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Recent ECJ judgements have implications for Irish corporation tax rate Back  
The two most recent ECJ judgements on the topic of cross border dividends have implications for Ireland's 25 per cent corporation tax rate. They also extend tax credit entitlement to all foreign dividends and appear to extend an exemption from tax on Irish dividends to non resident corporates, writes Brian Daly.
Franked Investment Income - FII - is the name given to the exemption from corporation tax that is granted to dividends from Irish resident companies when received by an Irish resident company. A similar exemption does not extend under domestic law to dividends received by an Irish resident company from a company resident outside of Ireland, nor to every non resident company which receives an Irish dividend.
Brian Daly

A broadly similar system applies within the UK. Their system additionally grants a credit in respect of corporation tax paid by the company making the distribution to the recipient of the dividend, especially where the recipient is liable to income tax on the dividend. To ensure that such a credit is given only where equivalent tax has been paid by the distributing company, that company has to pay advance corporation tax (ACT) in the amount of the credit attaching to the dividend, and may offset the ACT against mainstream corporation tax liabilities.

That is a simplified account of the ACT system which has complex rules dealing with interalia intra group dividend payments and dividends paid from income consisting of overseas dividend income. Ireland abolished its ACT regime and the associated tax credits on Irish dividends several years ago.

Two recent judgements from the ECJ have challenged these two tax regimes. One challenged the exemption granted to domestic dividends, in contrast to the lack of an exemption for foreign dividends. The other case challenged several aspects of the ACT system insofar as they appeared to discriminate unreasonably between domestic dividends and foreign dividends in the context of ACT.

Franked Investment Income (FII)
The ECJ concluded that the FII exemption system and the taxation of foreign dividends received by a resident company, with credit given for both withholding taxes and underlying taxes, both were regimes which had the common purpose of ensuring that a dividend did not attract multiple charges of tax over and above the corporation tax already paid by the company which paid the dividend. Either was an acceptable system and provided they both achieved the same result, a member state was entitled to apply the FII system to a domestic dividend and the taxation with credit system to a foreign dividend. There was no unlawful discrimination provided the end result was much the same in both cases.

It might be thought that that result was of little relevance so far as Ireland was concerned . Broadly, Ireland has the dual systems that the ECJ appeared to sanction. But there was a vital though obscurely expressed qualification to the ECJ approval. It required that the tax rate applicable in a domestic context be the same rate as applied to the foreign dividend. This condition was expressed in response to an argument that a domestic exemption for a dividend was available whether or not the profits being distributed had in fact borne tax, whereas the foreign dividend avoided double taxation only to the extent that it had in fact borne foreign withholding tax and to the extent the profits being distributed had borne foreign tax. Prima facie that represented discrimination that would be unlawful. But the ECJ said that provided the domestic tax rate was at least as high for the paying company and the recipient company of a dividend, any underpayment of tax should be exceptional and could be ignored when evaluating a tax regime.

Ireland applies a 25p.c. tax rate to a foreign dividend received by a resident company. It is only if the foreign tax borne amounts to at least 25p.c. that no Irish tax will arise on the dividend. On the other hand most resident companies pay tax at a rate of 12.5p.c. (or an effective tax rate of 10p.c. in many cases). Dividends from a resident company are exempt in the hands of another resident company notwithstanding that the tax rate borne on profits being distributed is significantly less than the tax rate that would have applied to a dividend had it not been exempt. Clearly the Irish tax system does not meet the ECJ condition, even though the UK system (with a single corporation tax rate for the most part) may do so.

One of the implications is that Ireland must either grant an exemption to foreign dividends in the hands of resident companies, or reduce the corporation tax rate on such dividends to 12.5p.c. The latter course might be the best if it leads to a decision to abolish the 25p.c. rate entirely. This would be a beneficial move generally because the higher rate hasn't produced much revenue but has caused much confusion and concern in the financial services sector on the question of what is trading and what is not.

A second implication of the ECJ judgement as applied to Ireland is that companies which may have paid corporation tax at the 25p.c. rate on foreign dividends (whether from subsidiaries or from shares held as portfolio investments) may be entitled to claim a refund of the tax with interest. Such a claim may go back as far as 1973, were records available for that far back. The claim would extend to world-wide dividends in cases where the shareholding in question did not confer ability to interfere with management and not only to EU source dividends as the freedom of movement of capital extends to world wide investments. However where the shareholding was eg in a subsidiary, the claim may be limited to EEA source dividends since in such a case it is the freedom of establishment which is breached and it is confined to EEA companies.

Other conclusions
The discussion above is based on the judgement in the FII case. The ACT case judgement has less significant implications for Ireland, as we abolished ACT several years ago and it never presented as much difficulties in Ireland as it did in the UK. However there are two comments by the court that may have some implications for Ireland. One comment suggested that a non-resident company, no matter where resident, was entitled to the same exemption from Irish tax on an Irish dividend as was an Irish resident company. This would seem to mean that no withholding tax could be applied to such a dividend.

Another comment appeared to suggest that an Irish resident company was entitled to be exempt from tax on a foreign dividend if it were paid from income that in turn consisted of a dividend from another Irish resident company. This situation is not likely to arise frequently in practice.
The FII case may also mean that Ireland's unilateral tax credit on foreign dividends, may have to be extended to portfolio dividends. At present it is available only where the resident company in receipt of a foreign dividend has a minimum 5p.c. shareholding in the company which paid the dividend. Such a limitation would seem to be contrary to EU law since there is no similar condition applied to FII on domestic dividends. This may give rise to claims for repayment of tax on such portfolio dividends.

Think of the economy
The typical initial reaction to a judgement of the ECJ in favour of a taxpayer may be to seek to limit the advantage to the taxpayer. But Ireland is not typical and it did not give birth to the Celtic Tiger by being typical. The 25p.c. corporation tax rate is an anomaly and by limiting the attractions of Ireland to activities that are unequivocally trading, it scarcely helps us to attract new investment based on intellectual property and new knowledge. We should grasp the nettle presented by the ECJ's FII decision and abolish the 25p.c. rate in the Finance Bill 2007.

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