The corporation tax rules will change in the next year, let’s choose wisely

“In a perfect world we make perfect choices. In the real world we make real choices”.  So said Anne Hathaway in a movie I saw over the Christmas break.  I thought that timely in that on December 23rd two tax consultations were issued by the Department of Finance; choices will have to be made as a result. To quote from my Christmas Indiana Jones binge-fest, we must “choose wisely”.

One consultation deals with investing into companies through the Employment Investment Incentive (EII) and the other dealt with financing companies through an EU directive requiring the restriction of certain financing costs.  We’ll focus on the latter but first, context.

We recently saw the Department of Finance’s expectation of a deficit of €19 billion in 2020 because taxes were down €2.1 billion and expenditure was up by €17.9 billion.  The Department explained 2020 tax receipts benefitted from a strong January and February just before the Jurassic economy hit.  It continued that corporation tax was the only major tax head to record an increase in 2020, coming in €945 million higher than 2019, as sectors such as pharma, ICT and financial services coped well with economic conditions. The press release continued that income taxes similarly held up well, ending the year down €224 million, or 1 per cent on 2019. Although a strong pre-Jurassic start was partly responsible, both PAYE and self-employed receipts significantly exceeded initial expectations. The “sector specific nature of the majority of job losses combined with the progressivity of the income tax system served to protect income tax receipts in 2020”. The combined year-on-year fall in VAT and excise receipts was €3,187 million, as personal consumption, particularly of services, was heavily impacted by the public health restrictions.  

Okay, not great but it’s a hell of a lot better than was expected.  On Budget night, the Minister for Finance said that a “deficit of €21½ billion, or 6.2 per cent is currently projected for 2020”.  That night he went onto say that “Budget 2021 forecasts a deficit of €20½ billion.  He continued “…This will require decisions in the future about how we reduce our deficit; about our levels of spending and taxation”.  It was reported before Christmas that we could expect to see tax increases in our future due to the Jurassic economy.  We were all expecting that but these increases should be appropriately designed and Budget 2022 already has several lined up including the form of the interest restriction mentioned earlier.

The Interest Limitation consultation document outlines some of the law that could be enacted depending on what stakeholders (i.e. you and me) have to say about it.  We mightn’t get all that we want in making suggested tweaks but “don’t ask, don’t get”.  The document is nearly 30 pages long and outlines 32 questions for consideration based on the draft legalese outlined within.

In a nutshell, a new-fangled Interest Limitation Rule (ILR) would restrict a company’s allowable net interest deductions (i.e. deductible interest expenses in excess of taxable interest income) to 30% of earnings before net interest expense, depreciation and amortisation (EBITDA – the tax version).  Amounts in excess of that are restricted and may be carried forward for use in future accounting periods.  This is based on the EU Anti-Tax Avoidance Directive’s (ATAD) requirement.  Various Ts and Cs apply and it may not matter whether the related borrowing funds day-to-day operations, corporate acquisitions or intragroup lending etc. in that the company may have its cost of financing reduced for tax purposes resulting in more tax payable. In essence, financing could become more expensive.  Thankfully, it looks like the Department wants to take up the ATAD’s option of exempting companies, which stand alone and, are not part of a corporate group.  The extent of that exemption has to be considered by the Department.    

Here’s the thing, our law on interest deductibility is already excruciatingly complex given the level of legal hoops companies have to jump through to achieve tax deductions for interest on their borrowings.  The transaction might be simple; step 1, borrow money; step 2, spend that money; step 3 pay interest on borrowing; but a related tax deduction may require pages upon pages of legislation to be considered before the related profits can be reduced by the interest expense. The consultation document explains that it is “intended to largely overlay the new ILR on top of the existing rules. Retention of the existing protections of the domestic regime will allow greater scope to exercise the optionality within EU’s directive…thereby minimising additional administrative burdens for small businesses”. The document admits that “overlaying” the ILR may bring complexities.  This is because companies will calculate their taxable profits as before but then do more number crunching through the ILR.  Our current rules seek to counter avoidance possibilities but the ILR as written generally doesn’t care whether there is avoidance or not, the interest is just restricted.  As a Finance Minister once said we “in the words of St. Paul, see the innocent suffer for the guilty”.  Therefore the add-on’s quid pro quo should be to simplify everything else; but to be fair the consultation does ask for views on opportunities to simplify existing rules.  Other EU countries have to implement this ILR so why make ours harder and by definition less competitive.      

This ILR consultation ends on 8th March.  However, that’s not game over as it’s intended that there be a second Feedback Statement in mid-2021 containing draft legislative approaches to the ILR provision as a whole, including all the group and exemption options.  And then there will be also be another process of stakeholder consultation on rules to neutralise the sci-fi sounding Reverse-Hybrid mismatches in early 2021, so buckle up mes amis.

But increases in tax yield don’t have to come only from increasing tax rates or restricting tax reliefs.  I’ve mentioned reducing the Capital Gains Tax (CGT) rate previously in this column.  The fall in VAT and excise yields means that we should focus on getting people to spend but also people must be encouraged to sell. Michael McDowell SC kindly wrote a foreword to my CGT book and explained that when the Minister “in 2002 halved the 40% CGT rate and quintupled the yield on CGT, it became very clear that the rate of CGT hugely influenced its yield in a manner quite different from other forms of taxation”.  Such a measure should form part of any choices reviewed as part of the Jurassic economy.

Overall, significant choices will be necessary in the next number of months, so let’s “choose wisely”.     

The above article was first published in the Business Post on 17 January 2021.

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