Legislation passed on the 24 February 2016 allows research and development (R&D) companies to ‘cash out’ their tax losses arising from R&D expenditure.
The new 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 current tax treatment of losses. However, the new rules are not intended to apply to highly structured or complex firms which have an R&D component.
Because the cash out is administered through the tax system, it is delivered in the form of a tax credit and is referred to as the ‘R&D loss tax credit’. Similar to other tax credits, only the net loss for the year can be cashed out and any losses that cannot be cashed out will be carried forward.
Repayments of the R&D loss tax credit are intended to occur when the company makes a return from the R&D and as a result derives taxable income. Essentially the R&D tax loss credit is repaid through tax paid on profits because there is no tax loss carried forward because it was cashed out. The benefit of the regime is to provide cash flow to start-up businesses.
The new rules apply to income years beginning on or after 1 April 2015.
To be eligible, a company must be the following:
- a tax resident of New Zealand for the whole year (not be treated under a Double Tax Agreement as a resident of a foreign country)
- have a net loss for the corresponding tax year
- meet the wage intensity criteria (discussed below)
- have incurred R&D expenditure in the relevant year (does not include expenditure that is allocated to a future year)
- own (solely or jointly) the intellectual property and know-how that results from the R&D activity
Groups may still be eligible as long as the company meets all of the above criteria and the group as a whole is in a loss position and meets the wage intensity calculation. The initiative is not intended to apply to companies owned by the Crown (50% or more), listed companies or look-through companies.
Wage intensity criteria
The wage intensity calculation must equal 20% or more. There are two options for calculating this:
Option 1 is the simpler of the two and takes into account salary or wages for employees, consideration paid to contractors and amounts paid to shareholder-employees that are not subject to PAYE.
Calculation: total R&D labour expenditure/total labour expenditure
Option 2 is more accurate and is calculated the same as option 1 except it also includes the remuneration and compensation paid to employees such as fringe benefits, superannuation contributions and other types of compensation for labour.
The terms ‘research’ and ‘development’ have the same meanings as they do for accounting purposes and deductibility, but are more restricted. Expenditure on certain activities and some types of expenditure are excluded from the measure. Activities that are excluded expenditure generally take place in a post-development phase, relate to routine work or where there is not a clear relationship between the activity and economic growth.
An important component of the R&D definition is that any intellectual property and know-how that results from the research or development is vested in the company, solely or jointly. These requirements are intended to ensure that the value of the amounts cashed out go to the company that is incurring the risk of investing in the R&D.
The eligibility requirements must be met for each income year that the taxpayer applies to cash out a loss. A company incorporated part-way through the year will be eligible as long as it meets all the requirements for the part of the year that it is in existence.
Amount of the cash out
The amount that can be cashed for any year will be the lower value of one of the following:
- the company’s net loss multiplied by 28%
- the company’s total R&D expenditure for the year multiplied by 28%
- the company’s total labour cost for R&D for the year multiplied by 1.5 and then multiplied by 28%.
In addition, the R&D loss tax credit will be capped at $140,000 for the 2015-2016 year, being a loss of $500,000 multiplied by 28%. The capped losses will increase by $300,000 each year until they reach $2 million. The actual R&D loss tax credit will be $560,000 being $2 million multiplied by 28%.
The R&D tax credits may be used to satisfy an existing tax liability of the company. The decision to cash out a tax loss is optional for each income year. A company may choose to cash out a loss in one year, and may choose not to for a subsequent year.
A cashed out loss can be thought of as an interest-free loan from the Government to be repaid from future taxable income. It is intended to provide a temporary cash flow timing benefit when the company is in a tax loss position.
Repayment of cashed out losses will occur when a company pays tax on taxable income that would have been sheltered by the cashed out losses if they had been carried forward.
Triggers for early repayments of amounts cashed out include the sale of R&D assets, liquidation or migration of the company, and the sale of the company. The early repayments will be effected via a new R&D repayment tax. Where a cashed out loss is required to be repaid early, a new deduction will reinstate the loss, which will be available to offset future income. The rule governing the repayments of cashed out amounts is not optional.
Applications will need to be made to cash out tax losses by the time the company files the corresponding income tax return. Companies need to register their interest online with the Ministry of Business, Innovation and Employment.
If you think you could be eligible for a R&D loss tax credit or would like any further information, please contact your local Crowe Horwath tax adviser.