What is the Knowledge Development Box?
The Knowledge Development Box (KDB) is a tax regime introduced by the Finance Act 2015 for companies whose accounting period commences on or after 1 January 2016. The KDB has introduced a new set of rules dealing with the corporation taxation of income which arises from patents, copyrighted software and, in relation to smaller companies, other intellectual property that is similar to an invention which could be patented.
The regime is only available to companies that carry or have carried out the research and development (R&D), within the meaning set out in the Taxes Act, that is it where it led to the creation of the patent, copyrighted software or intellectual property (IP) equivalent to a patentable invention.
The net effect of the KDB rules is the corporation tax rate on such income is halved to 6.25% as explained further below.
What will qualify?
A qualifying asset is a:
• Computer program
• An invention protected by a qualifying patent or
• IP for small companies (IP/qualifying assets of less than €7.5 million) In order for the income from the qualifying asset to come within the KDB rules the asset must have been created a result of R&D carried out by the company within the terms of the legislation
What is qualifying R&D expenditure on the qualifying asset?
Qualifying expenditure is expenditure on R&D which leads to the creation, development or improvement of a qualifying asset. In most cases the R&D will lead to the creation of a new qualifying asset. However, there are occasions when the qualifying asset already exists but that there continues to exist substantial scientific uncertainty which must be resolved through R&D.
How does the KDB tax rate work?
KDB relief may be available to a company where all of the following conditions are satisfied:
• The company undertakes the R&D activity in Ireland
• The R&D results in the development, creation or improvement of a patent, copyrighted software, or IP equivalent to a patentable invention
• The company generates income from the exploitation of the IP
The legislation provides that the “modified nexus approach” as endorsed by the Organisation for Economic Co-operation and Development (OECD) will apply to effect a reduction in qualifying profits. The formula applies as follows:
Qualifying Overall Expenditure/Overall Expenditure x Profit of the specified trade relevant to asset
The result of this calculation gives the qualifying profit to be taxed at 6.25% rate instead of the standard corporation tax trading rate of 12.5%.
When does it apply?
The legislation takes effect for accounting periods beginning on or after the 1st January 2016.
Although the legislation takes effect for accounting periods beginning after the 1st January 2016, costs prior to that date will be relevant in calculating the relief. Any intellectual property acquired prior to 1st January 2016 will continue to form part of the relevant calculation in future period.
Qualifying expenditure incurred prior to 1 January 2016 is subject to a moving 4 year average up to the point where the earliest point in that rolling average is 1 January 2016.
What are the time limits for making a claim?
The legislation provides that there is a time limit, of 24 months from the end of the accounting period to which the election relates, for electing that the KDB treatment apply to a qualifying asset.
What about documentation?
Companies who wish to claim the relief are required to maintain detailed records. It will be important going forward to ensure that the R&D qualifying expenditure is qualifying expenditure and relating to a qualifying asset. Also, where R&D expenditure is outsourced, the documentation relating to this will be relevant.
Ireland is the first country to introduce comprehensive OECD compliant legislation to encourage R&D expenditure on the creation of intangibles. The Revenue, in addition, published substantial guidance in August 2016 explaining the practicalities of the regime and how it will apply in practice.
While there is a possible likely distinction between start-ups and existing multi-national companies in their ability to use the relief and it may require re-structuring of existing operations to best maximise the relief going forward. However, it is hoped the relief should prove attractive for indigenous companies carrying R&D as well.
Finally, as with any significant change to the taxation of a particular source of income it is likely that there will be amendments in the coming years but Irish Revenue have indicated they are willing to engage and listen to taxpayers and their advisers to ensure the KDB achieves the aims and encourages further R&D in Ireland.