Business Taxes

Chapter 6Intellectual Property & Research & Development

AIM

The aim of this chapter is to outline the reliefs available for intellectual property.

LEARNING OUTCOMES

Once you have studied this chapter, you should be able to:

6.1 Outline the main forms of intellectual property and how they are exploited 160
6.2 Describe the main registration procedures for various forms of intellectual property 163
6.3 Describe the legal protections available for Intellectual property 165
6.4 Compare the circumstances in which licensing of intellectual property through Ireland is taxable as a trade and as an investment and judge which treatment is correct for a given set of circumstances 168
6.5 Set out the tax reliefs available in relation to specified intangible assets and apply in practical situations 172
6.6 Explain the application of the research and development tax credit 181
6.7 Explain the relief for key employees engaged in research and development 190
6.8 An awareness of the knowledge development box 191

PRE-READING

Personal Taxes Manual

Chapter 4 Taxation of business income - Schedule D Case I and II

Chapter 22 Charges for income tax purposes

Chapter 23 Exemptions and reliefs

MAIN LEGISLATIVE PROVISIONS

Chapter 3 of Part 7, Chapter 2 of Part 8, Part 9, Section 472D of Chapter 1, Part 12 and Part 29 of TCA 1997

Sections 101 and 2 of Stamp Duty Consolidation Act 2009

FURTHER READING

Corporation Tax, Finance Act 2010, Irish Tax Institute

Chapter 15 Corporation Tax Computation

The Taxation of Chargeable Gains, Finance Act 2016, Irish Tax Institute

Chapter 10 Company Chargeable Gains

Irish Tax Review

“Finance Act 2009 - Tax relief for investment in intellectual property” by John Heffernan, ITR, July 2009

Revenue Tax Briefing

Tax Briefing 57: Classification of activities as trading (CT)

Finak 2015

Section 32: Knowledge Development Box (KDB)

RELEVANT PAST EXAM QUESTIONS

2015, Autumn, Question 2(b)

2015, Autumn, Question 4(a)

2015, Autumn, Question 5(d)

2016, Summer, Question 4

2016, Autumn, Question 5(a)

2017, Summer, Question 4

2018, Summer, Question 5

6.1.Outline the main forms of intellectual property and how they are exploited

Intellectual Property (“IP”) is essentially creations of the mind for which property rights are recognised and may be sold, assigned, licensed and bequeathed similar to other property rights. Due to a favourable IP tax regime in Ireland, IP rights and exploitation are considered a valuable commodity to Irish companies and in order to advise clients on the tax regime, it is important that tax advisers understand the main types of IP, their registration requirements and the legal protection available to protect that IP.

6.1.1.Common types of IP rights include

1. patents,

2. trade marks,

3. copyright,

4. design, and

5. confidential information or trade secrets.

6.1.1.1.Patents

Patents are legal property rights granted in respect of inventions. The owner of a patent has the right, for a certain period, to exclude others from exploiting (marketing, selling, using, importing) the patented invention, except with the consent of the owner of the patent. An invention will be patentable if it (a) can be made or used in any kind of industry, including agriculture, (b) is new and (c) involves an inventive step.

6.1.1.2.Trade Marks

A trade mark is the means by which a business identifies its goods or services and distinguishes them from the goods and services supplied by other businesses. Examples of trade marks include words (including personal names), designs, letters, numerals or the shape of goods or their packaging. Examples of well known Irish trade marks include Dawn Milk, Eir, Dairygold, Ballygowan, Tayto.

6.1.1.3.Copyright

Copyright is the term which describes the rights given to the author or creator of certain categories of published and unpublished work. It offers protection by preventing the reproduction, including copying, of physical material. For example, copyright protection may be granted in respect of:

original literacy, dramatic, musical or artistic works;

sound recordings, films, broadcasts or cable programmes;

the typographical arrangement of published editions.

6.1.1.4.Design

A design is concerned with the appearance of the whole or any part of a product resulting from the features of, in particular, the lines, contours, colour, shape, texture or materials of the product itself or its ornamentation. Designs are registerable if they are new and have individual character. Examples of designs would include the shape of the Coco Cola bottle, or the red heel in Christian Louboutin shoes.

6.1.1.5.Confidential information

Confidential information, or ‘know-how’ of an organisation, is the name given to the trade secrets (i.e. processes, procedures, formulae in the manufacture of a product) of a business, which if disclosed, would cause harm to the owner.

6.1.1.6.Exploitation of IP Rights

IP can be owned outright by one person/company or can be co-owned by more than one person/company.

6.1.2.1.Licence through the payment of a royalty

Royalties may be paid in relation to many things: the use of a trademark or logo, the use of intellectual property or know-how, or the use of copyrighted material. Royalties and the sale of the related capital assets is a complex area of both law and tax and there are practitioners who specialise in this area. However, generally:

Royalties are income received from allowing other people use of these assets (generally under a non-exclusive licence agreement);

The owner of these trademarks, intellectual property or copyrights may decide that instead of earning income from them that they will sell them outright. In this case, the amount received is treated as the sale of a capital asset (you should refer to Capital gains tax fundamentals, chapter 3, on where these assets are deemed to be located for CGT purposes).

6.1.2.2.Assignment

An assignment involves the sale and transfer of ownership of the IP by the assignor to the assignee. This transfer of ownership is permanent and irrevocable. For example, if the owner of a trade mark sold its trade mark, it would assign it to the buyer. In contrast, when licensing IP, the IP owner maintains ownership.

6.1.2.3.Franchise

The IP owner may also grant a form of IP licence, called a franchise. A franchise is a right granted to an individual or group to use the trade mark to market a company’s goods or services within a certain territory or location under a clearly identifiable business format /business model. Some examples of today’s popular franchises are McDonald’s, Subway, Domino’s Pizza, Starbucks.

The use of trademarks or logos

These are usually the right to use a name in a specific geographic region. Intel is an excellent example of trademarks and logos. Every time a computer manufacturer mentions Intel in its advertisements it must show the Intel graphic and it must play the Intel music. The graphic and music are registered trademarks and logos of Intel and help Intel to protect its name.

Manufacturers will want to let the public know that there are Intel chips in their machines so that they can benefit from Intel’s image and will pay Intel for the right to do so. There are usually very strict rules about how and when trademarks can be used and the owner will have received strict assurances from the user of the trademark, in addition to fees, before allowing their trademarks to be used. These types of payments are not treated as relevant payments as they do not represent pure Income profits in the hands of the recipients and therefore an income tax deduction under Section 239 TCA 1997 is not required. The payments made are allowable against the company’s trade income.

The use of know-how protected by patent

Patent royalties are payments for the use of technology, products, know-how or other intellectual property that are protected by patent law. An inventor has created a new process or a completely new product. They patent their invention. However, an inventor may not wish to actually produce the product, or have the facilities that they need to use the new process. Therefore, they allow other businesses the right to use the process or create and sell the product in return for a fee. Once the know-how has been created, the inventor typically incurs no more costs and the royalties earned are ‘pure income profit’ in the hands of the inventor (refer to Chapter 4.2). Income tax at the standard rate must be deducted from all payments for the use of a patent or which are “annual payments” (Section 237 TCA 1997). As you will recall, patent royalties and annual payments are treated as “charges on income” and the expense per the accounts is added back in the corporation tax computation and allowed, on a paid basis, against the company’s income under Section 243 or Section 243A TCA 1997 as appropriate (refer to Chapter 4).

The use of copyrighted materials

Music is a copyrighted material. When an individual purchases a CD they are buying copyrighted material. This gives them the right to listen to the material personally but not to amend, distribute or otherwise use the music. Musicians and authors may either sell their copyright outright to a publishing house (a capital disposal) or they may receive a royalty of 10% of sales (the first €50,000 of which for the 2015 income tax year and subsequent periods may qualify for an exemption from income tax under Section 195 TCA 1997).

Software is also copyrighted. When an individual or business buys, for example, Windows Vista they have bought copyrighted material. They may use Vista as the operating system on their computer but they may not incorporate parts of it into products they sell or use it in any other way. With the exception of music, books, DVDs etc, the sale of copyrighted materials is usually done by way of a licence to use the product for a specific period of time after which time it will no longer be supported (to allow Microsoft in this example stop offering Vista support in 10 or 20 years time).

Copyright royalties are not treated as relevant payments unless they can be regarded as “pure income profit” (i.e. annual payments) in the hands of the recipient. Copyright royalties which are not relevant payments are not subject to withholding tax and do not fall within the meaning of relevant payment in Section 239 TCA 1997. The payments made are allowable against the company’s trade income provided they are incurred wholly and exclusively for the purposes of the trade and are not otherwise disallowed under some other tax provision.

6.2.Describe the main registration procedures for various forms of intellectual property

To ensure protection for their IP, business should register any IP capable of registration as soon as is reasonably possible. Detailed registration procedures exist in respect of patents, trademarks and designs.

6.2.1.Patents

There are two types of Irish patents available:

1. 20 year patent

2. 10 year patent

A 20 year patent and a 10 year patent are mutually exclusive.

(a) 20 year patents

These patents allow the inventor/applicant protection for up to 20 years. An application for a 20 year patent application is made to the Irish Patent Office In order for the Irish Patent Office to grant a patent, the applicant must provide evidence of the invention’s novelty. It should be noted that patents are territorial in effect (i.e. an Irish patent is only valid in Ireland).

As patent law and practice and the drafting of the specification are quite complex, in most cases the inventor/applicant often seeks the assistance of a patent agent, who specialises in making patent applications.

(b) 10 year patents (“short-term patents”)

Short-term patents are designed to assist smaller inventors or where the invention has a smaller market life. The procedure and threshold for the granting of a short-term patent is not as stringent as for a 20 year patent. For a short-term patent, there is no requirement to provide evidence of the invention’s novelty, thus reducing the cost and time involved in determining whether the invention is patentable.

International recognition of patents

Where patent protection is also required outside Ireland, one central application can be made in the European Patents Office in Munich for a person seeking to protect an invention in several EU member states (such states to be specified in the application). A European patent granted by the European Patents Office is treated as if it is granted by the Irish Patents Office.

6.2.2.Trademarks

Any individual or company who uses or proposes to use a trade mark can apply to register that mark. A trade mark may be registered in one of 45 classes (for example, food and drink, paper products, etc.).

To register the mark, the applicant must complete an application form and lodge that form with the Patents Office. An application may be made either before the mark is put in use or afterwards. Generally speaking an application should be made to register a mark as soon as possible to ensure priority over anyone else who applies to register the same or similar mark. A trade mark shall be registered for a period of ten years from the date of registration and registration may be renewed, on the payment of a fee, for further periods of ten years.

International recognition of trademarks

If protection of the trade mark is required outside Ireland, the holder of the mark can make an application to Office for the Harmonisation of the International Market (OHIM) to register a trade mark in all European countries. Furthermore, the Madrid Protocol recognises trade marks registered by the World Intellectual Property Organisation which allows applicants to apply for a trade mark in several jurisdictions by filing one application in one central office.

6.2.3.Copyright

In Ireland, there is no registration procedure for owners of a copyright work. Basically the act of creating a work (for example, music, artistic, literary) also creates the copyright, which then subsists in the physical expression of the work. Copyrights are protected by law and illegal use of these rights can be contested in the courts.

It is important to show that copyright is claimed in a work. Works should be clearly marked to show who the copyright owner is and the date from which copyright is claimed. The internationally recognised symbol © is normally used to indicate that a work is protected by copyright, for example: © Copyright Irish Tax Institute 2012.

The duration of the copyright and the protection afforded depends of the type of works involved. For example, in the case of the author of copyright in literacy, dramatic, musical or artistic work, the copyright will last for 70 years after the death of author.

6.2.4.Designs

As noted above, designs are registerable if they are new and have individual character. Both an application for registration and a registered design constitute a property right in the hands of the author of that design (or employer of the author).

In order to apply for the registration of a design, the applicant must be the first proprietor of the design. The author or person who creates the design is deemed first proprietor unless the design is created by an employee in the course of employment, in which case the employer is the first proprietor of the design, subject to any agreement to the contrary.

The procedures for registering a design operate in a similar fashion to how a trade mark is registered. Registration will last for a period of five years from the filing date of the application for registration and may be renewed upon payment of a fee for four subsequent periods of five years, resulting in a total period of registration of twenty-five years.

International recognition of designs

Alternatively, an applicant may apply to the OHIM for a community-wide registered design. Again, the registered design is protected for five years from the filing date of the application for registration.

6.3.Describe the legal protections available for Intellectual property

As a piece of property, which can be sold or assigned, licensed or otherwise similarly traded, the value of IP to a business may be considerable. It is for this reason that businesses are increasingly conscious of not only exploiting such IP, but also availing of the legal protections available to prevent third parties from availing thereof. The main legal protections as they apply to the different forms of IP are outlined below.

6.3.1.Patents

Once the patent is granted, the holder has the right to prevent all third parties not having his consent from using the invention either directly, (by, for example, making, offering, putting on the market or using a product which is the subject-matter of the patent) or indirectly (where third parties, in the absence of proprietor consent, seek to supply or offer to supply in the State with means, relating to an essential element of that invention, for putting it into effect).

Civil court proceedings for infringement of a patent may be brought by the holder of the patent in respect of any act of infringement, whereby he may seek a number of remedies including:

an injunction restraining the defendant from any apprehended act of such infringement;

an order requiring the defendant to deliver up or destroy any product covered by the patent in relation to which the patent is alleged to have been infringed;

damages in respect of the alleged infringement;

6.3.2.Trademarks

As noted earlier, the registration of a trade mark gives the holder of the mark exclusive right to use that trade mark in respect of the goods/services for which the mark is registered. Consequently, in the absence of the holder’s consent, usage of that mark by third parties is an infringement of the property rights of the holder.

Examples of infringement include:

affixing the mark to goods or the packaging;

offering or exposing goods for sale under the mark;

putting them on the market or stocking them for those purposes under the mark, or offering or supplying services under the mark;

importing or exporting goods under the mark or using the mark on business papers or in advertising.

Civil court proceedings for infringement of a trade mark may be brought by the holder of the trade mark in respect of any act of infringement. Where a holder’s rights have been infringed, he is entitled to avail of any remedies which are available in respect of the infringement of any property rights, including damages, injunctions or an order for erasure of mark from infringing goods, or otherwise. The District Court also has the power to grant a warrant for the search and seizure of infringing goods, and also to order their delivery up or destruction.

6.3.3.Copyright

As noted above, copyright is not registerable. Rather copyright exists on the creation of a work, and the author of such copyright may authorise other persons to avail of the work, which without such authorisation would constitute a breach of such author’s copyright.

The range of civil remedies available are vast, including damages, orders for delivery up, application to the District Court for seizure of infringing material, permitting the copyright holder to seize the infringing materials, permitting the copyright holder (with the assistance of the Revenue Commissioners) to prevent importation into the State of the suspected infringing material. There are also a number of criminal sanctions for infringement of copyright (fines and/or imprisonment).

6.3.4.Design

The registration of a design (in Ireland or the European Community) confers on the holder the exclusive right to use the design and to prevent third parties from using it without the holder’s consent.

A design right is infringed where a person who, without the licence of the registered holder of the design and while the design right is in force, undertakes or authorises another to undertake any act which is the exclusive right of the registered holder of the design. In addition, secondary infringement arises where a person trades in the infringing products or provides the means whereby an infringement may take place.

An infringement of a design right is actionable by the registered holder of the design. As is the case with the other forms of IP, all relief by way of damages, injunction, account of profits or otherwise is available to the plaintiff as it is available in respect of the infringement of any other property right. It is also possible for a court to order the delivery up and disposal of the infringing products.

6.3.5.Confidential information

Equitable principles are invoked in the case of protecting businesses’ know-how, as the court will seek to enforce a moral obligation where the person to whom something was made known in confidence cannot use the knowledge to the detriment of the informant. In order to successfully claim breach of duty owed, it must be shown that, as per House of Spring Gardens v Point Blank Limited1:

the information which the informant seeks to protect is confidential;

the information must have been imparted in such circumstances that it imposes an obligation of confidence on the person who received it; and

the information was used in a manner that was not intended by its owner and was not authorised by him.

6.3.6.Passing Off

Passing-off is an action that can be used to prevent third parties from exploiting the goodwill associated with another. It prevents a third party in the course of their trade from falsely representing themselves or their products to prospective customers in a manner likely to mislead the consumer or likely to deceive or confuse them into believing that the products in question are that of another person or business2.

In order to succeed in a passing-off claim, the plaintiff (person bringing the action) must show the court that the defendant’s actions have caused or are likely to cause damage to the plaintiff. An example of this is where the defendant has confused the public as to ownership of the goods and the defendant’s products are inferior, or where reputation/goodwill is established and the goods offered by the defendant are inferior.

6.4.Compare the circumstances in which licensing of intellectual property through Ireland is taxable as a trade and as an investment and judge which treatment is correct for a given set of circumstances

Ireland’s 12.5% corporation tax rate was introduced to attract inward investment without falling foul of the ban on State Aid imposed at EU level. At the time it was introduced a different rate was set to apply to passive income, although the term passive income is not used in the legislation.

The rate is seen as a major incentive in attracting inward investment and has been marketed as such by State agencies such as the IDA. There is a genuine fear among State bodies that abuse of the rate by locating low substance businesses, referred to generally as brass plate operations, will bring Ireland’s low tax rate under international pressure and encourage moves towards EU tax harmonisation. Revenue has agreed to give prior approval where there are areas of doubt as to the application of the 12.5% trading corporation tax rate to particular activities and tend to look closely both at the number of employees engaged in the activity here in Ireland and the level and nature of the activities generating the profits.

We outline below the factors to be considered in determining whether the licensing of intellectual property would be regarded as a trade but first we consider what intellectual property actually is.

6.4.1.Intellectual Property

Under IAS 38 an intangible asset is defined as “an identifiable non-monetary based asset without physical substance”. To be classified as an intangible asset it must come within this definition.

Task 6.1

Read s. 291A(1) TCA 1997 to see what assets qualify as “specified intangible assets”.

You should have noted that it is possible for an asset to be an intangible asset but not to be a ‘specified intangible asset’ under s. 291A(1) TCA 1997.

6.4.2.Factors to consider in determining whether the licensing of intellectual property through Ireland is trading or passive

In Section 1.3 of Chapter 1, we discussed the main factors to take into consideration when deciding on whether the company is engaged in trading or in the receipt of passive income, including in relation to intellectual property. Through case law, including the Noddy Subsidiary Rights case discussed in Chapter 2 and Revenue guidance, the main methodology of judging the distinction is based on the company actively seeking to exploit their intellectual property and employing/subcontracting expert individuals to assist with this.

Revenue have issued guidance in relation to this matter outlining the need for operations to have substance in Ireland in order for them to be considered to be trading in Ireland. The Revenue have identified the following key criteria in order to demonstrate substance in Ireland:

A commercial rationale for the Irish operation;

An expectation that profits from the activities will arise in Ireland should exist. This matter will be driven by arm’s-length considerations.

It is important that the day to day running costs should be borne by the Irish company. Other costs such as advertising costs, quality control costs, legal costs for drafting and reviewing contracts should also be borne in Ireland.

Real value added to the Irish economy

There should be an activity in Ireland beyond the mere holding and/or exploiting of the assets (in an intellectual property context we refer to the “managing, developing and exploiting” as the necessary requirements for an intellectual property trade). The level of activity carried out in Ireland is important. If the level of activity is not, in substance, significant and habitual in nature, then the likelihood of it being regarded as trading is reduced.

Also, a company is more likely to be regarded as trading if it is seen to accept commercial risk (e.g. bad debt risk, R&D risk, etc.) and its position is not guaranteed.

Employees in Ireland with requisite skills and experience to carry out the functions of the trade in Ireland.

The retention of sufficiently skilled employees is an important factor in determining trading status. Therefore, it is advisable to ensure there is sufficient expertise engaged to be able to run the business.

If a third party service provider is engaged you would expect to see a comprehensive services agreement in place between the company and the provider with some level of company oversight/monitoring of the services provided by the third party. As stated in Tax Briefing 57, the company should be able to demonstrate how it conducts, manages and controls the outsourced part of its business. Consequently, it must possess sufficiently skilled employees capable of taking on this responsibility.

Other factors that might influence Revenue in this regard are:

A real presence in Ireland, i.e. office space and people in Ireland;

Income commensurate with the substance, i.e. that income is being generated by the company in Ireland and this income is directly related to the substance of the company;

The frequency or number of income generating transactions, i.e. as with the badges of trade (please refer to your Personal Taxes manual or Tax Briefing 57 for the badges of trade) the company should be involved in a number of transactions not merely a single transaction to ensure the establishment of substance;

Books of account held in Ireland; and

Supplementary work on or in connection with the property realised, again this is related to the badges of trade above, i.e. that there is some evidence of trading and an organized effort to obtain profit.

Revenue will look at each case separately when it comes to considering the trading/substance issue. There is no pre-determined list of items that qualifies a company as trading in Ireland but the above is a guide to the items that Revenue will examine. In addition, no single factor will determine a company’s trading status in Ireland, rather the combination of factors in each case will together determine the trading position in Ireland.

There is an opportunity to apply to Revenue for a ruling on the trading/substance issue. Such a request would outline the proposed activities of the Irish company and all other relevant details pertaining to the proposed operations which demonstrate some of the factors outlined above. Revenue would then issue a formal opinion in relation to the company and whether its activities would be considered trading activities in Ireland and therefore qualify for the 12.5% rate of corporation tax.

Revenue have published the details of decisions given regarding the classification of activities as trading activities which were finalised in the period from December 2002 to December 2015. These are available in the Revenue Tax and Duty Manual Part 02-02-06 and give a useful insight into the Revenue’s thinking and the factors which they will consider when determining whether a company’s activities amount to trading or passive activities. A number of these included decisions on intellectual property. Some of the more relevant ones are as follows:

A company was to license third parties to exploit trademarks in different continents and eventually to expand into other activities, a small number of staff were to be employed. The company employees were responsible for continuous monitoring and review of existing licences and licensees, seeking out potential new licensees, ensuring maintenance of brand image by driving and advising on marketing strategies. The company was treated as trading due to the activity surrounding the licensing, including seeking out new markets etc (February 2004 decision).

A company was established to protect and exploit the intellectual property of a non-resident company, the operation would have no direct employees at the start but would outsource. The Revenue were unable to confirm that activities of the company constituted a Case I trade because the company was not involved in the key activities giving rise to the income. None of the main players in the case were located in Ireland and the company’s involvement was essentially passive. Revenue expressed the view that Case IV would apply if the company was resident in Ireland (February 2004 decision).

A company was formed to maintain an operations centre to include sales, distributions etc and also to manage intellectual property. A large number of staff were to be employed. On the basis that expert individuals had been employed and that the company was based in Ireland it was deemed to be trading (December 2004 decision).

A company was established to acquire and exploit the intellectual property of group affiliates. The operation would hire specialised staff with experience in this area and on that basis trading status was granted. (July 2011 decision).

A company was established to hold image rights and would have no staff or turnover. Revenue determined that it would not meet the requirements of the Badges of Trade and would only receive payments, therefore Case I status was not granted (2014 decision).

A company was established to carry out treasury activities in Ireland for group companies. Revenue granted Case I status as the employees which the company planned to hire would have the appropriate skill, expertise and authority to carry out these activities in Ireland (2015 decision).

As can be seen from the above the main considerations are:

(1) Are any trading activities taking place to actually generate income?

(2) Are there skilled employees?

(3) Are the activities taking place in Ireland?

Task 6.2

Review the Revenue classification list noted above and identify a number of positive and negative case I opinions given in relation to intellectual property trading.

Compare and contrast the differences between the facts of each case and the trading opinion given.

6.5.Set out the tax reliefs available in relation to specified intangible assets and apply in practical situations

6.5.1.Capital Allowances

The purpose of Section 291A TCA 1997 is to enhance Ireland’s competitiveness as a location for centralisation, management and development of intellectual property and is in line with the government’s policy on the “Smart” economy.

6.5.1.1.Specified intangible assets

Under the legislation companies can claim capital allowances for “specified intangible assets”, as defined in Section 291A TCA 1997.

These include costs incurred on intangible assets such as patents, registered designs, trademarks and names, brand names, domain names, copyrights, know-how (within the meaning set out in Section 768 TCA 1997), licences etc. and any goodwill to the extent that it is directly attributable to these assets.

The scheme applies to any qualifying capital expenditure incurred after 7 May 2009 on the provision of a specified intangible for the purposes of a trade. The specified intangible is deemed to be plant and machinery.

6.5.1.2.Rates of claim

The company will have two options in relation to the wear and tear rate:

1. 7% straight line for 14 years followed by 2% straight line in the 15th year (Section 291A(4) TCA 1997).

2. An amount equivalent to the depreciation/amortisation/impairment charge in the Statement of Comprehensive Income (Section 291A(3) TCA 1997). In order to avail of this provision, the expenditure will need to be recorded for accounting purposes as expenditure on an intangible asset under IAS 38.

The company can claim under either option at its own discretion for each individual asset. It should be noted that under IAS 38, assets with an indefinite useful life are generally not depreciated/amortised and therefore the company will choose option (1) above, in order to obtain tax relief.

There will be no balancing charge (although a balancing allowance may still arise) if the asset is sold more than 5 years after the first accounting period in which the asset was first provided (Section 288(3C) TCA 1997). For sales to connected parties the purchasing party can claim capital allowances on the lower of the purchase price paid or the selling parties tax written down value.

6.5.1.3.Restrictions on claim – relevant trade

Unlike ordinary capital allowances, there is a restriction on the amounts of allowance that can be offset. The capital allowances can only be offset against income from “relevant activities” (Section 291A(5) TCA 1997).

These activities include the managing, developing and exploiting of the specified intangible assets or the sale of goods deriving their value from the specified intangible asset (Section 291A(5) TCA 1997).

These activities are treated as a separate trade for the purposes of the offset of the wear and tear allowances under this section (known as a “relevant trade”).

S. 291A(5)(b) TCA 1997 states that if the company has other trade income, the income from the relevant trade should be split on a just and reasonable basis.

The interest cost of funding the acquisition of the intangible assets, including interest on borrowings to invest in a company that uses the money to acquire intangible assets (see Section 6.4), is deductible but is also restricted.

Once the income of the relevant trade has been identified, a further restriction applies in that only 80% of the income so derived (for assets acquired on or after 11 October 2017can be sheltered by the capital allowances and interest. For assets acquired between 8 May 2009 and 10 October 2017 100% of the relevant trade income can be sheltered. Therefore a loss can never be created and set against non-intellectual property income (Section 291A(6) TCA 1997).

In dealing with situations where assets are acquired both before and after 11 October 2017 it is necessary to track the income from each asset in order to ensure that the correct pre and post October 2017 split is in place. This should be done on a just and reasonable basis. Any unutilised capital allowances or interest is carried forward. The capital allowances are restricted in priority to the interest in applying the relief (Section 291A(6)(a) TCA 1997).

6.5.1.4.Step plan to calculate IP relief:

(1) Calculate relevant trading income

(2) Calculate capital allowances on specified intangible assets

(3) Calculate interest on relevant borrowings

(4) Set interest against relevant trading income, carrying any excess forward

(5) Set capital allowances against any remaining income from (4), carrying any excess forward

Example 6.1

IP Limited incurred expenditure on specified intangible assets of €500,000 for the year ended 31st December 2018.

The company borrowed €400,000 to fund the expenditure and paid €40,000 in interest. The company has chosen the 7% over 15 years option.

Trade results before interest for the year ended 31st December 2018 are €140,000. This is €60,000 for net sales of a product created using the company’s IP property and €80,000 for a non-IP part which is sold with the IP related product.

Calculate the usage of intangible assets relief under Section 291A TCA 1997.

Total income 140,000 Capital Allowances 500,000 × 7% 35,000
Income from relevant trade 60,000 Interest 40,000
Total claim 75,000
Income from Relevant Trade 60,000
Interest allowable (40,000) (Claimed first)
Capital allowances (20,000) (after restriction)
Taxable relevant trade 0
Add: Non relevant trade 80,000
Total income 80,000
Corporation Tax @ 12.5% 10,000

The restricted capital allowances of €15,000 (€35,000 − €20,000) are carried forward to be offset against future year’s relevant trading income.

Task 6.3

Griffiths IP Limited incurred expenditure on specified intangible assets of €600,000 for the year ended 30th June 2018.

The company borrowed €500,000 to fund the expenditure and paid €80,000 in interest. The company has chosen the 7% over 15 years option.

Trade results before interest for the year ended 30th June 2018 are €200,000. This is €120,000 for IP management and €80,000 for treasury operations.

Calculate the usage of intangible assets relief under Section 291A TCA 1997.

When an intangible asset is included in the purchase of a trade, allowances can be claimed provided the company can show that its valuations are reasonable.

In all cases Revenue can engage experts (subject to not prejudicing the company’s entitlement to trade secrecy) to assist in deciding whether the values or claims are just and reasonable (Section 291A(8) TCA 1997).

In relation to the relief for patents (Section 755 TCA 1997) and know-how (Section 768 TCA 1997) discussed in Section 6.8, this type of expenditure is included in the new scheme but if the company wishes, it may elect in writing to claim relief under these original sections on expenditure incurred before 7 May 2011 (Section 755(4) TCA 1997 and Section 768(8) TCA 1997 respectively).

Section 291A TCA 1997 does not affect capital allowances on expenditure incurred on computer software before 4 February 2012 if the company makes the appropriate election under Section 291(4) TCA 1997.

If the specified intangible is acquired from a member of the same capital gains tax group, the group members have the option of electing that the transfer does not fall within the normal CGT group relief provisions in Section 617 TCA 1997. This prevents a group from claiming the wear and tear allowances on the market value of an intangible and claiming CGT group relief on the disposal of the asset. CGT group relief will be covered in further detail at Part 3.

6.5.1.5.Summary

Even with the claims restricted to relevant trade only, the allowances are of great tax benefit in assisting company’s based in Ireland to locate their IP trades in this country. Companies that are continually investing in IP can effectively write this capital expenditure off against the income streams that the expenditure generates.

Furthermore, due to Ireland’s low corporation tax rates, any IP income in excess of the allowances due under Section 291A TCA 1997 relief will only be taxed at 12.5%.

As covered in Chapter 4, relief for non-relevant trade charges, such as interest on loans specified in Section 247 TCA 1997, can be claimed by companies against their profits under Section 243 TCA 1997.

6.5.2.Interest

In claiming interest as a charge relief, restrictions apply to the relief available for the investing company when the funds invested in or lent to the investee company are used by that company to acquire specified intangible assets. The restrictions are similar to those that apply to a company that incurs interest on the acquisition of specified intangible assets (outlined in Section 6.5.1.3) i.e. the interest relief in excess of taxable distributions from or interest received by the investing company from the investee company is restricted to the amount of relevant trade income of the investee company (Section 247(4B) TCA 1997).

The restriction is applied based on the relevant trade income of the company incurring the expenditure and ensures that such interest cannot exceed the amount of interest that would have been deductible in the hands of the company engaged in the relevant trade had that latter company incurred the interest expense. In fact, it may even result in a smaller interest deduction for the investing company than would have been available to the company engaged in the relevant trade if it had incurred the interest as Section 247(4B)(I)(B) TCA 1997 requires that where there are other deductions (e.g. capital allowances or other interest) that are to be restricted in respect of the relevant trade, the investing company’s interest is restricted in priority to those other deductions. This contrasts with the treatment outlined in Section 6.6 where capital allowances are restricted in priority to interest incurred by the company engaged in the relevant trade in determining the maximum claim. As outlined in the example below, any amount of the investing company’s interest that has been restricted may be carried forward to be treated as interest paid in the next accounting period of the company and so on for each succeeding period.

Example 6.2

IP Investor Limited borrows funds to provide an interest-free loan to a wholly owned subsidiary, IP Limited, which uses the money to acquire intangible assets in 2018.

The interest charged to IP Investor Limited on the loan in 2018 is €350,000.

IP Limited has relevant trading income of €250,000 and capital allowances of €100,000.

Assume both companies’ accounting periods correspond to the calendar year (i.e. 31 December year ends).

Calculate IP Investor Limited’s claim to interest relief.

Investing company IP Investor Limited
Interest paid by IP Investor Limited on funds lent to IP Limited 350,000
Interest paid by IP Limited to IP Investor Limited in respect of that loan 0
Amount of interest on which restriction is to be calculated (i.e. the relevant interest) 350,000
Intellectual Property Company IP Limited
Income from relevant trade 250,000
Max income to be sheltered (80%); 200,000
Actual computation of taxable income for IP Limited
Income from relevant trade 250,000
Capital allowances (100,000)
Taxable profits 150,000

Restriction of interest deduction in IP Investor Limited (i.e. rework computation of IP Limited’s taxable income as if the350,000 of interest paid by IP Investor Limited had actually been incurred by IP Limited)

Income from relevant trade 250,000
Max income to be sheltered (80%); 200,000
Capital allowances 100,000
Actual amount of interest deductible (restricted relevant interest) 100,000
Restriction required (set in priority against IP Investor Limited interest as opposed to against the capital allowances) 250,000
Actual amount of relevant interest deductible for IP Investor Limited 100,000
Interest available for carry forward in IP Investor Limited 250,000

Note:

€100,000 is the maximum amount of interest which IP Investor Limited can claim against its own profits in 2018. The balance of €250,000 (€350,000 − €100,000) is carried forward and treated as interest paid in the next accounting period (i.e. 2019). This is added to other interest paid in 2019 by IP Investor Limited on the loan mentioned in the example above (along with interest on other similar type loans used indirectly to invest in intangible assets) and the total interest relief for IP Investor Limited would be restricted in the same way (i.e. to the relevant trading income of IP Limited for 2019 less IP Ltd’s capital allowances and interest for that period). Any excess is once again carried forward to the subsequent accounting period, etc.

Example 6.3

Taking the same facts as the previous example except that the loan between IP Investor Limited and IP Limited is not interest free and IP Limited pays IP Investor Limited €100,000, what are the implications?

Solution:

Investing company IP Investor Limited
Interest paid by IP Investor Limited on funds lent to IP Limited 350,000
Interest paid by IP Limited to IP Investor Limited in respect of that loan (100,000)
Amount of interest on which restriction is to be calculated (i.e. the relevant interest) 250,000
Intellectual Property Company IP Limited
Income from relevant trade 250,000
Max income to be sheltered (80%); 200,000
Actual Computation of taxable income for IP Limited
Income from relevant trade 250,000
Interest 100,000
Capital allowances 100,000
Total deductions restricted to relevant trade income 200,000
Taxable profits 50,000

Restriction of interest deduction in IP Investor Limited (i.e. rework computation of IP Limited’s taxable income as if the €350,000 of interest paid by IP Investor Limited had actually been incurred by IP Limited)

Income from relevant trade 250,000
Max income to be sheltered (80%) 200,000
Interest and capital allowances of IP Limited (€200,000) 200,000
Actual amount of interest deductible (restricted relevant interest) 0
Restriction required (set in priority against IP Investor Limited interest as opposed to against the capital allowances) 250,000
Actual amount of relevant interest deductible for IP Investor Limited 0
Interest available for carry forward in IP Investor Limited 250,000

Notes:

1. As can be seen from this example, the “Amount of interest on which the restriction is to be calculated (i.e. the relevant interest)” for 2018 would have reduced to €250,000 (i.e. €350,000 – €100,000 to take account of the interest received from IP Limited). The €100,000 in Example 6.2 would no longer be deductible for IP Investor Limited as IP Limited’s total capital allowances and interest (including the interest payment of €100,000 to IP Investor Limited) for the period would now be €200,000, which equates to the maximum income to be sheltered thereby eliminating any interest deduction for IP Investor Limited in respect of the relevant interest. The balance of the unrelieved relevant interest of €250,000 would be carried forward as described before.

2. The net effect of IP Limited paying the €100,000 interest therefore is an additional deduction of €100,000 for it, no additional tax liability for IP Investor Limited and the utilisation of €100,000 of the relevant interest available to IP Investor Limited, which has been offset against the interest income received from IP Limited, leaving €250,000 interest to be carried forward.

3. It should also be noted that the interest deduction available to IP Limited in Example 6.3 is restricted in that it can only be set against relevant trading income whereas the interest as a charge relief of €100,000 available to IP Investor Limited in Example 6.2 could be set against its total income. Consequently, there may be circumstances where it is more tax efficient if the IP company does not pay interest to the investing company, assuming the investing company has sufficient other taxable income against which to offset the interest as a charge relief, assuming there are no transfer pricing provisions that would prevent interest-free loans (or loans granted at rates of interest that differ from market rates), between the two companies.

6.5.3.Corporation tax reliefs

Know-how (s. 768 TCA 1997)

Know-how is defined in s. 768(1) TCA 1997 as industrial information and techniques likely to assist in the manufacture or processing of goods or materials.

The Section operates by allowing a company purchase know-how for use in their trade and write-off the expenditure against its taxable Case I trading income.

The expenditure is not allowable if the know-how is acquired as part of the acquisition of a trade or part of a trade. However, if one party (A) purchases the know-how element of the trade and a connected party (B) purchases the non-know-how element of the trade, A can claim a deduction for the know-how but cannot transfer it to B or write the know-how off against any form of royalty income from B (the deduction for the cost of the know-how can only be set against trading income of a trade carried on by A in which the know-how is used).

As noted earlier, a company can make a written election to continue to claim relief under this heading for expenditure incurred until 7 May 2011 or it can choose to claim intangible asset relief under s. 291A TCA 1997 for any qualifying expenditure incurred after 7 May 2009.

Scientific research (s. 764 & s. 765 TCA 1997)

S. 763(2) TCA 1997 defines scientific research as “any activities in the fields of natural or applied science for the extension of knowledge” excluding expenditure on activities relating to petroleum/mineral extraction or exploration, s. 763(3) TCA 1997.

Scientific research is generally concerned with experiments and tests to acquire knowledge and to understand/define how various components work. It covers areas as diverse as stem cell research to population sampling and includes fields of knowledge from biology to economics.

The company incurring the cost must be carrying on a trade but does not necessarily have to incur the cost in relation to its trade in order to claim a deduction. For example if its pays a university to undertake scientific research in an area not related to its own trade it can write the cost off against its profits (Section 764(1)(b) TCA 1997).

S. 764 TCA 1997 allows for any revenue expenditure incurred to be set against income or profits of the trade carried on by the company.

Expenditure on capital equipment for research purposes qualifies for 100% capital allowances (s. 765 TCA 1997), provided it is in use at the end of the period. Relief cannot be claimed under any other capital allowances section.

Patents (s. 755 TCA 1997)

The cost of acquisition of a patent by a company is allowable against trading income or, if not trading, against taxable income receivable by the company in respect of the patent rights in equal instalments over the shorter of:

A. The period the patent rights are acquired for; or

B. 17 years

The subsequent disposal of the patent may give rise to a balancing charge/allowance similar to an ordinary wear and tear situation.

Any amount received on disposal of the patent in excess of the acquisition cost is taxed under Schedule D Case IV over six years, or if the company elects, in the year of disposal (see below in relation to Section 757 TCA 1997).

As noted above, a company can make a written election to continue to claim relief under this heading for expenditure incurred until 7 May 2011 or it can choose to claim intangible asset relief under Section 291A TCA 1997 for any qualifying expenditure incurred after 7th May 2009.

Charges on capital sums received for sale of patent rights (Section 757 TCA 1997)

S. 757 TCA 1997 provides that where a capital sum is received in respect of the sale (including through the grant of a licence) of patent rights within the scope of Irish tax (i.e. sale by an Irish resident or sale of Irish patent rights by a non-resident) a charge to tax under Case IV arises. The Section also applies to part-disposals (Section 757(5) TCA 1997).

The taxable amount to be assessed under Case IV will be the amount of the capital sum received less any capital sum incurred in acquiring those rights (or part thereof in the case of part disposals – in such cases the acquisition cost will have to be apportioned to take account of the amount of those costs that relate to the part of the patent rights being sold) (Section 757(4) TCA 1997).

Resident individuals/companies

Where the seller is Irish resident then the taxable amount is, in general, spread over a 6 year period commencing in the year the capital sum is received (Section 757(1)(a) TCA 1997). However, the seller may, by notice in writing within 12 months of the end of the chargeable period in which the capital sum is received, elect to have the entire taxable amount assessed in respect of that year and not spread out (Section 757(1)(b) TCA 1997) (the seller may decide to do this, for example, if they have losses to offset against this income in the chargeable period). The seller can also apply in writing, within 12 months of the end of the chargeable period in which the capital sum is received, to have the taxable amount spread over a period other than 6 years. In such cases, Revenue may direct that the charge be spread over a number of chargeable periods greater or less than 6, where it appears to them that the normal treatment would give rise to hardship (Section 757(1)(c) TCA 1997).

Non-resident individuals/companies

Where the seller is non-resident and the patent rights are Irish patent rights, Section 757(2)(a)(ii) TCA 1997 provides that the whole capital sum is treated as if it were an annual payment and the purchaser is obliged to withhold income tax at the standard rate from the capital sum (i.e. the purchaser does not take account of any associated acquisition costs for the purposes of applying the withholding tax (Section 757(4)(b) TCA 1997)). S. 757(2)(a)(i) TCA 1997 provides that the seller will be chargeable to tax under Case IV on the gross taxable amount (i.e. after deducting any relevant acquisition costs associated with those patent rights (Section 757(4) TCA 1997) but including any withholding tax deducted by the purchaser). The seller will be entitled to a credit for the income tax withheld at source. The seller may elect, by notice in writing within 12 months of the end of the chargeable period in which the capital sum is received, to have the charge to tax spread over a 6 year period. However, the capital sum is still subject to full withholding tax at source in the first year, with the necessary adjustments being made year by year by means of repayment.

6.5.4.CGT reliefs

There are no specific CGT reliefs available in respect of intellectual property assets.

Example 6.4

IP Activities Ltd made the following purchases in April 2009. Using legislative references calculate any reliefs available.

1. Purchase of a scientific research machine for €100,000.

2. Purchase of a 10 year patent for €150,000.

3. Purchase of trade know-how for €100,000.

As the expenditure was incurred prior to 8 May 2009 relief is not available under Section 291A TCA 1997.

The reliefs available are as follows:

1. Under Section 765(1) TCA 1997, capital allowances of 100% can be claimed.

2. The company can claim relief over the lesser period of 17 years or the length of the patent under Section 755(2)(b) TCA 1997. Therefore in this case, €15,000 (€150,000/10) is allowable against the company’s trade income.

3. S. 768(2)(b) TCA 1997 allows for the entire expenditure to be set against trade income.

6.6.Explain the application of the research and development tax credit

The objective of this section is to set out the relief available for expenditure incurred on research and development.

Research & development expenditure (Sections 766 & 766A TCA 1997)

Tax credits are available for research and development expenditure under Section 766 and Section 766A TCA 1997. This tax relief was introduced to incentivise large multinationals, such as drug and information technology companies etc, to locate an R&D unit here and to encourage Irish companies to invest in R&D activities.

Section 766 TCA 1997

This section provides that a company will be entitled to a tax credit (i.e. a reduction in corporation tax) equivalent to 25% of qualifying R&D expenditure incurred in an accounting period.

It is important to note that the R&D tax credit is calculated on a worldwide group basis initially and then allocated to members of that group. The meaning of “group” for R&D purposes is very broad.

Task 6.4

Review the definitions of “group expenditure on research and development”, “qualified company” and “qualifying group expenditure on research and development” in Section 766(1)(a) and the provisions of Section 766(1)(b) TCA 1997.

Meaning of “base year” for accounting periods beginning on or before 31 December 2014

The term “base year” is not a defined term in Section 766 TCA 1997 but the concept of a base year is taken from the definition of “threshold amount” in that section. The base year is a period of one year ending in the calendar year 2003 which corresponds to the date in 2004 which is the end of a 12 month tax accounting period. Therefore if a company has a 31 December 2004 year end, the base year is the year to 31 December 2003. If a company has a 31 October 2004 year end, then the base year is the year to 31 October 2003. This means that any incremental expenditure in any year in excess of that incurred in the 2003 base year qualifies for the relief.

For accounting periods beginning on or after 1 January 2012 the first €100,000 of qualifying expenditure from 2003 when calculating each year’s claim could be disregarded, Section 766(1)(a) TCA 1997. The disregarded amount was increased to €200,000 for accounting periods beginning on or after 1 January 2013 and it was further increased to €300,000 for accounting periods beginning on or after 1 January 2014.

For accounting periods beginning on or after 1 January 2015, the base year concept is no longer relevant.

For accounting periods starting before 1 January 2015, the relief is calculated by allowing a tax credit of 25% of the qualifying incremental expenditure against the corporation tax liability of the company. Qualifying incremental expenditure incurred in 2016 of €100,000 would give a corporation tax credit of €25,000, which can be set directly against the corporation tax liability. The relief is in addition to the normal deduction for expenditure incurred against Case I income.

Operation of the R&D credit

The credit operates as follows:

A. The credit is firstly set against the current period’s corporation tax liability.

B. The company may then make a claim under Section 766(4A) TCA 1997 to set back the amount of the credit in excess of the current period’s corporation tax liability against the tax liability of prior period(s) of corresponding length.

C. If an amount of the credit remains unrelieved after making a claim under Section 766(4A) TCA 1997, the company may make a claim under Section 766(4B) TCA 1997 for payment of the excess credit. Any payment under this section will be made in three instalments. This is best explained by way of an example – see below. The amount that can be paid under this section is subject to a cap that is set out in Section 766B TCA 1997 (discussed below). The amount of any payment made by the Revenue Commissioners following a claim by a company under Section 766(4B) is not to be treated as income of the company (Section 766(7A) TCA 1997). The payment is deemed, solely for the purposes of Section 960H TCA 1997, to be a refund of corporation tax (this allows the Revenue Commissioners to offset the payment against other unpaid tax liabilities of the company).

D. Any remaining excess is carried forward and offset against the corporation tax liability of the subsequent accounting periods (Section 766(4) TCA 1997).

The claim for the R&D expenditure must be made within 12 months of the end of the accounting period in which the expenditure was incurred. Ideally it would be made with the corporation tax return of the period (Section 766(5) TCA 1997).

Example 6.5

Red Limited incurred qualifying incremental R&D expenditure of €500,000 in the year ended 31 December 2017. This was the company’s first R&D project. The company’s corporation tax liability before R&D credits for various periods is:

Year ended 31 December 2016 €30,000
Year ended 31 December 2017 €20,000
Year ended 31 December 2018 €15,000
Year ended 31 December 2019 €12,000

The R&D credit available to Red Limited in 2017 is €125,000. The credit is firstly used to offset the corporation tax liability in the year in which the qualifying R&D expenditure is incurred being the year ended 31 December 2017. This uses €20,000 of the credit available leaving a balance unclaimed of €105,000. The company may make a claim under Section 766(4A) TCA 1997 to carry back this amount against corporation tax of the prior period of equal length (i.e. year ended 31 December 2016). This claim uses a further €30,000 of the credit leaving a balance of €75,000 for which the company can make a claim for payment under Section 766(4B) TCA 1997.

As noted above, this claim will be paid in three instalments. The first instalment equal to 33% of the amount due will be paid after the tax return due date for the period ended 31 December 2017 (i.e. sometime after 23 September 2018) – See Section 766(4B)(b)(i). Therefore, the company will receive an amount of €24,750 from the Revenue Commissioners (assuming all its other tax liabilities have been paid).

The second instalment is calculated as 50% of the excess remaining after the first instalment and after offset of the credit against corporation tax of the subsequent accounting period. This means 50% of €35,250 (€75,000 − €15,000 Corporation tax in y.e. 31 December 2018 - €24,750 first instalment payment). This second instalment amount of €17,625 is payable no earlier than 12 months after the tax return due date of the period in which the qualifying R&D expenditure is incurred (i.e. after 23 September 2019) – See Section 766(4B)(b)(ii) TCA 1997.

The final instalment is the balance remaining after the first and second instalment payments, the amount offset against corporation tax in the first subsequent accounting period and the amount offset against corporation tax in the next subsequent accounting period (year ended 31 December 2019). In this example, the final instalment amount is €5,625 (i.e. €75,000 − €24,750 first instalment - €15,000 CT y.e. 31 December 2018 - €17,625 second instalment - €12,000 CT y.e. 31 December 2019).

Section 766B TCA 1997 limits any refund payable under Section 766(4B) TCA 1997. The maximum credit which may be refunded is the greater of:

A. The total corporation tax paid in all accounting period’s for the ten years prior to the period in which Section 766(4A) TCA 1997 relief is claimed (reduced by any claims made under Section 766(4B) TCA 1997 in those earlier periods) or

B. The total payroll taxes liability of the company in the period in which the R&D expenditure is incurred, Section 766B(1) TCA 1997. This section also allows the prior corresponding periods payroll taxes to be included in the maximum claim, subject to restrictions if the company has previously made a claim based on its preceding payroll liabilities, Section 766B(3)(b) TCA 1997.

C. Any credits subject to this restriction can be carried forward and set against future corporation tax liabilities.

Qualifying expenditure

Qualifying expenditure is defined as expenditure, other than expenditure on a building or structure (separate relief available under Section 766A TCA 1997 – see below) incurred by a company wholly and exclusively in the carrying on by it of “research and development activities” in a country of the European Economic Area (EEA) in the relevant year. The expenditure must be

(i) allowed as a deduction in calculating Case I trading income of the company in the State,

(ii) relieved as a charge on income under Part 8 TCA 1997

(iii) incurred on plant and machinery (other than specified intangible assets under S.291A TCA 1997). In situations where relief will be claimed on plant and machinery, the assets must be used “wholly and exclusively” for R&D. For practical reasons, this is not normally the case as the machinery is usually put to commercial use after the R&D process has finished. It is now open to the company’s Inspector of Taxes to determine (presumably after representations from the company) the “just and reasonable” portion of plant and machinery to be allowed in the R&D claim (Section 766(1A) TCA 1997). “Just and reasonable” is not defined in the legislation; or

(iv) qualify for relief under Section 764 TCA 1997

The company is also entitled to claim credit for any R&D undertaken by a university (in the EEA) on its behalf of up to 5% of the total R&D spend or €100,000, whichever is the higher (Section 766(1)(b)(vii) TCA 1997).

The company is entitled to claim relief for any R&D undertaken by an unconnected third party provided that the third party is informed in writing that it must not claim R&D credit relief and the sum paid to the third parties does not exceed 15% of the expenditure or €100,000, whichever is the higher.

Relief can be claimed for expenditure incurred prior to the commencement of the company to trade (Section 766(1)(b)(vi) TCA 1997).

Qualifying expenditure excludes:

(i) Expenditure which is deductible or relieved for tax purposes in another jurisdiction. For example, an Irish resident company which has a research branch based in the UK would not qualify for relief if the branch expenditure would qualify for the equivalent UK R&D relief.

(ii) No relief is available for royalty payments paid to a connected party and which are exempt from tax in the hands of the recipient or if the amount paid is in excess of an arm’s length amount that would be paid between independent persons (Section 766(1)(a) TCA 1997).

(iii) Interest (even if included in determining the value of an asset)

(iv) Expenditure covered by grants from any Irish or EEA authority (Section 766(1)(b)(v) TCA 1997)

Research and development activities

The expenditure must be incurred on systematic, investigative or experimental activities in the fields of science and technology. It must include basic research, applied research or developmental activities and must seek to achieve scientific or technological advancement or solutions to scientific or technological uncertainties (Section 766(1)(a) TCA 1997).

R&D credit for expenditure on buildings & structures (Section 766A TCA 1997)

S. 766A TCA 1997 grants relief for expenditure incurred on an R&D building or structure. To qualify, the company must be entitled to claim industrial buildings capital allowances on the building. The cost of the site is excluded, as is any expenditure covered by grants. The relief will be clawed back if the building is sold or ceases to be used within 10 years by the company for research and development activities or for the same trade as when the building is first brought into use. Unlike Section 766 TCA 1997 for accounting periods beginning before 1 January 2015, there was no base year or incremental expenditure concept. Therefore all expenditure on the building or structure qualifies.

The qualifying conditions for expenditure incurred from 1 January 2009 are as follows:

A. To be a qualifying building it must be used at least 35% of the time as an R&D building over a 4 year period (from the time it is first brought into use after being built or refurbished) (Section 766A(1)(a) TCA 1997).

B. The credit will be 25% of the relevant expenditure. Relevant expenditure is based on the percentage of time it is used as an R&D building, which must be at least 35%. For example a building which costs €1,000,000 and is used for R&D 40% of the time over the four year period would have an R&D credit as follows: €1,000,000 × 40% × 25% = €100,000 (Section 766A(2) TCA 1997).

C. If the building ceases to be used within 10 years of the commencement of the 4 year period noted in A, the relief is clawed back (Section 766A(3) TCA 1997).

D. Similar claims in relation to carry back of any excess credit and claims for payment of the credit to those noted under R&D revenue expenditure in Section 766 TCA 1997 are available under Section 766A and the refunds are also subject to the limits under Section 766B TCA 1997.

Use of experts by Revenue

A further provision allows Revenue to consult external experts to assist in their determinations as to whether the R&D claim meets the legislative requirements. The company must be notified of the identity of the expert and of the information to be given to the expert.

If the company can prove that the disclosure of such information to the expert would be detrimental to its business, then Revenue will not engage the expert. It is then up to Revenue to decide on the claim internally (Section 766(7) TCA 1997).

Steps involved in claiming R&D tax credit

Step 1 Calculate R&D expenses incurred (2018)

Step 2 Calculate credit (× 25%)

Step 3 Set against current year tax liability (2018)

Step 4 Set against prior year tax liability (2017)

Step 5 Claim refund on 33% remaining when filing 2018 tax return

Step 6 Set against next year’s tax liability (2019)

Step 7 Claim refund on 1/2 remaining when filing 2019 tax return

Step 8 Set against next year’s tax liability (2020)

Step 9 Claim refund on balance unclaimed when filing 2020 tax return

Task 6.5

Review the Revenue R&D guidelines focusing on the section regarding what activities qualify as research and development.

Prepare a short list of commercial products which may have been created using research and development activities.

Example 6.6

Patrick Limited incurs R&D expenditure of €650,000 in 2017, €1,000,000 in 2018, and €1,100,000 in 2019. Its corporation tax liabilities are as follows:

2016 €50,000
2017 €60,000
2018 €262,500
2019 €80,000
2020 €60,000
2021 €100,000
2022 €110,000

Calculate Patrick Limited’s final corporation tax liability or refund for these years after claiming relief for R&D expenditure incurred in 2017, 2018 and 2019.

Solution:

Note - Letters in bold indicate order of set-off

Tax Year Tax liability R&D Credit offset R&D Year
2016 50,000 (b) (50,000) 2017
2017 60,000 (a) (60,000) 2017
2018 262,500 (d) (250,000) 2018
(e) (12,500) 2017
2019 80,000 (g) (80,000) 2019
2020 60,000 (j) (60,000) 2019
2021 100,000 (l) (35,325) 2019
2022 110,000
R&D Credit refund
2018 (c) (17,325) 2017
2019 (f) (11,338) 2017
2020 (h) (11,337) 2017
2020 (i) (64,350) 2019
2021 (k) (35,325) 2019
Workings:
R&D Claims & Usage
Tax Year 2017 2018 2019
R&D Claim 650,000 1,000,000 1,100,000
Credit × 25% 162,500 250,000 275,000
Offset 2017 CT liability (a) (60,000)
Offset 2016 CT liability (b) 50,000)
Offset 2018 CT liability (e) (12,500) (d) (250,000)
2019 Offset (g) (80,000)
2020 Offset (j) (60,000)
2021 Offset (l) (35,325) (see note 4 below)
Credit Refund 2018 (c) (17,325) from 23/9/18 (see note 1 below) Nil all relieved against 2018 liability
Credit Refund 2019 (f) (11,338) from 23/9/19 (see note 2 below)
Credit Refund 2020 (h) (11,337) from 23/9/20 (see note 2 below) (i) (64,350) from 23/9/20 (see note 3 below)
Credit Refund 2021 (k) (35,325) from 23/9/21 (see note 4 below)

Notes:

1. €162,500 − €50,000 − €60,000 × 33%

[(Credit − 2016 offset − 2017 offset) × 33%]

2. €162,500 − €50,000 − €60,000 − €17,325 − €12,500 × 50%

[(Credit −2016 offset − 2017 offset − 2018 refund − 2018 offset) × 50%]

3. €275,000 − €80,000 × 33%

[(Credit − 2019 offset) × 33%)]

4. €275,000 − €80,000 − €64,350 − €60,000 × 50%

[(Credit − 2019 offset − 2020 refund − 2020 offset) × 50%]

Practical application for claiming relief:

1. The company reviews its operations to ensure that it qualifies as a research and development company.

2. Its research and development procedures and processes are documented including how it engages in R&D activities. For example a flow chart of the process from start to finish would show where the R&D activity is included in developing the product for sale.

3. The direct qualifying costs are listed and calculated. This would include materials purchased, direct R&D staff etc.

4. Overheads are analysed and a portion included in the overall claim on a just and reasonable basis - for example based on turnover.

5. Grants received for R&D costs are deducted from the claim.

6. The total claim is checked to ensure that it is not in excess of the statutory amounts noted above.

7. The claim should be included on the CT1 return for the year of claim, this is within the 1 year time limit.

Task 6.6

Nova Limited incurs R&D expenditure of €400,000 in 2018, €100,000 in 2019, and €200,000 in 2020. Its corporation tax liabilities are as follows:

2017 €10,000
2018 €15,000
2019 €20,000
2020 €17,000
2021 €2,000
2022 €11,000
2023 €20,000

Calculate the company’s final corporation tax liability or refund for these years after claiming relief for R&D expenditure incurred in 2018, 2019 and 2020.

Example 6.7

A company incurred qualifying R&D expenditure in 2018 of €500,000 on an R&D building. The qualifying usage over the next four years is 60%. The relief will be €500,000 × 60% × 25% = €75,000 directly against the corporation tax liability.

Key Point

The company needs documented proof that it is engaging in R&D.

6.7.Explain the relief for key employees engaged in research and development

Payment of R&D credits to employees

S. 472D TCA 1997 grants the company the ability to transfer a portion of the R&D credits due to it to its key employees, following the making of a qualifying R&D claim. The employee claims relief for the credits by means of tax refunds on making a claim to their own tax office.

The main conditions to claim the relief are as follows:

The employee must be a “key employee” of the company.

Key employees are:

1. Employees who were never directors of the company, or connected to any directors.

2. Hold no more than 5% of the company shares and are not connected with any other individual or associated company who hold more than 5% or more of the company.

3. In the year of the company’s claim spent 50% of their time on R&D activities which gives rise to new knowledge.

The credit can only be surrendered where the company is liable to corporation tax and cannot exceed the company’s corporation tax liability in the year of the claim, s. 766(2A)(b) TCA 1997. Therefore this excludes loss making companies.

The employee is charged to paye as normal in the year that the company makes the R&D claim and then submits a tax return after that year end seeking a tax refund, based on the tax credit surrendered to him by the company. The refund is only processed if the employee’s (and his spouse/civil partner’s) effective income tax rate is at least 23%. Therefore the relief will only be of use to higher rated tax payers. Any unutilised relief can be carried forward to the next tax year, provided the individual remains an employee of the company. The employee does not have to be a key employee in the year following the R&D claim.

Example 6.8

Science Limited had qualifying R&D credits for the year ended 31 December 2018 of €500,000 and a corporation tax liability of €225,000. The company decided to surrender €25,000 of credits to a qualifying key employee, Patrick Rogan. Patrick is single and his only source of income is from Science Limited. His salary, income tax and R&D claims for the three years following Science Limited’s claim are as follows:

Tax Year Salary Paye Refund Claim Net Income Tax Effective Tax Rate
2019 €100,000 €30,000 €7,000 €23,000 23%
2020 €50,000 €10,000 €0 €10,000 20% (no claim)
2021 €110,000 €35,000 €9,700 €25,300 23%

As long as Patrick remains an employee of Science Limited he can obtain tax refunds to the value of25,000. He will carry the remaining refund due of8,300 (25,000 − €7,000 − €9,700) into tax year 2022 and forward if required.

6.8.An awareness of the knowledge development box

Knowledge Development Box

The Knowledge Development Box (KDB) which was introduced for accounting periods beginning on or after 1 January 2016 is linked to the R&D tax credit discussed in 6.6 and intellectual property relief (IP) which is covered in 6.5.

While the R&D tax credit and the relief for IP are two separate reliefs they are linked for the purposes of the KDB and a claim under the scheme.

A detailed discussion of the KDB is outside the syllabus, however the following commentary is provided to give a background to the new provisions.

Ireland was the first country to introduce a KDB which is in full compliance with the OECD’s modified nexus approach. This essentially means linking the relief to IP and R&D. The aim of the relief is to effectively tax qualifying income at a rate of 6.25%. It achieves this by deducting 50% of the qualifying income from taxable profits, therefore effectively halving the 12.50% rate.

In order to qualify for relief under the KDB the company must earn income from its IP assets, such as through their exploitation or management/licensing. In order to have income from IP assets it must incur qualifying expenditure on their development.

In essence therefore a company will incur qualifying expenditure (which in the legislation is identical to the definition of qualifying expenditure for R&D purposes) in creating an IP asset from which it will then earn qualifying income upon which it will then claim KDB relief.

In ascertaining the portion of IP income that qualifies for the relief the legislation provides for the formula as shown below:

QE (Qualifying Expenditure) is the qualifying R&D expenditure that leads to the creation/improvement etc of the IP asset. The legislation excludes outsourcing to related parties, for example outsourcing to a group company would not be within the definition.

UE (Uplift Expenditure) allows the QE to be increased by a lower of 30% of the QE or the amounts paid to group companies (excluded in QE) and the cost of actually purchasing IP assets.

OE (Overall Expenditure) is the overall expenditure on the qualifying assets and will include acquisition costs, qualifying expenditure and non-qualifying outsourcing expenditure.

QA is the income stream from IP assets less any normal costs incurred in earning this income on a just and reasonable basis.

As can be seen from the above the formula seeks to restrict purchases costs of IP (already allowed under s291A TCA97) and group outsourcing – this makes it more beneficial to Irish companies who do all the majority of the development work in house rather than multinationals who outsource elements to group companies.

The above formula will need to be used for every separate IP asset, however grouping is allowed in certain situations, known as “family assets”. The legislation also contains provision for transitional measures in relation to assets and certain costs incurred prior to 1 January 2016, interaction with the R&D refundable credits, the effect of a claim which gives rise to a loss and certain relieving measures for SME’s.

Claims must be made within 24 months of the period end.

The legislation is contained in Part 29 Chapter 5 sections 769Gs769Q TCA97 and runs from accounting periods beginning on or after 1 January 2016 and ending before 1 January 2021.

Example 6.9

KDB Limited is a company involved in providing technology services. The following information is provided in respect of the year ended 31 December 2018:
Expenditure on acquisition of a qualifying patent €50,000
Outsourcing costs relating to R&D carried out by a US group company €75,000
Qualifying expenditure on patents and computer software €90,000
Overall expenditure on qualifying assets €200,000
Profit of specified trade relating to the patents and computer software €450,000
Profit of non-specified trade €100,000

The relief is calculated as follows –

*Uplift expenditure is calculated as the lower of:

30% of €90,000 and

€125,000 (being the acquisition and outsourcing costs)

Lower of which is €30,000

The qualifying profits of €270,000 will be liable to tax at an effective lower rate of 6.25%. The manner in which the deduction operates to yield the lower effective rate is demonstrated below:

Taxable profits from non-qualifying assets €100,000
Taxable profits from qualifying assets €450,000
Total taxable profits 550,000
Less KDB deduction (€270,000 × 50%) (€135,000)
Taxable profits €415,000
Tax at 12.5% €51,875
Equivalent to (€280,000 (€100,000 + €450,000 - €270,000) × 12. 5%) + (€270,000 × 6. 25%)

Further reading and commentary is available in Finak 2015, section 32.

Task Answers

Task 6.3

Total income 200,000 Capital allowances €600,000 × 7% 42,000
Income from relevant trade 120,000 Interest 80,000
Total claim 122,000
Max claimable 120,000
Income from relevant trade 120,000
Interest allowable (80,000) (Claimed first)
Capital allowances (40,000) (after restriction)
Taxable relevant trade 0
Add: Non relevant trade 80,000
Total income 80,000
Corporation tax @ 12.5% 10,000

The restricted capital allowances of €2,000 (€42,000 − €40,000) are carried forward to be offset against future years relevant trading income.

Task 6.6

Tax Year Tax Liability € R&D Credit Offset € R&D Year
2017 10,000 (b) (10,000) 2018
2018 15,000 (a) (15,000) 2018
2019 20,000 (d) (20,000) 2019
2020 17,000 (g) (17,000) 2020
2021 2,000 (k) (1,675) 2019
(l) (325) 2020
2022 11,000 (n) (10,892) 2020
2023 20,000
R&D Credit Refund
2019 (c) (24,750) 2018
2020 (e) (25,125) 2018
2020 (f) (1,650) 2019
2021 (h) (25,125) 2018
2021 (i) (1,650) 2019
2021 (j) (10,890) 2020
2022 (m) (10,893) 2020
Workings: R&D Claims & Usage
Tax Year 2018 2019 2020
R&D Claim 400,000 100,000 200,000
Credit × 25% 100,000 25,000 50,000
Offset 2018 CT liability (a) (15,000)
Offset 2017 CT liability (b) (10,000)
Offset 2019 CT liability (d) (20,000)
Offset 2020 CT Liability (g) (17,000)
Offset 2021 CT Liability (k) (1,675) (see note 7)
Offset 2021 CT Liability (l) (325) (see note 8)
Offset 2022 CT Liability (n) (10,892) (see note 10)
Credit Refund (c) (24,750) from 23/9/19 (see note 1) (f) (1,650) from 23/9/20 (see note 3) (j) (10,890) from 23/9/21 (see note 6)
(e) (25,125) from 23/9/20 (see note 2) (i) (1,675) from 23/9/21 (see note 5) (m) (10,893) from 23/9/22 (see note 9)
(h) (25,125) from 23/9/21 (see note 4)

Notes:

1. €100,000 − €15,000 − €10,000 × 33%

[(Credit − 2018 offset − 2017 offset) × 33%]

2. €100,000 − €15,000 − €10,000 − €24,750 × 50%

[(Credit − 2018 offset − 2017 offset − 2019 refund) × 50%]

3. €25,000 − €20,000 × 33%

[(Credit − 2019 offset) × 33%]

4. €100,000 − €15,000 − €10,000 − €24,750 − €25,125

[(Credit − 2018 offset − 2017 offset − 2019 refund − 2020 refund)]

5. €25,000 − €20,000 − €1,650 × 50%

[(Credit − 2019 offset − 2020 refund) × 50%]

6. €50,000 − €17,000 × 33%

[(Credit − 2020 offset) × 33%]

7. €25,000 − €20,000 − €1,650 − €1,675

[(Credit − 2019 offset – 2020 refund − 2021 refund)]

8. €50,000 − €17,000 − €10,890 − €325

[(Credit − 2020 offset − 2021 refund − 2022 offset)]

9. €50,000 − €17,000 − €10,890 − €325 × 50%

[(Credit − 2020 offset − 2021 refund − 2021 offset) × 50%]

10. €50,000 − €17,000 − €10,890 − €325 − €10,893

[(Credit − 2020 offset − 2021 refund − 2021 offset − 2022 refund)]

1 [1984] IR 611
2 Erven Warnick BV v J. Townsend & sons (Hull) Limited [1979] Ac731