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Wednesday, 24th April 2024 |
| Surcharge on Business |
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| Budget 1999 contains a proposal to review the possibility of extending the surcharge on undistributed trading income of closely-held companies. This is by way of partial clawback of the reducing corporate tax rates. |
Fortunately the Minister is only examining the proposal, and has not committed himself to it. The proposal seems to represent confused thinking, and is likely to result in injustice, and may well be impossible to draft as legislation. There would, however, seem to be plenty of time for the drafting since the Minister indicated that the need for the surcharge “will become more immediate as the standard rate of corporation tax approaches 12.5 per cent.” That will not occur until 2002 approximately.
The Minister did not explicitly state the justification for this proposed extension of the surcharge. It might be speculated that the Minister is concerned that surplus assets may be built up in companies, where the yield from investments would be taxed only at a rate of 25 per cent, in contrast to the current top tax rate of 46 per cent in relation to investment income received by an individual. That is unlikely to be the thinking behind the proposal, for two reasons. Firstly investment income of closely held companies (broadly speaking, those controlled by 5 or fewer individuals) is already subject to a 20 per cent surcharge. Secondly, the proposal explicitly relates to trading income and not to investment income. In the light of that fact, it is difficult to see any strategy behind the proposal other than a deliberate attempt to reintroduce by the back door higher corporate tax rates on trading income. Once this is realised, obvious problems emerge.
The first evident problem is in the area of EU law. The 12.5 per cent rate is being introduced precisely because it is illegal to have a tax rate that discriminates between different industrial sectors, or between residents and non-residents. The 10 per cent rate of corporation tax proved critical to our economic development and we had no intention of abandoning a low tax policy, especially for multinationals. It may therefore be presumed that there is no intent to apply the surcharge to trading income of multinational operations in Ireland, some of which would be close companies under existing rules - for example those owned by wealthy foreign families. If an attempt is made to target the extended surcharge only on indigenous businesses, it will inevitably invite retribution from Brussels. It is therefore a futile exercise.
Any attempt at drafting this surcharge will, as the Minister admitted, have to take account of the legitimate investment needs of industry. It is inappropriate that the investment needs of the businesses of Ireland should fall to be judged by civil servants rather than by business people who have to back up their judgments with their own money. It is also inevitable that any approach to it will involve a simplistic formula which will prove unjust in very many cases. There cannot be a single rule that determines for all businesses in all circumstances, the appropriate dividend distribution policy.
It is interesting that the Minister does recognise that a surcharge should take account of investment needs. At present a surcharge applies to certain trading and professional income of companies. The approach adopted there to recognising the investment needs of a company carrying on a trade or profession is to impose the surcharge on only half of the distributable profits (broadly speaking). This takes no account of the fact that some companies may find the entire of their current profits completely inadequate to the investment needs of an expanding business, whereas other companies may not be expanding, and may have no investment requirements. Any rule has to be rough and ready and any rough and ready rule in this very sensitive area is likely to be disruptive to business and job creation.
It is unfortunate that the Minister is considering an extension of the surcharge on trading income. What would be more appropriate is that the Minister should consider the abolition of the existing surcharge on professional services income of companies. It is as crude and inequitable as any extension is likely to be and is open to the objections outlined above, including objections under European law. The Minister has had his eye glued to the wrong end of the telescope.
It is interesting that the concept of surcharge would seem to run counter to the philosophy lying behind the Commission on Taxation’s recommendations on the Irish taxation system. That report favoured low rates of tax, applying universally to income, and higher rates of tax applying only to so much of income as is spent or consumed. The surcharge adopts precisely the opposite approach - it seeks to assess to a higher rate of tax the trading income which has been set aside for investment rather than consumption. That part of the trading income which the owner of a company requires for personal consumption will be subject to the higher rates of income tax already when it is withdrawn from the company. The lower corporate rates of tax can be enjoyed only by forgoing the right to consume the income.
It is to be hoped that the Minister will reverse his position, drop this proposal and re-examine the basis for the existing surcharges. |
Ian Young is a partner in KPMG.
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| Article appeared in the January 1999 issue.
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