Five-year RDTI review confirms strong business backing and economic impact

By Brendan Ng, David Creagh and Aaron Thorn

The Ministry of Business, Innovation and Employment first five-year evaluation report of the Research and Development tax incentive regime asked whether the 15% R&D Tax Incentive tax credit (RDTI) is encouraging more businesses to undertake R&D and whether the government is getting “bang for the buck” on the investment.

What are the reports key findings?

For those who haven’t yet discovered it (we know you’re out there!), the RDTI was introduced in April 2019 and provides a 15% tax credit on eligible R&D expenditure. The purpose of the RDTI is to broaden access to R&D support and stimulate innovation.

The Report considered whether the 15% tax credit is incentivising further R&D to be undertaken and its effect on growth on New Zealand’s economy. In summary:

• Projected economy-wide benefit of the RDTI: 4.2 times government investment, equating to a boost to New Zealand’s GDP of $6.8 billion over the five-year period.
• Total additional R&D expenditure: $1.833 billion (present value) – with supported firms on average spending $274,000 more on R&D annually.
• “Bang for the buck” (BFTB) ratio (additional expenditure per dollar of support provided) is 1.4, consistent with OECD benchmarks. This compares to a BFTB ratio of 0.83 under the Growth Grant regime.
• Net impact after government costs: $221 million.
• Innovation gains appear two years post-support, with a 6.1 percentage point increase in innovation rates, with supported firms showing higher growth in output, capital, and employment.
• No significant productivity effect has yet emerged, reflecting the short evaluation window.

The RDTI regime seems to have achieved its goal, with key figures for the 2020-2024 period being:

• 1,752 firms supported, with $1.074 billion in tax credits provided.
• By 2023, supported firms accounted for 65% of total business R&D expenditure, compared to 44% under Growth Grants.

This all seems to suggest that the RDTI has made a positive impact and is a welcome addition to the New Zealand innovation landscape. However, behind the numbers there may be other considerations.

So, is the R&D tax incentive working as intended?

Short answer: yes. Long answer: there is room for improvement.

The report, prepared by Motu Economic and Public Policy Research and The University of Otago, is overwhelmingly positive in relation to the RDTI, noting that firms supported by the RDTI spent more on RDTI than they would have in the absence of RDTI support and that it is outperforming the Growth Grant scheme it replaced. The report states that given the rate of recent change in New Zealand’s approach to supporting business R&D, and the potentially positive impact of stability on business decision making, there appears to be a strong case for preserving a stable support mechanism (i.e. the RDTI regime) in the medium term.

However, there is unpredictability in the processing time for Supplementary Returns – which extends the time between businesses outlay on the R&D and when it received the incentive – and a lack of discretionary powers available to the Commissioner of Inland Revenue that is disproportionately penalising companies for minor missteps.  

Is New Zealand’s RDTI scheme globally competitive?

The Report briefly covers how the RDTI regime compares with similar overseas regimes, but notes that there are difficulties in comparison given different externalities and design features. Australia is the best and easiest comparison and the report found that Australia’s scheme may be more generous for SMEs and offer more flexibility for overseas and software R&D. However, the tightening of the requirements for Overseas Findings has had a significant impact on the ability to claim overseas costs in the Australian scheme.

The Report also notes that Inland Revenue takes a vigorous approach to reviewing eligible R&D expenditure, and the rates of revision following review appear to reflect a greater level of expenditure scrutiny when compared with some overseas schemes.

Deloitte’s experience has been that the additional certainty provided by the RDTI’s review process, which culminates with the issuance of a binding approval for the R&D activities, far outweighs the additional administrative burden of the review process. The report notes that these review processes are rare amongst R&D tax credit policies and are effective safeguards against error and fraud. This should hopefully protect New Zealand’s RDTI scheme from some of the issues with R&D incentive schemes that have been encountered overseas.

What else did we find interesting in the report?

The Report covered feedback from stakeholders on how well the RDTI is working for them. Some of the feedback noted:

• High compliance costs, particularly for firms spending under $300,000 on R&D.
• Administrative delays in processing Supplementary Returns.
• Restrictive software eligibility rules misaligned with the standard iterative development process.
• Policy instability which undermines confidence and planning.

Much of this aligns with the feedback Deloitte has heard on the RDTI, however we do note that many of these grumbles have fallen away as businesses gain a better understanding of the RDTI with time. In particular, R&D in the software development space is a very strong area of claim, with Officials and guidance supporting the inclusion of software R&D in the RDTI regime. We recommend reaching out if you have any queries on whether your software development work would qualify as an eligible R&D activity.

The Report doesn’t directly suggest immediate action is undertaken to make changes to the RDTI, but it does provide a number of suggested recommendations, including:

• Maintain policy stability to support long-term planning.
• Streamline compliance for smaller firms, possibly through simplified approval processes.
• Revisit software eligibility rules and clarify guidance.
• Introduce greater discretionary powers for the Commissioner of Inland Revenue to enable the correction of administrative errors.

It is notable that tiered credit rates (with a credit rate greater than 15% for the first $300k of R&D spend) and higher overseas expenditure caps were modelled and were found to deliver negative net impacts (based on various assumptions).

The report notes that the administrative challenges with running the scheme have swung from the initial overly restrictive application of the eligibility tests at the General Approval application stage to unpredictability in the processing times for Supplementary Returns. Underlying this are the challenges compliance officers encounter in determining the scope of the approved activities in the claim and therefore whether a particular expense relates to the approved activities. To help resolve this, the Inland Revenue and Callaghan Innovation (who have now moved into MBIE) teams are increasing their integration, with the Callaghan team beginning to receive Supplementary Returns to review for the first time.

Overall, it is clear from the Report that there are changes that could be made to the RDTI regime to enhance the benefits it provides both businesses and New Zealand alike.

What’s next?

The current Government hasn’t commented on the released Report, so it’s hard to say whether any changes will come out of it. However, we do understand that the RDTI is being considered, amongst other things, in relation to the Government’s Going for Growth initiative. Additionally, the increased scrutiny of the link between activities approved in General Approval applications and expenditure claimed reinforces the need to ensure the project’s costs are considered comprehensively at the General Approval stage.

If you have any questions on what changes might be coming to the RDTI, or if you have any questions on whether your business would qualify for the 15% tax credit, please get in touch with your usual Deloitte advisor.