The 2012 Finance Bill that issued on Wednesday, the 8th February, provides further details of the enhancements to the R&D Tax Credit scheme announced by Minister Noonan in his budget speech in December.
If they are to be enacted in their current form, then for companies in a position to benefit from the proposed enhancements, the changes represent a positive development. However, with regards to some of the changes (i.e. Rewarding of Key Employees, see below), it seems that the restrictive nature of the qualifying criteria will prevent many companies, particularly within the SME sector, from benefiting. As Minister Noonan had identified SME companies as the primary target for these initiatives, there is clearly disappointment in some quarters as to manner in which the changes are being introduced.
In addition, a number of other measures are included in the Bill that, if introduced, may significantly impact claimant companies. These proposed changes were not flagged in advance as part of Minister Noonan’s budget speech. Some of these changes are set to apply to accounting periods commencing after 1 January 2012. Others will apply to accounting periods ending after 1 January 2012. Therefore it is crucial that all stakeholders fully familiarise themselves now with the changes being proposed and the potential impact on their R&D Tax Credit claims.
The main features of the 2012 Finance Bill changes are set out below:
1. Rewarding of Key R&D Employees
This proposed change has generated significant interest since being announced on the day of the budget. Sections 8 and 26 of Finance Bill 2012 sets out details of how it is intended to operate. The main features to be noted are that:
- Directors of the company and/or associated companies or individuals connected to such directors are excluded;
- Individuals that hold a material interest (i.e. 5% or more of the ordinary share capital) of the company or an associated company or who are connected to such individuals are excluded;
- In the accounting period in which the R&D Tax Credit claim is made by the company, 75% or more of the activities undertaken by the employee must relate to the conception or creation of new knowledge, products, processes, methods and systems;
- 75% or more of the employee’s emoluments from his/her employment must qualify as eligible R&D expenditure in the company’s R&D Tax Credit claim for the year of the claim;
- Where the necessary conditions are satisfied, the employer company can surrender an amount of its R&D Tax Credit to its key employees. The employee can then make a claim to have his/her income tax liability reduced by the amount surrendered to him/her;
- The amount of the R&D Tax Credit that can be surrendered to key R&D employees is limited to the amount of the company’s corporation tax liability excluding the R&D Tax Credit i.e. companies that are loss making and have a “nil” corporation tax liability are unable to surrender the R&D Tax Credit to their key R&D employees;
- The amount surrendered to the key R&D employee must not reduce his/her effective income tax rate to below 23%;
- Where the key R&D employee is not in a position to fully utilise the R&D Tax Credit surrendered to him/her (i.e. insufficient PAYE paid for the relevant year), the excess can be carried forward to be used in future tax years provided the key employee remains an employee of the company
Finance Bill 2012 contains detailed claw-back provisions where it is subsequently found that the amount of the tax credit claimed/surrendered was not due.
For companies and employees that meet the qualifying criteria, the potential benefits of this proposed change are clear. However, what is also obvious is that the restrictive nature of the qualifying criteria are such that many companies/employees will be unable to benefit. For example, in many SME companies, company owners and directors are heavily involved in the carrying out of R&D activities. Yet, they are specifically excluded under the changes being proposed. Also, given the limited resources available to companies in the sector, the requirement that an employee spends over 75% of his/her time on qualifying R&D activities (or in other words, less than 25% of their time on all other activities including production, commercialisation etc) is particularly restrictive.
2. Limited Volume Based Approach
Under current rules, the R&D Tax Credit operates on an incremental basis. Eligible group expenditure in the claim period is compared to that in the corresponding period in 2003. The 25% R&D Tax Credit is calculated on the incremental spend between the two periods.
Section 26(1)(c) of the 2012 Finance Bill proposes to change the definition of qualifying group expenditure so that the tax credit will be calculated on the first €100,000 of group expenditure without reference to the company’s base year R&D spend. The base year R&D expenditure will be taken into account in calculating the R&D Tax Credit available on group expenditure in excess of €100,000.
3. Restriction on Sub-contracted R&D Activities
As announced by Minister Noonan on Budget Day, the restrictions on expenditure that can be included in respect of sums paid to universities and unconnected 3rd parties for the carrying on of R&D activities will be changed to the greater of a) the sums so paid up to €100,000 and b) the 5%/10% of in-house R&D expenditure as under current rules. These proposed changes are set out in subsections (1)(f) and (1)(g) of Section 26 of Finance Bill 2012. Section 26(2) provides that this change will apply to accounting periods ending after 1 January 2012.
4. Notification Requirements for subcontracted R&D Activities
Section 26(1)(f) of Finance Bill 2012 also provides that where a company (say, “ClaimCo”) wishes to include a sum paid to an unconnected third party (say, “SubCo”) in its claim, then ClaimCo must notify SubCo of the fact it intends to do so and that SubCo may not claim in respect of the R&D activities. This represents a change from the current rules which are worded in such a way that ClaimCo may only claim the expenditure where SubCo does not claim in respect of its expenditure i.e. SubCo would have an initial entitlement to claim.
This proposed change will impact the commercial and contractual arrangements negotiated and put in place between two parties. For example, SubCo may in the past have factored the benefit of the R&D Tax Credit into its pricing and resource allocation decisions on the basis that it was known with certainty that they had an entitlement to claim. Under the proposed changes, if there has been no agreement to the contrary, SubCo could receive a letter from ClaimCo advising that they have no entitlement to claim in respect of the activities, As this change is set to apply to accounting periods ending after 1 January 2012, companies need to start considering the implications of this immediately.
5. Definition of Expenditure on R&D
Financial Bill 2012 proposes to amend the definition of expenditure on R&D contained in S766 TCA 1997 so that the following expenditure is explicitly excluded:
a) Amounts paid to another person to carry on R&D activities other than amounts that fall within S766(1)(b)(vii) TCA 1997 (i.e. payments to universities) and S766(1)(b)(viii) TCA 1997 (i.e. payments to unconnected third parties).
b) Expenditure incurred by a company in the management or control of research and development activities where such activities are carried on by another person.
6. Grants and other assistance
S26(1)(e) of Finance Bill 2012 provides that expenditure met directly or indirectly by way of grants and other forms of assistance by or through the State or a relevant Member State (i.e. EEA/EU) must be excluded from the R&D Tax Credit Claim. Under current rules, it is only expenditure met directly or indirectly by way of by way of grants and other forms of assistance by or through the State that are excluded.
7. Group Reorganisations – Transfer of R&D Tax Credits
Finance Bill 2012 provides for the transfer of unused R&D Tax Credits between two group companies where one company commences to carry on the trade and R&D activities that had previously been carried on by the other company and in respect of which that other company had claimed R&D Tax Credits. This is subject to specified conditions being met.
In addition, it is proposed to alter the claw-back provisions set out in S766A TCA 1997 as they apply to R&D buildings that are sold or cease to be used for R&D within 10 years. Under the proposed changes, where the disposal of the building forms part of a transfer of a trade and the necessary conditions are satisfied, there would be no claw-back of the R&D Tax Credits claimed by the transferor company. In addition, the transferee company would become entitled to any unused R&D Tax Credits on the building.
In addition to proposed changes summarised above, Finance Bill 2012 contains other “administrative” provisions relating to a number of areas such as the application of interest to R&D Tax Credit refunds over claimed. Clearly there is much for all parties to consider. Given the potential impact, both positive and negative, on R&D Tax Credit claims, it is important that this is done now. If you have any questions regarding the impact of the Finance Bill 2012 changes on your R&D Tax Credit claim, contact us today.