Bigger than Brexit, so why go there?
It’s all go in Europe right now. We’ve seen Brexit, anti-avoidance directives, mandatory disclosure proposals, the pitch for the taxation of digital transactions in Tallinn and then there’s’ the Common Consolidated Corporate Tax Base (CCCTB). Seamus Coffey has said this last one is bigger than Brexit for corporate tax purposes.
The CCCTB currently requires unanimity to become law. The President of the European Commission Jean-Claude Juncker’s State of the Union Address 2017 suggested that moving from unanimity to qualified majority voting in certain tax areas can be done “if all Heads of State or Government agree to do so”. Minister Donohoe has said that our government will resist such a move and one can see why.
We know the economics and right now many countries have raised legal concerns about the common tax base which dates back to a paper in 2001! Cash matters but so does the rule of law. But it’s still being discussed at EU level and Disney’s salient “let it go” advice in Frozen is just not being heard. All together now “…the past is in the past, Let it go…”
The European Commission recently explained a carrot in the existing proposal. In August it published a working paper “An assessment of R&D Provisions under a Common Corporate Tax Base”. It notes that the common base presents “a unique opportunity” to “massively increase support for business innovation”. So the common base is great for R&D? Buy the former and get the latter free? So why are we not signing up tout suite to chew down on this carrot? Simple, overall it’s bigger than Brexit.
The CCCTB has two steps (The “Tallinn digital tax pitch” outlines quick fixes in the interim for that industry): Step 1 is a tax rulebook (containing the proposed R&D regime among other rules) for all EU member states. Step 2 requires consolidating taxable profits using that book for corporate groups operating cross borders and allocating those profits across the EU using various criteria.
Ireland’s R&D regime has been described as “best in class”. That’s not to say it can’t be improved, nothing’s perfect, but it’s arguably kilometres ahead of the EU proposal. Under our rules, the taxpayer company can claim a tax credit comprising 25% of the R&D expenditure concerned. However, where the R&D expenditure is tax deductible then our law generally brings about a potential reduction in cash tax payable of up to 37½% being the 25% credit added to an effective 12½% reduction in tax for the related costs; the latter arising when computing the company’s taxable profits.
The EU proposal suggests a full deduction for the R&D expenditure with an extra 50% of such costs (with certain exceptions) incurred during that year. Where the R&D costs exceed €20 million then the company deducts 25% of the excess. In addition, certain start-up companies may deduct an extra 100% of their R&D up to €20 million.
Take a well-established company incurring R&D costs of €30m. Under the EU proposal that company could deduct, including the various 50% and 25% super-deductions, an amount of up to €42.5 million in computing its taxable profits. This means the reduction in cash tax for that company would be almost €5.3m. Not too shabby. Our version comprises a possible deduction of the full €30m in computing taxable profits and an additional tax credit of 25% of that figure resulting in a cash tax reduction of almost €11m.
That’s just one element of the EU’s proposed common tax rulebook. Ireland, together with other countries, has already responded with a “non merci mes amis” to the European Commission arguing it contravenes EU law itself. And that’s before you into the detail of its R&D carrot, which is arguably more stick to our law in the end. The rhetorical question then is why would Ireland move to such a regime?
The recent Tax Strategy Group (TSG) papers were published in advance of Budget 2018 and noted that the purpose of the R&D Tax Credit is to encourage companies to undertake high-value add R&D activity in Ireland, thereby supporting jobs and investment here. It’s working. In 2015, a total of 1,534 companies availed of the credit with a total exchequer cost of €708 million.
The TSG notes that in October 2016, the Department published an Economic Evaluation of the R&D credit which found that “60% of the R&D undertaken by companies is due to the credit”. Gasp! Ireland’s credit also has a repayable element which the EU version doesn’t allowing companies to request a refund if their R&D claim is greater than their tax liability. The TSG notes that the introduction of the repayable element of the R&D Tax Credit coincided with a substantial increase in the number of companies availing of the tax credit.
How does all that stack up with Paul O’Neill’s (former US secretary of Treasury) logic “you find someone who says ‘I do more R&D because I get a credit for it’, you’ll find a fool”.
Because of human audacity, curiosity and tenacity R&D will happen. JFK famously said “We set sail on this new sea because there is new knowledge to be gained, and new rights to be won…We choose to go to the Moon in this decade and do the other things, not because they are easy, but because they are hard…” Let’s be clear, you don’t have to go to the moon to engage in creditable R&D!
The R&D credit may not make it happen but it will be a factor in determining “where” it happens and we want it to happen here. Don’t get me wrong there are improvements that can be made to the credit but CCCTB isn’t one of them. Neither is giving up our veto on tax matters. One size just doesn’t fit all particularly when we, as a small open economy, punch above our weight in the first place.
Bruce Lee (I’m a huge fan!) once said “Adapt what is useful, reject what is useless, and add what is specifically your own”. So to end on a positive note on the EU proposal, it does suggest an “Allowance for Growth and Investment (AGI)” to deal with the position where interest on debt can be tax deductible but profit distributions (e.g. dividends) cannot.
According to the common rulebook companies could be given the allowance where certain increases in equity would be deductible from the taxable base subject to certain conditions. The former Finance Minister Noonan noted earlier this year that this element of the CCCTB proposal “makes an interesting case for giving tax relief for equity investment in a business, which is something which should be examined further”.
We are now firmly in pre-Budget mode. So adopting a rhetorical approach again and taking Mr Lee’s advice, should we not just adapt the AGI to our law, continue to reject the CCCTB and add to the R&D credit?
Tom Maguire is a Tax Partner in Deloitte and his regular columns on tax matters appear in the Sunday Independent. The above article was first published on 01 October 2017.