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Tax Alert - special update - November 2007

Special update - November 2007 Tax Alert - special update - November 2007

Legislation one step closer

On November 11 the Finance and Expenditure Committee (FEC) provided its report back on the Taxation (Annual Rates, Business Taxation, KiwiSaver, and Remedial Matters) Bill (the May Bill).  The FEC has recommended changes to elements of the Bill which we summarise below.  The Bill is now back in Parliament to await its second and third readings and royal assent – hopefully all this side of Christmas however Parliament only has seven more sitting days left this year.

The major changes to the Bill relate to the new R&D tax regime, with only fairly micro changes made to the other proposals in the Bill.

The R&D regime – it’s time to act

By Aaron Thorn and Peter Felstead

When a new regime is introduced it can be hard to commit to the implementation planning process before the shape of the final legislation is known.  This no longer holds true for the new Research & Development (R&D) tax credit regime, and given the imminent commencement date for the regime it is time to ensure that preparations are well underway.

The regime applies from the 2009 income year, so the actual start date will be balance date dependent, with some early balance dates already in it.

The core aspects of the regime remain the same as originally introduced; however there has been some tweaking at the edges, both to tighten up on Officials’ perceived fiscal risks within the legislation, and in some areas widening the provisions to create the incentives intended.  As stated by the FEC, “we believe that sustainability of the credit is critical for increasing research and development.  In proposing amendments to the bill we have therefore adopted a cautious approach, to reduce the likelihood that substantive changes to reduce the scope of the concession will subsequently be required.”

What you need to know:

The core aspects of the regime remain as follows:

  • A 15% tax credit for eligible R&D costs
  • R&D is broadly defined consistently with other jurisdictions
  • Commencing from start of the 2009 income year
  • Credit offsets tax liabilities, however it is refundable in cash if no tax liabilities exist
  • Imputation credits are received for the amount of the R&D creditFor more information on the core features of the regime, please refer to our earlier Alert article.
So, what material changes have been made?

Some tightening of definitions

The news is not all positive and we’ll deal with the bad news first. 

  • What is R&D?  The core definition of what R&D is focused on the requirement for there to be either novelty or scientific or technical uncertainty.  There is now an additional requirement that the activity is intended to achieve an advance in science or technology by resolving scientific or technological uncertainty.  Whilst this additional requirement may seem to be restrictive, a review of how similar wording operates in the UK suggests that it may not create additional restrictions in practice.  It would seem that this is also the intention in New Zealand with comments made by the FEC that they do not consider this change will reduce the scope of the definition.
  • R&D Support Activities: R&D is comprised of core R&D and support activities.  Originally to be eligible to be a support activity, such activity needed to be “commensurate with, required for, and integral to” the carrying on of core R&D.  In an effort to clarify and tighten up on the range of support activities, support activities must now be “wholly or mainly for the purpose of, required for, and integral to” the carrying on of core R&D.  We believe this amendment is specifically targeting commercial trials where R&D in undertaken in operational circumstances.  We are disappointed about this change as much R&D needs to be undertaken to satisfy the commercial needs of businesses.

Internal Software Development

Like Australia, eligible software developed for resale qualifies in full, and the New Zealand regime included an additional concession that software developed for internal use could also qualify, subject to a cap.  This cap has been increased from $2 million to $3 million expenditure per group per annum.  In addition, the definition of internal software has been tightened to ensure that internal software cannot be classified as external, for example by the use of an implicit licence.  Other changes to this area of the legislation include –

  • Ensuring that the cap applies to all elements of internal software R&D, and specifically that internal software which supports other non software R&D projects are also brought within the cap;
  • Clarifying that the cap does not apply to firmware (i.e. software included in goods developed by the claimant mainly for sale).

However, the Minister of Finance retains his discretion to waive the cap where he feels this is justified.

Outsourced R&D

Originally it was necessary to satisfy a number of tests in order to be eligible for the tax credit. This included all three of the following tests:

  • The person controls the R&D activities; and
  • The person bears the financial and technical risk of the R&D activities; and
  • The person owns the results of the R&D activities (if any).

While intended to ensure that only one party can claim an R&D credit for a single piece of R&D, the original legislation would have the ability to disallow any party from claiming an R&D credit in certain circumstances.  This has been slightly relaxed through the removal of the need for technical risk to be borne by the claimant.

Intellectual property ownership

When the bill was first released, the IRD stated in their accompanying commentary that the claimant need not necessarily be the legal owner of the IP, but this was not supported by the wording of the legislation.  his point has now been clarified in the bill with the additional relaxation in that the person need only effectively own the results.  This could in practice mean that the claimant need only have the right to use or exploit the results of the R&D without full legal ownership.

Excluded activities

A substantial victory for claimants in resource industries.  Originally the “production” of minerals, petroleum, natural gas and geothermal energy was specifically excluded from being R&D with the corresponding potential to effectively prevent the majority of otherwise legitimate R&D claims in these resource industries.  The omission of “producing” in the latest legislation is a positive change for these critical industries.

Capitalised expenditure

Another positive change relates to the treatment of capitalised expenditure. Concerns were raised that expenditure which satisfies the R&D definition should be eligible for the R&D tax credit without having to satisfy the additional criteria that the expenditure is deductible for tax purposes. Changes to the legislation have addressed these concerns and there is now scope to claim more than just depreciation, specifically capital expenditure on the development of a depreciable intangible asset that is the object of R&D activities and expenditure incurred on creating depreciable tangible assets to be used solely for R&D (essentially a prototype).

Where to from here?

While it is fair to say that the legislation released yesterday is likely to be enacted in its current form, the R&D regime should be considered a work in progress with Officials’ keen to monitor how businesses interpret and apply the regime with the likely outcome being an operational review within three years.

In addition, to help businesses prepare for the regime, it is expected that Inland Revenue will shortly release some draft, but comprehensive, guidelines on the regime for comment.

Businesses should ensure that they’re investing enough time now to ensure they’re ready to run with the regime as soon as it applies.

R&D tax specialists
Auckland
Peter Felstead +64 (0) 9 303 0860
Simon Taylor +64 (0) 9 9 303 0761
Hamilton
Greg Harris +64 (0) 7 838 4805
Wellington
Robyn Walker +64 (0) 4 470 3615
Christchurch
Aaron Thorn +64 (0) 3 363 3813
Dunedin
Steve Thompson +64 (0) 3 474 8637

 

Aaron Thorn

Aaron Thorn
Partner
DDI: +64 (0) 3 363 3813
Email: athorn@deloitte.co.nz

Peter Felstead

Peter Felstead
Partner
DDI: +64 (0) 9 303 0860
Email: pfelstead@deloitte.co.nz

 

Other matters

No dividends for dividend imputation

The reduction in the company tax rate from 33% to 30% was swiftly dealt to with legislation introduced and enacted at the time of the Budget in May.  However, the consequential changes to other areas of the tax rules was rightly left to the May Bill to go through the full generic tax policy process.

The key area of reform relates to the payment of dividends to shareholders. There were two slightly controversial elements to these changes:

  1.  To the extent that tax is paid at 30%, dividends can only be imputed with 30% worth of imputation credits.  To the extent that taxpayers have a store of imputation credits generated under the 33% tax rate, they are able to pass these through to shareholders at 33%; however only until 31 March 2010.  The limited time period means that after this date shareholders will face a level of double taxation to the extent companies still maintain a balance of 33% imputation credits. It also penalises companies to the extent that it incentives early distributions of profits when optimally they may best be reinvested back into the business. 
  2.  Dividends paid to most New Zealand residents will still require 33% tax ‘paid’ on them before they reach shareholders.  As such, even if a company is fully imputing dividends at the new 30% rate an additional 3% RWT must be withheld from shareholders, adding potentially significant compliance costs onto companies.

Unfortunately despite submissions on these points the FEC has recommended very few changes in this area.  What is more disappointing in respect of the second item above is that it had been signaled at the time of the May Bill that a review of RWT may be undertaken to further consider the appropriateness of requiring RWT to be withheld on fully imputed dividends – alas this review was not included in the recently released tax policy work programme so it is unclear when it can be expected to occur.  On a positive note an exemption has been recommended for widely held unit trusts that have not previously accounted for RWT on dividends and are fully imputing dividends at the rate of 30/70.  It looks like all other businesses should start looking at putting RWT systems in place and undertaking shareholder education around this change.

Snippets
  • While a number of technical amendments to KiwiSaver have been proposed, the following key aspects remain unchanged –
    • Matching compulsory employer contributions to be phased in over four years, starting at 1% from 1 April 2008 and reaching 4% of gross salary or wages from 1 April 2011.
    • Employer tax credit of up to $20 a week for each employee to reimburse employers for their contributions to KiwiSaver. 
  • Very few changes have been made to the original penalty proposals.  On the whole the proposed amendments to the penalty rules are taxpayer-friendly (at least as far as penalties can be) and will assist in the rules being applied more consistently and fairly.
  • For IFRS taxpayers there are changes in store as to how your financial arrangements can be treated.  The original proposals have been improved to allow taxpayers greater flexibility
  • A supplementary order paper was introduced in June to deal with a base maintenance issue related to cross border leases; this was then removed from the May Bill due to complexities with the legislation.  This issue is still live with Officials’ working on this issue.  It is expected that legislation will be released again at a later date to deal with this issue, with the application date for any change expected to be 20 June 2007 being the date of the original announcement.
At a glance - when will these rules apply?

Assuming the May Bill runs its course through Parliament without any further changes the following table sets out when some of the key legislative changes take effect from. 

Legislative Change Application Date
Corporate Tax Rate Reduction and consequential changes
  • 2009 income year

 

Imputation credits can no longer be attached to dividends at the rate of 33%
  • 1 April 2010

 

Research and Development tax credit regime
  • Commencement of the 2009 income year

 

KiwiSaver

  • Compulsory employer contributions
  • 1% of gross salary or wages
  • 2% of gross salary or wages
  • 3% of gross salary or wages
  • 4% of gross salary or wages

 

  • 1 April 2008
  • 1 April 2009
  • 1 April 2010
  • 1 April 2011

 

  • Employer tax credit to reimburse for contributions made to employees’ KiwiSaver scheme up to a maximum of $20 per week

 

  • 1 April 2008

Penalties

  • Late filing penalty for GST returns
  • Late payment penalty
  • Tax agents and the shortfall penalty for not taking reasonable care
  • Refining the scope of the unacceptable tax position shortfall penalty
  • Abusive tax position shortfall penalty threshold
  • Late payment of PAYE
  • Reduction in temporary shortfall

 

  • 1 April 2008
  • Reduction in penalty for voluntary disclosure of tax shortfall

 

  • 17 May 2007
  • Late filing penalty for employer monthly schedules

 

  • 1 April 1999

 

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