| The issues in taxation in 2006 will include EU moves at tax harmonisation by the back door, growing concerns about an expanding black economy, judgements from the European Court of Justice of particular significance to Ireland, and an increasing awareness of the dangers to our prosperity of ill-informed comments in the domestic media; and we may also expect what the late Harold Macmillan referred to as “events” ie the unexpected. |
Tax harmonisation
The EU is steadily moving forward with its “base harmonisation” project. This purports to offer to companies operating in the EU, the prospect of pay and file in one member state only on the basis of a single set of computational rules. Inevitably it requires that the resulting revenue be shared between the member states in which the taxpayer operates its business, or from which it derives income.
 | | Brian Daly, Editor, Tax Monitor |
The stated logic for this ambitious programme is that it would reduce the regulatory burden on business in terms of its obligation to make tax returns and payments. However the EU Commission show no corresponding concern in the areas of taxation which is wholly or partly harmonised at an EU level, - VAT, Capital Duty, Insurance Premium Tax, Customs Duty, and Excise Duties. There is no similar proposal to reduce the number of returns and payments to be made under the heading of any of these taxes, notwithstanding that the regulatory burden of making returns for, eg, VAT must surely outweigh the burden of making a once a year return in respect of corporation tax.
Base harmonisation is widely seen as the first attempt at corporation tax harmonisation across the EU and a prelude to an assault on the right of member states to fix corporation tax rates. This is firmly denied by the EU Commission.
Our 121⁄2 per cent corporation tax rate is an important part of our economic policy and has contributed enormously both to our tax revenues and to our economic prosperity. One day we may have to face up to the fact that being popular in Europe, while generally pleasant and useful, is something that may have to be sacrificed when our critical interests are at stake. The EU has evolved long past the point where the three or four large members can threaten to expel a minor member which makes inconvenient use of its rights of veto. An approach that had credibility in an EU of twelve members does not in a community of twenty-five members.
The other side of the EU
While the EU Commission has set out on a path that ultimately could limit tax competition within the EU, the European Court of Justice continues to interpret the existing treaties between the member states in a manner which is dismantling the obstacles to tax competition. In 2006 we may expect judgements from the ECJ on the legality of controlled foreign company legislation, and on the legality of “franked investment income” regimes in the EU.
It seems likely that the right of member states to maintain controlled foreign company (CFC) legislation will be severely restricted but perhaps not totally outlawed. This will be good news for Ireland in that it will oblige the UK in particular to remove the obstacles which prevent UK firms from transferring operations to Ireland.
Ireland’s franked investment income regime exempts domestic dividends from further corporate taxation notwithstanding the foreign dividends remain subject to corporate taxation. The ECJ is likely to outlaw such discrimination, notwithstanding that the EU Commission, in its comments on the case taken on the point, argue in favour of a retention of such discrimination. Foreign dividends do not yield any great amount of revenue in Ireland due to the availability of foreign tax credits, and the fact that corporates are not obliged to repatriate income from their foreign subsidiaries. Ireland can accommodate an extension of the domestic exemption on dividends to EU source dividends without difficulty.
If other member states react to the ECJ decision, should it require the ending of discrimination, by extending their domestic exemptions to all EU dividends, that move would increase the attractions of Ireland as an investment location for firms within the EU, since the low taxed Irish income could be repatriated tax free. However there is a risk that if the ECJ outlaw discrimination between domestic and foreign EU dividends, member states may abandon domestic exemptions and replace them entirely with a credit system.
The black economy
The Revenue Commissioners are reported to fear widespread tax evasion in the construction industry. Anecdotal evidence might suggest that there is evasion on the fringes of the industry, especially in relation to small once-off contracts or refurbishing and extending residences. It would be surprising if there is any widespread evasion in the core of the industry, where there are large contracting firms involved. Unfortunately there is a risk that the focus of Revenue attention will be precisely on that sector.
Modern construction methods require widespread use of sub-contractors. Relevant contracts tax (or sub-contractors withholding tax as it is sometimes known as) is an important control mechanism used by the Revenue to police this area. It provides the Revenue with a complete audit trail of all payments within the industry and should make evasion very difficult and unlikely to be widespread as suggested.
Relevant contracts tax is a complex tax, operating at the penal rate of 35 per cent of gross turnover, where the necessary certificates are not in place. Any failure by a contractor to properly operate this system can have disastrous consequences for the contractor who can be faced with a huge tax liability notwithstanding that the contractor’s own tax affairs are in order (and in some instances, notwithstanding that the sub-contractor’s tax affairs are also in order!).
It is to be hoped that the Revenue Commissioners’ are not going to focus on this tax, whose rate is astonishingly high, and the burden of which falls on the compliant contractor, and not on the sub-contractor which the tax is intended to police.
It is possible that we have already seen some fallout from the Revenue’s current concerns with the construction industry in the shape of the restrictions announced in the budget in relation to the remittance basis of taxation, which is applied to those newly arrived in Ireland. This basis of taxation may have been utilised (possibly quite legally) by immigrants employed in the construction sector. Given that these immigrants are not entitled to the full range of social welfare and social security that Ireland provides, perhaps we should be more tolerant of migrants availing of a legitimate tax.
Damaging ourselves
Our prosperity is recent, and fragile. We have so rapidly become accustomed to full employment that even those of us who lived through the 1980’s and early 1990’s can now hardly recall them.
Inward investment has been central to our prosperity. It is therefore frightening to find the irresponsibility with which parts of the media have commented on the attractions of Irish taxation policies for US multinationals. These comments have been quickly echoed in comment in the USA media. To an outsider, it might seem that we have a suicide wish.
May we all have a prosperous 2006! |
Brian Daly is a partner in financial services at KPMG
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| Article appeared in the January 2006 issue.
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