Ireland's friendly tax approach to intellectual property pays off

Ireland is one of the largest exporters of intellectual property in the world, an impressive achievement for a country its size. The Irish government’s friendly tax approach to intellectual property is the chief reason the country has been so attractive to international companies establishing a European presence.

For companies that engage in IP licensing there are many favourable tax provisions, including:

• a generously capped exemption for income derived from patents;
• tax credits for research and development (R&D) expenditure; and
• an IP stamp duty exemption.

The cornerstone, however, of Ireland’s attraction for foreign companies is undoubtedly the 12.5% corporation tax rate. This applies to the profits of any Irish trading activity. In the context of IP licensing, therefore, it is important to be able to determine that a trade exists by reference to the traditional so-called ‘badges of trade’. The most important fact to establish is that the company is engaged in an active business, not merely in receipt of passive income. Further, the trade must not be carried out “wholly outside of Ireland”.

Irish tax legislation provides for a capped exemption from tax for income derived from qualifying patents when received by a party resident in Ireland. A ‘qualifying patent’ is defined as a patent in relation to which the research or similar activity leading to the invention (ie, the subject of the patent) was carried out in Ireland. It does not have to be an Irish registered patent. Where this exemption applies, both income from the qualifying patent royalties and certain distributions by companies made out of this income may be disregarded for the purposes of Irish tax.

Earlier this year the Finance Act relaxed the previous requirement that development activities had to be carried out in Ireland. From January 1 2008 the exemption will be extended to include any patent where the work that leads to an invention is carried out in a member state of the European Economic Area. In addition, while there was previously no limitation on the patent income exemption, from January 1 2008 the exemption will be capped at €5 million a year.

The pharmaceutical and software industries in Ireland tend to have patents and broader IP elements of their business embedded in their products, often with the realisation of the intellectual property’s value being taken as part of product sales. For multinationals the development of the intellectual property is done wholly within Ireland, or often on the basis of a cost-sharing arrangement with another international company within its group. In this way intellectual property is often developed on a shared basis and, as a result, owned on a shared basis. This allows for the realisation of value in Ireland through product sales, thus taking advantage of the favourable tax rates.

Such pharmaceutical and software companies often generate a return from their intellectual property by licensing other parties to manufacture or deal in the product. The profits from such licences may in many cases be taxed under Irish law as part of the overall trade conducted by the company.

There is also an Irish tax provision that allows for tax credits for a proportion of incremental R&D expenditure. The deduction is granted where a person or company incurs non-capital expenditure relating to scientific research. The credit is equal to 20% of the incremental expenditure incurred. A separate relief applies where the expenditure is of a capital nature and is incurred in relation to scientific research. The effect of this latter provision is to grant a person who incurs capital expenditure on scientific research capital allowances of up to 100% of that expenditure.

A full exemption exists from stamp duty on transfers of intellectual property and this exemption applies to most forms of intellectual property and the goodwill attributable to it.

Witholding taxes are generally not levied on IP royalty payments with the exception of patent royalties. Withholding taxes on patent royalties can, however, be overridden by the terms of a double tax agreement or by the application of the EU Directive on Interest and Royalties. Ireland has 44 double taxation treaties in force with a number of other tax treaties being negotiated. It is expected that Ireland will have 54 tax treaties in place by 2010.

The future looks bright for the continued creation and exploitation of intellectual property in Ireland. With increasing multinational inward investment, the Irish government’s friendly tax approach to intellectual property seems to be paying off.