The Startup Journey: When Your R&D Becomes an Asset
For many startups, research and development is one of their largest expenses. In the early years, the focus is often on conserving cash, proving the technology and claiming as much eligible expenditure as possible for the R&D tax credit – after all, cash is king.
As the business matures, the conversation changes. Investors want to understand what the company has created, whether the technology is commercially viable and what assets underpin its value. At that point, continuing to expense all development costs may no longer give a complete picture of the business, and, depending on the accounting standards applying to the business, may no longer be permitted.
The transition from expensing R&D to recognising an intangible asset is therefore more than an accounting adjustment. It is often an important milestone in the startup journey.
Research versus development
Financial reporting standard NZ IAS 38 Intangible Assets outlines the accounting and tax rules, and distinguishes between the research phase and the development phase of a project.
Research expenditure must be expensed as it is incurred. This generally includes early-stage investigation, evaluating alternatives and searching for new technical knowledge. At this stage, there is not enough certainty that the work will produce an asset capable of generating future economic benefits.
Development occurs later, when research findings or other knowledge are applied to produce a new or substantially improved product, process, system or service before commercial production or use begins.
A business applying NZ IAS 38 must capitalise development expenditure when it can demonstrate all six of the following:
- It is technically feasible to complete the asset so that it will be available for use or sale.
- The business intends to complete the asset and use or sell it.
- The business has the ability to use or sell the asset.
- The asset is expected to generate probable future economic benefits, including through an identifiable market or its usefulness within the business.
- Adequate technical, financial and other resources are available to complete the development and use or sell the asset.
- The expenditure attributable to the asset during development can be measured reliably.
These requirements create a relatively high threshold. However, once all six criteria are met, capitalisation is not optional for a business applying NZ IAS 38. The business cannot continue expensing the expenditure simply because that produces a more favourable tax outcome.
Capitalisation begins from the date the criteria are first satisfied. Costs incurred from that date are capitalised onto the balance sheet.
Why startups often expense R&D in their early years
At the beginning of the startup journey, there is usually considerable uncertainty. The business may still be working out whether the technology is feasible, whether customers will pay for it and whether sufficient funding will be available to complete the project.
That uncertainty often means the NZ IAS 38 capitalisation requirements have not yet been met. The expenditure is therefore recognised as an expense.
This treatment can also produce a valuable tax result. New Zealand’s tax rules generally allow an immediate deduction for qualifying research and development expenditure that is expensed for accounting purposes.
That deductible expenditure may also qualify for the 15% R&D tax incentive and also the 28% R&D tax loss cash out, provided the activities and costs meet the requirements.
For an early-stage startup, the ability to receive an R&D tax refund can be extremely important. Cash flow is king, and a tax credit received today may be more valuable than an accounting asset that produces deductions over a number of future years.
However, the accounting treatment must still reflect the true stage of the project. A business cannot choose to continue expensing development expenditure solely to maximise its tax deductions or R&D tax credit.
What changes once development expenditure is capitalised?
To claim the R&D tax credit, the expenditure generally needs to be deductible for income tax purposes. Once development costs are capitalised as an asset, they are generally no longer immediately deductible. This means the business will usually be much more restricted in what it can claim for R&D tax credit purposes.
There are some limited exceptions, but these depend on the nature of the asset and the expenditure involved. The key point is that capitalisation can significantly reduce the amount of expenditure qualifying for the R&D tax credit.
Businesses should therefore consider the accounting, tax and R&D tax credit implications together when development expenditure begins to meet the requirements for capitalisation.
However, the accounting treatment cannot be chosen simply to maximise the R&D tax credit. If the requirements for capitalisation are met, the expenditure must be treated accordingly.
The next stage of the startup journey
In its early stages, a startup’s financial statements may show accumulated losses and very few assets, even though the founders and development team have spent years creating potentially valuable technology. That is often the correct accounting outcome because the project has not yet reached the point where an intangible asset can be recognised.
As the technology becomes feasible, funding is secured and a route to market is established, the position may change. Capitalising qualifying development expenditure puts an identifiable asset on the balance sheet and provides investors with greater visibility over the resources being committed to the product.
It can also signal that the business has moved beyond open-ended experimentation. Management now has evidence that the product can be completed, the resources to complete it and a reasonable expectation that it will generate future benefits.
Plan for the transition
The point at which a project moves from early-stage research into capitalisable development is not always obvious. It should be considered each year as the product progresses, funding is secured and the path to commercialisation becomes clearer.
If your business is developing something new, your accountant needs to understand what you are working on and where the project is in its development journey. The accounting, tax, R&D tax credit and wider commercial implications need to be considered together.
If your accountant is not having this conversation with you each year, they may be missing an important issue. Equally, if they do not understand the R&D tax incentive rules, they may not appreciate how capitalising development expenditure could affect your claim.
We can work alongside you and your accountant to:
- identify when a project may have reached the point where development costs need to be capitalised;
- explain the effect on your tax deductions and R&D tax credit claim;
- help establish a practical method for separating and recording different project costs; and
- consider how the treatment fits with your funding plans and the information investors expect to see.
Getting advice early means the transition can be planned and properly documented, rather than discovered after year-end when the financial statements and R&D tax credit claim are already being prepared. Contact us for guidance.
Disclaimer
This article is intended for general information purposes only and does not constitute tax, legal or financial advice. The application of New Zealand's R&D tax incentive rules is highly fact specific, and the impact of the Budget 2026 changes will depend on individual circumstances. Professional advice should be obtained before taking any action or relying on the information contained in this article.
