Changes on the way for Ireland’s innovation-based tax incentives

OECD-led global tax reform has resulted in changes to two of Ireland’s key Foreign Direct Investment (FDI) offerings: the Research & Development (R&D) tax credit and the Knowledge Development Box (KDB).

Proposals made under Ireland’s 2023 Budget have an eye on the impact of the OECD Pillar Two proposals, specifically the minimum 15% corporation tax rate for group companies with turnover in excess of €750m.

R&D

The R&D tax credit is a value-based tax incentive that is designed to encourage investment in R&D by companies in Ireland.

A 25% tax credit is available for R&D expenditure in addition to the corporation tax (CT) deduction at the standard rate of 12.5%. The credit is first offset against CT, with the balance available in the form of three refundable instalments over a three-year period.

Budget 2023 has brought about two key changes to the regime, made in the context of new OECD international tax norms and European State Aid considerations, respectively.

OECD international tax norms

The proposed new global minimum effective tax rate of 15% under Pillar Two has required consideration at a domestic level as to how tax credits and incentives would operate in such a system.

Pillar Two provides that “Qualified Refundable Credits” may be treated as income, rather than reducing tax paid, thus preserving the value of the R&D tax credits in the context of the new minimum effective tax rate. In contrast, a non-qualified refundable tax credit is treated as reducing corporation tax paid, thereby requiring top-up tax in order to meet the 15% effective rate.

Changes announced in Budget 2023 align Ireland’s R&D tax credit regime with these new international norms. A fixed three-year payment schedule has been proposed. This “qualified refundable credit” would be treated as income and taxed under Pillar Two at the minimum rate (i.e. 15%). The company’s full tax liability, including tax settled by offset of R&D tax credit, is recognised for the purpose of the calculation of the effective rate of tax.

If the R&D tax credit is a “non-qualified refundable tax credit”, the credit is treated as reducing the corporation tax paid by the company. As the Irish headline CT rate is already below the Pillar Two minimum rate, this would result in an increase in the top-up tax required to be collected in order to meet the Pillar Two minimum effective tax rate, thereby wiping out the benefit of the credit.

European State Aid – Changes to payments due

Recent Budgets have sought to implement measures aimed at encouraging participation in R&D by smaller companies, notably a proposed increased 30% R&D tax credit rate for small and micro companies.

This specific measure has encountered obstacles at a European level with regard to State Aid provisions, thus requiring a rethink at a domestic level as to how to achieve the objectives.

Under changes announced in Budget 2023, the first €25,000 of a credit will now be payable in the first year. Previously, irrespective of the quantum of the credit, it was received by way of three instalments over a three-year period in the absence of corporation tax liabilities.

This new measure will particularly benefit smaller companies by vastly speeding up the repayment process, thereby providing a significant cash-flow boost while also avoiding State Aid obstacles.

KDB

The Knowledge Development Box (KDB) is an OECD-compliant intellectual property (IP) regime. It aims to incentivise companies to undertake innovative activities in Ireland by providing an effective 6.25% corporate tax rate for income generated from commercialising certain intellectual property (IP).

The KDB had been due to expire in 2022. However, Budget 2023 provides for an extension of the regime by a further four years to accounting periods commencing before 01 January 2027.

At the time of its introduction in 2016, Ireland’s KDB regime was the world’s first OECD-compliant intellectual property regime. Anticipated changes to international tax norms mean changes are required at a domestic level to remain compliant.

Current proposals under the OECD Pillar Two agreement, specifically the Subject to Tax Rule (STTR), do not provide specific rules for patent boxes and similar incentives.

It is in this context that Budget 2023 has reviewed the KDB and sought to increase the rate from 6.25% to 10%. The increased rate will be subject to a date set by a commencement order (anticipated to occur in 2023).

Since its introduction, there has been a significantly lower than expected uptake in the KDB incentive. While the extension of the KDB for a further four years is welcome, the increase in the rate to 10% is likely to further erode the attractiveness of the incentive.