Any independent software developer who aspires to claim valuable tax credits for R&D expenditure will lie awake at night thinking about these five words: an appreciable element of novelty.
From April 1 this year, New Zealand businesses can claim a tax credit for expenditure on research and development. For every qualifying dollar, the IRD will provide a tax credit of 15 cents. This can be offset against other tax payable, or if the claimant is in a tax loss situation, as many software developers are, the IRD will pay this sum in cash.
Most New Zealand independent software developers, or ISVs, produce outstanding software products, with many competing successfully in the hyper-competitive international market. In my experience, most ISVs describe their software developments as “R&D”.
However, for any expenditure on R&D to qualify for tax credits, a more rigorous definition is required. The tax legislation provides for two qualifying criteria. Firstly, the R&D may advance science and technology by resolving scientific or technological uncertainty, usually using conventional scientific hypothesis testing and scientific experimentation.
The second alternative is that the R&D activity must “involve an appreciable element of novelty” (Income Tax Act 2007 Section LH 7 (1) (b)). Fortunately, only one test is required to be satisfied, not both.
It is the test of “an appreciable element of novelty” that most ISVs will focus on. What does this mean? The tax legislation defines “novelty” as “a development of technology or a new use of existing technology, by comparison with the knowledge of the technology that is publicly available on a reasonably accessible worldwide basis” (LH 7 (4)).
The IRD has provided some guidelines and definitions to help interpret these terms.
It describes appreciable novelty as “seeking to develop the technology or use existing technology in a new way”.
Even if a product or process is the first in the world, that is not sufficient on its own to pass the test. The question is focused on “the way the use or development of the technology contributes to the product or process”.The test of whether something is new is addressed by comparing the current state of knowledge of the technology, as determined by a global search of publicly available sources, with the R&D project.
It is important to appreciate that the “novel” development does not have to be “major or successful” to pass the test. However, the “element of novelty must be meaningful or significant in the context of the claimed activities”.
This test is met by considering what a “competent professional in that field” would regard as a “meaningful or significant development, or new use”.
As is readily apparent, claiming R&D tax credits is not simple. The lure of lucrative tax refunds must be tempered by the challenges of passing these tests. As this is all new, for both the IRD and taxpayers, caution is advised before unrealistic expectations are raised.
To help software developers find a path through this jungle, my company, OneNet Limited, has launched an initiative called SuccessfulISVs.com, co-sponsored by IBM and Microsoft.
The first project is a seminar on R&D tax credits for independent software developers to be presented by members of the global R&D practice group from the “big-four” accounting firm, KPMG. The seminars are to be held in Christchurch on May 6, Wellington on May 7 and Auckland on May 8.
Further details on the seminar and registration may be found on the website SuccessfulISVs.com, launched this week.
Snowden is managing director of OneNet, an Auckland-based provider of on-demand computing services and applications.