R&D tax credit: attractive incentive but not without its drawbacks

With 2,600 companies claiming credits worth €650 million in 2019 alone, it is clear that the R&D tax credit regime is a very valuable incentive. The credit is open to all companies in Ireland that are undertaking qualifying research and development activities in Ireland or within the European Economic Area. Qualifying R&D expenditure generate a tax credit of 25 per cent which can be offset against corporate taxes. This is in addition to the normal tax deduction at the 12.5 per cent corporation tax rate.

This means that companies engaged in qualifying R&D activity can claim a refund from Revenue of €37.50 for every €100 spent. In effect, the R&D tax credit combined with normal deductions reduce the real cost of R&D by up to 37.5 per cent.

And it can be even more attractive for early-stage companies which are not yet making profits. Where a business doesn’t have taxable profits, the credit can be claimed in cash in equal instalments over three years. Very useful for cash flow. Alternatively, the tax credit can be offset against future tax liabilities.

But, as with most good things in life, terms and conditions apply. “Claims must be made within 12 months of the end of the accounting period otherwise the benefit is lost,” says Gerry Vahey, a tax partner with Mazars in Ireland.

Straightforward process

“The application process is relatively straightforward,” he adds. “Companies identify the R&D expenditure and include the claim amount on the corporation tax return. What can lead to difficulties is the delay in processing refunds and companies inadvertently missing the 12-month claim window. Suggested improvements would be to extend the time limit to perhaps 24 months and a full refund in year one rather than over three years.”

There are also some subjective issues. “One of the conditions that must be satisfied is that the project needs to seek to achieve a scientific or technological advancement,” Vahey explains. “This test is quite subjective and can lead to difficulties in ascertaining whether a project qualifies. Not all innovation qualifies for the credit and a suggested improvement would be to extend the credit to new product or service development subject to certain conditions.”

And Revenue can open claims for review for up to five years after the year in which the expenditure is incurred. “This open period can lead to uncertainties that the credit may have to be paid back if the conditions are not satisfied and a suggested improvement would be to reduce this period to 24 months,” he adds.

That uncertainty, coupled with a perceived heavy administrative burden, can deter smaller companies from claiming the credit. “The amount of documentation required can be a significant burden for indigenous SMEs who don’t have the resources to devote to it,” says Grant Thornton tax director James McMahon. “They have to meet the science test and the accounting test and many of them just don’t have the data to make a claim. SMEs by their nature are limited in resources. In fairness to Revenue, smaller claims up to €200,000 in qualifying expenditure are aligned with the Enterprise Ireland rules for R&D grants but firms are into unknown territory after that though.”

Clarity would help. “Some certainty would be welcome, particularly in relation to the accounting test,” he says. “For example, rent paid was always allowed. But Revenue without notice took an interpretation of legislation that rent was not allowed as an expense. There was no legislative change or updated guidance. That’s an example of the uncertainty.”

Mark O’Sullivan who leads BDO’s dedicated research and development incentives practice agrees. “The value of it undeniable, but there is definitely room for improvement,” he says. “Mainly in relation to administration and uncertainty. It’s a question of how much work is needed to make a claim and how certain they can be that it will be successful, and all the line items will be successful. Two-thirds of the applicants have less than 50 employees; they are SMEs and they are always going to struggle to have the resources for the administrative requirements.”

He notes that the administrative burden has been mentioned in general terms by the Department of Finance over the last decade but not much has changed. “The only real concession has been in relation to credits worth less than €50,000,” he adds.

In this case, the Enterprise Ireland approval for an R&D grant for the project is accepted as sufficient evidence to back up the veracity of the claim.

Uncertainty

“Different rules and regulations around what is allowable for Enterprise Ireland grants and the R&D tax credit does lead to challenges and uncertainty,” O’Sullivan continues. “Having put an application together for Enterprise Ireland a company might think they’ve got everything right, but they can then find it’s not right for Revenue. Canada has a single regime with set amounts for different costs and so on. That might be worth looking at.”

A new regime aimed specifically at smaller businesses which would increase the credit to 30 per cent and bring in some other changes has been announced but hasn’t been introduced yet. “It’s a fantastic idea,” says McMahon. “The aim is to encourage small enterprises to engage in R&D activity, but it hasn’t been enacted yet. It’s waiting for approval from Europe. There is also the potential for it to apply to businesses which are still at the pre-trading stage. That would be very helpful as the credit can be paid in cash. There is a lot in that piece of legislation, and it would be great if the Government could get it over the line.”

The other significant tax incentive for R&D activity is the “Knowledge Development Box”. This effectively halves the corporate tax rate to 6.25 per cent on profits arising from an invention or other qualifying piece of intellectual property where the R&D work has been carried out by a company based in Ireland.

While it is clearly very attractive, take-up has been sluggish. “It may be that there is a lack of public awareness about the knowledge development box regime, with many companies missing an opportunity to claim the relief,” says John Burke, assistant tax manager with Mazars in Ireland. “In addition, the calculation of the relief is quite burdensome and in order to make a correct claim the internal income and expenditure tracking system on qualifying needs to be set up correctly.”

McMahon is hopeful that this will be addressed soon by updated guidance notes from Revenue. “It can be difficult for companies to claim and there is a lot of grey areas, but Revenue really does want it to work. It’s quite similar to when the R&D tax credit was brought in back in the early 2000s. Over time a lot more companies claimed once they got comfortable with it.”