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Wednesday, 17th April 2024
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Financial services provisions of Finance Bill Back  
The Finance Bill 2003 has seen substantial progress in the transition from a financial services sector tax code which was largely IFSC focused, to one appropriate to a nationwide financial services sector. The securitisation code has been revamped, capital gains tax relief for foreign currency matching has been introduced for conduit companies, and the problems of Irish financial service companies acting as agents for non resident dealers has been resolved.
Securitisation
The Minister’s comments in the D?il debates on the Finance Bill on securitisation were heartening. There was a genuine appreciation in the comments of the remarkable development of this sector. The tone of the comments on securitisation stood out in debates that were sometimes negative towards the productive areas of the economy.

The key features of the taxation code now applying to securitisation vehicles are:
The computation of the taxable income in the securitisation vehicle will proceed as if it were the income of a trade. However if it does throw up a taxable surplus, the tax rate applying to the income will be 25p.c. and not 12.5p.c.

The principal significance of computing the income as if it were a trade is that in almost all circumstances the interest expense will be a deductible expense. The ability of an investor to deduct interest in computing taxable profits is much more restricted than is that of a trader. There is also specific statutory confirmation that bad debts are a deductible expense.

There are several provisions dealing with interest paid and received by a securitisation vehicle. Interest paid by the vehicle to an EU or treaty state resident is both exempt from withholding tax, and from all Irish taxes in respect of that income. There is also an exemption from Irish withholding tax in respect of interest paid to the securitisation vehicle by persons otherwise within the scope of Irish withholding tax.

The securitisation vehicle is permitted to have profit participating interest which will not be treated as a distribution, provided there is no tax avoidance involved.

The definition of a securitisation vehicle is broadly drawn. This reflects the rapidly evolving nature of securitisation business. Any tighter definition would probably have led to the need for revisions in each annual Finance Act hereafter.

One critical feature of the definition is that the financial assets held and managed by the company must have a value of at least €10m when the assets are first acquired by the company. It is not possible for a securitisation vehicle to ‘build up’ to the €10m limit from a lower initial base.
The securitisation vehicle must be both a resident company carrying on the business of holding and managing a wide range of financial assets and must also carry on no other activities.

Currency Matching
Because capital gains tax operates by converting into euro foreign currency expenditure on the acquisition of an asset at the date it is acquired, and similarly converting the sales proceeds at date of sale, you can end up with a gain expressed in euro which is greater or less than the foreign currency gain, when converted into euro.

This creates a problem when an Irish resident conduit company is used by a non-resident to make an investment in an Irish trading company or holding company of a trading company. Take the case of a conduit company financed in foreign currency, which expended that foreign currency in making the investment. On an ultimate disposal of the investment it may find that movements in exchange rates give a euro gain that, viewed from the perspective of the foreign currency, does not exist.

The Finance Act has tackled this problem by effectively taking into account for CGT purposes, either as an additional gain, or a deductible loss, the impact of exchange rate movements vis a vis the euro, of the currency in which share capital, loans or capital contributions have been made in order to finance the investment by the conduit company.

To some degree this mirrors, on a nationwide basis, a practice previously operated by the Revenue Commissioners specifically in relation to conduit holding companies investing into an IFSC company.

In order for the ‘matching’ to apply a company must elect within 21 days of making an investment that it should apply. It is also necessary that the investment made by the company should amount to at least 25p.c. of the share capital of a trading company, or of a holding company of a trading company.

This relief has been introduced for accounting periods ending on or after 6 February 2003.

Fund Management
A non-resident company which carries on a trade in Ireland through an agent may be within the scope of Irish corporation tax on its profits. Similarly, an individual or trust which employs an agent in Ireland to carry out trading transactions might be within the scope of Irish income tax in relation to trading income arising from those activities.

These rules are a potential barrier for the Irish fund management industry in taking on fund management for non-residents who may have a trading status. These rules have now been disapplied provided the non resident acts only through an investment business firm or authorised member firm authorised by the Central Bank, or authorised by an equivalent authority in another EU member state, or through an EU regulated credit institution.

The authorised agent is required to act in an independent capacity, and on an arm’s length basis, on behalf of the non-resident. However the Revenue are believed to accept that one member of a group may act independently and at arm’s length, when acting on behalf of another group member. The relief also restricts the extent to which the authorised agent in the State may have a financial interest in the trade carried on by the non-resident.

This exemption applies for chargeable periods commencing on or after 1 January 2002 (ie retrospectively).

Consultation
The three measures above (which are not the only measures introduced to facilitate the financial services sector) were the product of intensive consultation between the Revenue Commissioners, the Department of Finance, and interested parties in the financial service sector, including advisers. They are an example of how good the process of making tax legislation can be.

Unfortunately, there were a number of other measures in the Finance Bill as initiated that demonstrated the opposite – just how bad the process can be. A particular such example was the provisions relating to relief for interest as a charge, and to a deduction for interest accrued but not paid. In these instances misconceived measures were introduced without consultation, and without prior notice, and in particular in the case of interest as a charge, without any cogent explanation as to the purpose of the legislation. The implications of these measures as introduced for the financing of Irish business and in particular of inward investment, were profound.
Unfortunately many inward investors and potential inward investors may have received the impression from the publication of these measures that the Irish tax system is subject to arbitrary and irrational changes in fundamental respects. That may have damaged Ireland’s ability to attract inward investment.

Once representations were made a process of consultation was entered into. That underlines the fact that there was no reason why such a process could not have been entered into before the legislation was drafted. The Minister should ask himself how such damaging legislation came to be introduced by him. There is something wrong with the process which produced it. It would benefit the economy if the Minister spent some time to identify what is wrong.

He may find that the problems lie in an outmoded obsession with secrecy regarding Finance Bill measures. An obsessive interest in petty ‘abuses’ may also lead to measures being drafted without due regard to their wider economic impact, and without much focus on the financial structures legitimately used by Irish industry.

Another factor is the undue time pressure applied in the decision making process which leads to a Finance Bill. The Minister should not accept Finance Bill proposals unless it can be demonstrated to him that a process of consultation has been entered into. The Minister should reject the view that attaching the label ‘anti-avoidance’ to a measure precludes a proper consultation process. The fact that the difficulty over the interest as a charge measure was resolved only through a process of consultation demonstrates that the use of such a label is meaningless.

The Minister might also consider refusing to introduce any Finance Bill measure until he has had about six months to think about it. Is it really incredibly urgent to make technical changes in tax law, with a view to ‘protecting the revenue’ if the State has managed to exist for the best part of a century without those measures?

The scale of a Finance Bill each year is now so great that it is beyond the capacity of the Revenue Commissioners, and of the Minister, or the Department of Finance to properly evaluate in the time scale that applies. The first move towards better Bills may well be to move towards smaller Bills, with more consultation, and more time for consideration.

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