Patent boxes have been around for quite some time. Indeed, Ireland is frequently cited as first introducing the concept back in 2000, and was swiftly followed by other countries such as France, Luxembourg, Netherlands and the United Kingdom. The so-called box allows companies to pay a lower rate of tax on intellectual property (IP) assets such as patents.
However, as part of the OECD’s Base Erosion and Profit Shifting (Beps) project and the subsequent move to align where profits are taxed with where real business substance occurs, the approach has evolved significantly.
In November 2014 the UK and Germany agreed on the “modified nexus” approach, which set out a new departure for patent boxes around the world. This means tax relief will now be restricted to profits generated from IP initially developed within the home country.
“This is shaping our future IP regime,” notes Joan O’Connor, tax partner with Deloitte, adding that it means larger countries such as Germany and the UK will benefit more from the regime. Indeed, as she adds, the largest multinational operating in Ireland will not have more than 1,500 R&D employees on the ground here.
But once the larger countries set out the approach, “Ireland really had no choice but to follow,” says O’Connor.
“There really wasn’t anything the Government could have done,” she says, “I have to applaud the way they managed to steer a course through supporting Beps while ensuring as a small country with an open economy they did as much as they could.”
As a result it introduced its new patent box regime, the “knowledge development box” (KDB) in 2014, with further details emerging in last year’s budget.
Low tax rate The KDB came into effect on January 1st, 2016, and it provides for a special low tax rate of 6.25 per cent on IP assets that are the result of qualifying R&D activity in Ireland. It is the first and only country to meet the OECD’s modified nexus standard.
“There are no other countries that have a box regime that’s fully compliant [with the OECD],” says Kevin McLoughlin, head of tax at EY Ireland, adding that in this context competing regimes in other jurisdictions such as the UK, which may now look more attractive, will be phased out over next few years and probably replaced by a version that will be compliant.
“For other countries it’s only a matter of time before they follow suit,” he says.
However, while Ireland may have had first-mover advantage with its KDB, O’Connor bemoans the speed with which it came about.
“What the Government could have done is waited longer to produce it. If they waited a few years more the temperature could have dropped and there would have been less focus on international tax, and they may have been able to pick up ideas from other countries,” she says.
“It has certainly impacted on how effective the KDB will be for the future in terms of an incentivisation vehicle”.
For now, multinationals will have “little interest in it”, she says, adding that the percentage of income they could run through it at the 6.25 per cent rate is “tiny”.
Ahead of a forthcoming review of the new regime, McLoughlin says there will be a need for greater clarity about how the KDB operates, and what profits will be eligible for the reduced rate.
Companies will be entitled to relief based only on the proportion that the Irish company’s R&D bear to the total R&D costs incurred in developing the qualifying assets.
So if an Irish company performs 40 per cent of the R&D spend on developing the asset in Ireland then 40 per cent of the income associated with that asset will qualify for the lower tax rate. But, given multinationals do not currently have do vast amounts of R&D in Ireland, the opportunities for taking advantage of it are, at present, limited.
Evolving product This may change, however. “The knowledge development box could possibly serve to attract new R&D investment into Ireland,” is how Washington based Nick Giordano, tax policy leader for EY in the US, sees it.
McLoughlin agrees. “Ireland has been very good at attracting R&D into the country,” he says, citing use of the R&D tax credit, which allows for a 25 per cent tax credit against corporation tax.
This is backed up by recent economic growth figures, which show Irish-based companies have been engaged in significant acquisitions of IP.
“Over the next few years companies will take longer- term decisions on where best to locate,” says McLoughlin.
“The box regime gives them a lot of food for thought”.