R&D tax credit regime too onerous for SMEs

27 Apr 2011

Although 40pc of SMEs in Ireland are engaged in innovation of some description, smaller companies are most likely to be engaged in process innovation rather than product innovation because of barriers like finance.

Leyton Ireland’s consulting manager Eoin Brennan urges that these barriers need to be identified and removed and suggests the one-size-fits-all approach in the form of tax credits is not serving small companies well enough.

“Innovation brings long-term economic growth and job creation. There are empirical studies which have clearly established this link. Innovation must be made a central pillar in the development of our future economic policy. It is now time for all stakeholders to come together and put in place a framework and holistic set of specific measures that will make Ireland’s smart economy a reality,” said Brennan.

A recent Forfás report, Analysis of Ireland’s Innovation Performance, highlights a number of serious challenges facing innovative companies. One important conclusion of the report is that the challenges encountered by a company undertaking innovation will vary depending on its size.

It is estimated that only 40pc of “small” companies (one to 50 employees) engage in innovation. Small companies are more likely to be involved in process innovation than product innovation. Process innovation reduces costs, whereas product innovation drives growth. Companies actively engaged in innovation enjoy a reduced risk of failure. This finding has a number of consequences, most notably its impact on the drafting of policies to promote innovation.

“Clearly, the barriers our small and medium-sized enterprises (SMEs) encounter in undertaking product innovation need to be identified and removed. The one-size-fits-all approach has run its course,” Brennan added.

The R&D tax credit is a good example of an incentive where the one-size- fits all approach is in need of revision. The introduction of SME specific provisions is to be welcomed.

Time to widen scope of tax credit regime

“The R&D tax credit claiming process is onerous for SMEs, due to a lack of resources. Also, the way in which SMEs engage in R&D can be very different. Often there is no designated R&D function and greater emphasis is placed on ‘shop floor experimentation’.

“The process of identifying qualifying R&D can be more complex and time consuming. The UK is an example of a country that has recognised this and put in place a specific tax credit for SMEs and different offering for large companies.”

However, Brennan warned that care must be taken when introducing changes.

The technical criteria are basically sound in that they succeed in promoting the type of activities they set out to. To simply widen its scope, as has been called for from some quarters, could ultimately compromise the integrity of the scheme as a whole. Instead, it is the financial side of claims that requires simplification.

Calculating the R&D tax credit should be made as straightforward as possible. Schemes in other countries have developed along these lines and have proven successful. For example, in France, a proxy system operates whereby the R&D staffing costs form the basis of other expenditures included in the claim.

Changes are also required for large companies. While an outright removal of the base year may not be possible given the country’s financial circumstances, other options are up for debate. For instance, a cap could be placed on the total cumulative R&D tax credits available to such companies and linked to their tax contributions.

“We should also look to incentivise companies to employ graduates, as they do in the French scheme. The related expenditure included in the claim is enhanced. Any initiative that helps us to keep our brightest talent and avoid the brain drain of the 1980s requires careful consideration,” Brennan said.

·        On 26 May, Leyton and Vodafone will host an Innovation Conference on the theme ‘Securing Ireland’s Future Through Research & Innovation.’ To learn more go to Leyton’s website.