47 – 49 Pearse Street, Dublin 2, IRELAND

The Knowledge Development Box – Public Consultation

Tax Policy Division

Department of Finance

Government Buildings

Upper Merrion Street

Dublin 2

by email to KDBconsultation@finance.gov.ie

7 April 2015

Dear Sir/Madam

The Knowledge Development Box (“KDB”) – Public Consultation Paper

INTRODUCTION

We are writing to respond to the above named document issued on 14 January 2015.

We note the international discussions in relation to preferential IP regimes and the necessity to conform with these, specifically the proposal for the Modified Nexus approach which is currently under consideration within the OECD and EU.

In order for the KDB to meet the Modified Nexus Approach we believe that the following features should form part of the KDB criteria:

• Value creation – whereby qualifying companies are required to meet a minimum threshold of development activities in relation to the creation of the IP.
• The ‘applicant’ company must be the legal owner of the IP and bear all economic risk attached to it.
• The company must demonstrate a strong link between the qualifying patent income and the research undertaken.

In group scenarios, we would suggest that provision is extended to the wider group where the group is headed by an Irish company. For example, in the UK, if the company is a member of a group it must also actively own the patented invention by taking a significant role in managing its whole portfolio of eligible patents.

We have addressed five key questions outlined in the Public Consultation Paper and our comments are as below. Responses to Questions 4 and 5 are encapsulated in our responses to these questions.

Question 1: Please provide a description of the assets that you believe to be functionally equivalent to patents and the basis for that belief.

We welcome the recognition by the OECD Forum on Harmful Tax Practices (FHTP) of the need for clarity on the definition of qualifying IP, as noted in the report of the OECD Secretary General to the G20 Finance Ministers and Central Bank Governors in February 2015. We understand that the FHTP is to produce further guidance on this definition.

We believe that intangible property which is capable of legal protection should be recognised as qualifying IP. This could be defined to include IP assets which have been created from research or development activities that meet recognised international standards for scientific and technical/technological development such as those set out in the OECD’s Frascati Manual, 2002. The types of intangible assets which are capable of being recognised as separate assets under the identifiable technology-based assets definition in International Financial Reporting Standards would seem to us to present a useful starting place for defining qualifying IP assets.

The meaning of qualifying IP assets for IP regime purposes should therefore draw on existing international standards for R&D and for accounting standards recognition of assets. Therefore we suggest that qualifying IP assets should include:

• Patented rights (including plant variety rights and market authorisations related to patents)
• Unpatented technology
  • Software (whether or not protected by copyright)
  • Design rights
  • Trade secrets (secret processes, secret formulas and recipes)
  • Know-how which is the subject of a licensing agreement with an independent third party

It is worth noting that, at the time of writing, the UK definition of qualifying IP also includes the following:

• Infringement income
• Damages, insurance or other compensation related to patent rights

In the UK, a company can also benefit if it uses a manufacturing process that is patented or provides a service using a patented tool (in these circumstances, it is necessary to calculate a notional royalty).

Consideration should be given to also including the aforementioned income sources in any proposed Irish KDB regime.

Frequently, best commercial practice suggests that the output from R&D activity should not be codified in a patent application. It may be deemed more important to keep the scientific or technical advance acquired through R&D strictly confidential within the business for as long as possible. Different territories may have different procedures and standards of recognition, and indeed different turnaround times, in securing patents. Businesses with strong innovation content in their products can create IP assets which are recognised as trade secrets (which can, for example, include secret processes, secret formulas or recipes).

In other instances, the time and effort required for the patenting process may not be justified by the commercial benefit conferred in the use of the advance. This can be the case especially for smaller businesses operating internationally and for business based in smaller economies such as ours which seek to exploit the IP through sales of goods, products, etc. in larger markets. For many businesses operating in smaller economies, the costs of registering patents across multiple jurisdictions may simply not be merited in commercial terms.

Although IP assets in fast-moving industries may in some markets be capable of patent protection, a prime example being software, where the commercial emphasis is on the rapid application, rather than longer term protection the company may choose not to patent the application but seek to protect its interests by enforcing copyright or other rights. In some cases in the software sector, a company might deliberately choose to share technical developments in software applications it creates by writing the application in open source code so that it can earn future profits from the adoption and use of the application by others. These diverse commercial practices in protecting IP assets does not mean however that an IP asset which arises via technical/technological development activities and which is not patented is in any way less valuable.

Question 2a: In designing the Knowledge Development Box it is necessary to consider the interaction of the regime with current loss relief legislation.

In the early stages of IP development a company may derive income from its qualifying IP rights but not yet generate a profit. As a result the calculation of relevant IP profits will result in a negative figure, thereby creating an IP loss.

Loss relief legislation in the context of the UK’s Patent Box regime and existing loss relief legislation is worthy of note. We believe these rules set a clear precedent for any proposed Irish KDB regime. In that regime, companies who have elected into the Patent Box regime and who have realised a loss are still able to relieve any actual trading losses as if it had made no election into the Patent Box. However, it must still compute the amount of the relevant IP loss because this amount will then restrict other Patent Box benefits. In addition, an IP loss suffered by one company in a group can be set against the profit of other group members. Any remaining balance is then carried forward to reduce future IP profits in the same company or other group companies (in limited circumstances).

Question 3: What expenditure should be included in the definitions of “qualifying expenditure” and “overall expenditure” under the modified nexus approach?

Annex I of the Public Consultation Paper deals with the Modified Nexus Approach and outlines that qualifying expenditures should include the types of expenditures currently granted R&D credits under the tax laws of the relevant jurisdiction, in this case, Ireland.

Question 6: How should the tracking element of the regime (see paragraphs 22 & 23 of Annex I) operate to ensure that income benefitting from the preferential rate is traceable to the qualifying expenditure but also user-friendly for both companies and Revenue?

We understand that the OECD FHTP is currently working in this area and is due to reach agreement by June 2015. Clearly any tracking and tracing approach adopted by Ireland will need to be informed by their conclusions.

Question 7: Are there any provisions that should be included in the regime to specifically encourage small indigenous enterprises?

Recognising the limitations on R&D resources with narrow specialist skills that exist in smaller economies such as ours, we suggest that equal treatment should be given to outsourced expenditure of a company which is actively overseen and controlled by it e.g. if a business buys in specialist expertise available elsewhere in the group in carrying out its R&D activities, this should be treated in like manner to R&D costs and other expenditure on creating a qualifying IP asset that is directly incurred by it. Equally, there is merit in the proposition that where an Irish company operates an R&D centre outside of Ireland any IP created within the R&D centre should fall within the KDB regime whereby the R&D centre is owned by the Irish company and all profits from R&D activity flow to Ireland.

In implementing any such KDB provisions particular care should be taken to ensure that these provisions do not infringe on the Right of Establishment and Freedom to provide Services as laid down in Articles 49 and 56 respectively of the TFEU.

Consideration should also be given to implementing a procedure similar to that available in the UK regime that enables small companies to follow a simplified method when calculating qualifying KDB profits. Under UK legislation, for companies with just one trade, the amount of relevant IP profits can be the lower of 75% of the qualifying profit (as calculated) or the small claims threshold. The small claims threshold has been set at £1m pro rated for the number of associated companies also in the Patent Box regime. This optional claim would enable small indigenous enterprises to benefit from the regime without the administrative burden and cost of doing so becoming prohibitive.

In addition, a streaming approach is also available in the UK which is designed to recognise that in certain cases, the simple ratio of relevant IP income used in the UK to total gross trading income will not give an acceptable measure of a company’s profit from the exploitation of qualifying IP. This could occur where a company has significant non-IP income which generates little profit and less IP income that is far more profitable. This could also occur where, conversely, a company’s IP income is less profitable than its non-IP income.

Where the ratio of relevant IP income to total gross trading income does not give an acceptable measure of a company’s IP profits, the company may elect to use a “streaming” method to determine its relevant IP profits. Use of the streaming method is mandatory where any one of a number of specified conditions are met, including where a company receives a substantial amount of licensing income in respect of non-qualifying IP.

Where the streaming method applies, a just and reasonable apportionment of a company’s expenses, rather than the simple pro rata approach is required.

Comment on the general direction in which you would like to see tax policy in this area to develop

Existing R&D Regime

Careful consideration needs to be given to the current R&D regime in operation in Ireland. We would suggest that the regime be further enhanced to cement Ireland’s reputation as a centre of excellence for R&D activity. We believe that the KDB can and should work hand in hand with the R&D tax incentive scheme to ensure that a strong IP environment remains at the heart of Ireland’s FDI offering.

For example, the UK has recently further enhanced the rates of R&D tax relief/credit available to SMEs and large companies. This is in addition to the introduction in 2013 of an above the line tax credit available to large companies.

In the UK relief totalling 230% of qualifying expenditure is available to SMEs (as defined) with a payable tax credit of 14.5% available in loss making situations. Large companies can avail of relief totalling 130% on qualifying spend or they can choose to claim under the research and development expenditure credit regime which provides for an 11% above the line taxable credit on the same qualifying spend.

Ireland should consider doing likewise as the carrying out of R&D in Ireland will be at the heart of the KDB rules.

Anti-Avoidance

As with any system that provides tax incentives, anti-avoidance should be a key consideration in the development of any KDB provisions. Any anti-avoidance rules pertaining to an Irish KDB clearly should be formulated to ensure we do not fall foul of EU or BEPS harmful tax measures concerns.

Phased Approach

It is worth noting that in the UK the full benefit of the Patent Box regime is being phased in from 1 April 2013 with the full benefit not realisable until the Financial Year commencing on 1 April 2017. Italy has recently introduced a Patent Box Regime in 2015 and has also taken a phased approach to its implementation. We suggest that consideration be given to the merits of this approach regarding the KDB and whether the Irish KDB regime should be permanent and irrevocable (as in the UK) or reviewable after a period of time (as in Italy).

The method of providing relief for qualifying KDB profits should also considered. The UK provides a reduced rate of corporation tax of 10% (50% of the current UK main rate of 20%) whereas Italy provides a 50% exemption for qualifying royalties derived from the licensing of qualifying intangibles. The latter methodology (as opposed to a 6.25% rate of corporation tax) may be helpful in communicating the benefit of this incentive to prospective FDI investors.

CONCLUSION

We are mindful of the OECD FHTP’s work in relation to BEPS Action 5, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance. Work within the FHTP has led to the development of proposals for new rules, known as the Modified Nexus approach.

However these are far from final. Perhaps Ireland should consider an exemption from capital gains realised upon the sale of IP assets, under the condition that at a substantial % (say at least 90%) of the proceeds received are reinvested into research and development activities in Ireland.

You may wish to note that these comments are from a representative body. The Consultative Committee of Accountancy Bodies – Ireland is the representative committee for the main accountancy bodies in Ireland. It comprises Chartered Accountants Ireland, the Association of Chartered Certified Accountants, the Institute of Certified Public Accountants in Ireland, and the Chartered Institute of Management Accountants, which represent a combined membership of some 40,000 accountants.

Do not hesitate to contact Brian Keegan brian.keegan@charteredaccountants.ie or Deborah Casey deborah.casey@charteredaccountants.ie of this office should you require anything further.

Yours faithfully

Paul Dillon, Chairman, CCAB-I Tax Committee

Source: Chartered Accountants Ireland. www.charteredaccountants.ie