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The tax implications of foreign income need to be simpler for investors

Tom Maguire discusses the tax implications of foreign income in his Business Post Column

The public consultation on a potential move to a territorial system for tax purposes finished recently. That’s tax speak for allowing an Irish company to tax Irish income but exempt certain foreign income. Why exempt foreign income? It has probably suffered foreign tax and so by exempting that income in Ireland we are ensuring that the income is not taxed twice. We already have an exemption for Capital Gains Tax where certain conditions are met.

At first blush, you’d think Ireland might be losing tax on that basis. Not so. Seamus Coffey recognised that in his review of the Irish corporate tax system a number of years ago noting “Given the combination of pooling and carry-forward provisions for foreign dividends and branch profits and a low CIT [Corporate Income Tax] rate ensures that domestic firms do not generally face an Irish CIT charge on foreign income” . Right now Ireland adopts a “tax with credit” system for corporate tax purposes. That means foreign income is taxed in Ireland but credit is allowed for foreign tax suffered on that income. So is this much ado about nothing? Nope, because when it comes to investment simplicity eats complexity for breakfast.

Right now our laws on taxing foreign income are complex. An Irish company receiving dividends from a foreign country or having a branch in a foreign country will have much work to do. It will have to ask many questions of the paying country to determine the amount of credit available which will probably be more than the Irish tax on that income anyway. So why not just exempt that income and avoid all the calculations which will probably give the same answer anyway. Investors hearing income is exempt is more reassuring to them than hearing that tax will most likely not be payable on that same income.

Our laws are complex because over the years we’ve had to upgrade them for various EU directives and decisions of the Court of Justice of the European Union (CJEU). Now we’re taking stock to ask if we could make all this simpler, the same way other countries have done. In the past whenever such an exemption was asked for in Ireland, the general reply was that we didn’t have Controlled Foreign Company (CFC) legislation. We do now. We’ve implemented all of the EU’s Anti-Tax Avoidance Directive (ATAD); I’ll come back to that. This means that if a company was set up offshore to avoid Irish tax then the Irish Exchequer could reach out with its CFC rules and pull those profits back into the Irish tax net. Therefore, we have brought about additional protections for the Irish tax base in compliance with EU law.

Take an example. Years ago a case came before the CJEU on a simple question. In these matters the questions are generally simple, but the answer is something else entirely. The matter was on the UK’s treatment of dividends from foreign companies which was pretty similar to our law. Say a fully owned foreign subsidiary pays an Irish company a dividend €100 out of its profits which suffered foreign tax at the rate of 40%. Irish tax on that dividend may have been €25 but would likely have been wiped out by the credit arising from the tax paid on the profits out of which the dividend came.

However, if that dividend had been paid by an Irish company to the same Irish parent (certain exceptions apply, of course) then it would have been exempt. So there was a difference in treatment between foreign and Irish sourced dividends i.e. tax with credit versus a full exemption. The court said this difference could stand under EU law once the credit here on the foreign dividend was given at the lower of Ireland’s rate and the 40% rate, with certain Ts and Cs attaching. So we had to tweak our tax credit laws accordingly.

Similarly, say an Irish company sells a particular product. It sells them here and through a branch in foreign country. The branch will most likely pay foreign tax on its profits and will pay Irish tax again on those profits with credit given here for the foreign tax paid. Therefore, the amount of Irish tax payable may be negligible given our rules. Indeed, with the international tax law changes that may be coming our way then we need to consider all ways to improve our force of attraction for investment. Bringing about such an exemption would be one such move.

It ain’t all sunshine and rainbows though. I mentioned the ATAD earlier on and I’ve discussed its interest restriction and all that brings with it in these pages previously. This is complex legislation which was brought about by the last Finance Act. In a nutshell, subject to many Ts and Cs, a corporate tax deduction for financing costs is restricted to 30% of taxable Earnings Before Interest, Depreciation and Amortisation (EBITDA). However if some of a company’s income is exempt then that could reduce EBITDA and with it the related financing cost deduction available to the company. Not good particularly when you consider that if the company taxed the foreign income (say it was a dividend) and gave credit for the foreign tax then (although no tax would probably be paid on that income) it wouldn’t see its interest deduction affected. If the dividend was exempt then no Irish tax would be payable but the interest deduction would be restricted. Bad answer.

Therefore in my view it should be up to the company to choose between exemption and tax and credit given the likely similar taxing answer on the income. But in doing that the rules for tax and credit should be made simpler. Those rules are contained in Taxes Consolidation Act 1997 Schedule 24. I went all technical there because I’m daring the reader to say “Schedule 24” to a tax practitioner and watch their “no jam in my donut” reaction. The concept of “tax the foreign income and allow credit for foreign tax” may sound simple but the rules span almost 30 pages. Simplifying tax law makes it easier to understand, apply and administer thereby making it more attractive to investors.

Making our law more attractive to investors with minimal cost is a good answer right now.

Please note this article first featured in the Business Post on 16 march 2022 and was re-published kindly with their permission on our website.

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