How the new R&D scheme looks from outside New Zealand

New Zealand's latest tax incentive could attract more foreign investment, commentators say.

As the government’s new R&D tax incentive scheme moves on to the fast track in Wellington, experts are comparing it with similar programmes overseas – particularly Australia.

The basics are well-known by now: The scheme comes into effect in April next year and includes a tax credit rate of 15%, up from the 12.5% previously suggested; a minimum R&D expenditure threshold for eligibility halved to $50,000; a $120 million cap on eligible expenditure; and a short-term cash rebate for loss-making companies under fairly strict criteria.

Research, Innovation and Science Minister Megan Woods says the government received clear feedback on what changes were desired including lifting the 12.5% rate closer to the existing Callaghan Innovation growth grants that provide 20% of a firm’s R&D expenditure – although the minister says that 20% drops to just 14.5% on a net basis.

Theories of economics suggest the key driver for growth is innovation, which tends to lead to greater wealth. And while innovation is much wider than just R&D, it is a crucial part of the equation. But when companies have a bright idea the nature of competition is that they won’t capture all the possible benefits.

Someone might take the idea and set up a competing business while others might copy the idea now that they can see it is possible. This means others benefiting from an idea without paying, resulting in underinvestment in R&D overall. Inland Revenue policy manager Keith Taylor says this reality, in some rough sense, is what the incentive policy is designed to compensate.

Mr Taylor, who was involved in the original attempt at creating a tax incentive scheme in 2008, told the recent Chartered Accountants Tax Conference the new incentive should be seen as a kind of toolkit.

“It seems sensible that this scheme is seen as part of a balanced portfolio response across a complex issue. And to be a balanced response, it must be sustainable.

“In this sense, it is actually two policies: one where the government will give companies money for R&D, and another where the government will not give money for work that isn’t R&D. We’re trying to balance those two things."

He says one of the key insights of assessing the Australian version is that businesses either claim that everything is R&D or the “engineers will sit there with folded arms and say this is just the job and they don’t do R&D.”

Conversely, New Zealand businesses seem to have a good appreciation of what R&D is due to their exposure to the Callaghan Growth Grant.

“But just because something qualified for Callaghan doesn’t mean it will qualify for this incentive, which means there should be some education about exactly what this new scheme refers to as R&D if it is to be sustainable,” Mr Taylor says.

Providing certainty
EY partner Tim Benbow says ultimately taxpayers want certainty and to know where the boundaries are and what the risks might be in pushing against them.

Australia has possessed its own R&D incentive for about 35 years in one form or another. Although it went through a refresh seven years ago, the government sat on its hands for three or four years.

“As a result, businesses started to make claims on their own – even if it wasn’t R&D – which were often accepted and received funding. In the fifth year of the refreshed package, the government realised the scheme was costing a lot more. When they opened up the claims they discovered an absolute mess.

“Things that aren’t even close to R&D were being claimed and funded for years. For instance, some companies were saying their research depended on a production line, then businesses were claiming expenses from running the production line. And since the production line needs cleaning, then the cleaning lady was also being claimed,” Mr Benbow says.

“So, this idea in New Zealand of tweaking it over time is important if we want it to be sustainable over the long term.”

Mr Benbow likes the new scheme but points out the most consequential change is the relaxation of the ownership of intellectual property.

This means if a New Zealand subsidiary of a global company is doing R&D in the country, it will be able to claim for this spending. This is in line with what most global R&D schemes do as well. A couple of countries, such as Singapore and Japan, have programmes that don’t require R&D to happen in-country to qualify but instead require the IP to ultimately reside there.

“The relaxing of these rules is one of the greatest opportunities for New Zealand to increase its overall R&D spend because multinationals are competing globally for R&D. There is probably a 10-20% cost saving of moving an R&D team to New Zealand anyway because of the low cost of doing business anyway, which now has a 15c tax credit on top.

“So, suddenly the cost of doing R&D in New Zealand is 20-30% better than in Australia. Multinationals will be seriously considering moving to New Zealand. There will be very little movement in the first year but, if the programme is sustainable, then by the second year there we can expect an acceleration of R&D in New Zealand,” Mr Benbow says.

Two approaches
Mr Benbow says not only is the final New Zealand policy in excellent shape but also Wellington’s process of building is far superior to Canberra’s.

“New Zealand approaches these things differently from Australia. Let’s just say Australia has an idea behind closed doors, someone writes legislation which is eventually put into Parliament, no one in the private sector sees it, and then it gets debated on for three years but they never pass it. So, to see open discussions from the beginning in New Zealand has made a huge difference.”

He says the increase to 15% is a “smart move politically” and, crucially, isn’t worse than the 14.5% companies would have received if they were a Callaghan Growth Grant recipient.

“It’s difficult to compare this figure with Australia because there are a lot of different mechanisms that go into R&D tax. But in Australia, the R&D tax rates are 38.5c and 43.5c, which seems a whole lot more, but the way it mechanically works over there is that a business foregoes its normal tax deduction and instead gets a tax credit of the base plus an additional R&D uplift.

“And in the UK, companies can get an R&D tax credit of 14% but then they also have to pay tax on that. So, you can’t really compare like with like. But globally the decision of 15% for large companies is very competitive – in fact, it may be too competitive, but we’ll wait and see. However, it will be right in the ballpark for SMEs,” Dr Benbow says.

Chris Nave, principal executive of the Australia-based Medical Research Commercialisation Fund, says capital markets in New Zealand are generally thin and this scheme will encourage more startups.

“It lowers the bar for capital to arrive. Our VC fund is usually the first dollar in and the last dollar out of startups. So, having the government alongside you when that risk is greatest enables you to invest more, and also allows you to take on more opportunities.

“And it’s not only good for attracting offshore companies to New Zealand but it also gives local companies both large and small the confidence to spend on R&D. We know that countries which spend the most on R&D are the ones that perform the best. This will have a profound impact on the ecosystem."

But, while the government should be applauded, Dr Nave thinks it can do more.

“I compare it to our experience in Australia where we are also an active investor. For every dollar in R&D in Australia, companies get a 43.5% cash rebate. And if the company is non-tax paying and is still developing its product, app or a new drug, then the government actually becomes an investor alongside private investors.

“From New Zealand’s perspective, corporations right now only spend on average 1.3% of their income on R&D, which is incredibly low for an OECD country. I think the New Zealand government keen to encourage a greater spend but at the same time encourage true startups that are years away from revenue,” he says.

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