Access to cashed-out tax losses on the cards for small start-up firms
Thursday 22nd August 2013
The government has released a consultation document regarding changes to New Zealand’s R&D tax scheme in an effort to encourage innovation as part of the Business Growth Agenda. The proposed changes would give firms more timely access to tax losses owing to R&D activities, reducing the impact of capital and cashflow constraints on small innovative firms. The proposal also includes changes to how returns on intellectual property assets would be considered when recovering the cashed out tax losses.
While an R&D tax credit was available prior to 2009, the current tax system treats R&D expenditure in largely the same way as it treats other types of business expenditure, other than R&D tax losses being able to be allocated to future income years in certain circumstances.
Small firms investing heavily in R&D face a financial disadvantage due to high expenditure, unreliable cashflows, and lack of access to capital to fund development. Intangible assets are also often difficult to value at the early stages of development, further limiting the accessibility of debt financing and increasing the cost of investing in R&D relative to other assets.
Under the current proposal, New Zealand-resident unlisted companies (or groups of companies) spending at least 20 per cent of total wage and salary expenditure on R&D wages and salaries that are in a tax-loss position at the end of the financial year will be eligible. Interestingly, contracted R&D would also be eligible for the calculation of qualifying R&D wages and salaries.
The salary and wage cap is considered a good measure of the innovative activity of a firm, as a larger proportion of labour expenditure is directed toward the creation of intellectual property when firms are undertaking extensive R&D. As firms shift toward the commercial phase of development the proportion of expenditure on R&D staff declines relative to other types of wage and salary expenditure, meaning that only those firms actively and intensively engaged in R&D would be eligible. The OECD has also found that wage-based R&D incentive targeting is well suited to small firms.
The R&D expenditure would qualify for cashing-out until an intangible asset could be recognised under the relevant accounting standard. Among other criteria this requires the entity be able to demonstrate:
- the feasibility of completing the intangible asset for it to be ready for use or sale,
- the intention to do so,
- the ability to use or sell the asset, and
- the ability to reliably measure the expenditure attributable to the development of the intangible asset.
The proposed scheme also includes provisions for recovering the value of the cashed out loss when the intellectual property from the R&D has been sold, or shares in the company itself have been sold. Under current tax policy only income from royalty payments or the direct sale of patents is taxable, while capital gains realised from the sale of the company are not.
The amount of the loss able to be cashed out in a given tax year is proposed to be the lower of 1.5 times the company’s eligible R&D salary and wage expenditure, total qualifying R&D expenditure, or total tax losses. The maximum cap that can be cashed out will be $500,000, or $140,000 at the company tax rate of 28 per cent. This would be gradually increased to $2 million, or $560,000 at the company tax rate of 28 per cent. Losses above the cap would be able to be carried forward into future income years as per the current rules.
We will watch the development of this proposal with interest, as we believe that incentives to invest in R&D are good for business and good for New Zealand. An OECD report identified that R&D tax incentives had positive flow on effects including increased investment in R&D, increased innovative sales and numbers of new products, higher productivity growth, and increased societal welfare.
This article does not constitute legal or financial advice. We recommend that businesses consult with their patent attorneys and legal counsel before taking any action in respect of a new invention, to ensure they are fully aware of any associated risks, and to confirm that their strategy is commercially sound having regard to the structure of the business and its commercial goals. In particular if the proposed changes take place, assessment and valuation of intellectual property assets will become even more important for extracting value from those assets. Baldwins can help you assess, protect, enforce, and commercialise your intellectual property. For more information please contact David Alizade.
The full consultation document including discussion points and details about making submissions is available from http://taxpolicy.ird.govt.nz/sites/default/files/2013-ip-r-and-d-tax-losses.pdf
This article was written with assistance from Harriet Sandstad.