In broad terms the three main methods of exploiting IP rights are:
The tax implications of selling IP rights are addressed in phase 3.
Own use
When exploiting IP rights for own use the IP will usually form part of goods sold or a service supplied. Normally such activities should constitute a trading activity and qualify for the standard rate of tax of 12.5% (see below).
Licensing out
When exploiting IP rights by licensing there are a number of factors that need to be considered from a tax perspective such as what rate will the income be taxed at and will withholding tax apply and if yes what mechanisms for relief are available. This section of the guide addresses these issues.
Corporation tax – what rate applies?
12.5% on active income
The standard rate of corporation tax of 12.5% applies only to ‘trading’ income and is typically available on the active exploitation of IP rights in Ireland. A ‘trade’ is defined in Irish tax legislation as including ‘every trade, manufacture, adventure or concern in the nature of a trade’. There is no further definition of the term; therefore it has been left to the courts to decide whether a particular activity constitutes the carrying-on of a trade.
The key items for consideration in determining whether a trade is carried on by an Irish company exploiting IP rights include:
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The range of customers and the number of transactions entered into by the Irish company;
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Whether the company is actively involved in marketing and generally promoting the licensing of the IP;
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Whether the company is involved in the negotiation of the licences or other mechanisms to exploit the IP;
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The extent to which the company audits or monitors the use of the IP by its licensees or customers; and
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Steps taken by the company to promote or protect its IP, such as registering a trade mark.
The Irish tax authorities have issued a guidance note on how taxpayers may seek an opinion on whether a particular activity may be classified as trading. The guidance supports the active exploitation of IP rights as a trade taxable at 12.5%.
Visit www.revenue.ie for more information.
25% on passive income
The 25% corporation tax rate applies to profits of Irish companies to the extent that the profits do not relate to the operation of an Irish trade. Where a company is exploiting IP rights but is not regarded as being sufficiently active to qualify for trading status, the income arising would be subject to tax at 25%. For example, a company whose only activity is the licensing of the rights to IP and the on-licensing of such rights with no development or maintenance of the IP taking place is unlikely to be regarded as trading.
0% on patent royalty income
Irish tax legislation provides an exemption from Irish tax for “income” derived from “qualifying patents”, where the holder of a patent is tax resident in Ireland. A qualifying patent is a patent in respect of an invention for which the “research, planning, processing, experimenting, testing, devising, developing or similar activities leading to the invention” was carried out in Ireland this has been extended to all EEA countries with effect from 1 January 2008.
Patent royalties paid by an unconnected third party can be received tax free without restriction. Where the patent royalties are paid by connected parties, additional conditions must be satisfied before they can be received tax free by the recipient. With effect from 1 January 2008 the maximum amount which can be received tax free is limited to €5m in any twelve month period.
In addition the legislation also permits the payment of tax free dividends from companies in receipt of income from qualifying patents. In most circumstances, where the royalty income is received from a related company, restrictions apply which may limit the amount of tax-free dividends that may be paid.
For further details on the conditions to be satisfied to qualify for these exemptions see appendix II.
Example of a typical group structure used to maximise the benefit of this exemption:
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In summary, the Patent company develops, patents and licenses the technology to the Trading company which exploits it for the purpose of its trade. The Trading company pays a royalty to the Patent company which should be exempt from tax for the Patent company and tax deductible for the Trading company. The Holding company acts as an “umbrella” for the group facilitating future expansion, financing, intra group transfers etc.
Visit here and learn how one successful company, O’Donnell Enterprises, was able to take advantage of this exemption
10% rate on ‘qualifying’ activities
An incentive rate of 10% was available for an Irish company carrying on certain ‘qualifying’ activities that began before 31 July 1998. However this rate will cease to apply for these companies after 31 December 2010.
Withholding taxes on royalties
Outbound royalty streams
In the absence of relief provisions under a double taxation treaty or the EU Interest & Royalties Directive, an Irish resident company (or Irish branch of a non resident company) is required to withhold Irish income tax at 20% on payments of patent royalties or ‘other Annual Payments’ to persons who are not resident in Ireland. Payments that do not come within either of these two categories are not subject to withholding tax.
‘Other Annual Payments’ have been held by the courts to be payments that, in the hands of the recipient, are regarded as pure income profit. This in turn has been held to mean that the recipient does not incur any expenses to earn the payment. This has to be evaluated on a case by case basis and depends on the circumstances of the recipient of the annual payment, not those of the payer.
Double taxation treaties
Ireland has signed comprehensive double taxation agreements with 44 countries. The Irish tax treaty network continues to be expanded and updated. Companies that are resident in Ireland may avail of Irish treaties. These treaties secure a reduction, or in some cases, a total elimination of withholding taxes on royalties.
In the event that withholding tax applies but can be reduced or eliminated by the provisions of the tax treaties, it is necessary to make advance application to the Irish tax authorities to invoke the treaty provisions. This generally requires provision of evidence of the tax residence of the recipient and submission of copies of the agreements under which the royalties arise.
Details of the countries with which Ireland has concluded double tax treaties and treaty withholding tax rates in respect of royalties payable to and from Ireland are included in appendix III .
EU Interest & Royalties Directive
Under this directive, which Ireland implemented with effect from 1 January 2004, payments of royalties (and interest) to EU tax resident companies are exempt from any withholding tax provisions that might otherwise apply. Specifically, Irish companies can qualify for an exemption from Irish withholding tax on royalty payments that are made to EU companies if:
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the Irish company directly controls not less that 25% of the voting power in the other EU company (or vice versa); or
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a third EU resident company directly controls not less that 25% of the voting power in each of the Irish and other EU company.
Indirect participations are not allowed, the associated company relationship must be in place for an uninterrupted period of at least two years.
Inbound royalty streams
The imposition or otherwise of withholding tax on royalty payments received by an Irish company is dependent in the first instance on the domestic legislation of the paying company’s jurisdiction. If the paying company’s jurisdiction necessitates the imposition of withholding tax, relief can be sought under the appropriate double taxation treaty or the EU Interest & Royalties Directive if applicable (see outbound section for further details on double taxation treaties and the EU Interest and Royalties Directive). In the absence of this the withholding tax suffered may be creditable against Irish tax on the income.
Foreign tax credit system
Foreign taxes borne by an Irish resident company on royalty income may be credited in Ireland against Irish tax on the income where there is a double taxation treaty in force.
The credit is limited to the Irish tax referable to the particular item of income. It is very important to note this limitation as it often gives rise to a situation where foreign taxes are not fully creditable and thus withholding tax in practice can be a significant cost. The situation arises from the fact that the Irish tax is imposed on the net income whereas the withholding tax is normally imposed on the gross income. An example to illustrate the point is set out below. The example is a simplified version of the normal calculation. In practice the calculation can be quite complicated.
Foreign tax credit working example
Assumptions
Royalty income - €100
Expenses - €70
Net Royalty Income - €30
Foreign withholding tax rate - 10%
Irish tax rate - 12.5%
Withholding tax suffered = 10 (10% of the gross royalty of €100)
Irish tax imposed = 3.75 (12.5% of €30, the net royalty, i.e. the gross royalty less expenses)
As the credit for the foreign tax is limited to the Irish tax on the income a credit is only available for €3.75 of the €10 suffered. A deduction against trading income for the balance may be available.
Where there is no double taxation treaty in force any foreign tax suffered is not creditable against Irish tax on the income. In these circumstances the tax may be deductible as a business expense if deemed to be incurred in the carrying on of the trade, subject to the usual conditions that it is incurred wholly and exclusively for the purposes of the trade and is revenue in nature.
Negotiation of licence agreements and withholding tax
When negotiating the licence agreement(s) that gives rise to the royalty payments, a clause should be included addressing the withholding tax implications so as to clarify who has ultimate responsibility for payment in the absence of any relieving provisions. Who bears ultimate responsibility for the payment of withholding taxes will be dependent on a number of factors, including the relative bargaining strength of the parties to the agreement(s).
Phase 1 - Developing IP rights | Phase 3 – Disposal of IP rights