pwc.co.nz Tax Tips May 2018 In this issue: Proposed R&D Tax Incentive changes outlined New Zealand Budget Australian Federal Budget 2018-19 submission to the Tax Working Group on the future of the tax system
Proposed R&D Tax Incentive changes outlined On 19 April 2018, Research, Science and Innovation Minister Megan Woods and Revenue Minister Stuart Nash released the Research and Development Tax Incentive Discussion Document - Fuelling Innovation to Transform Our Economy - for public consultation. The Labour-led Government sets out in this Discussion Document and in media statements its commitment to New Zealand business growth and playing an active role in increasing investment in research, science and innovation with a target of increasing business research and development (R&D) expenditure in New Zealand from 0.64% to 2% of GDP by 2027. As previously indicated by Labour during the 2017 election, the proposed tax incentive comes in the form of a 12.5% tax credit on eligible expenditure for all businesses, regardless of legal structure, carrying out R&D activity in New Zealand from 1 April 2019. However, it is important to note that initially the tax credit is non-refundable, but this position may change. The wider goals of the R&D tax credit include offering greater certainty to businesses, increasing employment from greater innovative business activity, industry diversity, international engagement, profitability and overall sustainability for New Zealand. The tax credit incentive is a welcome addition to the New Zealand R&D landscape, especially if it is to be part of a wider incentive package for R&D focussed start-ups and innovative firms, as indicated by the Government. Growth Grants phased out and the future of R&D tax loss credit uncertain One headline from the Discussion Document that will be of potential concern to R&D businesses is that the Growth Grant scheme, administered by Callaghan Innovation, is to be phased out over the next two years. This is on the basis that the new R&D tax credit and the Growth Grants are funding similar types of activity and have a similar purpose. It is difficult to perform a direct comparison between the two R&D incentives, as one is a tax credit and one is a cash allowance, but as the Discussion Document acknowledges, there will be winners and losers because of the transition from cash grants to a tax credit incentive. The winners of the transition are likely to be businesses incurring R&D that currently do not qualify for Growth Grants and are in an income tax paying position. The Government sets out the transition process from Grants to tax credits in its report Managing the transition from Growth Grant to the R&D tax incentive that was released alongside the Discussion Document. New Growth Grant applications and extensions to existing Grant contracts will close on 31 March 2019 and all remaining Growth Grants will cease on 31 March 2020, even if the Grants were originally to be in place past that date. Once a business comes off the Growth Grant scheme either from 1 April 2019 by choice or 1 April 2020 at the end of the scheme it will then transition to the R&D tax credit. The loss of the Growth Grant will be a major blow to businesses in loss generating R&D phases past the 2020 tax year. For those businesses, they may have their future Government funding stream completely cut off, potentially causing operational uncertainty, increased financing risks as well as increased difficulty in obtaining outside investors (due to increased finance risk). The Government is currently considering an option for businesses in a tax loss position with a Growth Grant on 21 April 2019 to transition onto a temporary grant that mirrors the R&D tax incentive. This may be a temporary consolation for Grant recipients in a loss position, but does not create future comfort or certainty. The future of the current R&D tax loss credit which allows a portion of tax losses from eligible expenditure to be cashed out (instead of carried forward) also looks uncertain. The Discussion Document indicates a commitment only to retain it until the end of the 2019/20 tax year. 2
Cash is king In our view, the cash flow benefits of both the R&D tax loss cash out regime and Growth Grants are critical for early-stage R&D intensive business. This benefit is further enhanced when other sources of funding are assessed. New equity funding can be challenging to obtain, and dilutes existing shareholders. Bank funding is difficult for loss-making business without sufficient collateral to obtain bank debt. Typically, it takes many years for early stage R&D intensive businesses to reach an income tax paying position, so the value of R&D tax credits in these circumstances will be greatly reduced. We appreciate that the Government recognises further work is required to ensure businesses that are in a tax loss position, who would be unable to access the benefits from the proposed nonrefundable tax credit, are supported. We strongly agree with this and emphasise the critical need for a cash flow support mechanism to be introduced alongside the tax credit so that emerging R&D businesses are not detrimentally impacted by the lack of cash injection that the current regimes provide. Definitions a work in progress? The definition of R&D put forward in the Discussion Document will be a serious point for submission from stakeholders and consideration for the Government. The proposal is to move away from the definition currently used for Growth Grant and R&D tax loss cash-out application purposes (which is based on the definition of R&D for financial reporting purposes) and to apply a new definition. The proposed definition requires the use of scientific methods for the purposes of resolving scientific and technological uncertainty, and it is questionable whether the proposed definition achieves the intention of the Government to deliver a clear, robust and practical definition of R&D for New Zealand purposes. In our view, the provision of clear guidance with examples applicable to key industries will be critical to the successful application of the definition in practice. We also question the additional compliance costs that may be faced by businesses as a result of having to manage and apply different R&D definitions for different purposes. These additional compliance costs will be particularly painful for cash strapped loss making businesses. For many loss-making companies investing in R&D activities, the combination of no immediate cashflow benefit from the R&D tax credit, and an additional layer of compliance costs maybe a deterrent from accessing the R&D tax credit. Finally, we appreciate the Government s recognition that the proposed definition of R&D may not be suitable for software R&D. We consider there is considerable merit in having a separate definition of R&D to apply for software to ensure that software activities are not unduly excluded from the R&D tax credit as a result of having a definition that is generally not applicable for that type of activity. Potential loss of tax credits upon loss of shareholder continuity The Discussion Document poses the question of whether shareholder continuity rules should apply to the R&D tax credits in the same manner as other credits (which requires a certain percentage of shareholder continuity for credits to be carried forward to future years). The loss of carried forward R&D tax credits where significant ownership changes take place may be a sizeable blow to many early-stage R&D businesses. For these businesses, the early years are often loss-making and can involve many rounds of equity investment to fund development work. This funding structure will frequently result in many changes to shareholder continuity during the development phase meaning tax credits would potentially be lost to the business before their value can be realised. In such scenarios, the proposed R&D tax credit would not provide any additional incentive to engage in R&D activity. In our view, due to the lack of cash flow benefit to the early stage R&D intensive businesses with the likely removal of the R&D tax loss cash out and cessation of Growth Grants, the Government should consider allowing tax credits to be refundable or retained, irrespective of any shareholder continuity breaches due to increased investment or complete change in ownership. We note that there is the ability for companies to defer the deduction of R&D expenses. One policy reason for this concession is to reduce the impact of shareholder continuity if instead R&D expenses were deducted, resulting in tax losses to carry forward which are then subject to the shareholder continuity requirement. Early stage start-ups require considerable cash flow support and capital investment the R&D tax credit should encourage investment in smaller innovative businesses and the ability to carry forward the tax credit could aid this. The Government has requested submissions on this point and we expect there will be a strong response to this from businesses and other stakeholders. 3
Dual purpose test The Government has taken the position that the R&D incentive may be better targeted if it applies to an activity conducted only for R&D purposes, as opposed to activity carried out for both R&D and wider business purposes. The Discussion Document therefore suggests that expenditure for business as usual R&D activities will not qualify as an R&D activity. We are concerned that a potential result of this will be that in-house R&D activity, for example in-house software development or in-house product creation by larger players, could be excluded from the scope of the incentive despite its genuine R&D nature and value to the New Zealand economy. It would be useful if the policy intent as well as the application of the dual purpose test is clarified. Winners and losers? Emerging start-ups Unfortunately, emerging, R&D intensive small businesses are probably not the winners of the proposals. Currently these businesses face funding challenges and can access cash flow through Growth Grants and R&D tax loss credits. The uncertainty over cash flow support, the introduction of a new R&D definition, the uncertainty around if (or when) a benefit from R&D tax credits will be realised, along with increasing compliance requirements does not appear to provide a strong incentive for these businesses to undertake increased R&D. In our view, more needs to be done by the Government to maintain support for emerging innovative businesses if they are to achieve their ambitious R&D goals. Mid-market businesses Medium sized businesses, which are in a profitable position, will be more likely to benefit from the tax credit, especially if they have already taken advantage of the maximum Growth Grant funding. Growth Grant funding is limited to a maximum term of 5 years whereas there are no indications of a maximum claim period contained in the Government proposals. Similarly, the maximum funding under the current Growth Grant regime is limited to $5m per annum compared with a potential $15m per annum under the new R&D tax credit. Large developed businesses The tax credit has potential to be a significant benefit to New Zealand s major corporations conducting R&D work and will undoubtedly provide additional incentives for them to conduct this work. Although there is a cap of $15m tax credit each year, there are suggestions that there may be a mechanism through which the cap can be extended through Ministerial discretion or pre-registration for large claims. Due to the value of the R&D work undertaken by New Zealand s major corporations to the economy, we agree that there should be an ability to exceed the cap in some scenarios. While we appreciate the Government s concern around the tax credit applying to R&D activities that would have occurred anyway, we would caution that any proposal that looks to exclude such activities would need to be clearly defined and sufficiently targeted. In our view, the current description of the dual purpose exclusion is potentially too broad and could exclude legitimate R&D activities. Large developed businesses are more likely to be impacted by such an exclusion if R&D activity is undertaken on an established business activity. Submissions Submissions on the proposed tax incentive are due on 1 June 2018 with draft legislation is expected to be introduced into Parliament in September 2018 and enactment in early 2019. Please contact your usual adviser if you would like to discuss the potential impact of the proposals to your business. Anand Reddy Jennifer Pegg Amy Burrows 4
New Zealand Budget The New Zealand Government delivered the 2018-19 Budget on 17 May 2018. Health, education and conservation saw significant increases in operational spend over the next four years as outlined in the Budget, with few tax-related measures included. The tax-related measures included in the Budget were in relation to Inland Revenue funding, changes to the bloodstock tax rules and GST on low value goods. Budget allocations to Inland Revenue The Budget allocates additional funding to Inland Revenue to assist with increasing the integrity of the tax system and administering the recently proposed research and development tax credit. In summary, over the next four years the Government is allocating the following funding: $23.5 million to improve the ability of Inland Revenue to ensure filing of outstanding company tax returns $3 million for the identification of legislative opportunities to improve tax compliance in certain industries by way of third party reporting and withholding taxes $4.3 million to implement and administer the proposed research and development tax credit. Bloodstock tax rules The Government is proposing to introduce new deductibility provisions concerning the costs of stand-out yearlings in the bloodstock industry. The changes will be introduced into Parliament later this year. GST on Low Value Goods A proposal to implement GST on low value imported goods was announced by the Government before the release of the Budget. The measure seeks to establish a level playing field in the GST treatment of goods purchased locally and online. The Government estimates that the proposals if enacted will provide $218 million of revenue over the next four years with an expectation that the amount will increase each year as online shopping continues to grow. Tax Policy Work Programme As part of the Budget, the Government released its revenue strategy and updated tax policy work programme. The revenue strategy outlines the Government s objectives for the tax system within the Government s economic and fiscal strategies. The strategy reaffirms the longstanding broad-base low-rate approach New Zealand has taken in respect of its tax system. The tax policy work programme has been updated to reflect areas that were flagged by the Government as part of the 2017 general election, including the research and development tax credit, and the ring-fencing of rental losses. Other general updates include the intention to release a discussion document regarding various GST policy issues in the middle of 2018, and consideration of the ability for a business to carry forward losses when ownership of the business changes. The deductibility of feasibility and black hole expenditure also features on the programme. The full policy work programme can be found here. 5
Australian Federal Budget 2018-19 Earlier this month, the Australian Treasurer delivered the 2018-19 Australian Federal Budget. The Budget included an unexpectedly high number of tax measures, including personal tax cuts, reforms to their research and development incentive, extending GST to offshore sellers of hotel accommodation in Australia, and a number of other integrity measures, including thin capitalisation changes. The key tax changes included in the Budget are summarised below. Corporate tax The Australian Government remains committed to its ten-year corporate tax rate reduction proposal announced in the 2016-17 Budget. A 25 per cent rate has already been enacted for companies with aggregated turnovers of AUD$50 million or less, with a 30 per cent rate remaining for other companies. This is of interest from a New Zealand perspective, as the current Tax Working Group is considering whether a progressive tax rate for companies could improve the New Zealand tax system and business environment. The Government specifically requested that the Tax Working Group consider a lower tax rate for small companies, in line with the Australian approach. Global tax Thin capitalisation The Budget introduces a number of measures designed to increase integrity measures and further restrict deductions for interest under the thin capitalisation rules. New Zealand is also focusing on multinationals and BEPS measures, with proposed changes included in the BEPS bill currently before Parliament. Digital economy The Australian Government has already enacted changes to apply GST on imported digital goods and services. Furthering this commitment to tax the digital economy, the Budget indicates the release of a discussion paper on taxation of digital business in Australia. This follows a global trend to commence consideration of the taxation of the digital economy in advance of the original OECD proposed timeframe. Research and development (R&D) measures The Budget announced measures affecting the application of the R&D tax incentive. These include: Capping the refundable R&D tax offset at AUD$4 million annually for claimants with aggregated annual turnover of less than AUD$20 million. Introducing a new R&D Premium for companies with aggregated annual turnover of AUD$20 million or more. This will have a tiered rate of benefit that links the rate of non-refundable R&D tax offset to R&D intensity. Increasing the maximum R&D expenditure eligible for concessional R&D tax offsets from $100m to $150m. The New Zealand Government is also considering R&D tax credits and allocated funding for implementation of an R&D credit in the 2018-19 Budget. The current proposal in consultation is for a 12.5% tax credit for businesses who spend at least NZD$100,000 on eligible expenditure within an income year. Australia s full analysis of the Federal Budget is available on our website. 6
submission to the Tax Working Group on the future of the tax system The Government established the Tax Working Group (TWG) late last year, with a broad mandate to consider options to improve the structure, fairness and balance of the tax system. As part of the TWG s engagement with wider New Zealand, the group released the Future of Tax: Submissions Background Paper in March 2018, covering a wide spectrum of issues from the imbalance of taxation on gains from speculation in property to the impact of the global and digital economy. We support the TWG s review of New Zealand s current tax system and recognise the importance of regularly reviewing and challenging the appropriateness of the current tax settings to ensure the right outcomes for New Zealand are achieved. This is particularly important in the current environment, given the high rate of social, technological, and environmental change to ensure the tax system still aligns with New Zealand s objectives and operates efficiently. While we recognise that the tax system may be used to address other objectives, such as specific social and societal priorities, we emphasis the importance of the primary purpose of the tax system to fund public services that are vital to all New Zealanders e.g. healthcare, infrastructure, and education. We caution that any change should be considered in a coherent manner such that the tax system continues to deliver the required revenue. In our view, a stable tax system is one that is fair. It is promising to see that the fairness of New Zealand s tax system is a key area of focus for the TWG, particularly in the context of changing demographics (aging population and fiscal pressures) and concerns about inequality. We outline below our thoughts on some of the key issues raised in the Future of Tax: Submissions Background Paper. 7
Capital gains tax It must be acknowledged that New Zealand currently adopts an ad hoc and complex approach to capital gains tax (CGT). This contributes to a lack of compliance and erosion of the potential tax base. While there may be fairness arguments supporting the introduction of a more comprehensive CGT, we note that other factors, in particular design issues, require careful consideration. Based on overseas experience, it is sometimes argued that a CGT can be complex for the level of revenue it generates, particularly if many exclusions are included. In our view, a considerable amount of planning will be required to ensure any resulting CGT is able to contribute to a more balanced and efficient tax system while avoiding additional complexity and maintaining effective revenue generation. Any changes to the tax system that result in a more consistent treatment across different types of income should improve both fairness and efficiency. The varying effective tax rates, which currently apply across different types of income, in our view has a risk of threatening both horizontal and intergenerational equity. We note that on the basis the TWG is looking to maintain tax revenues at c.32% of GDP, it is worthwhile to consider other tax changes that are revenue negative but beneficial for New Zealand overall, in light of any additional revenue that may be generated by a more comprehensive CGT. Goods and services tax New Zealand s holistic approach to GST is broad base, relatively low rate, intuitive and largely unavoidable. Globally, similar value-added and consumption taxes tend to be riddled with exemptions and differential rates (often driven by political pressures), which can lessen the efficiency of the tax. However, we acknowledge that New Zealand s comprehensive GST system is regressive as lower income households tend to spend a larger proportion of their income on consumption and therefore on GST. The TWG is considering the use of exemptions for GST as part of their review. We question whether the use of GST exemptions would produce the desired outcomes given it is inherently difficult to target exemptions at particular groups. It is likely that any exemption will apply to all consumers and therefore the economic benefit of the exemption would apply to all households. In our view, there may be more appropriate ways to compensate households that currently suffer a disproportionate burden under the current GST system. The use of tax incentives New Zealand s tax system is relatively neutral in the sense that it does not overtly seek to change behaviour (with the noted exceptions of alcohol and cigarette duties). However, tax incentives may be appropriate to achieve greater horizontal equity and promote behaviour that serves New Zealand s social and economic goals. Again, design of any tax incentive must be carefully considered to ensure it is well targeted, adequately funded, and maintains the integrity of the tax system. New Zealand s past use of tax incentives has largely been expensive, poorly targeted, and inefficient. It is therefore always useful to consider if there are other ways for the Government to achieve the same outcome without the use of the tax system. Our view We emphasise the importance of remaining open-minded and open to change during these reviews in order to challenge the current tax settings and the thinking behind them. As noted above, we believe the TWG is doing this as it considers the use of new taxes, such as incentives, and seeks to consider the overall equity of the tax system. The current review is also making a conscious effort to open up the discussion to all New Zealanders therefore resulting in greater diversity in how we may challenge New Zealand s tax settings. We look forward to seeing the TWG s proposals in September, following their report to the Minister of Finance and Minister of Revenue. We understand the TWG will seek further comments on the proposals then. 8
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Contributors Anand Reddy Partner T:+64 9 355 8371 E: anand.s.reddy@nz.pwc.com Sandy Lau Director T: +64 4 462 7523 E: sandy.m.lau@nz.pwc.com Jennifer Pegg Senior Manager T: +64 4 462 7633 E: jennifer.a.pegg@nz.pwc.com Elizabeth Elvy Senior Manager T: +64 9 355 8683 E: elizabeth.a.elvy@nz.pwc.com Amy Burrows Senior Associate T: +64 9 355 8245 E: amy.e.burrows@nz.pwc.com Brittany Stewart Associate T: +64 9 355 8759 E: brittany.a.stewart@nz.pwc.com Jordan Yates Associate T: + 64 9 355 8193 E: jordan.r.yates@nz.pwc.com Connect with us Follow us on Twitter @_NZ Visit us online at pwc.co.nz Email us tax@nz.pwc.com 2018 PricewaterhouseCoopers New Zealand. All rights reserved. refers to the New Zealand member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.