R&D tax guidelines 2015 review
Revenue’s interpretation of R&D tax credit legislation
And its impact on submitting an R&D tax credit claim
On 14 January 2015, Revenue released an updated version of the R&D Tax Credit Guidelines. The updated guidelines were prepared by Revenue following an extensive review process. This was undertaken with the input of Deloitte and other specialists in the field of R&D tax credits. The process involved a series of submissions, TALC meetings and other correspondence. Deloitte welcomes the new guidelines, which contain a number of clarifications on Revenue’s interpretation of the legislation.
Having undertaken an analysis of the latest iteration of Revenue’s R&D Tax Credit Guidelines, a number of trends are apparent with respect to Revenue’s interpretation of the legislation. The two main trends being:
- Reduced scope for the inclusion of overheads in the claim and
- Increased importance of documentation in support of the R&D activities included in the claim.
In relation to overheads, the new guidelines are consistent with what we have experienced with Revenue during recent Revenue audits, with their view on the range of overheads allowable being further narrowed. Where previous practice accepted costs incurred “for the purposes of” or “in connection with”, Revenue states that only costs “incurred wholly and exclusively - 1. In the carrying on 2. by it (the company)” are to be included in the claim. In the updated guidelines, Revenue has prescribed a number of specific overhead costs that should be excluded from the claim.
Revenue has also placed increased importance on the retention of supporting documentation that is contemporaneous and relevant. There is a notable change in tone in relation to the supporting documentation. Revenue now state that the “failure to keep such documentation may result in the claim for the R&D tax credit being disallowed”. However, this tone is coupled with Revenue’s recognition of a wider array of supporting documentation and alternative development methodologies and life cycles.
Deloitte feels that there are a number of areas that still require further clarification and are not in full agreement with all of Revenue’s positions, as stated in the most recent guidelines. However, on balance, we view the updated guidelines as a positive move in conveying Revenue’s position with respect to a number of areas, and that they demonstrate the evolution of the legislation and its interpretation and application in the context of commercial R&D undertaken in Irish industries.
In addition, Deloitte has highlighted the main areas changed in the updated guidelines and how these may affect companies conducting qualifying R&D activities in claiming the R&D Tax Credit.
2. General scheme
We welcome the addition of further clarity and instruction provided with respect to payable credits. Of particular note is the clarification where cash instalments are outstanding.
2.7 - “while the claim for the first instalment must be made within the one year limit mentioned above, claims for the other instalments are not separately subject to this time limit.”
However, we query the reference to payment in the statement, “credits can be paid no earlier than the 21st day of the 9th month following the end of the relevant period, and 12 months and 24 months following the date the first instalment was paid”; this is at odds with the legislation that states that the second instalment will be made no earlier than 12 months following the specified return date for the chargeable period. This is of particular relevance in the event of a delay in payment by Revenue of the first instalment.
3. Qualifying research and development activities
This section of the guidelines saw a number of positive insertions that will assist companies in the identification of their qualifying R&D activities, particularly in software development. The emphasis on the retention of documentation that is “contemporaneous and relevant” in support of the claim has been greatly increased. This is highlighted by Revenue in the new guidelines by the inclusion of the statement, “Failure to keep such documentation may result in the claim for the R&D tax credit being disallowed.”
While additional detail on software development activities is encouraging, the insertion of certain broad statements such as, “much software development does not qualify as R&D activity”, “management tools such as; ‘Lean’ process improvement systems... does not constitute qualifying R&D” and in relation to large scale software projects, “tracking of qualifying expenditure should be a relatively straightforward exercise” are of concern. Deloitte feels that R&D activities must be assessed in accordance with the legislation. Activities surrounding the development of software or lean processes may meet the legislative qualifying criteria and should not be dismissed out of hand.
The new guidelines have provided a number of new examples for qualifying and non-qualifying R&D activities in the software sector. In the new version, Revenue has recognised non-linear approaches to R&D such as ‘agile’ and that apportionment of the expenditure for these approaches can be difficult. Deloitte sees no reason why such flexibility shouldn’t also apply across other industries.
4. Qualifying expenditure
Revenue has made a number of clarifications on its position regarding the qualification of expenditure. The inclusion of the terms “wholly and exclusively in the carrying on by a company” is a new addition in the description of R&D activity within the guidelines and is in line with the description provided for in the legislation. We would seek further clarification from Revenue with respect to the differences between “in the carrying on” “by it (the company)” from the previously included “for the purposes of” and “in connection with”.
The guidelines provide examples of indirect overheads that Revenue does not now consider to be qualifying expenditure, such as, “recruitment fees, insurance, travel, equipment repairs or maintenance, shipping, business entertainment, telephone, bank charges and interest”. Later in the document HR costs, payroll team costs and canteen costs are also explicitly mentioned. As a consequence, the scope for inclusion of indirect overheads which, from experience, were allowable within the R&D Tax Credit, has been reduced considerably, although the legislation has remained unchanged in this regard and prior versions of the guidelines indicated that such expenditure could qualify for the credit. Furthermore, Appendix 2 states that administration and general support services that are not wholly and exclusively undertaken in connection with a research and development activity do not qualify. This implies to a reader that where such services are wholly and exclusively undertaken in connection with a research and development activity, this activity would qualify. This contradictory information makes it difficult for companies when preparing their claim. Deloitte argues that, where demonstrable, a number of these costs can be consumed in the undertaking of qualifying R&D activities, such as costs for: repairs and maintenance; telephone service; shipping; and travel. Where this can be demonstrated, a straightforward and supportable apportionment could be made to include the aforementioned overheads.
Deloitte welcomes Revenue’s updated guidance of acceptable employee-related emoluments, which we believe is in line with general practice to date. The guidance on employee-associated costs has been updated with clarity on emoluments allowable under the scheme. This outlines pension contributions, bonus payments, health insurance and other items included in an R&D employee’s reward package. We query the apparent limitation of health insurance to exclude contributions made to cover that of the R&D personnel’s spouse (as per example 12), as it is our understanding that this contribution could form part of the employee’s reward package.
It is noted that in the case of proprietary directors or other persons with the capacity to directly control their own emoluments, payments that are significantly out of line with normal emolument practice within the company will generally not be regarded as eligible expenditure.
Revenue has also further tightened the scope of allowable overheads associated with the employment of an individual with specific reference to payroll team costs, HR costs and canteen costs.
Guidance has been provided where costs are incurred relating to an individual consultant hired on a short-term basis to undertake subcontracted R&D activities; this cost may be treated as a direct employee cost providing that certain conditions are met and that the engagement period spans at most six months. This treatment is broadly in line with what has generally been accepted by Revenue.
Section 4.6 of the new guidelines states that, “Materials used in qualifying research and development activities may be of further commercial value after their research use has concluded. In this situation, the lower of cost, or net realisable value of any materials or other saleable product which remain after the R&D activity should be deducted from the expenditure claimed.” We do not see the legislative basis for this and disagree with this as a basis for determining qualifying expenditure. Taking the example of a company that may realise the potential to sell some or all of its prototype products following success in achieving a technological advancement, is it reasonable that Revenue would seek to penalise a company for successfully carrying out efficacious R&D? Whether materials that are used in undertaking an R&D activity have or do not have further commercial value subsequent to the R&D project has no bearing on the resolution of technological uncertainty. Deloitte does not agree with Revenue’s stance on this issue as stated in the updated guidelines, and would question the legislative basis for this interpretation.
5. Capital expenditure
In the updated guidelines, Revenue states in relation to buildings and structures used for R&D that the credit can now be realised from the date the building was first brought into use. Where expenditure is incurred on the construction of a building which spans two or more accounting periods, the aggregate expenditure is treated as incurred from the date the building is brought into use. Revenue has clarified that the 12-month claim period applies by reference to the date the building is brought into use.
Revenue’s position on expenditure on plant and machinery, as previously stated in Tax Brief 59, 2005, is now included in the guidelines. This may be treated as incurred on either: (1) the date the plant and machinery is first brought into use for the purposes of a trade; or (2) the date the expenditure becomes payable. The latter option is subject to a condition that the credit will be clawed back if the plant or machinery is not brought into use for the purpose of a trade within two years of the date on which the expenditure becomes payable.
6. Subcontracting R&D activity
The 2015 guidelines state that, “It is important to note that the outsourced activity must constitute qualifying R&D activity in its own right.” We would welcome further clarification in relation to this newly inserted statement, as this appears to contradict Revenue’s previous working practice.
Deloitte is of the opinion that a holistic view of research and development activities should be taken in view of the overall context of the R&D project. While viewed solely in isolation, certain activities, undertaken in resolution of scientific or technological uncertainties, may not constitute qualifying R&D. However, when combined with other research activities they may be fundamental to the resolution of the technological/scientific uncertainty and would therefore constitute R&D activities in their own right.
7. Group expenditure on R&D
We welcome the clarity provided in section 7.6 with regard to the transfer of R&D activity within a group structure. Where a company is claiming a tax credit under TCA s.766 ceases to trade and another company commences to carry on that trade and continues the qualifying R&D activity related to that trade. The “successor company” may claim any R&D tax credit amounts not used by the former company.
This is allowed on condition that:
- Both companies were members of the same group of companies at the time of the transfer of the trade and
- The “successor company” carries on the qualifying R&D activity for a period of at least two years after the transfer.
The “successor company” may use any unused credits to reduce its current or future Corporation Tax liability, but it may not claim a payable credit in respect of any such unused amounts.
8. Requirements for a valid claim
Revenue’s theme of greater emphasis on the importance of contemporaneous documentation continues in this section of the guidelines. While we welcome the expansive list of examples of supporting documentation, the acceptance of the levels of record-keeping within different industries, and the acceptance of non-traditional hard copies as supporting documentation, we would welcome further clarification in relation to a number of areas.
For companies claiming the R&D Tax Credit, it is important to note that the list of information outlined in 8.2 (The Accounting Test) is not a legislative requirement and needs only to be retained “if relevant”. It is conceivable that companies may not prepare all of the documents listed for projects, and we would not view this as preventing the company from making a claim as long as contemporaneous evidence exists that evidences the qualification criteria, which are:
- The systematic, investigative or experimental nature of the project
- The scientific or technological advancement sought and
- The scientific or technological uncertainty being resolved.
We feel that consideration should be given to the administrative requirements to maintain records and a burden should not be placed on a company to maintain records that are prepared only for the purpose of supporting an R&D tax credit claim.
Revenue has included an expectation for the retention of the date where “activity associated with commercial exploitation begins”. We are also concerned that this may give rise to a view that qualifying R&D activities end when commercial exploitation begins. In practice, while this is often indicative of the conclusion of R&D activities, it is often not always the case and qualifying R&D activities often occur in tandem with non-qualifying commercialisation activities.
We view as progressive Revenue’s acknowledgement of supporting documentation in soft format and the acceptance of different regulatory requirements within industries. We would welcome further clarification of the “integrity of the records” and hope that Revenue does not require what can be impractical document management systems in order to use electronic records to support claims.
Overall we welcome the updated guidelines and the clarification that Revenue has provided in relation to a number of areas. While we disagree with Revenue’s stance in relation to certain issues (namely, the treatment of expenditure on materials, certain overheads, and subcontracting), we believe that the new and additional working examples, as well as the clarification of a number of issues, will provide useful assistance for non-practitioners in identifying qualifying R&D activities and correctly claiming the R&D tax credit.
We will be discussing and seeking further guidance from Revenue in respect of a number of issues raised.
Should you have any queries in relation to the new guidance and how it could impact on your company please do not hesitate to contact any member of our team.