KEY POINTS:
All the signs are that the Business Tax Review will result in a tax credit for research and development.
It is likely to come into effect in 2008 and the annual cost in revenue foregone could rise to about $200 million by 2012.
The Australian evidence is that
such measures earn their fiscal keep. "On balance Australia obtains good returns from its public funding support of R&D," the Productivity Commission concluded in a report this year. A tax concession represents the lion's share of public support for business R&D across the Tasman.
But Serg Duchini, who heads Deloitte's Australian practice in this area, warns that the level of concession foreshadowed by the New Zealand Government so far might be too low, especially if the aim is to be competitive with Australia.
The Government proposes a tax credit of 7- 15 per cent for qualifying R&D spending - that is, every $100 of expenditure would generate a tax credit (or cash refund) of $7-$15. That would be on top of the normal tax deduction for the spending.
At the current company tax rate of 33c in the dollar it is equivalent to a super-deduction of 121-145 per cent.
The Government claims international evidence on the level of assistance for business R&D indicates that it declines above $14 per $100 of R&D spending.
If that is so, our cousins across the Tasman don't seem to realise it.
Australia has a super-deduction of 175 per cent, equivalent to a tax credit of $22.50 per $100, one-and-a-half to three times as generous as the New Zealand proposal.
The rate was very important, Duchini said during a visit to New Zealand last week. Sophisticated businesses factored it in upfront when doing the cost-benefit calculation for proposed R&D spending.
Multinationals can often locate technical centres anywhere that meets certain basic conditions of infrastructure, skills and political stability.
Abuses of tax breaks in the pre-reform era, like claiming duty-free liquor as a market development expense, have given them a lingering bad name.
But the tax review's initial discussion document says that a targeted tax concession for R&D would bring New Zealand into line with other OECD countries. Three-quarters of them provide support for R&D through the tax system; New Zealand does not. And few of them have rates of private sector R&D spending, relative to GDP, as low as New Zealand's. What are the odds those two things are connected?
While it is generally undesirable for the tax system to favour some business activities over others, the discussion document says, it might sometimes be excusable.
It might be justified when there is under-investment. That's because much of the benefit would spill over to the wider community instead of just being captured by the firm undertaking the investment.
It is also necessary for the benefits of Government intervention to outweigh the costs and the tax system to be the most effective mechanism for providing that support.
This is the notion of "additionality". It only makes sense to give a tax break for something that would not occur otherwise.
In designing a tax break for R&D there are a number of basic questions to settle:
* What spending qualifies?
Officials have suggested a relatively broad definition, similar to Australia's, that includes "creating new or improved materials, products, devices, processes or services" and also allows overheads required for or integral to the research and development activities.
International experience is that the largest amount of R&D spending is in the manufacturing sector, not in glamorous "high-tech" outfits.
* Should all R&D spending get it or only the increase from some base?
Australia has a two-tier system, with a 125 per cent deduction of the baseline "volume" spending and 175 per cent for the incremental stuff beyond that.
Since the 175 per cent rate was introduced in 2000 business expenditure on R&D has risen sharply, Duchini says, citing Australian Bureau of Statistics figures.
The Government has indicated a preference for the incremental approach, with a base year of 2004-05, on the grounds that it would be cheaper and avoids subsidising activity that would have occurred anyway.
* Who should get it, those who pay for the R&D or those who carry it out?
The firms commissioning the R&D should get the tax break, the Government says, because they bear the risk and it is their behaviour that it is trying to influence.
* Do projects have to be officially approved in advance to qualify? And when it is a judgment call whether something meets the definition or not, whose call should it be: the Inland Revenue or another arm of government, less focused on defending the tax base?
In Australia those wishing to take advantage of tax concession for R&D must first apply for approval of the expenditure in advance.
Eligibility issues are decided not by the Australian Tax Office, however, but by AusIndustry, which is akin to the Ministry of Economic Development.
The advantage of that, says Duchini, is that AusIndustry is basically keen to encourage firms to do R&D and take up the concession, whereas the taxman's natural instinct is to jealously guard the revenue base.
Our Government would prefer to avoid the bureaucracy that pre-approval would entail, and favours instead a system of selective audits of the expenditure, by an expert body, perhaps in conjunction with Inland Revenue.
Prior approval might be retained as an option for businesses, if they wanted assurance that the expenditure would be eligible for the concession.
Either way, Duchini stresses the importance of the government agency assembling people with technological expertise so that they are not blinded by science.
