Submission. R&D Tax Losses Proposal

Transcription

1 Submission R&D Tax Losses Proposal 2 September 2013

2 30 August 2013 R&D tax losses proposal C/- Deputy Commissioner, Policy and Strategy Inland Revenue Department PO Box 2198 WELLINGTON 6140 Dear Struan R&D tax losses We appreciate the opportunity to submit on the officials Issues Paper, R&D tax losses. NZICA welcomes the release of this Issues Paper and agrees that this initiative sends the right signals to the business community and could increase the level of R&D undertaken in New Zealand. However, we are concerned that the proposals are too restrictive, which could result in them failing to assist their target market to the degree required to make a significant difference to innovation and growth. We appreciate that, for any proposal such as this, there needs to be a balance between making the incentives available and creating a free for all but we feel that the correct balance has not yet been achieved. In our view, the proposed restrictions will make the concession too complex and thereby could compromise the Government s policy intent. Detailed submissions Eligible entities A number of different entity types currently undertake R&D. While most R&D is likely to be undertaken by companies, this is not always the case. Sole traders are ineligible to access the proposed rules. Given that most sole traders undertaking R&D incorporate a company once they have reached a certain level of commitment to the project and received advice on the structure to use, and that companies generally provide an additional layer of governance that is beneficial, we understand the decision to limit eligibility to companies. We disagree that listed companies should be excluded from using this proposal. Many of the companies that are in the NZAX would benefit, as they suffer the same lack of capital as other small companies. They have merely chosen listing as another method of raising development capital. The Government is keen to encourage smaller, innovative companies to list on the stock exchange and grow their businesses and excluding such companies from eligibility seems inconsistent with that goal. In addition, we have some concerns about the decision to exclude look-through companies. An individual who has income from other sources may have chosen to use a look-through company on the basis that losses from the R&D can be offset against income from the other sources. We suggest that Officials consider the inclusion of a transitional DDI: aylton.jamieson@nzica.com

3 rule allowing LTCs that are undertaking R&D to convert to an ordinary company at no tax cost so that they can access the concession. This would relieve the owners of an LTC from having to establish a new company to carry out the R&D activities currently undertaken by the LTC. Level of R&D intensity required It is proposed that a number of filters be applied to determine whether a taxpayer is eligible to cash-out the expenditure spent on R&D. These filters include: A threshold of 20% of the wage and salaries incurred The R& D meets the definition of research and development in NZIAS 38 The expenditure must not be on certain activities that were excluded activities for the repealed R&D tax credit The expenditure must not be on two additional excluded activities The activity must not be one for which a government grant has been paid The expenditure must not be of certain types including interest and lease expenditure. 20% of Wages and Salaries paid The Issues Paper proposes a threshold of 20% of the wage and salaries paid, as the measure of the level of R&D intensity. As part of that, it proposes to exclude wages and salaries paid to shareholders. Small cash-strapped start-up businesses that are undertaking R&D will be attracted to the regime if these proposals will allow them to cashup their losses and continue to undertake the R&D. Many of these businesses will be small operations where the owner undertakes some of the R&D themselves. If the proposal is intended to assist cash-strapped small start-up companies as the Issues Paper suggests, we submit that either shareholder salaries should be included or a different method of assessing R&D intensity should be used - for example 5% of turnover. We also question the Issues Paper s reliance on the Research and Development Survey 2010 as justification for the 20% level and an indicator of the activities of these R&D startup companies. The businesses included in the Statistics New Zealand survey population are a different population to the group that would be seeking to access the proposed concession i.e. to qualify they either had to be economically significant, have applied for patents in the last two years, received FRST grants, recorded R&D activity in prior year surveys, be a university or have sales greater than $1,000,000. Excluded activities from the repealed R&D tax credit We agree with the limitation to expenditure that complies with NZIAS 38 and also the required intensity of 20% of the wage and salary spent (subject to the inclusion of shareholder salaries discussed above). However, we question some of the limitations in the excluded list at least to the extent that they are not subject to the limitations set out in TIB Vol. 20 No. 3. For example, Research in social sciences, art or humanities was excluded in Part C of Schedule 21. Upon reading the TIB it is clear that, where that research was used as part of the development of new or improved products or processes, it would qualify for a deduction under the former R&D provisions. The TIB gave the following examples: For example, if a business develops computer software for use in the film industry in a process that satisfies the criteria in the definition, the software development is not excluded under this paragraph. Similarly, if a business develops and manufactures innovative ceramic glazes, the development is not excluded under this paragraph because glazes are used in the visual arts.

4 Given that most of the language that supported this interpretation has been repealed, it would be useful if the drafting of the new concession ensures that the same interpretation will apply. We also recommend that Inland Revenue publish guidelines for the new concession to explain the rules in the same way as it published a comprehensive R&D manual for the R&D tax credit regime. Two further activities added to the excluded list A further filter is proposed for: Clinical trials; and The late stages of software development (for example, coding). We consider that, in many cases, clinical trials are not an outcome of research and development, but an element of the R&D in its own right. As noted in IAS 38, in the research phase of the process, an entity cannot demonstrate that has an intangible asset exists that will generate probable future economic benefits. In the case of clinical trials, when something is being trialled, there is no guarantee that the owner will be able to demonstrate that that they definitely have something that will generate future economic benefits. In our view the trials could be used for at least three purposes: 1. To resolve a technical question. 2. To determine whether a product is of a sufficient quality. 3. To determine whether there is market acceptance of a product. We consider the first two of these should be included within the meaning of research as they determine whether there is a product that will generate probable future economic benefits. In relation to the third type of trial, we consider that, by that stage, there is a product, it is more a question of its potential profitability and therefore it should be part of the excluded list. In the case of software, the Issues Paper assumes that software developers will follow a waterfall model of software development, through phases of conception, initiation, analysis, design, construction, testing, product implementation and maintenance. The more modern processes of software development result in software coding occurring at the same time as the R&D. We believe that the distinction being drawn here is outdated. We note that many of New Zealand s cash-strapped technology companies are software companies especially the software as a service hub that has been developing following XERO s success. We consider that including limitations in this area would be an impediment to one of the key areas where New Zealand has considerable potential to succeed. Expenditure funded by Government Grants The Issues Paper proposes to exclude expenditure that is funded by government grants. We consider that this is unnecessary as a government grant is treated under the Income Tax Act 2007 as excluded income and any deduction that is claimed is reduced to the extent of the grant received (refer sections DF 1 and CX 47). To the extent that the amount falls outside those provisions, the amount received would be income of the taxpayer. Accordingly, the amount of expenditure that a taxpayer could claim for R&D expenditure would have been reduced by an amount equal to the government grant. It would not be a case that the taxpayer would be able to claim the same amount of expenditure twice once in respect of a grant by Government and secondly as part of an R&D loss.

5 Additional excluded expenditure Four additional classes of excluded expenditure are set out in paragraph In our view, two of these categories of expenditure should not be excluded. These are: Interest expenditure in relation to R&D; and Lease payments. We have two concerns about these types of expenditure being excluded: 1) The concession is intended to benefit cash strapped start-up businesses. Many start-up businesses cannot afford to buy equipment outright or their own premises. Therefore it is illogical to limit the incentives to those businesses that can afford to buy equipment outright or own their own premises. Effectively this requirement would reduce the value of the concession to much of the group that the Government is intending to target. 2) There is already a selection method which limits the losses which can be cashed out to the lesser of: a. 1.5 times the R&D salary and wages. b. The total qualifying R&D expenditure; and c. The total tax losses for the year. We consider that the total tax losses for the year and 1.5 times the R&D salary and wages are a sufficient check on the level of losses that can be cashed out and that therefore the proposed exclusion of interest and lease expenditure should be omitted. Requirements to determine the contractor/purchaser of the services The proposal includes rules to ensure that losses from the same R&D project are not claimed twice. We have two fundamental concerns with what is proposed. The first is that, in some instances, it will depend on what the client has asked the supplier to provide. If the client has asked the supplier to provide a widget, and the manufacture of that widget requires some R&D, the supplier should be able to claim the R&D expenditure rather than the client. The converse is more common - where a client requests a supplier to undertake some R&D on a specified product obviously in that situation the client will be the owner of the R&D and should be able to claim the R&D expenditure. The rules should accommodate both scenarios. The second issue is the level of information which the Issues Paper proposes that a contractor will be required to supply (for example, the hours worked by staff on the project). In our view, a contractor would not be prepared to supply this level of information as they would effectively be disclosing their profit margin on the work that is undertaken. The suggestion that this level of information should be provided is commercially naive. If it became mandatory for research providers to disclose this information, we expect that many would not be prepared to undertake the work. Administrative Process We are concerned about how the R&D statement of R&D activity will be treated under the Tax Administration Act 1994 ( the TAA ). Some of the criteria are subjective and it is unclear whether a taxpayer will be subject to (say) a shortfall penalty under the TAA if Inland Revenue takes a different view of a particular item of expenditure. For example, if Inland Revenue took a different position on whether expenditure was excluded expenditure (as set out in paragraph 5.27, say activities involved in complying with statutory requirements or standards ), as opposed to qualifying as R&D, would the taxpayer be subject to shortfall penalties?

6 Our concern is not with being required to provide information such as details of company grouping, ownership and shareholding where the answers are reasonably clear cut. However, some of the requirements in relation to the R&D statements are very subjective and the standards imposed will need to be clarified particularly where many of these factors can change in their application from taxpayer to taxpayer. A further point that needs to be taken into account when this issue is being considered is how the excluded expenditure will be treated in subsequent income years. This will generally be a timing issue only that is, expenditure that is excluded expenditure in the 2016 income year (such that it does not qualify for loss conversion in the 2016 income year), could be converted to a loss which could be carried forward and offset against income earned in the 2017 income year. Integrity measures In our view, the proposed new integrity measures need to be considered as a package. Smaller companies that seek to take advantage of the proposed concession will need to meet different requirements to those imposed on larger entities that are able to fund their own R&D. A company that undertakes R&D and is a member of a group of companies is able to offset its R&D expenditure against other members of the group that are in a taxpaying position (subject to meeting the loss grouping rules). A group is able to sell a subsidiary that owns the IP and, in the absence of a capital gains tax, often no assessable income is derived. The proposed integrity measures mean that a company that has accessed the concession and subsequently sells the IP is not in the same position as a company that is a member of a group that uses the loss offset rules. A company that accesses the proposed concession is able to cash out its tax losses up to the thresholds proposed and subject to meeting all the requirements. As the Issues Paper acknowledges, in the event that the research does not provide a future income stream, the cashing out of the expenses effectively becomes a grant. In the case of a group of companies that undertakes R&D and uses the loss offset rules, the expenditure is offset against income generated by another company in the group, which effectively means that tax is not paid on that income from a group perspective. In the case of the small company that accesses the proposed concession, the Government is paying out an amount of tax that has been collected from another taxpayer, so the Government is left in a deficit position rather than a neutral position. We do not disagree that these two treatments should be different, but there are two ways in which the integrity measures need to be balanced. The Issues Paper does not discuss whether taxpayers that access the proposed concession will be able to use sections EJ 22 and EJ 23. These sections permit a taxpayer to allocate a deduction under section DB 34 to later income years, provided the relevant taxable income would not have been derived but for the R&D expenditure. We consider that this option should also be available to taxpayers under this proposal as it provides a valuable incentive to introduce new investors. The loss recovery rule is triggered when there is a purchase of shares greater than 5% of the shareholding. As the Issues Paper notes: The nature of R&D-intensive start-up companies is to seek additional capital throughout their life cycle, which means it can be unclear at what point the controlling shareholding actually changed. We consider that the controlling shareholding should be the trigger point for the loss recovery rule and that an appropriate level is the level set for control in all other companies (i.e. 49%). As a measure of safety, where a shareholder sells more than 49% of their interest, that is what should trigger the loss recovery for that particular shareholder, so that even where there are multiple shareholders selling

7 their interests, the controlling shareholding will not change without the loss recovery threshold being triggered. For example, if three shareholders each own 33% of a company, and a purchaser acquires 100% of the ownership of one shareholder, the new owner will only own 33% of the shares in the company so the controlling shareholding is not changed. However, if that new shareholder bought a further 10% of the company s shares from each of the other shareholders, the new shareholder would then own 53% of the company s shares, and have a controlling interest in the company. By having the loss recovery rule triggered (for the particular shareholder) by the sale of 49% or more of their share interest, this would ensure that the overall controlling shareholding for the company cannot be changed, without the loss recovery rule being triggered for at least some the shareholders. In the example, the loss recovery rule would be triggered for the shareholder who sold 100% of their shares, but not for the other two shareholders who only each sold a 10% shareholding to the new owner. We are keen to discuss our submission with you. Yours sincerely Aylton Jamieson Tax Counsel P: E: aylton.jamieson@nzica.co

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