Categories: Previous Articles
      Date: Sep 22, 2013
     Title: September 2013 Tax Update

In This Issue:

• Research and Development: Cash Back for Losses?
• Are Your Interest Payments Tax Deductible?
  
• Do You Have Tax Audit Insurance?
  

Research & Development: Cash Back for Losses?

The Government has released an Issues Paper which proposes to allow certain companies to cash out R&D tax losses early, rather than having to wait for the business to generate taxable profits.

The suggested changes target R&D-intensive start-up companies.  To be eligible, applicants would need to meet the following criteria:

• Company (and also group, if the company is part of a group) R&D expenditure on wages and salaries must be at least 20 percent of total expenditure on wages and salaries (the wage intensity threshold).

• The company (and also group, if the company is part of a group) must be in a tax-loss position for the applicable income year.
• The applicant must be a company resident in New Zealand. The company also cannot be a look-through company, listed company, qualifying company or special corporate entity.

The suggested R&D definition is based on the existing New Zealand equivalent to International Accounting Standard 38 (NZIAS 38), which is already used in the Income Tax Act 2007.  Certain expenditure items and activities will be excluded from the proposed R&D wage intensity threshold of 20 percent of the total group wage and salary expenditure and/or qualifying R&D expenditure, to ensure the proposals are correctly targeted.

The amount of the loss that can be cashed out under the proposals will be the lesser of:

• 1.5 times the company’s eligible R&D salary and wage expenditure in the relevant year;

• total qualifying R&D expenditure in the relevant year; and
• total tax losses in the relevant year.

Initially, the suggested maximum cap on eligible losses that can be cashed out will be $500,000, which equates to a cashed-out loss of $140,000 at the company tax rate (28%).  This cap would rise incrementally each year up to a maximum cap on eligible losses of $2 million. 

Loss recovery rules would be included, to recover the value of the cashed-out loss when a taxpayer derives a return from the sale of:

• intellectual property from R&D the company has performed;

• some of the shares in the R&D company; or
• the R&D company itself (all of its shares).

Are Your Interest Payments Tax Deductible?

A recent tax case has re-affirmed the importance of correctly structuring bank debt, when seeking to claim interest deductions on that debt.   In the case, the taxpayer borrowed significant amounts from a bank and on-lent to related parties.  The on-lending was on terms that interest was only payable if demanded by the lender.   The lender did not demand interest.  The Court held that the interest paid to the bank was non-deductible, as there was no income derived from the use of those borrowed funds.

This scenario is common in back-to-back loan situations, where an individual may borrow from a bank and on-lend to a company or trust which uses the funds to derive income.  If interest is not charged on the on-lending arrangement, the bank interest is non-deductible.

For example, John and Julie borrow funds from a bank in their personal names.  The funds are used in their company’s business (the company is owned by their family trust).  John and Julie do not document their loan to the company, and do not charge interest on that loan.  In this situation, the interest would be non-deductible.  John and Julie should have documented their loan to the company and charged interest on that loan.

Another common scenario which can lead to interest being non-deductible is where shareholders lend money to a company in proportion to their shareholding percentages and charge interest on those loans under a written loan agreement.    The tax legislation generally deems these loans to be share capital rather than loan capital, with the consequence that the interest paid by the company is deemed to be non-deductible dividend payments, rather than interest payments.  This is not a good outcome as the payments are non-deductible but the receipts remain taxable.

Other key points to note regarding interest deductibility:

• Most companies (not Qualifying Companies or Look-Through Companies) have an automatic deduction for interest.   However, interest incurred on funds lent by shareholders relative to their shareholding percentages is likely to be non-deductible.

• For borrowers who are not companies, it is critical to show that the funds have been used by the borrower to generate income to the borrower, or in a business being carried on by the borrower.

Do You Have Tax Audit Insurance?

In conjunction with Vero, our firm offers a tax audit insurance service.  This services allows clients to be covered for the professional costs (up to a certain level) that arise in the event of the IRD reviewing or auditing any tax return filed.  The benefits of this service include:

• The premiums are cost effective.  For example, a business group with total turnover between $500,000 and $1m can have cover of up to a limit of $10,000 for a premium of $405.
• There is no excess payment i.e. professional costs are covered from the outset of a review or audit.
• Cover extends to all associated entities in the group e.g. husband, wife, company and trust
• The premiums are tax deductible to most taxpayers
• All prior year tax returns are also covered, and all tax types for which a tax return has been filed are covered
• Professional costs are paid directly by the insurer to the professional

It is important to note that the insurance does not cover any taxes or penalties that may arise from an audit.

If you are interested in obtaining a quote for tax audit insurance, please contact Chris Lindsay on chris@lindsaytax.co.nz