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Tuesday, 23rd April 2024
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Why the Financial Conglomerates Directive is an opportunity for Ireland Back  
Recent legislative changes at EU level with regards to the Financial Conglomerates Directive, should, together with the holding company regime introduced in the Finance Act 2004, put Ireland firmly in the short-list of jurisdictions being considered as a location for financial conglomerate holding companies, and indeed, holding companies generally, Kevin Allen writes.
The Financial Conglomerates Directive is due to be transposed into Irish Law by the 11th August 2004, for application post 1 January 2005. The Directive addresses perceived gaps in the supervision of large financial groups. The principle purpose of the Directive is to ensure that financial conglomerates have sound capital adequacy policies that address the specific profile of the Group as a whole.

Under the current reggime it is possible to have an adequately capitalised financial service provider that complies with its individual sector rules being held by a highly leveraged holding company which does not have to comply with capital adequacy requirements.

In addition, there is also the potential for a firm artificially increasing its capital base through double counting of capital adequacy requirements as a result of the sectoral nature of the current regime.

Other regulatory challenges that arise by virtue of the sectoral nature of the existing regime are in the areas of monitoring risk concentrations and intra-group transactions that could have an adverse effect on a Group’s solvency. The new Directive addressed these issues also. It aims to ensure that financial conglomerates have sufficient capital to cover the undertaking of the Group as a whole and sets out the methods by which the solvency of the Group needs to be calculated.

A principle tenet of the Directive is the appointment of one EU regulator as co-ordinator. The co-ordinator will act as a cross sectoral lead supervisor to exercise supplementary supervision over and above that implemented by individual competent authorities.

As approximately one third of European deposit taking business is carried out by financial conglomerates, and almost one quarter of life assurance business, it is clear that this Directive will have significant impact. Whilst the Directive lays down general principles it will be interesting to see to what extent all of the European authorities will agree on day to day implementation of rules without feeding a regulatory arbitrage regime.

Where there is change there are also opportunities and this is particularly so for Ireland in the context of being able to attract entities to establish here. One area where opportunities could arise for Ireland are the rules in the Directive which address the supervisory regime that should apply to conglomerates that have operations both in Europe and outside Europe. Where business is domiciled outside Europe the Directive expects the non-European business to be adequately regulated and supervised. This does not mean that the exact same requirements as are imposed in Europe need to apply but the Directive does set down tests to challenge whether non-European jurisdictions do actually impose adequate regulation. Before considering what opportunities might exist for Ireland lets look at exactly what is meant by a ‘financial conglomerate’.

What is a Financial Conglomerate?
The Directive applies to a group that is a ‘financial conglomerate’.
Firstly, a financial conglomerate is one that contains at least one EU regulated entity. In addition, for the Directive to apply the Group must satisfy the following criteria:

The Group’s ultimate parent is a regulated entity or, where this isn’t the case, the Group’s activities are mainly financial, i.e. the financial sector entities within the Group account for at least 40 per cent of the Groups balance sheet,
• At least one entity in the worldwide Group is in the insurance/reinsurance sector, and at least one is in the banking/ancillary banking sector, and
• The Group is engaged in significant cross-sectoral financial activity, i.e. the following ratios exceed 10 per cent: -
• The balance sheet total of each of the banking/investment and insurance sectors to the balance sheet total of all the financial sector entities in the Group and
• The ratio of the solvency requirements of each of the banking/investment and insurance sectors to the total solvency requirements of the financial sector entities in the Group.

Third country conglomerates
If the parent undertaking is outside the EU the Directive requires the regulator that would be the co-ordinator if the parent company were in the EU, to decide (after consultation), whether the regulated entities in the Group are subject to equivalent supervision. If no third country imposing equivalency, the Directive requires supplementary supervision to be applied ‘by analogy’ to the regulated entities in the EEA.

The Directive also allows alternative methods to ensure appropriate supplementary supervisory measures are imposed. Specifically the Directive allows the competent authorities to require the establishment of a holding company which has its head office in the EEA, i.e. it may require that a sub-group have an EU holding company.

This provision is interesting in light of the recent changes to Irish tax law made in the Finance Act 2004, and provides an opportunity for Ireland in respect of attracting such holding companies.

Recent tax developments in Ireland
The 2004 Finance Act has introduced provisions to make Ireland an attractive jurisdiction for the establishment of holding companies.

A Group considering establishing a holding company in Ireland to satisfy the Financial Conglomerates Directive requirements would consider the following factors:
• The absence of foreign withholding taxes on the payment of moneys to a company located in the jurisdiction
• A low rate of applicable tax
• A developed tax network providing for full credit relief
• A low or zero rate of capital gains tax on the disposal of associate companies
• No withholding tax on payments from the jurisdiction; and
• Reduced foreign tax on dividends received from the jurisdiction.

On an analysis of these factors, Ireland’s tax regime, following the enactment of the 2004 Act, provides a substantial incentive to Groups wishing to set up holding operations in Ireland.

Firstly, Ireland has double tax treaties with 42 countries with several further treaties being negotiated. The treaty network provides, generally, that dividends/interest received from those jurisdictions suffer little if any withholding tax in the paying country. Where a holding company is established in Ireland it is subject to 12.5 per cent corporation tax on trading income and 25 per cent tax on passive income.
Both rates compare favourably with other jurisdictions.

Ireland’s treaty network ensures that the Irish holding company receives full credit against any Irish tax for foreign tax suffered on dividends received by the holding company. In addition to the treaty network Ireland has a very generous system of unilateral relief. The net result should be that the Irish holding company would pay no Irish tax on dividends received from subsidiaries except in very limited circumstances.

The 2004 Act has provided a very welcome incentive in respect of capital gains tax. The capital gains tax rate up to now has been 20 per cent on disposal of shares a company holds in subsidiary companies. In order to make Ireland a more attractive location for holding companies a complete exemption from this tax arising from the disposal of shares in certain subsidiaries and assets related to such shares, such as options to acquire or dispose of such shares, has, subject to EU Commission approval, been introduced.

In addition to the positive aspects of Ireland’s tax regime, the country is noteworthy for not having controlled foreign corporation legislation, and the existence of only limited thin capitalisation and transfer pricing rules.

Ireland has a treaty network and domestic provisions, which in most cases result in a zero withholding tax rate on payments from Ireland to other jurisdictions. Many of Ireland’s treaties, and the domestic law of the foreign jurisdiction, have the effect that little, if any, foreign tax is paid on dividends received from Ireland.

Ireland certainly meets the criteria laid down for an ideal holding company regime. It is likely that the recent legislative changes will put Ireland firmly in the short-list of jurisdictions being considered as a location for financial conglomerate holding companies, and indeed, holding companies generally.

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