Tax law will be "assimilated and resistance is futile" 

Fellow Star Trek fans (okay, I’ve admitted it!) will recognise humankind’s nemesis, the Borg. In Trek-land, the Borg “assimilate” humans into a form of cyborg, not human and not machine while having qualities of both. On capture, the standard dictum issued by the antagonist is “we are Borg, you will be assimilated; resistance is futile”. Tax law will be assimilated this year.

We’ve just gone through a public consultation (another one!) in relation to the EU’s “Anti-Hybrid” Rules. This one is excruciatingly complex and it ended on Friday. As part of the consultation the Department of Finance issued snippets of the legislation that it’s considering copying and pasting into the upcoming Finance Bill on this matter as a preview of coming attractions. This allowed you and I respond to the Department outlining the good, the bad and the ugly of what was suggested. With these things, you don’t always get what you want but regular readers of this column will know my mantra “consultation with us decreases consternation amongst us”.

The Anti-Hybrid Rules are creatures from the EU’s Anti-Tax Avoidance Directive (ATAD) which in turn started life as part of the OECD’s Base Erosion and Profits Shifting (BEPS) initiative. Basically this looks at “hybrid” instruments and entities in that they have certain characteristics allowing countries to look at them differently. For example, one country may see the return on a financial instrument as interest whereas other countries might see that return as a dividend.

So what? Interest, provided certain conditions are met, can be tax deductible in the hands of a paying company; dividends, not so much. Further, the recipient of the dividend may be able to claim tax relief on its receipt whereas interest is generally just plain taxable. So, and here’s the science bit, combine the two and you have an expense “Deductible” in the paying company’s country and “Not Included” in recipient’s taxable income in another country; otherwise known as a D/NI outcome or double non-taxation. That’s what BEPS and ATAD are all about dealing with.

Another example would be a “hybrid entity” where one country sees a particular entity as a company and another country sees it as something like a partnership. A company is taxable on its income but a partnership might not be taxable in its own right as the partners may be taxable on income arising to the partnership. This is another form of hybrid which may mean one country may see a taxable entity and another country might not which may lead to tax mismatches unless otherwise dealt with.

So why should we, or the EU, care what other countries do with payments made by companies here? Don’t they have sovereign rights over their own tax system so they can say you go their way and we’ll go ours? Yes, but when the entities are in the same group then double non-taxation could arise “under one roof” and that’s where the ATAD kicks in.

I’ve already mentioned this issue’s complexity. The BEPS report on Mismatch Arrangements weighed in at over 450 pages. The ATAD’s law came in at just over 10 pages and Ireland’s consultation document including legislative snippets rocked up at almost 30 pages. The basic concept behind this proposed law is that Ireland can deny a deduction for an expense incurred by a company (thereby increasing its Irish tax liability) where the corresponding receipt is not taxed or the expense is deducted again in another country where the parties are “associated” for tax purposes.

This means that a taxpayer in one country has to at least have a good idea of how the payment it makes is to be treated in another country. The legislative snippet generally says that the company must have a “reasonable to consider” level of knowledge of the tax treatment in the other country. This isn’t “beyond a reasonable doubt” territory but there’s still a level of work to be done when certain payments are made by a company cross border to one of its associates.

Here’s the thing: Complexity of legislation can bring uncertainty of application. I’ve paraphrased Adam Smith’s treatise “the Wealth of Nations” in these pages before where he noted that when it comes to tax there’s none so great an evil as a small degree of uncertainty. Right now if an Irish company makes certain payments it has to answer many tax deductibility questions e.g. was is it incurred wholly and exclusively for the purposes of its trade? There are others but the questions generally focus on why the taxpayer incurred the expense. After the Finance Bill’s enactment the company will have to look to tax laws of recipient countries as well and maybe beyond.

When I say “beyond” I’m getting at the position where if the recipient in the other country taxes it but it uses the payment it received from Ireland to fund a payment to another associate in another country that’s not taxed then Ireland may have “indirectly” funded a mismatch. In that instance, Ireland could deny a deduction for the payment made from here based on the draft law right now. You can see how this gets really complex really quickly given the Irish company may have to determine (the science bit: on a “reasonable to consider” basis) whether it funded a mismatch in the recipient and then the recipient’s recipient and so on. Readers may remember the scene in “Life of Brian” where a matter involving “their fathers’ fathers’ fathers’ fathers” is discussed. Tax meets the Borg meets Monty Python.

Much of the above is outlined in the ATAD such that we have to implement it or face infringement proceedings from the EU. Bottom line, when enacted this will bring about additional compliance burdens on taxpayers as to who did what with certain payments made within the corporate group. Taxpayer companies will have to review their cross border arrangements.

As we know, money talks, it don’t sing and dance and it don’t walk; these rules could increase companies’ tax liabilities and that’s before we work out how this provision joins the dots with the interest provisions I mentioned in my last column.

This is an EU directive so resistance is futile. The key is to remain competitive. We should implement the directive’s requirements and remain competitive. All EU countries have to implement this and if others want to do more than is necessary then we can say “you go your way and we’ll go ours”.