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Thursday, 13th August 2020
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Tax Monitor
Ireland and intellectual property
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The new economy is driven by brain power and not by steam powered machinery. Is Ireland a suitable location in which to park a company‚€ôs brain power?
Welcome high tech!
Ireland‚€ôs tax system is deliberately geared to attract inward investment, especially from the USA. In the last decade that inward investment has been in areas of the economy that scarcely existed before the decade began - PC and Internet related sectors especially. Low tax rates have probably also been a factor in the development of the indigenous Irish high tech sector.

Are we low tax?
Undoubtedly a 10 per cent (or 12.5 per cent) corporation tax rate is a low tax rate. But a low tax rate does not in itself produce a low tax jurisdiction. You are only a low tax jurisdiction if you apply a low tax rate to a computation of profits that fully takes into account all of the company‚€ôs expenses. If the 10 per cent CT rate applied where expenses account for 80 per cent of turnover and half of the company‚€ôs expenses were disallowed when computing taxable profits you would have a 30 per cent effective tax rate.

What has that to do with Ireland, you might ask? After all we don‚€ôt disallow a large proportion of the company‚€ôs expenses, do we? Surprisingly, in some instances we do.

Readers are likely to be aware that some legitimate business expenses, such as entertainment and the costs of more expensive cars, are disallowed. But except in a very small number of instances, these expenses are not a high proportion of overall expenses. The real problem arises because what is called ‚€ėcapital expenditure‚€ô is not regarded as a deductible expense in computing profits.

The ‚€ėcapital‚€ô problem
This disallowance goes back to the 19th century when the courts were faced with the fact that the word ‚€ėincome‚€ô was not defined in the Income Tax Acts. So what was it? It was decided that it had to be receipts of an income nature, from which you deduct expenditure of an income nature. Therefore you compute income without deducting expenditure of a capital nature. This was wonderfully logical but economically nonsense.

If you lay out capital expenditure to acquire an asset which after five years is worthless, but you generate enough sales from using the asset over the five years to recover its costs, a judge, but never an economist or an accountant, would tell you that that asset did not represent a real cost to you, which had to be taken into account in determining if you had any income. That however is what tax law says. Of course this nonsense has been alleviated for much of the capital expenditure of the ‚€ėold economy‚€ô. The cost of a steam engine or a smoke stack are both likely to attract what are called ‚€ėcapital allowances‚€ô which were deductible in computing taxable income. This was a reasonable fudge of a solution to a narrow judicial decision in an age when most long term expenditure was on tangible items such as buildings and plant. That age is long dead.

Buying in know how
Information is power. Information and knowledge are what drives corporate earning in many of the companies looking at Ireland as an investment location. The countries from which they come will demand that an Irish start-up operation pays for that existing knowledge before it is exported to Ireland. This is their way of protecting their tax base.

So typically, a new Irish operation of a multinational will have to pay its American parent for accumulated know-how and technology which is transferred to it, and will arrange that future developments of technology be made available to it on a cost sharing basis.

Payments on an annual basis for cost sharing of future developments are deductible in Ireland. But the up-front payment for existing technology may prove not to be tax deductible in Ireland. Since the payment will be taxable in the United States (and in most other jurisdictions) when received, the lack of a deduction in Ireland is perceived by the foreign investor as moving up the effective tax rate in Ireland for several of the initial years of the new venture.

Typically, Ireland will grant a tax deduction for an up-front payment for technology in three instances only.
‚€Ę Payment to an unconnected person for trade know how.
‚€Ę Purchase of patent rights.
‚€Ę Payment for computer software.
The write-off period for expenditure on acquiring patent rights can be as long as 17 years. The write-off period for the computer software is approximately seven years. Both write-off periods are fundamentally out of line with the likely life of the technology purchased (usually two to three years maximum) and with the taxation treatment abroad of the person from whom the intellectual property is being acquired. Where trade know how is neither patented nor consisting of software, it is almost certain to be bought from a connected party, and accordingly no deduction at all is available for its acquisition for an up-front lump sum.

Write off periods out of date
Increasingly intellectual property has a short economic life. Today‚€ôs technology is going to be fit only for a museum in three years‚€ô time. The rules relating to writing off the cost of acquiring such technology when computing taxable profits have not kept pace with the new economy. The question of a write-off for expenditure on capital assets (apart from buildings and plant which are already catered for) needs to be looked at. The 12.5 per cent CT rate is not that attractive if it is going to be applied to something which is far greater than the true income of a company.

We should also look at the write-off period in relation to software, and in relation to plant generally. Seven years may be fine in relation to a steam engine, but it makes little sense in relation to purchased software and other short life assets.

UK challenge
Ireland and the UK compete for inward investment. The Chancellor in the UK has announced that the UK is going to move to provide write-offs for expenditure on intangibles and intellectual property, most probably in line with the manner in which these are written off in accounts. We need to act now.

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