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.  However in the situation where patent royalties are paid by connected parties two additional conditions must be satisfied before the patent royalties paid by the related company can be received tax free by the recipient;

• the related company must be carrying on a manufacturing activity; and
• the royalty paid must not exceed an arms length amount, i.e. an amount that an independent person would be willing to pay for the use of the intellectual property.

It should be noted that the term ‘manufacturing activity’ has a broader meaning in this context than its normal every day meaning and would include activities such as data processing and software development (subject to the receipt of particular employment grants from Enterprise Ireland).

With effect from 1 January 2008 the maximum amount which can be received tax free is limited to €5m in any twelve month period

Tax exemption for dividends from a patent company:

Irish tax legislation also permits the payment of tax free dividends from companies in receipt of income from qualifying patents.  In a situation where the royalty income is received from a related company, unless the patented invention qualifies as a Radical Innovation (see below), two restrictions apply which may limit the amount of tax-free dividends that may be paid.

The amount that can be received by shareholders free of tax is restricted to the lower of:

• the amount of the patent company’s annual royalty income; and
• the aggregate amount of expenditure on R&D in the year in which the dividend was paid and the previous two years.  When calculating the aggregate amount of expenditure on R&D, expenditure incurred by a group company (including a non Irish company) can also be included.

R&D expenditure:

For these purposes, the definition of “expenditure incurred on R&D activities” is quite narrow.  It does not include capital expenditure and it is limited to expenditure incurred in Ireland.  However, provided 75% or more of the expenditure is incurred in Ireland the total amount is deemed to be incurred in Ireland. 

R&D expenditure comprises the aggregate of the following:

• Emoluments paid by the company to its employees who are engaged in carrying out R&D activities related to the company’s trade;
• Expenditure incurred by the company on materials or goods used solely by the company in carrying out the R&D activities related to its trade;
• Sums paid by the company to unconnected persons to carry out R&D activities relating to the company’s trade.

R&D activities means “systematic, investigative or experimental activities, which are carried on wholly or mainly in the State, involve innovative or technical risks and are carried on for the purposes of acquiring new knowledge with a view to that knowledge having a specific commercial application or creating new or improved materials, products, processes or services”. 

Certain activities are specifically excluded from qualifying as R&D activities.  These are:

• Market research, market testing, market development, sales promotion or other consumer surveys;
• Quality control;
• The making of cosmetic modifications or stylistic changes to products, processes or production methods;
• Management studies or efficiency surveys; and
• Research and social sciences, art or humanities.

Radical Innovation:

The Irish Revenue has not given precise guidelines as to what it regards as “Radical Innovation”.  Initially, when introducing the legislation the Minister for Finance referred to the OECD model guidelines on Radical Innovation and also to previously considered case law on the subject.  However, the Revenue has not been guided by either the OECD model or precedent case law.  Nor is the Revenue concerned with the commercial aspects of the invention, for example, how much revenue has been generated through the patent or have the markets accepted the product.

Based on current precedent, our understanding is that the Revenue is more concerned with the end product.  In their opinion, to come within Radical Innovation a fundamentally altered product must be invented.  Furthermore, according to Revenue it is likely that improvement of patent products, even if fundamental would find it difficult to qualify as Radical Innovation unless they produce a radically and fundamentally altered product.

Appendix I - R&D tax credit | Appendix III