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Budget 2020 and the R&D tax credit

Budget 2020 and the R&D tax credit Budget 2020 and the R&D tax credit

The budget represents an opportunity for the Government to add fresh impetus to progress towards its Innovation 2020 Strategy targets, writes Damien Flanagan.

The forthcoming budget offers the Government an opportunity to drive a significant increase in research and development (R&D) activity at a crucial time for the Irish economy. A few well-judged and either low cost or no cost actions by Minister Donohoe and his team could result in a positive and far-reaching reaction in terms of industry expenditure on R&D.

This is particularly the case with the Research & Development Tax Credit (RDTC), which has proven very successful to date in stimulating innovation activity but could be made even more effective with some relatively simple changes to the current regime.

The RDTC is open to all companies in Ireland that are undertaking qualifying research and development activities in Ireland or within the European Economic Area. Qualifying expenditure generates a 25% tax credit which is offset against corporate taxes in addition to the normal tax deduction at the 12.5% rate. Companies which are not yet generating profits on which they pay corporation tax, can claim the RDTC back in cash (in equal instalments over three years).

Survey of Irish SMEs

KPMG’s most recent Innovation Monitor has revealed a relatively low take-up of the RDTC among Irish owned SMEs. This year’s Innovation Monitor was based on a survey carried out by Red C Research on behalf of KPMG of 100 Irish SMEs, all of whom were in receipt of R&D grant funding from Enterprise Ireland. It would be expected perhaps that the participants should therefore be claiming or intending to claim the RDTC for their investment in R&D.

This was far from the reality, however. Just 55% of the participants said they had claimed the RDTC since it was introduced in 2004. And of those that had claimed the RDTC, 58% said they had not claimed the tax credit for all of the projects for which they were receiving Enterprise Ireland support.

This is a cause for concern as it suggests that the firms involved could have carried out even more R&D activity had they enjoyed the additional and quite considerable benefit of the RDTC in defraying its cost. 

The failure of many firms to apply for the RDTC is quite likely the result of a lack of knowledge rather than any inherent weaknesses in the scheme.

Opportunity cost

The opportunity cost here is all the more significant in light of the progress being achieved towards the Government’s Innovation 2020 Strategy target of total investment in R&D in Ireland of 2% of GDP (2.5% of GNP) to be reached by 2020.

Despite reaching a record €3.4 billion in 2017 (the latest year for which such statistics are available), total spend on R&D was 1.05% of GDP, which was actually a slight decline on the 2015 level. In some ways, Ireland was a victim of its own economic success in this respect. The unexpectedly strong growth over the period has only served to make the 2020 target all the more challenging.

The Government portion of that total spend is not insignificant. In 2018, direct incentives to stimulate R&D totalled €751 million, including €96 million from Enterprise Ireland in the form of RD&I supports.

In 2016, indirect supports through the RDTC were €670 million. A Department of Finance review of the scheme the same year found that for every €1 of tax revenue forgone an additional €2.40 is spent on R&D by companies claiming the RDTC. This represents quite a high “bang for the buck” for the Irish exchequer and compares favourably with outcomes for similar schemes internationally.

Why firms do not apply for the RDTC

However, the results of the KPMG Innovation Monitor suggest that there is scope for the taxpayer to reap even greater benefits for its investment if more companies were to avail of the RDTC.

On a positive note, the failure of many firms to apply for the RDTC is quite likely the result of a lack of knowledge rather than any inherent weaknesses in the scheme. Survey responses indicated a certain level of confusion in relation to the qualification criteria, the application processes, the value, and the rules governing the RDTC. It should be regarded as part of a continuum of support for R&D which sits alongside Enterprise Ireland assistance, but this is not the case for many of the survey participants.

Furthermore, a number of companies were not aware that the tax credit is worth 25% of the qualifying spend in addition to the 12.5% corporation tax deduction while others were unaware of the fact that it is payable in cash over three years to companies which aren’t paying tax.

Our recommendations to Government

The first step the Government could take to address these issues is to launch a campaign to promote awareness of the RDTC with a particular focus on those aspects which are poorly understood, i.e. the rate applicable, the fact that it can be payable in cash, and the rules on what constitutes qualifying expenditure.

We would also call upon the Minister to enhance the value of the RDTC to smaller companies not yet paying tax by making it payable over one year, instead of the current three. For smaller firms, particularly start-ups, three years is a very long time to wait. By contrast, the accelerated payment would entail no additional cost to the exchequer, other than the short-term cost of funds in a near zero interest rate environment.

In addition, the credit could be made more financially attractive and more easily understood if the costs allowable more closely matched those supported by Enterprise Ireland grant aid. This would entail a cost to the exchequer, but one that would be justified by the additional activity stimulated. At a time when the overall cost of the RDTC decreased to €448m for FY17, this should be more affordable.

A further change which should be considered by the Minister relates to the restriction of outsourced R&D activity under the current RDTC rules. Many start-up and smaller businesses simply do not have the facilities or equipment required to carry out scientific and technological research and have to outsource it to third party collaborators including academic institutions. Allowing more expenditure of that nature to qualify for the tax credit would further stimulate RDI activity with the economic benefits that entails.

The Department of Finance is currently undertaking its third major review of the RDTC since 2013, with the outcome to be announced, we understand, on Budget day. We would expect that the 2019 review will be as positive as the two earlier reviews and would hope to see many of the above recommendations implemented. This will ensure that Ireland remains ‘best in class internationally’.

This article first appeared on and is reproduced here with their kind permission.