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The Finance Bill’s changes to R&D could go further for start-up companies

Tom Maguire discusses the Finance Bill's updates to R&D tax credits in his latest Business Post column

I’ve written about the R&D credit many times in these pages. Last week we saw the Finance Bill make changes to the credit. The explanatory note that accompanies the Bill states that the changes are being made to “reflect international tax changes”, more on that below.

The explanatory note continues that “These are timing changes and do not affect the quantum of credit that a company is entitled to claim”. Let that sink in for a second. The credit is the same, only the timing is affected. The Bill is still at the early stages and can be amended as it goes through the Oireachtas. Indeed, the Minister for Finance’s press release accompanying the Bill’s publication said “the draft legislative provisions relating to a number of issues are being held over for introduction at Committee Stage of the Bill. These include the provisions relating to the Key Employee Engagement Programme” which I have written about in these pages previously. He also said there will be more on tax depreciation “for the construction of slurry storage; and the extension of a number of agricultural tax measures”. So, there’s more law coming our way so we’ll just have to wait and see if further developments on R&D can emerge.

But back R&D, and I mentioned “International tax changes” earlier. This is all about the 15% rate of corporation tax for large corporate groups that may be coming our way in next year’s Finance Bill based on the proposed EU directive. This is the so called “Pillar Two” directive after the OECD agreement on the matter. Let’s be clear here, Pillar Two isn’t just a “rate changer” but rather a “rulebook changer” with all countries having to adopt similar systems.

The Tax Strategy Group papers published during the summer explain that if the R&D credit is “a qualified refundable tax credit” then it’s treated as income (like a taxable grant) and taxed at 15% under Pillar Two. The company’s full tax liability, including tax settled by offset of the R&D credit, is recognised in computing the company’s effective tax rate. If the R&D credit is a non-qualified refundable tax credit, the amount of the credit is treated as reducing the corporation tax paid by the company. The TSG notes that as Ireland’s 12.5% rate is already below the 15% minimum rate, “this would result in an increase in the top-up tax required to be collected in order to meet the Pillar Two minimum effective tax rate, thereby wiping out the benefit of the credit”.

Further, to be “qualified”, a credit must be paid as cash or available as cash equivalents, within four years from when the claimant satisfies the conditions for receiving the credit. It is this “four-year cash equivalent” point that was addressed in the Bill, subject to certain transitional arrangements, which I won’t go into here.

This is the story so far. The R&D corporation tax credit remains as 25% of qualifying R&D expenditure incurred. The credit (other than expenditure on buildings or structures) will generally be payable over three years. The first payable instalment in year one is the greater of €25,000 (or if lower, the amount of the R&D corporation tax credit) and 50% of the amount of the R&D corporation tax credit. The second payable instalment in year two is three-fifths of the remaining balance of the R&D corporation tax credit. The last payment in year three is the remaining balance of the credit in respect of the accounting period, less the sum of the first and second instalment amounts.

The €25,000 credit was brought about for small companies and start-ups in that if the total credit available to them is less than that amount then it will be paid to them in full in the first year; no waiting around for this to be paid in instalments.

This potential “all in one year” refund is a significant cash-flow for companies affected but many companies will incur qualifying R&D expenditure in excess of an amount that would give rise to such a credit. Therefore, it would be good to see that amount increased as the Finance Bill progresses through the Oireachtas. You have to remember that, as the explanatory note explains, the credit remains, it’s just its timing that will be affected. The recently published Commission on Taxation report had recommended that “consideration be given to a limited acceleration of the refundable element of the R&D tax credit from three years to one in order to support early-stage and R&D intensive businesses”. Its use of the word “limited” is of note but increasing the amount beyond €25,000 would still be within its literal meaning when you look at the costings of this credit for the country.

The Commission on Taxation also included a table in its report outlining a “Breakdown of R&D claimants by size (number of employees), 2017 – 2020”. For example, it noted that the cost to the Exchequer in 2019 was €33 million and €37 million in 2020 for claimant companies with less than 10 employees. For claimants that had 11 to 49 employees those respective costs were €55 million in 2019 and €56 million in 2020. Don’t get me wrong these aren’t insignificant numbers but compare them with the total R&D credit cost to the Exchequer in those years of €627 million and €658 million respectively.

Finance Act 2019 suggested bringing about a 30% R&D credit for micro and small sized companies. That was subject to a commencement order and the 2022 Bill repeals those provisions given as its accompanying explanatory memo explains “it is not possible to commence for State aid reasons”.

The Commission on Taxation also recognised this EU law difficulty but nonetheless suggested that alternative measures should be found. You can see their point. They continued: “This may involve the development of a two-tiered system or separate research and innovation focused relief for smaller firms, if possible. It is essential that the tax system is modified to encourage and improve uptake by smaller businesses, particularly early-stage and pre-revenue start-ups who are engaged heavily in R&D activity”. My view – what they just said!

Please note this article first featured in the Business Post on Sunday, 30 October 2022 and was re-published kindly with their permission on our website.

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