Following the announcement regarding the new policy framework set out in the ‘Road Map for Ireland’s Tax Competitiveness’ as published in October 2014, the Irish government declared on 13 October 2015 that from next year it would cut the corporate tax rate to 6.25 per cent from the existing 12.5 per cent for revenues tied with companies’ patents and certain intellectual property (IP).
The new tax rate is aimed to offer a lower effective rate for onshore exploitation of IP and to attract IP from offshore locations to further support investment by multinationals in Ireland. Based on recent European and OECD developments, the Knowledge Development Box (KDB) is going to apply to a narrow category of IP, primarily generated by Irish research and development (R&D) and it will therefore form part of the solution for those wishing to bring IP onshore.
Currently the European Commission (EC) has been conducting an investigation into Ireland’s ‘special tax deal’ with the multinational company (MNC) Apple, which reportedly uses Ireland to channel almost all of its non-US profits through Irish companies. The investigation was prompted from allegations that the deal was secret for one company and the offer was not meted out across the board. If proven, Apple may have to pay back tax shortfalls going back 10 years.
There was a perception that Ireland would take measures so that MNCs can sidestep this EC dictate, and thus came up with this general concession with 6.25 per cent tax rate for all the companies with R&D and IP.
As is widely acknowledged, knowledge-based capital has become a significant driver of profits in many MNCs. As a result, certain countries have introduced regimes commonly known as Patent Box regimes which are a form of preferential arrangement that provides an effective tax rate for IP income that is below the normal headline rate of corporation tax in the jurisdiction in question. In a move to keep the US MNCs based in the USA and thwart the European drive to lure them to EU countries, the US Congress recently released a discussion draft of proposed legislation that would enact a patent box regime in the United States. The package is termed ‘Innovation Box’ and will charge companies a 10 per cent tax rate on income they generate from patents and other intellectual property. Similar legislation already exists in several European countries and the EU move is considered to be threatening to US budget position. Worse, European countries are expected to start requiring U.S. and other firms to move research jobs to qualify for their patent boxes.
The OECD’s Base Erosion and Profit Shifting (BEPS) project addresses these income-based IP regimes and puts into focus harmful tax practices under Action 5. BEPS aims to ensure that the preferential tax treatment regimes of certain member countries fulfil the substantial activity requirement— thereby preventing their being deemed harmful. The work is building upon previous work carried out by the OECD and essentially involves a detailed elaboration of principles laid out in the 1998 report on harmful tax practices.
One likely consequence is that the BEPS project may ultimately drive MNCs to choose a location to develop their IP, where they align taxing rights more closely with the substance of their operation. As such, MNCs will have to show real substance in specific jurisdictions in order to be able to qualify for tax benefits. The Irish government reportedly designed the tax system to cover such income-based IP regimes so as to ensure that tax benefits arising under preferential regimes for IP are directly related to real economic activity. Experts however expressed doubt that this package would ultimately drive the transfer of MNC R&D from some established locations in USA to Ireland.
For some time, international tax competition has been intense, particularly in Europe. Just as in Ireland, MNCs are also allegedly using the Netherlands and Luxembourg to shift their profits from elsewhere to pay less or no tax at all. What’s more, the United Kingdom has recently announced that it would reduce company tax rate from the present 20 per cent to 18 per cent by 2020. Given this competitive environment and the likely erosion of its revenue base further, the Irish government proposed this new measure to thwart such competition from its bigger neighbours.
According to the Irish Finance Ministry, attracting investment that generates economic activity with real substance has been a central column of the Irish taxation system for more than 50 years and it is within this context that the introduction of the KDB has been considered.