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Finance Bill 2004 modernises financial services tax legislation Back  
The Finance Bill has made a number of beneficial changes to areas of relevance to the financial services industry in Ireland. These include the introduction of a holding company regime, improvements in the treatment of small ticket leasing business, helpful clarifications of the VAT treatment of the management of CIU’s and securitisation vehicles, and in the treatment of foreign taxes on dividends Brian Daly reports.
FForeign tax credits
Foreign tax credits can be important to the profitability of transactions. The changes made by the Finance Bill remain within the principle of avoiding double taxation of foreign dividends. In order to avail of unilateral credit relief (as opposed to credit relief provided by way of a double tax agreement) it was necessary that a dividend should have been on a shareholding of at least 25% in the dividend paying company. This threshold has been reduced to 5%.

A further radical change has been made in allowing for credit not only for taxes imposed by the central authority of a foreign state on the profits out of which a dividend has been paid, but also for the state taxes that may have been imposed on those profits. This is particularly relevant where a dividend is paid from a company resident in a federal state, where there may be several subsidiary taxing authorities within the state e.g the USA where not only is federal tax charged on profits, but state taxes may also be charged on profits.

It might be thought that extending the taxes covered by the unilateral credit to state taxes would not matter greatly since in many instances the foreign tax may already exceed the effective Irish rate of 25%, payable on the dividend. That can be true in many cases, including that of dividends from the USA. However a further change to the double tax credit rules gives even greater significance to the ability to take credit for state.

Hitherto it was necessary to calculate the Irish tax on each separate dividend received, and it was against that portion of Irish tax only that the foreign tax credits in relation to that dividend could be offset. Where the foreign tax credit exceeded the Irish tax on the dividend, that excess could not be offset against Irish tax on another dividend, where the foreign tax credit might be less than the Irish tax.

This has now been changed so as to allow such an offset. All foreign tax credits on dividends may be offset against all Irish tax on dividends, where they meet the conditions for offset. This is sometimes known as “onshore pooling”. Traditionally, in order to obtain the same result, it was necessary to trap foreign dividends in an offshore holding company where they could be “mixed”, before paying them on to Ireland.

The new treatment does not extend to forms of return on an investment other than dividends. This may have implications for the form of which financial institutions structure transactions with overseas entities.

Not only is “onshore pooling” of foreign tax credits now permitted in each accounting period, but where the aggregate of foreign tax credits exceeds the Irish tax on the aggregate of dividends for that year, the excess may be carried forward for relief against Irish tax on foreign dividends in the following accounting periods. Generally such an excess is a deductible expense in computing corporation tax on the dividends and therefore an effective 25% Irish tax relief is already available in the same accounting period for such excess foreign tax credits. What is carried forward therefore is effectively 75% of the excess foreign tax credits.

Deductibility of interest
The Finance Act 2003 restricted the deductibility of trade interest on an accruals basis where it was owed to a connected person not liable to tax on an accruals basis, or if owed to a non resident associate , who would not be liable to Irish tax on such an accrual basis if resident. This had the unintended effect of denying relief for interest expense which was accrued but unpaid at a year end, where it was payable to a non trading foreign associate of the Irish company. That has now been corrected, with retrospective effect, by excluding from the restriction interest payable to a non resident company.

Short life assets
Capital allowances are available on plant and machinery over an 8 year period. Many items of plant and machinery have a shorter effective life than eight years. Finance leases on such assets typically involve full recovery of capital cost and of the interest element of the transaction, over a much shorter period than eight years. In consequence the taxable income from such a lease in its early years tends to exceed the true commercial income, whereas surplus capital allowances tended to arise in the later years, in excess of the commercial income in those years.

Where a financing transaction on short life assets was structured as a hire purchase agreement, this unrealistic basis of taxation was avoided, since the hire purchase transaction was taxed only on its true economic profit as recognised in accounts.

The Finance Bill sensibly has permitted a leasing company, in relation to leases of short life assets, to elect for taxation on the basis of accounting treatment. Effectively, this involves the deduction of the capital cost over the life of lease.

As drafted there are a number of aspects which may be problematic. For example, where a company elects for the new treatment in respect of it’s short life assets, those assets may be treated as being “outside the leasing ring fence”. Therefore the income on them for tax purposes may not be capable of being relieved by the excess capital allowances of other leasing business including the excess capital allowances in relation to short life asset leasing done before the election was made. Hopefully these difficulties will be resolved before the Finance Bill is finalised by the Dail.

The short life asset is one whose expected economic life is less than eight years, and which is leased on terms such that 90% of the present value of the lease income stream as valued at the date of inception of the lease, can be expected to be received in under eight years.

Foreign Banks
The Finance Bill as initiated contains a provision authorising a Revenue official to seek a court order against the bank requiring it to produce to a Revenue official the books and records of any non resident banking company controlled by it.

It is common knowledge that some of the major Irish banks have subsidiaries which carry on banking business outside the state e.g in the USA, or continental Europe, or the Isle of Man and Channel Islands.

It is a puzzle as to why this provision was put into the Finance Bill. It is unlikely that any Irish court would give the necessary order where it would require the non resident bank to act in breach of its contractual obligations of confidentiality entered into with its customers under foreign law, or where it obliged the bank to produce confidential banking records and to do so would be in breach of banking regulations in another jurisdiction.

The scope of the purported order seems wide. It need not identify the customer whose affairs the Revenue are investigating. Indeed they may be unable to identify any of a whole class of persons in whom they may be interested. In short, it looks almost like a licence to trawl. The scope of the powers would seem to be even more ambitious than the scope of the exchange of the information agreements that the Revenue is seeking to negotiate with authorities in the offshore islands.

VAT and fund management
The Finance Bill has clarified the availability of an exemption from VAT on the management of collective investment undertakings and also on securisation vehicles within the meaning of Section 110 of the Taxes Consolidation Act. Doubts had arisen in recent times about the VAT treatment of some such services but the matter has now been satisfactorily resolved.

Other measures
Loss relief on a value basis will not be available to a life assurance company against corporation tax, where the corporation tax is in relation to policy holders profits.

The Savings Directive has been implement into Irish domestic law.
The charge to tax on exit from gross funds has been extended to include a situation where units in the fund are cancelled to compensate the fund for the tax which it is obliged to account for in certain circumstances where no cash payment from which a withholding could have been made arises. The drafting in this area is not satisfactory, whatever about the principle, and hopefully will be amended.

The Finance Bill has seen useful progress in modernising the tax legislation as it applies to the financial services Industry.

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