Introduction

The Irish R&D Tax Regime is considered one of the most competitive and innovative schemes worldwide. The most recent Finance Act introduced further measures to broaden and enhance the benefits of the credit to Irish companies and, as of 1 January 2012, the key employees whom are carrying out the R&D activities.

The R&D Regime also places Ireland at the forefront in terms of attractiveness for foreign direct investment by companies who are engaged in a significant level of R&D. This stimulates economic growth and employment where foreign multinationals choose Ireland as a location for their R&D activities.

Companies, ranging from SME's to large multinationals, incurring expenditure on research and development (“R&D”) activities could benefit from tax relief resulting in an effective deduction of 37.5%. This comprises a 25% tax credit on the qualifying expenditure in the period, in addition to, a full corporation tax deduction for the expenditure incurred.

Overall Benefit of the R&D Scheme

From an economic perspective, the R&D scheme provides an incentive for companies engaged in R&D to locate in Ireland which creates jobs and promotes economic activity. It also encourages Irish companies to engage in R&D in-house and thus, contribute to Ireland and the ‘knowledge economy’ by encouraging innovation.

At a corporate level, companies have the opportunity to get more ‘bang for their buck’ in terms of incurring expenditure on R&D activities in light of the tax benefit they can obtain under the scheme. Now that the unused credits may be available as cash refunds, this is particularly beneficial to start up companies or loss making SME's as it can act as valuable cash flow and essentially, part fund the R&D activities.

Employees will be motivated and incentivised where companies surrender their excess tax credits to key employees.

For foreign entities, it can also be an attractive aspect of their secondment or relocation package where they wish to locate key staff in Ireland from other jurisdictions.

Qualifying Criteria

To qualify for the R&D credit, a company must incur expenditure in carrying on qualifying R&D activities in the European Economic Area (EEA).

Expenditure must be incurred on systematic, investigative or experimental activities in a field of science or technology within one of the following research categories:

• Basic Research
• Applied Research
• Experimental Development (work undertaken which draws on scientific or technical knowledge or practical experience for the purposes of achieving technological advancement and which is directed at producing new, or improving existing, materials, products, devices, processes, systems or services including incremental developments thereto.)

The activities should seek to achieve scientific or technological advancement and should involve the resolution of scientific or technological uncertainty.

Examples of R&D activities include:

• Changing existing manufacturing processes or developing new technologies that obtain a better yield from a product, less waste, reduced packaging or quicker manufacturing of batch times whilst preserving quality.
• Testing manufacturing processes in light of changes to a product's component parts i.e. raw materials, supplier of raw materials etc.
• Cost of aligning current processes with environmental, safety or other regulatory regulations which may impact on the manufacture of a product.
• Development work in relation to changing an existing manufacturing process following the introduction of new equipment to the manufacturing line.
• Introducing new packaging and carrying out tests to analyse the impact of sterility, shelf life and/or quality of the product.
• Developing a machine to enable an activity previously performed manually to become an automatic/mechanical process.

Types of Companies that qualify for the R&D Credit

The common misconception is that the R&D Tax Credit is only available to companies in the pharmaceutical and medical sectors or laboratory type companies, however, this is not necessarily the case.

The definition of what is regarded as qualifying R&D has evolved from when the legislation and guidelines were first introduced in 2004, and activity across all sectors of the economy can now come within the realm of the R&D Regime.

Companies in sectors such as Financial Services, Retail, Life Sciences, Engineering, Technology, Manufacturing, Food/Agribusiness and beyond have successfully claimed R&D tax credits for innovative activity that they are carrying on in their business. The common element being that these companies are carrying on activities which are regarded as experimental development, with uncertainties and advancements, in the science or technology aspect of their business and that is relevant to their particular sector.

While the majority of these companies are not ones that you would traditionally consider to be carrying on R&D activity, these companies are often carrying on development work which would be considered to be qualifying for R&D tax credit purposes, being in most instances, experimental development, defined above.

Qualifying Expenditure

Qualifying expenditure includes both current and capital expenditure.

Examples of expenses that may qualify include plant & machinery, fixture & fittings, raw materials, consumables such as power/light & heat, director and staff costs, sub contracted R&D costs (subject to certain restrictions).

Supporting indirect costs incurred can be allocated on a “just and reasonable basis” to the qualifying R&D activity. Examples of such costs would be Human Resources Dept, Finance Dept, Maintenance Dept costs and so on.

In addition, building costs may qualify where buildings or structures are used for the purposes of R&D 35% of the time over a four year period.

Tax Relief

Recently introduced in Finance Act 2012, the 25% tax credit is now guaranteed on the first €100,000 spent on qualifying R&D expenditure. This ensures a tax credit of €25,000 based on €100,000 of expenditure which may be offset against the current year corporation tax liability (or refunded where appropriate).

Traditionally, the tax credit was calculated by reference to the incremental expenditure above the expenditure incurred in the base period which was 2003. The new provision, which was introduced with the SME sector in mind, outlined above, ensures that companies who had incurred a significant amount of expenditure in 2003 as part of a start up/large investment would still obtain a benefit from the R&D Regime going forward despite there being no incremental spend.

In addition to this ‘volume based’ approach, the government have further incentivised companies to engage in R&D activities in Ireland in recent years, by introducing increased flexibility in how the credit may be used.

Traditionally, the credit was available against current year taxable profits with any unused credits being carried forward indefinitely.

Successive Finance Act changes since 2009 can be summarised as follows:

• From 2009, in circumstances where the company has insufficient corporation tax, they may claim a cash refund over a 3 year cycle. The amount payable will be limited to the greater of the corporation tax payable over the preceding 10 years or payroll taxes for both the current and prior period (as adjusted).
• As of 1 January 2012, the credit may be surrendered to key employees reducing their effective tax rate to 23%.

Generally speaking, ‘key employees’ refers to employees who perform 75% or more of their employment duties undertaking R&D.

Other Key Aspects

Group Reorganisations

New reliefs have been introduced to cater for the transfer of R&D tax credits in the context of group reorganisations. Subject to certain conditions, where a trade is transferred between 2 group companies, the transferee company may claim any R&D tax credits not previously used by the transferor company.

Where a building, on which R&D credits have been claimed, is disposed of as part of transfer a trade, then, subject to certain conditions, the transferor company will not suffer a clawback of any credits previously claimed and the transferee company may claim any unutilised credits arising on the building.

Sub-contracted R&D Costs

Improvements to the sub-contracting provisions should also provide an additional benefit to R&D undertaken by SME's that do not have the facilities or capabilities to carry out R&D in-house. Originally, sub-contracted R&D costs were eligible where they did not exceed 10% of total R&D costs or 5% in the case of sub-contracting to third level institutions. However, this limit has now been increased to the greater of 10%/5% (as appropriate) or €100,000. Again, this measure sought to benefit the SME sector directly.

It is important to note that the area of payments to 3rd parties has been tightened and will need careful consideration by companies engaging externally provided workers, particularly in the context of their contractual arrangements.

Costs Incurred in EEA and EU/EEA Grants

The tax credit applies to companies within the scope of Irish tax and who are engaged in R&D activities anywhere in the EEA, however, the majority of the work should be carried out in Ireland as the company is required to be within the scope of Irish tax.

The provisions regarding grant assistance has also been extended. Previously, only grant assistance from the State was permitted but now grants or other assistance received from EU/EEA jurisdictions have been incorporated into the Irish R&D Regime.

Administrative Requirements

The claim for an R&D tax credit must be made within 12 months of the company's accounting year end in which the expenditure is incurred. In most cases, the claim will be made at the time the corporation tax return is due to be submitted. The claim is incorporated into the corporation tax return, if the claim is made after the return has been submitted then a letter to Revenue providing the relevant details is an alternative approach.

Appropriate records must be maintained in order to substantiate the claim in the event of an enquiry by Revenue.

Documentation Requirements

The R&D activities must be systematic, investigative or experimental in nature. The guidelines issued by Revenue require documentation to be maintained on:

• The nature of the project, the objective of the research and the research method;
• The field of science or technology concerned;
• The scientific or technological uncertainty that is being addressed by the R&D and the project's scientific or technological goals;
• The skills and qualifications of the research team;
• Time records;
• Expenditure analysis including third party expenses and royalty payments.

Further detail has been published in Revenue's Tax Briefing 71.

Revenue Advance Opinions

The Irish tax authorities are prepared to give advance opinion as to whether a particular project would qualify for an R&D tax credit. This provides comfort to companies that they are entitled to the credit.

Rebecca Greene is a Tax Consultant with PricewaterhouseCoopers

Tele: (01) 792 5059

Email: rebecca.greene@ie.pwc.com