Topical personal tax issues
Private matters, September 2012
In this article we will focus on some topical personal tax issues in the lead up to the income tax filing deadline in October/November.
Property-Based Capital Allowance Incentive Schemes - A Caution for Preliminary Tax 2012
In the last Budget, a surcharge of 5% was imposed on the amount of income sheltered by property-based capital allowance schemes, for individuals with gross incomes in excess of €100,000. This charge is essentially a higher rate of Universal Social Charge to be applied to those availing of property-based capital allowances.
As this surcharge relates to 2012, many would not expect to feel the effect of this change until October/November 2013 (i.e. the due date for filing their 2012 income tax returns). However, the Finance Act 2012 specifically states that provision for the surcharge must be made by the deadline for the payment of preliminary tax for 2012 (i.e.31 October/15 November 2012).
For those with significant property-based capital allowances, this surcharge could amount to a considerable increase in their preliminary tax payment for 2012. Therefore, it is something that these individuals should bear in mind at this stage from a cashflow perspective, as it will form part of the preliminary tax payment due this October/November.
Bond interest – potential minefield?
Given the uncertainty surrounding the Euro and the perceived security of deposits held in banks, many clients have invested in non Irish Governments bonds over the last number of years.
However, the taxation of bond interest can be more complicated than might first appear. The following example is illustrative of the complications which may arise:
- A client purchases a 2% 10 year German Government Bond in April 2011 at a price of €301, 500 with 90 days of accrued interest (approximately €1,500) at the time of purchase
- The bond pays its annual coupon each year in January
- The client then sold the bond in October 2011 (i.e. after a further 180 days) when the accrued interest on the bond was approximately €4,500 and when the sale price of the bond was €309,500
- What tax is payable on the sale of the bond?
Many investors would assume that they would pay capital gains tax on the profit realised from the sale of the bond (i.e. €309,500 - €301,500 = €8,000).
However, there are specific provisions in tax legislation which deal with the situation where a person has held a bond for less than 2 years and the bond is sold with the benefit of accrued interest. Therefore in these circumstances the client would be subject to tax as follows:
- €3,000 (i.e. €4,500 - €1,500) as interest at income tax rates of up to 55%
- €5,000 at capital gains tax rate (i.e. 30%)
Given that many clients have substantial capital gains tax losses accumulated over the last number of years, it can come as an unpleasant surprise to many that they may have to pay income tax on part of the “gain” on the sale of a bond.
Where the person has physically received a payment of interest during the time that they held the bond it will be necessary to compare the amount of interest actually received versus the amount of accrued interest earned during the time the person owned the bond. For example:
- A client purchases a 2% 10 year German Government Bond in January 2011 for €300,000
- The bond had just paid out its annual coupon (i.e. it had no accrued interest at the time of purchase)
- The client received an interest payment on the bond in January 2012 in the amount of €6,000
- The client then sold the bond in October 2012 when the accrued interest on the bond was €5,000 and when the sale price of the bond was €307,000
- What tax is payable on the sale of the bond?
In this case the individual has earned €11,000 in interest during the entire period that they owned the bond but they will have paid income tax on the €6,000 interest payment physically received in January 2012.
Therefore in these circumstances the client would be subject to tax as follows:
- €5,000 (i.e. €11,000 - €6,000) at income tax rates of up to 55%
- €2,000 at capital gains tax rate (i.e. 30%) i.e. €302,000 - €300,000
The income tax position of a person that purchases a bond with a substantial amount of accrued interest just before the bond pays out is less clear cut and would require further scrutiny.
Tax relief on pension contributions
Tax relief on contributions to Revenue-approved pension schemes is currently subject to a maximum rate of 41%.
However, this position is coming under considerable scrutiny. In the National Recovery Plan published in 2010, it was stipulated that there will be a phased reduction on the income tax relief on pension contributions, to 34% in 2012, 27% in 2013, and 20% in 2014. This reduction was reiterated in the Stability Programme agreed with the bailout partners with the first cuts to be implemented by Q4 of 2011.
However, due to the changes in pension arrangements in recent Budgets and the pension fund levy required to fund the Jobs Initiative in 2011, the Department of Finance concluded that the pensions sector was already making a sizeable contribution to public finances in the short-term, and the rate of relief remained at 41%.
Nonetheless, Minister Noonan reiterated that the tax relief system would have to be altered in the future, and a sizeable take of tax is earmarked from the cutting of pension relief up to 2014.
As a result, if you were considering a pension contribution in 2013 in respect of the 2012 tax year and you have sufficient cashflow, it may be worth considering making this pension contribution before the forthcoming Budget, in addition to any pension payments in respect of 2011 that you are making in advance of the tax filing deadline on 31 October 2012.
CGT refunds – earnouts
Finally some good news in relation to earnouts for those fortunate enough to sell companies within the last number of years.
Part of the amount receivable from the sale may have been subject to certain targets being met over a number of years following the sale (also known as an earnout).
If the maximum amount payable under the earnout was ascertainable at the time the company sale occurred, capital gains tax would have been paid on the amount of the earnout even though the funds had not been received at this stage.
Given the contraction in many business sectors over the last number of years, the maximum amount under the earnout might not have received.
In these circumstances, an individual may be entitled to a refund of the capital gains tax paid on the earnout when the company was sold.
Therefore, it would be worth revisiting the maximum amount achievable under the earnout versus what was actually paid.
For more information, please contact;
T: +353 1 417 2317