The Irish Budget was delivered on October 13, disclosing some details of Ireland’s planned introduction of a knowledge development box and country-by-country reporting. Unlike many other jurisdictions, the Irish budget speech is not accompanied by draft legislation. Last year the draft legislation followed ten days later.
Minister of Finance Michael Noonan’s speech disclosed a tax rate for knowledge development box income of 6.25 percent, half the prevailing corporation tax rate applicable to active business income.
Following the nexus approach of the final OECD/G20 base erosion profit shifting (BEPS) report under action 5, the accompanying budget documents detail that the knowledge development box rate would apply to income from qualifying patents and software where the research and development is done in Ireland. The reduced rate is available for the percentage of income that is in proportion to Irish R&D costs over total R&D costs.
The questions arises, though, as to whether Ireland’s scheme, and the nexus approach in general, would be able to withstand a challenge in the Court of Justice of the European Union.
The European Commission initiated infringement proceedings against the previous Irish patent income exemption because that law required that R&D giving rise to the patent take place in Ireland. The Commission argued that this breached the EU treaties in relation to the Freedom of Establishment and the Freedom to Provide Services. Ireland removed the domestic restriction in 2005, and the issue was never litigated.
This same line of reasoning could be used to argue that Ireland’s knowledge development box scheme breaches EU law, and that argument could be successful given the Court’s jurisprudence on France’s previous scheme for research and development.
Since the EU treaties are binding on Ireland, unlike the BEPS output or the EU Code of Conduct, Ireland’s wish to make the knowledge development box BEPS compliant and not EU law compliant sends a clear signal. When Ireland said that the knowledge development box would be “best in class,” many assumed it was looking from the perspective of the MNEs, and not that of the OECD.
The timing of any introduction needs to be considered. It is generally assumed that the European Commission will approve the knowledge development box. But to remove any risk around compliance with EU competition law, the draft legislation should be sent to the Commission before enactment. While the Commission has dropped its investigation into the UK patent box on the basis that legitimate expectations had been created by its previous approval of the Spanish regime, the fact that it opened those proceedings into the UK regime to begin with could evidence that their thinking has changed.
Whether Ireland does this may depend on how the knowledge development box interacts with other reliefs. If the knowledge development box is notified to the Commission, this could delay introduction by several months. If it is not notified and the Commission later forms the view it breaches competition law on tax reliefs, any benefits can be clawed back from taxpayers.
In the current European tax climate, with the Commission flexing its competition muscles in the tax arena, investigating Apple’s tax affairs among others, it might be wisest to seek Commission pre-approval, even if that risks a delay in introducing the rules.
Having announced they would introduce the knowledge development box last year before the OECD agreed on modified nexus in relation to patent boxes, Ireland had to deliver something. By delivering the knowledge development box with a headline rate of 6.25 percent, Ireland is generating international publicity; while the costing of the measure suggests it will reduce the corporation tax take by about one half of one percent.
Along with the budget, the Department of Finance released its 2015 Update on Ireland’s International Tax Strategy and an IBFD-commissioned spill over analysis on Ireland’s impact on developing countries taxation.
The key message is that Ireland is embracing some elements of BEPS and changes to EU law, especially around transparency. The introduction of country-by-country reporting will be included in the Finance Bill, and Ireland has committed to making this compliant with BEPS action item 13. Ireland is also to become an early adopter of the new EU directive on the sharing of tax rulings.
In contrast, Ireland has restated its opposition to the common consolidated corporate tax base at an EU level. Ireland also restated its opposition to any EU treaty change which could move corporation tax to an EU level.
Until we have draft legislation we won’t be clear on all of the details of the knowledge development box, or indeed country by country reporting. But at this stage, the overall message Ireland wants to project to the world is that it is not okay with tax abuse, and is absolutely committed to transparent tax competition.
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