R&D tax credits yet to meet targets

April 28, 2021

The government’s research and development tax incentive scheme (RDTI) appears to be doing better than its predecessor, but not nearly as well as was hoped.

Software companies, in particular, remain unimpressed.

New Zealand Software Association president Roger Ford sees New Zealand as a country of adapters as much as innovators.

“[New Zealanders are] more likely to find a new use for No 8 wire than finding a new material to make the wire from,” he said.

The RDTI offers companies a 15% tax credit on R&D spending. Businesses would obviously like that number to be higher, but the real problem for some remains the definition of R&D.

To get the tax credit, the R&D activity has to occur in New Zealand; seek to resolve scientific or technological uncertainty; follow a systematic approach; and seek to create new knowledge, or new or improved processes, services or goods.

Criticism remains that the system incentivises pure science over developing existing technology to new tasks.

“There’s a lot of uncertainty,” Ford said. “We went through a fantastic consultation process but … ended up with something that didn’t work for us.”

Ford pointed to the issues around pre-revenue companies doing a large amount of R&D but not being able to take advantage of a tax credit, the high administrative costs required to get into the scheme, and the uncertainty of how the criteria apply to software firms.

How it’s going
As of April 2021, 864 business have enrolled in the RDTI, far lower than the estimated 3000 that Research, Science and Innovation Minister Megan Woods announced in 2018.

Of this number, 9% are listed as information media and telecommunications, which is where most software companies would sit (although some may also be represented in professional, scientific and technical services).

However, the 864 enrolled number is almost three times as many as the 294 supported under the previous system of growth grants handed out by government agency, Callaghan Innovation. These grants, covering 20% of a qualifying business’s eligible R&D expenditure (capped at $5 million a year), ended in March 2021.

The non-discretionary grants provided co-funding for businesses to invest in a multi-year programme of research and development. In 2019/20, about $102.6m was paid to 179 businesses under the Growth grant scheme.

A transition period was allowed for those receiving the growth grants from the start of the RDTI in April 2019 until the end of March 2021. Many of these companies have yet to move to the new RDTI. As such, their claims may not come through until 2022 or 2023.

The government has spent $2.4m on the total operational cost for the scheme for June 2019 to January 2021, and the potential credit to date is $2.7m from an eligible gross R&D expenditure of $18.2m.

Based on numbers provided by Stats NZ, the change in R&D support has not meant businesses intend to spend less in this area.

Information collected in the Business Operations Survey 2020 showed that of the businesses which anticipated their R&D spending would change due to Covid-19, 24% expected it would increase. The most common reason cited (70%) was a change in demand for existing goods and services.

Stats NZ also reported that in 2020, businesses in New Zealand undertook $2.7 billion worth of R&D activity, compared with $2.4b in 2019.

Investment target
The government has set a goal to raise overall R&D expenditure to 2% of GDP by 2027. To achieve this, the Ministry for Business, Innovation and Employment estimated government expenditure would need to increase from its 2019 level of $1.6b to just less than $3b in 2027 (excluding the RDTI). Correspondingly, business expenditure on R&D would need to increase to almost $5b in 2027.

The Productivity Commission’s Frontier Firms report published this month recommended that by the end of 2021, there should be a stocktake of the operation of the RDTI from its start to the end of the 2020–21 tax year. Without raising any criticism of the scheme, the Productivity Commissioner Andrew Sweet said: “It’s possible, I suppose, that we’ve got it right the first-time round, but it seems unlikely.”

It recommended the stocktake should:

  • assess the causes of difficulties that some firms have found in establishing the eligibility of their R&D activities for the RDTI;
  • assess whether the RDTI is on track to meet its policy objectives;
  • identify and implement amendments to statutory eligibility criteria, guidelines and administrative procedures that will best resolve identified problems; and
  • consider supplementing the RDTI with the use of grants to fill eligibility gaps, to help the RDTI better meet its policy intentions.

The last point is key for early-stage companies. As Ford pointed out, tax incentives and grants targeted different things: one keeps R&D in New Zealand, while the other encourages new businesses.

Over the Tasman
In Australia, the system is seen as working well though it has had several tweaks.

Brandon Capital chief executive Chris Nave, who is based in Australia, said the system works because of its simplicity. The Australian RDTI offers a 43.5% refundable tax offset for eligible companies whose annual aggregated turnover is less than $20m, and a 38.5% non-refundable tax offset to eligible companies whose annual aggregated turnover is more than $20m.

“I would argue that [the Australian R&D Tax Incentive] has had a significant impact on the startup space,” Nave said. “And it’s attracting investors to that space.”

Nave also pointed to overseas companies setting up in Australia, bringing an influx of cash and upskilling opportunities to the area.

“It’s a huge shot in the arm for the industry. The [local] research industry and universities are growing to keep up. [The incentive] enables companies to take more risks and lowers the cost of capital.”

He noted there was an issue with the spend required for eligibility in the programme – businesses must have eligible R&D expenditure greater than $20,000 – but noted there was a tax credit scheme for industries spending less than that.

The caveat here is that Nave was talking about the biotech industry, and he acknowledged that software is still an issue for Australia. The list of excluded activities from the RDTI scheme covers a lot of work software companies do as part of the development stage of new products, such as transforming manual processes to digital and systems testing.

The criteria
IRD’s updated advice on the RDTI’s criteria attempts to clear up any confusion for tech companies in particular. However, much like Australia, New Zealand’s ineligible activity list seems to target the software industry.

The criteria are focused on creating new knowledge, or new or improved processes, services, or goods. The definition of new versus improved is contentious. The process to improve a piece of software could include user experience (UX) research, for example, which is excluded in the criteria.

In an interview with NBR last month, Digital Economy and Communications Minister David Clark said the problem was the criteria for the tax credits were focused on new research and new technology. Coding is an existing technology so, strictly speaking, is not included in the R&D tax credit criteria. But he was talking to the industry about that and considering whether the government had got the balance right.

In a written statement to NBR, a government spokesperson said: “The government is aware of the concerns of the tech sector that the RDTI may not have been providing the level of support that was originally expected, and that some growth grant businesses, especially software businesses, have been finding the transition from the growth grant to the RDTI challenging.

“However, the move to a tax incentive was a deliberate policy choice regarding the role of government in innovation and where we get the best return on investment. What we want to fund is the creation of new knowledge. What we don’t want to fund is business-as-usual coding activities. It’s important to note that as we went through the design phase of the R&D tax incentive, between the initial proposals and the final design that was legislated, we worked extensively with the software sector.”

The government has directed officials (MBIE, Inland Revenue and Callaghan Innovation) in charge of implementing the process to take a more hands-on approach when engaging with businesses to help them better understand the processes. Officials will also begin work with the software industry over coming weeks to produce the first of a series of sector-specific guidelines.

National Business Review
Hadyn Green
28 April, 2021

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