When it was ﬂagged last year, the Government’s Knowledge Development Box (KDB) tax incentive was pitched as almost a straight swap for the controversial ‘Double Irish’ scheme, which is being phased out. The ﬁnal version of the KDB that was unveiled in Budget 2016, however, is a somewhat different animal. It’s narrower in scope, and contrary to expectations, the biggest beneﬁciaries in the short term at least are likely to be Irish SMEs rather than the many large corporates whose Irish operations were originally intended to gain the most.
The Knowledge Development Box’s rate is set at a very attractive 6.25 per cent: half the 12.5 per cent corporate tax rate for which Ireland is famous – or notorious, depending on your point of view. Arguably more importantly, the KDB is the ﬁrst such scheme in the world to comply with the OECD’s rules on base erosion and proﬁt shifting (BEPS), which have been designed to curb global corporations’ efforts to minimise their tax liabilities by artiﬁcially moving proﬁts to low-tax or no-tax locations where little or no real economic activity takes place.
In other words, to qualify for KDB tax relief in Ireland, a company’s proﬁts must derive from intellectual property, such as patents and copyrights, where a proportion of the spending to create that IP took place in this country.
“The substance of the activity must be in Ireland for the Knowledge Development Box to be attractive for a company. It’s not about a brass-plate operation or smart tax planning; it’s about real R&D activity happening in Ireland,” says Ken Hardy, tax partner with KPMG Ireland. “There are many tools in our toolbox that assist in attracting FDI into Ireland, and the KDB, as it’s designed now, is BEPS-compliant. Everyone who wants to be BEPS or OECD-compliant is going to have to take this approach.”
Some commentators, including the New York Times, rushed to declare that companies such as Apple, Microsoft, Google and Face- book – all with substantial presences in Ireland – would nevertheless beneﬁt due to the substantial amounts of IP they hold which could be eligible for the new tax treatment. Having picked through the ﬁner detail of the KDB, tax experts now say this outcome is unlikely in the short term because of how most businesses – and large multinationals in particular – calculate their revenues.
“For multinationals doing R&D on a globalised basis, a lot have a follow-the-sun approach and the beneﬁt to them wouldn’t be as high. Multinationals will be less interested in this, given the base where they start from,” says Hardy. “We believe it’s particularly good news for Irish SMEs doing most of their R&D in Ireland. In that case, the vast majority of the Irish company’s income from that patent could qualify. Whereas if a multinational company is doing the vast majority of its R&D outside Ireland or the EU, the KDB is not as attractive.”
Global corporates in sectors such as pharmaceuticals or software typically have multiple R&D teams working on the same project across several locations. To avail of the KDB, they will need to attribute income to speciﬁc products, assets or business lines whose origins can be traced back to a particular piece of R&D activity that happened in this country. It’s said success has many fathers; ﬁguring out the paternity of some IP promises to be a complicated business.
There are close to 1,500 companies in Ireland claiming the existing R&D tax credits and they are obvious candidates to consider making additional gains through the KDB system. Eoghan Hanrahan, senior investment adviser at Enterprise Ireland, suggests the percentage of those taking up the new scheme will only become clear with time. “Companies have to make a decision: is the return enough to justify making a transition to go down that route? I think it will be an incremental take-up; it won’t be immediate,” he says.
In the past, some Irish companies have been reluctant to go down the route of creating intellectual property. Hanrahan hopes the attractive tax rate and the potential to marry it with other R&D tax reliefs will encourage more indigenous ﬁrms to look at this option more closely than in the past. Over the coming months, Enterprise Ireland plans to carry out a number of seminars aimed at informing Irish businesses about the KDB relief and how it works.
Damien Flanagan, tax director at KPMG, points out that SMEs don’t actually have to patent an asset; it just has to be patentable. “That’s a welcome improvement. For SMEs, a concern that we would hear is that the cost of patenting or defending a patent is too large, but for companies of a certain size, they don’t have to patent and I think that takes away an element of the complexity. And, if SMEs are already claiming the R&D tax credit, they will already have done a lot of work to qualify for the KDB. We talk to our clients a lot about the documentation requirements and they are very similar for the KDB,” he says.
The KDB relief will be operational for accounting periods beginning on or after January 1st, 2016, and before New Year’s Day 2021, so it can’t be applied retrospectively.
Ken Hardy doesn’t believe that the system as it’s currently designed will be too complicated to be practical. “Tax legislation by its very nature is complex; it needs to be written in a precise manner. It will be important to see the legislation and any guidance issued by the Revenue Commissioners about how it’s applied practically. If there’s enough of a tax beneﬁt, then companies will get over the complexity but if they arrange your affairs from the get-go to avail of this relief, then I don’t think it is way more complex than any other piece of tax legislation. Time will tell whether KDB will be effective or not. What the Government and the Revenue Commissioners have proved many times previously is that where something needs adjustment where it wasn’t working well previously, they’re very adept at adjusting it so that it works as intended.”
IDA Ireland chief executive Martin Shanahan is hopeful the new scheme will help in attracting new research and development investment projects into Ireland. “The Knowledge Development Box is a welcome addition to Ireland’s overall corporate tax offering, in my view. We believe it will assist innovation and research. Because it’s compliant with OECD guidelines, it will give investors great comfort; other countries do not currently have that advantage.”
Extracts from the following article appeared in Business Ireland in December 2015 and are produced here with their kind permission.