Wednesday, July 6, 2011

One solution: How to increase New Zealand's R&D spending and stop educated people from leaving the country

I've engaged in an interesting debate with TUANZ Chief Executive, Paul Brislen (@paulbrislen) on Twitter. Paul asked this country's politicians:

"NZ has some of the lowest R&D spend in the OECD. What will you do to fix that?"

My response to Paul is that I don't believe that the statistics are accurate. New Zealand companies don't have an incentive to account for R&D. In fact there is a big disincentive to account for it. If you hired someone or purchased something and your intention is R&D, that means that it is a capital expense. Capital expenditure is not immediately tax deductible. You have to capitalize and depreciate it. This means that not only you are out of pocket for investing into something that doesn't bring you any immediate return, but you also can't claim it as tax deductible expense. I believe that the way New Zealand businesses structured is to ensure that their efforts are considered operational expenses and not R&D. This is why the statistic Paul refers to is inaccurate and meaningless.

To this, Paul responded:

"not according to the OECD and that means investors looking for new stuff pass us by." "... if you're looking around the world for centres of innovation what do you look for? R&D spend. If we hide ours..."

I don't believe it works like that with investors. I believe investors are looking for returns on their investment, not centres of innovation. Technology investors, in particular, are looking for two things: (a) Availability of talented people to perform the R&D and (b) Markets to sell the resulting products. In New Zealand we are short on both.

Paul's latest comment was:

"I'm talking about the angel investor funds and the like. If all it takes to get on the radar is an accounting change, why not?"

That comment has prompted me to write this blog, as I don't think 140 characters is enough for this important subject. It is not as simple as an accounting change, as I described earlier, as people will loose real money. However, even if it wasn't for that, some government statistic is still not enough incentive for businesses to change their accounting practices.

Last government's answer to the problem was to introduce tax rebates for R&D. That policy was a complete failure and didn't achieve the desired result. The definition of R&D was too narrow and didn't cover any real commercial R&D. However, being a "tax credit" - translation, "cash handout", if you made the definition any broader, anyone and everyone who's business relates in any way to any technology will be asking government for cash. I applaude the current government for dumping that tax credit scheme.

The problem of trying to drive R&D through other company tax incentives is that by its nature, R&D doesn't produce any immediate income, therefore there is no tax to pay. So what can you do?

I believe I have an answer to this problem. Here are a simple two step solution:

Step 1. Make all R&D related expenses 100% tax deductible, same as operating expenses.

This step will remove the accounting disincentive. However, in itself it is not enough.

Step 2. Redice the income tax burden for all employees that are engaged in Research & Development activities. Make it so the higher the qualification, the lower the tax burden.

This will achieve many goals desired by the people of New Zealand:

  1. It will be more attractive for people with higher education that can be applied to R&D (scientists, engineers, programmers etc...) to stay in New Zealand - they've just got a pay raise!
  2. In fact, educated people from overseas will want to come and work here so they can earn more
  3. It will be more attractive for investors to set up shop in New Zealand - they will have happier staff earning more money without themselves having to shell out extra.
  4. It will be more attractive for business people to account for R&D appropriately - their staff will earn more so will be happier to stay
  5. It will be more attractive for young people to pay for higher education - your student loan is no longer such a burden, it will be paid for by the tax break
  6. You will have young people more interested in science and engineering than arts and law
  7. You will have larger pool of talent so international technology investors will be interested in coming here to set up shop.

And this policy is not too expensive to implement. According to that OECD report there isn't much R&D accounted for in New Zealand, so there will be minimal revenue loss to the government. They will pay in tax breaks to the researchers, however that will be made up by other activity of the companies doing R&D. Also, the ratio of research to other staff in those companies is pretty small.

It will also be a very minor cost to businesses - we already have a system of PAYE tax codes, so all that needs to be implemented here is a new code.

So, would any political party like to adopt this policy? You'll have my vote!

And, to top it all, this policy is really easy to sell to New Zealand public. At the end of the day you are not giving any money to someone as extra profit. You are leaving more money for the worker - the researcher and the engineer.


  1. Here is the tweet from Paul in response to this blog:

    "@igorportugal oh I'm with you... I'd like to see more R&D in NZ. I don't believe we do enough by whatever measure you like. More please."

    So we all agree!

    Now, how do we make this happen?

  2. nicely put and what I see in the field is what you describe for how R & D is currently handled. Timing is everything, so the window of opportunity prior to the election is fairly small.

    The only point I question is in relation to higher qualified component - I understand the point and see merit in it, but also see the value of experienced people in the field, who may not have the high level qualifications, so would suggest that there is value of this experience is factored in.

    If you extend the thought process, to how decisions are made on replacement of systems within Companies, you have a similar issue in that accounting treatment is impacting on moving forward. On the con side is the large capital cost and on the pro side, there is no value for the data / information for the business to leverage it's position and move forward.

  3. interesting idea, ...we need a clear definition of what R & D activities are. As was rightly pointed out problem with the IRD's R & D tax credit is that is had a very narrow definition of R & D. The narrow definition was to assure that the D activities didn't get the credit. The Universities have a clear definition of Research (Frascati) order to give a tax break to the researcher, the IRD needs to know they are engaged in research. Most of the jobs for researchers in New Zealand are in Universities or Crown entities like IRL or AggResearch. If you allow Development activities to qualify for the credit then almost all the bespoke development activities in software, electronics, and even infrastructure projects would qualify. How do you propose to define which Development activities qualify?

  4. Great thinking and I'd be even more brave. In our country (Czech Republic) we have introduced 200% tax deduction on R&D spent. This unfortunately employed more bureaucrats checking whether or not what you claim is R&D but as an incentive it worked quite well.

  5. @John good point. I know how I would define R&D it in my business, but it is hard to define it for everyone else. I guess this is where we need a good debate by all interested parties.

    In my business that would be any work that is done for the purposes of creating and improving our product. That work can't be commissioned or directly paid for by a single customer as a one off. It must become a part of the intellectual property of the company that is made available (for sale or otherwise) to all customers.

  6. Also, some interesting views by Jason Kemp on the subject:

  7. I'm a software developer and don't know much about accounting rules.
    Anyway, even if I would like to pay less taxes, I don't think giving a tax break to highest paid group would be fair to anyone else.
    We're already a privileged, overpaid lot. We've received an education, we work in comfortable offices and ok, it can be stressful at times, but what about dealing with a class of school brats, performing brain surgery or facing armed and dangerous drug dealers?
    Let's get real, we need all professions, even the (perhaps) less educated ones, like bakers, teachers, police...
    Do we really want to be another Iceland or Ireland? they had pretty fat R&D tax brakes.
    Finally, reducing taxes... would that really keep people here? I don't think so. They go because they want to see the world!
    Do we really need educated kiwis to stay here? probably not: we as a country are in the lucky position to chose from the best of the crop from India, UK, Italy, Spain...
    By the way, Igor: what's your twitter account? :-)

  8. ZiglioNZ,

    First, I am talking about R&D in general, not software development in particular. R&D includes research performed in Universities where researchers get paid way less than what you are used to. It also includes development of products such as electronics based products etc.

    You can't put the word "tax" and the word "fair" in the same sentence. Tax is always unfair to someone. Tax is our money that we earn that are taken away from us. That is never fair. It maybe necessary, but it isn't fair.

    The government needs to collect taxes in order to provide essential services to the public that (arguably) only government can provide. It has been proven by economists that the best way to increase the amount of tax the government can collect is through increasing the amount of money the country can earn. Taxation system is often viewed as an instrument to stimulate that earning capacity.

    Fairness has nothing to do with it. The more money we can all earn, the better off all of us (including the underprivileged) will be.

    One of our problems here in New Zealand is that our productivity is low. Investment in R&D can improve our productivity.

    My twitter account is @igorportugal

  9. Thanks Igor,

    I should really go to sleep...
    Anyway, yes, I was thinking of R&D just as software, and yes, researchers are probably paid less than the average software person.
    I've always worked in the electronics sector, last with 4RF and now with @Sirtrack (mind that penguin!). Ironically I now deal with researchers for the wildlife sector around the world, which I find very interesting.

    Correlation: R&D -> productivity, true : false ?
    I would suggest this one: R&D -> quality/value.
    We mainly export primary or low tech goods.
    But we can't increase productivity of our dairy exports by that much while keeping all the cows free to roam...
    In the manufacturing sector you could increase productivity simply by buying more expensive equipment, no R&D is necessarily needed.
    With R&D though you can add value, create a better, more expensive product for richer niche markets. That's what they say we should be aiming for.

    I'll tell you where my productivity goes: all the seconds wasted waiting for a remote google server to give me an answer!
    All the time spent fixing bugs because the quality of my software is not improving (cronic lack of investment in training).
    The time I used to waste commuting because nz companies culturally aren't keen on teleworking.

    I should also mention graduates, they go overseas also because no one wants to employ them!

    Last but not least, I finally work for a public owned company (landcare). But for the past 3 years at a private company half of my salary was paid by the public through grants. I believe I was costing to the company less than a person in production. I think our various governments have contributed to R&D quite substantially.
    What's failed has been creating companies that would grow and then last. Look at Navman...

  10. If your company is heavily involved in R&D, then you know it consumes considerable resources. I feel lucky that Lucid is focused on technical innovation and as such, prepared to invest resources into R&D.