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When interest is a trade receipt Back  
The Revenue Commissioners have published their views as to when deposit interest income constitutes the receipt of a trade, rather than income taxable as such. The statement has no legal standing. Nonetheless it is likely to be decisive in determining the matter in most cases.
The Revenue statement as to the circumstances in which they will accept that deposit interest is taxable as part of trading income is important. Trading income is currently taxable at the rate of 20 per cent (reduced to an effective 10 per cent rate where manufacturing relief is available, including for financial service trades in the IFSC). This rate will be 12.5 per cent by 1 January 2003.

In contrast, interest income which is not a trade receipt is taxable in the hands of a company at a rate of at least 25 per cent. If the company is a close company and it does not distribute an equivalent amount of profits as dividends etc, it may suffer an effective tax rate on the interest of 40 per cent, by reason of close company surcharge. The contrast between 40 per cent and 12.5 per cent speaks for itself.

Broad outline
The broad outline of the Revenue statement may be summarised as follows:

Deposit interest will be treated as trading income if
• It is from the investment of a level of permanent capital required to be retained in the business by a regulatory authority eg a central bank.
• It is interest received by banks and by insurance companies from deposits.
• It is interest received by agency treasury companies, stand alone treasury companies, captive finance companies, asset finance companies (where deposits are an integral part of the financing arrangements), leasing companies (where deposits are an integral part of the lease arrangement) and investment traders.

The instances above are instances where the treatment of the deposit interest as trading income is accepted. The Revenue agree that a taxpayer may, on the basis of the facts and circumstances of the case, establish that there may be other instances, apart from those listed above, where deposit interest is a trade receipt. However they say that the burden of proof is on the taxpayer in such instances and they regard the level of proof required as being high.

The grey zone
In addition to the ‘black and white’ distinction made above, the Revenue do appear to admit of a grey zone. They accept that where a manager of a financial service or similar type company can demonstrate that they hold a deposit as an essential part of their business and necessarily must hold that deposit in the course of the business, and that the deposit is actively employed and at risk in the business, the interest may be treated as trading income.

Depending on the circumstances of their case insurance or reinsurance managers, insurance brokers, fund mangers or fund administration companies, trustee and custodian companies, and managers of agency treasury companies or captive finance companies may find themselves in this grey zone.

Groups don’t count
Interestingly, the Revenue state that in examining the facts and circumstances on a case by case basis, they will not take account of the fact that a company is part of a larger group. Neither will they have regard to the activities of other group members, in considering the status of interest in a particular group company. The determination as to the trading status of interest will be made solely on the basis of the facts and circumstances relating to the company which made the deposit.

This particular statement could be quite significant. The Revenue statement would seem to imply that being a member of a banking group is not relevant to considering whether a company earns deposit interest as a trading receipt.

Sinking funds out
The Revenue statement rules out the possibility of regarding deposit interest as trading income where it arises from the investment of a sinking fund eg for the replacement of a wasting asset. This decision by the Revenue seems to be based on the UK case of Nuclear Electric plc v Bradley, which was decided in the UK House of Lords in 1996. In that case the issue was whether interest on a sinking fund created to meet the costs of decommissioning nuclear plants was trading income. The House of Lords held that it was not trading income.

The Revenue Commissioners statement says that their views are in accordance with the judgement in the Nuclear Electric case. If anything, the views expressed by the Revenue Commissioners are more liberal, and potentially wider in their scope of treatment of interest as trading income, than some readings of the judgement in Nuclear Electric would suggest.

The Nuclear Electric judgement identified only banking and insurance as clear examples of trades in which interest was a trading receipt. It admitted that there could be other companies (their Lordships were challenged to think of any and cavilled at tour operators as being such) where interest could be a trading receipt. In general it seemed that the thrust of the Nuclear Electric was to ask whether the essential service provided by a company was the payment of cash (whether repayment of deposits, making of loans, or meeting of insurance claims) or whether it was otherwise.

Back in the real world
At the outset the importance of the distinction between interest as a trading receipt, and interest as income in itself was highlighted. Most companies who are not financed by borrowings and bank overdrafts necessarily need to keep moneys on deposit in order to carry on their trade. Of course it is not strictly true to say that they need to keep it on deposit. They could keep it in a shoe box, but in reality some level of deposit interest is a normal incident of carrying on a trade.

Against that background the Revenue Statement, like the Nuclear Electric judgement in the UK, is excessively restrictive. It does not reflect the manner in which business is carried on.

As the House of Lords itself emphasised in the recent landmark UK case of Westmoreland Investments Limited, a concept such as income from a trade is an undefined concept essentially of a commercial nature. Whether or not any particular matter is income from a trade needs to be determined against a business background, and not against a legal background. The Revenue statement is strongly based on legal precedent but does not show a great grasp of business matters.

This is a statement which should be reconsidered, freed from the burden of legal views expressed in another jurisdiction.

The real debate
The Revenue statement is the beginning of a wider debate. The 12.5 per cent corporation tax rate for trading income is going to focus attention on what constitutes trading income. This will be particularly so in difficult areas such as the exploitation of intellectual property and activities generating royalties. There are major decisions to be made in this area. The decisions will impact on the attractions of Ireland as a location for international investment.

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