Controlling R&D expenditure

Taxing Times is a weekly column that looks at various aspects of tax and money management.
Taxing Times is a weekly column that looks at various aspects of tax and money management.

This week the research and development (R&D) merry-go-round went around again with the release of a Government-issued discussion document on yet more R&D proposals.

In July this year an announcement on R&D was made that had the merry- go-round spinning after the previous R&D regime had not long been repealed. At that time I wrote about the then latest proposal to subsidise R&D expenditure through the tax system, and commented on the irony in the press releases that accompanied the removal of the previous R&D scheme and the announcement of the July proposals in that both claimed the changes would reduce distortions in our tax system and improve investment decisions.

However, putting the humour aside, while I am a strong advocate of a broad-base low-rate tax system that takes a neutral approach to such things, I do have some sympathy with a policy approach that supports R&D expenditure when it can be shown the market needs a push to get it moving. However, rather than trying to justify special treatment for R&D on the grounds of removing distortions in our tax system, as the press releases do, the better way is to simply acknowledge the incentive, the rationale for it, and move on.

So what has the latest turn on the R&D merry-go-round brought?

The discussion document highlights three areas where potential exists for "black hole" expenditure. "Black hole" expenditure is a term used to describe expenditure that is neither immediately tax deductible nor depreciable: in other words, the expenditure falls into a black hole. R&D expenditure can fall into all three of these categories: it is sometimes deductible, sometimes depreciable, and sometimes neither.

It all depends on the nature of the expenditure, whether it creates an asset or not and, if it does create an asset, whether that asset is capable of being depreciated.

In short, the proposals released this week aim to ensure R&D expenditure is either fully deductible or fully depreciable.

The proposals are threefold: Allowing an immediate tax deduction when the R&D expenditure would have created a depreciable asset, but failed, or when the expenditure did create an asset but the asset transpired to be fruitless. This change essentially means R&D expenditure will be tax deductible in one form or other;

Allowing expenditure that has created an invention that is the subject of a patent or patent application or given rise to a plant-variety right to be depreciated over the legal life of the asset to which it relates; and

Clarifying that software development expenditure incurred by a person to develop software for use in that person's business can be depreciated.

How does this differ from the proposals released in July?

The July proposals suggest allowing losses to be cashed up by targeted R&D-intensive start-up companies. To qualify the proposal was that the loss- making company has a ratio of at least 20 per cent of R&D expenditure on salary and wages to total salary and wages.

That is, companies that spend at least 20 per cent of their payroll on staff undertaking R&D activities. The rationale given for the 20 per cent threshold is to try and ensure the refund is appropriately targeted to highly innovative businesses.

The proposals in the latest turn of the merry-go-round are not targeted at R&D intensive businesses, but rather, will be available for all businesses that have R&D expenditure.

» Craig Macalister is tax principal at accounting firm WHK. He can be contacted on 03 211 3355.

The Southland Times