How a US tax change will hit Kiwi startups

Kiwis are an idealistic lot. We like to dream about how our country can nurture leaders that change the world. It’s a genuine and deeply resonant belief captured well in Sir Paul Callaghan’s idea that New Zealand could be player in the global commercialisation of R&D and technology.  One aspect of that dream is the idea that New Zealand is a good place to start a technology company. Historically the facts backing that have been things like a solid education system, imaginative but inexpensive skilled workers and an environment that makes it easy to start a business.  

The only trouble is pesky facts keep popping up to undermine our dreams. The latest is an obscure but important recent change in US tax policy whose ripples are about to hit our shores.

To explain it involves a small detour in accounting. Normally start-up companies lose money in the early days and are helped along in those important formative years by freedom from tax bills. This is because they can fully offset their people costs against any revenue in any year they are unprofitable. 

The change the US has signed into law requires the cost of people working in research and development) in places like NZ to be capitalized and depreciated over a 15-year period.  So, if a US start-made say $1 million in revenue but spent $2 million in R&D costs in NZ, it could owe up to $182,000 in US Federal tax despite its cashflow still being highly negative. But how does a change in the US affect us, you ask? In several ways.

 1. No longer a home for US tech talent

First, US citizens will not want to move to NZ to start a tech business. Americans are required to pay taxes to Uncle Sam even after they are permanently resident in another country. You may have noticed that American’s don’t like tax and generally won’t move to countries that result in paying even more of them. Sure, we will still have great Kiwi founders, but the idea that we can be a home for US talent just went out the window.

2. Harder for Kiwis to raise 

Second, NZ entrepreneurs will find it harder to raise capital from the US. These US tax obligations kick in when over 50% of a company’s shareholders are American even if the entity remains foreign domiciled. Investing in companies that have non-US R&D just became much less attractive to offshore VCs or even to US investor migrants to New Zealand.

3. Less attractive target

Third, US companies are less likely to buy NZ companies. While there is a lot of hype about “IPOs” in fact most successful NZ tech companies get acquired by larger offshore companies. Any US acquirer now needs to factor in the extra cost of this new tax obligation. That makes their ROI hurdle on an offshore acquisition harder to meet.

Lastly, US tech companies are less likely to establish engineering centers in New Zealand. This is really important, since many emerging start-up ecosystems are accelerated by the osmosis from employees spinning out of large tech to start new ventures. Being uncompetitive as a location for R&D effectively removes a common flywheel for growing our country’s tech capabilities.

Like a huge tariff on dairy

Tax policy can be dry but is a critical foundation for driving economic growth. 

These changes in the US happened without any commentary or push-back from our politicians. There is no “out” through tax treaties between our countries. 

This is not too different from the US government doing something like randomly deciding to put a huge tariff on our beef or dairy exports. It’s deeply protectionist and surprising from a country that is already so completely dominant in the global technology sector. 

Economic development lives on hope and aspiration but it also requires deep attention to the nitty gritty detail of cross border policy. We need our politicians and policy makers to ensure the Great American Dream does not squash our heartfelt Kiwi Dreams.

The Seattle-based Lovina McMurchy (Ngāti Rongomai) is chief operating officer for Wellington-based startup Kry10. She was previously a general partner for Movac and held senior roles with Microsoft, Amazon and Starbucks in the US.

Here are some of the key LinkedIn comments on the article:

Matthew Jackson – cofounder at Alimetry Systems

As an EHF Fellow focusing on a deep tech start-up in the clean water and climate while raising $4.5 million, the recent US tax policy changes present a significant challenge.

New Zealand's sources of capital are already constrained for those of us working on science and R&D. Therefore, any additional barriers to R&D funding in New Zealand, especially those of us working in the government and export businesses, are a cause for concern.

Funding is critical to address climate change issues, and while we plan to expand to the US in five years, this tax change complicates that move.

We must be recognised as a New Zealand company that upholds the Treaty of Waitangi principles. However, this policy shift makes it more challenging to attract US investors or partners, potentially stymieing our growth and the positive environmental impact we aim to have both domestically and internationally.

Our policymakers and leaders must engage with this issue to support local innovation and maintain New Zealand's reputation as a hub for global R&D commercialisation.

Frayne Cook - Plait co-founder

Is there a stronger argument for US VCs to invest in NZ IP-holding entities that do enjoy the benefit of expensed R&D?

John La Grou – imersiv founder

We had plans to open an R&D lab in Nelson-Tasman area as an extension of our US corp but then the pandemic hit. As we’ve learned, the tax and financial rules when straddling two countries are complex. This just piles on.

Andy Hamilton – Kiwi advisor/investor

So then don’t let US investors get over 50 percent unless total buy out. Or flip before.

• Lovina’s reply: I think maybe this clause was intended to be anti China but we are getting in the cross hairs. We need our government to be watching this stuff and advocating on behalf of the tech sector. And yes, US tax policy is massively complex. So is New Zealand’s btw.

Ben Young – Nudge CEO

There’s an amendment coming through at the moment to undo or satiate this – looks like it has bipartisan support.

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