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UK Tax Reform Back  
The UK Treasury has published a consultation document on the reform of UK corporation tax. It has implications for Ireland in so far as the ideas may influence thinking on Irish corporation tax. It may also have implications for Irish businesses with investments, whether in trading companies or property, in the UK. It will be of particular interest to Irish financial service companies since it may ultimately impact on their competitive advantage vis a vis UK financial service companies.
Reform in the air
The reform of UK corporation tax has been on the agenda at least since August 2002 when the UK government published their first consultation document on the topic. This has recently been followed up by a second consultation document, taking into account feedback from the first.

Four main topics have been identified as a framework for reform.
• More closely aligning tax rules with accountancy rules.
• Taxing trading companies and investment companies on a similar basis.
• Providing relief for capital expenditure on buildings and plant more in line with accountancy treatment, than with current capital allowance rules.
• Abolition of the so called ‘scheduler system’ under which different types of income are ring fenced, and taxed according to different rules, and without offset of losses from one category of income against income from another category, in some instances.

Accounts basis of taxation
There is a superficial attraction in proposing that as far as possible the taxable income of a company be taken to be the income disclosed in its accounts in each period. There are two major risks involved with this concept.

Firstly, it could lead to a corruption of accounting standards as businesses feel the tax cost of accounting standards that tend to increase disclosed profits. This risk may be balanced by the countervailing tendency of some businesses, especially those encountering difficult trading conditions, to exploit accounting rules to give the most favourable possible view of their profits.
The second risk is that it will lead to undue political interference in the setting of accounting standards, and accordingly in the reporting of profits. If accounting standards begin to closely impact on tax receipts, will not the government feel that it cannot allow accounting bodies unrestricted freedom to determine accounting standards?

This may sound a bit far fetched. However readers with longer memories may recall the fate of the original standard which the UK and Irish accounting institutes attempted to introduce, to deal with inflation accounting. It was a good standard, logical and reasonable. The British government intervened to veto it.

Tax computations are to some degree based on the accounts produced by a business. However once those accounts depart from straightforward deduction of outgoings from income, statutory taxation rules tend to override the accounts. Thus there would be no question of obtaining deductions in Ireland for notional expenses such as share options given to employees. The treatment of finance leases in the hands of the lessee is similarly radically different for tax purposes in Ireland than it is for accounting purposes.

In many ways the proposal to more closely align the basis for taxation with accounts is related to other proposals, such as the abolition of the scheduler system, and the basis for separate taxation of investment companies and trading companies.

The scheduler system, and the distinction between trading companies and investment companies, are largely unknown in accounts. A decision to base taxation largely on accounting profits would probably make sense only if all forms of profits are being taxed on a similar basis, whether they be investment profits, or trading profits, or capital profits.

The distinction between trading income and all other forms of income is central to the current Irish taxation system. The 12.5p.c. corporation tax rate is available solely in relation to trading profits but not in relation to other forms of income. Similarly the older 10p.c. rate of corporation tax is available only in relation to certain trading income. As the 12.5p.c. corporation tax rate is central to economic policy in Ireland, Ireland will be able to follow the UK down the accounting path fully only by abandoning the 25p.c. corporation tax rate on non-trading income. That is something not likely to happen in the near future.

Taxation of investments
International Accounting Standards require regular revaluation of investment assets in accounts. If the resulting profits were subject to taxation it would impose cash-flow problems on companies who would be taxed on unrealised profits.

There is also a risk that in the long run they could end up taxed on more profits than they ever realise, even in accounting terms. This could occur where tax is paid on unrealised revaluation surpluses in a bull market, and those surpluses are subsequently wiped out in a bear market, with no ability to offset the later losses against the earlier gains for tax purposes.

Taxation of Capital versus Revenue
The proposal to provide tax relief for commercial depreciation instead of providing relief via capital allowances is seen as being difficult to implement as it will encourage swifter depreciation rates and will remove the ability for government to target tax relief on capital expenditure in certain specific industries.

Ending the scheduler system
The scheduler system, under which different types of income are taxed according to different rules, and under which losses from one type of income may not be available for offset against all other types of income, dates back to the beginning of the 19th Century.

Ending it would have a cost for the government since the present system involves the practical reality of taxing taxpayers on more than their real income. If losses from one source cannot be offset against gains from a different source, the government can still obtain taxation from people who overall, when taking the results of all sources together, have no income at all. This is a fiscally useful if rather nasty aspect of the tax system. Equity would suggest ending it. Government deficits would suggest the opposite.

Leasing Companies
The UK government have two proposals on the table in the area of capital allowances. The first concerns leasing companies. One possibility being looked at is that leasing companies should, in relation to finance leases, be taxed only on the inherent interest element of their income, and not on their gross receipts less capital allowances as at present. In so far as capital allowances exceed the capital repayment element of a finance lease rental, leasing companies receive some deferral of tax in the present system. They would lose that under the proposed alternative.
Of course for those leasing companies leasing short life assets (ie those where the capital recovery period is in Ireland less than eight years) the present system has the opposite effect ie the leasing company is taxed on more than its true profit in the early years of a lease.

To balance that proposed change in treatment it is suggested that the lessee would receive the entitlement to capital allowances on the leased assets, and that the deduction for lease payments by the lessee would be restricted to the true financing element of such payments.

Such a change in the system would get the UK off the hook on one problem they have in terms of EU law. At present a UK leasing company receives higher capital allowances on plant leased to UK companies than it does on plant leased to companies outside the UK, including in other EU states. Such discriminatory treatment is illegal under EU law. Some action is necessary and the proposed change to the treatment of leasing companies is one possible solution.

The matter is still at consultation stage. There are numerous problems facing any attempt to sweep away the present structure of corporation tax, and replace it with a more simple taxation largely based on profits disclosed in accounts. But some changes will occur and those changes will affect Irish businesses exposed to UK tax, and Ireland’s financial service companies competing with UK companies, or providing services to them.

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