The Tax Strategy Group outlines some good moves for entrepreneurs in terms of EIIS and equity financing

Tom Maguire discusses the Tax Strategy Group's Budget papers in his Business Post column

The Tax Strategy Group’s (TSG) Budget papers were published recently on the Department of Finance’s website with the caveat that “the group is not a decision making body and the papers produced are simply a list of options and issues to be considered in the Budgetary process”. The TSG is a government think tank chaired by the Department of Finance and the published papers cover everything from Income tax to EU developments to climate change.

The “Capital & Savings Tax” paper looks at Capital Gains Tax (CGT) and other stuff. The TSG paper looks at certain specific reliefs that facilitate investment by investors and one of which was the Employment and Investment Incentive Scheme (EIIS).

I’ve written previously in these pages about a Scale Ireland webcast I attended earlier this year. It was chaired by its CEO Martina Fitzgerald and its Chairman Brian Caulfield which at the time had just submitted their response to the EIIS consultation which included a discussion on losses on such investments. Tánaiste Leo Varadkar made the keynote address. The panel comprised speakers from various technology companies but all agreed that the need to improve the regime was in everybody’s benefit.

EIIS has to interact with CGT, and it does…sort of. If you invest in an EIIS company and it succeeds, then you pay CGT on any gain arising when you sell the shares, just as you would with other investments. Fair enough and so in Ireland there’s no discrimination between investors where a gain arises.

However, when an investor makes a loss on disposing of their investment in EIIS shares then that loss may not be allowable for CGT purposes. Had that investor put his or her money into a non-EIIS company and lost money on that investment then they can use that loss in reducing other capital gains in the same or future years. How you exit an investment has to be thought about when considering making the investment in the first place. How many times have you said “what’s the worst that can happen?” when making any investment decision? Ensuring loss relief on EIIS investments would serve to reduce, but not eliminate, the risk element when investing in such companies and thereby increase their appeal to would-be investors.

The TSG dealt with this issue. They explain that the issue of loss relief for CGT purposes came up as part of the Department of Finance’s public consultation on EIIS. Specifically a number of submissions sought the introduction of CGT loss relief on failed or loss-making EII scheme investments, part funded by allowing a deduction for the acquisition cost of the EIIS share from the ultimate disposal proceeds, therefore eliminating any “doubling up” of income tax and capital gains tax relief on gains. The group continues that the issue was also raised by Indecon in its 2018 review which was commissioned by the Department of Finance. It referenced a view that the availability of tax relief on losses in the UK schemes was a useful dimension which made the UK EIS/SEIS investments more attractive for investors given the high-risk nature of investments in start-ups.

The TSG states that the impact of loss provisions on risk taking and its consequences for the riskiness of capital portfolios is complex “but that there is good reason to believe that incomplete loss offset will discourage risk taking. Nevertheless any such review of this area is likely to spill over to other areas where treatment of losses is restricted e.g. in relation to the treatment of funds”. You can see their point, but this would be a good law change for entrepreneurs when considering investing in such companies in the first instance.

Earlier in its Capital Taxes paper the TSG point out that the OECD had noted that, more generally, “relatively high effective tax rates on capital gains and dividends may exacerbate a tax distortion favouring debt finance over equity”. The issue of “debt-equity bias” is of more general interest outside of CGT.

Simple question: debt or equity funding? That’s what companies have to decide when seeking investment. If a company is debt financed then it may get a tax deduction for interest on borrowings used to finance its activities where certain Ts and Cs apply. If it finances itself with equity then there is no tax deduction. This dilemma was discussed by the EU Commission earlier this year. Even the EU Commission’s proposed Common Consolidated Corporate Tax Base (CCCTB) - Remember that one? - contains an "allowance for growth and investment" which gives a form of equity deduction.

Before continuing, it should be noted that the CCCTB hasn’t gone away. The TSG paper notes a European Commission intention to create a new framework for business taxation in the EU. The “Business in Europe: Framework for Income Taxation” (BEFIT) aims to provide a single corporate tax rulebook for the EU and would replace the CCCTB. The TSG explains that, to date the precise details of the BEFIT proposal are unknown, and Ireland will maintain the position that matters of direct taxation remain a Member State competence under the treaties and that unanimity in tax matters is maintained. Ireland will continue to engage actively on this issue.

Back to debt-equity. The “Debt Equity Bias Reduction Allowance” (DEBRA) is an EU proposal to address the tax treatment of debt vis-à-vis equity when financing of a business. The TSG explain that the debt-equity bias may also place innovation at a disadvantage in some cases as it creates a situation where it is more beneficial from a tax perspective to raise debt over equity for start-up companies. It notes also that it can also be challenging for start-ups, with no track record, to raise debt. The EU Commission has signalled an intention to launch a legislative proposal to address the debt-equity bias in corporate taxation, through the introduction of an allowance system for equity financing, and Ireland will engage in the EU negotiations of the proposal.

With so much change coming our way the introduction of CGT losses for EIIS companies and a DEBRA would be good moves for entrepreneurial companies. Let’s make them happen.

Please note this article first featured in the Business Post on Sunday 26 September 2021 and was re-published kindly with their permission on our website.

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