For a country that prides itself on its innovative mindset and a long legacy of government-supported science, New Zealand has had to face some hard facts about its commitment to home-grown R&D over the last 15 years. While the island nation has experimented with multiple forms of support—direct subsidies, loans, tax credits, loss cash-outs, even a lottery—the government’s default for catalyzing R&D has historically been grants: a time-limited option with a complex application process that’s tended to leave many innovative companies out in the cold.
In 2008, New Zealand put its toe in the tax-incentive waters—offering a potential 15% R&D tax credit—then withdrew it after a year, opting to continue incenting innovation primarily through its Growth Grants program. Between 2009 and 2013, the government shelled out between NZ$33 million and NZ$90 million per year in direct subsidies. And while a 2015 study found that receiving an R&D grant almost doubles the probability that a firm introduces a major innovation, grants also put the burden on government to pick winners and losers, at the expense of boot-strappers who’d more likely put their energies into creating something new than in filling out application forms—in other words, the very companies most likely to drive overall economic growth and productivity.
With this in mind, New Zealand decided to tweak the algorithm again in 2015, introducing an R&D loss tax offset aimed at supporting cash-strapped innovators by alleviating their R&D spend. One hundred percent of this funding went to SMEs, whose numbers nearly doubled (180 to 330) in its first two years of operation.
The composite results were, at best, a mixed bag. At worst, the business and government sectors looked to be rowing in opposite directions. Despite a robust 40% increase in R&D spending by the high-tech sector from 2014 to 2016—the sign of a startup ecosystem beginning to flourish—the government’s share of spending as a percentage of GDP had fallen to 0.26%, according to the opposition Labour Party, after four years of steady decline.
In 2018, with Labour in power, and total R&D spend as a share of GDP a paltry 1.23%—barely half the share of neighboring Australia, well below the OECD average of 2.38%, and nowhere near the league of competitive innovators such as Israel and Korea—the government had its R&D Road to Damascus moment. It announced it would go big on tax incentives as a way of bolstering Kiwi R&D: setting a target of total-share-of-GDP R&D spend at 2% by 2028—and kicking it off with an investment of NZ$1 billion of new funding over four years.
With the sweetening of a double-barreled R&D tax-support program—a 15% tax credit on eligible expenditures of between NZ$50,000 and NZ$120 million, plus the 2015 loss tax offset—on top of the announcement of the sunsetting of the Growth Grants program, New Zealand’s innovation culture finally looked to have found its legs. And when the pandemic hit, it turned out to be New Zealand’s moment to shine, with nominal infection rates that were the envy of the world. Riding that positive wave, the government announced in mid-June 2020 that it would pump an additional NZ$400 million in grants: a shot in the arm to help entrepreneurs continue with their R&D despite the disruption. More than four in 10 businesses said they planned to increase their spending over the next year—and in fact, despite the economic shock of COVID-19, they made good on that expectation.
The country’s stellar performance during the pandemic itself—and the unprecedented fiscal and monetary stimulus that followed—provided plenty of fuel for the rapid recovery that ensued. Now New Zealand has a golden opportunity to ride that wave and address some of the structural shortcomings that long predated the pandemic—notably its underperforming (and interrelated) rates of R&D investment and productivity.
So where does New Zealand stand as an innovation nation now, at this global pivot point for economic recovery? A look under the hood shows that the trend lines are finally pointing in the right direction. Whether there will be enough fuel in the fire to help it reach its full potential will likely be an ongoing debate. One thing is for sure: it’ll be incumbent upon interested companies to stay on top of the R&D complexity in the simplest, most cost-effective way they can.
Qualifying, Incentives, and Compliance
New Zealand’s R&D tax credit system is straightforward: it’s granted to eligible entities conducting eligible activities and incurring eligible expenses.
Eligible entities for the tax credit are private-sector companies that carry on business through a fixed establishment in New Zealand and perform a core R&D activity in New Zealand, either directly or through a local contractor. A foreign entity with a PE in New Zealand can qualify as long as the overseas associate is in a country that has a tax treaty with New Zealand (the U.S., Canada, and 38 other nations fall into that category at present). Intellectual property born of the R&D activities must be owned by the company or entity (solely or jointly) that conducted it.
Like Australia, its neighbor across the Tasman Sea, New Zealand categorizes eligible R&D activities as either “core” or “supporting” activities. Core activities satisfy three conditions: they’re conducted using a systematic approach; they have a material purpose of creating new knowledge, or new or improved processes, services, or goods; and they have a material purpose of resolving scientific or technological uncertainty. These activities must also take place in New Zealand (although under certain conditions, up to 10% of the total qualifying R&D spend can be performed overseas). Supporting activities include other activities that are solely or mainly in support of and integral to a core R&D activity.
Specifically excluded from this definition are activities where the “uncertainty-resolving” knowledge is already publicly available or could be separately deducible by a competent professional in the relevant scientific or technological field.
These definitions roughly align with the four-part criteria—qualified purpose; elimination of uncertainty; process of experimentation; and technological nature—applicable in the United States, although the U.S.’ defined qualifications have arguably been on a course of greater leniency.
Eligible expenses are defined as costs incurred on eligible activities directly involved in conducting the R&D—salaries, input materials and services, payments to contractors, depreciation incurred on assets. Software developed strictly for internal administrative use doesn’t qualify for the R&D tax credit—but if it was developed to enhance non-digital services to customers, it does, up to a yearly cap of NZ$25 million.
While the R&D tax incentive and R&D loss tax offset regimes were the brainchild of the Ministry of Research, Science and Innovation, they are administered by Inland Revenue, which has significant record-keeping requirements—far beyond what is ordinarily required for corporate income tax purposes. Contemporaneous record-keeping is key. Those records must show that the business is eligible to claim the R&D credit, that the R&D activity qualifies, and that the R&D expenditure is eligible.
Qualifying taxpayers can get a 15% tax credit on eligible R&D expenditures of between NZ$50,000 and NZ$120 million—although large enterprises can apply to Inland Revenue to exceed that cap. Refunds for payments to approved research providers are uncapped. Approved research providers are consultants approved by the Ministry of Research, Science and Innovation and taxpayers using them are not subject to the NZ$50,000 minimum threshold.
The refund cap for R&D credits typically aligns with the total amount of payroll taxes paid to the government during the year. Any remaining credits can be carried forward indefinitely. R&D expenditure can either be capitalized to intangible assets or expensed. There’s also a limited concession available for costs capitalized to tangible depreciable assets.
R&D Loss Cash-out: The Fine Print
Here’s where things get interesting. In addition to, and independent of, the R&D tax credit, New Zealand allows companies meeting certain criteria to cash out their R&D-related losses and receive a refundable tax credit. While the R&D loss cash-out and refundable R&D tax credit can be claimed at the same time and on the same expenditure, the two regimes—helpful for accountants, but perhaps less so for laypersons—have differing criteria for what they define as qualifying R&D expenditure.
If the company is engaged in “intensive R&D”—meaning, 20% or more of its labor costs are spent on R&D—it’s entitled to cash out 28% (that’s the statutory corporate income tax rate) of the lesser of the following amounts for the tax year:
- its net loss (loss carryforwards are not eligible)
- its total R&D spend
- its total labor expenditure x 1.5
Those cash-out losses are repayable when the company becomes profitable, in the event of specified shareholding or IP ownership changes, or if the company is liquidated. The max loss cash-out allowable, as of the 2021 tax year, is NZ$560,000.
So how does this all compare, stateside? Although less generous, the Kiwi program is similar to that of the U.S.—with its federal 20% gross R&D credit (14%, if using the simplified ASC method). Unlike in the United States, however, there are no regional or other local R&D incentives in New Zealand.
Also worth noting: While the New Zealand government long used Callaghan Innovation Growth Grants as a key vehicle for funding R&D in select companies, as part of its pivot to an R&D tax-credit policy, the government disallowed them for organizations applying for the tax credits—and let them expire completely in early 2021.
The government still does provide some support through Callaghan Innovation—namely, student or project grants focused on businesses undertaking R&D for the first time. These project grants normally fund 40% of eligible R&D expenditures—including labor costs, materials and consumables, depreciation, and new lease costs. Beyond NZ$800,000, they are funded at 20%.
At this pivot point for both the global and New Zealand economy, there are undoubtedly many changes brewing. A tax bill before Parliament proposes allowing expenditures on employee costs contributing to the cost of tangible property to be eligible for the regime. Other proposed changes include bringing forward the due date for applying for criteria and methodologies approval, amendments to the schedule of excluded expenditure, and amendments to the definition of eligible R&D expenditure to meet the policy intent.
How to Get in the Game
In 2021, the New Zealand government altered its application criteria by introducing the concept of pre-approval. Businesses that are likely to spend less than NZ$2 million on R&D activities must first apply for advance approval of their R&D activities before completing a year-end form with their income tax return. That initial application must be filed less than five weeks after the end of the tax year—although companies are encouraged to file earlier in the year to help smooth the process. As in the United States, no industries are favored in New Zealand, and none are excluded from R&D tax incentive programs.
Businesses that expect to spend more than NZ$2 million on R&D activities can opt out of that in-year approval process and into the Significant Performer application process, which requires a certificate of compliance from an independent R&D certifier.
To apply for the loss tax cash-out, companies must file by the due date of their income tax return.
Small Business, Big Impact
While New Zealand’s programs are targeted at all business sectors and sizes, SMEs have historically been the ones who’ve most availed themselves of the benefits—especially the R&D cash-out benefits. (In fact, SMEs accounted for 100% of those tax benefits in 2018.) This underscores the importance of refundable incentives to small and medium-sized corporates, and the government’s awareness of the outsize role cutting-edge startups can play—big on ideas, low on cash—especially during a time of economic recovery.
By contrast, since the passage of the 2015 PATH Act, the U.S. has offered a payroll offset to startups with under $5 million in current-year gross receipts that have had gross receipts for no more than five years—stirring up new revenue streams in a given jurisdiction and pumping new money into the economy through consumption. If the credit is more than the tax owed, the remainder carries forward.
The Takeaway: Fresh Thinking for a Fresh Start
New Zealand has historically underperformed most of its counterparts when it comes to both public- and private-sector R&D investment. But while it has struggled to bring to fruition to many ideals as an innovative culture, the government seems to have turned the corner when it comes to catalyzing R&D.
There’s plenty of ground to cover, still, and there will likely be plenty of policy arguments when it comes to fine-tuning the generosity and specifics. But for an island nation in today’s (and tomorrow’s) knowledge economy—where geography is far less important than brain power—there’s also plenty of opportunity for fresh thinking and a fresh start.
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SENIOR MANAGER, R&D TAX CREDITS
Lydia Clowney is a CPA specializing in R&D tax credits. She works as a subject matter expert on CrossBorder Solutions’ R&D tax credit software solution helping enable the future of simpler tax compliance through technology. Before joining CrossBorder Solutions, Clowney worked as an R&D tax credit consultant at BDO USA, LLP.