Irish royalty companies and the taxation of IP

Intellectual Property (“IP”) can be one of the most valuable business assets that a company may have and it is, therefore, paramount that this asset is to be protected and utilised. In today’s globalised economy, many of the world’s largest companies are primarily built on IP, for example, Google, Facebook, and Amazon.

For companies with a focus on innovation and technological advancement in their industry, utilising IP, acts as a core competency for success. For this reason, many companies may set-up an ‘IP Holding Company’ or ‘Royalty Company’. This is a separate entity created to utilise, administer, and commercialise intellectual property.

These companies will commercialise their IP assets through licencing the assets to subsidiaries or third parties for trading purposes. Through licence fee payments and/or royalties, a trading company can benefit from the intellectual property while carrying out its business operations.

Due to the intangibility of IP as an asset, it can be held anywhere.

Ireland is now a very popular IP jurisdiction for those involved in knowledge-based industries as it offers considerable tax benefits to companies which hold and exploit IP though Irish resident companies.

In addition to the above, Ireland has a number of tax incentives that are of benefit to companies which use Ireland as location to carry out research and development activities and to commercialise any IP developed as a result of those activities.

A special exemption from corporation tax for the first three years of trading (or 5 years for newer companies) applies to certain start-up companies with new trades. The company may be entitled to relief if the CT due is €40,000 or less in a tax year. If the CT due is between €40,000 and €60,000, partial relief may be available. The amount of relief available depends on the amount of employer's  Pay Related Social Insurance (PRSI) paid by the company. The period for which the relief may be claimed is also being extended from three years to five years for companies that commence a qualifying trade on or after 1 January 2018.

Where an Irish resident company incurs capital expenditure on specified intangible assets, capital allowances (or tax depreciation) are granted in respect of the capital expenditure, and these allowances reduce the company’s taxable profits for the year.

The type of expenditure that qualifies for the relief is quite broad and includes capital expenditure on patents, trademarks, licences, copyrights, brands, industrial know-how, and goodwill directly attributable to any of these intangible assets.

The allowances are available for use against the taxable income of “relevant activities” constituting a trade, which include:

• managing, developing, and exploiting of specified intangible assets.
• making sales deriving the greater part of their value from the use of specified intangible assets.
• making sales where the IP assets contribute to the value of goods or services.

It should be emphasised that the company claiming the IP allowances must have sufficient Irish substance and engage in sufficient activity in Ireland to be deemed to carry on a trade.

The amount of tax depreciation available will be the same as the amount of depreciation or amortisation on the intangible asset charged to the profit and loss account of the company under the relevant accounting standards. However, the company may decide to claim the relief over 14 years at 7% per annum and 2% in year 15.

Where IP assets are acquired on or after 11 October 2017, the aggregate amount of capital allowances, plus any deductions for interest on borrowings in respect of specified intangible assets cannot exceed 80% of trading income from the relevant trade for the accounting period. However, any unused capital allowances can be carried forward for use against future profits.

The relief also applies to capital expenditure on intangible assets acquired from group companies, but this is capped at an arm’s length price. The relief does not apply unless the expenditure was incurred wholly and exclusively for bona fide commercial reasons and was not incurred as part of tax avoidance arrangements.

All capital expenditure incurred on the provision of specified intangible assets on or after 14 October 2020 will be subject to a balancing charge (clawback) on a subsequent disposal if the proceeds of the disposal exceed the tax-depreciated value of the asset. For assets acquired prior to 14 October 2020, no balancing charge will arise where the asset has been held for more than five years.

A tax credit of 25%, or 30% from 1 January 2024, of qualifying research and development expenditure is available to Irish tax-resident companies and branches engaged in in-house qualifying R&D undertaken within the European Economic Area (EEA), provided such expenditure is not otherwise eligible for tax benefit elsewhere within the EEA.

In summary:

• A 30% tax credit is available on qualifying R&D expenditure incurred by Irish tax-resident companies within the EEA. However, such expenditure may also be deductible against 12.5% corporation tax, which means the full tax benefit is 5% of expenditure.
• If a company’s corporation tax liability is insufficient to claim the credit via a cash refund from the Revenue Commissioners over three accounting periods.
• The R&D tax credit is available on “qualifying buildings” which are defined as buildings with a minimum R&D usage of 35% over a defined 4 year period; and
• R&D work sub-contracted to unconnected parties or third-level institutions also qualifies for the credit, up to the greater of €100,000 or 15% of the company’s qualifying R&D expenditure in any one year.
• A portion of the credit can be used to reward key R&D employees in a tax efficient manner.
• A recent change will allow companies to claim up to €50,000 of the R&D tax credit in the first year of the claim period.

In a bid to grow the R&D industry in Ireland, the Irish government developed a corporation tax incentive known as the Knowledge Development Box (KDB). This incentive targets the profits generated by IP developed in Ireland.

For companies that qualify for KDB, trading profits earned from patented inventions and copyrighted software are taxed at 50% of the 12.5% standard rate, i.e., companies are taxed at a rate of 6.25% to the extent that those profits are related to any research and development undertaken by the company in Ireland. 

Going forward, the effective rate of tax will increase from 6.25% to 10%.

To benefit smaller companies, the relief also applies to a 3rd category of qualifying assets. This will include inventions that are certified as being novel, non-obvious, and useful (i.e., patentable, although not actually patented.

As part of Budget 2022, the Irish Government announced the introduction of a digital games tax credit, subject to European Commission State Aid approval. The relief will be available at a rate of 32% on eligible expenditure of up to €25 million. The eligible expenditure is expenditure incurred on the design, production, and testing of a digital game.

Companies supplying IP services e.g., licensing IP or granting the right to use IP should register for Irish VAT and must register where the value of services supplied is likely to exceed €37,500 in a 12-month period. While 23% VAT may be chargeable to Irish customers, a zero rate will usually apply to non-Irish business customers. VAT registered companies can recover VAT incurred by them on their business-related purchases. Where intellectual property assets are transferred as part of the transfer of a business, transfer of business relief may apply such that no VAT is chargeable.

Stamp duty does not apply to the sale, transfer, or other disposition of IP in Ireland. This exemption also applies to the value of any goodwill attaching to the IP. For the purpose of this exemption, IP includes any patent, trademark, copyright, registered design, design right, invention, domain name, supplementary protection certificate or plant breeders’ rights.

Certain clawback provisions apply where a company or group ceases to be within the charge to Irish tax.

Where it is desirable to establish an Irish resident IP Company, care should be taken to ensure that that company is Irish resident for the purposes of Irish tax law.

A Company is regarded as resident in Ireland for tax purposes by default if it is incorporated in Ireland unless the company is required to be tax resident in another jurisdiction under the terms of a double tax treaty.

Notwithstanding the above, as mentioned, a non-Irish incorporated company can still be tax resident in Ireland under general principles if its central management and control is in Ireland.  The meaning of “central management and control” is derived mainly from tax case law.  Central management and control typically means the highest level of control of the business of the company, i.e., key strategic decisions. It is largely determined by the facts, focusing particularly on whether those who are legally entrusted to exercise the management and control of the company in fact do so in Ireland.

Some of the factors which will determine where central management and control reside include-

• Where the directors' meetings are held
• Where key questions of company policy are determined
• Where the majority of directors reside
• Where the shareholders’ meetings are held, both general and extraordinary
• Where the negotiation of major contracts is undertaken
• Where the head office of the company is located
• Where the books of account are kept, the accounts prepared and examined, the accounts audited, minute book, company seal and share register kept.

The place where directors meet is usually indicative of where central management and control is exercised and consequently where the company is resident. This is because central management and control is in most cases exercised through the medium of directors’ meetings. In summary, it is important that the directors meeting in Ireland in fact effect control and management over the company’s affairs.

Care needs to be taken to ensure that the above factors help demonstrate that Ireland is the place of central management and control. Similarly, major decisions/conclusion of contracts, etc. should not take place in any country other than Ireland. This will minimise the risk that a company could be deemed tax resident in another jurisdiction. Board meetings should be held at regular appropriate intervals and the board members should have the expertise appropriate to carry out their roles.

Ireland’s transfer pricing regime applies to most intra-group transactions but there is an exemption for “small and medium sized” enterprises (“SME”).  A company is an SME if it has-

• Fewer than 250 employees; and 
• Either a turnover of less than €50 million, or assets of less than €43 million.

These figures apply to the worldwide group and are reviewed on an annual basis.

Transfer pricing may be relevant where group members pay IP royalties to an Irish company or where an Irish company acquires IP assets from other group companies.

Transfer pricing rules do not generally apply to transfers of assets if the value of the assets transferred does not exceed €25 million.

As part of Budget 2022 the Irish government introduced a cap of 30% of EBITDA in respect of the deductibility of net interest. This rule does not apply to certain legacy debt, the debt of certain standalone entities or entities with net interest costs of less than €3 million. In addition to other conditions, the 30% threshold can apply on a group basis.

As part of its commitments under the EU Anti-Tax Avoidance Directives, Ireland has introduced comprehensive anti-hybrid and anti-reverse hybrid measures.

EU Council Directive (EU) 2018/822 (“the DAC6”) introduced a mandatory disclosure regime for certain cross-border transactions that could potentially be used for aggressive tax planning. This regime has applied in Ireland since 2021 and requires taxpayers to file a return when engaging in certain cross-borders transactions that give rise to a tax advantage.