We need to do more on tax than our competitors
The recently published 2017 Exchequer returns explain that in cumulative terms Ireland’s corporation tax receipts of €8,201m came in €486m or 6.3% ahead of target for the year as a whole. In year-on-year terms, receipts grew by 11.6% or €850m in 2017. Cumulative income tax receipts at end-December of €20,009m were up 4.4% or €840m in year-on-year terms.
When it comes to tax the view is that we play fair but we play to win. But how are we doing when compared to our European competitors?
Just before Christmas the European Commission published its report on tax policies within the EU. It looks at each Member State’s tax policies under four priorities being (1) facilitating investment, (2) boosting employment, (3) ensuring tax compliance and (4) reducing inequalities while noting significant interdependencies between those priorities. The report is almost a hundred pages long but it does give some pointers as what we’re doing well and where we can do better.
It notes that decisions on whether to invest in a country will be influenced by the effective marginal tax rate (EMTR) i.e. the tax burden on the last euro invested in a project that just breaks even. The smaller the EMTR the more conducive to investments the tax system will be. The EMTR encompasses a wide range of factors going beyond statutory corporate tax, such as the source of financing (debt, retained earnings or new equity) and the asset in which the investment is made (machinery, buildings, intangibles, inventory and financial assets).
Ireland came in above average in effective marginal tax rates so not too shabby there. One of the factors that affect such rates is the cost of making investments. A company can borrow or it can receive and/or use its own equity to make an investment. In Ireland, a tax deduction is generally given (terms & conditions apply) for interest on borrowings but no deduction is given for the cost of equity capital. This is the so called “debt bias”.
The report notes that this bias is “particularly problematic for young and innovative companies that often have no access to external funding and are therefore put at a disadvantage”. It goes on to say that this bias can be addressed by different reforms such as abolishing the deductibility of interest costs (to be clear: bad answer!), or by extending the deductibility to include the return on equity.
The point is made that interest reforms would increase the overall mean cost of capital for new investment in almost all EU countries while the abovementioned equity reforms would reduce it. Critically, the cost of capital is directly linked to the level of the EMTR which impacts the investment-friendliness of the tax system. It’s noted that Portugal has taken measures to address the debt bias granting its allowance for corporate equity (ACE) to all companies (not only SMEs). Belgium, Italy and Cyprus continue to apply ACE regimes.
You’ll remember our play fair but play to win mantra. Right now, we don’t have that ACE up our sleeve and we need to look at this. Even the proposed Common Consolidated Corporate Tax Base (CCCTB) contains an “allowance for growth and investment” which gives a form of equity deduction. This is pointed out by the EU Commission in their report; qu’elle surprise mes amis! Our thoughts on CCCTB are well known but in January of last year Minister Noonan noted that the CCCTB proposal “makes an interesting case for giving tax relief for equity investment in a business, which is something which should be examined further”. This wasn’t addressed in Finance Act 2017 (signed into law by President Higgins on Christmas Day) and it can be seen that many countries have examined this and have made this ACE move. Are we getting left behind?
Ireland scores well on tax incentives for R&D and especially well on the number of hours required by a medium-sized company to comply with taxes in a particular year. As the report notes tax compliance cost are influenced not only by tax rules but also by how simple it is to deal with tax authorities. All of this matters when companies are looking at where to invest.
The report explains that tax policy can have a major influence on employment decisions, investment levels and the willingness of entrepreneurs to expand. On entrepreneurship, Ireland is specifically called out: “Focusing on the entrepreneur himself, Ireland introduced a reduced capital gains tax for entrepreneurs”. We did but other countries are ahead of us in this area.
Under our rules if an entrepreneur builds up a business then he can avail of entrepreneur relief which reduces the rate of Capital Gains Tax (CGT) to 10% on the first €1m of gains on disposing of the business. Finance Minister Donohue was asked in the Dail just before the Christmas break the full year cost of increasing the lifetime limit for CGT entrepreneur relief to €5m, €10m and €15m respectively. He noted that, based on various assumptions regarding asset disposals, the cost would be €49m, €54m, and €56m respectively in a full year. Compare those numbers to those mentioned in the starting paragraphs to this column.
As I’ve written previously in this column this is the time to focus on our indigenous industry and the next “Aghaidh Leabhar”. Where will it come from? What can we do to make this happen? An enhanced entrepreneur relief could be significant in answering those questions. 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…”. Time to look again at entrepreneurs.
According to the Commission’s report other countries may be behind us in some areas but ahead of us in others with ACE’s up their sleeves and enhanced reliefs for the entrepreneurial gene etc. Some will say that we have to look at our tax system “in the round”, “on balance” and “as a whole” while focussing on the “big picture”. I’d agree once there’s no chink in our armour. Anthony Hopkins said chillingly in “Fracture” (2009) “You look closely enough, you'll find that everything has a weak spot where it can break, sooner or later.” The trick is to remove armour chinks as soon as you find them. Competitive advantages need to stay competitive.
Tom Maguire is a Tax Partner in Deloitte and his monthly columns on tax matters appear in the Sunday Independent. The above article was first published on 14th January 2018.