It is becoming increasingly important to review how a multinational enterprise (MNE) can effectively approach development activities to optimise the impact of tax concessions on global investment decisions. In this article, we consider the top questions commonly asked in order to understand the reasons why Research and Development (R&D) incentives and concessions are part of tax and economic policy, and what this means for MNE’s.
- Why do countries introduce and regularly change these incentives?
There are a number of reasons for change and they typically include the following -
- Targeting R&D investment as a lever for economic growth
- Supporting job creation, maintenance, and security
- Providing financial support for start-up companies
- To attract foreign direct investment
- Reducing the marginal cost of R&D spending and thereby supporting R&D projects that might not otherwise take place
- How can the desired business growth from R&D be optimised from accessing the available concessions?
The growth may be via new products or services, an enhancement to existing products or services or, most frequently, a combination of both. The analysis is likely to include:
- Where the relevant work will be carried out (with the consideration of the availability and cost of expertise)
- How to safeguard and monetise ownership of the intellectual property (“IP”) used in, or developed in the process
- The potential routes to market (e.g., location of new and current customers, and the access to, and use of, online channels)
- The extent to which the MNE has sufficient internal funding to meet the project requirements or will be drawing on external sources
- The current and future supply chain shortages - disruptions, flexibility etc.
- Time requirements – how long the project will take, and whether is it part of an ongoing development pipeline
The final part of the analysis is to consider the future trends. The latest moves in the G20/OECD’s plans to introduce a global minimal tax rate of 15% (Pillar Two) signal a broader shift in how tax incentives globally will be evaluated by Tax Authorities (and used by taxpayers). More details will be announced later in 2022. However, it is critical for present purposes that an MNE’s R&D strategy includes the necessary scenario planning.
We turn now to the operational matters to consider. Each country has its own specific rules, but a broader understanding will allow MNE’s to set in place a robust process that can be applied wherever R&D activities take place.
- What is the process for filing a R&D claim?
The process will vary according to the detailed technical and administrative requirements in each country, with the taxpayer responsible for ensuring the requirements are satisfied and the R&D claim is appropriately documented.
In the UK for example, the R&D claim is assessed by the UK tax authorities, and the onus is on the taxpayer to articulate how the company's activities meet the qualifying criteria. This will be a combination of a tax analysis setting out the company's eligibility, and a technical report explaining how the activity is qualifying R&D (e.g., an activity seeking an advance in science or technology, through the resolution of scientific or technological uncertainty).
As projects have become more complex in nature, tax professionals are increasingly supported by scientists and engineers in the drafting of technical reports, to better articulate a company's eligibility. In Canada and Ireland, there is greater onus on the technical report, and hence a need for more input from the technical teams.
- When is the cash benefit obtained?
Different rules often exist for small and larger companies (generally classified by reference to turnover) although, in the UK, the rules follow a European Union definition that incorporates turnover, gross assets, and employee numbers. In some cases, there will be a refund payable, whereas in others, there is a credit against, or reduction in, future tax liabilities. Therefore, it will be essential to know how the company will be classified to plan the relevant cash flows.
In the UK for example, the benefit is delivered as a reduction in corporation tax payable, or in some circumstances, a payable credit. For SMEs, the net benefit is 33-46% and for large companies, it is 11%.
In Canada, the incentive rate of the credit for large private, publicly traded, and foreign controlled companies is 15%, compared to a total incentive rate of 35% for Canadian controlled private companies. Provincial governments across Canada also provide a tax credit ranging from 3.5% to 20%. Therefore, when considering that salary costs can be increased by 55% (as a proxy for overheads) as well as the credits at the two levels of government, the tax credit can be as high as 65% of eligible salary expenses.
There is always a time lag between incurring expenditure and receiving the benefit. This is because costs are incurred in an accounting period, but until that period has ended, and accounts, tax returns, and the R&D submissions have been prepared, an R&D claim cannot be made. The typical time lag will be 18-24 months from cost incurred to receipt of benefit.
- Does the IP need to be owned by the company that carries out the R&D work?
This is an important consideration and needs to be aligned with the ongoing business assessment of how the economic value of the IP is to be utilised and its ownership safeguarded. For example, in Ireland, companies claiming the R&D tax credit are not required to hold the IP rights resulting from the R&D work. Equally, there is no requirement for the R&D work to be successful.
This is similar in the UK, where the IP ownership condition was removed several years ago, albeit even though ownership of the IP is a useful indicator when assessing other eligibility criteria, including whether it is the company’s ‘own R&D’ (as compared to R&D undertaken as a subcontractor to another party).
In Canada, ownership of IP matters; the claimant must either own the IP or have the right to exploit it in Canada.
- What is the Tax Authority review process for claims?
Tax authorities globally are becoming more active in reviewing claims, but each country will focus on different aspects of R&D. It is important to review the local priorities of the relevant tax authority in the country in which the claim will be made, and plan resources accordingly.
The UK tax authority has traditionally been overwhelmingly supportive of claims, providing appropriate diligence was put into preparing a suitable claim, but recently, more compliance activity has been seen, in particular for claims involving software.
The Irish tax authority is quite active in monitoring R&D claims, and it has built up a team of officials with specific responsibility for monitoring compliance. The tax authority’s current guidance provides a very clear outline and sample documentation to support a claim, and this provides practical guidance for claimant companies to ensure alignment with the tax authority’s expectations.
The Irish tax authority is empowered to enlist the assistance of consultants with specialised knowledge in the relevant fields of science or technology. These individuals act on a consultancy basis for the tax authority and report whether, in their opinion, the activities examined constitute R&D activities. All such individuals are required to sign a confidentiality agreement with authorities prior to engagement.
The Canadian tax authority has also been active in introducing guidelines and publishing eligibility criteria (including, in August 2021, a new Eligibility Policy based on why and how a claim should be made). It is now estimated that over 40% of Scientific Research and Experimental Development (“SR&ED”) submissions are now being audited or reviewed.
This is the first in a series of insights innovation tax credits in the UK, Canada and Ireland. Our experts will share their recommendations in the next instalment in the series.
If you have any questions around the insights shared in this article, please contact us.