Do you care about your company’s bottom line? Do you want to demonstrate that you have a business focus that is wider than your technical field? Then give the Research & Development (R&D) tax credit some serious consideration.
This might look like a tax issue that is something only the bean counters have to worry about. In fact, the accountants rely heavily on the engineering/technical staff to identify projects that could qualify for the R&D tax credit. Without you, they have no basis for making the claim so be proactive about this issue.
The R&D tax credit has been around for more than ten years, but it is only in the past few years that claims have really accelerated. In recent times, the availability of the tax credit has expanded significantly and the method of calculating the credit has been simplified.
Overview of the R&D tax credit regime
- The R&D tax credit is available to an Irish tax-resident company (or group of companies) that incurs expenditure on qualifying R&D activities in Ireland or in a country located in the European Economic Area, being the EU Member States, Iceland, Liechtenstein and Norway.
- The R&D tax credit may be claimed on eligible expenditure, which includes revenue and capital expenditure, incurred wholly and exclusively for R&D purposes.
- The cost of a limited amount of outsourced R&D activities may also be eligible for the credit.
- The R&D tax credit may be claimed on expenditure incurred on buildings used to house the R&D activities, as long the R&D activities constitute at least 35% of all activities in these buildings over a four-year period.
- Since 1 January 2015, all eligible expenditure incurred in a relevant period (generally, the accounting year) will qualify for the credit, assuming all conditions are met. Before then, complicated rules for assessing the amount of qualifying expenditure applied.
- The rate of the tax credit is 25%, which is in addition to the usual corporation tax deduction applicable to the expenditure (currently 12.5% for trading companies). This means that the total deduction will be at a rate of 37.5%. Another way of looking at this is that the company gets three times the usual deduction for this spend.
If Acme Engineering Services Ltd incur €200,000 of eligible expenditure in a relevant period on qualifying R&D activities, then assuming all conditions are met, the tax benefits will be:
| |
€ |
| €200,000 x 12.5% (standard corporation tax deduction) |
25,000 |
| €200,000 x 25% (R&D tax credit) |
50,000 |
| |
|
| Total tax benefits |
75,000 |
R&D tax credits are extremely valuable as they can be used for a number of purposes. Firstly, they can reduce corporation taxes for the accounting year in which the R&D monies were spent. The next possibility is that they can reduce taxes for the previous accounting year, which usually generates a
tax refund. The company then has an option either to use the credits to reduce future corporation taxes or to generate further
cash refunds.
Another possible use of the R&D tax credit is for the company to
surrender its credit to one or more
key employees¸ which generates personal tax refunds for those employees. While this appears to be an excellent way to incentivise key employees, be aware that in practice, the conditions attaching to this surrender can limit the use of this incentive/reward.
Qualifying R&D activities
What are ‘qualifying R&D activities’? The primary tests are that the activities must:
- Seek to achieve scientific/technological advancement and
- Involve the resolution of scientific/technological uncertainty.
Note that the advancement being sought must be an overall advancement in the field and not just an advancement in the company’s own knowledge or capability. To qualify the activities must meet the tests above and fall into one of three categories;
basic research,
applied research or
experimental development.
This last category probably comprises the majority of activities underlying R&D tax credit claims as it is defined as work that draws on scientific/technological knowledge and practical experience. Experimental development is directed at producing new (or improving existing) materials, products, devices, processes, systems and services.
In order to qualify, the activities must be in a recognised science and technology field within the broad categories of natural sciences, engineering and technology, medical sciences and agricultural science.
There is generally no interaction with Revenue before a company makes a claim for R&D tax credit, i.e. there is no advance approval or sign-off that a particular project constitutes R&D activities. Instead, it is for the company’s management, engineering/technical team and accountants to judge whether a particular project will qualify.
You can see then why the input of the engineering/technical team is so important to a claim for R&D tax credits. It’s also why all engineers operating within the recognised fields listed above should be familiar with the credit and have an understanding of the definition of ‘qualifying R&D activities.’
Revenue challenge to an R&D tax credit claim
There may be no advance approval but many R&D tax credit claims are audited by Revenue after the claim has been made. The focus of the Revenue auditors may be two-fold: to assess whether the project constitutes ‘qualifying R&D activities’ (
science test) and to determine if all of the project spend included in the claim is eligible for the credit (
accounting test).
The accounting test is of course one for the accountants, while the science test will be handled by the engineering/technical team who may have to defend their position to an external expert contracted by Revenue. This potential line of Revenue attack raises the stakes when making a judgement on whether R&D tax credits should be claimed for a particular project.
The good news is that Revenue have recently relaxed their strict approach to the science test in certain circumstances: this is extremely welcome and will encourage more Irish companies to claim R&D tax credits.
As you know, many R&D projects are grant-aided by Enterprise Ireland (EI) or the IDA. The strict position is that a company may not rely on the fact that a grant has been received from one of those bodies to conclude that the particular project constitutes ‘qualifying R&D activities’ for tax credit purposes. This means that a project could be grant-aided but still fail the science test.
Revenue has now stated that where a small/micro enterprise (meaning a company with less than 50 employees and an annual turnover
and/or balance sheet of less than €10 million) receives an EI/IDA grant for an R&D project
and the total project spend does not exceed €200,000, then Revenue will not generally assess the company on the science test. Note that companies that breach the small/micro enterprise thresholds or spend more than €200,000 on a grant-aided R&D project may still be challenged in relation to the science test.
As if the potential benefits of R&D tax credits noted above were not enough, there is a further possible tax benefit to a company that carries out ‘qualifying R&D activities.’ Companies that carry out these activities resulting in the creation of a qualifying Knowledge Development Box (KDB) asset, may be entitled to a lower corporation tax rate of 6.25% on profits generated from exploiting that KDB asset.
In general, a KDB asset is a piece of intellectual property, including computer programs and inventions protected by patents. The new KDB regime was introduced with an effective date of 1 January 2016. In addition to the mainstream regime, a KDB scheme specifically targeted at SMEs and allowing for a relaxation of the requirement for patent protection of inventions, is also in the pipeline.
We can see that carrying out qualifying R&D activities can be the basis for very significant tax benefits that could have a major impact on a company’s bottom line. If this article has encouraged you to consider whether your company is carrying out R&D activities, then this author will regard her work here has done. Engineers, the accountants need you!
Kerri O’Connell, accountant, tax adviser & principal, Obvio Tax Services
For a more detailed review of the R&D tax credit and KDB regime, see Kerri O’Connell’s book Small and Expanding Businesses: Getting the Tax Right. Recently published by Chartered Accountants Ireland, the book is available through their website and in selected bookshops. O’Connell’s book covers a wide variety of topics including; choosing the right business structure for start-up and expansion, business financing, handling a Revenue audit, getting VAT and payroll taxes right, and internationalising the business.
For your chance to win a copy, answer the following question: What does 'KDB' stand for?
Email your answer to
mcarrigan@engineersireland.ie before Tuesday, 7 March.