This article appeared in Finance Magazine

Taxation for international financial services - post IFSC
Deirdre Power outlines the taxation framework for international financial services in the post-IFSC era.
Dublinā€™s IFSC was established by the Irish Government in 1987. Its main focus was to create employment in the financial services industry and without doubt it has achieved this objective with flying colours. Many of the attractions of having an IFSC tax certificate are well known at this stage but it is useful to recap on the main selling points from a tax perspective:

ā€¢ 10p.c. tax rate; No withholding tax on interest payments to non-residents; Deductibility of interest payable to non-resident 75p.c. group companies; Access to Irelands double taxation agreements (DTAs); Accelerated tax depreciation allowances of up to 100p.c. on certain items of capital expenditure; Tax exemption for Irish investment funds and life funds managed from the IFSC; The ability to offset certain capital allowances on leasing activities against other IFSC sources of income; Unilateral foreign tax credits in respect of income earned from countries with which Ireland does not have a DTA; Double rent allowances for certain IFSC tenants.

In return for all of these tax benefits, the IFSC company had to meet certain employment targets within a set timeframe. In addition, all transactions with related parties had to be on arms length basis.

Companies that have IFSC certificates fall into two categories: those whose tax certificate ceases to have effect after 31 December 2002, and those whose tax certificate ceases to have effect after 31 December 2005.

There are obviously a number of companies at this stage whose IFSC tax certificates are no longer valid. What this means is that from 1 January 2003 they are treated no differently to any other Irish company, regardless of location.

With the passing of the tax benefits associated with having an IFSC certificate, the question is whether life is all that different ā€˜post an IFSC tax certificateā€™? The very general answer to this question is that such companies are not as badly off as one might think. The reason being that the Irish Government saw the success that the IFSC tax advantages brought to Ireland and over the last few years have extended some of those advantages to Irish companies in general. Irish companies, regardless of their location, can benefit from the following incentives:

ā€¢ 12.5p.c. corporation tax on trading income
ā€¢ 25p.c. tax rate on passive income (same for IFSC companies)
ā€¢ No withholding tax on interest paid to a company resident in the EU (other than Ireland) or in a DTA country.
ā€¢ Access to all of Irelandā€™s DTAs (41 DTAs with another 9 treaties under negotiation).
ā€¢ Deductibility of interest payable to 75p.c. non-resident group companies in an EU or DTA country.
ā€¢ Unilateral foreign tax credit relief on income from a non-DTA country.
The real differences for an IFSC company whose certificate has ceased to have effect are as follows:
ā€¢ Additional 2.5p.c. tax on trading income
ā€¢ Consideration of whether the activity being carried on qualifies as a trading activity.
ā€¢ Interest payable to companies not located in an EU or DTA country may be subject to withholding tax (currently 20p.c.)
ā€¢ Interest payable to a non resident 75p.c. group company located in a country which is not an EU or DTA country, will not be tax deductible.
ā€¢ 100p.c. accelerated capital allowances are no longer available and standard capital allowances of 12.5p.c. straight line per annum apply.
ā€¢ No employment commitment.
ā€¢ No arms length requirement.

The double rent allowance incentive for operations located in the IFSC will end on 31 December 2008 but the availability of the allowance during that time is dependant on a number of factors, including the date on which the construction and refurbishment of the building was completed.
All in all, many of the differences highlighted above affect companies to varying degrees. For example, an IFSC company funded 100p.c. by its Turkish parent will need to restructure its funding to ensure tax deductibility of its interest costs and to ensure no withholding tax arises. Borrowing from an EU or DTA resident group company instead can achieve this. A company that was already funded using EU/DTA source funds does not face this issue. The loss of accelerated capital allowances for leasing companies may require a change in pricing and structuring of new deals, but loss of accelerated allowances to other IFSC operations would not have the same impact. The increase in tax rate and the question of whether the activity is truly ā€˜tradingā€™ are issues common to all companies and the impact of these issues can only be ascertained on a case-by-case basis.

As mentioned above, the Irish Government was very conscious that the IFSC tax benefits would run out after 2005. For this reason, specific incentives were introduced over the last few years, the objective of which were to ensure the smooth transition from an IFSC regime to a standard tax regime. Some of these additional tax changes are outlined below.

Funds: The Finance Act 2000 completely overhauled the Irish investment funds and life funds tax regime. The effect of those changes is that any fund that was previously an IFSC fund or any fund launched on or after 1 April 2000 is not subject to any direct tax charge on their income or gains i.e. they benefit from gross roll up. Irish funds are liable to pay tax on gains arising on ā€˜chargeable eventsā€™ but such chargeable events do not arise where non-Irish residents or certain qualifying Irish residents, who have made appropriate declarations to the Irish fund, hold the fund units. If Irish residents hold units in the Irish fund, then tax must be withheld by the fund on any payment or gain arising to that particular Irish unit holder. Tax is currently 20p.c. on any distribution and 23p.c. on any gain or transfer made in respect of the Irish unit holder.

Securitisation: The Finance Act 2003 completely overhauls the securitisation tax legislation. Any new securitisation vehicle established on or after 6 February 2003 falls within the scope of these new rules. These new rules essentially mean that the distinction between an IFSC certified vehicle and a non-IFSC vehicle no longer exists. It is important to note that any existing securitisation vehicle which holds a valid IFSC certificate (i.e. one that runs until 2005) remains within the scope of the old rules and is unaffected by the new legislation. The new legislation means that many of the positive benefits arising to IFSC vehicles and non IFSC vehicles are now amalgamated within one piece of tax legislation. It means that it is possible to structure securitisation vehicles where interest can be paid gross, where all interest costs are tax deductible and where there is no Irish income tax exposure for investors on the returns they earn from the bonds / loan notes issued.
The tax legislation continues to evolve so that many of the IFSC tax incentives have been expanded to more general application. It is not so much a case any more of selling the IFSC across the world, but rather selling ā€˜Ireland Incā€™ as a financial services location which offers attractive incentives, regardless of physical location in Ireland.
Deirdre Power is a tax director in Deloitte & Touche, Dublin who specialises in financial services.
This article appeared in the April 2003 edition of Finance Magazine.