Research and Development Tax Credit
Private matters, September 2012
Ireland’s research and development (R&D) tax credit system is considered as being one of the most attractive schemes available to reward science and technology development and is a major benefit to both multinational companies and SMEs within Ireland. The Department of Finance is continuously making innovative changes to the legislation to keep Ireland in the game and Finance Act 2012 was no exception despite the fiscal constraints that exist today. Although international mobility is a major consideration in making changes to the regime, this year’s changes have been predominantly targeted at SME’s.
Tax definition of R&D?
The scheme has financial requirements, often referred to as “the accountancy test”, and technical criteria, “the science test”, for companies to meet. The “science test” is often broader than many peoples initial expectations as to what would be R&D, and is not restricted to ground breaking research.
The development process must be systematic, investigative or experimental in nature and R&D credits can be claimed for projects in various stages of technology development from basic research at a theoretical level with no particular application or product in mind, through applied research where there is an intended purpose or practical application, to experimental development which builds on and improves existing products, devices, processes, materials or systems. Ultimately the company must be attempting to make an improvement or “advancement” which would be recognised as such within their industry and has to be overcoming technological or scientific challenges or “uncertainties” in order to do so.
Companies are required to have contemporaneous documentation in support of the claim.
To get across the relief, it might be useful to briefly describe an example of how the credit works.
A company claims credits in respect of a number of IT projects developing new software interfaces, database management routines and file control software. In 2003 the company spent €245,000 on qualifying R&D. The R&D tax credit claim consisted of
|Salary related expenditure (including company pension contributions, company PRSI, bonus)||€600,000
Apportionment of general overheads (including rent, rates, electricity, telephone)
|Total internal expenditure||€675,000|
|Outsourced R&D (subject to an upper limit of 10% of €675,000)||€50,000|
|Less base year expenditure||€245,000|
|Total Qualifying Expenditure||€480,000|
|Tax credit at 25%||€120,000|
How R&D tax credits are utilised
Credits can be used in a number of ways. Primarily they are used to reduce a company’s current year corporation tax. As detailed later, Finance Act 2012 introduced legislation whereby credits can now be transferred to key R&D employees who can reduce their personal tax liabilities, within certain boundaries. If excess credits remain, they can be used in the order of:
- reclaiming prior year tax paid
- the credit can be carried forward
- Revenue will repay the credits in three instalments over three years
It should be noted that the final option of a cash repayment is subject to an upper limit which relates to payroll liabilities or corporation tax paid in the previous ten years.
These options are probably the most flexible use of credits available in any of the main stream countries offering R&D tax incentives.
Finance Act 2012 – Corporation Tax Perspective
Finance Act 2012 has brought some welcome enhancements to the scheme. Although all sizes of company could benefit from the changes introduced, the focus has been to assist small and medium enterprises whose claims will be assisted by the relaxation of the 2003 base year, potentially enabling a larger level of R&D subcontracted expenditure to be claimed and the carrying forward of unused credits.
In previous years, R&D expenditure was measured as the incremental R&D expenditure over the R&D costs incurred in the base year, 2003. From 1 January 2012, the first €100,000 of expenditure will not be linked to expenditure incurred in 2003.
Sub-contracted R&D is where a company pays a third party to undertake research and development on its behalf. The limits on the amount of sub-contracted R&D that can be claimed are being increased to the greater of €100,000 or 10% of total internal expenditure for third parties and 5% for third level institute research.
Prior to Finance Act 2012, R&D credits being carried forward would be lost if the trade of the company was transferred. This is no longer the case with new legislation being introduced which now allows the R&D credit being carried forward to transfer when a trade is transferred within a group.
These changes also come with some restrictions to the relief; third party payments that do not relate to sub-contracted R&D can no longer be claimed. Also, any grants received from the EU or EEC will be deducted when computing the credit.
Example 2 provides an illustration of how the changes could benefit a company.
|Pre Finance Bill 2012|
|2003 base year expenditure||€150,000|
|2011 R&D expenditure||€250,000|
|Tax credit =||€25,000||i.e. 25% x (€250,000 - €150,000)|
|In 2012, the company with the same level of current year R&D expenditure|
|Tax credit =||€50,000||i.e. 25% x (€100,000 + (€250,000 - €150,000))|
Let’s also say that the company in example 2 also had €100,000 of R&D it funds by subcontracting work to suppliers in addition to the €250,000 if internal expenditure.
In 2010, it’s claim would include:
|Sub-contracted R&D to third parties||€25,000 (10% of €250,000)|
|University R&D||€12,500 (5% of €250,000)|
Under the new rules, the company will be able to claim the greater of up to €100,000 or the 10% + 5% of internal expenditure i.e. €100,000.
Finance Act 2012 – Personal Tax Perspective
Finance Act 2012 also introduced legislation whereby R&D tax credits can now be surrendered to key employees to be used against their personal income tax liability. This is a welcome incentive for key employees engaged in R&D who, if the conditions are met, may reduce their effective tax rate to a minimum of 23%. R&D tax credits arising from periods starting after 1 January 2012 can be surrendered in this manner.
In order to qualify, a number of conditions have to be met. The most significant are outlined below:
- The company has an actual corporation tax liability in the year of the R&D tax claim, and this sets an upper limit to the amount of credits which can be surrendered
- The employee is not a director nor has a material interest in the company. This condition applies retrospectively and also applies to the employee’s connected parties
- The employee spends at least 75% of their time undertaking qualifying R&D activities
The tax credit can be carried forward if the individual cannot use it all in the first year, i.e. if it would reduce the individual’s effective tax rate to below 23%. It should be noted that the 23% minimum effective income tax rate can be applied to the combined income with the employee’s partner and applies to income tax only and not to the Universal Social Charge or Social Security.
Careful consideration should be given to this incentive as it can provide benefits to employer and employee alike. However, it is important to note that if the employee leaves the company any remaining credit will be lost to both the employer and the employee.
When a cash bonus is paid to an employee, typically the employee receives only 48% of the bonus after the deduction of tax, USC and PRSI. The employer also has to bear an additional 10.75% employer PRSI over and above the bonus awarded though a deduction is allowable against corporation tax. In contrast an employee receives the full R&D tax credit award as there are no payroll deductions and there are also no additional costs to the employer.
As an example, it costs an employer €20,188 to provide a net bonus of €10,000 to an employee. The cost of providing the R&D credit is €10,000 – a saving of over 50%.
Lastly, careful planning should be undertaken to ensure there are no adverse effects in using R&D tax credits as opposed to existing cash bonuses so that employers do not fall foul of salary sacrifice legislation. Consideration should also be given to maximising the positive aspects of the R&D tax credit and communicating this effectively with the employee population.
The research and development tax regime is a great opportunity for companies with technical staff developing new ideas, new knowledge, new levels of product, process or equipment performance and who are overcoming existing technical limitations to do so. I’m sure that we can look forward to further improvements to R&D tax credits to keep Ireland amongst the global front runners for R&D tax relief. In doing so the scheme will hopefully become even more aligned with Industry’s needs for increased reliability for in the claim process, improved efficiency for preparing claims and clear rules which encapsulate the development costs incurred.
For more information please contact;
T: +353 1 417 2242
T: +353 1 417 2243