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Action is needed on post-IFSC regime Back  
The end of 2005 will see the international financial services companies move out of the IFSC tax regime into the normal Irish tax regime. Many of the features of our normal tax system which will apply post-2005 need to be amended to ensure our tax system firstly remains attractive, in particular to the group finance, treasury and asset financing sectors, and secondly doesn’t fall foul of EU anti-discrimination provisions.
The key provisions which need attention are:
• interest withholding tax regime,
• deductibility of trading interest and,
• the ring fence on leasing losses.

The Department of Finance are currently being actively lobbied by industry representative organisations, industry itself and ourselves to make changes in these areas. It is essential in my view that the same vision which saw the tremendous development of the international financial services community in Ireland is repeated at this critical time so the key components of our international financial services industry can continue to thrive and grow.
Brian Daly, Editor, Tax Monitor


This article will focus on the legislative changes needed in the Finance Bill 2006. Topics such as the practice on the ground in relation to ‘trading’ i.e. what is considered to be trading income or not, and the treatment of branch to head office supplies from a VAT point of view are also critical matters of relevance to the attractiveness of Ireland as a location for international financial services activity. We will deal with these latter matters in a subsequent article.

The international financial service industry in Ireland has grown enormously in its size, sophistication, international stature, and tax revenues generated.

This achievement was brought about by action by the Department of Finance to remove or adapt many of the tax rules and restrictions that had accumulated over decades and which had been adopted in the context of a purely domestic financial service industry. Without this proactive role of the Department of Finance, the international financial services industry would have been stillborn, or indeed never conceived. The Department now needs to respond in a similar manner to ensure that the success can be continued. This must all be done in a way which will allow the overall Irish tax package to be satisfactory in an EU context.

The financial service industry matters more than the jobs, revenue, and taxation it generates. On the world stage it has given credibility to Ireland as a high skill, high education, modern society. That change in international perception of Ireland has been one of the keys to the ability of the IDA to credibly market Ireland as a location for high tech knowledge based industries, for example in the pharmaceutical and in the IT areas. Financial services matter to Ireland in one other respect. Other industries rise and fall in their importance in the world economy, and in their growth potential. But financial services have represented a critical industry in Europe for over a thousand years. For as long as the world has an economy, financial services will be a key element. Treat it kindly, and it will last, safe from the obsolescence that can afflict all other industries.

The threat and the opportunity
The financial service industry in Ireland today is an international industry. Cross border payments and receipts are absolutely critical to its existence and indeed are the rationale for its existence. Tax rules have to be accommodate such cross border flows of moneys without creating artificial obstacles and costs in relation to the flows. Otherwise the flows won’t happen and the industry will go elsewhere.

There is a need to balance possible costs of removing restrictive rules, against the opportunities that exist for growth in tax revenues, in employment, in Ireland’s reputation, and in prosperity.

Key issues
The payment and receipt of interest are every day routine occurrences for a financial service industry. It is important that foreign recipients of interest should not be exposed to Irish withholding tax, or Irish liability to tax, on interest paid from Ireland. It is equally important that interest paid as a cost of the financial service industry should be deductible in computing its taxable profits. Unfortunately these basic requirements for a financial service industry will not be present, based on existing law, on 1 January 2006. These are not issues that can be fudged. They are fundamental.

Withholding tax exemption
Ireland imposes a withholding tax on Irish source interest (other than short term interest). It then lifts that obligation to withhold from a myriad of different transactions and persons. The exemptions have been built up over the years, reflecting special needs at different times. The patchwork of exemptions falls short of what the financial service industry needs. In particular withholding tax, and technical liability to Irish tax, continues to apply on interest payments by treasury management companies, when made to many jurisdictions where multinationals operate, and from which a treasury management company may borrow from an associated company.

We don’t have the option in the long term of leaving the present rules as they are. It takes no more than a glance at those rules to see that many of them are open to challenge as regards their compatibility with EU law. They are replete with references to persons carrying on business in the State paying interest, or to the recipients of interest being resident in certain places, or to the borrower or lender in a transaction being in certain industries. All such references are sensitive in the context of EU law.

As an alternative to the total abolition of withholding taxes, consideration could be given to ensuring that interest paid to persons resident in EU or Treaty states (including states we are negotiating new treaties with) or controlled by EU or such Treaty residents would be exempt (as was done in the dividend withholding tax area), whilst retaining the blanket exemptions in areas such as banking, securitisation and quoted Eurobonds etc. This may in package terms be more acceptable in an OECD/EU context, and would satisfactorily deal with the EU discriminatory aspects of the current regime while substantively dealing with the needs of the international financial services sector.

Technical charge to tax
It would logically follow from the alteration of our interest withholding tax regime as outlined above that the liability to Irish tax on Irish source interest paid to a non-resident should likewise be altered so that the charge does not arise where the withholding tax exemption is available. Its retention in its current form would be open to the same objections as the withholding tax - that it inhibits the growth of an industry while yielding no revenue whatever. The retention of a technical charge when an exemption from withholding tax is available also has the capacity to bring the Irish tax system into disrepute for failing to pursue the collection of taxes that it is technically owed but has no practical means of collecting.

Interest deductibility
Our 12.5% corporation tax rate on trading income is the main plank of our tax regime to attract inward investment generally, and to promote the growth of the financial service industry. But 12.5%, when levied on a multiple of economic profits can represent an effective rate of 25%, 37.5%, or indeed of close to 100%. If real commercial costs of earning income are not deductible in computing taxable profits, the 12.5% rate becomes meaningless in terms of being an incentive to locate in Ireland. Interest is an inevitable cost to a financial service industry. It is a cost no matter to whom paid. Treasury management in particular cannot be carried on if interest paid to non resident associates is to be disallowed in the tax computation. One might as well introduce a law prohibiting treasury management companies from operating. The result is not to increase tax revenues. It is in fact to decrease tax revenues by entirely eliminating commercial transactions in that area. The treatment of interest paid to non resident associates, as a distribution and hence as non deductible in computing taxable profits, has to be ended. The current distribution rules are far too crude and can lead to double taxation and are inappropriate for an international financial services tax environment. Creative thinking to come to an acceptable framework is important - use of the EU/Treaty resident or controlled concept referred to earlier in the withholding tax area might be also worth consideration here.

Leasing ring fence
Just as the disallowance of interest expense in computing taxable profits results in tax on non existent profits, so too the various ring fences on leasing losses can result in an effective tax rate, as opposed to a headline tax rate, far in excess of 12.5%. If we think a 12.5% corporation tax rate is necessary to encourage investment in Ireland, why do we suppose that potentially a multiple of that rate will be effective in encouraging big ticket leasing in Ireland? The logic that it will discourage such big ticket leasing in Ireland is unavoidable. The elimination of the ring fence will not create EU concerns as it will merely put the leasing sector on the same footing as all other sectors of the Irish economy i.e. tax losses generated by claims of capital allowances can be offset against the same income irrespective of what sector the companies are involved in. If the leasing ring fence issue is resolved by widening the definition of leasing income so as to include all asset financing income, it will equally not create concerns at an EU level because all that will be happening will be that the 1984 (pre-IFSC regime) ring fence rules will continue to discriminate against the leasing sector in terms of how they can use tax deductions and capital expenditure, as compared to how non-leasing companies can use capital allowances, but that discrimination will be less significant than it would otherwise be. A less discriminatory regime for a particular sector can hardly be described as being a State aid.

Concluding comments
In looking at withholding taxes on interest, deductibility of interest, and leasing ring fences, we are really asking ourselves, ‘do we want Ireland to be a major centre for treasury management and for big ticket leasing? Even though doing so will yield us almost no tax revenues from other sources, do we wish to kill off these sectors?’ Even if, incredibly, the answer were ‘yes’, we should not forget that you cannot kill two of the principal pillars of an international financial service industry and hope that the remaining sectors will flourish unaffected. Financial services are about dealing in money and providing money related services. You need the flexibility to deal with money through all forms of techniques and transactions and with all forms of customers, or you are not in the business. It is as reasonable to expect a bank that cannot provide credit cards, or cheque books, or electronic banking to flourish nonetheless, as it is to expect a financial service industry that cannot provide big ticket leasing or treasury management, to be a major success.

What we do now in providing a sensible tax regime for the financial service industry nationwide has implications beyond the financial service industry. The IFSC success created a positive international image for Ireland. If we now permit the industry to be seriously damaged, the message which will go out to multinationals in other sectors, whether they be telecommunications, software, nanotechnology, - would be that we may not be as business friendly and as stable in our attitudes to business as had been believed. A country is only as good as its last success, or as bad as its last failure, when it comes under the review of mobile investors.

The big picture
The Department of Finance, and the industry, are faced with a great opportunity to extend and grow the astonishing success that their predecessors created in the Dublin docks. Doing nothing is not an option. Change will occur whether we like it or not. We have the choice indeed the obligation vis-?-vis ensuring our regime is EU compliant to make changes in our tax rules, or watch changes occur in the financial service sector, and in our national prosperity. Making a decision on change is not easy but it is best done by taking a broad view of the sector and of its needs, and by putting in place at one time a complete package of measures to sustain the industry, rather than introducing change bit by bit. It is time to focus on the big picture.

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