Taxing other countries’ money is coming our way, are we ready for that?
This year we’re putting a Controlled Foreign Companies (CFC) rule into our tax law. This could be the quintessential corporation tax moment of our time so far (more will come!) given that it will tax foreign companies’ money by requiring Irish companies to foot the bill. I’ve already written about the 2016 movie “Sully” in this column where Tom Hanks in the lead role says that “everything is unprecedented until it happens for the first time”. CFC will be the new normal.
Getting the jargon out of the way, a CFC rule taxes a foreign company’s profits in Ireland. Those profits can be taxed in that foreign country but under the rule they can be taxed again here. That foreign company must be at least a 50% owned subsidiary of an Irish entity and can comprise certain foreign branches. Where the relevant conditions are met then the Irish Exchequer can reach out and pull that foreign company’s profits and tax them back home. Critically cash doesn’t have to come here but the Exchequer will want the tax as if it did! It will affect all Irish companies with subsidiaries abroad unless certain exceptions apply. More on that later.
First things first: This shouldn’t be a tax generator for the Irish government but rather it should act as a deterrent against having certain operations abroad. If Ireland gets tax from this then that’s a bonus for the Exchequer. The version of the rule that Ireland is going with says that an Irish company should include the CFC’s undistributed income in its tax return where it arises from a “non-genuine arrangement” put in place for the “essential” purpose of obtaining a tax advantage. A non-genuine arrangement is one where the foreign entity wouldn’t own assets or have taken on the risks which generate its income if it were not controlled by its Irish parent company. That parent would have to have relevant people who are instrumental in generating the controlled company's income. To be clear that‘s not quite the Irish company pulling the foreign company’s strings as that gives rise to other issues.
The Department of Finance are consulting on this new approach. Regular readers will know my view that consultation with us decreases consternation amongst us. On CFC’s it’s good to talk because it’s equivalent to taxing someone else’s money and requiring your company to write the cheque. The CFC rule has been an international tax tool for many years; it’s just that we have not previously gone that way. Now, we’ve no choice because the European Commission brought about a directive to say that all EU Member States must have one.
The directive also has other rules that have to be brought about such as a restriction on the tax deductibility of interest paid by companies on their financing arrangements. Ireland has told the Commission that it will wait until 2024 at the latest to bring about that rule and we’ll be consulting on that rule later on in the year. The CFC one has to be ready to go by 1 January of next year, so time is tight on this one.
The Tax Strategy Group (TSG), which I’ve previously written about in this column, asked some pertinent questions. Should we adopt the deminimus rule permitted by the directive allowing companies with accounting profits lower then €750k and non-trading income of €75k to be excluded? My view, yes we should. This CFC rule has broad application and anything that reduces taxpayer companies’ work to help them confirm compliance should be taken up. Should we have lists of good countries where an Irish company can invest without fear of falling foul of the CFC rules? My view, yes, for the same reason as previous question.
But I’d also add in connection with both these questions that other competitor countries may well take up these exclusions making them more attractive to inward investment.
The TSG also asks whether the rule should go beyond the directive’s reach and tax other arrangements which may be outside its application. That’s different because that applies to the whole directive and means unnecessarily putting ourselves in harm’s way competitively speaking.
I’ve written in these pages before that when I was in school there were two types of student being the swots and everybody else. The “everybody else” group produced engineers, lawyers, doctors, award winning photographers, accountants etc. Therefore, being a swot isn’t necessary and can be a competitive disadvantage in tax terms. If all EU member states have to comply with a set of rules and they do but we say that we will make those rules harder than everyone else’s then how will that affect inward investment?
Stepping outside the directive is one thing and it can be done but that step generally cannot go beyond EU law. The European courts have said that a country can restrict foreign investment for tax reasons but that ability is not usually unfettered. A country can impose restrictions where it can be independently verified that the investment was “in whole or in part, a purely artificial arrangement” (there’s a riddle, wrapped in a mystery, inside an enigma right there!) whose essential purpose was to circumvent tax legislation back home.
In addition, the taxpayer should be given an opportunity, without an undue administrative burden, to provide evidence of any commercial justification that there may have been for that arrangement i.e. an innocent until proven guilty approach. You can see where the courts were coming from in that freedom to establish genuine operations and to move capital within Europe for genuine reasons is fundamental to life within the EU. It’s what we all signed up to and this directive recognised those freedoms. Therefore, if we are going into swot territory then we have to ask ourselves the question as to what type of swot do we want to be, presumably a lawful one.
If your company has a foreign subsidiary then it will have to ask itself many questions in 2019 depending on how the forthcoming Finance Act ultimately deals with this issue. That will be decided following the consultation I mentioned earlier. Setting up abroad is one thing but Ts and Cs matter and our legislature has choices to make. We are going where we have never gone before and as I write I’m reminded of the maxim “first do no harm”; we can do this.
Tom Maguire is a tax partner with Deloitte and his fortnightly columns on tax matters appear in the Sunday Independent. The above article was first published on 9 September 2018.