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Simplifying Ireland’s double tax regime    
Danielle Ryan reviews the proposals and implications of a potential move from Ireland’s current worldwide basis of taxation to a limited territorial system of tax, the subject of a recently closed public consultation by the Department of Finance.
With the continued evolution of the digital economy and globalisation there has been an increased emphasis on ensuring the tax framework of the country is aligned with international standards, as we have seen most recently with Ireland’s joining of the OECD inclusive framework agreement Pillar One and Pillar Two. As result of the ever-changing tax landscape, we have also seen frequent public consultations for stakeholders to consider proposed changes to Ireland's tax framework and provide feedback on the potential impact of same. One such public consultation that was recently completed considers a potential move from Ireland’s current worldwide basis of taxation to a limited territorial system of tax. Such a move would see a change from the current credit method of double tax relief to an exemption method, specifically (and as suggested in the Coffey Report) in respect of a participation exemption and/or foreign branch exemption.

Ireland’s existing worldwide basis of tax brings into scope all profits relating to Irish and foreign source income, with double tax relief available for foreign tax paid on the latter. As result, in general, foreign source profits should only incur a charge to Irish tax to the extent the Irish tax charge exceeds the foreign tax paid on such profits. By comparison, a territorial regime exempts foreign source profits of resident entities.
Danielle Ryan

Potential changes being considered
As part of the public consultation the Department of Finance asked stakeholders to consider the potential impact of transitioning to a limited territorial system of taxation as well as the possible simplification of existing double tax relief rules. In addition to this, feedback was also sought on how transitioning to a limited territorial system of taxation could interact with the implementation of the Anti-Tax Avoidance Directive and the recent OECD Inclusive Framework agreement Pillar One and Pillar Two.

These key areas have been considered in further detail below:

Transition to a Limited Territorial System of Taxation
Within the EU and OECD community it is important to note that Ireland remains somewhat of an outlier with most member states operating some form of territorial taxation system. A move to a limited territorial system could be provided for with the introduction of a foreign branch profit exemption and a participation exemption (in line with many other EU Member States) on an elective basis. Although the existing double tax relief rules contained within Schedule 24 of the Taxes Consolidation Act 1997 provide for a de facto participation exemption, the application of same requires a series of complex steps to be completed as part of the tax compliance process. As a result, an elective exemption for foreign branch income and/or foreign dividend income would ensure equitability among taxpayers and a reduction in the existing compliance burden which arises when claiming relief for same under this Schedule. A reduction in the compliance and complexity associated with claiming double tax relief for foreign branch profits and foreign dividends could see Ireland enhance it’s competitiveness as a location to do business.

On transitioning to a limited territorial system of tax, consideration should also be given to the implementation of provisions to allow for the timely use of unrelieved foreign tax carried forward from prior years in respect of dividends or foreign branches.

Simplification of the existing Double Tax Relief rules
The evolution of Schedule 24 over time to address EU law concerns has led to the existing rules for double tax relief being quite complex and requiring significant analysis on application. The simplification of same would help bring clarity across many industries that operate internationally. For example, many Irish insurers have branches abroad and annually face this additional compliance burden, that by comparison, many of their competitors in other EU and OECD member states are not required to complete. Both the broadening of the categories of income for which relief is available and simplification of the existing measures in place for the pooling and carry forward of unrelieved foreign tax are areas that may assist with this.

Interaction with ATAD and OECD Inclusive Framework
The synergies and risks associated with the potential transition to a limited territorial system and the implementation of ATAD and the OECD Inclusive Framework is a key area the Department of Finance have requested feedback from stakeholders on.

Ireland has over the past number of years adopted many of the ATAD provisions, with Finance Bill 2021 introducing new measures to complete its transposition. Consideration must therefore be given to the impact of the potential change of Ireland’s taxation system on such new measures. For example, potential legislative amendments may be required to appropriately bring exempt foreign branches within the scope of CFC rules.

With regards to the implementation of future measures, the current Pillar Two model rules and the existing draft Directive on same effectively exempts foreign dividends and foreign branch profits from Irish tax. Therefore, a limited territorial-based regime would be consistent with the objectives of Pillar Two.

Certain outcomes of Pillar Two as currently drafted would also lead to the same outcome irrespective of the implementation of the limited territorial system of taxation being proposed. For example, the calculation of the Global anti-Base Erosion (GloBE) Income and Loss and Adjusted covered taxes for Pillar Two purposes requires (in general) adjustments to be made to remove dividend income and tax expenses associated with such income. Furthermore, a ‘constituent entity’ for the purpose of the GloBE rule is an entity or permanent establishment that is part of an MNE group or a large-scale domestic group. Accordingly, top-up tax levied with respect to a foreign permanent establishment would likely be collected in that other Member State, with foreign permanent establishments to be treated as constituent entities for the purpose of Pillar Two. This is the likely outcome irrespective of whether Ireland adopts a foreign branch exemption or continues to maintain a worldwide basis of taxation.

However, interaction between the subject to tax rule (STTR) of Pillar Two and the introduction of a potential exemption for foreign branch profit could in theory result in the levying of source taxation by virtue of such an exemption. This is because the STTR allows source jurisdictions to impose source taxation on certain related party payments that are subject to tax at a rate of less than 9% in the other contracting jurisdiction (i.e. the jurisdiction of the payee). Such an outcome however does not appear to be in line with the objectives of the STTR. Further work may therefore be needed to fully understand the interaction between the STTR rules and a potential limited territorial system of taxation prior to any legislative change.

What’s next?
Th public consultation on the potential implementation of a limited territorial system of taxation closed on March 7th. The outcome of this will be closely monitored, with many across the financial services industry with foreign branches and offices abroad, in favour of a move towards a double tax regime that promotes more taxpayer certainty and user-friendly compliance obligations.

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