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Thursday, 18th April 2024 |
| Ireland’s brave new 12.5 per cent corporation tax rate distracts attention from an effective tax rate of 40 per cent on certain passive income and an effective tax of 19 per cent on professional income of a company. It does not have to be that way. |
By now most financially aware people should have heard that Ireland’s corporation tax rate will become 12.5 per cent on 1 January 2003 - less than six months away! But of course that is the corporation tax rate on trading income only. What is the corporation tax rate on other income? Fewer people may know the answer to this and most would reply ‘25 per cent’.
The reality for most Irish family-owned companies is that the rate is 40 per cent. It is indeed true that in the year in which non-trading income arises to a company, it would pay a tax charge of 25 per cent. But if a closely owned company does not distribute that income to its shareholders in that year or within 18 months of the end of the year a surcharge is imposed upon it which brings the effective tax rate up to 40 per cent. Large quoted companies would not normally suffer this additional charge as they are not usually closely owned (ie broadly, controlled by five or fewer persons).
This higher tax rate applies not only to unearned income in a company, but also to professional services income of a close company. In the latter case however the surcharge is at a lower rate and subject to looser conditions.
Is it legal?
At the present time the EU Commission has shown no interest in this area. In the long term however it must be doubted if it is in compliance with EU law to have an effectively higher rate of corporation tax on professional service income of closely held companies, than it is on the similar income of widely held quoted companies in Ireland. If a major professional services firm sets up in Ireland, in corporate form, it is quite likely that it would not be a close company in that really large professional service firms tend to have a wide spread of ownership. In such a case it would be untenable that the smaller closely owned Irish rival should be disadvantaged compared to its larger competitor by virtue of having a higher tax rate.
The purpose of a surcharge on unearned income in a company is to encourage its distribution to shareholders. In other words, the company is discouraged from building up reserves and retaining cash. Where a company is entirely an investment company that may not matter much as a matter of public policy. Where the company is also a trading company or part of a trading group, a tax policy that discourages retention of capital is dubious.
Link it to R&D encouragement
If the Minister feels he has to retain this anachronistic tax policy, he might consider linking it to the issue of investment in research and development. The UK has recently introduced a 125 per cent tax deduction for R&D spending. At the UK corporation tax rate of 30 per cent, that is a significant incentive. A similar multiple deduction in Ireland (we have one subject to such onerous requirements that it is never availed of) would ordinarily be at the 12.5 per cent corporation tax rate or at the effective 10 per cent corporation tax rate that will continue to apply until 2010 for some manufacturing operations. At those lower rates, multiple deductions do not work as well as an incentive.
Why not encourage R&D in smaller groups by relieving those groups from surcharge on unearned income to the extent that the unearned income is matched by R&D spending? Effectively, this is providing a tax relief at 40 per cent - a real incentive.
Group transactions distortion
There is another area the Minister should look at, if surcharge is retained. At present if a company within a group pays a dividend to its holding company in the group, that dividend is treated in the holding company as unearned income attracting potentially a surcharge (where the holding company is a close company). The only consequence of this particular treatment is to make it most unusual for closely owned groups to make dividend or other profits distribution payments within the group. In other words, normal commercial activity is stultified but little or no tax is raised.
Some plausible argument can be put forward to support the use of surcharge as a means of encouraging the distribution of unearned income from a company into the hands of individual shareholders. But surely any such argument could not apply to a group which earns no unearned income from external sources, but generates it entirely internally, whether in the form of rental payments, or interest payments, or royalty payments or dividend payments intra group. The group as a whole has no investment income. Why then is the surcharge applied to penalise intra group transactions entered into in the normal course of business?
The minimum reform the Minister should make in this area is to exclude all intra group payments from liability to surcharge. Even in these tight budgetary times, this would not cost much or any tax. Only the unwary walk into this trap at present and it must generate very little tax indeed. The main effect is to interfere with commercial arrangements within a group, and wastes considerable time in various paper shuffling exercises. |
Jim Clery is a Partner in KPMG.
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| Article appeared in the June 2002 issue.
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