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Wednesday, 17th April 2024
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20 years - what a difference tax makes! Back  
Tax policy has been central to our economic turnaround over the last 20 years and the IFSC regime has fundamentally changed the whole Irish tax landscape. Let's reflect on how this success story unfolded and how a new chapter can be written for the next generation.
Introduction
Cast your mind back to 1987. You may recall handing more than half of your hard earned salary over to the Exchequer. Nowadays, a marginal income tax rate of 58p.c., top corporation tax rate of 50p.c. and capital gains tax rates varying between 30p.c. and 60p.c. seem inconceivable. Yet they existed, and higher rates before them, and it's not that long ago. To what extent did the radical tax changes which have subsequently taken place shape the economic turnaround of the last 20 years? To what extent did the IFSC change the tax landscape? What role will tax policy play in shaping our future economy? I may not be able to answer all those questions here but perhaps I can give some food for thought.

Setting the scene
The 1980s was the decade with the second highest emigration since independence of the State. Ireland was bleak. Political debate centred on unemployment and calls for 'jobs creation' and views differed on whether and how to solve the big issue of the 'tax wedge'. The tax wedge represents the difference between labour costs to the employer and the corresponding take home pay of employees. The larger the wedge, the greater the disincentive to work. Who would have predicted that a 2005 survey would show Ireland having the lowest tax wedge in the EU and the second lowest in the OECD?

The late 80's brought a turning point. The Culliton report, published in 1992, highlighted the issue of the tax wedge. The concept that low tax could lead to economic growth which would generate the resources to tackle infrastructure and social deficits was born. The dramatic fall in tax rates applying to income and profits had a pivotal impact on the economy. So too did the development of the tax regime governing international financial services activities and the property tax regime with its plethora of incentives.

IFSC - changing the tax and economic landscape
The establishment of the IFSC and its 10p.c. corporate tax rate in 1987 gave birth to Ireland's international financial services industry. With it came a sense of vigour and enthusiasm which retained some of the country's best young talent, fuelling rejuvenation in every aspect of society. Today the industry continues to prosper and is now critical to the country's overall continued economic wellbeing. Total employment in the three core sectors of banking, funds and insurance achieved record growth of 16p.c. in 2006. Former IFSC companies contributed over €1.1billion in corporate taxes in 2006, which was the first year in which they were all taxed at 12.5p.c.. Since the standardisation of the corporate tax rate to 12.5p.c., the international financial services industry has spread to centres throughout Ireland, spreading its benefits beyond Dublin.

The advantages of the IFSC and thus the factors contributing to its spectacular success, were not only its 10p.c. corporation tax rate but also a range of secondary benefits including exemptions from adverse distribution treatment and from withholding tax on interest payments, exemption from Irish taxation of non Irish counterparties on interest income, availability of leasing losses for offset against other income, tax matching of foreign exchange gains and losses on trading assets with those on share capital funding, gross roll-up regime for certain life assurance companies, comprehensive securitisation vehicle regime etc.

The Department of Finance worked closely with industry to ensure that most, though still not all, of the critical provisions have been safeguarded in the post IFSC regime. The shortcomings have been well documented in other editions of Tax Monitor but they include the Department's failure to eliminate withholding tax on interest paid to certain overseas affiliates, to remove the technical charge to Irish tax on interest income received by non residents and to confirm the trading status of SPCs. The case for elimination of dividend withholding tax should also be considered as it acts as a disincentive to the holding of Irish shares and is no longer necessary as a means of securing the payment of income tax by Irish shareholders given the high levels of compliance.

The IFSC contributed to the build up of bodies of detailed legislation and experience in industries such as leasing, funds, insurance and securitisation where Ireland is recognised as a world player. Progress continues with, for example, the introduction of onshore pooling for the purposes of double tax relief on dividends, interest and branch profits; comprehensive unilateral reliefs; abolition of capital duty etc.

Conversely, some very damaging measures have been introduced such as the deemed disposal rules in respect of life assurance products and mutual funds and the abolition of the remittance basis. Here the Department has steadfastly ignored suggestions put forward which would limit damage whilst still achieving the core objectives. Given the external threats which we face and which are discussed later, it is unwise not to tackle obstacles within our control.

Property
No discussion on tax or economic policy over the last 20 years would be complete without reference to the role played by property based tax incentives. What started as a brave experiment had astonishing success but the jury is still out on the long term implications. Urban renewal relief introduced in 1986 in relation to Customs House Docks was the first major tax based incentive scheme and led to the IFSC. Several new schemes were approved throughout the 90's and a review of their costs versus benefits was only commissioned in 2004. By the late 90s, the government started to have concerns about overheating of the property market. In April 1998, the Bacon Report confirmed such concerns and recommended a temporary reduction in capital gains tax on development land from 40p.c. to 20p.c. to free up land for development and therefore resolve the supply shortage, after which rates were to rise to 60p.c.. The reduction was made but the subsequent increase or even reinstatement to original levels never materialised. The government initially followed the report's recommended removal of deductibility of interest on borrowings, financing residential property, against rental income but reinstated the relief in 2001. Experts differ on whether these policies should have been followed and whether prolonged incentives have contributed to over-inflation and excess supply in some areas.

Now we have come full circle and all property incentives are finally being phased out except those relating to nursing homes, hospitals and childcare buildings. General rules now restrict all benefits where the amount of the relief exceeds 50p.c. of adjusted income. The government has made a commitment to establish a cost benefit analysis and a clear planning policy to ensure any future incentives are used to support improvements in infrastructure and services going forward and, hopefully, not development for development's sake.

Credit to Revenue and Department of Finance
We are quick to criticise failures of government agencies to respond to business and society's needs. We should give credit where it is due. The Revenue Commissioners and the Department of Finance have been, without doubt, two of the most productive government agencies over the last 20 years when you consider the many challenges they have had to face. Tax compliance was poor in the late 1980s. The system was riddled with evasion. In the late 90's, the Revenue had to deal with the resultant DIRT and Ansbacher scandals. The Revenue received criticism in the wake of the DIRT tribunal etc but they were quick to react and put the necessary procedures in place.
It has been a time of unprecedented reform by the Revenue and the Department. Examples include the challenging process of consolidating first the income tax, capital gains tax and corporation tax acts and later the stamp duties acts and the introduction of the Revenue Online Service 'ROS', an entire computerisation of the income tax system and a single taxpayer information source.

Self-assessment was successfully introduced in 1988. The tax year for income tax was changed to the calendar year in 2002. The rate of return filing has increased dramatically since the advent of self assessment. According to papers issued by the Tax Strategy Group in 2000, 76p.c. of income taxpayers were then filing their returns on time compared with just over 50p.c. in 1987-88.

The rates for corporation tax also showed a steady increase in returns filing by the due date to 66p.c. as compared with 43p.c. in 1989. It is doubtful that many other government agencies have had to deal with so many fundamental changes to their governing rules and operational framework in the last two decades and they are to be commended in their response. The challenge is now to keep up these efforts.

European dimension
Our membership of the EU has been another important building block of our success when we consider the infrastructural grants received until relatively recently. Over the last few years we have begun to also see a more marked reduction in our sovereignty as regards tax affairs. EU policies signalled the end of tax favoured sectors such as manufacturing and financial services.

The influence of European policies over VAT has been longstanding but it is only since the late 80s that the impact has been felt in relation to direct taxes. As well as case law, Directives have played a major role with the Parent/Subsidiary and Merger Directives introduced in 1990, the Interest and Royalties Directive in 2003 and the Savings Directive in 2004. During the 80's the ECJ only decided a handful of cases every year whereas they began to reach double figures in late 90s.

The proposal for common consolidated corporate tax base 'CCCTB' is the current major talking point and fear from an Irish standpoint. The genesis of the European Community lay in political union to prevent war. The treaty of Rome refers to an 'ever deepening' union which some argue should lead to harmonisation of all policies. However, certain powers of veto were introduced for good reason. Any move to deny such powers would be to the detriment of smaller states.

Future role of tax policy
Thankfully, we don't talk so much about jobs creation anymore. However we should have learned from the last 20 years that our success did not come from plans to create jobs but rather from radical tax policy change which created a climate which fostered foreign investment, development and a will to work. Our experience of our low tax environment has been remarkably positive.

Economic growth was generated and tax revenues did not suffer with total tax revenue as a percentage of Gross Domestic Product increasing. We must remember that this has been heavily influenced by increases in capital gains tax and stamp duty collection on property transactions however, with top stamp duty rates higher than 20 years ago.

We face risks in relation to tax policy. The taxes which we have relied upon to generate revenue to compensate for our low income and corporation tax rates may be set to decline if the property market stagnates to any degree or, indeed, if the environment for international financial services activity in Ireland does not continue to be attractive. Meanwhile, in the medium to long term the competitive advantage generated by our low corporation tax rate may be challenged by CCCTB or by the lower tax rates of our competitors, in particular the new EU Member States. We need to take a radical look therefore both at how tax incentives in new areas can contribute to our growth and where we can compete outside of the tax arena. Critical work is being done by the Department of Finance and many other interested parties in resisting the proposals to introduce CCCTB. It is just as important that the much needed financial services tax reforms mentioned above be implemented and that we move on to focus on innovative ideas for new development.
Emphasis of the tax based incentives to date has been on encouraging property development. Now we need to consider how they can be used to foster entrepreneurialism. BES and seed capital schemes have been of limited use in this regard due to their capping. The substantial increases to limits and extension of timeframe of the reliefs to 2013 (subject to EU approval) introduced in the 2007 Finance Act are very welcome, it would be useful to see further focus on investment in higher risk ventures perhaps along the lines of the Venture Capital Trust scheme in the UK.

The Culliton report stated that the basic engine to promote employment was tax reform as in no other area did the government have such tools at its disposal. We have used these tools well. We need to face the reality that we might not have these tools as readily at our disposal in the future and we must have alternative bases for advancement other than tax.

If not tax policy, what now?
Education, communications, infrastructure, peaceful labour relations, encouragement of entrepreneurial skills and regulation will be key factors in our future success. The Financial Regulator is to be congratulated for its innovation in taking a principles based approach to regulation.

Other jurisdictions are catching up however and many of the regulatory requirements deriving from European Directives are rules based and potentially diminish competitive advantages through harmonisation.

The Financial Regulator needs to remain competitive by making authorization and consultation processes as efficient as possible. As regulation always seems to increase, perhaps the idea of introducing some form of enterprise ombudsman to take on board complaints about regulation and continually reassess what efficiencies should be introduced could be considered.

We can seek to identify skills available for development of other sectors just as the IFSC was developed on the basis of a high concentration of skills in banking, finance, accounting and legal services. Possible skill sets to exploit would be those involved in writing, publishing, film-making, software development, intellectual property.

There remains further scope for development of various areas within the international financial services sector to confirm their status as centres of excellence - specialised debt financing, securitisation, funds servicing, aviation finance, offshore life products to mention but a few.
Undoubtedly, tax policy played a central part in our success story and the IFSC regime successfully spread its benefits across the tax landscape. While we must resist any moves to return to the high tax era, this policy might only be enough to maintain the status quo.

Continuous growth may depend on radical thinking as to clever new tax incentives and other policy areas. If we have reached a stage where the grim reality of 20 years ago seems but a distant memory or a tale of fiction which could never be repeated, then we are blinded by our success and such blindness will render our success very fragile. The time for reinvention is now.

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