax credits. Claimants have to satisfy a number of criteria to be eligible for the credit, which include having a core activity in New Zealand and carrying on business through a fixed establishment in New Zealand.

Excluding tax exempt entities from the R&D tax credit regime

Tax exempt entities are currently eligible for non-refundable R&D tax credits in year one of the R&D tax credit regime. Since these entities do not pay any income tax and do not qualify for year one refundability, they are unable to benefit from any R&D tax credits they receive in year one.

Broader refundability rules

In year one of the incentive (that is, the 2019–20 income year), limited refundability rules applied to provide refundable credits for a small portion of eligible R&D tax credit claimants. The limited refundability rules built on the existing R&D tax loss cash-out regime. The Government committed to reviewing the refundability rules, so that broader, more accessible refundability would be available from year two of the incentive (the 2020–21 income year).

Refundability is important, because it ensures all claimants doing R&D are able to immediately benefit from the tax credits they are eligible for under the incentive. Without refundability, some claimants may not be able to benefit from the incentive until a much later date (if at all, depending on the circumstances of each claimant). Removing the corporate eligibility and wage intensity criteria (section LA 5(4B(a)(i) and (ii)) should make refundable tax credits available to more claimants.

It is proposed that the existing $255,000 cap be replaced with a payroll tax-based cap. The payroll tax-based cap would be based on the total PAYE (which includes withholding taxes paid on behalf of contractors), FBT, and ESCT paid by a claimant. This is in line with approaches taken in other jurisdictions and is intended to prevent refundable tax credits being paid out for fraudulent claims.

Some exceptions are proposed to the payroll tax-based cap, so that the cap would not apply to credits resulting from eligible approved research provider expenditure and credits claimed by levy body researchers. There is a lower fraud risk associated with approved research provider expenditure and claims by levy bodies. This is because approved research providers have to be registered with Inland Revenue and have record-keeping obligations, and levy bodies are industry organisations empowered to collect levies under legislation (such as the Commodity Levies Act 1990).

Detailed analysis

Tax exempt entity exclusion (sections LA 5(4B), LY 3(2)(f), LY 8(2B), CW 9, CW 10 and YA 1)

It is proposed that from year two of the R&D tax credit regime, most tax-exempt entities will be ineligible for the R&D tax credit (so they will be unable to receive any R&D tax credits from year two). It is also proposed that any credits received by these entities in year one cannot be carried forward to year two but instead will be extinguished from the beginning of year two.

The rationale behind this exclusion is that tax exempt entities sit outside the tax system, so should not benefit from incentives provided from within the tax system. Charities, which come within the tax-exempt entity exclusion, do not pay income tax, and receive additional Government support in the form of GST concessions, an exemption from FBT, and the donor tax credit regime.

A carve-in is proposed for levy bodies and claimants whose only exempt income is from foreign or intercompany dividends under section CW 9 or 10. Claimants who receive exempt dividend income will typically be businesses who also derive assessable income and otherwise sit within the tax system. Levy bodies’ members are normally businesses, and these businesses fund R&D performed by the levy bodies for their benefit, so levy body R&D is fundamentally business R&D.

New payroll tax-based cap for refundability (sections LA 5(4B), LA 5(5B), LA 5(5C), YA 1)

The proposed amendment to LA 5(4B) would replace the existing $255,000 cap with a payroll tax-based cap.

Under the payroll tax-based cap, a claimant that is unable to offset all of their R&D tax credits against their income tax liability would receive refundable R&D tax credits equal to or less than the amount of payroll taxes (PAYE, FBT, and ESCT) they have paid for the relevant income year. That is, the maximum amount of refundable R&D tax credits a person may claim in an income year is the lesser of:

• The amount of payroll taxes paid by the person for the relevant income year; or
• The amount of R&D tax credits claimed by the person.

The proposed payroll tax-based cap would not apply to refundable R&D tax credits paid to levy body researchers or derived from eligible expenditure on approved research providers.

Allocating payroll taxes paid by other companies

The proposed payroll tax-based cap would include payroll taxes allocated to the claimant that have been paid by other companies. This is through proposed new sections LA 5(5B) and (5C), which provide the formula for calculating the payroll tax-based cap:

own payroll + other wholly-owned payroll + other controller payroll – double dip allocation

Table 2: Definitions for the proposed formula

Term	Definition
Own payroll	The total payroll taxes paid by a claimant for the relevant tax year.
Other wholly-owned payroll	The amount of payroll taxes allocated to the claimant that have been paid by a member of the claimant’s wholly-owned group for the relevant tax year.
Other controller payroll	The amount of payroll taxes allocated to the claimant that have been paid by a company that controls the claimant for the relevant tax year.

The “double-dip allocation” part of the formula strips out any amounts allocated to a claimant that have already been allocated to another person. This prevents the same payroll taxes going towards more than one claimant’s payroll tax-based cap.

It is important that any given amount of payroll taxes is only allocated to one claimant.

Ordering rules for R&D tax credits (section LA 5(4B))

The proposed amendment to section LA 5(4B) retains a reference to section LA 6(2), which relates to the treatment of refundable tax credits. It is proposed that any R&D tax credits claimed by a person must first be used to satisfy their income tax liability, if any, for the income year to which the credits relate (note that non-refundable R&D tax credits are applied to satisfy income tax liability before refundable R&D tax credits).

Once a person has used their credits to satisfy their income tax liability for that year, different rules apply depending on whether any remaining R&D tax credits are refundable or non-refundable.

Table 3: Rules for treatment of remaining R&D tax credits

Non-refundable credits

Refundable tax credits

Any remaining non-refundable tax credits can only be offset against income tax liabilities in the current year and must then be carried forward.

Before any remaining refundable R&D tax credits can be refunded, the credits must first be applied to any other liabilities in this order: An income tax liability for the current year; An income tax liability for a previous year; An income tax liability for a future tax year; A current provisional tax liability for a future tax year; and A different tax period or type (as requested by the claimant, or as applied by Inland Revenue if the claimant has any other tax outstanding).

No corporate eligibility criteria for refundability (section LA 5(4B))

The proposed amendment to section LA 5(4B) would remove the corporate eligibility criteria (LA 5(4B)(a)(i)). The criteria currently restrict refundable tax credits to firms that:

• are companies;
• are New Zealand tax resident (both under domestic law and any applicable double tax agreements);
• don’t have fifty percent or more of their shares held by a public or local authority, crown research institute, or state enterprise;
• are not established by, or subject to, the Education Act 1989, the New Zealand Public Health and Disability Act 2000, or the Crown Entities Act 2004; and
• are not a listed company or otherwise listed on a recognised exchange.

Removing the corporate eligibility criteria may bring the following claimants within the scope of refundability from year two:

• all businesses regardless of their legal structure – including companies, partnerships, and trusts – provided they carry on business through a fixed establishment in New Zealand;
• levy body researchers;
• council controlled organisations and state enterprises; and
• listed companies.

No wage intensity criteria for refundability (section LA 5(4B))

The proposed amendment to section LA 5(4B) would also remove the wage intensity test (section LA 5(4B)(a)(ii)). Currently, the wage intensity test requires at least twenty percent of a firm’s labour costs to be R&D related.

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TIMEFRAME FOR COMPLETING DISPUTES PROCESS

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(Clauses 122 and 123)

Summary of proposed amendment

The Bill proposes an amendment to allow the Commissioner to adjust a person’s R&D tax credit claim upwards if the person has initiated the disputes process through issuing a notice of proposed adjustment (NOPA) within four months of filing their income tax return or a year after their income tax return due date.

Application date

The proposed amendment would apply from a business’s 2019–20 income year.

Key features

It is proposed that sections 108(1E) and 113E of the Tax Administration Act 1994 be amended to allow the Commissioner to adjust a person’s R&D tax credit claim upwards if the person has initiated the disputes process through issuing a NOPA before the earlier of:

• four months of filing their income tax return; or
• a year after their income tax return due date.

Background

A person can only file a NOPA to increase their R&D tax credit claim once for each R&D tax credit claim they make (section 113E).

The legislation currently requires the disputes process to be completed within a year of a person’s income tax return due date if the person seeks to increase their R&D tax credit claim. This is contrary to the policy intent, which is that a person must initiate the disputes process within a year of their income tax return date. The policy rationale for this rule is to prevent the retrospective reclassification of expenditure.

The retrospective reclassification of expenditure includes where R&D activities or expenditure are identified after the end of an income year. If a person receives R&D tax credits for R&D they were unaware of at the time the R&D activities took place, the R&D tax credit regime has not provided any incentive to the person to undertake additional R&D. The retrospective reclassification of expenditure has been problematic in other jurisdictions.

The proposed amendment will require a person to initiate the disputes process by filing a NOPA within a year of their income tax return due date but does not require the disputes process to be completed within this time frame. This time limit is intended to provide a person with enough time to prepare the required information to file a NOPA while nevertheless discouraging the retrospective reclassification of expenditure.

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DECLINING R&D CERTIFIER APPLICATIONS

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(Clause 127(1) and (3))

Summary of proposed amendment

The Bill proposes an amendment to clarify the circumstances in which a person’s R&D certifier status will be declined. The amendment allows the Commissioner to decline a person’s application where approving the person as an accepted R&D certifier would adversely affect the integrity of the tax system.

Application date

The proposed amendment would apply from a business’s 2020–21 income year.

Key features

It is proposed that section 124ZI of the Tax Administration Act 1994 be amended so that the Commissioner can decline a person’s application to be an accepted R&D certifier, where approving the person’s application would adversely affect the integrity of the tax system.

Background

Accepted R&D certifiers are able to provide R&D certificates to claimants in the significant performer regime. From the 2020–21 income year, all claimants will be required to either obtain activity approval under the general approval regime or opt into the significant performer regime. Significant performers must provide R&D certificates to the Commissioner with their R&D supplementary returns (which are due within 30 days of a claimant’s income tax return due date).

The proposed amendment provides the Commissioner with another ground for declining a person’s application to be an accepted R&D certifier. The amendment is consistent with the policy intent, which is that the Commissioner should be able to decline a person’s application where their status as an accepted R&D certifier would adversely affect the integrity of the tax system.

It is arguable that the Commissioner already has this ability because of section 6 of the Tax Administration Act 1994. For the avoidance of doubt, however, this amendment clarifies that the Commissioner can decline a person’s application in these circumstances.

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REVOKING R&D CERTIFIER APPROVALS

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(Clause 127(2) and (3))

Summary of proposed amendment

The Bill proposes an amendment to extend the circumstances in which the Commissioner can revoke a person’s accepted R&D certifier status. The amendment requires the Commissioner to revoke a person’s approval as an accepted R&D certifier where the accepted R&D certifier has provided an R&D certificate to another person in the last two years who has entered into a tax avoidance arrangement for R&D tax credits, or where allowing the accepted R&D certifier to retain their R&D certifier status would adversely affect the integrity of the tax system.

Application date

The proposed amendment would apply from a business’s 2020–21 income year.

Key features

It is proposed that section 124ZI of the Tax Administration Act 1994 be amended so that in addition to the grounds under which the Commissioner can currently revoke a person’s approval, the Commissioner can also revoke a person’s approval as an accepted R&D certifier where:

• allowing the person to retain their approval would adversely affect the integrity of the tax system; or
• the person has provided an R&D certificate to another person, and that other person has entered into a tax avoidance arrangement for R&D tax credits.

Background

Claimants in the significant performer regime must obtain an R&D certificate from an accepted R&D certifier.

The proposed amendment to section 124ZI is consistent with the policy intent, which is not reflected in full by this provision as currently enacted. It provides the Commissioner with additional grounds to revoke a person’s approval as an accepted R&D certifier.

Revoking approvals with adverse effect on tax system integrity

As with the other remedial amendment to section 124ZI regarding declining a person’s application to be an accepted R&D certifier, the policy intent is that a person would have their approval revoked if their retaining it would adversely affect the integrity of the tax system. It is arguable that the Commissioner already has this ability because of section 6 of the Tax Administration Act 1994. For the avoidance of doubt, however, this amendment clarifies that the Commissioner can revoke a person’s accepted R&D certifier status in these circumstances.

Providing certificates to participants of tax avoidance arrangements

The legislation currently allows the Commissioner to revoke a person’s approval as an accepted R&D certifier if they have provided an R&D certificate in the last two years to a person who received shortfall penalties arising from tax evasion and taking an abusive tax position (this is through the references in section 124ZI(7)(b) to sections 141D and 141E). Tax avoidance may not always involve taking an abusive tax position, however, so this amendment is proposed so that providing an R&D certificate to a person who enters into a tax avoidance arrangement is another ground on which the Commissioner must revoke a person’s approval.

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CHALLENGING THE COMMISSIONER’S DECISIONS

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(Clauses 128 and 145)

Summary of proposed amendment

The Bill proposes an amendment to prevent a person from challenging the Commissioner’s decisions made for the pilot approval scheme and exceeding the $120 million cap.

Application date

The proposed amendment would apply from a business’s 2019–20 income year.

Key features

It is proposed that section 138E of the Tax Administration Act 1994 be amended so that a person cannot challenge the Commissioner’s decisions made for the pilot approval scheme (see sections 68CB and 68CC) and exceeding the $120 million cap (section 68CD).

Background

Pilot approval scheme

In year one of the R&D tax credit regime (the 2019–20 income year), a pilot approval regime will be in place. The pilot is aimed at enabling the Commissioner to test and refine the in-year approval regimes before they are rolled out more broadly in year two (the 2020–21 income year).

To be a part of the pilot, both the Commissioner and a person must agree that the person will take part in the pilot. The person will be required to submit an approval application by a prescribed date, which the Commissioner will then approve or decline. There is a legislative requirement that the Commissioner notify the person of her intent to decline their application before declining it. This is to provide the person with an opportunity to provide additional information in support of their application where appropriate.

It is proposed that taxpayers will not be able to challenge the Commissioner’s decisions made for the pilot approval scheme, other than through judicial review.

Exceeding the $120 million cap

There is a cap of $120 million on the amount of eligible R&D expenditure for which a person can claim R&D tax credits. This equates to a cap of $18 million R&D tax credits. A person can apply to exceed the $120 million cap by applying for an approved R&D cap. The Commissioner can approve an application for an approved R&D cap if she is:

• satisfied the relevant R&D activities give rise to substantial net benefit for New Zealand; and
• she has consulted with the chief executive of the Ministry of Business, Innovation and Employment.

It is proposed that taxpayers will not be able to challenge the Commissioner’s decisions made about approved R&D caps. This is through adding section 68CD to section 138E(1)(e)(iv) from year one of the R&D tax credit regime.

No right to challenge in other parts of R&D tax credit regime

Section 138E currently prevents a person from challenging the Commissioner’s decisions made about:

• approved research providers (sections 124ZH and 138E(1)(e)(iv));
• R&D certificates and certifiers[3] (sections 124ZI and 138E(1)(e)(iv));
• general approval[4] (sections 68CB and 138(1)(e)(iv)); and
• the significant performer regime[5] (sections 68CC and 138E(1)(e)(iv)).

Adding sections 68CB, 68CC and 68CD to section 138E(1)(e)(iv) from year one of the regime is consistent with the approach taken in the rest of the regime regarding decisions made by the Commissioner. It is also consistent with the policy intent, which is for decisions made by the Commissioner regarding the R&D tax credit to be final and not subject to challenge other than through judicial review.

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ALLOCATING CREDITS TO JOINT VENTURE MEMBERS

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(Clause 105)

Summary of proposed amendment

The Bill proposes an amendment to correct the allocation of R&D tax credits claimed for R&D activities performed by joint ventures, so that these credits are allocated in accordance with members’ interests in the joint venture rather than the members’ interest in the income of the joint venture.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

It is proposed that section LY 1(4) of the Income Tax Act 2007 be amended so that credits are allocated in accordance with each member’s interest in the joint venture. This is to ensure the provision operates as intended for joint ventures regardless of whether they derive income. The onus will be on joint venture members to use an appropriate methodology to determine their interests in the joint venture for the relevant income year.

Section LY 1(4) currently requires credits claimed for R&D activities performed by unincorporated joint ventures to be allocated in accordance with each member’s interest in the income of the joint venture.

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INTERNAL SOFTWARE DEVELOPMENT EXPENDITURE

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(Clause 113(5))

Summary of proposed amendment

The Bill proposes an amendment to broaden the definition of internal software development expenditure subject to the $25 million cap, so that it includes all software development expenditure that isn’t external software development or software development undertaken for the purpose of internal administration.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

It is proposed that the definition of “internal software development expenditure” in section YA 1 of the Income Tax Act 2007 be amended because the current definition may not cover expenditure on all activities that would be normally considered internal software development (such as operational internal software development). The expanded definition would cover any software development expenditure that isn’t:

• software development undertaken for the purpose of internal administration of a person’s business or their associate’s business (this comes within the existing definition of “ineligible internal software development” in YA 1); or
• external software development expenditure.

Background

“Internal software development expenditure” is currently defined in section YA 1 to:

• include expenditure/loss incurred on developing software to provide services, if the main reason recipients of the software use the software is not to use the software or technology but rather the services themselves; and
• exclude external software development expenditure (which is expenditure/loss incurred on developing software if the software is developed mainly for the purpose of sale/disposal to third parties, either in its own right or as an integral part of goods disposed of in the ordinary course of business).

Without the proposed amendment, it is likely that contrary to the policy intent, some internal software development expenditure (such as operational internal software development expenditure) would either be completely excluded through the definition of ineligible internal software development or be completely uncapped.

[3] These sections come into force in year two.

[4] These sections come into force in year two.

[5] These sections come into force in year two.