An R&D incentive scheme will be introduced on April 1 with a more generous tax break than billed at the Budget, and businesses will have to spend far less to qualify - but Research, Science and Innovation Minister Megan Woods maintains the changes won't break the policy's billion-dollar budget.

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Budget 2018 saw the government allocate $1 billion to cover the first four years' cost of a 12.5 per cent tax break, on the basis that around 2000 firms would take up the incentive (which compares to around 300 on Callaghan Innovation grants at present).

Firms who spent at least $100,000 a year on R&D would qualify.

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This morning, at an event hosted by bathroomware maker Methven, Prime Minister Jacinda Ardern announced the rate will be set at 15 per cent, with the eligibility threshold lowered to $50,000 (the maximum stays at $120m).

Despite a blowout across the Tasman where spending on an R&D tax incentive scheme ballooned from an originally budgeted A$1.8b ($1.9b) in 2011 to A$3b last year, Woods maintains our version will stay within budget.

"We left ourselves a lot of head room," she says.

She adds MBIE has done a lot of work modelling how many companies will be eligible under the rules. It doesn't anticipate more than 2000 will apply, or at least at a deal that will blow the $1b ceiling.

Earlier this year, Woods argued a 12.5 per cent rate and $100,000 threshold were attractive next to the $300,000 cut-off for R&D grants from Crown agency Callaghan Innovation today.

But she says after a round of consultation, it became clear that a 15 per cent tax break with a $50,000 cut off was required to motivate small businesses - a key target for the policy - to spend more on R&D.

Woods says the government wants to boost R&D spending as a percentage of GDP from the current 1.3 per cent to 2 per cent within a decade - though even that would still lag the OECD average of 2.38 per cent.

"We want to introduce an R&D culture," Ms Woods says that. "A $300,000 cut-off would mean hiring three staff, which is a pipedream for most small businesses."

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Another change is that the tax break can now be claimed for any level of spending on an R&D project that is contracted out to a university or Crown Research Institute.

No bright ideas emerged from the consultation round to address criticism from entrepreneur Doug Hastie and others that many startups can't qualify for any tax break because they make a loss.

Small Business Minister Stuart Nash, Green Party spokesperson for Small business Chloe Swarbrick and Prime Minister Jacinda Ardern outside Methven. Photo / Chris Keall.
Small Business Minister Stuart Nash, Green Party spokesperson for Small business Chloe Swarbrick and Prime Minister Jacinda Ardern outside Methven. Photo / Chris Keall.

Woods says the policy work involved is complex, and won't be finished by April 1 next year. The minister has bought more time by tiding over current policy for another year (which sees a loss-making company that spends at least 20 per cent of its labour budget on R&D able to claim up to $255,000 or 15 per cent of R&D spending up to $1.7m).

The increase to 15 per cent also followed criticism from innovation expert Anna Lavelle and others who pointed out our proposed R&D tax break was much more generous across the Tasman, where a company with less than A$20m could claw back up to 43.5 per cent of eligible spending (although many companies will be able to claim much less in the 2019 tax year; see below). Lavelle maintains a sizable tax break is needed to motivate business - especially small business - to lift R&D.

NZ's looming R&D tax break is also modest by international standards, at least by headline rates.

The OECD's "B Index", which attempts to compare R&D tax incentives across varying schemes in different countries, includes refundable tax credit rates for Canada (35 per cent), the Netherlands (32 per cent), France (30 per cent), Ireland (25 per cent), Norway (20 per cent) and the UK (11 per cent plus a 130 per cent "enhanced allowance" for small business). But once the complete company tax picture is taken into account, effective rates are a lot lower (see table below).

While Woods has been careful not to draw a direct line, and constantly highlights that Callaghan Innovation will have a continued role in supporting R&D, her government is funding the R&D tax break in part by axing Callaghan's Growth Grant programme.

Callaghan dished out some $149.5m in matching R&D funds to successful applicants in 2017. No more Growth Grants will be awarded from March 31 next year, though multi-year grants already in place will continue until March 31, 2021.

A long-running debate has seen Labour criticise Growth Grants as an inefficient attempt by government to pick winners, while National has maintained that businesses tried to game the R&D tax break when it was last in place (which was for less than six months before National scrapped it when it came to power in 2008).

National's theory is bolstered by developments across the Tasman, where R&D tax break costs blew out from A$1.8b per annum when it was introduced in 2011-12 to A$3b in 2016-17 and a Budget 2018/19 initiative seeks to crack down on ineligible spending.

Woods wants to minimise gaming of the system on this side of the Tasman by giving detailed guidelines about what can, or can't, be claimed as R&D. Lessons have been learned from 2008, she says.

An MBIE discussion document suggests a laundry list of excluded spending, including that related to market research, legal and administrative costs associated with patents, prospecting for oil or gas, quality control, research that makes only "cosmetic" changes to an existing technology, and any research related to the arts, social sciences or humanities.

Megan Woods sees the 15 per cent tax break boosting R&D spending from 1.3 per cent of GDP to 2 per cent within a decade. But even then NZ would lag behind the OECD's average 2.38 per cent.
Megan Woods sees the 15 per cent tax break boosting R&D spending from 1.3 per cent of GDP to 2 per cent within a decade. But even then NZ would lag behind the OECD's average 2.38 per cent.

There will also be a requirement for companies to have an established presence in New Zealand, and carry out 80 per cent to 90 per cent of R&D work here, Woods says (a little wiggle room will be allowed on the basis that not all research and development work is able to be carried out in NZ).

Meanwhile, the Aussies are scaling back their scheme.

A PwC report says Budget 2018/19 measures mean companies now on the lowest tax rate will now see an R&D tax offset of 12.5 per cent.

Beyond the allegations of rorting, which are now being investigated, OECD figures show R&D spending in Australia has actually tailed off after the tax incentive scheme was introduced seven years ago.

In 2011, research and development spending as a percentage of GDP stood at 2.11 per cent. In 2013 it was 2.01 per cent. By 2015, it had fallen to 1.88 per cent.

Woods maintains the Australian system was over-complicated. She says the original scheme's headline numbers looked generous, but complex formulas came into play as companies at different revenue and tax levels received different levels of incentives.

Revenue Minister Stuart Nash adds, "When talking to the Australians, they said: 'Look, can we give you some advice? Don't do it the way we've done it.' They've had a bit of a nightmare and in the last Budget they've had to pull some stuff back. But we've learnt from their mistakes."