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Quick Guide

 
Quick Guide to R&D Tax Credits
 

Introduction to the R&D Tax Credit Regime

Most software companies are engaged in some level of R&D, developing new functionality or enhancements to products and processes.

The R&D tax credit is a 25% tax credit for companies incurring incremental qualifying (both capital & revenue) expenditure on R&D activities over and above their expenditure in 2003 i.e. the "base year". The credit is available to companies that undertake R&D activities within the EEA. The credit is primarily available to offset against Irish Corporation Tax, however, since January 2009, companies that are not in a Corporation Tax paying position, or those in a loss making position can now claim a cash refund from Revenue on qualifying expenditure, subject to certain conditions.

The myth that R&D is only performed in labs by "men in white coats" is beginning to be addressed with many software companies now successfully claiming the R&D Tax Credit for software development (whether it is developed for sale or specifically developed for internal use).

Software companies have found eligible expenditure in:

· Software programming relating to processing speed, performance or connectivity

· Wireless and telecoms applications

· Development of new Communication protocols

· Internet security and content delivery

· Advanced mathematical modelling

Advances in software are typically made through innovation in software architectures, designs, algorithms, techniques or constructs. If the software's competitive edge stems from advance in an area other than technology, such as business management, or improvements in financial management techniques, the project is unlikely to be eligible. Almost any software developed for sale is developed systematically and the uncertainties are systematically resolved.

Example of Technological Advancement in the field of Information Technology.

ANewSoft Co's competitor recently released a new tool for the compression and modification of electronic maps. The tools are designed for use on small platforms (PDA's, Blackberry's, Palm Pilots etc.). They allow the user to make notes and modify electronic maps as they are doing fieldwork. In order to maintain market share ANewSoft Co. must develop a new compression technique to enable their software to at least meet the performance levels of their competitor's product.

At this point ANewSoft Co. is unclear as to how they will achieve the required performance. They have investigated the matter and no one in the market is providing a bespoke solution which could assist them in securing the desired performance levels. They set about developing a new compression tool in a structured and systematic way. This project may be eligible for the R&D credit.

The details relating to the R&D Tax Credit are based on 2012 information.

a) First €100k qualifying

The first €100,000 of qualifying R&D expenditure will benefit from the 25pc R&D tax credit on a "volume" basis. Effectively this will mean the first €100k of a company's base year R&D expenditure will not be included in calculating the R&D tax credit available to the company. 

b) Subcontracting of R&D activities

At present sub-contracted R&D costs are eligible where they do not exceed 10% of total costs or 5% in the case of sub-contracting to third level institutions. This limit can disproportionately affect smaller companies who may have greater need to outsource R&D work than larger multinationals with greater internal resources. The outsourcing limits for sub-contracted R&D costs are being increased to the greater of 5% or 10% as appropriate or €100k. This will provide a targeted benefit to SMEs.

c) Use of the credit to reward R&D employees

Companies will now have the option to use a portion of the R&D Tax Credit to reward employees who have been involved in the development of Research and Development.

Further details on the mechanics of the above changes should be announced in February 2012 when the Finance Bill is published.

Please see below an example of an R&D Tax Credit Calculation:

Some key points that should be remembered about the R&D tax credit regime are as follows:

  • The 25% R&D tax credit is available in addition to the 12.5% trading deduction available for trading expenditure.
  • Claims must be made within 12 months from the end of the accounting period in which the expenditure on R&D giving rise to the tax credit was incurred.
  • The credit can be used to offset a company's (or group's - conditions apply) current year Corporation Tax ("CT") liability. Any unused credit can be carried forward indefinitely.
  • Where a company does not have a sufficient CT liability in the current accounting period, it can choose to carry the credit back for offset against the preceding period CT liability.
  • Any remaining excess can be carried forward indefinitely against future CT liabilities. Alternatively, a company may claim to have any remaining excess paid to them by the Revenue Commissioners over three years (rules apply).
  • Qualifying expenditure must be net of any grants which relate to the R&D activities being carried out.
  • Revenue expenditure can include expenses such as salaries, overheads and materials consumed. However, to qualify for the R&D tax credit these expenses must be tax deductible for the purposes of computing CT.
  • Capital Expenditure on plant and machinery ("P&M") can also be included in an R&D claim to the extent that it is used wholly and exclusively for R&D purposes. Where the P&M is not used wholly and exclusively for R&D activities the expenditure on P&M must be apportioned in a just and reasonable manner.
  • Expenditure on buildings and structures can also be claimed but is treated differently.
  • It doesn't form part of the base year expenditure
  • The building must be in use for a minimum of 35% for R&D purposes for 4 years
  • The building must remain in use for R&D purposes for a 10 year period.
  • Expenditure incurred on subcontracting R&D activities to a third party is limited to 10% of the overall R&D spend incurred by the company itself on R&D activities, or €100,000, which ever figure provides the higher limit.
  • Payment made to universities or institutes of higher education is limited to 5% of the overall R&D spend incurred by the company itself on R&D activities, or €100,000, which ever figure provides the higher limit.

To be considered R&D activities should:

  • Be either systematic, investigative or experimental activities. Almost any software developed for sale is developed systematically and the technological uncertainties are systematically resolved. 
  • Fall within a field of science or technology (extensive list provided by Revenue) but includes: Computer Sciences, Software Development, Computer Engineering, Mathematical Sciences, Systems Analysis
  • Fall under the categories of basic research, applied research or experimental development: Software development usually satisfies the Experimental Development definition
  • Seek to achieve scientific or technological advancement. R&D activity must seek to achieve as opposed to succeed in achieving scientific or technological advancement.
  • Involve the resolution of scientific or technological uncertainty i.e. a) it is uncertain if a particular technological objective be achieved or b) there is certainty that a particular technological objective can be achieved but there may be uncertainty as to which alternative, will work, or will meet desired cost or other specifications such as reliability or reproducibility?

Please refer to www.bdo.ie/en-gb/services/tax/research-development-tax-services for further details