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A corporate tax exemption on foreign income is a good move

May 8 was the closing date for responding with comments on the Department of Finance’s recent consultation on bringing about a participation exemption to Ireland. That’s tax-speak for exempting foreign dividends from tax. There are also suggestions of an exemption for foreign branch profits but that’s for another day apparently. Both exemptions would be good moves for Ireland.

In the press release accompanying the consultation document, Minister McGrath explains “The introduction of a participation exemption will be a very important step towards simplification of the Irish corporate tax system and reflects Ireland’s continued efforts to promote a business environment characterised by certainty and clarity. In a time of unprecedented change in international taxation, this move will give confidence and foresight to key stakeholders, maintaining Ireland’s reputation as a business-friendly destination and encouraging companies to establish and expand their operations in Ireland”.

We’ve seen significant reforms in the area of taxing companies, most recently with the introduction of new-fangled effective 15% minimum effective tax rate for in-scope companies (OECD’s Two-Pillar Agreement) was just brought about into our law. Therefore, the press release notes that introduction of a participation exemption for foreign dividends reflects Ireland’s commitment to ensuring that our corporation tax code is competitive and attractive to business investment and aligns with international best practice. Further it has the potential to bring about much needed simplicity to a very complex area of tax law. I’ll come back to that potential in a minute, but regular readers of this column know my view that when it comes to investment here and tax then “simplicity eats complexity for breakfast”. 

Right now, Ireland operates a worldwide or “tax and credit” system. In this way foreign dividends received are subject to Irish corporation tax, but credit is given in Ireland for tax paid in other jurisdictions, up to the amount of Irish tax payable on the income. Given our competitive corporation tax rate and our comprehensive double tax relief provisions, it is commonly reported that no or negligible incremental tax in Ireland arises on group dividends received.  

Say a foreign company pays tax on its profits in country A and then pays those profits to its parent in Ireland in a dividend. Because of a tax treaty with Country A, or indeed certain unilateral measures contained in Irish law, the parent company gets credit for the Country A taxes paid such that no or little tax is paid in Ireland by that parent company. In that way tax is only paid once on the distributed profits. The participation exemption pushes all that number crunching aside and says just exempt the dividend. 

“Tax and credit” sounds easy in theory but it can, and does, involve significant calculations regarding withholding and underlying tax on “dividend-ed” profits as well as research on a country by country basis. Much of this is contained in part of the law known as “Schedule 24” and just mention that to any tax adviser and watch their reaction. That alone will demonstrate the need for simplification.

Now back to that potential I mentioned. The consultation brings about a “strawman” approach to the dividend exemption and the document itself notes that “Depending on feedback received and further analysis to be completed, the final design of the participation exemption may closely resemble the Strawman approach or may deviate significantly from it”. Put another way let’s have a conversation because right now we’re in a position to influence change.

The strawman suggests that participation exemption apply to dividends received from companies resident in the EU/EEA or jurisdictions with which Ireland has a double taxation agreement. There’s a lot of planet earth that would be left out here and some of our significant partners would not be in scope. Therefore, in my view, consideration should be given to expanding this to at least include all countries subject to the Pillar 2 regime I mentioned earlier, and consideration could be given to excluding dividends received from the EU list of non-cooperative jurisdictions.

The strawman doesn’t require companies to exempt the dividends i.e., they can go by the old Schedule 24 way if that’s the way they want to go. But where they elect to exempt dividends then the strawman’s approach is that the election stands for three years. Three years is a very long time in economic and tax law terms and a lot can happen in those three years, and right now once you’re in you’re in.  Therefore, consideration should be given to the choice to be in or out of the regime being allowed on an annual basis.  Also, what if you get it wrong, or you change your mind, then right now the three year exemption stands.  In other words, it would be good to adopt the John Maynard Keynes approach in our law by allowing for “'When the facts change, I change my mind - what do you do, sir?'”

Of course the strawman has certain anti-avoidance provisions and by definition this brings about complexity to the law.  One of the reasons we never had a participation exemption for dividends in the past was that we didn’t have a Controlled Foreign Company (CFC) law, we do now.  The CFC provisions effectively says that where a company has operations abroad for a tax avoidance purpose then Ireland can reach out and pull those profits back home and tax them here.  We had to bring in such a provision as a result of the EU’s Anti-Tax Avoidance Directive.  That directive also required a generally anti-avoidance rule to be brought in and we had one of those since 1989.  In other words we have sufficient laws in place and the participation exemption should be as simple as possible to operate.

Overall it’s good to see this exemption come into our law and its due in the next Finance Act.  As always though the devil will be the detail and it will be crucial to watch as this Strawman matures into Ironman in our law. Many more conversations will have to be had between now and then.  It’s good to talk.  

Please note this article first featured in the Business Post on Sunday, 12 May 2024 and was re-published kindly with their permission on our website.