It is well established that the creation and exploitation of new ideas is critical to a company’s development and growth, write Ken Hardy and Eoin McCarthy of KPMG's R&D tax credits practice.
A clear example of this is in the tech industry, where the persistent development of new ideas is a core element of the business, very much built into their day to day culture. This strive for innovation has seen many of the tech giants of today make rapid ascents to the top, in a relatively short period of time. In a broader sense innovation is a key economic driver across most industries, enhancing commercial profitability and improving the landscape for consumers. So how is innovation assessed, measured and compared?
Measuring innovation within global economies is led by the World Intellectual Property Organisation (WIPO), who publish the Global Innovation Index (GII) annually – this year it published its report on 2nd September. The GII provides detailed metrics about the innovation performance of 131 countries across ~80 indicators including research & development (R&D), infrastructure, market & business sophistication, political environment, and education, as well as the impact and diffusion of knowledge & technology outputs.
In the 2020 assessment Ireland ranks 15th in the global rankings, slipping two places from last year. Although this may appear concerning at first sight, Ireland remains an innovation leader and scores highly in multiple critical economic drivers. For example, we rank first for FDI outflows, ICT services exports, knowledge impact and knowledge diffusion. This shows our strength in translating innovation investment into realisable, tangible returns, which is in part a reflection of the national support mechanisms from the IDA, Enterprise Ireland (EI), Know Knowledge Transfer Ireland (KTI) and R&D Tax Credits related to innovation. Indeed, the KTI is highlighted within the GII 2020 report for developing a successful model to assist businesses in handling their IP within complex situations. For companies based in Ireland there a multiple incentives available to finance innovation, especially important in the current climate.
Innovation and R&D are very much complementary, and companies based in Ireland can leverage their innovation activity through multiple incentives such as the R&D Tax Credit, Knowledge Development Box (KDB) and RD&I Grants.
The precursor to innovation is commonly R&D, of which Ireland is ranked in the top twenty globally. Our high ranking is a result of extensive FDI from large multinationals in the pharma and tech space, in addition to strong investment in highly skilled researchers. Companies based in Ireland can maximise the benefit from their R&D activity through the R&D Tax Credit, a valuable tax based incentive of 25% credit on qualifying R&D expenditure in the science and technology areas. Although not specifically captured in the GII report, SME’s are a key stakeholder in our economy, and represent 54% of the R&D Tax Credit claimed in the latest report published by Revenue. Introduced in the Finance Act 2019, SME’s may claim an R&D Tax Credit of 30% on qualifying R&D expenditure (These measures are subject to a commencement order.).
Within the rankings, Ireland’s strength in knowledge and technology outputs is marked by ranking first in both knowledge impact and knowledge diffusion. IP generation is a key indicator that feeds into these metrics and is commonly born from R&D activity. In generating IP from qualifying R&D activity, a company can claim the Knowledge Development Box (KDB) which provides a 6.25% corporate tax rate for income generated from commercialising certain IP. In general, the KDB is underutilised, with only a small number of companies availing of the tax credit. This does not reflect Ireland’s high ranking in knowledge and technology outputs, and companies may be missing an opportunity to claim the KDB.
The path from an innovative idea to profitable exploitation can be extremely challenging. Industry sectors such as semiconductors, biopharma / pharma, and medical device require significant investment in physical infrastructure, as well as highly skilled personnel, before an idea can be realised. In addition, it can take a long time to move through the stage gates of development, especially in highly regulated industries. For example, it takes on average 10 years to develop a new drug. For SME’s there is the dreaded ‘valley of death’ in the development cycle, a critical period where the probability of failure is highest and attracting funding is at its most critical and difficult time to come by. RD&I Grants can be leveraged from the IDA and EI to support companies during this critical phase.
In addition, companies can de risk their R&D by collaborating with academia, generally supported through the Science Foundation Ireland (SFI). This has the added benefit of taping into leading edge experimental infrastructure and skills. These collaborations can also nurture future experts in their specific industry.
Horizon Europe will also provide opportunities to access research and innovation funding, particularly through ‘Factories of the Future’ type calls. There are challenges here too however; the funding is highly competitive at the application stage and generally relies on forming consortia with multiple partners, across multiple geographic locations, which are often other companies. This can result in a complex legal framework and challenges around IP ownership, on which KTI provide a recognised framework. In a positive move, the European Commission have proposed to increase the Horizon Europe budget by €13.5 billion to support health and climate-related research and innovation activities.
Ireland’s national incentives framework is especially important now, in a time of tremendous economic uncertainty. Indeed, the GII 2020 report outlines the importance of financing innovation through economically challenging times. Companies should consider long term sustainability in balance with short term challenges.
In the current environment many companies are focussed on short to medium term sustainability and in some cases survival. This will be reflected in the cadence of innovative activity. For example, the pharmaceuticals and biotech sector will likely experience growth in R&D as a result of the renewed focus on health. In the medical devices sector, there may be a shift in developments towards respiratory applications and remote diagnostics. Generally, companies will seek to diversify their supply chains to de-risk future unpredictable events. Moreover, accelerated development of Industry 4.0 is likely, in order to enable remote or autonomous control capabilities.
When considering the future, we learn from events in the past. Historically business R&D expenditure moved in parallel with GDP, slowing during economic downturns. Although this may not be the case across all sectors (pharma, med tech and ICT being the exceptions), there is an expected contraction in expenditure on innovation, and as business innovation expenditure declines, government may strive to counteract that effect through expenditure boosts to innovation, via mechanisms such as the R&D Tax Credit, KDB and RD&I Grants.
A version of this article is also published on Chartered Accountants Ireland.