Knowledge Development Box: what you need to know for your business
23 June 2016
On 14 October 2014, Finance Minister Michael Noonan announced in his budget the abolition of the controversial ‘Double Irish’ structure and the subsequent introduction of the Knowledge Development Box (KDB), a system based on existing patent and innovation boxes within other countries.
The KDB was introduced for companies under the Finance Act 2015 for accounting periods commencing on or after 1 January 2016 and is an important element in Competing in a Changing World: A Road Map for Ireland’s Tax Competitiveness.
The KDB is a regime for the taxation of income that arises from patents, copyrighted software and, in relation to smaller companies, other intellectual property (IP) that is similar to an invention which could be patented. It is worth nothing that the location of the ownership of the IP is not a factor that impacts on the relief under the KDB.
In brief, a company that qualifies for the KDB will be entitled to a deduction equal to 50% of its qualifying profits in computing the profits of its specified trade. In effect, the profits arising from patents, copyrighted software or IP equivalent to a patentable invention are taxed at 6.25% rather than 12.5%.
How is it calculated?
The modified nexus approach requires that the income from IP that can be taxed at the preferential rate of 6.25% is limited by the proportion of income arising from R&D activities. The calculation used is presented in Figure 1.
Where qualifying expenditure in the above formula includes the following:
➢ Expenditure incurred by the company itself on R&D activities undertaken in the European Economic Area where such activities lead to the development, improvement or creation of IP. The definition of R&D expenditure is similar to that used in the R&D tax credit;
➢ Capital expenditure used for R&D;
➢ Outsourcing costs to unconnected parties (no territoriality test or restriction).
However, qualifying expenditure does not include the following:
➢ Amounts paid in acquiring qualifying assets;
➢ Any amount of interest paid or payable;
➢ Amounts paid to members of a group to carry on R&D activities, whether under a cost sharing arrangement or otherwise;
➢ Expenditure under a cost-sharing arrangement with another company to the extent that such expenditure exceeds an arm’s-length price;
➢ Any amount paid to a group member in excess of what that group member incurs in the carrying on of R&D activities;
➢ Any amount that can be taken into account for the purposes of tax in another country.
Uplift expenditure in the above equation is the lower of:
➢ 30% of qualifying expenditure; or
➢ Acquisition costs plus group outsourcing costs.
Overall expenditure in the above equation is:
➢ Qualifying expenditure; plus
➢ Any acquisition costs in relation to the qualifying asset; plus
➢ Group outsourcing costs.
A simplified example
An Irish tax resident company in a global group of companies was engaged in R&D activities in partnership with an American partner group company in relation to the development of a new product in 2014 and 2015.
The Irish company incurred €15 million in qualify expenditure and incurred outsourced expenditure to the American partner group company in the amount of €6 million, which represented the cost of the R&D activities to the American partner. Resulting in a total of €21 million in overall expenditure incurred to develop the IP asset.
The R&D activities were successful and the invention was awarded a 20-year patent in late 2015 and commercial sales of the product began in early 2016. Sales related to the qualifying asset (patent) in the year ended 31 December 2016 were €7m with related costs of €3 million. Under the proposed regime, the following amount of income would benefit from the 6.25% rate:
IP-related income €7,000,000
IP-related expenditure (€3,000,00)
Qualifying profits €4,000,000
The income allowable for the 6.25% rate is then calculated as follows:
(€15m + €4.5m*/€21m) X €4m = €3.7m
This €3.7 million is then reduced by 50% (taken as a deduction) and taxed at 12.5%, resulting in an effective rate of 6.25% and a liability of €231,250 as opposed to €462,500. The uplift expenditure is calculated as the lower of 30% of the qualifying expenditure
(€15m x 30% = €4.5m*) or the acquisition costs + the group outsourcing costs (€6m).
So, where to next?
Choosing your R&D and KDB advisors is an important decision for you. It is essential that your advisors have the skills and experience required to deal and grow with the financial and technical needs of your business. It is equally important to know that your dedicated advisors will be able to form and maintain an excellent working relationship with your team and conduct their work in a professional and flexible manner.
Within Mazars, we have a proven track record with the key credentials to provide a first-class detailed and tailored service that will go beyond our client’s expectations. It is this commitment which has our clients returning year on year. We have a specific dedicated Research & Development Tax Group which focuses on assisting companies in identifying activities that qualify for the KDB and Research & Development Tax Credit. In addition, we have the significant in house scientific experience to assist and advice in both the claim and technology. Our service also extends to support our clients in the event of an audit. For more information, please contact Dr James Kennedy at firstname.lastname@example.org.
James O’Hagan, BBS (Hons), ACCA, Tax specialist – Tax Credit Group, Mazars
Gerry Vahey, FCA, AITI, Partner – Tax Credit Group, Mazars
Dr James Kennedy, NCert (Eng), NDip (Eng), BEng, CEng, HDip (Research), MBA, PhD, MIEI, Manager – Research & Development Tax Credit Group, Mazars