The Benefits of R&D Tax Credits and the Knowledge Development Box for the Construction Sector
Post provided by Mazars.
From building technologies and enhanced decision-making systems, the advances in both digital technology and connectivity with established engineering systems and principles has created the much needed drive for innovation in the construction sector. Given recent opportunities and prior reflections, owners and practitioners alike should seek efficient projects, lower costs, advance materials and integrated intelligent building management systems.
In September 2015, the Government published its new Infrastructure and Capital Investment Plan which presents the Government’s new €42 billion framework for infrastructure investment in Ireland. The Capital Plan combines direct investment by the Exchequer of €27 billion, a third phase of PPP investments of about €500 million and State-owned sector investment of around €14½ billion. In total, this State-backed investment package represents over 3½ percent of GNP each year between 2016 and 2021, and it will support more than 45,000 construction-related jobs [1]. In light of this, the output of the Irish construction sector in 2015 was estimated to be €12.5 billion which represented an increase of 14% over the previous year. According to the team at BruceShaw [2], they expect that the recovery in the industry to accelerate in 2016 and are predicting an output level of just over €15 billion, representing an annual increase of 21%. However, they also go on to state, while such a recovery is to be welcomed it is worth remembering that at €15 billion the industry output will still only be at approximately 40% of the 2007 peak output of over €38 billion. This level of output was unsustainably high but the current level which represents 7.6% of GNP is still well below the recognised European sustainable level of 10% to 12% [2]. So how does the sector reach these sustainable levels? One strategy is through smart R&D Tax planning.
Construction is perceived as a traditional and well-proven sector, and because of this, there is a tendency for R&D to be overlooked as a means of tax reduction. It is not difficult to conceive why traditional misconceptions about R&D Tax credits exist, many believe that only that multinational companies can benefit from these credits. However, the reality is that many industries, including the construction industry, conduct activities that may qualify to claim the benefits of the R&D credit (25% on qualifying expenditure). It’s important to know that R&D does not just apply to inventions, but rather encompasses the design, development or improvement of products, processes, techniques, formulas or software. Within the construction industry, if a company is financing activities to develop or improve energy efficiency, mechanical systems, process design, pilot plants, construction techniques or other products, processes or software, then it’s likely performing activities that qualify for research and development (R&D) tax credits [3].
Many in the construction sector may not think that they perform R&D in the perceived sense and consequently don’t appreciate the extent to which their expenditure might qualify. It is for this reason there is a low uptake of R&D tax credits in the sector. The CSO/Forfás survey on Business Expenditure on R&D (BERD) contains indicators relating to R&D personnel and expenditure across all sectors of the economy. Construction activities are included within a broader utilities group, and it is evident from the survey results for 2009/10 that BERD in this grouping is negligible compared to other manufacturing and services sectors. As regards total headcount of all R&D staff, the construction and utilities group comprises 61 out of the 15,773 across all sectors, and accounts for only €4.6 million out of a total of €1.9 billion expended by all sectors on R&D [4]. Similar trends can also be found in the UK, where, of the 18,965 R&D tax credit claims made in 2013-2014, only 380 (2%) were from construction businesses. This supports the fact that the construction industry is not claiming the tax credits available to them, largely due to the fact that this sector does not believe it is eligible for this relief [5]. Perhaps there is little surprise in the BERD figures and limited R&D engagement between the industry and HEIs in Ireland. The construction sector globally has traditionally been slow to innovate. In recent years however this image has changed somewhat, driven by advances in information technology that have transformed project delivery, and the application of new technology and materials to meet progressively higher environmental standards. Innovation has a central role to play in how the Irish construction sector positions itself for recovery and sustainable future growth both domestically and internationally [4]. A number of Irish building products manufacturers have proven their innovative capabilities in the application of new materials technologies, with some achieving widespread international prominence. Now owners are increasingly realising value as construction firms pre-fabricate building elements off-site. Instead of sequentially constructing facilities, contractors are starting to deliver multiple project elements at the same time to streamline schedules. With some of the most technical work performed off-site, in a more controlled environment, safety is improved, too. Combining pre-fabrication with 3D BIM, project teams avoid potential conflicts regarding the use of building space. And owners see a safer, faster, less expensive project [6]. Some of the most exciting technological advances are having a transformative effect within the construction sector. The surge in demand for greener construction projects in particular is a key force in driving innovation in the production and re-engineering of building materials and their deployment [4].
The Construction sector operates in a unique and competitive environment with a complex regulatory landscape. To help offset that cost for companies in the construction industry and help them remain competitive the R&D credit may allow some contractors to bid on technically challenging projects more competitively, knowing they’ll be able to recoup some upfront research costs on the back end.
R&D tax credit provides a provision for a tax credit for certain expenditure on R&D activities, plant and machinery and buildings. Salaries paid to employees who conduct qualified activities are generally the largest component of qualifying R&D expenses. The money paid to the staff performing the qualified R&D activities as well as project managers and personnel who directly support the R&D can qualify. The goal of the R&D tax credit is to encourage R&D investment by indigenous and foreign owned firms alike by rewarding qualified research. To help offset the R&D cost to companies and to promote innovation and competitiveness, the R&D tax credit and the recent Knowledge Development Box (KDB) are valuable tax resources which encourage companies to create new and improve existing products and processes and intellectual capital in Ireland. The incentive provides a 25% cash refundable tax credit on the qualifying R&D expenditure or it can be used to reduce the company’s cooperated tax bill. In relation to the KDB, profits arising from patents, copyrighted software or IP equivalent to a patentable invention are taxed at 6.25% rather than the headline rate of 12.5%.
This tax mechanism offsets against tax liability because the credits can help companies increase their cash flow and earnings per share, reduce their effective tax rate, hire more staff, develop new products, and finance other business objectives [7]. In Ireland, the cost of the scheme to the exchequer was €421 million in 2013 [8] and almost 1,400 companies, employing nearly 150,000 people, have availed of the incentive [9], yet many in the construction sector aren’t aware of the credit. Examples of some of the qualifying activities are:
- Green building design or improvement
- Energy efficiency design or improvement
- Experimenting with alternative material combinations
- HVAC system design for airflow
- Electrical system design for efficient power usage
- Plant production system design and optimisation
- New modular off-site fabrication methods
- Construction equipment development and improvement
- Building information modelling (BIM) for sub-system coordination
- Design functions directed at improving performance, reliability, quality, safety, and costs
- Unique infrastructure design
- Structure and facility design for constructability
Traditional research activities that take place during the development of advanced materials aren’t the only activities that qualify for the R&D tax credit. So, as long as companies are attempting to develop new and improved products, product lines, manufacturing processes, or software, they could be eligible. While companies are beginning to plan for the coming year and beyond, there is no time like the present for R&D and financial professionals within the sector to evaluate whether they’re taking full advantage of the R&D tax credit. From our experience there are 3 questions which are commonly asked;
- How does the credit work? The R&D credit works by providing a company with a credit calculated as 25% of qualifying R&D expenditure. In addition to the 12.5% trading deduction, this effectively means that the company can benefit from an effective tax benefit of 37.5% on their R&D spend.
- What are qualifying expenditures? This is expenditure incurred in developing processes which are systematic, investigative and experimental and as such qualify for the credit as set out by the guidelines issued by Revenue. Eligible expenditure includes direct and indirect costs so long as they are incurred in the carrying on of R&D in addition to capital expenditure on related plant and machinery. Basically, the company must be incurring expenditure on qualifying activities which are seeking to achieve a scientific or technological advancement through the resolution of a scientific or technological uncertainty in a 12 month accounting period.
- Why would a company claim the credit? Primarily, the principle gain to a company claiming the R&D tax credit is cash. This credit should not be undervalued or understated as cash is vital to the sustained health of any business. However, value can also be received for the R&D tax credit in a number of different ways, such as;
1. Including offsetting the tax credit against Corporation Tax,
2. As a refund by reference to payroll taxes and/or
3. Corporation Tax paid or as a reward to key staff in a tax efficient manner.
The natural follow on from the R&D tax credit is the Knowledge Development Box (KDB), which was introduced by Finance Act 2015 for companies whose accounting period commences on or after 1st of January 2016. As previously outlined the KDB, it is a regime for the taxation of income which arises from patents, copyrighted software and, in relation to smaller companies, other intellectual property (IP) that is similar to an invention which could be patented.
Recently, the Government has published the Knowledge Development Box (Certification of Inventions) Bill 2016 and provides that the Controller of Patents, Designs and Trade Marks will oversee and operate this certification scheme. This Bill is aimed at eligible SMEs involved in R&D activities in Ireland with income arising from intellectual property of less than €7.5m and with global turnover of less than €50m where the profits result from R&D.
Under the new scheme, a relevant company may make an application to the Controller of Patents, Designs and Trade Marks in order to avail of special tax treatment for such inventions i.e. the reduced corporate tax rate of 6.25% under the Knowledge Development Box (KDB). To qualify for the Knowledge Development Box Certificate (“KDB Certificate”), the invention must: (i) prior to the application, not be publicly available in any manner, (ii) not be obvious to someone ‘skilled in the art’, and (iii) have a specific, credible and substantial utility, i.e. be capable of being made or used in one or more industries [10]. An application for a KDB Certificate should be accompanied by an opinion and supporting evidence from a patent agent attesting to the invention being novel, non-obvious and useful. Where the Controller is satisfied that the invention meets all the requirements, he or she shall issue a KDB certificate in the specified form to the applicant.
It is important to note that a KDB Certificate does not confer any additional intellectual property rights or protections on the invention. However, the Bill is intended to incentivise companies to undertake innovative activities in Ireland [10].
In summary, choosing your R&D and KDB advisors is an important decision for you. It is essential that your advisors have the skills and experience required to deal and grow with the financial and technical needs of your business. It is equally important to know that your dedicated advisors will be able to form and maintain an excellent working relationship with your team and conduct their work in a professional and flexible manor. Within Mazars, we have a proven track record with the key credentials to provide a first-class detailed and tailored service that will go beyond our client’s expectations. It is this commitment which has our clients returning year on year. We have a specific dedicated Research & Development Tax Group which focuses on assisting companies in identifying activities that qualify for the KDB and Research & Development Tax Credit. Our service also extends to support our clients in the event of an audit. For more information please contact Gerry Vahey at gvahey@mazars.ie
Authors
Gerry Vahey, Partner- Tax Credit Group, Mazars
James O’Hagan, Assistant Manager- Tax Credit Group, Mazars
Dr. James Kennedy, Manager – Tax Credit Group, Mazars
References
- www.per.gov.ie/wp-content/uploads/NCIP-Online.pdf [Accessed 2th of February 2017].
- http://www.bruceshaw.com/knowledgecentre/chapters/ireland [Accessed 1st of February 2017].
- http://www.construction-today.com/sections/columns/2700-the-benefits-of-r-d-tax-credits [Accessed 2th of February 2017].
- https://djei.ie/en/Publications/Publication-files/Forf%C3%A1s/Ireland-s-Construction-Sector-Outlook-and-Strategic-Plan-to-2015.pdf [Accessed 3rd of February 2017].
- https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/460042/RD_Tax_Credits_Statistics_September_2015.pdf [Accessed 1st of February 2017]
- http://www.forconstructionpros.com/article/12162200/10-construction-trends-shaping-the-industry-in-2016-and-beyond [Accessed 2th of February 2017].
- http://www.pharmexec.com/refuting-rd-tax-credit-myths [Accessed 2th of February 2017].
- https://www.kildarestreet.com/wrans/?id=2016-01-28a.276 [Accessed 2th of February 2017].
- http://www.irishtimes.com/business/just-15-firms-to-benefit-from-bulk-of-50m-tax-break-1.2084764 [Accessed 3rd of February 2017].
- http://www.mccannfitzgerald.com/McfgFiles/knowledge/7464-Knowledge%20Development%20Box%20(Certification%20of%20Inventions)%20Bill%202016.pdf [Accessed 3rd of February 2017].
