R&D Tax Incentives An IDA Perspective on Research & Development Leo Clancy, 10th September 2014 Where does IDA Fit? Department of Jobs, Enterprise & Innovation Building Irish Academic Base Supporting Indigenous Irish Companies Supporting Multinational Companies in Ireland 1
IDA Ireland Business Focus Global Business Services Information Communication Technology Life Sciences & Food High Value Manufacturing Research, Development & Innovation Engineering, Industrial & Clean Industries Content Industry, Consumer & Business Services International Financial Services 3 Why is R&D Important? 4 Agency Supported Foreign Owned Companies...directly employed 172,326, and a further estimated 124,000 indirectly in 2013.contributed 72 percent to total corporation tax revenues in 2012.spent 13.2 billion on materials and services sourced in Ireland (2012).invested just under 1.4 billion in R&D (2012) equating to over 70 percent of all business expenditure on R&D Source: Policy Statement on Foreign Direct Investment in Ireland, July 2014 5 2
IDA Ireland s Core Value Proposition 6 R&D Tax Credit 2004 2011 Business Expenditure on R&D 1.2bn 1.86bn Tax Credit Paid 70.5M 261M # of Beneficiaries 75 ~1,500 Source: Department of Finance, Review of R&D Tax Credit 2013 7 Direct State R&D Spending & Related Support Academic Infrastructure SFI & Technology Centres Innovation Partnerships Feasibility Studies Enterprise R&D Grants Innovation Vouchers Commercialisation Fund Fellowships (IRC / SFI) Horizon 2020 Supports SFI Spokes & Partnerships.and others Source: State Investment in Research & Development, Forfás, November 2013 8 3
Direct State Investment in R&D, 2004 to 2013 Source: State Investment in Research & Development, Forfás, November 2013 9 In-house R&D Spend and Employment (IDA Client Companies) 12,000 1,400 10,000 1,200 8,000 1,000 800 6,000 600 4,000 400 2,000 200 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 0 Total R&D Employment (LHS) Total R&D in-house Expenditure m. Some Simple Ambitions for Irish R&D More R&D (Volume & Participants) Increased Collaboration & Connections Local Development & Commercialisation Reputation for Delivering Research Excellence Sustainable Economic Impact 11 4
To learn more log on to idaireland.com +353 1 603 4000 idaireland@ida.ie 5
6
7
8
Optimising your R&D incentives 10 September, 2014 9
Agenda The R&D incentive in the current environment Overview of the R&D regime The science test The accounting test Overview of documentation requirements Putting a framework in place How to prepare for a Revenue audit Page 27 The R&D incentive in the current environment The R&D incentive in the current environment Key improvements in recent years: Cash refunds for excess R&D credits from Irish Revenue 1st 100K/ 200K/ 300K on a volume basis Use credit to reward key R&D employees Very successful regime: Encouraging growth in R&D spend in Ireland 2003 R&D spend was 0.78% of GDP increasing to 1.17% of GDP (2011) The EU 2020 target for Ireland is 2.5% of GDP Greater flexibility around refunds Department of Finance Review published The R&D tax credit regime is October 2013 a fundamental cornerstone to building Ireland as a cost Government s commitment to maintain the competitive knowledge economy R&D tax credit Among best in class internationally Page 29 10
The R&D incentive in the current environment Company is profitable and paying Irish tax 25% Credit available on qualifying incremental R&D expenditure Allowable against Irish corporation tax Where excess credit is available the excess will be refunded per below Company in losses and declares Nil Irish tax 25% Credit available on qualifying incremental R&D expenditure Available as Cash Refund Refunded over three years Page 30 The R&D incentive in the current environment Example of tax credit/cash refunds Corporation Tax liability y/e 31 December 2013 100,000 R&D tax credit 500,000 Excess R&D tax credit available for repayment 400,000 Repayment of the excess R&D tax credit of 400,000 is as follows: Excess R&D tax credit payable no earlier than 1st Instalment (33%) 132,000 23 September 2014 2nd Instalment (50% of balance) 134,000 23 September 2015 3rd Instalment (remainder) 134,000 23 September 2016 Page 31 The R&D incentive in the current environment Example of tax credit/cash refunds (cont d) 31 Dec 2013 31 Dec 2014 31 Dec 2015 Excess R&D tax credit for repayment 400,000 400,000 400,000 R&D Tax Credit Total Due R&D tax credit not repayable before 23 Sept 2014 23 Sept 2015 23 Sept 2016 FY13 400,000 132,000 134,000 134,000 23 Sept 2017 FY14 400,000 132,000 134,000 134,000 23 Sept 2018 FY15 400,000 132,000 134,000 134,000 Total 1,200,000 132,000 266,000 400,000 268,000 134,000 Page 32 11
Overview of R&D regime Overview of R&D regime Key highlights Qualifying R&D project with 20% grant aid: R&D spend of 100 Grant aid (20) Net of grant aid 80 CT deduction @ 12.5% (10) R&D credit @ 25% (20) (30) Net cost 50 Significantly reduces net cost of doing R&D in Ireland Accelerate investment provide a budget to pay for targeted hires Increase ROI on R&D spend Increase margins on qualifying projects Can account for the R&D tax credit above the profit line Page 34 Overview of R&D regime Key highlights (cont d) Credit in addition to corporation tax deduction 37.5% tax relief on net of grant expenditure How is relief obtained: Credit to be offset against current year corporation tax liability Excess R&D tax credits can be carried back and offset against corporation tax paid in the previous year Claimed on corporation tax return Cash refunds for excess credits Claims must be made within 12 months of the period end The introduction of a cash refund scheme can offer significant cashflow and financial statement benefits Page 35 12
Overview of R&D regime Key highlights (cont d) Limits on subcontracting costs capped at the greater of: Up to 5% (University or Institute of higher education) and 10%/15% of qualifying inhouse R&D spend where subcontracted to an unconnected third party respectively, or 100,000 For 2012 onwards, onus on principal to claim the R&D benefit and notify subcontractor in writing Insert clause in contract terms Letter of notification etc. Form CT1 panel to be completed Always bear in mind the 25% incentive when negotiating with R&D subcontractors Page 36 Overview of R&D regime Key employee Must be 50% involved in R&D Poor uptake Cannot be director or connected to director Claw-back provisions Key Employee Cannot have >5% shareholdin g Capped at corporation tax liability Effective income tax rate cannot be <23% Page 37 Overview of R&D regime Key Finance Act (No.2) 2013 changes Increase volume base credit from 200K to 300K Outsourcing limits for unconnected third parties increased from 10% 15% Key employee claw back provisions onus now on the company Pre Finance Act (No.2) 2013 Post Finance Act (No.2) 2013 Difference In-house R&D expenditure 1,500,000 1,500,000 Nil Subcontracted R&D expenditure* (10%)/(15%) Base Year R&D expenditure 2003* ( 200K/ 300K volume basis) 150,000 225,000 75,000 (100,000) (0) 100,000 Qualifying R&D spend 1,550,000 1,725,000 175,000 R&D tax credit 387,500 431,250 43,750 *Subcontracted expenditure 300,000 Base Year expenditure 300,000 Page 38 13
Science test Science test 5 Tests R&D activities means: 1. Systematic, investigative or experimental activities 2. In a field of science or technology 3. Being one or more of the following categories of R&D: Basic Research (experimental/theoretical work without a specific objective) Applied Research (work undertaken for a specific objective) or Experimental Development (producing new/improving existing, materials, products, devices, processes, systems or services including incremental improvements thereto) It s not just people in white coats in labs that qualify! Page 40 Science test 5 Tests (cont d) 4. 5. Scientific or technological advancement Scientific or technological uncertainty AND Activities which seek to achieve an advance in science or technology The solution, or method of arriving at the solution is not readily apparent to an appropriate skilled competent professional Page 41 14
Science Test Is your company doing R&D? Development of Proof of Concepts, prototypes, etc Development of new products, systems, equipment, processes Automation of manual processes which involved significant technological uncertainty Use of universities/external experts that have specialised knowledge Are you involved in any of these and were faced with unknowns/uncertainties that could only be resolved through experimental development? Process improvements, e.g., Increased efficiency, cost savings, improved throughput, etc Change of product material input effects on biocompatibility, durability, consistency etc Scale-up experimental trials on the processing lines Technical failures Page 42 Accounting test Accounting test expenditure incurred by the company wholly and exclusively in the carrying on by it of R&D activities.. Staff costs and overheads directly attributable to R&D activities, including: Salaries of R&D personnel Direct costs Plant and machinery Third party royalties Page 44 15
Accounting test Examples of some eligible costs Direct staff costs Plant and machinery Buildings (special rules apply) Heat Raw Materials/Consu mables Sub-contracted R&D costs (rules) Fixtures and Fittings Rent Direct overheads Computer software and hardware costs Light Rates N.B., Any tax allowable expense incurred in the carrying on of qualifying R&D activities of the claimant. Page 45 Accounting test Plant and machinery Claim may include plant and machinery Used wholly and exclusively for R&D Or Based on the % R&D usage/economic life of the asset Must be entitled to claim capital allowances Prior year review where R&D usage no longer just and reasonable Page 46 Accounting test Buildings overview 25% credit for current year spend No base year Must be entitled to IBAs Buildings used partly for R&D activities may qualify on the basis that at least 35% of the building is used for R&D Page 47 16
Overview of documentation requirements Overview of documentation requirements Self assessment Write up on a project by project basis Key documentation requirements of Irish Revenue Satisfy both accounting and science tests Page 49 Overview of documentation requirements No standard template used by Revenue Project reports do not have to be submitted to Revenue unless requested 23 Point Revenue Query letter (next slide) Ensure written by a scientist/technologist and not an accountant Bear in mind external expert used by Revenue Page 50 17
Overview of documentation requirements Revenue s query letter R&D department: 1. The number of projects undertaken? 2. Summary of the R&D activities for each project? 3. Date the project started? 4. Date the project ended (if applicable)? 5. Specific scientific/technological advancement sought at the start of the project? 6. Specific scientific/technological uncertainty the company sought to resolve at the start of the project? 7. Was the solution already known to a competent professional in the field? 8. The field of science/technology involved? 9. The type of R&D, being one/more of the following: Basic research, Applied research, or Experimental development 10. Where did the R&D activities take place? 11. If claiming for subcontracting activity, outline the work carried out by those other parties? Page 51 Overview of documentation requirements Revenue s query letter Finance/HR department: 1. Is the claim in respect of s766 or S766A TCA 1997? 2. The amount of the FY2003 base year amount? 3. Has all group spend been included in the FY2003 base year? 4. Once the uncertainty has been resolved, confirm no further spend attributed to R&D? 5. Qualifications of each project leader? 6. The number of staff employed in R&D activities? 7. Quantify expenditure paid to a third party contractor/service provider? 8. Quantify expenditure paid to a university/institute? 9. Where spend allocated to R&D by apportionment, detail the basis and method used? 10. If claim includes P&M, state the % used in R&D over the useful economic life of the asset? 11. Details of any grants received in respect of R&D? 12. Computation of tax credit claimed for the accounting period, showing itemised analysis of each expenditure item? Page 52 Putting a framework in place 18
Putting a framework in place Annual process Identify Identify your target projects within your business Identify and categorise the project staff Articulate the scientific/technological advancement and uncertainty present in the project Consider concise front-end assessment Quantify Determine which activities have contributed to the scientific/technological advancement and scientific/technological uncertainty Understand how the project staff have contributed to the qualifying activities by individual or role Allocate qualifying percentages to staff/roles Substantiate Finalise project write ups Identify Quantity Substantiate Leverage existing internal company documentation including grant claims/patent applications, etc. Page 54 Putting a framework in place Practical challenges Identification of qualifying R&D projects Time apportionment Interaction between R&D and finance teams Completion of technical documentation Costs directly supporting R&D activities Page 55 How to prepare for a Revenue audit 19
How to prepare for a Revenue audit Economic situation Increase in the number of claims for cash from Revenue Significant increase in the level of queries from Revenue R&D tax credit highly visible High risk area Many Revenue audits yield settlements Failing on the science test Failing on the accounting test Revenue Audits Cash refunds Page 57 How to prepare for a Revenue audit Types of R&D audits Financial and tax audit Revenue will not appoint an expert to review the science test (at this point!) Will focus on the accounting test Qualifying expenditure Scientific audit Revenue will appoint a technical expert Due diligence by the company first Non-disclosure agreement signed between Revenue and the expert Usually focus on the science test and the accounting test Page 58 How to prepare for a Revenue audit Factors influencing audit selection? Industry Sector Responses to Revenue Query Letter Size of the R&D claim District Project Revenue Audit Cash repayment vs. tax paying Random Selection Track record with Revenue Compliant tax payer Page 59 20
How to prepare for a Revenue audit Common pitfalls - science test Companies are required to maintain and record source documentation to satisfy the science test. Should be maintained contemporaneously. Technical documentation: Eligible activities overlooked Activities don t meet the technical criteria Company cannot identify project parameters When did the R&D project activities commence and cease? Poor presentation on site visit/lack of quality information Not maintaining sufficient documentation Not being briefed by technical people Poorly prepared Fail to prepare, prepare to fail! Page 60 How to prepare for a Revenue audit Common pitfalls - accounting test Companies are required to maintain and record source documentation to satisfy the accounting test. Should be maintained contemporaneously. Financial documentation: Base year incorrectly calculated/unsupported due to insufficient documentation Over allocation of costs Inclusion of non qualifying expenditure Not tax deductible (e.g. depreciation) Relates to R&D activities not carried on in the EEA Incorrect apportionments being used for salaries/ overheads/plant and machinery Not apportioning costs for commencement/ cessation of R&D projects Allocation methodology unsupportable Fail to prepare, prepare to fail! Fail to prepare, prepare to fail! Page 61 How to prepare for a Revenue audit Common pitfalls - accounting test (cont d) Companies are required to maintain and record source documentation to satisfy the accounting test. Should be maintained contemporaneously. Financial documentation: No amendment of plant and machinery for usage test Capital expenditure does not qualify for capital allowances Incorrect treatment of subcontracted costs and agency staff Incorrect treatment of grants 12 month deadline is missed Order of offsets not applied correctly Refundable credit not appropriately capped Fail to prepare, prepare to fail! Page 62 21
How to prepare for a Revenue audit The process Main concerns cost and reputation Code of Practice 21 days notice of audit 14 days issue notice of intention to make qualifying disclosure Qualifying disclosure mitigates penalties and avoids publication and the risk of prosecution. Financial and/or technical review Audits can be lengthy and costly process 21 days or to be agreed Months years? Audit Notification Agree technical assessor and date of audit Revenue Audit Technical Assessor s and Revenue s assessment Company Appeal? Page 63 How to prepare for a Revenue audit Site visit presentations Company overview Science presentation Accounting presentation Source records Page 64 How to prepare for a Revenue audit Scientific source documentation some examples Developer s Journals/Lab Notebooks Defect Tracking Records Test Results Logs and comments from control systems Project Plans Test Plans Design Review Minutes Emails Status/ Progress Reports Page 65 22
How to prepare for a Revenue Audit Financial source documentation some examples P35 records Third party contracts P&L Base year documentation Financial records Apportionment methodology used Invoices Fixed asset register Grant documentation Corporation tax return and computations Page 66 How EY can help How EY can help How we can help Revenue audit support Prepare technical project reports Feasibility study Mock audits Conduct technical interviews In house R&D workshops R&D grant assistance Develop optimal claims methodology Calculate R&D expenditure Page 68 23
Contact details Ian Collins Head of R&D Tax Services Tel: +353 1 221 2638 Email: ian.collins@ie.ey.com Page 69 Thank you EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com. 4795.pptx. Artwork by BSC (Ireland). 02.14 2014 Ernst & Young. Published in Ireland. All Rights Reserved. The Irish firm Ernst & Young is a member practice of Ernst & Young Global Limited. It is authorised by the Institute of Chartered Accountants in Ireland to carry on investment business in the Republic of Ireland. Ernst & Young, Harcourt Centre, Harcourt Street, Dublin 2, Ireland. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com 24