We must tread carefully with owner managed companies
Tom Maguire, Tax Partner
The Public Accounts Committee (PAC) published its report in relation to receipts from corporation tax recently. It says that the highly concentrated nature of Corporation Tax receipts represents “an unacceptable level of risk to the sustainability of the Corporation Tax regime and to overall exchequer income”. According to the report, 36% of Corporation Tax paid is accounted for by 10 companies and 70% is paid by 100 companies.
It goes on to make a number of specific recommendations regarding a company’s use of trading losses, double tax agreements, measuring effective rates of corporate tax and Real Estate Investment Trusts. It also says that the Committee wasn’t satisfied that Revenue could demonstrate that the application of closely held company rules is achieving its intended purpose – Gasp!
Let’s get the jargon out of the way. A closely held (‘close’) company is a tax law concept and generally refers to a company controlled by five or fewer owners. The explanation of “owner” (or “participator” if we’re getting technical) in these companies is very broad. Control means answering, what I call, the “Star Trek Next Generation” (STNG) test. There Captain Picard had an expression “make it so” and stuff just got done. Where five or fewer persons in a close company can control the affairs of the company and meet the STNG test then the company would generally be regarded as close for this tax law provision.
Family companies, “mom and pop” companies, two friends incorporating a start-up company; all of these would be closely held companies. Even some quoted companies can be closely held companies. So, let’s just say there’s a lot of them out there.
The PAC recommended Revenue should gather the appropriate information required to assess the effectiveness of the close company rules because it was not possible to see details of PAYE paid by close companies’ owners.
Why focus on PAYE? The close company rules are anti-avoidance measures put together such that owners of these companies couldn’t squirrel their activities away into a company where the rate of tax on profits would be lower than income tax rates. A close company which didn’t make significant profits wouldn’t pay much Corporation Tax where those profits were taken out by the owners in PAYE-able salary; that would be fine because tax is paid. It could of course be the case that the level of corporation tax paid reflected such companies’ trading difficulties where there was nothing to take out in salary anyway.
But here’s the thing, close companies are subject to stringent anti-avoidance rules where other companies are not. The close company can’t always justify its activities with commercial reasons because the law sometimes seems to assume that such companies were engaging in avoidance. For example, if a company doesn’t pay out certain profits to its owners within a specific timeframe then those profits will be liable to a 20% surcharge. The idea here of course is to ensure the company does pay out so that the owners are liable to the higher rates of income tax on that distribution. That’s all grand in the short term from an exchequer point of view but what if the company needs that money itself?
What if the company wants to invest such profits in certain activities to grow its business? That doesn’t matter because unless it’s distributed to the owners then the extra 20%, in addition to its “normal” corporation tax, becomes payable. On top of that if such a company makes a loan to an owner then withholding tax is payable on that loan, albeit it can be refunded when the loan is repaid. Certain expenses paid on behalf of owners wont be deductible in computing the company’s tax bill and will be subject to income tax. Interest paid on loans to certain directors over a particular limit will be subject to income tax.
Last year’s Finance Act brought about a provision taxing arrangements that allowed for the complete exit of the owners in favour of others as income which Samantha McCaughren previously wrote about in this paper. Normally such transactions, given the complete exit of owners, would be taxable at the Capital Gains Tax Rate of 33% and not the higher income tax rates.
That’s just some of the more common anti-avoidance provisions for close companies which other companies are not subject to.
The law for close companies may not look to why the company was setup in the first place. Of course there may be instances where a tax avoidance motive was present (see below for a suggested countermeasure) but I always remember Finance Minister Richie Ryan’s comment when certain Capital Gains Tax Rules were being brought about “I fear we must, in the words of St. Paul, see the innocent suffer for the guilty.”
If there is a concern that there is avoidance going on then Revenue always has the General Anti-Avoidance Rule (GAAR) to rely upon and that wasn’t around in Minister Ryan’s time. Its purpose is that if all else fails then a tax advantage can be removed where it was “reasonable to consider” (that’s how it’s written – i.e. not “beyond a reasonable doubt” etc.) that something was done primarily to achieve a tax advantage. There’s a whole book on the GAAR but modesty prevents from mentioning its author!
So bottom line? These companies are already the subject of substantial anti-avoidance provisions, just look at the STNG test alone! Of course, like every other piece of law it’s necessary and perfectly reasonable to review its effectiveness. If one change could be made then it would be to remove the surcharge mentioned earlier given it actively discourages the reinvestment of funds to allow such businesses live, thrive and survive. Thriving means more tax, be it corporation tax or income tax, would be paid anyway!
Other than that, I’d say tread carefully when suggesting changes in this complex area. These companies are entrepreneurial and indigenous and may morph into the next Aghaidh Leabhar agus Gugail. They need to be encouraged and not put off from making investments to drive our economy. For close companies and to paraphrase Jack Nicholson as Colonel Jessup in “A Few Good Men” (1992): “we live in a world that has walls, we want them on our wall, we need them on our wall”. We got 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 1 July 2018.