In Budget 2016, Minister Noonan announced the introduction of the Knowledge Development Box (“KDB”).
With the release of the finance bill came news of the 6.25 per cent rate that would apply to profits derived from patented or similarly protected inventions and copyrighted software. The news of this rate was broadly welcomed.
Ireland’s KDB meets the OECD’s “modified nexus standard”*. This nexus approach only allows that a taxpayer can benefit from an IP regime to the extent that it can clearly show the incurred expenses that resulted in the qualifying asset (IP). Where the qualifying asset is acquired rather than being developed by the company then the acquisition costs of such an asset will not meet this modified nexus standard.
It is a requirement of the KDB that the claimant company has incurred expenditure on R&D and that this expenditure is subject to the same technical qualification criteria as would be the case for R&D tax credit claims under the existing R&D tax credit legislation.
The KDB regime is also intended to enhance Ireland’s offering as an IP location alongside the 12.5 per cent corporate tax rate, the R&D tax credit and the IP amortisation regime.
The technical criteria for inclusion of expenditure under the R&D tax credit and the KDB are intrinsically linked. This is due to the fact that R&D has to be undertaken to generate the qualifying asset. So, whether or not a company has claimed the R&D tax credit for the activities resulting in the qualifying asset, they must still evidence the fact that these technical or scientific qualifying activities were undertaken. This underpins the importance of well-managed R&D systems and controls. Companies that approach their R&D tax credit claims with a correct, critical view on qualifying activities and, who manage and measure their R&D well will have already performed some of the necessary steps in claiming under the KDB rules.
Who can claim under the KDB?
Irish-resident companies with qualifying R&D activity that results in the creation of qualifying assets can claim under the KDB. Qualifying activity includes copyrighted software, patented or similarly protected inventions and, in the case of smaller companies, registered inventions that are certified by the Controller of Patents to be novel, non-obvious and useful. “Small” companies for the purposes of the KDB are companies with income arising from IP/qualifying assets of less than €7.5 million.
When can I claim under the KDB?
The KDB becomes relevant to claimant companies for accounting periods that commence on or after 1 January 2016 and before 1 January 2021. The KDB calculation forms part of the Corporation Tax return.
Evidencing expenditure on Qualifying Assets
Claimant companies will need to be familiar with the qualifying criteria under S766 (the R&D tax credit). If KDB amounts are scrutinised by Revenue, the documentary evidence that will be required to defend the claim will be substantial. A company will have to demonstrate the overall income from the qualifying asset, the qualifying expenditure (R&D) in the development of the qualifying asset, as well as the total overall expenditure to develop the asset. Again this clearly shows the necessity for good systems and controls around R&D project management, to minimise cost, time and effort. Importantly, it will also be necessary to demonstrate a clear link between these expenditures and the profit derived from them.
What to do now?
Companies resident in Ireland who generate profits, which are derived from certain intellectual property in Ireland (qualifying assets), will need to assess whether the KDB will be beneficial.
Some items to think about are:
How do you manage and evidence your R&D activity that results in qualifying assets?
Are there any transfer pricing issues arising from R&D activities that are geographically distributed?
If a company is multi-jurisdictional, then there may be a requirement to complete “Country by country reporting” (CbCR).
Importantly, what systems and controls are required to be put in place now that will assist in identifying what profit results from each qualifying asset held?
We welcome the introduction of the Irish KDB regime, but the narrow scope of qualifying assets included may limit the uptake of the scheme. However, where a company has R&D performed in Ireland that makes a significant contribution to the creation of qualifying assets in Ireland, and which in turn generate profits, then the KDB will be a useful mechanism to reduce the effective tax rate.
Unfortunately, the nature of the ‘modified nexus’ model developed by the OECD is such that there is likely to be an onerous ‘tracking and tracing’ requirement. This is because separate profitability streams should be computed for each individual qualifying asset, in determining the extent of any tax benefit under the Irish KDB regime. This results in an administrative burden that needs to be considered.
While the pharmaceutical industry already has certain ‘serialisation’ features that will alleviate this burden to some extent, for the most part no such features exist outside of the pharma sector. We would envisage complexity in allocating income and expenditure to each copyrighted software/patented IP or similarly protected invention that is embedded in a particular product or service being offered for sale.
In our view, a pragmatic approach is required in dealing with these ‘tracking and tracing’ provisions. Failing this, qualifying taxpayers, need to ensure that their internal systems are aligned in such a way that the relevant data can be collated in a reliable and efficient manner to compute the relief that may be due under the Irish KDB regime.
Groups that are affected by the CbCR requirements should begin to assess the tools, and even perhaps system changes, that may be required to gather the information and to model the potential results. It may be necessary to take action in respect of their structure/tax strategy.
At a time of increasing competitiveness (for example, the UK corporate tax rate is reducing to 18% from 2020), it is important that Ireland remains competitive in an FDI context. As other countries amend their IP box regimes to become OECD compliant, and as countries take action in respect of further BEPS actions, Ireland should continue to evolve its overall offering as a location of choice for investment.