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Tuesday, 4th August 2020
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Research and development tax breaks Back  
The vision shown by the Minister for Finance in proposing the introduction of significant tax breaks for research development has been let down by the draft legislation in the Finance Bill. There are fears that the manner in which the Minister‚€ôs proposals are being implemented may result in the expected benefits not being achieved.
GGood idea
The Minister‚€ôs idea to compete internationally for research and development spending, and to stimulate research and development amongst indigenous Irish firms, was a good idea. Many other member states of the EU have special tax incentives for research and development.

Multinationals
The legislation has two objectives. One objective is to persuade multinationals to locate their research and development units in Ireland. A key issue for such multinationals is the extent to which the taxation effectively subsidises research and development cost. A dollar spent in the United States may save 40 cent of tax. Hiterto in Ireland, a dollar spent on research would save either 10 cent or 12.5 cent, depending on the tax rate applying for the company. Ireland had to be do something to make itself attractive.

What is proposed is that in addition to allowing for a write off in the computation of taxable income, which yields a saving of 12.5% at the most, Ireland would give a credit of 20% of the expenditure against the remaining tax bill. A total tax saving of 32.5% potentially would be available.

This is not the highest level of ‚€útax subsidy‚€Ě which a multinational can achieve worldwide. The UK can offer approximately 37.5% of a tax subsidy. The Netherlands can offer a tax subsidy of up to 40% on wage costs related to research. France can offer a tax subsidy of approximately 50%.

The SME
The second target for the incentive was the indigenous Irish SME. Expenditure on research and development by SME‚€ôs is low. If such companies are to grow to become mini multinationals, there are likely to achieve it only by increasing their level of research spending. However research spending involves immediate cost with very uncertain future benefits. For that reason some tax subsidy towards the cost of research seemed desirable to induce the SME to embark upon research. The proposed 32.5% ‚€útax subsidy‚€Ě is attractive for an SME.

So what went wrong?
There are four major flaws with the legislation. The definition of research and development for the purpose of the legislation is ambiguous and unsuited in particular to an SME.

The tax credit proposed is based on escalating expenditure over a period of time, something which is irrelevant to attracting a multinational and off putting to an SME.

Sub contracting of research by an SME is limited to a low level of 5% of total expenditure.

The minimum level of research and development expenditure required to qualify for relief has been set at so low a level as to invite dubious claims.

The problems with the legislation may well have originated from the failure to distinguish clearly between the requirements of a multinational, and the requirements of an SME. The challenge was to produce a single piece of legislation that met the requirements of two quite different types of businesses, without having overt discrimination which would be objectionable to the EU. A ‚€úone size fits all‚€Ě approach was taken to the legislation (with one exception, relating to restrictions on outsourcing for SME‚€ôs) and the only result is that the one size doesn‚€ôt fit anyone very well.

The Definition
The definition adopted of research and development expenditure which would qualify for relief is basically good. It ranges from pure research, down to attempts to improve a specific product. Unfortunately, onto this basically sound definition was tagged some words that exclude from being qualifying research, research which does not aim to resolve technological problems from a worldwide perspective.

This particular piece of wording mirrors similar wording in the UK legislation. The Inland Revenue had already identified it in a published consultation document as a flaw in their legislation, and as one of the factors that has made their regime less than totally successful. The problem with the requirement that research be aimed at resolving technological problems from a worldwide perspective is that for an SME in particular most research and development expenditure is aimed at resolving problems solely from the perspective of the SME and the result of the research and development may well be to do no more than to discover that the same problem has been resolved elsewhere already.

Escalating expenditure
The tax credit, which is the form of relief given, is available only in respect of incremental expenditure over and above what you might broadly think of as the 2003 level of expenditure. Furthermore, after 2007 it would be confined to increments over expenditure in 2005, and so on. Anyone basing their research and development in Ireland will know that they will receive the benefits of the relief only if they are committed to continuing escalating expenditure.

What has this to do with the objective of attracting a multinational research and development unit to Ireland? The objective is to get the unit in here, not to persuade it to forever increase its spending.

A multinational will sensibly ask itself whether the tax subsidy it seeking is ‚€úin the bag‚€Ě if it should set up in Ireland. The answer to that question is ‚€úno‚€Ě.

If budgetary constraints, or commercial needs mean that expenditure in 2008 is not greater than expenditure in 2005, the expected subsidy will not materialise. Indeed in 2008 the expected subsidy will not apply to that part of the expenditure in that year equal to the expenditure in 2005. Bearing in mind that we are probably trying to attract a research unit out of the USA, or out of the UK, this feature of the scheme means we are uncompetitive and have little chance of success.

It is understandable that there would be a wish not to grant a tax incentive to a company which incurs the same level of research and development expenditure as it had already incurred in 2003. The tax incentive may seem unnecessary to such a company.

Bearing in mind that such multinational research and development as does occur in Ireland could easily relocate to the UK over the next few years, that viewpoint is flawed. We need the credit on existing levels of expenditure merely to keep the research and development we already have.

Furthermore, from a viewpoint of an indigenous company, it is fundamentally unfair that two competing companies should have different tax treatments. You might have a position where one company was already spending on research and development, but because it has no commercial need to increase its spending, it will not receive the tax incentive. A competitor who is a Johnny Come Lately to the research field and spends no more than the first mentioned company will get the tax incentive as a reward for being a late comer.

Ireland previously had a special tax incentive for research and development. It was one of the most complete failures we ever experienced in terms of tax incentives. A major cause of that spectacular flop was precisely the requirement for incremental expenditure. Having proven once that this requirement is a killer to a research and development incentive, why do we go ahead and introduce it again?

Outside Expertise
Generally, payments to third parties to carry out part of the research are not intended to attract the tax credit. An exception is made in that up to 5% of expenditure can be in respect of payments to a university or some other third level institute.

How does an SME get started on research and development? Most likely it will be by subcontracting a substantial part to a university, as they initially will not have adequate expertise. As their confidence grows, they may obtain in-house expertise, but initially subcontracting is likely to be important. However for all practical purposes tax credits are denied to such subcontracted expenditure.

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