Let’s talk about R&D

Last week saw the end of the public consultation on the R&D Tax credit.  As I’ve always said Consultation with us decreases Consternation amongst us. So let’s talk.

A tax credit may not determine whether R&D is undertaken in the first place, but it may be a factor in determining where the R&D is organised, in addition to other issues such as: wage costs, infrastructure, political ethos etc.  Humans are naturally curious creatures and like to solve problems.  As JFK said: "We go to the moon in this decade and do other things not because they are easy but because they are hard…".  Therefore R&D will happen; we just need to make sure it happens in this country with all the ancillary benefits that come with it.  

That’s what the consultation was all about in that it effectively questioned the good, the bad and the ugly of the R&D tax credit.

The consultation document explains that the central purpose of the R&D Tax Credit is to encourage companies to undertake high-value-add R&D activity in Ireland, thereby supporting jobs and investment here. The principal benefit of the R&D Tax Credit is that it reduces the costs of undertaking R&D in Ireland by 25%.  Where a tax deduction can be taken for the expenditure incurred in computing a company’s trading profits then the benefit to the company concerned can be 37.5% of the related expense.   Of course significant Ts & Cs apply; it wouldn’t be tax otherwise.   

To put this in some perspective the cost to the Exchequer of the credit in 2017 was €448 million which was claimed by 1,505 companies.  The previous year cost the Exchequer €670 million. So the relief is a significant one but here’s the thing:  The credit is an important enticement for R&D investment here, in creating new and sustaining employment here and not just in R&D functions but in downstream activities here such as manufacturing operations and related functions.    

Now for the science bit.  The R&D tax credit reduces a company’s corporation tax bill for the year in which the relevant expenditure is incurred. Any unused amount can be carried forward and used to reduce corporation tax bills in subsequent periods. Where an excess amount remains, instead of carrying it forward, a company can use it to reduce its preceding period’s tax bill which may give rise to a tax refund. Any amount left over can still be carried forward by that company to reduce its future tax bills or the company can claim to have the excess amount refunded by Revenue in three instalments over a period of nearly three years from the end of the accounting period in which the expenditure was incurred. So reduce or refund is the mantra here. 

A number of questions in the consultation document focussed on the SME sector and asked why there was a “relatively low uptake” of the current credit by SMEs and how can it be made more attractive for them.   For a start, resources are not always available to SME’s to undertake qualifying R&D as the time period between the R&D phase and having an income generating product may be significant unless a eureka moment happens early on.

Indeed the SME might not have the capability available to it to carry out the R&D and in that instance they may have to subcontract the work out to others who have that missing link.  However, the activity and related costs that can be incurred on subcontracting activity out to others may be restricted from a credit perspective. Therefore, a company with in house capability may be in a better “tax credit position” than another company that has to look elsewhere.  The result for either company may be the same but the costs to each company may differ because of the credit. 

But that problem isn’t just confined to SMEs e.g. where a company pays a university or institute of higher education to carry on certain R&D activities then that cost should be creditable to the extent of the greater of 5% of that expenditure or €100,000.  Creating an environment where universities and industry complement each other results in a self-sustaining R&D process makes for the best of all worlds.  Myron Scholes (Nobel prizewinning economist) and others once wrote: "Success is achieved when the tax rules subsidise activities that benefit society as a whole more than they benefit the individuals engaging in the activities ...".  Increasing the above limits would fall within this dictum.

But back to SMEs and the cash flow challenges can be added to by the time between making the claim and receiving the tax credit payments. Refunds are over three years and waiting for jam tomorrow is not as easy has having jam today.  Therefore, it would be preferable to reduce the number of cash instalments from three to one for SMEs to reduce the cash flow burden. To be clear that “one” takes the place of the first instalment, not the last!

Why not increase the credit for SME’s?  It will be recalled that tax law allows incentives for certain companies in start-up mode to reduce their corporation tax so why not follow that lead for R&D.  Why does the credit have to reduce corporation tax? Why not let it reduce other tax liabilities such as payroll taxes thereby effectively reducing the company’s labour cost until such point as they are no longer an SME. David becoming Goliath is always a good news story.

I recall the intro to the “Six Million Dollar Man” TV series from years ago (I watched repeats!) where the narrator recounts the fate of a severely wounded Steve Austin: “We can rebuild him. We have the technology. Better than he was before. Better, stronger, faster”.  We might not be that advanced yet technologically speaking but wouldn’t it be fantastic if the R&D credit helped us get there?  We got this.

Tom Maguire is a tax partner with Deloitte and his column on tax matters appear in the Sunday Business Post. The above column was first published on 16th June 2019.

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