The research and development tax credit encourages new ways of thinking… just not, as it seems, from everyone, writes Dr Brendan McCarthy
The most recent Worldwide R&D Incentives Reference Guide from EY demonstrates how most of the 46 jurisdictions discussed in the guide give preferential tax treatment to business research and development (R&D) expenditure in broadly similar ways.
Subject to maintaining detailed records, eligible companies can typically offset the credit against their other tax liabilities or claim a refund in the form of cold, hard cash.
When we consider the amount of money large pharmaceutical, medical device and other similar companies are likely to invest in R&D on an ongoing basis, it should come as no surprise that this credit can often run into many hundreds of thousands of euros, facilitating even further investment in R&D by both multinational companies and SMEs year after year.
Ireland remains an outlier, however, in two important respects.
First, for accounting periods commencing on or after 1 January 2024, eligible companies in Ireland can now claim a credit of 30 percent (previously 25%) of qualifying R&D expenditure, payable in three annual instalments. This amount exceeds that offered by most Western countries (in some cases by double digits) and is twice that offered by New Zealand, a similarly sized economy.
However, apart from the level of the credit itself, what sets the Irish regime even further apart from most other jurisdictions is the concept of ‘key employees’.
Recognising the reality that it is not companies that have innovative ideas but rather the people working for them, eligible companies have a further option: they can choose to use the credit to reduce the income tax liabilities of their R&D workers.
Not all workers are eligible. Irish legislation stipulates that they must spend at least half of their time working in R&D, cannot be company directors, and cannot hold more than a five percent stake in their company. In other words, they must be bona fide R&D workers and cannot have a vested interest in the idea's success.
Opting to surrender the credit in this way presents a dual benefit – not only does the company stand to benefit from the R&D underway, but the wider workforce is also incentivised to continue their good work.
Even the most well-meaning of provisions can have unfortunate consequences, however.
Having satisfied the criteria of being a key employee, the legislation states that the individual’s effective tax rate, after claiming the credit, can be no lower than 23 percent.
This stipulation inevitably favours those paying tax at the higher rates (predominantly, the more senior and thus higher-paid workers), effectively leaving those paying the lower rates (the lower-paid, junior staff) out in the cold.
Research has shown that employee input, or ‘voice’, can make a positive contribution to an organisation through, amongst other things, increased innovation, the identification of new and more efficient work practices, and the early detection and prevention of problems. This is irrespective of the employee’s rank or tenure within the organisation.
Yet, this same research has also shown that employees, particularly those at the most junior levels, frequently withhold their voice on a wide variety of matters. One of the primary reasons for this is an overwhelming sense of futility, fuelled by an awareness of their low rank or position and a sense of ‘it’s not my place’.
The requirement that the R&D worker’s effective tax rate can be no lower than 23 percent arguably adds fuel to this fire. By favouring those on higher incomes, the message seems to be that innovative ideas from lower earners are not worth the company’s time or investment.
This baffling provision is not only overtly managerially biased but is patently contra to the spirit of the legislation, the primary objective of which was the promotion of new ideas and new ways of thinking. Moreover, it is hopelessly out of date.
The provisions governing the R&D tax credit were first introduced into Irish tax two decades ago. Together with one of the lowest corporation tax rates on trading profits in the world, it remains central to the country’s efforts in attracting foreign direct investment.
By leading the way in championing the contribution of ‘key employees’ and recently increasing the amount of the credit from 25 to 30 percent, successive Irish governments have not only shown a continued commitment to the R&D tax credit regime but also a willingness to make adjustments to its provisions, in a more equitable pursuit of its overall objective.
So, it is fair to say that the Irish R&D tax credit encourages new ways of thinking… just not, as it seems, from everyone. It’s time we gave this some thought.
Dr Brendan McCarthy is Assistant Professor in Tax at the University of Limerick
LOADING...