State forced to change tax policy

The Government has been forced to change a key tax policy that it uses to retain research and development (R&D) investment, following a legal threat by the European Commission.

The Government has agreed to offer tax exemptions on patent royalties to firms, even when they carry out the fundamental research in other EU states. Until now, firms were only offered a tax exemption when the R&D for the patent was undertaken in the Republic. This served as an incentive to create and retain jobs in the highly skilled R&D sector - a priority for the Government's enterprise strategy.

The commission warned the State two years ago that this discriminated against other EU member states and was incompatible with the freedom of establishment and free movement of services enshrined in the EU treaties.

It argued that it dissuaded Irish firms and individuals from contracting out research to institutions established elsewhere in the European Economic Area (EEA). It also dissuaded Irish-based firms from establishing research centres in other EU states because income generated from the resulting patents would not benefit from the domestic tax exemption.

The commission issued a final warning yesterday to the Government and threatened to take it to the European Court of Justice unless it changed the practice. It gave the Government two months to respond or face legal action. The Department of Finance confirmed yesterday it has inserted an amendment into the Finance Bill that should meet the concerns of the commission. The amendment will enable firms conducting R&D in any state in the EEA to apply for tax exemption on royalties earned from patents in Ireland.

It has also changed the legislation to cap the level of exemption each firm can receive from patent royalty income. Firms will only be able to receive an exemption on royalty taxes of €5 million from January 2008.

A department spokesman said section 45 of the Bill would be debated in the Senate next week. He said it would broaden the definition of a "qualifying patent" so as to provide that the work leading to the invention which is the subject of the patent can be carried on elsewhere in the EEA. Tax exemption on patent income cost the State €62 million in 2004.