R&D Tax Credit and KDB

In this report we set out responses to the questions raised in the Department of Finance consultation into the Research and Development (“R&D”) tax credit and Knowledge Development Box (“KDB”) regimes.

Our responses are based on (i) our extensive experience in assisting companies with the preparation of their R&D tax credit (“RDTC”) claims and managing Revenue enquiries/audits, and KDB claims since the inception of the RDTC in 2004 and the KDB regime in 2016 and (ii) Responses to a detailed survey KPMG conducted with R&D performing companies in May of this year. 

Our survey – key observations

Our survey of 78 Irish and foreign owned businesses who engage in R&D activities in Ireland reaffirmed what has been widely accepted since the RDTC was first introduced in 2004 - the RDTC plays an important role in attracting investment in R&D activity as well as sustaining the R&D activity already here. 

In 2020, the cost of the RDTC to the Exchequer was €658m.This means that claimant companies invested over €2.6 billion on qualifying (for RDTC purposes) R&D expenditure – a large proportion of which is made up of salary costs. This Figure disregards the non-qualifying expenditure including support staff, activity outsourced to third parties which may not be claimable, and ancillary supporting activities in the local community (facilities, maintenance, canteen etc). Therefore, in reality, the claimant companies invest significantly more than €2.6 billion in both the actual ‘doing’ of the R&D activity but also to facilitate/enable the R&D to take place. This is a crucial contribution to our economy. 

The key takeaway points from our survey can be summarised as follows: 

• 63% of survey respondents increased overall R&D expenditure over the last 3 years in Ireland with the same percentage planning on increasing R&D expenditure over the next 3 years 
• 74% of MNCs responded that if the RDTC was not available there would be a marked decrease (at least one third) on the current level of R&D activity that takes place in Ireland. 
• 50% of MNCs said that without the R&D tax credit more than two thirds of R&D activity would likely move abroad. 
• 83% of survey respondents believe that an increased R&D tax credit rate of 35% would see more R&D undertaken by their company in Ireland. 
• 92% of survey respondents believed that an enhanced R&D tax credit rate of 50% would incentivise R&D of green technologies (e.g. solar, wind, hydro or biomass energy etc.). 
• 85% of MNC respondents believe that the RDTC at least compares equally well to other regimes, with only 15% believing that Ireland’s R&D tax credit regime is less favourable to other schemes. 
• The 25% rate and the availability of the RDTC as ‘cash back’ were the two most attractive features of the regime across all companies surveyed. However, for SMEs the availability of ‘cash back’ was No.1.

In our view, the survey responses very clearly demonstrate that the R&D tax credit is a vital incentive for companies who undertake R&D activity in Ireland and is integral for attracting additional R&D investment (i.e. jobs and capital expenditure) while also sustaining existing levels of R&D activity.

Business Expenditure on R&D

Business Expenditure on R&D (“BERD”) in Ireland has increased every year since 2011 and in 2019 it amounted to €3.3bn with estimates for 2020 at €3.4bn. In 2019, the business sector accounted for 74.5% of total Gross Expenditure on R&D (“GERD”) (which includes R&D expenditure incurred by business, academic and government sectors), well above the EU average of 66.5% and second only to Hungary. What this demonstrates is that Ireland disproportionately relies on its business sector to fund R&D. The RDTC, and to a significantly lesser extent the KDB, are the principal tax incentives available to support the companies who engage in R&D activities. 

Suggested enhancements to R&D Tax Credit

The responses from our survey confirm that the R&D tax credit is a very valuable incentive to companies conducting R&D activity in Ireland and compares favourably internationally. However, the ever-changing international tax landscape requires that the RDTC must continue to evolve and be improved. We believe that the following enhancements to the RDTC would ensure that it remains fit for purpose, and amongst the ‘best in class’. All of these enhancements should be available to all taxpayers, but would be particularly impactful for SMEs: 

1. Ensure Ireland’s R&D tax credit scheme meets the criteria to be a “Qualified Refundable Tax Credit” under GloBE rules and also complies with the new 2021 US Regulations. 
2. The rate of the relief should be increased to at least 35% for the first €1M of qualifying R&D expenditure. 
3. Increase the RDTC rate to 50% with respect to R&D carried out on green technologies. 
4. Allow for automatic cash refunds in one instalment in Year 1 where the RDTC amount is below €300k. The only cost to the State is cash flow. 
5. Expand the costs which may be included as qualifying R&D expenditure to include specific indirect supporting and ancillary activities. 
6. Increase the limits on the amount of allowable expenditure on outsourced activities to third parties to the greater of 25% of a company’s non-outsourced R&D expenditure or €250,000. 

In addition, we believe the following enhancements should be made to the KDB regime to increase its relevance and uptake amongst Irish companies: 

• Extension of qualifying IP to include ‘know-how’ and trade secrets. 
• Extend the provisions of S769R (i.e. the section that applies to companies with income arising from IP of less than €7.5m) to bring larger companies within scope. 
• Clarification and extension of ‘transitional measures’ to R&D activity carried out pre 1 January 2016. 
• Consideration of whether the scheme could be made fully refundable (similar to the RDTC) in light of the OECD BEPS Pillar 2 rules. 

Throughout this document we expand on each of the above points.