Loss-making companies that invest in eligible research and development will be able to claim cash refunds in proportion to their payroll figures from the 2020/21 tax year.

The policy, hidden in an omnibus tax bill tabled in Parliament in late June, represents an important last step in the government's decision to stop relying on direct grants from Callaghan Innovation and allow individual firms to claim the cost of research against their payroll tax liability instead.

The policy answers the major flaw in the current policy: that many firms investing in R&D are at an early stage of development and plan to make losses while they pursue growth and eventual profitability. That prevents them taking advantage of tax rebates on R&D until they turn a profit at some time in the future.

That excluded many start-up and fast-growing, innovating companies from the policy, despite being one type of firm that the government wants to encourage to undertake research and development to deliver eventual profitability.

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New Zealand's most prominent example is the software accounting firm Xero, which has racked up losses totalling $343.9 million since 2006, according to its 2019 annual report, as it has pursued profitability only since achieving sufficient global scale. The company is close to declaring a maiden profit and has begun reporting positive cashflow.

Science and Innovation Minister Megan Woods on Friday drew public attention to the changes, which are tucked away in the Taxation (KiwiSaver, Student Loans and Remedial Matters) Bill, which has yet to have its first reading in Parliament.

The extension to allow refunds for loss-making companies will allow companies engaged in eligible R&D to claim a refund of 15 per cent of those costs, limited only by the size of the firm's payroll.

In other words, a firm with a $100,000 payroll that undertook $100,000 of R&D could claim a $15,000 refund, but no more.

The 15 per cent refund rate is the same as the rebate offered to profitable firms claiming for deductible R&D expenses, which currently allows rebates up to a total of $255,000, equal to $1.7m of eligible R&D expenditure. However, the new bill proposes "that the existing corporate eligibility criteria, wage intensity test, and $255,000 cap be removed and replaced with a payroll-tax based cap", according to explanatory notes from the Inland Revenue Department.

"What they are concerned about is fiscal risk" and the possibility of fraudulent claims, Deloitte tax partner Patrick McCalman told BusinessDesk .

"Your PAYE bill tells me (the tax department) you're real," he said.

However, tax practitioners are waiting for further detail on whether refunds will be possible where a firm contracts with an external provider to conduct R&D rather than employing its own staff to undertake research.

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The latest changes also come with a sting in the tail for tax-exempt entities, such as charitable research institutions and companies that trade commercially, but have charitable status, such as Sanitarium.

"It is also proposed that entities that derive tax-exempt income (other than levy bodies, and claimants that only receive exempt income from certain inter-company and foreign dividends) be ineligible for the R&D tax credit," the IRD notes say.