Making the R&D Tax Credit work for you

There is no question but that the R&D Tax Credit has been a resounding success for Ireland. It has helped attract new inward investments and assisted in the creation of a vibrant research ecosystem creating many thousands of new jobs in the process. Without it we would not have the Digital Hub, the emerging fintech sector and many of the new wave of born-on-the-internet technology investments which have come to Ireland in recent years.

From a purely financial perspective the R&D Tax Credit is very valuable. The scheme offers a 25% tax credit for R&D expenditure which can be set against a firm’s corporation tax liability. This means that if a firm has a tax liability in a year of €100,000 and R&D expenditure in that same year of €200,000 they can reduce their corporation tax bill by €50,000.

It should be noted that the €100,000 liability would have been calculated with the €200,000 already included as a business expense meaning that the net tax deduction actually works out at 37.5%. Very attractive indeed.

And you don’t have to be making profits to benefit from the incentive. A loss making company with no tax liability can have the credit paid to them in cash over three years. In the case of a company with a €200,000 spend in a year this would work out at €16,666 annually over three years.

This is a particularly important feature of the scheme for start-up and early stage firms in sectors like technology. In the technology sector the funding model in the early years very often involves R&D Tax Credit refunds from the exchequer.

This is due to the nature of these companies. For the first five to seven years of their lives technology companies tend to be still at the design and development stage. They start off with funding from family and friends and then move onto Local Enterprise Offices, Enterprise Ireland and seed and venture rounds. The further they go along this cycle the more the R&D refunds are worth to them. In the first year it’s worth €16,666 but by the third year it’s worth three times that and even more if the spending on R&D has increased in the meantime.

It becomes a very important part of the funding mix. If you own a company which is building a product or platform with no revenue in the early years this is not just useful, it’s absolutely critical.

A straightforward process

Qualifying for the R&D Tax Credit is quite a straightforward and very transparent process but there are some things to be aware of. The first is the science piece. Not everything qualifies as true R&D. You can’t just paint localise a piece of software to make it more suitable for a certain market and claim that as R&D. The project you are working on must be aimed at producing something that nobody else on the planet has done before.

This may sound quite onerous. How can a small or mid-sized Irish company develop something brand new in its space in the face of global competition? The first thing to note is that there is no actual requirement to find a solution. You could spend years and years trying to develop a product to do something but never actually achieve that objective.

But it needn’t be all that difficult. In the technology industry it can be as straightforward as the development of a new algorithm to carry out data analysis in a specific way to meet the needs of financial services industry in areas such as changing risk models.

And there are ways to establish if your project qualifies. The Frascati Model is effectively an international standard developed by the OECD to define R&D. With countries throughout the world competing to attract genuine, value adding R&D activity, this model tends to be the common benchmark used.

In Ireland, Revenue has been very helpful and has produced a set of 23 questions which it uses to define R&D. If you can provide adequate answers to those questions your project will qualify.

The Grant Thornton team has worked on a raft of R&D Tax Credit projects over the years and in our experience the process adopted by Revenue in assessing the responses to these questions is straightforward and fair and there is no sense of there being any attempt to trip up applicants or exclude them on technicalities.

Once you establish that your project qualifies it’s then a question of deciding what expenditure can be included. Again, this is quite straightforward and encompasses all direct spending on a project including wages and salaries, expenditure on prototypes, and so on. Overheads are also included but this can be a little tricky if not done properly.

The overheads of a business include the overall costs of the premises including rent, rates, light and heat and so on as well as other administrative functions such as finance, HR, procurement, management and so on. There are some exclusions which apply to the overheads which can be apportioned and these have to be taken into account as well.

The problem which many companies face is trying to figure out how much to apportion. The critical thing is to record the time spent on a project by everyone who is not employed to work exclusively on it. This means keeping timesheets for everyone and figuring the number of changeable hours per month which can be allocated to the project. The number will assist in calculating what share of the premises overheads should be apportioned.

From time to time there can be some differences of opinion between Revenue and a company when it comes to what level of overhead which can be included in the overall R&D expenditure. These can usually be resolved amicably with the assistance of professional advisors.

It is worth pointing out that it is not a prerequisite of qualification to apply for the credit before commencing a project. Indeed, it is likely that in the majority of cases with early stage companies the credit is applied for retrospectively and the process is back-engineered to a certain extent.

This is quite natural as the almost exclusive focus of technology start-ups is to develop a product and get to market quickly. Business planning comes later. Once they get into the development process and are looking for funding the R&D Tax Credit comes into view and they apply for it after the event. Once they apply and qualify for it and get used to the accounting and recording practices required it becomes part of normal business practice.

A further point worth noting is that the experience with the R&D Tax Credit has not been the same for everyone. There is a divide between the multinational community and domestic Irish firms. Large multinationals have the methodologies in place and the resources to ensure that they qualify. Domestic companies may experience difficulties, possibly because they don’t pay enough attention to scheme and the qualification requirements.

This is one area that probably requires attention but not so much from the point of view of making any revisions to the scheme. The scheme itself is very good and has been outstandingly successful by any standard. What might be needed at this point is assistance for indigenous Irish firms in certain sectors to help them benefit from it to a greater extent.