The Knowledge Box Regime
The Finance Act 2015 introduced a knowledge development box regime. A 6.25% tax rate applies to profits from qualifying assets earned by an Irish company carrying on a specified trade.
The profits available are the proportion of the profits of the specified trade that the expenditure on qualifying assets bears to total costs incurred to develop the qualifying assets. It is the proportion that the Irish company’s expenditure on the assets bears to the total cost of developing the qualifying assets.
The specified trades under the legislation are any one or more of the following:
- managing, developing, maintaining, protecting, enhancing or exploiting of intellectual property; researching, planning, processing, experimenting, testing, devising, developing or other similar activity leading to an invention or creation of intellectual property; or
- the sale of goods or the supply of services that derive part of their value from activities described above, where the above forms part of a trade.
The specified trade is deemed to be a separate trade and the provisions apply to the specified trade, isolated from the other trades of the company.
Qualifying asset is an intellectual property, other than marketing-related intellectual property, the result of research and development activities. It includes computer programs, inventions protected by patents, supplementary protection certificates for medicinal and plant or plant protection products and plant breeders’ rights.
Only patents which have undergone a substantive examination will qualify. Patent legislation is to be amended so that Irish patents include a substantive examination for novelty and inventive steps. Unexamined patents certified prior to 1 January 2017 may qualify. In the case of patent granted prior to 2016, the certification requirements do not apply.
The profits of the specified trade are the total income from the qualifying asset comprising royalty income and licence fee income, from the use of or the exploitation of the qualifying asset.
It also includes parts of the sale price, calculated on a just and reasonable basis attributable to the qualifying asset. Expenditure in earning the income is to be approportioned and distributed to this specified trade on a just and reasonable basis.
Qualifying profits in relation to qualifying assets are the profits of the specified trade as defined above in the proportion of the qualifying expenditure incurred on the qualifying asset to the overall expenditure.
Qualifying expenditure on a qualifying asset is expenditure wholly and exclusively incurred by the company in carrying on research and development activities in an EU State, where the activities lead to the development, improvement or creation of a qualifying asset. This is equivalent to the definition of research and development activities for the purpose of the research and development tax credit.
Qualifying expenditure excludes costs incurred to related parties. It excludes acquisition costs and group outsourcing costs.
Uplift expenditure may take account of this excluded expenditure. It is the lower of 30% of qualifying expenditure or the aggregate of amounts paid to group companies and acquisition costs.
Qualifying profits of the specified trade calculated under formula determine the amount of profits qualifying for the knowledge development box relief. The relief gives the company an allowance of 50% of such qualifying profits to be treated as a trading expense. This allowance halves the rate of tax on qualifying profits to 6.25%.
The claim must be made within 24 months of year end. Revenue may take expert advice to determine any aspect of the claim. The knowledge development box relief is ignored for the purpose of the research and development tax credit, which is refundable. It cannot be taken into account in order to increase the cash refund.
Where a claim is made for relief on a qualifying asset, the company must continue to claim the relief for periods until the qualifying asset is disposed of or ceases to be used. The qualifying profit is calculated by the sum of the qualifying expenditure and uplift expenditure divided by overall expenditure, multiplied by the qualifying profits. The qualifying profits are effectively taxed at half rate.
Reliefs available under the knowledge development box do not increase the refundable research and development tax credits. The amount of unused research and development tax credit arising from the knowledge development box relief is not available for the R&D tax credit refund. It is ring-fenced and must be carried forward.
Where a company has a number of qualifying assets that are linked, family of assets for this purpose is the smallest grouping of assets for which income and expenditure can be reasonably identified. The knowledge development box is applicable to this family of assets as a single qualifying asset.
Separate documentation is required in respect of each family of assets. The records must support the claim of scientific technologies and engineering challenges underlying the activity, which produce the qualifying asset. There must be a link between the expenditures and the family of assets. Detailed records are required of income and expenditure on the qualifying assets. They must be documented
Anti-Avoidance / Transfer Pricing
Anti-avoidance provisions seek to ensure that qualifying expenditure on a qualifying asset and income from a qualifying asset include only amounts incurred or received for bona fide commercial purposes that are not part of scheme of arrangement, the main purpose of which is tax avoidance.
Large companies must use the transfer pricing rules to determine market value in intellectual property, apportionment of income in relation to the overall income from the qualifying asset, apportionment of R&D activities for the purpose of qualifying expenditure and the qualifying asset apportionments relating to corporation tax referable to be specified trade and transitional measures respectively.
Transitional rules may apply until 2020. Acquisition cost and group outsourcing costs incurred prior to commencement of the legislation on 1 January 2016 may limit the relief as they are not part of qualifying expenditure.
Qualifying expenditure and qualifying assets is determined with reference to the expenditure on all qualifying assets in the two year period ending on the last day of the accounting period. Accordingly pre-2016 expenditure may be incurred in the case of group outsourcing costs; a just and reasonable allocation must be made, where appropriate.
2019 Act SMEs
Finance Act 2019 includes additional supports for micro and small companies who undertake Research and Development (R&D) activities. These measures, are subject to a commencement order by the Minister for Finance pending State aid approval from the European Commission, include:
- An increase in the R&D tax credit rate from 25% to 30%.
- The addition of an enhanced method to calculate the payable element of the R&D tax credit, based on twice the current year payroll liabilities.
- The introduction of a new provision to allow pre-trading R&D expenditure to qualify for an R&D tax credit, which is limited to offsets or repayments calculated by reference to payroll tax (PAYE and USC) and VAT liabilities for the same period.
2019 Act General Changes
The section also makes several changes to the operation of the credit more generally, including:
- Increasing, from 5% to 15%, the allowable limit on R&D expenditure outsourced to universities or institutes of higher education.
- It provides that grants funded by any State and/or the European Union must be deducted from qualifying R&D expenditure.
- A company which outsources to third parties must now notify in advance of, or on the day of, payment, if that company intends to make a claim for the R&D tax credit.
- It aligns the penalty application in respect of an R&D tax credit over claim to the penalty procedures for other credit over claims.
- It clarifies that where a payable amount or amount surrendered to a key employee is later withdrawn, then it is not permissible to use any offset of losses or credits to shelter the clawback of such an amount.
Finance Act 2019 allows capital expenditure on buildings or structures, which are scientific research, qualify for an allowance and where a company may qualify for a scientific capital allowance and the R&D tax credit, then both reliefs cannot be claimed in respect of the same expenditure.
Finance Act 2020 provides for the extension of the Knowledge Development Box relief for a further two years until 1 January 2023. The Knowledge Development Box provides for a deduction equal to 50% of the profits from patented inventions and copyrighted software (qualifying assets) earned by a company to the extent it relates to Research and Development (R&D) undertaken by the company.
2022 Act Changes I
Finance Act 2022 amended the Research and Development (R&D) tax credit regime. The changes were made to reflect international tax changes. They are timing changes and did not affect the quantum of credit that a company is entitled to claim.
The caps which were imposed on the amount of the payable R&D tax credit no longer apply for accounting periods beginning on or after 1 January 2022.
Finance Act 2022 introduced, provisions relating to R&D expenditure other than on a building or structure and relating to qualifying R&D expenditure on a building or structure, to apply for accounting periods beginning on or after 1 January 2022. It introduced the new system for payment or offset of the R&D corporation tax credit. A company has the option to specify whether the R&D corporation tax credit is to be offset against the company’s tax liabilities or is to be paid to the company.
Finance Act 2022 provides that the R&D corporation tax credit in respect of qualifying expenditure (other than expenditure on buildings or structures) is payable over up to three years, as follows:
- The first payable instalment in year one, shall equal the greater of:
- €25,000, or if lower, the amount of the R&D corporation tax credit, or
- 50 percent of the amount of the R&D corporation tax
- The second payable instalment in year two, shall be three-fifths of the remaining balance of the R&D corporation tax credit.
- The last payment in year three shall be the remaining balance of the R&D corporation tax credit in respect of the accounting period, less the sum of the first and second instalment amounts.
2022 Act Changes II
Payment of the R&D credit is over a three- year period in respect of expenditure on buildings or structures used for qualifying R&D activities, as set out below:
The first payable instalment in year one is 50% 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 R&D corporation tax credit in respect of the accounting period, less the sum of the first and second instalment amounts.
Payment of the R&D corporation tax credit applies in full is within 48 months from when a valid claim is made and where all conditions to qualify for the R&D corporation tax credit are met, which includes satisfying Revenue Commissioners in respect of the company’s entitlement to the R&D corporation tax credit claim by furnishing any information which may reasonably be required.
There are interest and penalty provisions and other administrative matters.
Finance Act 2022 amends the key employee relief provisions for the R&D tax credit. It includes references to the new provision which contain the new payment mechanisms for the R&D tax credit.
2022 Act Repeals
Finance Act 2022 repealed the non-commenced provisions relating to micro and small sized companies, which were not possible to commence for State aid reasons. It amended as follows:
- The pre-existing system, which offsets the R&D tax credit against corporation tax liabilities followed by three payable instalments, was changed to a new three-year fixed payment schedule.
- A company has the option to call for payment of their eligible R&D tax credit or to request for it to be offset against other tax liabilities.
- Pre-existing caps on the payable element of the credit were
- The first €25,000 of a claim on R&D expenditure is payable in full, to provide a cash-flow benefit for smaller R&D projects and encourage more companies to engage with the regime.
- Pre-trading expenditure incurred on qualifying R&D activities can be claimed as a payable R&D credit over a three-year period from the year that the company commences to trade.
- Finance Act 2022 put transitional measures in place for one year, to smooth the transition to the new payment system for companies already engaged in research & development activities