The 2020 Tax Strategy Group Report
What in your view are the most impactful issues dealt with in the annual report of the Tax Strategy Group (TSG), from the point of view of the impact on your clients, and for the economy generally?
Ciara Sharkey, Assistant Manager, Corporate Tax, Deloitte: One of the key issues dealt with in the recent TSG report is in relation to the incoming interest limitation rules in Ireland under transposition of the Anti-Tax Avoidance Directive (ATAD) and the latest suggested date for implementation in Ireland from 1 January 2022.
Article 4 of the ATAD, provides that a tax deduction for exceeding borrowing costs will be limited to a portion (30%) of the taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA). As the requirements of the ATAD in this regard are quite detailed and will involve the consideration of several policy options, the transposition process may not be as straightforward as a ratio-based limitation method may appear.
The mechanics of operating the interest limitation rules based on an EBITDA ratio will present a significant departure from the regular corporation tax computation preparation process for many Irish taxpayers. Ireland’s existing interest limitation rules are different in structure to the ATAD rule. Therefore, the transposition process will require consideration as to how the ATAD requirements will integrate with Ireland’s existing domestic provisions, which will likely require amendment as part of the process.
Corporate tax payers should begin to assess the impact the interest limitation rules will have on their existing lending structures, and the potential cash tax impact for companies. As Brexit has the potential to lead to reduced EBITDAs and increased borrowings, this may result in a greater interest restriction under ATAD than intended. A feedback statement for consultation is expected to be published by the end of 2020, with final legislation to be introduced in Finance Bill 2021.
The recent TSG report also notes that the remaining reverse anti-hybrid rules are still expected to be transposed by the end 2021, also taking effect from 1 January 2022. A reverse hybrid mismatch may arise where a corporate entity is treated as transparent in one jurisdiction and opaque in another resulting in the non-taxation of income. While at this stage, many companies will have already considered the application of the existing anti-hybrids rules to their structures, the introduction of the reverse anti-hybrid rules will provide an additional layer of consideration. A consultation process is expected in early 2021 which should provide further clarity.
Class S PRSI contributors: a 7 p.c. increase?
The TSG report references the possibility of raising Self Employed individual payments to the 11% rate that Employers and Self Employed Taxpayers pay in Employer PRSI contributions in respect of their Employees. How might this impact incorporated businesses and principals in SMEs with employees, and how, since it is stated to be a means of replenishing and supporting the Social Insurance Fund, might its benefits match the posited increase in contribution suggested?
Stephen Lowry, Senior Manager, Private Clients, Deloitte: In the context of the self-employed, the report of the TSG essentially advocates for an alignment of the PRSI contributions made by self-employed individuals with that of employers on the basis that self-employed contributors are now covered for most of the same benefits available under the social insurance scheme as that of employed contributors but in exchange for a significantly lower contribution. With Class S PRSI contributions currently capped at 4%, self-employed contributors currently have access to benefits which comprise over 90% of the value of all benefits available to employed contributors - in return for a contribution which is currently 11 percentage points lower than that made in respect of employed contributors.
To rectify this imbalance, the TSG has suggested a phased increase to self-employed PRSI rates (which would take effect over a 4 year period) and ultimately bring the Class S rate from its current rate of 4% to the higher rate of 11.05%. While the stated aim of these proposed increases is to fund the phased expansion of certain benefits currently unavailable to self- employed individuals (specifically, Illness Benefit, Carer’s Benefit, Health and Safety Benefit and Occupational Injuries Benefits) the direct impact of these proposals for individual employers and self-employed persons operating a business is significant.
If implemented, Class S contributors will be required to pay an overall 7% increase in social insurance contributions annually (effectively bringing the overall tax rate for certain self-employed individuals to circa 62% - taking account of the 3% USC surcharge) – thereby reducing the after tax profits available for reinvestment in the business (on the assumption that the self-employed contributor will need to be in the same net income position), impacting much-needed cashflow and arguably reducing the capacity of such businesses to create additional employment at a precarious time for the Irish economy.
ATAD - should SMEs plan for change in the medium term?
The Department of Finance has expressed an opinion that the Irish approach, which differs from the EU Directive (ratio based approach) in this area, can be as effective in combating the effects that the ATAD seeks to counter. It has also adverted to the potentially wide impact of this across the economy, in that it can affect the tax levels of SMEs. Nevertheless, if this is a battle that Ireland loses eventually, would it be advisable for companies to be now taking planning measures to mitigate risks arising from potential breaches by them of the 30% EBITDA rule in future years?
Shane Murphy, Director, Corporate and International Tax, Deloitte: In short, yes, it would be recommended that taxpayers potentially affected by the 30% EBITDA rule provided for in ATAD should be actively assessing the impact this may have on them.
At this stage, the timing of when potential changes may come into effect is unclear. The recently published Tax Strategy Group Papers have reiterated the Irish position that the existing interest deductibility rules are equally effectively to that proposed under ATAD, and as such, the requirements of ATAD as regards the 30% EBITDA interest limitation only needs to be effective from 2024 in Ireland. That said, these papers also acknowledge that although the transposition of these rules into Irish law is complex and further consultation is required, it would seem likely that any new rules should be effective potentially from 2022 (as opposed to 2024).
Although the application of a 30% EBIDTA rule may seem a relatively straightforward concept for taxpayers to assess, the ATAD requirements are quiet detailed with a variety of potential outcomes in terms of the actual legislation that is implemented. Therefore, assessing the possible impact on taxpayers is not as simple as might first be thought and requires working through the various options for implementation, considered previously in the April 2020 issue of this publication by Aine Gibney.
The interaction of any new interest limitation rules with the existing section 247 and other interest deductibility and extensive anti-avoidance provisions currently in Irish law presents an additional layer of complexity, as well as the wider economic factors (Covid-19 and Brexit being two of note) currently in play.
Even if specific detail and the effective date are not yet fully known, the complexity around this means taxpayers do need to factor these into reviewing existing and future financing transactions to assess their potential impact now.
ATAD and long term equity strategy
Could the ratio based ATAD approach of the Directive be a stimulus for a shift towards more equity-based forms of financing of balance sheets from financing by credit and debt securities in the medium term? And, could this conceivably be a stimulus towards equity financing across the EU generally, to the benefit, in the medium term of the development of Capital Markets Union objectives?
Eugene O’Keeffe, Director, Corporate Tax, Deloitte: One of the underlying goals of the ATAD is to promote financing through equity rather than debt. So depending upon the impact of the Directive it could see a stimulus for a shift towards more equity based forms of financing of balance sheets from financing by way of debt. However, from an Irish tax perspective, it is too soon to understand the impact of the measures until 2021 when Ireland is expected to move towards implementing the Directive. Only then can business start to get clarity on what exemptions from the Directive Ireland might apply and how key terms in the provisions are to be applied in practice.
Under the provisions of the Directive a tax deduction for “exceeding borrowing costs” will be limited to 30% of a taxpayer’s earnings before interest, tax, depreciation and amortisation (EBITDA). At this stage the Directive lacks specific definitions around a number of terms. For example it is not clear how to quantify taxable interest revenues “and other economically equivalent taxable revenues” when quantifying if you have “exceeding borrowing costs”.
Furthermore the Directive enables jurisdictions to build in to domestic legislation a number of exemptions and carve outs from the provisions including regulated entities and stand-alone entities. Therefore until progress is made, through a consultation process between Department of Finance/Revenue and impacted taxpayers, and draft guidance and legislation begin to emerge it can be most difficult to establish the impact, if any, of the measures upon a business.
What might be found is that the Directive is likely to be mostly applicable to leveraged entities with a significant amount of interest expense. Certainly impacted business should be carrying out an impact assessment, however any responsive action to the Directive should be postponed until guidance and the proposed legislation emerge, likely during 2021.
Until then it is difficult to surmise whether impacted business will seek to replace debt with equity funding. Certainly restrictions on interest deductibility will be unhelpful to business. However, having regard to the goal mentioned earlier of a move from debt to equity financing, perhaps for this to happen there needs to tax incentives to support equity financing such as deductibility for costs associated with raising capital.
The Knowledge Development Box
Figures revealed in the Tax Strategy paper reveal that the Knowledge Development Box, has by any standards not been a success, as only a handful of companies have availed of it (12 in 2016, 13 in 2017, and ‘less than 10’ in 2020). The TSG report says that “In part this is due to the restrictive requirements of the relief”. It also points out that Sunset Clauses, (KDB is currently set to expire on 31 December 2020) are good practice, and raises the possibility that it should be rolled over nevertheless. In your view, would there be any interest amongst companies in improving the benefits in the Budget, where possible, and where compliant with overall BEPS objectives, etc?.
Geraldine McCann, Director, Corporate and International Tax, Deloitte: When the then Minster of Finance, Michael Noonan, announced in Budget 2016 the introduction of the Knowledge Development Box (“KDB”) with the possibility of the 6.25 per cent rate that would apply to profits derived from patented or similarly protected inventions and copyrighted software, the news of this rate was broadly welcomed by companies. The intention was that the KDB regime (which meets the OECD’s “modified nexus standard”) would enhance Ireland’s offering as an IP location alongside the 12.5 per cent corporate tax rate, the R&D tax credit and the IP amortisation regime.
Where a company has R&D performed in Ireland that makes a significant contribution to the creation of qualifying assets in Ireland, and which in turn generate profits for the Irish R&D performing company, the KDB can provide a useful mechanism to reduce the effective tax rate of a company. However, as the numbers have shown, only a small handful of companies have to date availed of the regime.
This limited uptake was anticipated by many tax advisors at the outset, due to both the narrow scope of what constitutes as qualifying assets for the purpose of the relief and also the nature of the ‘modified nexus’ model developed by the OECD and encompassed in the KDB regime is such that there is onerous ‘tracking and tracing’ requirements in order to claim the relief.
In terms of what qualifies for relief, the relief is limited to copyrighted software, patented or similarly protected inventions and, in the case of smaller companies, registered inventions that are certified by the Controller of Patents to be novel, non-obvious and useful.
In relation to the “tracking and tracing” requirements, separate profitability streams need to be computed for each individual qualifying asset, in determining the extent of any tax benefit under the Irish KDB regime. This results in an administrative burden that needs to be considered by companies. In addition, companies are aware that if KDB amounts are scrutinised by Revenue, the documentary evidence that will be required to defend the claim will be substantial.
This requires the necessity for good systems and controls around R&D project management, to minimise cost, time and effort. While some industries e.g. the pharmaceutical industry already has certain ‘serialisation’ features that will alleviate this burden to some extent, for the most part no such features exist in many industry sectors.
From experience, companies initially are interested in the KDB regime given its potential to reduce the effective tax rate. However, once the limited scope of the regime and the tracking and tracing provisions is understood, many companies ultimately decide not to proceed any further. If the Budget was to expand the scope of what constitutes as qualifying assets, this together with a pragmatic approach in dealing with the tracking requirements, may lead to a greater increase in the uptake of the relief.
CRS: how the new reports will work
What are the up to date requirements for Irish Financial Institutions regarding CRS (Common Reporting Standards)?
Ireland has adopted the ‘Wider Approach’ to CRS due diligence and as a result, Irish Financial Institutions are required to carry out due diligence on all (but some specifically excepted customers), including Controlling Persons of Passive NFEs, and to obtain a Self-Certification upon account opening.
Revenue has recently provided clarification of the Common Reporting Standards (CRS). What significant clarifications emerge from this?
Kate McKenna, Assistant Manager, Corporate Tax, Deloitte: Under the CRS, jurisdictions obtain certain financial information from reporting financial institutions and automatically exchange this information with exchange partners, as appropriate, on an annual basis with respect to all reportable accounts identified by financial institutions on the basis of common reporting and due diligence rules.
Part of the technical solution to support the CRS was the development of a “schema” and related instructions.
A schema is a data structure for holding and transmitting information electronically an in bulk. XML “extensible mark-up language” is commonly used for this purpose. The User Guide explains the information required to be included in the CRS XML file.
In September 2020, Irish Revenue published updated CRS FAQ’s to include an updated FAQ 10 which clarifies what schema Irish Financial Institutions should use to prepare and report under CRS to the Irish Revenue Commissioners.
FAQ 10 confirms that CRS XML Schema Version 1.0 and CRS User Guide Version 2.0 are applicable for all exchanges until 31 December 2020. As the CRS filing deadline for the 2019 reporting year was extended to 30 September 2020, with exchanges between tax authorities taking place in advance of the 31 December 2020 deadline, the CRS XML Schema Version 1.0 and CRS User Guide Version 2.0 should have been used for these filings.
The CRS XML Version 2.0 and CRS User Guide 3.0 will be effective from all CRS exchanges from 1 February 2021.
Digital Tax Issues
Digital Tax issues are of critical issue for Ireland, not least because of its hosting of major digital enterprises, both large and small, and the sustained evolution of tax measures at OECD, EU, US and unilateral measures such as in the UK and India makes for an uncertain picture right now. In view of the conflicting policy views that are in play, what in your view should, and can, Irish digital enterprises act to plan for mitigate future risks?
Claire McCarrick, Senior Manager, Corporate and International Tax and Paul Geoghegan, Senior Manager, Corporate Tax, Deloitte: Existing corporate income tax laws are primarily concerned with the physical presence that a company has in a jurisdiction and level of personnel the company employs in that jurisdiction. However, it has been argued that in an increasingly digital world, many digital businesses do not require a physical presence and/or personnel on the ground in order to generate income in country, and as a result a digital business may not be required to register for corporate income tax in a given country.
The OECD is hosting negotiations of its member countries for an agreed approach to address this area. However, notwithstanding these negotiations a number of countries have pursued unilateral measures. The pursuit of unilateral measures by countries is particularly challenging for businesses as there is no uniformity with regard to DST. As a result, what is and is not subject to DST, how DST is calculated, and payment and filing compliance all differ between countries.
The digital businesses that provide services abroad must keep informed as to what countries have introduced or are planning to introduce a type of DST. A company’s tax advisor can keep them abreast of these developments. DST requires companies to have information on where their customers/users are located. Understanding the scope of what that DST captures is critical and is understandably one that many companies struggle with. The method of calculating, filing and paying the tax differs for each country (in some countries a local country bank account may be required) and this is something that companies have to contend with. The level of guidance published by tax authorities varies and the company may need to obtain local specialist advice .
From the company’s own perspective, data and the accuracy of data with respect to the location of customers/users and sales to those customers. Data of this nature may not have been required to be internally reported for financial/tax purposes previously and companies need to understand how they can pull the data they need for DST calculations.
Depending on the company it may be appropriate to have DST managed centrally from Ireland by someone with designated responsibility for DST. That person would likely need to work closely with accounting team on accounting for DST, the treasury team for any tax payments and the sales and operations teams so they are aware of the jurisdictions where the company currently has customers/users and also of any proposed new product service offerings that could bring the company within the scope of DST in a given country. Deductibility of DST and the impact on transfer pricing will also need to be considered.
The final countdown: Brexit, customs, tax and tariffs
Irrespective of the outcome of Brexit negotiations, from January 1st next the rules of the single market and the customs union will no longer apply to the UK and a range of customs formalities and taxation sensitive requirements will be in place for goods that move through, or to and from, Ireland and Britain. What measures can importers/exporters be undertaking now with just 12 weeks to go to minimise disruption from a customs, excise and sales tax (VAT) point of view?
Donna Hemphill, Senior Manager, Indirect Tax, Deloitte: Businesses should review existing contract terms and incoterms to determine which party is liable for customs formalities in both the UK and Ireland.
Businesses should ensure that they have all the information available to make an import declaration, such as the commodity code, customs value and specific origin of goods.
Businesses should consider whether to obtain a deferred payment account, use a cash TAN account or use the broker’s deferment account for the payment of import duty. In the absence of a free trade agreement, the EU TARIC rates will apply to goods imported from the UK into Ireland.
Businesses importing food products or animal or plant products should review the additional compliance requirements including the requirement for a health certificate and advance notification through the TRACES system in order to enter the EU.
Businesses moving excise goods will no longer be able to use the Excise Movement and Control System (EMCS) to move goods to/from the UK as these will become export and import movements.
It is expected that from 1 January 2021, Ireland will move to a postponed accounting system for Import VAT whereby import VAT payable will be accounted for through the Importer’s VAT return rather than at the time of import. Businesses should ensure that they can comply with any new VAT reporting requirements.
Businesses should consider if they will purchase software and make declarations in-house or whether they will outsource this to a customs broker.
Businesses selling to the UK will be required to make an export declaration and to act as exporter of record; a business must be established in the EU for customs purposes. Businesses should review if they meet the conditions to act as exporter or if they may have to appoint another party such as a customs agent or third party to act on their behalf.
If a business is storing or processing goods, it should consider if it would benefit from operating a Revenue approved warehousing or processing authorisation as this can delay, reduce or remove the requirement to pay import duty.
If volumes of EU/UK trade are significant, a business may want to assess the benefits of making an application for Authorised Economic Operator or ‘trusted trader’ scheme which would provide reduced levels of checks on imports, priority clearance and reductions in financial guarantees.
Making your Tax Department ‘future ready’
Budget 2021 is just one facet of the tax landscape of interest to finance directors and boards, and changes and challenges will continue even after the Finance Bill process in 2020. In the face of a rapidly changing tax landscape, how can directors take steps to make their tax departments future ready?
Roxana Popescu, Director, Tax Management Consulting, Deloitte: We are living in a new type of challenging world due to the current economic measures and restrictions triggered by Covid 19, yet it is expected that the current Budget 2021 may only cover limited tax measures to address the budgetary deficit for the possible yet to be defined economic hardship.
Nevertheless, we do expect the development of tax reporting obligations to accelerate at a rapid pace in a direction to enable less or no tax leakage for tax authorities. Increasing taxes may not be the best solution, particularly in a COVID environment where the taxpayer is stretched to its financial limits. So, if raising or increasing taxes at a pace required to bring us back on track economically is not an optimal approach, we expect that the Revenue Commissioners (and other tax authorities around the world) to have an increased focus on their plans to implement or improve the collection of taxes.
Firstly, there will likely be an increase in the number and frequency of tax audits across all tax heads and these will be conducted in a more sophisticated and expedited manner. Through the adoption of the right technology Revenue Commissionaire resource’s would not become a barrier.
Secondly, we have seen measures such as PAYE modernisation in Ireland and SAF-T and real-time-reporting being implemented around the world already. We expect that Covid will bring this type of tax reporting from source to a completely new level that would lead to a fine tuned, deep dive into the taxpayer’s data and compliance process. Tax authorities are likely to require real-time-access to books and records with the view of extracting the data and calculate the tax themselves. Covid may be the catalyst to give Governments the green light to scrap the taxpayer self-assessment in favour of a regular assessment, with the taxpayer being left to implement reconciliatory measures. Current sophisticated BI technologies and Cloud storage solutions certainly enable the capability to drive tax assessment and ultimate collection.
With all these possibilities to come, as a finance or tax director, one should always consider defining the tax function’s people skillsets, compliance processes and data granularity that allows complete transparency and leaves very little room for manual adjustments. Solid internal controls, process definition (to include roles and responsibilities) and quality of data produced from the ERP system(s) will need to meet a new standard that generates confidence when fulfilling compliance obligations and on selection for audit. This state of mind will also ensure the ultimate goal of the tax function: providing visible value to the business with tax impacted insights yet being invisible to the business through lack of extended queries, underpaid tax, interest, penalties and time spent on correspondence with tax authorities.