The R&D tax credit regime, there’s a lot done but more we can do

Tom Maguire discusses R&D Tax policy in his Business Post column

In February of this year Minister Donohoe noted in the Dáil that a review of the R&D tax credit was to take place during 2022. He explained that “the review would consider the potential impact of the agreement reached at the OECD/G20 Inclusive Framework on BEPS on the R&D tax credit, particularly the Pillar 2 global anti-base erosion rules. It will also have regard to any elements of the ongoing process of international tax reform which may be of relevance to the credit. The review will inform any policy considerations to be undertaken in advance of Budget 2023, and it is therefore intended that the review will be published on or before Budget Day, this October”. We recently saw the commencement of a public consultation on the matter.

On the BEPS point, we know that the Ecofin failed to agree recently on Pillar 2 but nothing’s over ‘til it’s over. Executive Vice-President Dombrovskis noted in his related press release “We also regret that agreement was not possible in today's Ecofin and would like to commend the French Presidency's outstanding work and commitment to make sure that there is consensus and agreement on this important file. We do hope that this agreement will be possible at the next Ecofin”. That meeting is on 24th May.

You don’t need me to tell you that Ireland competes for foreign direct investment with multiple geographies. We also compete for R&D activities performed by established multinationals. In Ron Suskind’s “the Price of Loyalty” the author notes that Paul O’Neill (former US secretary of Treasury) said “you find someone who says, ‘I do more R&D because I get a credit for it’, you’ll find a fool”. A tax credit won’t therefore be R&D’s driving force, but it can be a factor in determining where such R&D happens. Therefore, our regime should be sufficiently attractive that R&D is carried on here.

The nutshell version is that the R&D tax credit allows a company to claim a 25% tax credit in respect of expenditure incurred on qualifying R&D activities. Companies must satisfy two tests: the activity must be a qualifying activity (the so-called science test) and the amount of the claim must be based on R&D expenditure incurred. The definition of qualifying R&D activities requires that a claimant company engage in a systematic, investigative or experimental activity which seeks to achieve a scientific or technological advancement in a field of science or technology and involves the resolution of scientific or technological uncertainty.

Narrowing allowable expenditure within claims creates significant difficulty for taxpayers. The removal for example, of certain rental costs as an allowable expense meant a reduction in the R&D tax credit’s value for many taxpayers. We know the UK government said in its recent Spring statement that from April 2023, all cloud computing costs associated with R&D, including storage, will qualify for its equivalent relief. It also said that the definition of R&D for tax reliefs will be expanded by clarifying that pure mathematics is a qualifying cost to support the growing volume of R&D underpinned by mathematical advances.

Therefore, it would be a positive move to see a broadening of the direct R&D costs that qualify for the credit to include e.g., outsourced services which are not R&D when considered as stand-alone activities. This should encourage companies and in particular SME’s, to invest in R&D and ensure that they get the benefit for the specific costs that are essential to the R&D process. The types of expenditure could include certain work on prototypes/materials/samples and where materials and equipment are modified or transformed by external suppliers so that the claimant company can use these items in their R&D. Indeed, an increase in the monetary amount that can be subcontracted out by the respective companies to other operators would be beneficial so that the cost of R&D could be reduced.

Going off point a minute, the UK Spring Statement said that “Where required, legislation will be published in draft before being included in a future Finance Bill to come into effect in April 2023.” We have seen similar draft legislation as part of a feedback statement process with the Department of Finance. In my view, it would be beneficial if such an approach could be continued as a matter of course. We’ve had multiple public consultations in the past on policy matters, and that’s fantastic, but legislation is where the policy rubber hits the taxing road, and it would be valuable to adopt such an approach in general. That way tax and industry boffins could give their views on draft law before the President puts his signature on it. Consultation decreases consternation and it’s always good to talk.

Back to R&D. An immediate benefit for Ireland’s competitiveness would be to increase the R&D tax credit for all taxpayers. Finance Act 2019 suggested such a 30% relief for smaller enterprises which was subject to Ministerial order due to EU approval being required. The Minister said in the most recent Finance Bill debates that following initial engagement with the EU Commission it was determined that it would be necessary to introduce some changes to secure state aid approval. He noted that as the measures in their current form are enhancements to the existing general research and development tax credit this could pose a significant administrative challenge to taxpayers and Revenue if different criteria were to apply to two elements of a claim for the same research and development cost. The Minister continued that adding complexity and an administrative burden would be counter-productive in assisting small and micro companies.

Increasing the tax credit appropriately would reduce the cost of conducting high value activities, managed and conducted by a skilled workforce in Ireland. It also has the added benefit of closing the gap on Ireland’s R&D specific competitiveness when compared to other European and international geographies where more generous tax benefits exist for undertaking R&D activities.

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; we like to solve problems. So R&D will happen; we just need to ensure it happens here with all the ancillary benefits that come with it.

Please note this article first featured in the Business Post on Sunday, 24 April 2022 and was re-published kindly with their permission on our website.

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