Boxing clever - why Noonan's Knowledge Development Box isn't just for the big players, it's for SMEs as well
When Finance Minister Michael Noonan, announced nearly two years ago that the Government would introduce a Knowledge Development Box (KDB), he pitched the proposal as an attempt to increase Ireland's attractiveness to compete for Foreign Direct Investment.
This could have given SMEs the impression that the KDB was an incentive for multinationals only. But as details of the regime have developed it is clear that the KDB will incentivise all Irish companies that, through Irish Research and Development (R&D) efforts, create exploitable intellectual property (IP).
There are measures in the legislation that are aimed at the SME sector. Also, recently issued Revenue guidelines, which detail the administration of the relief, demonstrate aspects of it that should assist certain SMEs.
The KDB offers an effective corporate tax rate of 6.25pc (instead of 12.5pc) on profits generated from the exploitation of qualifying IP from January 1, 2016.
In short, qualifying IP is IP- generated as a result of R&D activities carried on in Ireland which would qualify for the R&D tax credit.
However, only certain types of IP will qualify - patents, certain computer programs, plant breeder rights, supplementary protections for medicinal or plant protection products, and in certain cases inventions that are certified by the Controller of Patents, Designs and Trademarks as being novel, non-obvious and useful.
The legislation and Revenue guidelines have three areas in particular that are designed and worded with SMEs in mind.
1 Patent Lite
It can be expensive and time-consuming to obtain a patent. In this regard, the legislation includes a class of qualifying assets that is specifically designed for small companies. Inventions that are certified by the Controller of Patents, Designs and Trademarks as being novel, non-obvious and useful will qualify for the purpose of the KDB. But only small companies will be entitled to KDB relief in relation to such assets.
A small company for this purpose is defined as an SME with an income from IP of less than €7.5m in a 12-month period and if a member of a group, group turnover is less than €50m.
While primary legislation is required to empower the Controller to provide the above certification, it is expected this process will be much cheaper and less time consuming than applying for a full patent.
2 Notional Royalty Rate of 10pc
Establishing qualifying income from your IP can be quite difficult, in particular where the IP is one of only a number of components in a product.
For example, a large quantity of technology included in the iPhone is patented, so how do you establish how much of the sales price should be attributable to a qualifying patent royalty versus any brand IP (the latter of which is non-qualifying for KDB purposes)? For large companies, this is likely to require an economic analysis and a transfer pricing study to be carried out by an expert. The new Revenue guidelines recognise it's not financially feasible for a small company to do this.
In this regard, Revenue is prepared to accept, unless there is evidence to the contrary, a notional royalty rate of 10pc. This is anticipated to give comfort to small companies in relation to the level of claimable embedded royalty, without incurring the costs of an independent study.
This provision only applies to small and micro companies (with fewer than 50 employees and turnover or balance sheet of less than €10m) but does not extend to medium-sized companies.
It is important to the integrity of the relief that companies can create a clear and documented link between the various elements of the KDB for the qualifying criteria to be met.
This is important for all potential claimants, however, helpfully the Revenue guidelines confirm that a lower burden of proof is expected from SMEs than that expected of larger companies. Also, the guidelines note that SMEs would not be expected to have documentation to a transfer pricing standard. As the company grows a higher level of documentation is expected.
The KDB is an important relief in terms of encouraging the carrying out and exploitation of R&D activities here. This will lead to greater employment levels for our educated workforce.
The inclusive nature of the development of the KDB and the SME-focused provisions are welcome.
Given the developments since it was first announcement at OECD level, the KDB is arguably, in the short-term, most applicable to indigenous Irish companies that have been carrying on R&D activities here.
As mentioned, the relief is in place since January and therefore this is something that requires immediate consideration by SMEs now to ensure an IP review is carried out as soon as possible and that any documentation requirements are addressed in a timely manner.
Where necessary, SMEs should seek advice to ensure they are appropriately informed and correctly positioned to avail of the benefits of the KDB.
Derek Henry is a partner at BDO