Software the big winner in forum

By BRIAN FALLOW

The Government has foreshadowed a more liberal tax treatment of research and development, from which the software industry in particular is expected to benefit.

But some tax accountants have warned that the proposed changes are far from a cure-all in this vexed area.

Finance Minister Michael Cullen told the Business to Government forum in Auckland yesterday that the changes would mean all research, and most development spending would be deductible.

All research and development will be tax deductible as soon as it occurs, unless the spending gives rise to an identifiable and valuable asset under accounting standards.

A spokesman for Dr Cullen said that in the case of software, accountants the Government had spoken to had suggested a significant proportion of development expenditure would not meet the criteria for being capitalised and so would be deductible.

Under present rules for software, only pre-development costs are immediately deductible.

Development costs have to be capitalised until the project is completed and then depreciated over three years.

The president of software developer Soft Tech, John Ball, said the industry would welcome the move.

"Almost all of us have found out how to get around [the existing rules] and the effect was not to recognise research and development in our balance sheet or our management accounts.

"But that makes research and development as something you have to hide, instead of something you should be proud of, and that is a measure of your future as a company," Mr Ball said.

Under the generic tax policy process, the Government will put out a discussion paper, with a view to introducing legislation next year, most likely taking effect from April 1, 2002.

It is a reversal from the Budget, which maintained that the cost of introducing the full deductibility of research and development, which Labour had campaigned on, would be too high.

Prime Minister Helen Clark said then that the Treasury had "scared the pants off" Dr Cullen, with an estimate of over $100 million a year as the likely cost of such a scheme.

But now the Government is saying that further inquiries, via four or five accounting firms, into what businesses are actually doing suggests that almost all are deducting their research and development spending anyway - even if they are not confident that they are on firm ground for doing so.

PricewaterhouseCoopers partner John Shewan said the change would provide more certainty, and that should increase research and development spending.

"All the companies we have spoken to have said: 'We are writing off all our research and development but we are pretty worried about it.

'The IRD is beginning to make noises that maybe we should be capitalising some of it'."

But Deloittes tax partner Thomas Pippos said Dr Cullen was mistaken if he thought the boundary between capital and revenue in this area was any clearer under the accounting standards than under the tax laws.

In any case, Mr Pippos suggested that the present uncertainty may work to the taxpayer's advantage.

"Currently, IRD auditors are not looking at the issue with rigour.

"When there's uncertainty, people can make the deduction on the basis that they can mount an argument for doing so," Mr Pippos said.

Ernst and Young tax partner Michael Stanley said it would still be a matter of subjective assessment whether the criteria for capitalising development expenditure were met and that the IRD would have to give taxpayers the benefit of the doubt.

"It is important the IRD approach accepts the new provisions are entirely permissive and that the accounting standard requires expenditure to be expensed if there is any doubt," Mr Stanley said.

The criteria are that:

All the costs attributable to the product or process can be separately identified and reliably measured.

The technical feasibility of the product or process can be demonstrated.

The company intends to produce and market, or use the product or process.

The existence of a market for the process or product can be demonstrated, or its usefulness to the company if it is to be used internally.

Adequate resources exist to complete the project and market or use the product or process.