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Saturday, 13th April 2024
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Foreign tax credit relief - is our progress sufficient? Back  
The 2007 Finance Act made welcome changes to Ireland's foreign tax credit regime in respect of foreign taxes paid by branches and foreign capital gains tax suffered in certain jurisdictions. There remains some scope for improvement however, if we are to maximise Ireland's attractiveness, in particular, as a location for headquarter companies.
Introduction
The introduction of a unilateral form of foreign tax credit relief for taxes paid by foreign branches, together with the introduction of a pooling system for such credits, improves the attractiveness of Ireland as a location for headquarter companies. Unilateral credit relief introduced for capital gains tax suffered in certain countries whose tax treaties with Ireland may not grant such relief is also helpful. These represent further steps in a process of reform and improvement of Ireland's tax credit regime. The reform has been piecemeal however, with the Department responding to particular requests and events. The result is very complex legislation.

Foreign Branch Income
Finance Act 2007 extended double tax credit relief to foreign tax suffered by foreign branches of Irish resident companies which are not located in jurisdictions with which Ireland has a double tax treaty. Irish companies were previously only entitled to a deduction for branch taxes in non treaty locations. In addition, where the foreign tax paid on branch profits exceeds the Irish tax payable in any year (e.g. because the foreign effective tax rate is higher), the excess credit in respect of taxes paid in one country can now be 'pooled' and credited against Irish tax on branch profits in other countries where those foreign taxes are not sufficient to cover the Irish tax.

Unfortunately, no provisions were made to allow any excess credits which are not used in a particular year to be carried forward to the next period despite the existence of a precedent for such carry forward in respect of similar relief introduced for dividends in 2004. This means that any unused credits for a particular period are of no value whatsoever.

The UK High Court's judgement in the Legal & General case last year confirmed that the correct limit to the amount of foreign tax credit relief, in the case where the foreign tax was borne on a trading receipt, was the corporation tax attributable to the overall income from the trade and not merely that portion of the corporation tax which could be attributed to the particular receipt. The Irish rules in this regard, although not identical to the UK, appear to be broadly similar. Yet the 2006 Finance Act introduced a turnover based apportionment method for calculating foreign tax relief which runs contrary to the method advocated in the Legal & General case. Assuming the case is not overturned at appeal, the position under Irish legislation may be open to challenge following this case.

Furthermore, the 2006 Irish changes may worsen the position in relation to Irish entities with foreign branches. Where such entities previously calculated double tax credit in relation to branch profits using a direct apportionment basis, where appropriate, the credit will now be calculated by reference to tax on a portion of overall profit, which includes therefore an allocation of domestic expenses and may result in a reduced credit being available. This would seem to be contrary to treaty provisions which tend to refer to profits and do not require domestic expense apportionment. This remains an issue though the situation has been alleviated somewhat with the introduction of pooling this year.

Dividends
Provisions for onshore pooling in respect of taxation of dividends were introduced at the same time as the participation exemption for capital gains in 2004. Prior to this, the withholding tax attaching to a dividend could not be used to reduce Irish tax arising on other foreign dividends received. Finance Act 2004 changed this and allowed an Irish company to aggregate all of the credits on foreign dividends received to be set off against the Irish tax arising on these dividends. Excess credits can be carried forward to future years. The relief is only available for a company that is related to the parent company i.e. one which has a 5p.c. direct or indirect relationship in terms of voting power and the ordinary share capital of the company. Such dividends are chargeable to tax in Ireland at 25p.c., given their non trading nature, though the implication of the recent European Court of Justice('ECJ') FII judgement seems to be that Ireland should either abolish the 25p.c. rate and tax foreign dividends at 12.5p.c. or not tax them at all, treating them in the same way as domestic dividends. (These points were dealt with in February's edition of Tax Monitor).

Interest
The 2006 Finance Act introduced onshore pooling in respect of certain interest received from particular associated companies in double tax treaty countries provided the interest is taken into account in computing the recipient's trading income. This arrangement is similar to the dividend pooling regime. Where in any accounting period, the foreign tax exceeds the Irish tax in respect of a particular source of foreign interest income, the excess is now allowed to be offset against Irish corporation tax on other similar qualifying interest income taxable in the period. Unfortunately, like the new branch regime, no provision is made for carry forward of excess credits.

Royalties
Given onshore pooling has been introduced in relation to dividends, interest and now branch business profits, there would appear to be a gaping omission in the area of royalties. While certain reliefs do exist in this area, software development companies can justifiably feel hard done by in relation to the pooling issue. A speedy resolution of this inconsistency would be welcomed by this important sector.

Capital Gains Tax
The recent Finance Act also introduced unilateral relief in respect of capital gains tax ('CGT') for both companies and individuals in respect of gains arising in countries with which Ireland has a double tax treaty which was in place prior to the introduction of CGT in 1975. The countries in question are listed in the legislation. There has been debate over the years as to whether relief was already available under the treaties in question. Now, the credit is explicitly provided for under domestic legislation. This is welcome but the matter may soon be clarified anyway by a case before the courts on the point. There is still no unilateral relief in respect of gains arising in non treaty jurisdictions.

Ireland already has a form of participation exemption since 2004 to exempt gains arising on the disposal of subsidiaries, by Irish resident companies, from CGT provided certain conditions are satisfied, for example the subsidiary company must be resident in a relevant territory, which includes the EU and countries with which Ireland has a double tax agreement. If the conditions for this participation exemption are not met, reliance can be placed on the new provision to at least secure double tax relief for overseas CGT against the Irish CGT.

Double Tax Treaties
This year's Finance Act also made legal changes to the procedure for bringing double tax treaties into force. All treaties must now be formally enacted in the Taxes Consolidation Act 1997 after the treaty has been agreed and signed, before it will be considered to be brought into force. Ireland currently has 44 treaties in force which is well behind some of our competitors, such as the Netherlands for example. Any development that further slows the process of getting treaties in place is not very helpful and reinforces the need to urgently advance with concluding the current target list of treaties. Areas of focus should be Asia and South America where we have notably few treaties.

The Big Picture?
Double taxation is inherently unjust and not well tolerated by inward investors. In principle, the source country where the asset is located has the prior right to tax. The country of residence of the owner of the foreign asset must therefore give way to some extent. Our whole economic development is based on encouraging inward investment rather than maximising tax squeezed out of indigenous activity. Our double tax credit regime needs to support this philosophy.

We have made significant progress in relation to our double tax relief provisions over recent years. Addressing the specific points mentioned above would further enhance the appeal of Ireland for head office activities. Furthermore, we need to take stock of recent developments at ECJ level and consider the case for reducing the domestic corporate taxation of foreign dividends to 12.5p.c. or extending the domestic exemption to such dividends. This would be simpler than the current unilateral tax credit regime. It would also be useful to revisit some of the complexities of the current turnover based apportionment method introduced last year to calculate double tax credit relief for trading income and consider whether credits should only be limited by reference to the tax chargeable on the overall income of the trade, in line with the Legal & General case.

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