IRD have released an exposure draft that is up for comment and discussion regarding Research and Development (R&D) loss tax credits. The statement discusses two parts; the first being the eligibility criteria for when a company can claim a R&D loss tax credit. The second part looks at the company’s obligations once they have received the tax loss credit.

Background

R&D loss tax credits were introduced to encourage innovation among businesses. Companies engaging in intensive R&D tend to have large upfront costs and losses in their first few years of operation, so the aim of the credit is to assist these companies with their cash flow through loss tax credits. This means instead of carrying forward the loss to use against income derived in another year, companies can choose to receive a payment to cash out the tax loss in the relevant year.

Only companies are eligible for these credits and can choose whether to apply or not in any particular year however they must meet the eligibility requirements.

Part One: Eligibility for the R&D Loss Credit

In order to be eligible for R&D tax loss credits, the company must:

• Be a NZ resident
• Have a net loss in the relevant tax year
• Satisfy the wage intensity calculation
• Incur R&D expenditure in the relevant income year
• Own, solely or jointly, the intellectual property and know-how resulting from the R&D
• not be a:

o a company established under or subject to the Education and Training Act 2020, Pae Ora (Healthy Futures) Act 2022 or Crown Entities Act 2004 (s MX 2(c));

o company where 50% or more of its shares are owned by a public authority, a local authority, a Crown research institute or a state enterprise (s MX 2(d)); or

o listed company or listed on a recognised exchange (s MX 2(e))

The Wage Intensity Calculation

In order for a company to claim a R&D loss tax credit, 20% of a company’s total labour expenditure must be on R&D labour. This requirement ensures that there is sufficient expenditure on R&D. The following formula is used to make the calculation:

total R&D labour expenditure / total labour expenditure

The deductibility of expenditure is not relevant for the calculation e.g., where amounts are for capital expenditure or funded by government grant, the expenditure is still included in the calculation.

The amounts that must be included in the calculation are:

• salary and wages paid to employees for providing R&D material
• amounts paid to shareholder employees for providing R&D material
• the total amount of contractor R&D consideration multiplied by 0.66

Part Two: Obligations and Repayments

Having determined that the company is eligible for the tax loss credits in part one, part two sets out the obligations they must fulfil.

Calculation of Credit

The amount of the R&D loss tax credit is calculated under s MX 4. The amount of the available tax credit is the lowest of:

• For the 2021 and subsequent income years, $560,000
• The company’s net loss for the tax year x the basic tax rate for the company (28%)
• The company’s total R&D expenditure for the income year x 28% and
• 1.5 x the company’s total R&D expenditure in the income year x 28%

Treatment of Losses

Once the available amount of credit has been calculated, the company will have some or all of its net loss extinguished. It is extinguished by the company cashing out and claiming the credit. The amount of loss extinguished is:

the amount of the R&D loss tax credit / the basic tax rate for a company (28%)

If the amount of loss extinguished is less than the company’s available net tax loss, the remaining losses for that year may be carried forward to the next tax year. If losses are carried forward the company cannot cash out these losses in a later year, but it can offset them against income or can be carried forward to future years.

Example provided by IRD:

Research Co is carrying on an R&D project in the 2022 income year and has:

• a net loss of $700,000;
• total R&D expenditure of $525,000; and
• total R&D labour expenditure of $450,000.

The amount of R&D loss tax credit available is the lowest of: 

• $560,000;
• net loss ($700,000) x 28% = $196,000;
• total R&D expenditure ($525,000) x 28% = $147,000; and
• 1.5 x R&D labour expenditure ($675,000) x 28% = $189,000. The amount available as the R&D loss tax credit is $147,000.

The amount of tax loss extinguished under s MX 5 is: $147,000 / 28% = $525,000.

Research Co meets the requirements to carry forward its remaining losses and carries forward those tax losses to the next tax year. This is calculated as: net loss for the year - losses extinguished = losses carried forward $700,000 - $525,000 = $175,000 Research Co cannot claim the tax losses carried forward ($175,000) as R&D loss tax credits in any subsequent tax year.

Repayment Obligations

Once having claimed the credit, the company incurs obligations that must be fulfilled. The credit operates as an interest free loan and  must be repaid to the IRD once the company is making a profit.

Early Repayment Events

In certain situations, the company is required to make an early repayment of a previously claimed R&D loss tax credit. These situations are referred to as “loss recovery events”. If a loss recovery event occurs the company will have a liability for an amount of R&D repayment tax. The amount of R&D repayment tax depends on the type of event that has occurred.

The types of loss recovery events are when:

• the company disposes of or transfers intangible property, core technology, intellectual property or know-how for less than market value, and/or where the amount is not assessable income of the company;
• the company is no longer New Zealand resident;
• a liquidator is appointed; or
• there is a loss of the required shareholder continuity.