Accounting for Research and Development Tax Incentives
Accounting for Research and Development Tax Incentives
How should your business account for the R&D tax incentive?
Many businesses have asked us how they should be accounting for the proposed R&D tax incentive.
In this update we discuss the requirements under NZ IFRS. The two accounting standards we consider are:
- NZ IAS 12 Income Taxes; and
- NZ IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.
We consider the accounting impact on both profit making entities and loss making entities.
Our initial view based on the proposed legislation, is that the tax incentive is more akin to a Government grant and would therefore be accounted for under NZ IAS 20, recognising the incentive as income in the year received.
This does not conclude however, that the incentive cannot be accounted for by reference to Income Taxes under NZ IAS 12. In some scenarios the Income Taxes approach may be more appropriate.
As the legislation is still before parliament, our analysis has focussed on determining the correct treatment based on the draft legislation, in order to enable taxpayers to make an informed decision on how to recognise the tax incentive for accounting purposes.
We provide a more detailed analysis of the accounting treatment below.
Is the R&D tax incentive an investment tax credit?
There is no formal definition of investment tax credits (ITCs) under NZ IFRS, In practice, investment tax credits are usually government incentive schemes delivered through the tax system, e.g. in the form of reductions in income tax liabilities or increases in tax-deductible expenses. Accounting for ITCs is not addressed directly in NZ IFRS because they are scoped out of NZ IAS 12 and NZ IAS 20. However, NZ IAS 12 applies to all temporary differences arising from ITCs.
In our view, determining the accounting for ITCs it is necessary to consider all the relevant facts and circumstances, and in particular the indicators discussed below [NZ IAS 12.4, 20.2(b)].
Such ITCs are accounted for using either NZ IAS 12 or NZ IAS 20 by analogy. Applying one or the other standard by analogy will have different recognition, measurement, presentation, and disclosure consequences.
Companies will need to choose an accounting approach that best reflects the economic substance of the tax incentive. This determination requires judgement in light of all relevant facts and circumstances.
If the substance of a tax credit is more akin to a government grant, then we believe that the application of NZ IAS 20 by analogy is more appropriate. In determining whether the economic substance of a tax credit is more akin to a government grant, the definition of a government grant [NZ IAS 20, paragraph 3] and the following indicators are considered.
Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the entity. (NZ IAS 20:3)
Indicators to be considered include:
- the amount of tax incentive is independent of the amount of taxable profit or tax liability; and
- the expenditure must be made on a particular asset or activity and other substantive conditions may be attached to the tax incentive relating to the operating activity of the entity.
Accounting treatment if a government grant
Tax incentives that are in substance government grants are recognised as income over the periods necessary to match them with related costs for which they are intended to compensate. The tax incentive is presented in the statement of financial position by setting up the grant as deferred income or, if the grant relates to an asset, then either as deferred income or as a deduction in arriving at the carrying amount of an asset. The tax credits are subsequently presented in profit or loss either as other income or as a deduction from the related expense.
Government grants are recognised only once there is reasonable assurance that the entity will comply with conditions attaching to them and the grants will be received.
The application of NZ IAS 12 maybe more appropriate when the economic substance of a tax incentive is akin to a tax allowance.
For example, under a general R&D tax incentive scheme, which is available to all taxable entities, a government allows entities to claim an additional 15% tax deduction for a broad range of generic R&D expenditure in the period in which the expenditure is incurred. If the additional deduction exceeds taxable income, then the resulting tax loss can be carried forward and utilised in a future period of up to three years. If any part of the tax incentive remains unclaimed after three years, then the tax incentive expires. In this case, in the absence of any other relevant indicators, we believe that the economic substance of the scheme is more akin to a tax allowance and should be accounted for by analogy to NZ IAS 12.
Accounting treatment if a tax allowance
If the substance of the tax credit is considered to be a tax allowance it would be presented in the statement of financial performance as a deduction to current tax expense to the extent that the entity could claim the credit in the current reporting period. Any unused portion of the tax incentive should be treated as a deferred tax asset provided it meets the recognition criteria.
Our initial thoughts
Based on the proposed legislation our initial thoughts are that the appropriate accounting treatment for the R&D tax incentive is as a government grant by analogy to NZ IAS 20. This is because:
- The proposed R&D tax incentive is effectively a transfer of resources from the government to entities that meet the eligibility requirements of the scheme and comply with the conditions relating to the research and development activities carried out by the entity.
- The incentive is largely independent of the entity’s taxable profit or tax liability – as detailed in the tax bill describing the main attributes of the scheme.
- The eligibility criteria restricts entry of entities into the scheme and then specifies the nature of the research and development expenditure that is eligible under the scheme’s rules.
Does the accounting treatment change if the entity is tax loss making?
The proposed New Zealand incentive is partially refundable, with further policy development to take place following the introduction of the incentive so as to increase the scope of refundability in subsequent years.
The refundable incentive is only available to certain loss making companies. For that limited group of companies the refundable value is subject to a prescribed limit and a further eligibility requirement.
In our view the refundable R&D tax incentive can still be accounted for as a government grant and NZ IAS 20 applied.
How should the non-refundable R&D tax incentive be accounted for?
Application to the non-refundable R&D tax incentive for profit-making companies
In principal, the non-refundable R&D tax incentive entitles taxpayers to an additional tax offset in relation to eligible R&D activities. As the incentive provides additional tax offsets for specific expenditure on eligible R&D activities it prima facie meets the definition of an investment tax credit. On this basis, it could be argued that the Income Taxes approach could apply.
However, in our view it is possibly more appropriate to apply the Government Grants approach by analogy. The tax offset is simply the means by which the government settles the grant. The substance of the scheme is that the amount of the grant is independent of taxable profit and expenditure is only made on clearly specified R&D activity. Further, the R&D tax incentive also acts as a waiver of expenses. A waiver of expenses is akin to a Government Grant.
Such grants should be recognised in profit and loss on a systematic basis as the entity recognises and expenses the costs the grant is intended to compensate.
Taxpayers will need to be consistent with the treatment of the R&D tax incentive and any other similar tax incentives.
To the extent that a company fully offsets its tax expense for the year and has an amount of incentive able to be carried forward to a future period, an entity will need to assess whether it will benefit from any non-refundable portion and only recognise the carry forward amount to the extent that amount will be able to be enjoyed by the entity.
What should I do if eligible R&D expenditure has been capitalised?
NZ IAS 20 addresses this issue and should be applied.
As legislative detail is still pending on capitalised expenditure, we expect to be able to provide an update once we have further information.
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