Cathal Noone considers the R&D tax credit regime and what is expected of a company claiming the R&D tax credit in 2021.

The R&D tax credit regime has been in place since 2004 and has been a key pillar in Ireland’s long-term strategy to become a knowledge economy. Ireland is now recognised globally as a leading innovator across the STEM (science, technology, engineering, and mathematics) sectors. While the legislation has not varied greatly, the policing and the compliance requirements of the regime are constantly evolving. Since 2009, Irish Revenue has issued nine versions of their guidelines: each introducing changes in the administration and interpretation of the regime. The question is: where we are now and what is expected from a company compiling a R&D tax credit claim in 2021?

What claims typically consisted of pre-2015

For many years the compliance documentation required for the regime had been relatively consistent. There were two areas: a financial file that aligns the R&D activities to the costs incurred in carrying out those activities, and a technical compliance document. These technical documents need to outline, on a project-by-project basis:

• A project description;
• The scientific or technological advancement that the project is seeking to achieve;
• The scientific or technological uncertainties the company faces when seeking to deliver that advancement;
• The field of science or technology to which the project relates;
• Details of any state-of-the-art review carried out in relation to the project;
• Details of commercialisation – whether the output is for internal company use or for external parties;
• Details of any IP, whether transferred into the company or acquired, that is used for the project; and
• A sequential description of the activities carried out as part of the project, including where they fit in terms of the technology readiness level (TRL), and how they align to the advancements and uncertainties of the projects.

Traditionally most, if not all, companies would compile both documents at the year end. They would do so relying on whatever business processes, if any, were in place that could be leveraged to support the financial and technical files. These would be in addition to surveys of, and conversations with, the technical R&D teams.

What happened since then?

If you think of the compliance process above, there were two distinct elements: the financial calculation and the technical compliance documents. In an audit, there would be a technical review by an external expert and a financial review by the Revenue team. A company might pass the science test and the financial test based on the legislative definitions.

The issue was and has always been, that the alignment between the two elements was very much subject to the company’s internal processes. Those processes were not designed to capture the information required for R&D tax compliance. How well those processes allowed for the technical activities to be aligned to the financial costs varied greatly across companies. The result was, in the opinion of Revenue, the numbers associated with the claim were too often high-level accounting estimates with little auditable support to validate them.

That gap in processes and controls led Revenue to challenge some very large claimants as to whether they were meeting the legislative definition of a “qualified company”.

Under section766 TCA 1997 “qualified company” means a company which – “…. maintains a record of expenditure incurred by it in the carrying out by it of those activities”.

Revenue began taking the opinion that if a company is not putting controls and processes in place to allows it to track the activities and costs against the R&D activity, that the company was not “maintaining a record of expenditure incurred by it in the carrying out by it of those activities”. Therefore, any such company was not a “qualified company” to claim a R&D tax credit. The expectation was that the information would be tracked against qualifying activities as defined within the context of the legislation and their guidelines, rather than just at project level. The 2019 guidelines were brought in to clarify these requirements.

Defined and auditable processes and controls around your R&D tax credit and some form of timesheets for technical staff are now a requirement

‘Where does it say this in the guidelines?’ you may ask. Well, believe it or not, you will have to go to the appendix to see these requirements explicitly called out. “Appendix 3: R&D Tax Credit Claim, Suggested File Layout” to be exact. There was a significant update in the 2019 guidelines from a compliance perspective.

These changes can be seen in question 18 of Appendix 3 in reference to staff cost details. Points b. to d. are the relevant ones. They describe what Revenue expects to see documented in the company’s compliance file. These are outlined below.

Example:

• Where a company has timesheets, please provide same, details of when the timesheets are created, details of when reviews took place to identify the qualifying and non-qualifying elements and who undertook the review
• A record retained for grant awarding bodies, please supply these records

1. Allocation between qualifying and nonqualifying please provide the basis for the allocation and the process and control procedures around monitoring same (while this may not be done on a contemporaneous basis it should be done in a timely basis e.g. month in arrears, quarter end review, it is imperative the allocation is completed prior to R&D claim on CT1 and that supporting documentation is available for review)

So, what are the newly defined requirements based on the above?

1. Companies will now need to provide a description of the project management process and work assignment methodology, outline the underlying documentation that is produced, and describe the project management systems used. This needs to include a description of how and when employees record their activities.
2. Additionally, companies will need to describe the methodology used to allocate staff time between qualifying and non-qualifying activities, and outline the processes and controls around reviewing and monitoring this allocation. That review must occur in an interval not longer than quarterly.

What this all amounts to is that a year-end compliance process is no longer sufficient if a company is looking to claim a R&D tax credit. Revenue expects that companies will know what their employees have been working on and, monthly or quarterly, review their employees’ activities in the context of the legislative definition of R&D. Using that technical review, the company must allocate the time spent by each employee over that period to both qualifying and non-qualifying activity. They also expect to see a timestamped record to show when these reviews took place. This represented a fundamental shift for a lot of companies’ claiming practices, and many companies needed to introduce dedicated systems to ensure compliance with the R&D tax credit regime.

Underlying R&D project books and records

When these changes are outlined to companies, they often feel that all of this represents a moving of the goalposts by Revenue. However, the Irish Revenue maintain that the requirement for underlying books and records has always been in place. A lot of the expectations around the maintenance of underlying books having been in the guidelines for a long time.

Sections 3.1 and 8.4 of the guidelines outline the expectations. They have appeared with almost identical wording all the way back to the guidelines published in February 2011. The only change is the in-year review process around employee time allocations, which Revenue would have expected companies to be maintaining anyway.

What is being seen in audit now is a renewed focus on the supporting details. Investigations are more focused on whether the activities as described in the technical compliance documentation can be supported by the underlying project records and/or project management system. It is important for companies to realise that, as soon as you submit a R&D tax credit claim, all the underlying project information now forms part of your books and records from a tax perspective. As such, this will need to be maintained for a period of six years after the company’s year-end.

Many companies have found that their normal documentation policies would not require such retention of their project management records. Companies can find themselves in difficult situations in audits having lost documents due to staff turnover, short retention periods or underlying system changes. You need to make sure as part of your compliance process that supporting information is collated and retained. As the last chapter in section 3.1 of the guidelines clearly states, “It is important that claimants realise the importance of contemporaneous and relevant documentation to support the claim. Failure to keep such documentation may result in the claim for the R&D tax credit being disallowed.”

What’s on the horizon?

It is hard to envisage where this is likely to go next. If a company sets up the processes and controls that Revenue wants, it will be in a great position to claim for many years into the future. The science test will still be subjective, and companies will still have to convince an external expert that they are meeting the advancement and uncertainty criteria.

The financial elements of the claim will be more straight forward too. If the processes outlined are implemented, it should make the inclusion of staff costs a simple calculation. Rent is the latest of an ever-increasing list of overheads that are no longer deemed to be “costs incurred in the carrying on of R&D activities” in a lot of cases, to the point where most companies do not even consider anything past utilities, software, or cloud computing costs. That only leaves revenue expenditure that can be considered directly incurred in the R&D activities – with the associated contractor and university caps – and any capital apportionments as claimable costs.

The next big thing is, hopefully, the Minister for Finance signing the Commencement Order for the enhanced regime for small and micro companies, as announced in the Finance Act 2019. Based off the 2019 figures the increase from 25 percent to a 30 percent credit will see approximately 66 percent of the claimants in the State increasing their claims. With the average claim for small and micro companies going from €82.5k to €99k annually. The hope is more small companies will see this enhanced reward and decide that it is worth their time to collate a claim. Where a small company is considering a R&D claim it is important to give some serious thought to their processes and controls before making it.