The Knowledge Development Box (“KDB”) was introduced by Finance Act 2015 for accounting periods commencing on or after 1 January 2016. Its aim is to encourage companies to exploit Intellectual Property (“IP”) from Ireland arising from Irish based Research and Development (“R&D”) activities.

Companies have 2 years to make a claim for the KDB. This time limit for the first eligible period, i.e. 31 December 2016, will therefore be 31 December 2018.

KDB Overview

The KDB offers an effective corporate tax rate of 6.25%, instead of the standard 12.5% rate, on profits generated from the exploitation of qualifying IP. In short, qualifying IP is IP generated as a result of R&D activities carried on in Ireland which would qualify for the R&D tax credit regime1. However, it is important that potential claimants are aware that only certain types of IP will qualify, namely;

• Qualifying patents,
• Certain computer programs,
• Plant breeder rights,
• Supplementary protections for medicinal or plant protection products,
• Where certain criteria are met, inventions that are certified by the Controller of Patents, Designs and Trademarks as being novel, non-obvious and useful.

Where a company has qualifying assets for KDB purposes, the qualifying income from those assets will include all trading income generated from their exploitation including royalties and licence fees. Also, where the price of a product or service includes an amount which is attributable to a qualifying asset, a portion of the income from those sales can qualify (i.e. embedded IP scenarios).

Given the links between the KDB and the R&D tax credit legislation, companies that already claim the credit should examine the benefits of also accessing the KDB regime.

KDB Origin and Amendments to Date

Minister for Finance, Michael Noonan, announced in his Budget 2015 speech that he was publishing a “road map to secure Ireland’s place as the destination for the best and most successful companies in the world”. In this regard, he announced his intention to introduce “a ‘Knowledge Development Box’ along the lines of patent and innovation boxes which have existed for many years in countries that compete with us for foreign direct investment.” The Minister acknowledged that at the time, EU and OECD discussions in relation to an acceptable ‘Box Regime’ were ongoing and that once these discussions were concluded, an Irish regime, compliant with international standards, would be introduced that would be “best in class and at a low competitive and sustainable rate of tax”.

Upon conclusion of these international developments, the Department of Finance in January 2015 issued a public consultation paper on KDB. Following this, a feedback statement was issued in July 2015 and legislation was drafted and introduced in Finance Act 2015. This represented the introduction of the first OECD compliant box-type regime.

In 2017, the ‘Knowledge Development Box (Certification of Inventions) Act 2017’ was signed off by the Oireachtas, providing for an additional category of assets that can be regarded as qualifying assets, specifically for Small and Medium-sized Enterprises (“SMEs”). This was done with a view to increasing access to the relief for certain SME’s which might otherwise consider patenting to be restrictive. This act expands the definition of IP for SME’s to include inventions that are certified by the Controller of Patents, Designs and Trademarks as being novel, non-obvious and useful.

For KDB purposes an SME is defined as a company with annual income from IP of up to €7.5m, group turnover of up to €50m, less than 250 employees across the group and a group balance sheet of under €43m.

KDB Commencement Date and Claim Deadlines

The KDB is claimable for accounting periods commencing on or after 1 January 2016. However, any claim made under the KDB regime must be made within 2 years of the end of the accounting period to which the claim relates.

This deadline means that companies considering making a claim for accounting periods ending 31 December 2016 must have such a claim submitted before 31 December 2018. Given this deadline is not far away we would advise companies who are considering making a KDB claim to commence the process soon.

KDB Calculation

Once calculated, the KDB allows for the qualifying profits to be halved by way of a 50% tax deduction in order to give effect to the 6.25% rate on those profits. In order to calculate the qualifying profits the following formula must be used:

QE + UE
	×	QA
OE

Where: QE is qualifying expenditure on qualifying assets

UE is uplift expenditure

OE is overall expenditure on qualifying assets, and

QA is the profit from the qualifying assets

Qualifying Expenditure is expenditure on a qualifying asset which has been wholly and exclusively incurred by the company in the carrying on by it of R&D activities in a Member State, where such activities lead to the development, creation or improvement of a qualifying asset.

Outsourcing to third parties is included in qualifying expenditure however spend on outsourcing to related parties is excluded. Acquisition costs relating to qualifying assets are also excluded. A portion of these excluded costs may be brought back in under the calculation of uplift expenditure.

Qualifying expenditure also excludes interest expenses, expenditure to group companies in order to take on R&D activities under a cost sharing agreement or otherwise and any expenses which are relieved for tax purposes in a territory other than Ireland.

Overall Expenditure is all of the qualifying expenditure on the asset as above together with the acquisition costs and related party outsourcing costs. Given the nature of this aspect of the formula it is likely that the maximum benefit from the regime is to be derived where the company which is generating income from the qualifying IP is the same company that developed and incurred the cost of associated R&D activities which were carried on in Ireland.

Uplift expenditure is calculated as the lower of:

• 30% of the qualifying expenditure, or
• The aggregate of acquisition costs and group outsourcing costs.

The profit from the qualifying asset is the profit from the KDB trade which is related to the qualifying asset(s) before the 50% KDB tax deduction is taken into account.

Irrevocable Election

For the KDB relief to be claimed an irrevocable election must be made for each qualifying asset. Once made any future profits or losses of the qualifying asset will be regarded as KDB profits/losses (profit/losses of the specified trade). KDB losses and charges incurred in the specified trade are relieved on a value basis, i.e. the value of the losses or charges are reduced by 50% (to reflect the tax value of the losses i.e. 6.25% rate of tax).

This means that companies need to make an important decision about the expected profitability of qualifying assets in the future before making the irrevocable election because if the qualifying asset becomes loss making the tax value of these losses will be reduced as a result of the KDB election made in an earlier period. The timing of this decision is also important to ensure that the tax value of any early phase losses are maximised.

Conclusion

To date, there have been only a small number of KDB claims submitted. It is understood that the following are challenges that are impeding take up of this new relief:

1. The complexity of the calculation – As can be seen from the high level summary of the calculation above, there are a number of areas including transfer pricing, that need to be understood and clearly defined by companies before any KDB claim can be submitted.
2. Documentation and systems – The OECD has mandated quite onerous tracking and tracing requirements that need to be met to avail of the KDB. Many companies need to introduce new methods to ensure that income and expenditure can be clearly tracked to the asset to ensure their KDB claim can be substantiated.
3. The science/technology test – While a summary of the type of IP that might qualify is set out above, there is equally a requirement that the IP is derived from underlying activities which would be deemed to qualify under the R&D tax credit regime, albeit that a claim under the R&D tax credit regime does not need to have been made.
   While the R&D tax credit regime has been in existence since 2004, we still see a large amount of uncertainty and inconsistency in how this regime is reviewed across districts and Revenue appointed reviewers. We believe that this level of uncertainty may act to deter companies from claiming the KDB and/or the R&D tax credit.
4. The irrevocable election – Many companies considering the electing into the KDB are unsure of the potential future profitability of the qualifying asset and in this regard, are reluctant to commit to the potential restriction of loss relief if the qualifying asset is not as commercial successful as hoped.
5. Corporate structures – Some companies have historic structures that are not compatible with the KDB, e.g. some companies have historically held their IP in separate group companies from the company that carried out the R&D for asset protection reasons or to avail of historic tax patent tax reliefs. Such a structure will not allow either company to qualify for the KDB.
6. The 24 month deadline – Given that there is an extended period within which to file a claim, in comparison to the 12 month timeframe for R&D tax credit purposes, it is possible that companies are waiting in the hope that further guidance/experience on the KDB process may become evident prior to the first applicable claiming deadline of 31st December 2018.

Overall we feel that the objective of the KDB regime is positive, however our experience and that of our clients to date is that this is a highly complex area to navigate at present. We would hope that this complexity will lessen as the regime matures but we would equally remind potential claimants that the benefits of the KDB regime are such that it should not be ignored by those who have invested in the development of IP over the past number of years.

Derek Henry is Tax Partner and Head of the R&D and KDB services team at BDO Ireland

Email: dhenry@bdo.ie

Mark O’Sullivan is the senior scientific/technical advisor within the same services team

Email: mosullivan@bdo.ie

1 In accordance with Section 766 Taxes Consolidation Act 1997