Irish Finance Bill 2022 amendments related to the OECD Pillar Two Rules

The Irish Finance Bill 2022, which is due to be enacted this month, December 2022, provides for changes to the Irish research and development (R&D) tax credit and Knowledge Development Box tax regime in light of OECD Pillar Two model rules and the EU draft Pillar Two Directive.

Ireland has a generous R&D tax credit for qualifying expenditure on R&D activities, plant and machinery and buildings. Credit is given at 25% of allowable expenditure. The R&D tax credit currently operates first as an offset against a claimant company's current and prior year corporation tax liability, with any excess credit either carried forward for use against future corporation tax labilities of the company or claimed as a payable credit in three instalments over a period of 33 months (the value of this payable credit is subject to a cap linked to the greater of the corporation tax paid by the company in the previous 10 years or the payroll taxes remitted by the company for the relevant periods).

In order for the R&D tax credit to continue to be of benefit to taxpayers within the scope of the Pillar Two rules, once effective, it will need to be a “qualified refundable tax credit” (QRTC) within the meaning of the OECD Pillar Two model rules and the EU draft Pillar Two Directive. Both the OECD and EU definition of a QRTC require the tax credit to be paid as cash, or available as cash equivalents, within four years of the date on which the taxpayer is first entitled to it. Where the tax credit is a QRTC, it would be treated as income and not as a reduction in taxes paid in calculating the relevant group effective tax rate for the purposes of the global minimum corporate tax rate (GloBE).

The Finance Bill changes to the R&D tax credit seek to align it with the QRTC criteria, including providing for the credit to be fully payable in cash or cash equivalents. The Finance Bill measures provide that the first instalment of the R&D tax credit should be equal to the greater of (a) €25,000 or, if lower, the total amount of the credit claimed or (b) 50% of the value of the credit claimed, with the balance of the credit being refunded in the subsequent two periods.  The cap on payable credits linked to the corporation tax/payroll tax payments will no longer apply. While the Finance Bill amendment is aiming to maintain the benefits of the Irish R&D tax credit incentive for groups that are affected by the Pillar Two rules, a consequence of the change is that companies that could have obtained the full value of the credit in a current year, as an offset as against their corporation tax liabilities, will now instead see that benefit spread over three years.

R&D tax credit claims are often subject to Irish Revenue scrutiny. In order to align with the Pillar Two rules, R&D credit payables should be paid within the four-year period, in all circumstances, including where there is an open investigation or audit by a tax authority. The Finance Bill provides that refund payments will not be made until the Irish Revenue accept that a "valid claim" has been made.  A "valid claim" being whether in the view of the Irish Revenue sufficient information has been provided by the claimant company to evidence entitlement to the tax credit claimed. It remains to be seen how this requirement for a valid claim will interact with the four year rule in practice.  

The Finance Bill also provides for Pillar Two related changes to Ireland's Knowledge Development Box (KDB) tax regime, the commencement of which are subject to Ministerial Order. The KDB is a form of patent box regime. The KDB allows for a 50% reduction of qualifying income, resulting in an effective tax rate of 6.25% for the taxpayer concerned with respect to qualifying income. However, the conditions for qualifying are restrictive, including, generally, that the R&D activity and exploitation of the relevant IP are carried out by the same entity and the scope of the relief is broadly limited to income from patents. Information published by the Irish Revenue and the Department of Finance indicate a very limited uptake of the regime, with the number of claimants peaking at a mere 20 in 2019.

The KDB is being extended for a further four years, to include accounting periods commencing before 1 January 2027. An extension of the KDB at the current rate could result in certain Irish tax treaty partner countries requesting Ireland to include the Subject to Tax Rule (STTR) in their respective treaties with Ireland. The STTR is the proposed treaty-based rule that allows source jurisdictions to impose source tax on certain related-party payments subject to tax at below a minimum tax rate, proposed to be 9%.

The benefit of the KDB is likely to be reduced or eliminated by withholding in foreign jurisdictions and the counteracting effect of any GloBE top up tax. Increasing the rate to 9% or more should avoid the STTR issue and the potential treaty amendment requests but would obviously greatly reduce the value of the relief for those taxpayers outside the scope of the Pillar Two rules. The Finance Bill measures provide that the KDB trading expense deduction is reduced from 50% to 20% of qualifying income, resulting in a new effective rate of 10% (rather than 6.25%) on qualifying income. However in any event, groups in scope of the Pillar 2 rules are unlikely to obtain a net benefit from the regime after the operation of the GloBE top up tax.

For more information on this please contact Philip McQueston, Emma Hartnett or any member of A&L Goodbody's Tax team.

Date published: 15 December 2022