Contrary to international perceptions, Ireland does not offer many tax reliefs for corporates beyond its starring act of the 12.5%. The launch of Knowledge Development Box (KDB) was something akin to a Hollywood block buster (in as much as you can stretch tax to a comparison with Hollywood blockbusters!) by virtue of the fact that new tax reliefs are so rare and because of the backdrop on the world tax stage at the time.

Over the last number years, Ireland has had to defend its corporation tax policy against disapproval coming from fellow EU Member States, the USA and the OECD so the introduction of a new corporation tax relief in Ireland had to be carefully constructed to avoid further criticism. Hence the KBD was developed with the OECD’s modified nexus formula built into the calculation of the relief. The nexus approach provides that a taxpayer can benefit from an intellectual property (IP) regime only to the extent that it can clearly show that expenditure it incurred has resulted in IP. Even though other countries operate a KDB without a modified nexus formula, Ireland had just been the focus of an international debate which culminated in a change to our laws to block the infamous ‘Double Irish’ so it’s likely that the Government wanted to keep critics quiet by going one step further. The outcome was a KDB with a modified nexus approach.

How does the relief operate?

The rules and conditions to qualify for tax relief under the KDB are complex and are provided for in Chapter 5 of Part 29 of the Taxes Consolidated Act 1997 (TCA 1997) from section 769G TCA 1997 to section 769R TCA 1997. The following discussion is a general outline of how the Irish KDB operates and detailed guidance from Revenue is expected in the near future.

A company which qualifies for the KDB is entitled in effect to have its profits from patented and similarly protected inventions taxed at a rate of 6.25%. This lower rate arises because the company can claim a deduction equal to 50% of its qualifying profits arising from the qualifying asset in computing the profits of a specified trade relevant to the qualifying asset. Therefore a qualifying company is required to treat the activities that qualify under the KDB as a separate specified trade. The KDB is closely linked with the R&D regime and a claimant company must incur expenditure on R&D and such expenditure is subject to the same technical qualification criteria as required for R&D tax credit claims.

The KDB is available for accounting periods that commence on or after 1 January 2016 and before 1 January 2021 and the claim forms part of the Corporation Tax return. A “relevant company” can make a claim for KDB relief. A relevant company is a company which carries on a specified trade and is within the charge to tax in the State. The relevant company must have qualifying R&D activity that results in the creation of qualifying assets. Qualifying assets are defined in section 769G (1) TCA 1997 as an invention protected by a qualifying patent as defined in section 769(G)(1) TCA 1997, copyrighted software and generally any asset which is intellectual property which is the result of research and development activities.

Any marketing related IP such as trademarks, brands, image rights and other intellectual property used to market goods or services cannot be a qualifying asset.

The KDB tax relief only applies to income from the sale or exploitation of the IP in the same company which undertakes the R&D activity. While this condition may not suit the manner in which international groups structure their R&D operations, the relief is still beneficial for many Irish companies that operate R&D activities. In 2014, 1,570 companies claimed the R&D tax credit to a value of €553.3 million so no doubt many of these companies can enhance their tax relief entitlement going forward with the KDB if the relief is claimed correctly.

The main components for calculating profits which qualify for tax relief under the KDB are:

1. overall income from the qualifying asset,
2. the qualifying expenditure (R&D) in the development of the qualifying asset, and
3. the total overall expenditure to develop the asset.

Qualifying profits

For each qualifying asset, the qualifying profits (per section 769I (1) TCA 1997) must be calculated by applying the following formula:

Qualifying Expenditure + Uplift Expenditure	× Profits of the Specified Trade
Overall Expenditure

For the purposes of the above formula, qualifying expenditure means expenditure incurred by a relevant company wholly and exclusively in the carrying on by it of research and development activities in a Member State (i.e. an EU or EEA State), where those activities lead to the development, improvement or creation of the qualifying asset. The definition of R&D activity under the KDB is the same as the definition used for the R&D tax credit as per section 766 TCA 1997.

Acquisition costs relating to the qualifying asset are excluded from the definition of qualifying expenditure as are interest and payments deductible as a charge such as patent royalties. Payments made to a related group member for the carrying on of R&D, including cost-sharing arrangements are also excluded from qualifying expenditure, although R&D payments on outsourcing to non-related parties are considered to be qualifying expenditure for the purposes of the relief.

To make some allowance for excluded expenditure on acquisition and group outsourcing costs, an uplift in the amount of qualifying expenditure is available to include the lower of:

• 30% of the amount of the qualifying expenditure; or
• the aggregate of acquisition costs and group outsourcing costs.

Profits of a specified trade

As noted already, the qualifying company is required to treat its KDB-qualifying activities as a separate “specified trade”. The income for inclusion in the computation of the profits of a specified trade is defined under section 769G (3) TCA 1997 as profits which consists of one or more of the following:

1. the managing, developing, maintaining, protecting, enhancing or exploiting of intellectual property,
2. the researching, planning, processing, experimenting, testing, devising, developing or other similar activity leading to an invention or creation of intellectual property, or
3. the sale of goods or the supply of services that derive part of their value from activities described in (i) and (ii) above, where those activities were carried on by the relevant company.

If only part of a company’s trade meets these conditions, then that part of the trade is a specified trade. The profits of the specified trade must be calculated as overall income from the qualifying assets less:

• expenses incurred in earning that income; and
• any relevant capital allowances claimed in relation to assets used for the purposes of the trade.

Overall income from a qualifying asset is defined in section 769G(1) TCA 1997 and it covers any amount which a company earns from exploiting a qualifying asset (e.g. royalties, licence fees) which is taxable under Schedule D, Case I. It also includes a portion of the sales price of goods or services where the sale price includes an amount attributable to the qualifying asset.

Qualifying expenditure on the qualifying asset

Qualifying expenditure is defined in section 769G(2) TCA 1997 and is very similar to the definition of ‘expenditure on research and development’ used in relation to the R&D tax credit. There are differences however so it is important to check the KDB legislation to ensure that only KDB qualifying expenditure is claimed.

Calculating the relief

Under the KDB, a company can claim a deduction of 50% of the profits arising from each qualifying asset in the calculation of its tax on the profits of a specified trade. The deduction is calculated as 50% of the qualifying profits after capital allowances but before relief for trading losses.

Example

Anseo Ltd has undertaken successful R&D activities which resulted in scientific innovation and advancement culminating in the development of a computer program it has launched on the market. The computer program is a qualifying asset for the purposes of the KDB. The key financial information is as follows:

	€
Qualifying expenditure	1,200,000
Uplift expenditure	240,000
Overall expenditure	2,000,000
Profit of the specified trade	3,800,000
Taxable profits from non-qualifying assets	930,000

Step 1 Calculate qualifying profits for KDB purposes

		Qualifying Expenditure + Uplift Expenditure
Qualifying profit	=		×	Profits of the Specified Trade
		Overall Expenditure
	=	1,200,000 + 240,000	×	3,800,000 = 2,736,000
		2,000,000

Step 2 Calculate overall corporation tax liability with KBD relief claim

Corporation Tax Calculation for the year ended 31 December 2016

Taxable profits from non-qualifying assets	930,000
Qualifying profits of the specified trade	2,736,000
Non-qualifying profits of the specified trade	1,064,000
Total taxable profits	4,730,000
Less KDB deduction (€2,736,000 × 50%)	1,368,000
	3,362,000
Tax at 12.5% =	420,250

Interaction with the R&D credit and loss relief

The amount of a refund generated by the R&D tax credit is restricted by reference to the KDB relief as per section 769J TCA 1997. This means that companies cannot claim a greater refund from the R&D tax credit as a result of claiming tax relief under the KDB.

Losses and charges available for use against other Case I income, against the other profits of the company on a value basis or surrendered by way of group relief are calculated in the same manner as the profits which would have qualified for KDB treatment. The losses and charges so calculated which may be claimed for loss relief purposes are reduced to 50% per section 769K TCA 1997.

Conclusion

The world of tax was a very different place three years ago when the KBD was originally announced in comparison to the current climate considering the outcome of the Brexit vote and signals from the UK that they will introduce a lower corporation tax rate. The prudence demonstrated by Ireland in 2014 and 2015 when developing the legislation for the KDB was understandable. That prudence may now need to be reassessed so that Ireland can hold its position in an increasingly tough FDI market. To give credit to the Government, the R&D tax credit regime has been refined over successive Finance Acts and it is now recognised that a competitive version of the relief is now in operation. The KDB may have to take a similar journey before it achieves its FDI objectives. Chartered Accountants Ireland will be there to inform the Government through submissions and discussions at TALC meetings of necessary changes but we will need members to inform us of ways in which the relief can perform better on the international tax stage.

Norah Collender is Tax Technical Manager with Chartered Accountants Ireland.

Email: norah.collender@charteredaccountants.ie