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Refundability a Pillar of improved R&D Tax Credit Regime

AUTHORs: Mark O'Sullivan co-author(s): Eimear Meally Services: Tax DATE: 21/12/2022

Ireland's Finance Act 2022 (the "Act") was signed into law on 15 December 2022 and some welcome amendments were made to the existing Research and Development (“R&D”) tax credit regime.  These amendments should ensure that the R&D tax credit regime remains attractive to taxpayers, even after the introduction of the OECD's minimum tax proposals under Pillar Two and changes which were made to the US foreign tax credit regulations earlier this year.

The Previous R&D Credit Regime

Prior to the promulgation of the Act, Ireland's R&D Tax Credit provided for a tax credit at a rate of 25% on certain qualifying R&D expenditure.  The credit only became available as a cash payment if excess credits still remained unutilised after the expiration of two years.

OECD – Minimum Effective Tax Rate

The OECD's Pillar Two model rules introduce a new global minimum effective tax rate of 15% for large multinational groups.  The European Commission has published a draft directive which closely follows the OECD's model rules,  which is designed to implement the Pillar Two model rules within the EU.    Following the Hungarian government's recent decision to drop their objection, EU member states have now reached agreement on implementing the Pillar Two rules and it is likely that the 15% minimum effective tax rate for MNEs will apply in the EU (including Ireland) from 1 January 2024.  Under the new rules, "a qualified refundable tax credit" is treated as income and recognised for the purposes of the calculation of a company’s effective tax rate.  

The old R&D tax credit regime did not meet the Pillar Two requirements for a "qualified refundable tax credit" due to the obligation to use the credit, in the first instance, to reduce the corporation tax liability of a company.

If a credit is considered a non-qualified refundable tax credit, then the amount of the credit is treated as reducing the corporation tax paid by the company, which would have a detrimental impact on the effective tax rate of a company which has claimed R&D tax credits.  The Tax Strategy Group papers published by the Department of Finance earlier this year noted that as the Irish corporation tax rate is already below the Pillar Two minimum rate of 15%, “this would result in an increase in the top-up tax required to be collected in order to meet the Pillar Two minimum effective tax rate, thereby wiping out the benefit of the credit”.

US Foreign Tax Credit Regulations

Similarly, in order to be considered a refundable credit under US Foreign Tax Credit ("FTC") Regulations, the relevant tax credit must be available to the taxpayer as a cash payment.  If this is not a feature of the relevant credit, that credit would not be considered a refundable credit for US FTC purposes and could instead have the result of reducing the amount of tax which was deemed to have been paid with a commensurate reduction in the amount of creditable foreign tax for US purposes.

New features in the Finance Act

The amendments outlined in the Act introduce a new system which grants the taxpayer the option to specify whether the R&D tax credit is offset against their corporation tax liabilities or is paid directly to the taxpayer over a fixed payment schedule.

As taxpayers now have an option to request payment of the credit over a three year fixed payment schedule without offsetting it against other tax liabilities first, the R&D tax credit should qualify as a refundable tax credit for both Pillar Two and US FTC purposes.

The new regime is effective for accounting periods ending on or after 31 December 2022.  This means that taxpayers with a calendar year end who qualify for R&D tax credits, fall within the new regime for expenditure incurred since 1 January 2022. Transitional measures will be in place for one year to assist the transition to the new payment system for companies that are already engaged in R&D activities. 

This is a welcome update to the R&D tax credit regime and should ensure that the credit continues to remain attractive to taxpayers engaged in R&D activities in Ireland.