Cashflow for trailblazers: Inland Revenue’s guidance on the R&D Loss Tax Credit Regime
Tax Alert - August 2023
By Ian Fay, Brendan Ng & Zara McLellan
In today’s competitive business landscape, innovation can be the key to success. However, Research and Development (R&D) endeavours can be financially taxing, often leading to substantial upfront expenses and losses - especially for businesses in the start-up phase. To encourage and support innovation, there are a number of R&D support mechanisms, that serve as powerful incentives for businesses to invest in new ideas while easing the burden of R&D costs. This includes the R&D Loss Tax Credit (RDLTC) regime which has existed since 2016 and enables companies in a tax loss position to exchange these losses, that would otherwise be carried forward, for cash.
In July the Inland Revenue released a draft interpretation statement IS XX/XX Research and development loss tax credits (the draft interpretation statement) on the RDLTC regime, providing a deep dive into the rules and ongoing obligations of the regime. Until now, there has been minimal guidance on the intricacies of the RDLTC regime, an issue IRD aims to solve with the release of the draft interpretation statement.
What is the RDLTC Regime?
The RDLTC is designed to operate like an interest-free loan which must be ‘paid back’ over time. The RDLTC assists with cashflow through enabling R&D intensive companies to receive the tax effect of their losses as cash following the year incurred, instead of carrying forward these losses to offset these against future profits. The RDLTC and the R&D Tax Incentive (RDTI) regime are not mutually exclusive, so provided the specific individual regime definitions of R&D are met, companies can claim for the same expenditure under both (more detail on the RDTI can be found in this previous Tax Alert article).
The RDTLC operates on an annual basis. It has a strict eligibility criterion (which Inland Revenue has now elaborated on), and stringent filing timeframes apply. To apply for the RDLTC a company must file an R&D statement with Inland Revenue.
There are two key aspects the draft interpretation statement provides guidance on:
- Applying the eligibility criteria
- Considerations regarding the ongoing obligations of the regime
Applying the eligibility criteria
The eligibility criteria for the RDLTC are outlined in the Income Tax Act 2007, however, uncertainty has existed when applying the rules to individual company circumstances. The draft interpretation statement seeks to answer many of these questions and we’ve highlighted the most noteworthy below.
Definition of “research” and “development”
The RDLTC regime adopts the definitions of “research” and “development” as described in the New Zealand equivalent to International Accounting Standard 38 Intangible Assets (NZ IAS 38). The guidance elaborates on what qualifies as research and development, noting that this definition is different from that under the RDTI.
Wage intensity calculation
An eligible company must satisfy an R&D wage intensity calculation, requiring 20% of a company’s total labour expenditure to be on R&D labour. This ensures that R&D forms a key part of a company’s business activities.
The interpretation statement clarifies that the deductibility of labour expenditure is not relevant for the wage intensity calculation, meaning although R&D labour may be funded by other grants and rebates which make it ineligible expenditure, it is still relevant for this calculation.
Further, the guidance is not prescriptive in the methodology used to apply appropriate apportionment rates to labour costs when determining a split between R&D effort and other goods and services. However, it does note that the apportionment method needs to be fair and reasonable and supported by documentation showing how an outcome was reached.
How the eligibility criteria apply to R&D groups
If a company is a member of an R&D group, this can affect its eligibility to claim as:
- The wage intensity calculation must be satisfied for the R&D group; and
- The R&D group must have a net loss
The concept of an R&D group follows the same general company grouping rules as for other purposes. It is worth noting though, that although overseas expenditure is ineligible under the RDLTC, the guidance clarifies that this doesn’t mean non-resident companies are excluded from being a member of an R&D group.
There are also considerations when one member of the R&D group undertakes the R&D itself, while another member of the group owns the intellectual property (IP) /results of the R&D. In this situation, without more the company undertaking the R&D cannot claim the RDLTC because the IP is owned by the IP company (and vice versa).
Qualifying expenditure
Unlike the RDTI regime which requires a minimum of $50,000 of eligible R&D expenditure, there is no minimum amount of eligible R&D expenditure to qualify for the RDLTC. However, the amount of eligible R&D expenditure is relevant for determining the amount of losses that can be cashed out.
The guidance provides flexibility in choosing the apportionment rates for costs which relate to both R&D and other activity, so long as they are reasonable and appropriate. The interpretation statement provides two examples of what might be an appropriate method of apportionment:
- Salaries and wages for overhead staff may be appropriate to apportion based on a percentage of R&D Staff as compared with non-R&D staff.
- Overhead costs such as electricity, insurance and rent may be more appropriately apportioned using the percentage of area used for R&D compared with other activities.
Considerations for the ongoing obligations of the regime
Until the value of the loss tax credit has been repaid in full, there are ongoing obligations that the company must meet each year (including when the loss cashed out is required to be repaid). Inland Revenue have provided clarification of these obligations and our key takeaways are below.
Extinguishing losses and carrying forward excess losses
When a company cashes out its tax losses under the RDLTC, these are extinguished, meaning they have been used by the company and are no longer able to be carried forward and used in a subsequent income year.
If the amount of loss extinguished is less than the total available net tax loss, the remaining losses can be carried forward. Taking advantage of the RDLTC regime does not remove the requirements associated with carrying forward company losses that are not cashed out and these rules must still be considered each year.
Loss recovery events, requiring R&D repayment tax
When a company becomes profitable and pays tax on income, this is treated as repayment of the RDTLC. However, there are a further four loss recovery events, which may trigger an early repayment obligation. These are:
- disposal of intellectual property
- appointment of a liquidator
- company migration or no longer a company
- shareholding change of greater than 90%
Given the complexity associated with business transactions, restructures, and wind-ups, it is no surprise that these rules are not simple to apply. The guidance released aims to support companies in applying the rules to their unique circumstances, including outlining which calculation to apply if multiple events occur during one income year. If one of these may apply to you, we would recommend getting in touch with your usual advisor.
Imputation credits
Inland Revenue is conscious of the implications of being in an imputation debit position at year end. The draft interpretation statement clearly outlines that the amount of imputation debit is limited to the amount of tax paid during the year, therefore a company will not have a closing debit Imputation Credit Account balance due to the RDTLC.
The main consideration here, in many scenarios, is that a company will not be able to attach an imputation credit to dividends until it has repaid the RDTLC in full.
What should I do next?
Inland Revenue’s RDLTC draft interpretation statement is open for public consultation until 30 August 2023, after which submissions will be considered and a final statement issued. If your business is currently enrolled in the regime and has questions about how the draft interpretation statement will affect your business or you have any feedback on the draft, we recommend you get in touch with the specialist Deloitte R&D team or your usual Deloitte advisor.
We also suggest that you consider whether the R&D Tax Incentive (RDTI) is right for your business. The RDTI provides a 15% tax credit (or refund in certain circumstances) for eligible R&D expenditure spent on an eligible R&D activity. The RDTI process has also been recently improved with the introduction of the in-year payment scheme, allowing businesses earlier access to the cash benefits of the RDTI.
If your business is not currently enrolled in the RDLTC or the RDTI and you think your business might be eligible, we can help.
