IT IS not in the least surprising that there has been a clampdown on the tax reliefs on patent royalties. There were many abuses of the scheme. Worse, these abuses were growing.

However, it is important that reliefs exist to encourage innovation and inventions. A tax environment that fosters new ideas that are translated into new products can only benefit the economy, as well as the inventors. But a tax environment that persuades generators of new ideas to locate manufacturing facilities in more tax conducive geographical areas has to be very negative.

The Minister for Finance, Mr Quinn, in last week's Finance Bill, 1996, said the Bill was designed to provide measures to curtail abuses in the manufacturing sector of the tax exemption for patent royalty income. He was on very firm ground when he noted that there was evidence that the relief was being used by some manufacturers "as a means of rewarding directors and certain employees in a tax efficient manner without any clear benefit to the economy from greater R&D activity".

What must have rung alarm bells was the sample survey undertaken by the Revenue Commissioners. This indicated that the relief was being claimed for minor changes to manufacturing and ancillary processes involving little, if any, technical innovation.

The reliefs were never intended to reward minor changes. However, the tax exemption on royalty income will not be limited where it is shown, to the satisfaction of the Revenue Commissioners, that the patent is in respect of a radical (my italics) innovation, and was patented for bona fide commercial reasons, and not primarily for the purpose of avoiding liability to taxation.

Does this mean that more powers are to be accorded to the Revenue Commissioners? Who decides what "radical" means?

According to the Bill, the Revenue Commissioners will, after consideration of any evidence, and after consultation (if any) with experts they deem may be of assistance to them, make the decision. At the end of the day it could well be a very subjective decision.

If the taxpayer disagrees with the decision, an appeal can be made to the Appeal Commissioners who make the final decision. The Bill allows for the retention of tax relief for patent royalties received by a company, from a manufacturing company, whether connected or not, subject to a restriction. The amount of tax exempt patent royalty income received by an individual patent holder, or company, from a connected company, will be restricted to the amount which would be paid if the transaction were at arm's length.

That restriction is designed to empower the Revenue Commissioners to challenge the amount where it bears little relation to the commercial value of the patent. It would be hard to grouse at that curb.

The 1996 Bill also allows the retention of full tax relief for distributions to shareholders made by companies out of patent royalties received from unconnected companies. That also is fair enough.

Where a company receives a patent royalty income from a connected company, the amount of tax exempt distributions which the company can make in an accounting period to individual shareholders has to be confined to an amount equal to the actual level of R&D expenditure incurred by the company, in that accounting periods and in the two preceding.

This would appear to put severe restrictions on inventions that cost little to manufacture but produce substantial income for the inventor, unless it is considered "radical". That word again!

Mr Quinn said the changes were necessary to curb the more dubious claims for relief, to reduce an unnecessary cost to the exchequer and refocus the relief on productive R&D expenditure. The cost to the exchequer is reckoned to have been between £10 million and £20 million over the past four years and was growing, so the abuse had to be curbed.

However, as pre clearance from the Revenue Commissioners will be needed to get the relief, it may well be more difficult for new projects to get off the ground because investors would be reluctant to pledge money up front for investments with uncertain tax commitments.

Mr Quinn has tried to strike a balance between curbing the abuses and still encouraging innovation. Only time will tell if he has got it right.