Innovation can be a fundamental factor in an SME’s development, from the exploration of an idea through to market and continuing as the business evolves its lifecycle towards growth and maturity. There are significant direct tax and funding supports available in Ireland to encourage innovation and business growth.
There are three key direct tax supports for Innovation after the funding stage:
While these supports can apply to all Irish companies, due to lack of take-up in the sector, they have become more targeted at SMEs - most recently with the announced increase in the R&D tax credit to 30% for such entities. For SME’s availing of these supports, there can also be less paperwork required and there should be more flexibility in obtaining cash refunds especially in the startup phase.
Summary
For the majority of SMEs, the most valuable relief will be the R&D tax credit and thus the focus is here. The Intangible Asset relief is undoubtedly the simplest from an administrative perspective and the key takeaway should be awareness - it will be relevant for capital investment decisions.
All profitable companies qualifying for the R&D credit should consider their eligibility for the KDB and an outline of this set out below. It is almost certain that some SMEs have entitlement to KDB but are just not claiming this relief. It operates by reference to total R&D activities carried out in Ireland, so Irish SMEs are more likely to fully benefit here than say large multinationals which can have international R&D programs.
1 R&D Tax Credit
The credit operates by giving the company 25% of R&D expenditure (including capital expenditure on machines, buildings) in a tax credit or in cash subject to certain criteria. This available in addition to the 12.5 % corporation tax deduction, so in effect resulting in a net 37.5% subsidy on costs.
The regime will be enhanced for SME’s – under provisions published in late 2019 a credit of 30% will be available for such companies; thus resulting in a 42.5% subsidy for such companies. Furthermore their entitlement to a cash refund will be extended and can be triggered in the startup, pre trade phase. As a result, the credit can effectively part-fund the R&D activity, acting as a valuable source of cash-flow. These enhancements for SMEs are still awaiting EU approval [as at APRIL 2021]
Furthermore, qualifying expenditure was extended so that additional amounts of outsourced third level expenditure will now qualify for the R&D credit. While this applies to all companies, it is expected to have more benefit to SMEs as they generally tend to avail of a more collaborative approach with respect to innovation.
Entitlement
The most important part of an R&D tax credit claim is determining eligibility.
A good initial test to determine if the work undertaken qualifies as R&D, is whether the project team faced uncertain outcomes at the start of the project. If you can show that the company is taking a risk by innovating, improving, or developing a process, product, or service, then it could qualify. Has the project gone beyond simply applying existing technologies?
Quite often R&D is the work a team would regard as an everyday activity: developing a new product; devising or making improvements to a production process; trying out a new material to reduce costs. The list is extensive and includes R&D activities carried out in a wide variety of science and technology areas such as software development, engineering, food and beverage production, pharmaceuticals, financial services, agriculture and horticulture. It is oft quoted but true – this does not necessarily need to be lab, whitecoat activity.
Tax efficient salary
The tax regime also has a mechanism whereby a profitable company can allocate its R&D credit to certain employees who worked on qualifying project. This can be a tax efficient way of providing a salary or bonus. To date, this has had relatively little take-up for SMEs - most probably because of the condition that the employee must not be or have been a director or 5% shareholder of the company. If this is not a stumbling block, then this mechanism should at the very least be explored. To illustrate, for an individual earning €200k it can result in a cash tax refund of in excess of €20k.
Administration
By far the most important administrative requirement here is the deadline – the claim needs to be submitted to Irish Revenue within 12 months of the end of the accounting period.
There can be a bit of work in quantifying the claim and ensuring adequate backup documentation in place. For SMEs, the making, recording and justifying claims can be onerous – the rules were likely designed with large established R&D intensive (e.g. pharma) companies in mind, where processes are very detailed and structured. This can all be achievable though and it will be best to have an outline of what is required at the outset rather than mid or post project.
2 Capital costs of Intellectual Property
Companies can claim tax allowances in respect of the capital cost of intangible assets where they are used in the course of a trading operation.
The scheme applies to a broad range of specified intangible assets. Examples include patents, copyrights, trademarks, licences, copyrights, computer software, brands, know-how, and goodwill directly attributable to any of these intangible assets.
The tax allowances can be written off in line with the amortisement charge in the company’s accounts or over 15 years. The tax deduction will reduce the company’s trading profits arising from exploitation of the IP. There is no clawback of the allowances after the fifth year of ownership.
Also, it is worth noting that this relief is not necessarily aimed at technical innovation but can also apply to a purchase of any brand or trademark etc.
Finally, Irish tax legislation also provides for a stamp duty exemption on the acquisition of such IP.
Whilst this relief is relatively straightforward, it can be a real factor when considering a capital investment structure. The vendor may propose the sale of a corporate (which owns the IP assets) rather than the IP assets directly. An equivalent amortization deduction for share acquisition costs would not be available on acquisition of the corporate directly.
3 Knowledge Development Box
Under the Knowledge Development Box (KDB) regime, a tax rate of 6.25% can apply to profits arising to certain Intellectual Property Assets which are a result of qualifying R&D activity carried out in Ireland.
The regime relates to income that arises mainly from patents, copyrighted software, and, for SME’s other intellectual property that is similar to an invention that could be patented i.e. inventions that are novel, non-obvious and useful. This will need to be certified as such by the Intellectual Property Office of Ireland and further details including the application form are available here
The regime does not apply to any marketing related IP such as trademarks, brands, image rights and other intellectual property used to market goods or services. This contrasts with IP allowances (1 above) whereby such assets would qualify.
The KDB regime is most beneficial to companies that carry out most or all of their underlying R&D activities in Ireland - the more R&D relating to an asset that takes place in Ireland, the more income from that asset will qualifies for the special 6.25% tax rate.
The next step after R&D tax credit…
If a company is entitled to the R&D tax credit (irrespective of whether it was claimed) having achieved an innovation, then eligibility for the KDB should be explored. In determining the relief available, a crucial part of the work will be in determining the profits arising from the qualifying IP for example profits relating to marketing activities need to be excluded. It is helpful here that Revenue will accept a notional royalty rate of up to 10% for key IP used by small companies (unless there is evidence to the contrary).
The deadline for making a claim here is two years after the end of the accounting period so a bit more generous than the deadline for the R&D credit. The company will need to be able to track and trace all expenditure and income linked to the qualifying IP – though it should be able to leverage the information already maintained for the purposes of the R&D credit. The first claim will be the most time-consuming, but after that with a process in place the KDB applications each year will become much easier to undertake.
