R&D Tax Credit updates - Rate and payment increases

Introduction

The international tax landscape has been altered substantially by changes introduced through the OECD BEPS Pillar Two, which will lead to man companies’ falling within a new minimum effective corporation tax rate of 15%. Therefore, the significance of Ireland’s 12.5% corporation tax rate, which has been one of the pillars in Ireland’s offering as a location for foreign direct investment, may be reduced for many multinational companies.

What this will mean is that the R&D incentives that Ireland offers will take on more significance and will play a greater role in attracting R&D investment from the world’s largest companies in the future.

The need for a best-in-class R&D tax credit regime is more pronounced in Ireland. Larger economies have many more resources available to them, as well as larger universities and deeper talent pools, all of which position them well for R&D activities. Ireland’s R&D tax credit must therefore be better to address the inherent disadvantages that we face as a smaller economy.

This is evidenced by the EU’s 2023 European Innovation Scoreboard (EIS), an annual survey of each country’s relative strengths and weaknesses in the research, development and innovation (RD&I) space.

On the one hand, the EIS listed Ireland as a “strong innovator” with an overall score above the EU average. On the other hand, it noted that Ireland’s performance lead over the EU is becoming smaller and flagged a decrease in government funding for business’s R&D since 2016.

Critical changes to Ireland’s R&D tax credit regime were introduced by Finance Act 2022 (see our article “Finance Act Measures Updating R&D Tax Credit, KDB and Digital Games Tax Credit”, Irish Tax Review 2023, Issue 1) to align the R&D tax credit with international tax reforms and to ensure that the credit remains an important and relevant incentive for all claimant companies.

The changes brought in by Finance Act 2022 have safeguarded the Irish R&D tax credit by ensuring that it meets the Pillar Two definitions of a “qualified refundable tax credit”, meaning that it does not reduce the effective rate of corporation tax for companies that are within the scope of Pillar Two.

Building on the changes brought in by Finance Act 2022, two important enhancements to the R&D tax credit were announced by the Minister for Finance, Michael McGrath TD, as part of Budget 2024, with further details now outlined in Finance (No. 2) Act 2023:

the increase in the R&D tax credit rate from 25% to 30% and
the doubling of the amount of R&D tax credit available to be refunded as a first-year R&D tax credit instalment (from €25,000 to €50,000).

In this article Damian Flanagan and Cian Smith discuss these enhancements and their impact on companies claiming the R&D tax credit in Ireland, as well as other updates to the R&D tax credit contained in Finance (No. 2) Act 2023.

Changes to R&D Tax Credit Regime

Increasing the R&D tax credit
Doubling first-year payment
“Pre-notification” requirement
Additional amendments

The first and most significant enhancement to the R&D tax credit regime is an increase in the rate of the tax credit from 25% to 30%, which is available to all claimants, regardless of size. This change, which builds on the important enhancements relating to how the credit is utilised by claimants that were introduced in Finance Act 2022, is one of the most consequential changes made to the R&D tax credit in the last 15 years.

The increase in R&D tax credit rate to 30% will apply for accounting periods starting on or after 1 January 2024; therefore the positive impact will be seen in R&D tax credit claims that are filed in 2025.

As noted by the Minister for Finance in his Budget speech, there is a dual purpose to the increase in the R&D tax credit rate. On the one hand, it is designed to maintain the net value of the existing credit for those businesses subject to the new 15% minimum effective tax rate resulting from BEPS Pillar Two. On the other hand, it will deliver a substantial benefit to SMEs and those companies outside the remit of Pillar Two.

Reaction

The increase in the rate has been received very positively across the business community, both by the SME sector, which can now avail of an additional 5% benefit, and by the multinational sector, where it will help to preserve Ireland’s competitiveness when aligning with international tax reform.

It is worth bearing in mind that the R&D tax credit is in addition to the normal 12.5% trading deduction available for R&D expenditure incurred by companies carrying on R&D activities, resulting in an effective tax deduction of 42.5% from 2024.

Calculations

The positive impact of this increase can be seen if we apply it to a typical example of an R&D tax credit claim. The average R&D tax credit claimed by companies in 2021 (the latest year for which there are Revenue statistics) was €462,000 (based on 1,629 companies claiming the credit in 2021, with a total cost to the Exchequer of €753m).

If we take a company that is claiming this average amount as its R&D tax credit (at the 25% rate), its R&D tax credit if the new, 30%, rate is applied to the same level of R&D expenditure would be €554,400 – a significant increase of 20% in the overall value of the R&D tax credit to be claimed by the company.

In respect of companies that come within the scope of Pillar Two, guidance released in July 2023 states that qualifying R&D tax credits (which the Irish R&D tax credit is considered to be after the changes brought about by Finance Act 2022) should be included in GloBE income in calculating the effective tax rate. The effective tax rate of a company must then be topped up to the required 15% minimum rate.

If we take a simplified example, including the qualifying R&D tax credit in GloBE income means that a company receives the R&D tax credit benefit but the top-up tax due under Pillar Two is increased by 15% of the R&D tax credit – this means that there is a net benefit of 85% of the R&D tax credit for companies that are within the scope of Pillar Two.

The increase in the R&D tax credit to 30% essentially compensates companies for this increase in top-up tax.

As another example, before the implementation of Pillar Two and where the 25% R&D tax credit rate is in effect, a company with qualifying R&D expenditure of €1m would receive an R&D tax credit of €250,000 – this would be the net benefit received by the company. After the implementation of Pillar Two and the application of the new R&D tax credit rate of 30%, a company within the scope of Pillar Two and with qualifying R&D expenditure €1m would receive an R&D tax credit of €300,000.

However, as the €300,000 tax credit is now included in GloBE income, there will be a top-up tax cost of 15% of the €300,000 credit, equalling €45,000. This means that the net benefit for the company after the implementation of Pillar Two and the introduction of the 30% R&D tax credit rate is €255,000 (i.e. €300,000 R&D tax credit less €45,000 top-up tax). As can be seen, the value of the R&D tax credit has been maintained (with a small net benefit) for companies that come within the scope of Pillar Two.

It is worth noting that this is the first increase in the R&D tax credit rate since Finance (No. 2) Act 2008 increased it from 20% to 25% (and also introduced the cash refund mechanism, allowing companies at the time to claim a refundable tax credit over three years).

Possible impact

The positive impact that the previous increase in the rate of R&D tax credit had can be seen in the fact that the number of companies claiming the credit doubled from c. 600 to c. 1200 within two years of the rate increase from 20% to 25%.

Although we are unlikely to see the number of companies claiming the credit double in the short term after the latest rate increase (the total number of claimants in 2021 was 1,621), it will be interesting to see the impact that the 5% increase in the headline rate of the R&D tax credit has on the number of companies claiming it.

The second enhancement of the R&D tax credit regime is a doubling of the amount of the credit available to be refunded to a company as part of its first-year instalment. This has increased from €25,000 to €50,000.

As a reminder, claimants of the R&D tax credit have the option either to offset the credit against their tax liabilities in three instalments over a three-year period or to have the credit repaid in the form of refundable instalments over the same three-year period. Many loss- making companies will continue to opt for refundable instalments, serving as a crucial source of funding for their R&D activities.

The refundable instalments will now be payable as follows:

The first instalment is the greater of:
- €50,000 (or the credit due, if lower), or
- 50% of the credit claimed.
The second instalment will continue to be based on three-fifths (30%) of any balance of the remaining R&D tax credit.
The third instalment will continue to be any balance of the R&D tax credit remaining (20%), being the credit claimed less the first and second instalment amounts already claimed.

This change is designed to provide quicker access to funding for SMEs with R&D tax credit claims of less than €100,000. This cohort of claimants generally makes up two-thirds of the total R&D tax credit claims filed each year. Coupled with the increase in the rate of the credit to 30%, the acceleration of the repayment of the R&D tax credit will no doubt have a significant beneficial cash-flow impact on the indigenous SME sector.

The increase in the amount available as part of the first-year R&D tax credit instalment will apply for accounting periods starting on or after 1 January 2024.

In addition to the enhancements discussed above, Finance (No. 2) Act 2023 introduces a “pre-notification” requirement for new R&D tax credit claimant companies or companies that have not made an R&D tax credit claim in the three previous accounting periods. Where applicable, the following details must be provided to Revenue within a period of 90 days before the R&D tax credit claim is made:

the name, address and corporation tax number of the company;
a description of the R&D activities carried out by the company;
the number of employees carrying on R&D activities; and
details of expenditure incurred by the company on R&D activities that has been, or is to be, met directly or indirectly by grant assistance or any other assistance.

In addition to the information listed above, as part of the pre-notification process, Revenue may require the company to provide further information and provide any assistance that may reasonably be required for the purpose of Revenue’s inspection of the R&D tax credit claim information.

Practically, this update will mean that companies coming within the above rules will need to commence the R&D tax credit claim preparation earlier to ensure that the relevant details of the R&D activities and associated expenditure are collated in the manner required by Revenue and are available 90 days before the R&D claim is made. For a new R&D tax credit claimant company with a 31 December accounting period, under the existing R&D tax credit rules, its deadline for filing its 2024 R&D tax credit claim would be 31 December 2025.

However, the pre-notification rules provide that the relevant details need to be submitted to Revenue before 2 October 2025. If the intention is to file an R&D claim in the tax return on 23 September 2025, the relevant details will need to be submitted to Revenue on approximately 23 June 2025, in effect bringing forward claim preparation by a full three months.

It is unclear at this stage what Revenue will do with this information on receipt and whether it will provide some kind of “approval” before the claim is submitted. The Minister for Finance, Michael McGrath, explained at the Committee Stage of the Finance Bill that “the purpose of this pre-notification is to enable resource planning in Revenue to facilitate efficient processing of claims”.

It is important to note that based on the current changes implemented by Finance (No. 2) Act 2023, the pre-notification requirement applies independently to claims for the R&D tax credit on buildings expenditure under s766D Taxes Consolidation Act 1997 (“TCA 1997”) i.e. if no credit on buildings expenditure has been claimed within the prior three accounting periods, a notification will be required for such, regardless of whether any other kind of expenditure (i.e. a non-buildings R&D tax credit) has been claimed within the same timeline.

Although the pre-notification requirement is new to the Irish R&D tax credit regime, it has been introduced in the UK, where for accounting periods starting on or after 1 April 2023 there will be a requirement to notify HMRC of an intention to claim within six months of the end of the relevant accounting periods.

We will have to wait and see how the notification process operates in practice under the Irish regime, and whether the absence of notification, or of notification within 90 days, will deny entitlement to claim the R&D tax credit. Although at this point in time there is no provision in legislation for penalising companies that do not make a pre-notification, it is important that companies monitor this situation and are aware of this update to avoid any potential loss of R&D tax credit amounts due to the failure to adhere to the updated pre-notification deadline. We understand that guidance and information in respect of the reporting mechanism for the pre-notification will be released in due course.

A number of technical amendments are also introduced in Finance (No. 2) Act 2023, to rectify some oversights in the “new” R&D tax credit rules introduced in Finance Act 2022. These include legislating for the inclusion of the following provisions in the “new” R&D tax credit rules:

a plant and machinery R&D apportionment provision and
the ability for unused R&D tax credits to transfer with a trade transfer in certain group restructures.

These technical amendments were previously provided for in the context of the “old” R&D tax credit rules and now apply to the “new” R&D tax credit rules, so in effect these updates are just maintaining the status quo.

Conclusion

The amendments included in Finance (No. 2) Act 2023 build on the positive changes introduced in Finance Act 2022 to make the Irish R&D tax credit regime a fully payable credit regime and to abolish the maximum limit on an R&D tax credit that can be monetised.

The amendments also endorse the importance of the R&D tax credit regime in anchoring and stimulating investment and high-quality employment in R&D activities in Ireland.

This article first appeared in Irish Tax Review, Issue 1, 2024 (Vol. 37 No. 1), published by the Irish Tax Institute, and is reproduced here with their kind permission.

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In KPMG’s R&D Incentives Practice we have significant experience in identifying the right approach across the varied funding mechanisms and can add value to your RD&I.

If you are a business seeking advice on conducting R&D activity, please contact Damien Flanagan or Cian Smith of our R&D Incentives team. We'd be delighted to hear from you.