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Financial transactions and the Budget Back  
Some of the measures proposed by the Minister relating to relief for interest payments seem misguided. The proposals relating to ring-fences on capital allowances need to be fleshed out but are welcome in principle. Many important measures required by the financial service industry in the context of the ending of the IFSC regime are left in limbo. The abolition of capital duty, while welcome, should not distract from these facts.
Relief for interest - property
The Minister announced two measures impacting on relief for interest payments. The first measures denies relief for interest payments made on or after budget day by individuals in respect of loans, where the borrowed money is used to invest in, or lend to, a company whose income is principally from Irish rental income. In practice that relief, now being eliminated, was also available where companies earned rental income in other EU Member States.
Conor O'Brien

The loose drafting of the relief (which is quite old) lent itself to being used for investment in companies which, notwithstanding that their income was principally from rent, were not using the funds mainly for the purpose of earning that rental income, but were using it for other purposes. It would not have been surprising had the Minister chosen to amend the legislation so as to ensure that the relief was available only where the funds invested in a company were employed in acquiring rental income properties. The measure actually taken by the Minister, of entirely abolishing the relief, makes no sense at all.

If a company goes out and borrows money to purchase a rental property, it will obtain tax relief against the rental income for those interest payments. If instead the owner of the company borrows money, then lends it to the company, and the company employs the money to purchase the rental property, neither the company nor the individual will now obtain relief for interest payments on the borrowing. What policy is the Minister pursuing in deciding that the borrowing must be by the company, but not by the individual for on-lending by the company? If there is a policy, it has not been stated.

It must be borne in mind that rental income arising in the company would be taxed at 25p.c. initially, and would be subject to a further 20p.c. surcharge (which brings the overall effective tax rate to approximately 40p.c.) unless the rental profit is distributed as income to the shareholder within 18 months of the end of the accounting period in which it arises. In practice the shareholder will usually need taxable income so that he can finance the payment of the interest in any event. An individual who borrows as a means of financing the rental income company is not likely therefore to achieve any effective minimisation of tax by claiming a personal tax relief on the cost, while the related income lies within the company.

The tax relief was available not only where borrowed moneys were used to subscribe for the share capital of a rental income company, but also where they were used to purchase the share capital of an existing rental income company. This is where the measure may have the sharpest impact. Where a property is held within a company, a vendor will often be unwilling to sell the property, but will offer only the shares in the company for sale. In doing this he will be seeking to avoid a double charge to capital gains tax on the realisation of his investment (one charge on sale of the property by the company, and a further charge on liquidating the company). From the viewpoint of a purchaser, the stamp duty cost of acquiring shares will usually be one ninth of the cost of acquiring the property directly. If the Minister proceeds with his proposal it will become more difficult to carry out transactions for the sale of the property owning company in this fashion, as borrowings to acquire the shares will no longer attract tax relief.

If it were this particular situation that the Minister had in mind (and we have no reason to believe it is), it would not have been necessary to entirely abolish the relief not only in respect of the purchase of shares, but also in respect of the subscription for new shares.

Overall, this looks like a poorly thought out measure which may have been foisted on the Minister without proper consideration, and certainly without consultation with the property industry.

The measure has implications for the financial service industry in considering the security of funding arrangements for property transactions and investments. The new measure does not apply to loans already in existence on budget day.

Interest in groups
The second measure proposed by the Minister is a further restriction on interest relief available to a company where the interest is paid to another group member, and is on borrowings used to finance an intra group transfer of shares. It is stated the measures are not intended to impact on “legitimate commercial” transactions.

There are two ways of looking at this matter, and it is not certain that the Minister has chosen the right way. This interest relief is capable of being used, as described by the Minister, in the context of a multinational group, to minimise its total tax exposure in Ireland. Is this a bad thing? To the extent that the Minister appears to lose taxes, he might say it seems to be a bad thing.

But Ireland in reality is competing for inward investment. It has been progressively forced from a zero rate of tax (export sales relief) to a 10p.c. rate of corporation tax (manufacturing relief) and now to the standard trading income rate of corporation tax of 121⁄2p.c.. None of these increases were adopted by reason of domestic considerations. They were adopted under pressure from the EU, and to bring our tax law into conformity with EU law. If there are aspects of our tax code which can produce an effective lower tax rate than 121⁄2p.c. for a multinational operation in Ireland, and if that is not in breach of EU law, is that a bad thing? Does the Minister necessarily lose tax as a result, or does an increase in inward investment actually increase his overall tax take?

Subject to seeing the detailed legislation it may be argued that the Minister could damage one of our remaining flexible tools for competition for inward investment, in an apparent outburst of fiscal righteousness.

The remittance basis
Ireland’s economy has grown not only on the back of the undoubted talents of Irish entrepreneurs and graduates, but also because of our ability to attract in seconded expatriates for multinationals located here. If talented top managers of multinationals are reluctant to come to a tax jurisdiction, the multinational is less likely to invest there. Our remittance basis of taxation has been a major tool in the attraction of inward investment.

This regime was first damaged by the previous Minister, Mr McCreevy, when he extended capital acquisitions tax to expatriates in the country after five years’ continuance residence. The Minister has compounded that error by the proposed limitation of the remittance basis in relation to duties exercised in Ireland. The justification given is “equality”. If you pose the question “why should the expatriate sitting in the office next to an Irish worker pay less tax on the same salary than the Irish worker?” there is a simple answer. It is because that lower tax may have influenced the multinational to locate here to give the Irish worker his job and his office in the first place.

“Equality” in the real world is not associated with prosperity. It is associated with poverty. We should aim at equality of opportunity in our economy, but our economy will be prosperous only if it is willing to tolerate inequality of outcome.

Ring fence
The Minister’s statement that he would partially relax the ring fence on leasing capital allowances is encouraging in that it is a response to submissions over several years. But little detail has been given as to the nature of the proposed relaxation, and the language used is guarded. The reasonable request from the financial services industry has been that all of the income from a financial service trade should be treated in a similar manner, and that the costs and outcomes of all transactions in the trade should be taken together for tax purposes. It is artificial to isolate leasing transactions out of a financial service trade, and to ring fence the tax losses from those transactions from the taxation of the financial services trade overall. However provided the definition of income ancillary to leasing is drafted sufficiently widely and flexibly, the outcome may satisfy the industry.

End of IFSC
The IFSC tax regime is finally closed down at the end of 2005. Much progress has been made in adapting the tax regime which supported its growth, to the needs of a nation wide financial services industry. But on budget day where were several important measures awaiting the Minister’s decision. The Minister’s silence on those measures is disquieting. Possibly the most important of those measures was the need to introduce a unilateral and comprehensive exemption from withholding tax and from liability, and deductibility for the payer on interest payments to non-residents. If the Minister intends to take action in this area, it is critical that the decision be known ahead of 1 January 2006 since interest payments which are currently exempt from withholding tax will become exposed to it on that date.

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