Medical-device development – are you missing out on R&D tax credits?

The medical-device industry is the number-one industry for innovation globally, with 8% of sales being invested in research and development (R&D) and a new patent filed every 50 minutes. This dynamic environment has an innovation cycle taking just 18-24 months, which means that a new product will be superseded by an improved version in less than two years (1). The relative costs of performing R&D in one country versus another (i.e. the after-tax cost of R&D) are important factors in evaluating where and under what circumstances these activities should take place. Ireland has built strength and critical mass in a number of research areas that underpin the medical device sector including materials, nanotechnology, biomedical research etc. With this in mind, the Irish Government is focused on further strengthening Ireland’s position as a hub for medical devices, through integrating existing enterprise and research strengths to drive the development and manufacturing of next-generation medical devices (2). The medical-device sector is constantly driven by academic and industry-based research and development and continues to demonstrate strong growth prospects, which is reflected in the number of spin outs, indigenous and multinational companies based in Ireland.

Ageing population and demand for medical devices

According to the US Department of Health and Human Services, the over-sixty age bracket is expected to increase from 23% to 32% within developed countries by the year 2050. The growth of the ageing developed-world population in turn grows the demand for medical devices, especially diagnostic equipment that focus on disease prevention (3). While there are over 500,000 medtech products on the market (4), the global medical device market is currently valued at $228 billion, up from $164 billion in 2010 and projected to reach $440 billion by 2018. It is growing at an approximate 4.4% compound annual growth rate per year. This growth is expected to outpace the prescription drug market by 2018, which is in comparison growing at a rate of 2.5%. Diagnostics are predicted to be the industry’s top segment, achieving global sales of $54.5 billion. Neurology devices are expected to grow the fastest, expanding by 6.1% annually while orthopaedics will grow the slowest at 3.1% (3). The United States remains the largest medical device market in the world, with a market size of around $148 billion, and it is expected to reach $155 billion by 2017. The US market value represented about 43% of the global medical-device market in 2015. There are more than 6,500 medical device companies in the US, mostly small- and medium-sized enterprises (SMEs). More than 80% of medical-device companies have fewer than 50 employees, and many (notably innovative start-up companies) have little or no sales revenue (5). The American medical technology industry invests nearly $10 billion in research and development annually to advance patient care in the United States and around the world (6). In Europe, the industry generates over €100 billion annually and employs approximately 575,000 people. As many as 95% of these companies are small-to-medium enterprises (7). Europe also invests about €7.5 billion annually in R&D (~8% of sales) (8).

Ireland’s medical technology sector

The medical technology sector in Ireland is recognised as one of the five global emerging hubs. The sector employs over 29,000 people in Ireland and is the second-largest employer of medtech professionals in Europe. Ireland is one of the largest exported of medical products in Europe, with annual exports of €12.6 billion and companies here directly export to over 100 countries worldwide. As many as 18 of the world’s top 25 medical-technology companies have a base in Ireland and 50% of the 400 medtech companies based here are indigenous. Ireland also boasts an incredibly strong services and contract research and manufacturing base; in fact 50% of the companies located here are in the business-to-business space. Pressures on healthcare systems have resulted in a greater focus on enhanced efficacy of treatments and cost reduction (9). According to a survey conducted by the Irish Medical Devices Association (IMDA) on the success and confidence of indigenous medical device companies, some 94% of Irish medical-device companies are expressing confidence about their business. It concludes that 73% of companies are expecting rising exports, some 77% expect rising sales and nearly one half of companies expect to hire more staff (3). In previous years, medical-technology companies have invested €652 million in Ireland. Ireland also secured one third of all medtech investment into Europe in 2015. This has resulted in strong job growth in the sector over the previous two years. Investment has occurred in several regions and the type of employment created includes high-value manufacturing roles, support services and R&D. R&D is growing in importance in the Irish medical-device sector: Medtronic, Cook Medical, Stryker and DePuy Synthes all announced investments in new R&D and innovation centres in the last two years (1). However, there must be no sense of complacency across the Irish Medtech sector where industry and Government alike are constantly looking for new ways to enhance competitiveness, develop new capabilities and ultimately generate new sustainable growth. Economic theory provides a strong justification for government support for R&D, including subsidies and incentives for business research. Without such support, companies are likely to underinvest in research (from the standpoint of the economy as a whole) because the results of R&D cannot be fully appropriated by the investing firm (10).

R&D tax incentives

So how can the government help address these concerns? One mechanism is R&D tax incentives. The theory of optimal taxation requires that a form of tax be neutral on an individual's or a company's decisions, for example between one form of investment and another. Neutrality would therefore imply that a company should not be incentivised to invest in R&D over other investments. However, given the externalities that exist in respect of private-sector investment in R&D, R&D incentives are regarded by economists as one of a small number of examples of where policy makers should explicitly depart from neutrality (11). The R&D tax credit provides a provision for a tax credit for certain expenditure on R&D activities, plant and machinery and buildings. Salaries paid to employees who conduct qualified activities are generally the largest component of qualifying R&D expenses. The money paid to the staff performing the qualified R&D activities as well as project managers and personnel who directly support the R&D can qualify. The goal of the R&D tax credit is to encourage R&D investment by indigenous and foreign owned firms alike by rewarding qualified research. To help offset the R&D cost to companies and to promote innovation and competitiveness, the R&D tax credit and the recent Knowledge Development Box (KDB) are valuable tax resources which encourage companies to create new and improve existing products and processes and intellectual capital in Ireland. The incentive provides a 25% refundable tax credit on the qualifying R&D expenditure and in relation to the KDB, profits arising from patents, copyrighted software or intellectual property (IP) equivalent to a patentable invention are taxed at 6.25%, rather than the headline rate of 12.5%. This tax mechanism offsets against tax liability because the credits can help companies increase their cash flow and earnings per share, reduce their effective tax rate, hire more staff, develop new products, and finance other business objectives (12). In Ireland, the cost of the scheme to the exchequer was €421 million in 2013 (13). A Government review found that almost 1,400 companies, employing nearly 150,000 people, have availed of the incentive (14), yet many companies are not aware of the credit. Traditional research activities that take place during the development of advanced devices aren’t the only activities that qualify for the R&D tax credit. Medical-device companies may think they are not performing as many qualified activities as they are because many of the costs that qualify for the credit are accounted for as ‘R&D expenses’. So, as long as companies are attempting to develop new and improved products, product lines, manufacturing processes, or software, they could be eligible (7).

Questions about R&D tax credit

While companies are beginning to plan for the coming year and beyond, there is no time like the present for medical device and/or financial professionals to evaluate whether they’re taking full advantage of the R&D tax credit. From our experience, there are three questions that are commonly asked:

How does the credit work? The R&D credit works by providing a company with a credit calculated as 25% of qualifying R&D expenditure. In addition to the 12.5% trading deduction, this effectively means that the company can benefit from an effective tax benefit of 37.5% on their R&D spend.
What are qualifying expenditures? This is expenditure incurred in developing processes which are systematic, investigative and experimental and as such qualify for the credit as set out by the guidelines issued by Revenue. Eligible expenditure includes direct and indirect costs so long as they are incurred in the carrying on of R&D in addition to capital expenditure on related plant and machinery. Basically, the company must be incurring expenditure on qualifying activities which are seeking to achieve a scientific or technological advancement through the resolution of a scientific or technological uncertainty in a 12-month accounting period.
Why would a company claim the credit? Primarily, the principle gain to a company claiming the R&D tax credit is cash. This credit should not be undervalued or understated as cash is vital to the sustained health of any business. However, value can also be received for the R&D tax credit in a number of different ways, such as: a) Including offsetting the tax credit against Corporation Tax, b) As a refund by reference to payroll taxes and/or c) Corporation Tax paid or as a reward to key staff in a tax-efficient manner.

Knowledge Development Box

The natural follow-on from the R&D tax credit is the Knowledge Development Box (KDB), which was introduced by Finance Act 2015 for companies whose accounting period commences on or after 1 January 2016. As previously outlined, the KDB, it is a regime for the taxation of income which arises from patents, copyrighted software and, in relation to smaller companies, other IP that is similar to an invention which could be patented. The official guidelines for this scheme was issued by Revenue in August 2016. In summary, choosing your R&D and KDB advisors is an important decision for you. It is essential that your advisors have the skills and experience required to deal and grow with the financial and technical needs of your business. It is equally important to know that your dedicated advisors will be able to form and maintain an excellent working relationship with your team and conduct their work in a professional and flexible manner. Within Mazars, we have a proven track record with the key credentials to provide a first-class detailed and tailored service that will go beyond our client’s expectations. It is this commitment which has our clients returning year on year. We have a specific dedicated Research & Development Tax Group, which focuses on assisting companies in identifying activities that qualify for the KDB and Research & Development Tax Credit. In addition, we have the significant in-house scientific experience to assist and advice in both the claim and technology. Our service also extends to support our clients in the event of an audit. If you would like more information, please contact Dr James Kennedy at jkennedy@mazars.ie. Authors

Dr James Kennedy BEng CEng MBA PhD MIEI, manager – Research & Development Tax Credit Group, Mazars
James O’Hagan, tax consultant, Tax Credit Group, Mazars
Gerry Vahey, partner, Tax Credit Group, Mazars