Recent years have seen unprecedented focus on corporate tax and in particular, the taxation of multinational companies. The OECD Base Erosion and Profit Shifting (“BEPS”) Project and European Union (“EU”) Directives have resulted in significant law change across many countries to address perceived aggressive tax planning by companies.
Ireland is no exception. The European Commission’s state aid investigation and subsequent negative decision in the Apple case has certainly brought Ireland into the spotlight. However, the Irish Government has demonstrated its willingness to engage in debate around the future of our corporate tax system and make legislative changes where appropriate. Ireland was the first to introduce a fully compliant Knowledge Development Box and was an early adopter of Country-by-Country Reporting provisions.
However, one feature of the Irish system that is not under review is the 12.5 percent rate of corporate tax, with a firm commitment by the government that the 12.5 percent rate is and will remain the cornerstone of the corporate tax system, regardless of what Donald Trump says! It also recognizes that a competitive and transparent tax system remains key to attracting foreign direct investment and has undoubtedly played a role in Ireland’s recovery from the financial crisis, to become the fastest growing economy in the Eurozone in the three years from 2014 to 2016 (IDA Ireland).
Nonetheless, the required introduction of measures such as Controlled Foreign Company (“CFC”) and anti- hybrid rules under the EU Anti-Tax Avoidance Directive (“ATAD”) are challenging for the Irish tax authorities. Unlike many other EU Member States, Ireland has never had CFC or anti-hybrid provisions, and although we do have a capital gains tax exit charge, there is comprehensive exemption from the charge subject to conditions. Implementation of CFC rules is required by January 1, 2019 with many additional changes required, potentially up until 2024. The legislature has a short time frame in which to radically reshape the Irish corporate tax code. In addition to this, one cannot ignore BREXIT and increasingly likely U.S. tax reform when considering the overall impact of any legislative change.
Direction of Travel
In recent years, the government has provided an international tax strategy update as part of the annual Budget (Update on Ireland’s International Tax Strategy and Consultation on Coffey Review, Department of Finance, October 2017). In 2016, the government also announced the appointment of an independent expert to undertake a review of Ireland’s corporate tax code: Seamus Coffey was appointed in October 2016. This was followed by a six-week consultation period which ran from February 21 to April 4, 2017 in which the views of a wide range of stakeholders were sought.
The terms of reference of the review encompassed the following areas:
- achieving the highest standards in tax transparency including exchange of information on tax rulings with other jurisdictions;
- ensuring that the corporation tax code does not result in preferential treatment for taxpayers;
- reviewing Ireland’s commitments to the OECD BEPS project;
- ensuring the Irish tax code provides certainty for businesses and maintains Ireland’s tax competitiveness;
- maintaining the 12.5 percent rate.
The Department of Finance released the conclusions of this review on September 12, 2017. The Report’s conclusions were extremely positive and acknowledged both the Irish Government’s commitment to the OECD BEPS initiative and to maintaining a transparent, fair and competitive corporate tax system. Indeed, Ireland was recently recognized by the Global Forum on Transparency and Exchange of Information for Tax Purposes, having been awarded the highest rating following a review of Ireland’s compliance with the exchange of information between tax authorities.
The Report endorses Ireland’s consultative approach to legislative change, which has been successful over the years. Nonetheless, the Report contains a number of recommendations. Whilst the government is not under any legal obligation to implement any of the recommendations, from a political perspective change is inevitable, particularly as the tax burden for individuals, although reducing, remains high and the tax affairs of companies are front page news.
In launching the Report, Minister Donohoe stated:
I welcome this comprehensive review which presents an overall positive message for our corporate tax code. The Review provides a clear road map and time frame for Ireland to implement important international reforms.
Ireland’s 2018 Budget was announced on October 10, 2017. In tandem, the Department of Finance launched a consultation period aimed at getting the views of stakeholders on how future legislative amendments are implemented. The consultation is open from October 10, 2017 to January 30, 2018 and sets out 10 questions. The questions focus on the implementation of the ATAD, BEPS Actions 8, 9 and 10, the broadening of the transfer pricing provisions and the potential move to a territorial system of taxation, which are discussed further below.
Albeit that the pillars for maintaining a stable and competitive system are strong, clear direction and timelines will be very important for companies as the changes coming our way will be very significant, and accordingly, the aim is to set a roadmap for legislative change from now until 2020. What is clear is that we will have a more complex tax system going forward and it is crucial that any new legislation is carefully thought through. Of course, Ireland is not alone in this and many other EU Member States will also see a radical change in the shape of their corporate tax systems.
What are the Key Recommendations and what’s Happened Since?
The Review recommends a number of changes to Ireland’s domestic transfer pricing legislation which would result in a wider application of the provisions. Currently, Ireland’s transfer pricing legislation only applies to trading transactions (activities which are subject to corporation tax at 12.5 percent). However, the Report recommends the extension of the provisions to transactions the terms of which were entered into before July 1, 2010 (previously grandfathered transactions), small and medium-sized enterprises (“SMEs”), non-trading and capital transactions. It also recommends the implementation of Actions 8 to 10 and Action 13 of the OECD BEPS project, together with the adoption of the 2017 OECD Transfer Pricing Guidelines (rather than 2010). The suggested timeline for the commencement of any amendments is January 1, 2020.
The enactment of these recommendations into law will undoubtedly bring an increased compliance burden to companies, particularly if SMEs are included, and the cost to business of these changes will need to be considered carefully. Multinational companies locating intellectual property rights or business functions in Ireland will need to ensure that they have sufficient substance in Ireland to ensure compliance with the new standards. However, this is an area where change is inevitable if we are to comply with the OECD’s approach to transfer pricing, and indeed the EU’s review of transfer pricing arrangements via the mechanism of state aid investigations, about which there is already much commentary.
As most will be aware, Ireland has two rates of corporation tax; the well-documented 12.5 percent, but also a 25 percent rate of tax which applies to passive income. To the extent that transfer pricing rules are amendedsuch that both trading and non-trading transactions are included, it will be necessary to consider carefully the interaction of both rates, as this could give rise to unintended mismatches and consequential double taxation. The International Tax Strategy document notes the commitment to maintain both rates of tax. However, in an era when corporation tax rates are reducing across the world, a rate of 25 percent is now high in an international context. By comparison, the U.K. corporation tax rate is currently 19 percent, and the recently released U.S. tax reform bill proposes a reduction from 35 percent to 20 percent.
The sustainability of the two rates is certainly an area which requires consideration. This is particularly relevant in the context of Ireland’s interest deductibility rules, which are complex, with trade interest only deductible at 12.5 percent on an accruals basis and non-trade interest deductible on a paid basis at 25 percent. If broad scope transfer pricing legislation applies, interest income could be taxed in a non-trading entity at 25 percent with either no deduction or only a deduction at 12.5 percent, leading to effective double taxation. As the government has notified the European Commission that it is of the view that the Irish interest deductibility rules are equally effective as those outlined in Article 4 of the ATAD, any law change is unlikely before January 1, 2024. Consideration will need to be given to the interaction of these provisions and indeed the anti-hybrid rules (when implemented in 2020 and 2022) to avoid double taxation.
The Report noted the impact of the onshoring of intellectual property (“IP”) on Ireland’s national accounts in recent years. Since 2015, there has been a significant rise in the value of intangible assets held in Ireland, with the associated profits generated included in the gross measure of Ireland’s national income. The Report notes that whilst corporation tax receipts are sustainable at a higher level in the medium term, changes in the success of the economy could reduce the tax take in the future. Therefore, it suggests a change to the quantum of tax depreciation available on intangible assets, to provide a more sustainable level of corporation tax receipts. Currently, tax depreciation is available for capital expenditure (including interest) incurred on the acquisition of qualifying intangible assets. The definition of IP is widely drawn. Until 2015, there was an 80 percent restriction on the amount of profits that could be sheltered by tax depreciation. The Report recommends the reintroduction of the 80 percent limit to achieve the “smoothing” of corporation tax revenues over time.
The government has already acted on this recommendation and the Finance Bill 2017 provides that the 80 percent restriction will apply to IP acquired on or after October 10, 2017. IP acquired prior to this date will continue to benefit from a 100 percent allowance. The Finance Bill is silent on how the 80 percent restriction will interact with the existing regime. As the allowances are offset against profits arising from the exploitation of the IP, the Bill does not specify whether an apportionment of profits is necessary. Ultimately, the introduction of the restriction results in a change to the timing of the relief rather than the quantum of the relief available over either the IP life or 15 years. In response to the fact that the cap applies from October 10, Seamus Coffey has questioned why the 80 percent restriction does not apply to existing rather than newly-acquired IP. The progress through the Committee Stages of the Bill may see further clarification of this legislative amendment.
Introduction of a Territorial Regime and CFC rules
The EU ATAD requires Ireland to introduce a CFC regime by January 1, 2019. Article 7 sets out the basis on which the CFC rules should be drafted and provides two potential options for an EU Member State in choosing carve outs from the CFC provisions. From an Irish perspective, applying a carve out for EU subsidiaries carrying on a substantive economic activity may not represent the best option for Irish headquartered companies with substantial operations in non-EU countries. Equally, the adoption of a “significant people function” approach will also require careful consideration.
However, on closer reading, the preamble to the Directive does seem to provide flexibility to the Member States in how they implement the provisions. It notes that rules can target a low taxed subsidiary, particular income types of income or a targeted rule which taxes profits which have been artificially diverted to that subsidiary. Helpfully, the preamble also permits exemption for low profit entities where there is lower risk of tax avoidance, thus recognizing the compliance burden which can result from a CFC regime. Therefore, adopting a multifaceted approach may provide more clarity for companies. Certainly, providing for a “white list” or indeed entity level exemptions would reduce the complexity and compliance burden. Therefore, the consultation period does provide groups with the opportunity to input into the shape of the system.
With the introduction of CFC legislation into Ireland, the Report recommends a move to a territorial system (rather than the current worldwide basis) of taxation and either introducing a participation exemption on dividends and branch profits or amending Ireland’s double tax relief provisions with a view to simplifying the calculation of foreign tax credits generally. Whilst Irish double tax relief provisions are generally effective,
they are undoubtedly complex. It also suggests that alternatively a simplification of the double tax relief provisions would negate the need for the introduction of a territorial system.
In my view, the optimum solution would see the introduction of a participation exemption on dividends and branch profits (Irish legislation already provides for a participation exemption on gains subject to conditions). Such an exemption would have the advantage of reducing the complexity and compliance burden for taxpayers at a time when other aspects of the tax system are becoming more complex. In addition, it would put Ireland on an equal footing with the majority of other EU Member States who have an exemption system for many years. Recent trends are towards exemption systems, with the U.K. introducing such provisions in 2009. However, in the case of branch exemption, careful consideration needs to be given to how this is implemented. In the U.K., an election to opt into branch exemption is irrevocable. This may be an optimum solution at a time when companies are profitable, but can mean that losses cannot be utilized in a downturn. Nonetheless, the trend towards territoriality remains, with even the U.S. tax reform proposals advocating for a territorial basis of taxation. However, safeguards will be required to ensure that either undistributed income is taxed as it arises or it is taxed on repatriation.
If we are to pursue the stated aim of achieving certainty of treatment and competitiveness, then an exemption system is a chance to balance the scales as other facets of our tax system grow more complex.
Ireland’s corporate tax system will change over the next few years. However, companies have a window of opportunity to input into the shape of the rules going forward and should certainly respond to the consultation before the January 30, 2018 deadline.
Further change may come as the European Commission reignites the Common Corporate Tax Base/Common Consolidated Corporate Tax Base, which it sees as a mechanism for dealing with the taxation of the digital economy. In response to this EU initiative, the Minister for Finance stated that the taxation of the digital economy is better managed in a global environment, and welcomed the work of the OECD in this area. The government is clear in its commitment to the 12.5 percent rate and the view that unanimity at EU-level remains a core principle of tax policy. As Minister Donohoe recently stated:
The right choice for Ireland is to continue our commitment to a corporation tax system that is competitive, transparent and stable.
The next few years will see a radical reshape of the Irish tax system, but with proper consultation and a clear schedule for change, affected companies will have an opportunity to review their business models and get ready for the inevitable change.
And who said tax was boring?!
Reproduced with permission from Tax Planning International Review, 44 TPIR 11, 11/30/17. Copyright ©2017 by the Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
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