Treatment of R&D Tax Incentives under the Pillar 2 GloBE Rules

Tax incentives for R&D are a common way for a jurisdiction to attract foreign direct investment (FDI). A key question for the purposes of the Pillar Two GloBE rules (along with all other tax incentives) is to what extent they may lead to a reduced GloBE effective tax rate (ETR), and potentially lead to additional top-up tax.

A very common tax incentive for R&D expenditure is some form of tax credit. Many jurisdictions offer some form of tax credit eg:

However, R&D tax incentives are not limited to tax credits. Other methods include enhanced capital relief, super deductions and patent boxes or other similar arrangements.

Jurisdictional Amendments

Given the Pillar Two Global Minimum Tax is likely to apply from 2024 (or 2025 in certain jurisdictions) many countries are already actively looking at their R&D tax incentives.

For instance, Section 27 of Irelands 2022 Finance Act includes amendments to their R&D tax credit regime. 

The Irish R&D tax credit operated as an offset against a company’s current and prior year corporation tax liability. Any excess was then either carried forward for use against future corporation tax labilities or claimed as a payable credit in three instalments over a period of 33 months (which was subject to a cap linked to the higher of the corporation tax paid by the company in the previous 10 years or the payroll taxes paid by the company for the periods).

However, in order to be a Qualified Refundable Tax Credit for GloBE purposes the refund amount must not be limited to any ‘tax liability’. This would therefore prevent the Irish R&D tax credit being a Qualified Refundable Tax Credit for Pillar Two purposes if amendments were not made. As such, the 2022 Finance Act included a number of amendments to the R&D tax credit regime to ensure it qualified. 

The OECD report on Tax Incentives and the Global Minimum Corporate Tax warns against simply changing a tax credit to fit the definition of a Qualified Refundable Tax Credit (as although it may lessen the impact of the GloBE Rules on the incentive, it could also lead to substantial revenue losses). However, in practice, many jurisdictions will be looking at their R&D regimes as part of a general review of tax incentives after the Pillar Two Global Minimum Tax. 

In this article we look at the financial accounting, domestic tax and Pillar Two treatment of some of the main R&D tax incentives including standard deductions, capitalization, super deductions, tax credits and patent boxes or other similar arrangements.

Standard Deduction

In some jurisdictions, a company is just permitted an immediate write-off of the full amount of R&D expenditure for tax purposes.

On the assumption that this is mirrored for financial accounting purposes (as is usually the case), there would be no additional impact under the GloBE rules.

GloBE income is based on financial accounting income, and therefore the accounting expense would flow through into the GloBE income base.

This would reduce income for GloBE purposes (when compared to if no deduction had been given) and (other things being equal) would lead to an increase in the GloBE ETR and a potential reduction in any top-up tax payable.

If for financial reporting purposes the R&D was amortized over a number of years then there would be deferred tax implications due to the timing difference between the accounting and tax treatment – see below.