A tax policy paper released yesterday suggests allowing certain NZ resident companies to cash-out tax losses arising from certain research and development (R&D) expenditure. The intention is to enable R&D intensive start-ups to access the benefit of tax losses from R&D activity in the start-up phase, when income (if any) is not sufficient to absorb the losses.

The suggested criteria are that the NZ resident company:

  • is not a look-through company, qualifying company, listed company or special corporate entity (other business structures such as trusts and partnerships are also excluded); and
  • incurs at least 20% of its labour costs on R&D activity, on the basis that a greater proportion of labour costs is invested in R&D in the early years as intellectual property is created for later exploitation.

It is proposed that the amount of loss for a tax year that can be cashed-out would be the lesser of:

  • 150% of deductible R&D labour costs in the relevant year;
  • total deductible R&D expenditure in the relevant year; and
  • total tax losses in that year.

However, a maximum cap on the eligible losses that can be cashed-out is also proposed. The cap would begin at $500,000 of losses (for a refund of $140,000 at the current company tax rate), rising incrementally (over a time period not yet specified) to a cap of $2 million of losses (for a refund of $560,000).

Many research or research-related activities would be excluded under the proposal, mirroring those excluded from the former R&D tax credit. Clinical trials and late stages of software development (eg coding) would also be excluded, as would R&D expenditure funded by government grants or research funding.

The cashed-out loss is regarded as an interest-free loan to be "repaid" by means of tax payable on the taxpayer's future taxable income, since the taxpayer will have cashed-out the losses that would otherwise shelter that future income from tax. However, as a fiscal protection measure, it is proposed that the cashed-out loss would be repayable from realising a capital return on the R&D investment by the sale of:

  • intellectual property related to the qualifying R&D expenditure; or
  • all or some of the shares in the company.

That proposal would apply to the extent that the "loan" has not already been "repaid" by the generation of unsheltered future taxable income.

The Government has heralded the proposal as helping to build a more productive and competitive economy that supports New Zealand business. It is not before time that the current Government gets serious about tax relief to promote R&D expenditure, after repealing the former modest R&D tax credit when it came into office in 2008.