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Thursday, 25th April 2024 |
| Tax in turbulent times - easing corporate pain |
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Managing a group’s tax affairs can be equally challenging in times of rapid expansion or retrenchment. However different issues take centre stage as economic circumstances change.
Brian Daly raises some tax issues which corporates may face in the current environment. |
Fortunately, it’s been some time since the management of losses has been a focal point of tax planning for many companies. However, this may change as a result of the ongoing credit crunch, coupled with adverse stock and property market conditions.
Here I hope to give some flavour of tax areas which may need additional focus in the months ahead, including deductibility of provisions/write downs; utilisation of losses; raising of alternative finance; restructuring or rationalisation. | | Brian Daly |
“Credit Crunch”
At the time of writing, the reduced availability and increased cost of obtaining credit from traditional sources shows little sign of abatement. You may be looking at financing alternatives for your company, many of which raise tax issues, for example:
- If you are replacing debt with capital which comprises equity features, you need to meet certain conditions to achieve a tax neutral conversion and loss of tax deductions for funding costs is likely.
- If you are replacing external debt with group finance, you need to review the restrictions which deny relief for interest as a charge on related party borrowings in certain circumstances. You also need to ensure you do not fall within the broad provisions which restrict interest relief where capital is recovered by the borrower, or by connected companies, and is not used to repay the loan on which relief is being claimed. If interest free loans are provided, these issues will not arise as interest deductions will be foregone and Ireland does not have rules to impute interest income on the lender.
- Forgiveness of inter-group debt or waivers of interest may be proposed. In the latter case you will need to look at anti-avoidance provisions which potentially tax such interest waived.
- It may be tax efficient for a major shareholder to purchase the company’s distressed debt at a discount. You would need to consider whether the company can continue to claim a tax deduction for interest paid.
- If debt is being discharged by other group members or guarantees are being activated, you should appraise the tax-deductibility of such payments.
- If it is possible to transfer assets off balance sheet, depending on the transferee’s location, issues may include transfer pricing, interest withholding tax, the risk of trapping losses in off-balance sheet vehicles, whether the transfer is a trading or capital event for tax purposes.
Is it a tax loss?
Losses due to credit write-downs are likely to be tax deductible for financial traders. However, the unusual financial market in which we find ourselves could result in transactions or flows which fall outside normal expectations – e.g. if your company makes a voluntary subvention to another company to protect its reputation or credit rating, you will need to carefully line up arguments supporting a tax deduction.
Focus on bad debts is likely to increase. Once a bad debt has been incurred, a tax deduction is normally available. Specific bad debt provisions made in accordance with accepted accountancy principles have traditionally been considered tax-deductible. However, we have seen instances where Revenue challenge deductibility so attention to detail is important. Where companies prepare their accounts under IFRS, a more precise method is used for calculating all bad debt provisions, rendering them specific in nature.
Issues can also arise in relation to the recognition of losses on financial instruments. Under IFRS, and equivalent Irish GAAP rules, the accounting treatment is followed for tax purposes. The accounting classification of financial assets determines whether fair value adjustments are taken through the profit and loss account or not, though there is an option to choose fair value where this provides a true and fair view.
The IFRS principles have little impact for financial concerns which previously accounted for (and were taxed) in respect of such instruments on a mark to market basis. However, the classifications can give rise to issues for some companies, e.g. where write-downs of assets classified as “available for sale” are taken through equity, rather than the profit and loss account resulting in tax relief not being available until the loss is realised upon disposal.
Loss utilisation – the basics
Once you have calculated losses, you need to establish whether and how they can be utilised.
It is worth refreshing on some basic rules.
Broadly, you can use trading losses to shelter trading profits of the same accounting period and of a previous accounting period of equal length. Remaining trading losses can then be carried forward indefinitely to shelter future profits of the same trade until they are utilised.
You may also be able to obtain relief for trading losses on a value basis against taxes payable at higher rates but you would use up twice as many losses to offset tax on income chargeable at 25%, for example.
You can surrender current year trading losses to cover other group companies’ current profits where there is a 75% group relationship or a consortium relationship, as defined. Remember you can choose to surrender losses before covering your company’s non trading profits and the claimant company may choose to claim only some of the losses available. You may find that payments for group relief are a useful tool to move cash to where it is needed.
Where a trade comes to a close, you can carry back the last 12 month’s terminal losses against the trade’s income for the 3 previous years, provided you have made all other available loss relief claims.
It is also sometimes possible to claim relief for losses incurred by subsidiaries resident in other EU/EEA countries with which Ireland has a tax treaty. This relief is restricted to situations where you have already claimed all reliefs mentioned above and the surrendering company has exhausted possibilities for using the losses. You are however restricted in offsetting most non trading losses against profits from similar sources.
Basic compliance in this area warrants special focus. Make sure that you file returns and make formal claims on time. If returns are filed late, there are provisions for restricting loss relief. Routine planning can often yield valuable savings, e.g. ensuring that offsets and carry backs are maximised, by making early filings, timing payments of interest as a charge etc you might expedite tax repayments.
If the capacity to offset losses in current and prior years is limited and a return to profitability is in doubt, this may jeopardise even the recognition of deferred tax assets in respect of the losses.
Restructuring and “Loss Buying”
At first blush, it may appear attractive for profitable companies to look at opportunities to acquire loss making companies and utilise the tax losses. However there is specific anti-avoidance to prevent the carry forward of losses where a change in ownership is combined with a major change in the nature or conduct of the trade. There are also restrictions on pre-entry capital gains tax losses.
However, if your company is taking over a trade of another group company which has accumulated trading losses, you may be able to avail of them, subject to certain conditions including a formal election.
The participation exemption from capital gains tax for disposal of shares may be valuable for companies divesting of trading subsidiaries as part of a rationalisation. However many divestments currently being considered may have to be sold at a loss. The flip-side of this exemption is that corresponding losses are not available for relief.
You may need to examine closely if you fall outside the scope of the rules in which case a loss could be allowable.
It is worth noting that the exemption (and therefore disallowance of loss) does not apply to disposals of shares deriving the greater part of their value from Irish based land or certain mining and mineral rights.
While various provisions exist to facilitate tax efficient reorganisations, always beware of the possibility of clawback of previously claimed reliefs which can apply to a range of taxes, including corporate tax, CGT, stamp duty and VAT.
An overseas move
Companies may contemplate offshoring some activities in an effort to reduce costs but the tax benefits might not always stack up. The destination may have higher corporate or other taxes and the move may give rise to additional tax costs, e.g. VAT on cross border charges.
You may need to consider issues such as whether losses will be lost on such a move, whether relief will be available for restructuring costs, what additional tax compliance costs will arise, including dealing with termination payments, whether Irish personnel will be involved in the overseas operation resulting in potential double taxation etc.
If you are looking at the possibility of a company or group migrating residence from Ireland, you need to establish whether the exit charge provisions apply (in which case the participation exemption would not apply), whether these result in multiple tax charges and whether gains or losses may be crystallised on previous intergroup transactions.
Share based compensation
Where employees are sitting on stock options with strike prices that are well above current share prices, these will only serve as a reminder of what has been lost rather than a motivating influence.
The tax, legal and other implications of reorganising a share incentive scheme can be complex but it may be opportune to consider possible alternatives, such as repricing the options or replacing them with some form of restricted stock grants.
Valuations of share options give rise to profit and loss fluctuations under IFRS, and its Irish GAAP equivalent, which often didn’t exist previously. This has put share awards on a more level playing field with stock options from an accounting perspective. Share award schemes also have the advantage of at least ensuring some award is given to employees in volatile stock markets as they cannot go underwater.
Conclusion
As seen above, dealing with the effects of a downturn can present complex tax issues but you may find opportunities present themselves following careful review. Such opportunities can ease the pain of negative results. |
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| Article appeared in the August 2008 issue.
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