This section introduces the new corporation tax relief that is known as the KDB. The amendments in the names of Deputies Pearse Doherty and Tóibín were discussed reasonably extensively yesterday. The legislation provides that profits from certain qualifying assets that were earned by a company chargeable to corporation tax in this State, to the extent that the assets relate to research and development undertaken by that company, can be effectively taxed at a rate of 6.25%. The purpose of the KDB is to encourage companies to develop intellectual property and thereby engage in substantive research and development operations that have a positive impact on the Irish economy.
The KDB is based on the OECD modified nexus rules, which were agreed as part of its BEPS project and subsequently approved by the EU code of conduct group. These rules seek to align taxing rights on substantive operations. This is consistent with Ireland's overall approach to corporation tax.
The KDB is a general measure and is targeted at firms of all sizes and origins that undertake substantive research and development. However, as was discussed on Second and Committee Stages, it is likely that, because of the operation of the OECD modified nexus formula, the KDB will be of most immediate benefit to single companies that carry out their research and development activities in Ireland. From an FDI perspective, the KDB should also operate in such a way as to encourage larger multinationals to locate more of their high-quality research and development activities in Ireland.
The essence of the OECD modified nexus formula is that, if a company performs 50% of the research and development that develops an asset in Ireland, 50% of the income arising from that asset can qualify for the 6.25%. As a result, the more research and development that is carried out by the Irish taxpayer, the greater the profits that can be availed of under the KDB.
Regarding the amendment, reports of this nature have already been prepared and published. In line with the Department of Finance's 2014 tax expenditure guidelines, an ex ante evaluation of KDB was carried out this year and published on budget day. It included an analysis of the expected economic impact of the tax incentive and the estimated Exchequer cost in terms of tax forgone. The report included consideration of the economic literature on the impact of patent boxes that have existed for some years in other jurisdictions. The conclusion was that, as the KDB had a substance requirement in line with the modified nexus approach, it would have an additional benefit for the Irish economy. It is estimated that, in the early years of the KDB, there will be an annual cost of €50 million in terms of tax forgone. The ultimate Exchequer cost will depend on the level of uptake by firms, but it is expected that, because of the design of the KDB, it should incentivise additional activity in terms of employment and investment.
To ensure that the KDB will be assessed to confirm that it delivers value for money for the Irish taxpayer, the report also includes a term of reference for an ex post evaluation. This is scheduled to take place in 2020, by which time it is expected that at least three years worth of data will have been collected by the Revenue Commissioners from the tax returns of claimant companies. This means that there will be sufficient information to carry out an effective evaluation. In the meantime, and as is usual for all corporation tax incentives, the impact and uptake of the KDB will be monitored on an ongoing basis. Given the fact that the report has already been prepared and published, I am not accepting the Deputies' amendment.
Deputy Pearse Doherty raised a question about the level of analysis that had been carried out of the dependence of the economy on corporation tax policy and the need for an analysis of corporation tax receipts. Over the course of 2014, officials from my Department engaged in a substantial project that sought to quantify the effects of Ireland's policy, including the question of how important FDI was to our economy. The eight reports that set out the results of this research were published in last year's budget and included a paper on the context and concentration of corporation tax benefits.
Deputy Boyd Barrett raised the issue of the effective rate of tax that was paid by companies. A substantial report was prepared on this topic last year. As it was discussed on Committee Stage, I will not repeat the analysis. On the issue of the payment of royalties, subsidiaries of multinationals, be they located in Ireland or elsewhere, will necessarily incur certain bona fide expenditures, including royalty payments to group companies in foreign jurisdictions. The profits charged on in Ireland reflect the functions, assets and risks located in this country by the multinational group.
The payments to the non-resident company represent the required remuneration of extremely valuable intellectual property assets funded and owned outside the State. Ireland cannot expect to receive or retain the remuneration of these assets. Nevertheless, Irish resident companies are chargeable to corporation tax at the standard 12.5% rate on the full trading profits that are generated from their economic activities here.
Deputy Murphy raised a number of questions. I have addressed the costs of the knowledge development box. They are published on the Department's website. I have not precluded a company from being able to join the research and development tax credit in the knowledge development box. They complement each other as part of the overall corporation tax offering.
As required by the OECD modified nexus rule, the definition used for qualifying expenditure in the knowledge development box is related to the knowledge development box tax credit. They are targeted at different stages of the business cycle. The research and development tax credit is intended to support firms when they are actively engaged in research and development while the knowledge development box credit is aimed at the future income generated from the results of research and development activity, which come at a later stage. Not everybody who claims the research and development tax credit will be able to use the knowledge development box because they may not have developed qualifying assets and because they may not have been able to generate profits from them. The cohort of taxpayers that will be able to avail of both is, therefore, expected to be quite limited.
On how the Government will be able to confine the knowledge development box to activity in Ireland, I remind the Deputies that this is the very essence of the OECD modified nexus approach as Ireland can give a tax benefit only to the extent that the profits are the result of substantive activity in the State. There are a number of safeguards in the legislation to ensure this is the case, such as the restriction on the use of acquired assets and the specific anti-avoidance clause in section 769M.