Irish R&D Tax Credit: No evidence of rising business innovation; Facts don't matter
By Michael Hennigan, Finfacts founder and editor
Feb 1, 2015 - 4:30 PM

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Irish R&D Tax Credit: The Irish Times reported last Friday that Department of Finance officials expressed concern that changes to tax breaks to promote innovation in budget 2015 would cost at least €50m in foregone taxes annually and reward a relatively small number of companies. It's not new that politicians  would ignore evidence to keep an open door or telephone line for the "anxieties" of US business folk as Enda Kenny, taoiseach, promised at a March 2014 meeting in the US Chamber of Commerce headquarters in Washington DC.

On budget day last October, Michael Noonan, finance minister, "announced improved tax incentives for research and development aimed at attracting inward investment. This tax break allows firms to lower their corporation taxes by giving them a tax credit of 25% of a firm’s expenditure on research and development.

But records show officials at the Department of Finance expressed concern that changes to the tax concession would cost at least €50m in waived taxes annually while benefiting a small number of companies."

Today in a report in The Sunday Independent with the headline, "R&D credits do work, despite what government says - BDO," the accountancy firm defends the tax break but it cites ZERO data to support its claims.

"It is hugely disappointing that the soundings coming from the Department of Finance point towards a level of concern with this recent change" said Derek Henry, head of R&D at BDO according to the newspaper.

"BDO currently work with almost 100 clients who carry out high end R&D activity in Ireland.

"They are growth focussed ambitious companies of all sizes and they are creating world-leading advances in technology," he said.

"Over the last 10 years the R&D tax credit has stimulated activity that has delivered a huge net benefit for the Irish economy.

"Yes, the system wasn't perfect - but the recent legislation change has now made our current system best in class," Henry said.

It's reassuring that the Department of Finance officials are not making recommendation based on the blather of vested interests but facts don't matter for politicians when responding to demands of US firms.

The 25% tax credit on R&D expenditures became operational in 2004 with spending in 2003 as a base.

It is claimed via self assessment on corporation tax returns and while the Revenue has a definition of research and development (R&D) there is a lot of flexibility to fiddle the system.

The first audits on claims were carried out in 2013 - in its 10th year - and there were problems with 26 out of 32 firms examined, resulting in €6m being returned to the Exchequer.

In a consultation process on the R&D tax credit launched by the Department of Finance in 2013, the Department of Jobs, Enterprise and Innovation submitted a joint submission [pdf] on behalf of Forfás/ Enterprise Ireland/ IDA Ireland/ Science Foundation Ireland.

It said: "Irish business expenditure on research and development has grown significantly since the introduction of the R&D tax credit in 2004. BERD as a percentage of GNP has increased from 0.93% in 2003 to 1.46% in 2011. It now exceeds the 2011 EU27 average of 1.2% and is moving closer to the 2011 OECD average of 1.58%. However, it remains behind that in leading countries."

The words 'patent' or 'patenting' does not appear in the submission while it is claimed that an increase in spending, which does not merit patenting, based on actual patent data, means it would not have happened without the tax credit - this is simply not credible analysis.

Irish patent filings at European Patent Office fell in 2014

The Department of Finance said in 2013:

  • The tax credit supports over 1,400 companies that, between them, employ nearly 150,000 people and have turnover of nearly €100bn;
  • The take-up and corresponding cost of the credit have increased from €70.5m in respect of nearly 75 beneficiaries in 2004 to €261m in respect of just under 1,500 beneficiaries in 2011. Over the same period, BERD (business expenditure research and development) has increased from €1.2bn to €1.86bn.
  • In FDI terms, the principal benefit of the R&D Tax Credit is that it reduces the costs of undertaking R&D in Ireland by 25%.
  • The payable credit can effectively be treated as a grant for accounting purposes – this allows a company to account for the credit as income "above the line‟ in their annual accounts.

The tax credit "supports" - again where is the actual evidence on innovation??

This was the Finfacts submission [pdf].

The inconvenient facts:

  • While patent quality can differ, it is bizarre to ignore the patent data when making a case for an R&D tax credit: Irish resident patenting not suggestive of 'world class knowledge economy';
  • Forfás, the Irish government's policy advisory agency, said in a report in 2004 that analysis of the profile of Irish-based companies engaged in patenting showed that none of the top 50 exporters were among the top ten foreign-owned patenting companies, and leading computer manufacturers were entirely absent. Only one of the top 15 pharmaceutical exporters (Abbot) appeared on the list. Analysis of top indigenous patentees showed that they were mainly SMEs operating in traditional sectors. "However, the omissions tell us more about the state of indigenous industry than those that are included. The Irish food sector contributes two-thirds of all indigenous industry exports but no major food company or co-operative appears on the list." The number of patent applications from public (government) research bodies in Ireland was very small - as few as 2-3 per year;
  • A decade later the situation hasn't changed;
  • IDA Ireland, the inward investment agency, uses the tax credit as an inducement. It does not define what it terms the 'R&D component' in a new project and it appears that the tag 'centre of excellence' is an imprimatur for a knowledge activity that would support use of the tax credit;
  • The number of IDA client companies investing more than €100,000 per annum in R&D was at 293 in 2012 - 28% of the total;
  • Dr Fred Logue, founder of New Morning IP, the intellectual capital consultancy, said in 2012: "Our analysis does not show any link between the introduction of the R&D tax credit and increased patenting activity by indigenous Irish companies. In fact in our experience this tax credit has been used as a way of getting 'free money' without any real attempt to protect the R&D results through patenting or other IP strategies. In fact the R&D tax credit scheme is widely promoted by tax advisers and is primarily seen as part of a tax reduction strategy rather than as a foundation to build an IP strategy."

Localisation isn't R&D and the big services companies such as Google are mainly administration operations.

The cost for the credit now exceeds €300m annually despite the low headline corporation tax rate of  12.5% and much lower rate for some of the big US companies.

Only about half of the total employment of 87,000 in ICT (information and communication technologies) firms in Ireland is in so-called 'techie' or scientific positions.

Foreign firms account for almost three-quarters of business R&D and the indigenous sector remains small.

Israel is the preferred location for US R&D centres where up to 220 R&D centres of multinational corporations employ over 50,000 Israelis -  half of Intel Israel's almost 10,000 staff work in development.

Replacing the Double Irish with Knowledge Development / Patent Box - Part 2

Dublin Web Summit 2014: Separating hype and reality - Paddy Cosgrave, co-founder of the Web Summit commented in a tweet: "Phenomenal level of research + info in this post about Irish tech policy & startups in general"

Tony Owens, founder of Shibumi Consulting, responded to the points raised in the article:

My ‘standing’ in doing so is as an Irish R&D microbusiness owner/operator (3 FTE’s) since 2006 and as a past director of New Morning IP, whom you quote in your article. My background is 30 years of inventive engineering, product development and patent analytics, mostly in Ireland/UK. We work with a mixture of companies from microbusinesses to MNC’s each year on innovation and IP projects, across many sectors, and our views about the credit reflect this. We contribute a number of inventions annually to our clients annually, some for patenting some not. For transparency, our own firm also benefits substantially from the credit each year.

Your main thesis is that the burgeoning R&D credit since 2004 appears not to correlate with a corresponding increase in observable innovation, and you also describe the credit being treated by many state agencies, tax advisors and participating companies as a grant. I agree with the latter observation, which I have observed directly at a seminar on the credit hosted by the IRDG (one of the state-supported ‘glove puppet’ not-for-profit enterprises). I disagree with the points you adduce in support of your main thesis however, and some of them indicate a misunderstanding of how/where patenting is used and of available alternatives to patenting. Taking your points in order:

1. “While patent quality can differ, it is bizarre to ignore the patent data when making a case for an R&D tax credit: Irish resident patenting not suggestive of 'world class knowledge economy'.”  In an Irish public policy development context, the power of patent data to inform is largely ignored. Why then highlight the tax credit administration as “ignor[ing] the patent data” when no other aspect of enterprise policy development is subject to this?

2. The Forfas 2004 observations about large exporters:  The structure of Irish exports ten years ago was not dominated by services exports as it is today and engineered product exports (medical devices and pharma formulations) were more prominent. However, the common factor then and today was the dominance in export statistics of implanted FDI ‘factories’, whether of products or services, with no significant product/service development capability (encompassing R&D and other activities too such as market research and IP management). These more knowledge-intensive activities are commonly carried out in the US, UK, India, Israel and elsewhere. It is hardly surprising therefore that few FDI firms are prolific patenters.

3. The points made about the food industry: There is little scope for patenting as a means of IP protection in the food industry. Patents are for protecting technical inventions but are rarely suitable for protecting valuable formulations or recipes. (One reason for this is the problems of observability of infringement)  They are the wrong asset class for defending the proprietary know-how, brands, livery and designs that dominate the food sector, and whose development the tax credit has facilitated. While patenting is entirely appropriate in the world of food process machinery, there are very few Irish firms actually operating in the field of food and drinks industry technology development.

4. Re your point about there being only 2-3 patent applications per year from state- funded R&D performers: This is explained by the fact that there are very few of them left. My own research in 2012 showed that most state R&D labs have been either disbanded or integrated into Irish universities; all of whom are financially dependent on the state, and whose business strategies are therefore largely state- controlled. Irish publicly-funded research is administered or controlled by a small number of funding agencies and spent almost exclusively to support the staff of a handful of academic institutions. These collectively file between 50-100 patent families (inventions) annually at present. It should be noted however that there has been little commercial return on this portfolio of state-controlled IP, either directly (licencing income from commercial entities practicing the patents) or indirectly (e.g. an international reputation for prolific inventive output in any technological domain). The Irish public R&D system is still almost unique in Europe by being largely academic-led rather than industry led. I am quite sure this is a major reason why most of the 2000 or so patent families in the national patent portfolio are not practiced and have never been licenced.

5. “The situation hasn’t changed…”.  What is known is that there has been an explosion in uptake of the credit. Whether patenting or innovation output has changed or not as a direct result, is unknown in the absence of detailed research. Considering no detailed research has been published or commissioned, your comment appears to be an opinion. My own opinion based on on-the-ground engagement with companies who claim the credit, is that:

a.  R&D intensity is gradually increasing in Ireland among SME’s;

b.  Patent output from the state sector (academic patenting) is steady and substantial but remains mostly irrelevant to innovation; c.       The recent focus of science and enterprise-promoting agencies on supporting cloud computing startups (a domain not based on any hard technology or science) will not result in patents, nor should it in most cases.; d.      Patenting by Irish-domiciled companies is still dominated by Accenture and similar IT outsourcers, many of whom like to file in Ireland for tax structuring reasons. FDI filings may be expected to dwindle, given the ongoing hiatus in US software/business methods/financial patenting.

e.  Patenting by indigenous Irish businesses is generally inconsistent, of poor quality, motivated by local competitive or funding considerations and reflects the impoverished nature of the sector. In this regard it is comparable with what is seen in Chinese patenting. There are positive signs however, for example, the fall in Irish utility patent publications, which suggests greater export focus and/or more patenting sophistication.

f.   A small cadre of genuinely commercial Irish R&D performers exists, in response to unmet local Irish needs and the irrelevance of most state R&D performers (universities) in the minds of Irish businesses. Many of these are R&D tax credit claimants. The IP output of such firms is generally assigned to their clients, demonstrating the limitations of patents and registered designs as proxies for innovation. Would you argue that such firms should not qualify for the credit because they must assign their inventions to the clients who commission them, and therefore have few or no patents of their own?

g.  The 2013 Finance Act introduced a measure to allow the financial sponsors of R&D work to claim most or all of the available R&D credit in multi-party projects (most are), breaking the principle that the credit should stay with the R&D performer. This was a negative step I feel, and a clear example of discrimination against small indigenous R&D consulting companies in favour of the sponsoring entities who contract their services due to lacking adequate R&D capability of their own.

Your comments attributed to New Morning IP concerning the absence of a link between the tax credit and patenting activity are familiar to me, but are polemical rather than credible:

a) No detailed research has ever been published in Ireland into whether such a link exists;

b) There is no clear-cut evidence that increased patenting leads to more productive or successful innovation, in a timescale of a few years. To imply that the tax credit is a poor value-for-money tax expenditure because the patenting output of Irish resident businesses is not rising substantially is not well-founded;

c) The suggestion that the tax credit is ineffective unless it correlates with more and/or better patenting or IP strategies is questionable (e.g. where the R&D performer and the R&D exploiter are different businesses as is very often the case), and in any case IP strategies are frequently not observable.

In conclusion, patents are important principally to firms engaged in a technological field in a sustainable way. Looking at the Irish business landscape, there is little such activity. Rather than attacking the R&D tax credit per se, I think it might be constructive to limit access to it to firms who:

1.      Actually perform R&D themselves, whether for their own consumption or as a profession;

2.      Are committed to R&D across at least one product development cycle (implies at least three years activity);

3.      Even if not producing patent-grade technology are required to be systematic and to not ‘reinvent the wheel’;

4.      Are committed to reinvestment in growing their technological capability The present Irish system has started moving away from these principles with the 2013 and 2014 Finance Acts. That is very much to be regretted, as the R&D credit risks being tarred with the same brush as other aspects of our tax code which have the effect of encouraging or attracting insubstantial businesses mainly concerned with tax optimisation to establish in Ireland.

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