Let’s do more for R&D so that more R&D will happen here

Tom Maguire discusses the R&D aspects of the Tax Strategy Group Budget 2023 paper in his latest Business Post column

The Tax Strategy Group (TSG) Budget 2023 paper on Corporation Tax weighed in at around 50 pages covering many issues; one of which included the R&D credit regime. The paper explains the credit’s primary objective is increasing business R&D in Ireland to contribute to higher innovation and productivity. The TSG continues that the tax credit forms part of Ireland’s corporation tax offering aimed at attracting FDI and building an innovation-driven domestic enterprise sector.

Ron Suskind’s book “The Price of Loyalty” tells the story of Paul O’Neill (former US secretary of Treasury) saying “you find someone who says, ‘I do more R&D because I get a credit for it’, you’ll find a fool”. The key is where that R&D happens. We want it to happen here.

In a nutshell, the R&D legislation provides a 25% tax credit for all qualifying expenditure. It reduces the company’s corporate tax liability for the accounting period in which the relevant expenditure is incurred. Any excess credit can be carried back to a prior period and anything left over can be carried forward for use against future corporate tax liabilities or can be refunded.

That refund is available in effectively three annual instalments. The first comprises 33% of the excess amount. The remaining balance will be used to reduce the company’s tax liability of the next accounting period and if any of excess still remains, a second instalment amounting to 50% of that remaining amount will be refunded not earlier than 12 months after the corporation tax pay and file date for the accounting period in which the R&D expenditure was incurred. Anything still remaining reduces the company’s Corporation Tax liability of the following accounting period, and if any part still remains, that amount will be refundable not earlier than 24 months after the corporation tax pay and file date for the accounting period in which the R&D expenditure was incurred.

The refund amount is limited to the greater of the Corporation Tax paid by the company for the previous ten years, reduced by any R&D Credit claimed, or a measure of general payroll liabilities (PAYE, USC and PRSI) for the claim period. We could change the law so that the refund is made in Year 1 rather than spread over a number of years. Same cost to the Exchequer but the timing would change. That would be a significant benefit for start-ups and scaling businesses. Cash is the lifeblood of business, and given what’s probably coming our way this winter, at least such refund could be made available to SME’s in the first year.

For large corporate groups, we may see a 15% tax rate based on the proposed EU directive (the so called “Pillar Two” directive after the OECD agreement on the matter). One of the key measures available to Ireland to remain attractive, if the draft directive is agreed, is our R&D regime. The TSG notes that “Officials are examining whether policy adjustments should be made to the R&D tax credit to adapt to these new standards, to ensure that it can continue to meet the policy objective”. Let’s be clear here, Pillar Two isn’t just a “rate changer” but rather a “rulebook changer” with all countries having to adopt similar systems. Policy differences can enhance competitiveness.

Here’s the science bit. The TSG paper explains that if the R&D credit is “a qualified refundable tax credit”, it is treated as income (like a taxable grant) and taxed at 15% under Pillar Two. The company’s full tax liability, including tax settled by offset of the R&D credit, is recognised in computing the company’s effective tax rate.

If the R&D credit is a non-qualified refundable tax credit, the amount of the credit is treated as reducing the corporation tax paid by the company. The TSG notes that as Ireland’s 12.5% rate is already below the 15% minimum rate, “this would result in an increase in the top-up tax required to be collected in order to meet the Pillar Two minimum effective tax rate, thereby wiping out the benefit of the credit”.

Further, to be “qualified”, a credit must be paid as cash or available as cash equivalents, within 4 years from when the claimant satisfies the conditions for receiving the credit. I say all this because there are limits on the cash refund and we may change our credit to get qualified so while we’re at it let’s make the most of what we can change.

R&D projects and particularly those that involving digitisation, include significant spend on annual subscriptions for software licences, digital platforms, data costs and renting cloud services etc. Indirect overhead costs such as certain rent, recruitment fees, insurance, travel, equipment repairs or maintenance, may not qualify as relevant expenditure. These costs should be qualifying if we are to continue to encourage R&D activities here.

Broadly, expenditure incurred on R&D activities carried out by third parties would not be qualifying expenditure. There are exceptions e.g. where a company incurring expenditure in carrying out R&D activities also pays a sum to a university or institute of higher academic education in the EEA to enable it to carry out R&D work on behalf of the company. That sum, up to the greater of €100,000 or 15% of the expenditure incurred on R&D activities carried out by the company should qualify for credit. Expenditure incurred by a company on subcontracting R&D work to an unconnected party should qualify for relief up to a limit of the greater of €100,000 or 15% of qualifying R&D expenditure incurred by the company in any one year. Removing these limits would encourage interaction and collaboration between Irish businesses and with Irish third level institutions.

Finally, the TSG notes that Finance Act 2019 provided for a number of targeted supports for micro and small companies within the R&D tax credit e.g. an increased credit rate of 30%. The paper explains that they were made subject to a commencement order pending further engagement with the European Commission. It was then determined that it would be necessary to introduce some changes to the measures in order to secure State aid approval which could present a significant administrative challenge to both taxpayers and Revenue if different criteria were to apply to two elements of a claim for the same R&D costs. It is important that we do what we can to encourage this sector given the next Instagoogletweetface could come from such initiatives.

We want R&D to happen here. Let’s make it happen.

Please note this article first featured in the Business Post on Sunday, 11 September 2022 and was re-published kindly with their permission on our website.

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