A taxing time ahead for the Commission on Taxation and Welfare

The closing date for submissions to the Commission on Taxation and Welfare ended since my last column. No doubt various submissions have been made by numerous stakeholders about how to make our tax and welfare environment a better place. You could say that Tax is almost a four-letter word, but Myron Scholes (Nobel prizewinning economist) and others once wrote: "Success is achieved when the tax rules subsidise activities that benefit society as a whole more than they benefit the individuals engaging in the activities ...". That’s where we need to be and in my view that’s what we saw through the various Covid19 tax and expenditure measures over the past couple of years.

Starting with the corporate side and some of the changes that could be made there. In Ireland, a tax deduction is given (terms and conditions apply) for interest on borrowings. Our interest deductibility rules are galactically complex. We have brought about the new-fangled Interest Limitation Rules (“ILR”) as required by the EU’s Anti-Tax Avoidance Directive (ATAD) and have layered it on top of the “old” interest deductibility rules (which we had said were “equally effective” as the ILR). Now’s the time to revisit the complexity of our old rules. Adopting a legislative approach whereby tax relief is permitted for finance costs based on a company’s financial statements where the monies have been applied for business and other commercial purposes of the taxpayer concerned would not extend tax relief inappropriately and should be considered.

Right now, no deduction is given for the cost of equity capital. Last year, the European Commission adopted a new “Communication on Business Taxation for the 21st century” which included a proposal for a Debt Equity Bias Reduction Allowance (DEBRA). While the exact mechanics aren’t final, the DEBRA could be some form of deduction calculated as a percentage of equity.

The proposal aims to address the pro-debt bias that exists in the tax rules of various EU countries where businesses can deduct interest attached to debt financing, but nothing related to equity financing. The EU Commission will make a DEBRA proposal in 2022. Regardless of EU developments, Ireland should proceed with a DEBRA like regime. Even the former Common Consolidated Corporate Tax Base (CCCTB) contains an "allowance for growth and investment" which gives a form of equity deduction. Okay, our thoughts on CCCTB are well known but the Finance Minister at the time noted that it made "an interesting case for giving tax relief for equity investment in a business, which is something which should be examined further".

In particular, the Small & Medium-Sized Enterprises (“SME”) tax system should be amended to not only facilitate start-ups but also to incentivise entrepreneurs to remain and scale up their businesses. The taxation of entrepreneurs in a broad context should be addressed within the context of personal taxation, as well as looking at how funding/financing returns and capital gains are taxed. We need to ensure that our SME’s have access to capital and talent and receive the necessary support to drive research, development and innovation here.

Moving to the human side because we need to revisit how we tax labour here. In particular, Ireland has high marginal rates and such rates have a low entry point compared to competitor countries. We know that people are increasingly mobile. One of the factors which will determine where such employees locate is personal tax rates.

Ireland’s high personal tax rate can be seen as a disincentive to businesses locating in Ireland and employees taking on additional work. It can also discourage foreign based talent (including our own diaspora) relocating to Ireland. Our marginal rate of 52% is one of the highest in the EU and puts us at a competitive disadvantage compared to other countries competing for inward investment. The marginal rate of tax should be reduced from its current level of 52% and the entry point to the higher rate of tax should be increased. In addition, a roadmap to demonstrate to workers when this burden will be reduced would be welcome.

In the current market, many businesses are struggling to attract and retain employees. It’s important that measures are introduced for SMEs to firstly, assist them with their remote working offering, and secondly to facilitate non-cash reward mechanisms to help attract and retain key staff. That brings up the issue of share options.

The KEEP (Key Employee Engagement Programme) is a share option scheme introduced specifically for certain qualifying SME companies. There is no tax charge on the date of grant or exercise of the share option. The Capital Gains Tax (CGT) charge arises only on disposal of the shares acquired on exercise of the KEEP option at the rate of 33%.

The introduction of the Key Employee Engagement Programme (“KEEP”) was seen as a welcome move to incentivise SMEs to retain and reward staff in a tax efficient manner and to assist SMEs in competing with publicly quoted companies who have the ability to use share-based remuneration to attract talent. However, it is understood that the numbers adopting a KEEP scheme have not materialised. Therefore consideration should be given to making it easier to implement as a cost-effective way to offer shares to employees. In addition, I’d argue that the type of businesses that can avail of KEEP be expanded and that CGT treatment be allowed on the buy-back of shares to reflect the fact that the employer company represents the likely buyer of employee shares in the SME sector.

Of course, with limited resources you can’t always get what you want but, if you try, sometimes you can find you get what you need. I’ve no doubt that the Commission will have a lot of options to consider before making its recommendations to government. But in my view, the words of Myron Scholes I mentioned earlier, should form some basis for their decisions. I look forward to their page turning “John Grisham-esque” report later this year which should form the basis for discussions on tax law into the foreseeable future.

Please note this article first featured in the Business Post on Sunday, 30 January 2022 and was re-published kindly with their permission on our website.