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R&D deduction changes should encourage technology

R&D deduction changes should encourage technology innovation, says KPMG partner

Auckland, 13 May 2005 - New rules on research and development tax deductions foreshadowed this week by Finance Minister Michael Cullen should be generally welcomed by the New Zealand’s emerging technology industry, says KPMG tax partner Ian Kowalski.

Mr Cullen has announced that the rules are to be made more flexible by allowing companies to defer their R&D deductions. R&D deductions are typically generated in the early stages of a company’s business, when it is creating the intellectual property needed to develop a successful business. At this stage, the company does not have an established revenue stream and as a result the R&D deductions give rise to tax losses, which must be carried forward.

In order to commercialise the intellectual property created, a company typically requires further investment from a private equity or venture capital source. However, under New Zealand’s current tax rules, any significant change in shareholding means that tax losses carried forward are forfeited.

“This means at the very time the company starts trading profitably, the R&D deductions that should be available to offset against this income are lost,” says Mr Kowalski. “The company starts paying tax at a critical time in its life cycle, just when it needs funds to expand and develop its business.”

The new tax change will give companies the option of deferring the deduction of R&D expenditure. This will allow companies to elect to take the benefit of the R&D deductions at a time when they are generating income from their innovation, and reduce tax liabilities, rather than lose the deductions as a result of shareholding changes.

“This change will reduce tax liabilities, and allow companies to increase their after-tax profits,” said Mr Kowalski. “This should encourage new investors to provide funding to reward innovation, in the knowledge that their investment will not go straight into the Government coffers in the form of income tax.”

However, he warns that there may be fishhooks for the unwary. That’s because deferred R&D expenditure will only become deductible once income is generated from the development. If no income is generated, the expenditure may fall into a “black hole”, where no deduction ever becomes available. There are other unanswered questions also, such as whether there will be limits on how long companies will be able to defer expenditure. As always with tax changes, the devil may be in the details, says Mr Kowalski.

ENDS

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