Will Ireland’s tax-incentive ‘knowledge development box’ beat the competition?
The new tax incentive for innovation will probably be curtailed due to global pressure
By the end of this month the Department of Finance is due to complete its plan for a new corporate tax incentive to encourage innovation and provide a counterattraction following the abolition of the controversial double Irish tax relief. But with controversy growing internationally about the way companies pay tax, the clear signals are that the new incentive – the so-called knowledge development box – will be no tax bonanza for business.
The wider game is also changing, with the OECD due to bring forward plans on how international corporate tax is calculated, in the wake of the controversy about the extraordinarily low tax paid on profits earned outside the US by companies such as Google and Apple. With tax being vital in Ireland’s attraction of foreign direct investment, the coming months will be important. Here are the key questions.
1 WHAT IS THE KNOWLEDGE DEVELOPMENT BOX? It is a not-very-elegant name thought up by the Department of Finance for a new tax incentive for businesses investing in innovation. The background is that Ireland, coming under international pressure, decided to abandon the controversial “double Irish” tax relief, which was of significant value to many multinationals here. The announcement was made in the last Budget and the tax break was not available to companies establishing here from the start of the year, although those already using the double Irish have until 2020 to phase it out.
The knowledge development box was designed to provide a new attraction for foreign direct investment, particularly as a number of other countries – notably the UK – have similar structures, generally known as patent boxes. These types of arrangements offer companies tax relief based on the amount they spend on research and innovation. The relief effectively ensures that the profits flowing from the innovation are taxed at a lower rate than general corporate profits.
“As other countries already offer similar regimes, in many cases with a tax rate considerably lower than our 12.5 per cent headline rate, it’s important that we have a similar offering,” says Peter Vale, tax partner at Grant Thornton. “As we already offer companies a very attractive tax credit for R&D costs, effectively a partial rebate of salaries, the knowledge development box completes the picture by granting a low tax rate to the profits earned.”
2 SOUNDS FAIRLY STRAIGHTFORWARD? If only. The taxation of intellectual property – the brainpower which goes into developing products and services – is complex. The tax system was not originally designed to cover a situation where products and services are designed, developed, managed and sold across international boundaries. Yet a method is needed to recognise the investment companies make in innovation when calculating their taxable profits.
The controversy over the low tax paid by many big corporations means the rules in this area are being tightened, with the OECD undertaking a major study and the EU actively fighting areas of “harmful tax competition”. For example, the UK introduced a patent box in 2013, offering 10 per cent tax on profits originating from qualifying intellectual property. However it was forced to adjust the rules, following EU pressure led by Germany and from next June the relief will only apply in cases where the work developing the intellectual property actually took place in the UK.
Here, a Department of Finance paper published last week makes crystal clear that the Irish rules will be drawn up to comply with the approach recommended by the OECD. In other words the rules will be relatively tight and, crucially, will – like the reformed UK patent box – restrict the relief to innovations which result from spending in Ireland, and draw the qualifying list for these fairly tightly.
“It looks to me as if it will go as far as the OECD allows and not a step further,” says Brian Keegan, director of tax at Chartered Accountants Ireland.
In particular, and of relevance to the big US multinationals, strict limits will be put on the amount of relief which can be claimed here in relation to innovation undertaken in other parts of an international group’s operations. The department had been lobbied to permit companies to claim relief on innovation undertaken elsewhere within their own group, but managed from Ireland, which would have made it worth a lot more for some big US players.
The initial draft suggests that this will not be allowed, though the department will not finalise the rules until the end of this month. We don’t yet know the tax rate which will be set for qualifying earnings, with speculation it could be 5 per cent not confirmed in the initial draft.
3 IN PRACTICE, WHAT WILL THE NEW RULES MEAN? The knowledge development box will be a useful addition to Ireland’s attraction to FDI and to domestic companies undertaking innovation, but its impact will be limited enough. When the Minister for Finance Michael Noonan, first announced the idea in last October’s Budget, it had initially appeared that it might offer greater relief.
“As many multinationals have substantial R&D activities outside Ireland, for some the relief will be not as attractive as originally hoped,” says Vale. “However, for groups that can isolate the R&D activities and related intellectual property derived income to Ireland, the box will definitely be of interest and will provide further incentive to locate activities in Ireland.”
According to Keegan, a key issue for the department is that it will want to be sure that any new relief does not have to be amended due to international pressure, as is happening in the UK. So while the Irish system may not be as attractive as some of the other longer established regimes in other EU countries, in the short term most of those – including that of the UK – will change soon enough and ours will at least be “future proof”, in terms of emerging rules from the OECD and EU.
The relief will also be “of significant interest to Irish groups which will in many cases carry out all R&D activities in Ireland”, says Vale, “and can thus maximise the benefits.” For some of these firms it may reduce their effective tax rate – the rate they end up paying – below the headline 12.5 per cent.
4 HOW RELEVANT IS THIS IF OUR ENTIRE CORPORATE TAX STRUCTURE COULD CHANGE AS NEW INTERNATIONAL RULES COME INTO PLAY? In mid-2013 an international move to examine corporate tax began under the aegis of the OECD, following the controversy about low rates paid by Apple, Google, Starbucks and others. The initial OECD move had serious threats for Ireland, particularly relating to intellectual property and international financial services and with suggestions that tax should be paid where the product is sold. Tax experts feel that many of the major dangers to Ireland have lessened, although complex rules on intellectual property and transfer pricing remain to be agreed. While the OECD study will be published in the autumn, it is not clear how – or even if – implementation will proceed.
That said, there are still dangers in the medium term, not least in the move by the EU Commission to revive suggestions that it lead a process of coming up with a consolidated tax base on which corporates would pay their tax, a move which would carry considerable perils for Ireland. UK patent box: Treasury committed £1bn a year Ireland’s “knowledge box” is not the first of its kind. In April 2013, the UK launched its own “Patent Box”, under which companies were subject to a 10 per cent corporation tax rate on worldwide profits earned from patents and intellectual property. At less than half the main rate of 23 per cent (which has since been reduced to 20 per cent), the Treasury committed £1 billion (€1.42bn) a year to cover Patent Box claims.
Proposed by UK chancellor George Osborne (inset) as an incentive to spur on the UK’s R&D sectors, there were some welcome early results.
GlaxoSmithKline praised the scheme as it announced a £200 million investment in advance manufacturing facilities in December of 2013.
Multinational corporations began to see the potential benefits of the programme. Many analysts saw the potential for substantial tax breaks on R&D as one of the main motivators of Pfizer’s controversial bid for UK pharmaceutical firm AstraZeneca in May 2014.
The Patent Box soon came under scrutiny during forums on tax evasion by the OECD and G20, however. Particularly criticised was a loophole that allowed corporations to handle R&D abroad and commercialise their patents in the UK. Calls for its reform were led by the German government, whose finance minister Wolfgang Schäuble said the scheme had “no European spirit”.
In November 2014, Schäuble and Osborne announced a new proposal that would see Patent Box tax breaks restricted to R&D activity in the UK. Osborne said the compromise would “protect our vital scientific research while making sure there are international rules that stop aggressive tax avoidance”. International tax: The jargon buster Patent box/knowledge development box A mechanism to give companies tax relief on their investment in innovation. Broadly, they pay a lower rate on the resulting profits. Dressed up as encouraging innovation it also offers the lure of lower tax for big companies.
If you are talking to an Irish accountant . . . they all call it the “KDB”.
Transfer pricing The price set for goods and services transferred within different parts of a company, typically across international borders. In turn this affects where profits are declared. Hugely controversial, as it is at the heart of why many big companies pay so little tax. Head-wreckingly complicated.
Intellectual property Defined as “creations of the mind” which lead to advances in any field. In business this relates to the development of new and improved products or services, many of which will then be patented so that the organisation can claim ownership. Accounting for this financially is complicated, particularly when the complications of transfer pricing is added on.
BEPS This stands for base erosion and profit sharing, the study being undertaken by the OECD which will recommend new ways to ensure big international companies pay more tax. May be watered down by international lobbying.
CCCTB The common consolidated corporate tax base, a concept promoted by the EU Commission as a single set of rules for companies calculating their profits. Has appeared to be about to be killed off many times, but has had more comebacks than Frank Sinatra. Now Ccctb is being floated again.
Grandfathering rights When a tax relief is abolished, but those already availing of it are given a prolonged period of grace to phase it out. Modified nexus The rules promoted by the OECD for intellectual property tax reliefs such as the knowledge development box. Put intellectual property, transfer pricing, grandfathering rights and lots of other stuff in a bowl and mix . . .