Annual Conference 2019
11-13 April 2019
International Tax Measures – 2019 and Beyond
Louise Kelly & Emma Arlow, Deloitte
The international tax landscape continues to evolve. The objective of this session is to present some significant recent international tax developments from the perspective of a tax practitioner, particularly with regard to the number of key changes on the global stage both currently in force and on the horizon. Given the pace of change, this paper will become dated quite quickly and therefore this should be borne in mind when referring to it at a later date.
The suite of tax changes in the past year have been significant with a number of immediate changes to the tax landscape as well as a number of challenging proposals and consultations in the pipeline. In addition, there are wider economic challenges such as Brexit and the potential for trade wars across various jurisdictions.
While the changes are numerous and ever developing, we will be focusing our attention at present on the following key areas:
- Recent Global Developments;
- Irish Controlled Foreign Company (CFC) legislation;
- Exit tax and other Finance Act 2018 changes;
- Digital tax; and
- Taxing business in a digital world focusing on the OECD proposals.
- Recent Global Developments
The international corporation tax framework has experienced a period of unprecedented change in recent years both in terms of the range of changes the speed at which these have taken place.
Previously, the current international tax approach that was established in the 1920s formed the bedrock of how companies are taxed around the world and was based on a more bricks and mortar type business environment. This framework however has been questioned in recent years as the business environment in which companies operate has been increasingly globalised and digitalised.
This has led to an increased focus on tax transparency and a need to better align the corporation tax framework with changing commercial realities. The result of this has been a deepening mismatch between the international corporate tax framework and the commercial realities of doing business in the modern world.
This has led to a number of changes at both OECD and EU level which have impacted on Ireland and has resulted in a change to how we operate our corporate tax framework.
At an OECD level, we have had the BEPS project over the last number of years as well as recent consultations on the taxation of the digital economy. The EU has introduced ATAD and ATAD 2. There have also been digital tax proposals as well as discussions on moving to qualified majority voting for tax matters. We have had significant tax reform in the US as well as unilateral changes in a number of countries. For example, the UK measures in relation to offshore receipts in respect of intangible property had resulted in many companies reviewing their structure. Also, many companies are still assessing the potential impact of the substance requirements that were introduced by a number of countries such as Cayman and Bermuda.
- Multi-Lateral Instrument
Firstly, in terms of OECD level changes, one of the most notable developments in recent years has been the Multi-Lateral Instrument, or MLI.
The MLI is one of the outcomes of the OECD/G20 Project and operates to modify tax treaties between two or more parties and will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures, without the need to renegotiate each relevant tax treaty (also referred to as a Covered Tax Treaty or CTA). For a specific tax treaty to be covered by the MLI, both treaty partners need to meet a number of conditions. Both treaty partners must have signed the MLI and must have listed the relevant treaty as covered by the MLI. Both treaty partners must have ratified the MLI and deposited an instrument of ratification, followed by the entry of the MLI into force in their domestic legislation.
At the initial signing ceremony on 7 June 2017, 68 jurisdictions signed the MLI. The number of signatories has grown since then and various countries have indicated how they will implement various provisions in different ways. The MLI is therefore to be viewed as a living, breathing document with a number of moving pieces. As the mechanism for the implementation of certain provisions may vary from country to country, it can be difficult to pin down exactly how certain rules will apply. Consequently, the OECD has published a list of up to date signatories, ratification and entry into force details on their website as well as a matching database, to show the interaction of the various rules between countries. This database which is continually updated for changes, should be the first port of call in determining the position adopted with regards to specific rules and provisions across different jurisdictions.
A number of key BEPS Actions are addressed by the provisions of the MLI:
- Action 2: Hybrid mismatches;
- Action 6: Treaty abuse;
- Action 7: Avoidance of PE status; and
- Action 14: Improving dispute resolution.
There is a number of key provisions in the MLI which are targeted at addressing these actions. In terms of addressing Action 2, the MLI aims to address this through the introduction of Article 4 of the MLI, dealing with tax residence and how this is determined. Under the existing OECD Model Tax Convention, generally where a company is resident will be determined by its place of effective management (i.e. where decisions are taken, where the staff members with actual decision-making capacity are located). Under Article 4, tax residence is now to be determined by mutual agreement between the competent authorities, such as Irish Revenue, HMRC, etc.
While this change would on the face of it appear to be relatively straightforward, such a change would likely present a logistical issue for some taxpayers. Specifically, the wording of Article 4 does not include any guidance as to how the Competent Authorities are to agree as to the tax residence of the applicants, nor are the provisions helpful in identifying with any great degree of clarity what will provide evidence of tax residence. The wording of Article 4(1) notes that the Competent Authorities will make their decision “having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors”.
What remains to be seen is how much weight the competent authorities will give to these various factors and whether they will issue a series of coordinated guidelines to taxpayers. Article 4 is likely to have a practical impact on taxpayers, and logistical details need to be considered including whether tax authorities have the capacity to actually handle requests for a determination of residence.
Another notable change brought about by the MLI is in Article 7, which outlines measures for the prevention of treaty abuse. Article 7 is a minimum standard, meaning that it is mandatory for all signatories, but it does provide an element of flexibility in its implementation, by providing three options to signatories;
- Principal purpose test (PPT);
- Simplified limitation on benefit and principal purpose test;
- Detailed limitation on benefit test (akin to double tax agreements with the US).
Ireland has opted in this case for the Principal Purpose Test, the result of which is that a benefit under a tax agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all the relevant facts and circumstances, that obtaining the benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.
Article 12 introduces a notable change in terms of the definition and scope of a permanent establishment (PE) and should be considered to be an area for focus.
Under this provision, where a person is acting on behalf of an enterprise and in doing so habitually concludes contracts, or habitually plays the principal role in leading to the conclusion of contracts that are routinely concluded without material modification, then the enterprise will be deemed to have permanent establishment in the country in which the person undertakes these activities.
Consider the existing provisions under many double tax agreements (DTA) and in the model tax convention which says that where a person other than an agent of independent status is acting on behalf of an enterprise and has, and habitually exercises, in a contracting state, the authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment. Article 12 essentially widens the scope for what will be classified as a PE globally (where adopted).
It is worth noting at this point that Ireland has exercised a reservation on this Article, so the revised PE provisions do not apply to any DTA with Ireland. However, other EMEA-based countries have not exercised a similar reservation.
Finally, with respect to Action 14, Article 16 sets out standard time limits and procedural rules for how disputes under tax treaties should be dealt with. This is a minimum standard.
Articles 18 – 26 deal with mandatory binding arbitration. Countries must first decide whether to opt into this at all and where they do so, whether they adopt or reserve on a number of articles detailing how the arbitration would work.
Ireland has opted into this arbitration procedure. The position paper released by Irish Revenue (before the MLI was deposited with the OECD) notes that “mandatory binding arbitration provides an important mechanism for ensuring disputes are resolved and that double taxation does not arise. Within the various articles, Ireland is open to the type of arbitration that is used”.
Article 23(1) provides for a “final offer” type approach, namely that after a case is submitted to arbitration, the competent authority of each jurisdiction shall submit a proposed resolution which addresses the issues in the case. The competent authority may also submit a position paper for consideration by the arbitration panel. The arbitration panel shall select one of the proposed resolutions for the case submitted but will not include a rationale or any other explanation of the decision. Article 23 also provides Contracting States the options to exercise a reservation and to adopt an “independent opinion approach”, whereby each competent authority presents evidence which is then adjudicated on to produce a binding written opinion. Ireland has not exercised any such reservation with respect to Article 23 and therefore the “final offer” type approach is to be followed post implementation of the MLI into domestic legislation in Ireland.
The focus in the MLI on arbitration and increased communication between tax authorities is a welcome development, but also an area for caution – taxpayers need to be more aware as we move forward that there is a greater flow of information between tax authorities. Global tax teams who may have once worked independently of each other with some guidance from a single tax lead now need to blend seamlessly and communicate effectively if they are to navigate the changing environment.
In terms of the timeline for the introduction of the MLI into Irish law, many of you will be aware that Ireland deposited its instrument of ratification with the OECD in January 2019. It is therefore expected that the MLI will enter into force on 1 May 2019, with non-withholding tax related provisions coming into effect from 1 November 2019 and all specific withholding tax related provisions coming into effect from 1 January 2020.
- EU Anti-Tax Avoidance Directive (ATAD)
In terms of EU led developments, a key area of focus for many corporates has been on the Anti-Tax Avoidance Directive and how the various provisions have been transposed into national law. The European Council formally adopted the Anti-Tax Avoidance Directive on 12 July 2016, and it aims at ensuring effective taxation in the EU using a variety of mechanisms and by addressing a number of key themes. Some of the key elements addressed are:
- Interest restrictions;
- Controlled foreign company rules;
- Exit tax; and
- Hybrid mismatches.
- Interest limitation rule
The most significant provision of the ATAD in practice is likely to be the introduction of fixed ratio interest limitation rules contained in Article 4. This operates to deny a deduction in respect of net interest expense (being gross interest less interest income) that exceeds 30% of the taxpayer EBITDA.
The limitations provided for in the article can be applied on an entity-by-entity basis or at group level. The deduction is restricted to 30% of EBITDA or €3million, whichever is higher.
To ascertain the potential impact of the interest limitation rules, domestic groups and multinational groups with Irish operations should review their current financing structures in respect of Irish and EU entities, identifying entities that might exceed the 30% limit.
The interest limitation rules must be transposed into law by 1 January 2019 unless there is a derogation claimed which applies on the basis that there is a pre-existing rule which is equally as effective. Where this applies, the deadline for the interest limitation is pushed out to 1 January 2024. We understand that discussions continue between Ireland and the EU in relation to a derogation for Ireland. It has been flagged, however, that Ireland may introduce interest limitation rules in Finance Bill 2019. A consultation was held by the Department of Finance earlier in the year on this topic.
- Exit tax
Legislation will be introduced to replace the current provisions with an ATAD compliant exit tax, to take effect no later than 1 January 2020. As we will see when we discuss the changes introduced in Finance Act 2018, this change has actually taken effect in Ireland as of 9 October 2018 – will discuss in more detail when we look at the Finance Act 2018 changes.
- Hybrid mismatches
A hybrid mismatch can arise due to the difference in how entities are treated for tax purposes in two different jurisdictions. In some cases what can arise are situations where the same expenditure item is deductible in more than one country or where expenditure is deductible but the corresponding income is not fully taxable. Given that these arrangements can result in a tax leakage overall, the ATAD aims to counteract this through the introduction of anti-hybrid rules. The Corporate Tax Roadmap released by the Irish Government indicates that legislation will be introduced into Irish law to deal with this in Finance Bill 2019, with effect from 1 January 2020. A consultation on this topic was held by the Department of Finance earlier in the year.
The reverse of this can also arise, i.e. the state of resident classifies the foreign partnership as taxable, but the other state classifies the entity as taxable. Given the complexity associated with these reverse hybrids, further legislation on this will be introduced in a subsequent Finance Bill in line with the ATAD schedule.
- US Tax Reform
One of the most impactful changes to the global tax landscape, and one of the most recent, has been the introduction of US tax reform. The reform of the US tax regime at the end of 2017 was announced against a backdrop of years of discussion around same, given that the last major reform took place in 1986.
In early discussions on the reform of the US tax system, a few key factors appeared:
- The introduction of a repatriation tax for offshore income at a reduced rate;
- Lower corporate income tax rates;
- A move to a territorial tax system;
- A general broadening of the tax base and measures to effectively protect the tax base; and
- An end to the “lock out effect”, whereby multinationals were free to effectively keep large amounts of cash offshore permanently in specific locations.
As we move through the various features of US tax reform, it becomes clear that while the aim of the reforms have been to move to a territorial system of taxation, the mechanism by which this has been achieved has the potential to nevertheless tax foreign source income albeit in a different manner.
It may be therefore fairer to say that the US has introduced a territorial tax system with long arms to still catch foreign source income.
Another key feature of US tax reform often described as the “stick” portion of the changes to the regime is the concept of Global Intangible Low Taxed Income (GILTI) charge. In the face of increased globalization and the growing importance of intangible property to value creation, the GILTI charge operates by treating all income in excess of a specified return on tangible property such as property plant and equipment as flowing from intangible property, and taxing that income on a current basis in the hands of the US parent company even where the income may actually be booked in a foreign subsidiary.
The rationale for this charge seems to rest on the recognition that the participation exemption regime which would apply under territorial rules creates an incentive for US corporations to allocate income away from the US, to foreign affiliates operating in low or zero tax jurisdictions.
Generally, GILTI inclusions are subject to tax at a rate of 10.5%. As there is a credit for 80% of the foreign taxes in relation to the GILTI income (subject to some complexities), the Irish rate of 12.5% is well placed.
While the GILTI regime is regarded by some as the “stick” of US tax reform, the Foreign Derived Intangible Income (FDII) regime appears to be the “carrot”. The FDII rules provide for a deduction for domestic corporations in order to incentivise them to locate IP back in the US, with a view to competing with other jurisdictions who may have similar IP or patent box type regimes. Under this regime, a domestic corporation is generally entitled to a deduction of 37.5% of its foreign derived intangible income, which means that such income is taxed at an effective rate of 13.125%. For the purposes of the regime, it includes any income derived in connection with certain sales of property and the provision of services.
While this would appear to be an attractive mechanism for incentivising the return of IP to the US, one of the concerns with respect to this is that the effective tax rate which can be achieved is very much dependent on the headline rate of corporate income tax in the US. While it is worth noting that the US corporate tax rate has been reduced, there is some uncertainty as to whether such a reduction in the rate is sustainable and whether future administrations will revise the rate upwards, thus eroding any real benefit from onshoring IP. Another concern is whether it could be challenged by the World Trade Organisation.
The last key area which we want to touch on with respect to US tax reform is in the area of Base Erosion Anti-Abuse Tax (BEAT) rules. The rationale behind the BEAT rules is to prevent US multinationals from eroding their tax base through making tax deductible payments to foreign companies. The rules operate to impose a minimum tax on the corporation by effectively denying a deduction for such base eroding payments through a specific formula.
Again, through the BEAT rules we can see how the US tax system while in name now a territorial regime, has developed long arms to effectively reach out to tax foreign income through other means. What is most challenging about the BEAT rules is that they do not appear to take into account the fact that there may be genuine commercial reasons for making such payments to the foreign affiliates or that they are supported by Transfer Pricing documentation.
Ireland’s 12.5% rate of corporation tax still remains attractive when compared with the US combined federal income tax and state rate tax (approx. 5%) which is likely to see most US businesses taxed at corporate income tax rates of approx. 25%. However, with a narrowing of the rate differential and focus on “America First”, the US will now be a bigger competitor than before. The introduction of the GILTI charge will be of relevance to a number of US headquartered companies, and in particular companies may be incentivised to invest in overseas tangible assets to reduce the impact of the GILTI charge. At the same time, the introduction of a reduced rate of tax on income arising from certain IP assets feeds into conversations with respect to IP structuring more than before reform. Lastly the BEAT regulations are likely to have a variety of impacts on US and non-headquartered companies, which may require a change to supply chain to minimise the impact. I’m sure there will be further commentary on the impact of US tax reform as part of the panel discussion.
- Irish Controlled Foreign Company Rules
A key development in Irish tax law has been the introduction of CFC rules. CFC rules are an anti-abuse measure, designed to prevent the diversion of profits to offshore entities in low or no tax jurisdictions. Prior to 1 January 2019, Ireland had no CFC rules in domestic legislation.
As set out in the Budget 2019 documentation, the CFC rules are expected to be tax neutral and no actual tax revenue is expected to be generated through the new rules. However, they still require consideration by taxpayers and documentation is likely to be needed to support the position taken by companies within the scope of the legislation.
By way of background, Anti-Tax Avoidance Directive 1 (ATAD 1), articles 7 and 8 make provision for the introduction of CFC rules into domestic legislation across all EU Member states.
Under Article 7, member states were given two options when determining how to implement the new CFC rules:
- Option A: This applies a CFC charge on undistributed income of the entity or PE which is derived from certain types of passive income such as interest, royalties, dividends or financial leasing income, or
- Option B: This applies a CFC charge on undistributed income of the entity or PE arising from non-genuine arrangements which have been put in place for the purposes of achieving tax advantage.
Ireland has adopted the Option B approach after much consultation on the matter and has introduced these new rules into domestic law with effect from 1 January 2019.
As you can appreciate, this is a significant piece of work to introduce a change such as CFC rules into Irish law. As with any new piece of legislation, the key focus is on stepping through the rules and conditions in a methodical manner to determine whether a CFC charge is likely to arise.
- Control and 50% ownership.
The first step to consider is firstly whether there is any control – it follows from the name of the rules that if there is no control there cannot be a controlled foreign company.
A CFC is defined as a company which is non-resident in Ireland and is controlled by a company or companies resident in Ireland. For the purposes of the legislation, control is defined as having the right to acquire or control the greater part of the share capital or issued share capital of the company or voting power. It also includes rights to income/assets on distribution on winding up or control over the composition of the board of directors.
Essentially the concept of control is based on the existing close company provisions we have under Section 432 TCA 1997 with some additional measures such as the ability to control the composition of the board of directors.
- Undistributed income
The second step to consider is whether there is any undistributed income in the sub held by Ireland.
If a CFC has no undistributed income then there is nothing to apply the CFC charge to in the first instance. That term is defined in s835Q TCA 1997 as being the distributable income of the CFC per the accounts less any relevant distributions.
One point on s835Q TCA 1997 is that it looks to accounting profits of a company “notwithstanding any prohibition on the making of a distribution under the laws of the territory in which the controlled foreign company is resident or otherwise”. It must be remembered that even close company legislation has an “out” for such prohibitions.
For the purposes of the definition, relevant distributions are those made:
- To a resident of a relevant member state;
- Within 9 months of the end of the accounting period; and
- Subject to tax in the relevant member state and does not fall to be repaid.
These conditions are therefore key, and the time limits for payment of distributions will likely need to be factored into standardised compliance review processes. In due course, we would expect that this will become part of the compliance calendar for many taxpayers.
- Significant People Functions (SPFs) performed by Irish company
Section 835R (2) TCA 1997 applies the CFC charge to undistributed income attributable to relevant Irish activities i.e. functions performed in Ireland on behalf of the CFC. This effectively means you look to the significant people functions or key entrepreneurial risk taking (KERT) functions exercised by Ireland.
KERT functions and SPF are to be construed in a manner consistent with the 2010 Report on the Attribution of Profits to Permanent Establishments. While this is a lengthy document, it does note that the SPFs which will be relevant will vary from one business sector to the next so whether or not the Irish company exercises any SPFs will very much be based on the facts at hand.
- Reasonable to consider TP
Once you have identified any SPFs or KERTs (i.e. once you have found the Irish fingerprint), the next step is to consider whether there are arm’s length arrangements in place.
The legislation as drafted says that the CFC charge will not apply where is it reasonable to consider that such arrangements would be entered into by persons dealing at arm’s length.
This means that where normal third-party commercial T&Cs apply to the arrangement, the CFCs charging provision should not apply to the undistributed profits.
- Reasonable to consider – tax essential purpose
Where we fail on the first four tests, we must then look to the next step which is the first of our tax essential purpose tests in the legislation.
This is set out in Section 835R TCA 1997 and states that the charge won’t apply where it’s reasonable to consider that it was not the essential purpose of the arrangement for the controlling entity to secure a tax advantage – so this is worded in the negative, from the perspective of the controlling party i.e. Ireland.
When we look at how this is worded – the use of the words “essential purpose” are key here. There is a clear marker between what is “essential” and what is “reasonable to consider”.
This effectively brings us into a Cadbury Schweppes type analysis – as a brief reminder, this was a case where the group had established two subsidiaries in Ireland solely in order that profits relating to the internal financing activities might benefit from the favourable tax regime here.
Para 37 of that decision notes that purely establishing in another state to benefit from more favourable legislation is not an abuse of the freedom of establishment, but there is a difference where tax is the essential purpose of the transaction.
- Arrangements subject to Irish TP rules
Section 835R(5)(a)(ii) TCA 1997 adds to the Transfer Pricing analysis alluded to previously, and essentially says that where an Irish entity has received an arm’s length remuneration for the SPF or KERT function provided, then the CFC charging provision will not apply in respect of that undistributed income.
This would make sense, given that the aim of the CFC rules is to essentially identify areas where an Irish company should in fact be paying tax on profits but has diverted profits offshore. Where they are however being remunerated for their services and being taxed on same, the aims of the CFC rules are essentially being met so it makes sense for this exemption to apply such that the same activities/support are not being taxed twice.
What is critically important at this juncture is to ensure that where no other exemptions can be relied upon to avoid the CFC charge, robust benchmarking and TP documentation is in place.
- Negligible undistributed income/small companies excluded
Failing the previous other exemptions mentioned, there are a number of other exemptions which may be relied upon.
Firstly, a low profit margin exemption is available to remove the CFC charge where the accounting profits amount to no more than 10% of the operating costs.
Secondly, a low accounting profits exemption is available which provides exemption where:
- The accounting profits of the CFC are less than €750,000 AND the non-trading element of those profits is less than €75,000, or
- The accounting profits are less than €75,000.
In addition, where there is a negligible increase in the undistributed income of a CFC post assumption of the risks or assets from the controlling entity, a CFC charge will not apply on this negligible income.
The question arises as to what is meant by negligible in this regard. It is worth pointing out that Section 538 TCA 1997 refers to negligible from a capital gains tax perspective and Revenues manual (Part 19-01-09, which is currently being updated by Revenue) on the section points out “As stated in Tax Briefing 52 the word ‘negligible’ is not defined for the purpose of the Capital Gains Tax Acts and therefore takes its normal meaning, i.e. not worth considering; insignificant. The concept of negligible value is not comparative in nature.”
- Reasonable to consider – non-genuine arrangements
Section 835R (10) TCA 1997 reads that the CFC charging section shall not apply in an accounting period where the CFC did not have any non-genuine arrangements in place.
A non-genuine arrangement is defined as one where:
- The CFC would not own the asset; or
- Would not have borne the risks which generate the income,
- But for the relevant Irish SPFs, and
- It would be reasonable to consider that the relevant Irish activities were instrumental in generating that income.
This condition is worded from the perspective of the CFC and asks whether the CFC would have taken on the risks and assets associated with the arrangement in the absence of the Irish company performing the significant people functions previously identified.
- Tax essential purpose
This bring us on to our second tax essential purpose test, contained in Section 835R TCA 1997. Again, this refers to the “essential purpose” being to obtain a tax advantage. However, the difference between this and the previous essential purpose test is that it is written from the perspective of the CFC rather than the controlling company.
The same considerations still apply as with the first essential purpose test previously referred to, namely is the essential purpose of the arrangements, from the perspective of the CFC, to obtain a tax advantage?
- Effective tax rate test
This is the last step in the analysis, which relies on looking to the effective tax rate in question.
Under this test, the undistributed income of the CFC won’t be subject to an Irish CFC charge if the controlled entity’s foreign effective tax rate (ETR) is more than 50% of the tax that would have been suffered had the income been taxed in Ireland at the notional Irish rate.
The notional Irish rate in this instance is calculated by reference to the Irish rules – the approach here is to take the undistributed income of the CFC and treat it as if it were subject to Irish tax rules, using some key assumptions:
- That the CFC is Irish resident;
- No change in place of activity;
- The CFC is not a close company;
- All relevant claims have been made by the controlled company;
- The CFC is not in a group; and
- No double tax relief is available to the controlled company.
Having the effective rate test so far down the chain in identifying whether a CFC charge arises seems unusual given that the wording of the ATAD does focus on the rate being key in identifying a CFC. However, by having the effective rate test so far down the list in terms of priority it effectively means that a tax payer is not required to prepare numerous calculations of the effective tax rate under Irish principals to determine a potential charge, when there are a range of exemptions available in priority to same.
An example of a scenario where the CFC rules would require further consideration and documentation would potentially include financing structures involving, say, an offshore entity. Take for example the financing arrangement whereby a subsidiary of an Irish headquartered group lends to other group companies on an interest-bearing basis. Under the CFC rules, some of the key questions to ask would be:
- What is the level of control?
- Is this a “non-genuine arrangement”?
- Are significant people functions exercised by Ireland?
- Is the transfer pricing for any SPFs in Ireland appropriately remunerated?
- Is a tax advantage the essential purpose? Are there commercial elements to the structure?
- Are any carve out provisions available?
3. Exit Tax and other Finance Act 2018 Changes
Effective from 9 October 2018 an exit tax rate of 12.5% on unrealised gains will apply on companies migrating their residency from Ireland. This charge will arise where:
- a company transfers assets from its permanent establishment in Ireland to its head office or permanent establishment in another territory,
- where a company transfers the business carried on by its permanent establishment in Ireland to another territory, or
- where an Irish-resident company transfers its residence to another country.
Prior to the change in law, many companies would have been able to claim an exemption from this exit tax under domestic rules. This amendment to exit tax rules in Budget 2019 was somewhat unexpected considering that Ireland is not required to bring their domestic exit tax rules in line with EU ATAD standards until 1 January 2020.
The 12.5% rate is certainly welcome rather than the normal 33% CGT rate on disposals of assets and provides certainty for those considering investing in Ireland at a time where many companies are considering moving IP to Ireland. However, there is an anti-avoidance provision which provides that the standard capital gains tax rate of 33% will apply where the transfer/migration forms part of a transaction to dispose of the asset and the purpose of the transaction is to ensure the chargeable gain accruing on the disposal of the asset is charged to tax at the 12.5% rate rather than the 33% rate. This anti-avoidance provision needs to be considered where groups are trying to restructure their operations which could involve consolidating IP or other assets into a single jurisdiction.
Section 291A TCA 1997
In terms of addressing changes to the taxation of innovation, we would note one point regarding the technical amendments to s291A TCA 1997 in Finance Act 2018 relating to the 80% cap introduced by Finance Act 2017.
The original wording Section 291A(6) TCA 1997 as introduced by FA 2017 provided that any allowances made for specified intangible assets will not exceed 80% of the amount of trading income from the relevant trade i.e. from the exploitation or management of the assets or from the sale of goods or services deriving their value from the assets in question. While the original wording (Section 291A(5)(b) TCA 1997) indicated the relevant activities and other trading activities would be streamed on a just and reasonable basis, the legislation was not explicit with respect to the streaming of income derived from intangible assets purchased pre and post 11 October 2017.
A technical amendment has been introduced by Finance Act 2018 in respect of the application of the 80% limit. This requires that income generated from such qualifying intangible assets acquired before and after 11 October 2017 is segregated into two separate income streams. While this technical amendment clarifies the law in this regard, the wording of the Finance Act states that the amendment will apply retrospectively to corporation tax returns already filed by the company which may cause difficulties for companies that filed their returns on another basis.
One final point we would note in terms of FA 2018 developments is the extension of the start-up relief for companies to 2021, which is welcome as it is often used by MNCs investing in Ireland for the first time.
- Digital Tax
The concept of a digital tax, and how to apply taxation in an increasingly digitalised world, has been more and more prevalent in discussions in the international tax world, and a key focus in recent months has been on how digital transactions are taxed.
Until relatively recently, the European Commission had been proposing a range of interim measures to introduce a digital services tax. This interim tax would apply on revenue generated from the supply of certain digital activities where users play a major role in value creation, and which are the hardest to capture with current tax rules. The proposals refer to a tax rate of 3% on such revenues.
Included within the scope of the digital services tax would have been the online placement of advertising, the sale of collected user data and the provision of digital platforms that facilitate interaction between users. The proposed tax would have had a threshold such that it would not apply where total worldwide revenues are below €750m and total annual revenue from digital activities in the EU are below €50m.
However, as of 12 March 2019, the interim digital tax proposals have effectively been shelved by the EU in favour of working towards greater unanimity in how such measures are to be applied on a global level given the OECD work in this area. While this will be a welcome development for many companies in the digital space, they will still encounter tax charges from specific jurisdictions such as the UK, France and Spain who have introduced unilateral measures to tax digital transactions.
One key example is the UK, where the Digital Services tax will be introduced from April 2020. In comparison to the 3% rate previously proposed by the Commission, the UK rules apply a 2% tax on revenues of specific digital business models where revenue is linked to the participation of UK users. The tax suffered by a UK entity will be an allowable deduction for corporate tax purposes, but importantly will not be allowable as a credit against corporate tax.
The scope of the UK tax will include search engines, social media platforms and online marketplaces but will exclude financial and payment services, the proviso of online content and television or broadcasting services.
In addition to the unilateral UK measures, another key jurisdiction which has pushed ahead with its own version of the digital tax is France. On 6 March 2019, the French Government submitted a draft bill detailing the proposed measures to the French Council of Ministers. Its main features are similar to the Digital Services Tax (DST) proposed by the European Commission on 21 March 2018, with a single rate of 3% levied on gross income derived from certain digital services for which the French Government deems user participation is essential for creating value; namely, targeted online advertising, which include the sale of user data, and online intermediation services (i.e., platforms). Similar to the UK, the tax levied would be deductible from the corporate income tax base as opposed to available as a tax credit.
- Taxing Business in a Digitalised World
People may recall that as part of the BEPS project, Action 1 covered the tax challenges of the digital economy but did not make any clear recommendations in relation to international tax matters except that there was a need for monitoring developments in the digital economy over time. Work has continued in this area since that report. In January 2019, the OECD released a policy note detailing its views on the challenges of taxing business in a digitalised world.
The report acknowledges that the digitalisation of the global economy is pervasive and cannot be effectively ring-fenced to solely digital transactions. The policy document notes that the proposal involving two pillars should be looked at. The first pillar addresses the challenges of the digitalised economy and focuses on the allocation of taxing rights, while the second pillar addresses other remaining BEPS issues. To progress the issue, the Inclusive Framework agreed to hold a public consultation on possible solutions to tax challenges on 13th and 14th March 2019 at the OECD Conference Centre in Paris. The objective of this consultation was to provide external stakeholders an opportunity to provide input on the digitalisation of the economy and potential tax changes to accommodate this.
The consultation document circulated in February 2019 sets out a number of proposals for change. In particular, the report examines three proposals for revising profit allocation and nexus rules in response to challenges posed by digitalisation.
- The user participation proposal
This proposal focusses on value created by certain highly digitalised businesses through developing an active and engaged user base and soliciting data and content contributions from them. Therefore, the proposals are aimed at social media platforms, search engines and online marketplaces. The proposal seeks to revise profit allocation rules to take into account the value created by an active user base and would revise the nexus rules so that user jurisdictions have the right to tax additional profit allocated to such users, irrespective of whether the business has a local physical presence. A proportion of the non-routine profits of the business would be attributed to the value created by the activities of the users and allocated between the countries in which the users are based using an agreed allocation metric.
- The marketing intangibles proposal
A secondary proposal under discussion is based on the concept of marketing intangibles and would apply to all types of businesses whether or not highly digitalised. For the purposes of the proposals, marketing intangibles are to be defined in line with OECD Transfer Pricing guidelines, and so may include trademarks, customer lists, customer relationships, and proprietary market and customer data. The proposal is intended to address situations where a company can use marketing intangibles to reach into certain countries to develop a user/customer base and other marketing intangibles.
The proposal would extend taxing rights to market jurisdictions. A portion of non-routine profits would be attributable to the use of marketing intangibles related to that market jurisdiction and allocated across the market jurisdictions based on an agreed metric such as sales or revenues.
- The significant economic presence proposal
Lastly, the third proposal being considered is the concept of a significant economic presence. When we think of highly digitalised businesses, there can be a view that certain technological advances have made it possible to do business in a country without having significant physical presence – for example a video or film streaming service may be availed of from a company with minimal presence in Ireland. Under this proposal, a taxable presence would arise when a non-resident enterprise has a significant economic presence. Key features would likely involve revenue generated on a consistent basis, but revenue alone would not be sufficient to show nexus. Other features which would suggest significant economic presence could include:
- The existence of a user base;
- A high volume of digital content derived from the jurisdiction;
- Some form of local billing and collection of payments;
- Maintenance of a website in a local language;
- Responsibility for customer service and delivery of services locally; or
- Sustained marketing and sales activities locally.
Different options will be considered as to how the profit should be allocated to the significant economic presence. This could include a fractional apportionment method under which the tax base could be determined by applying the global profit rate of the group to revenues generated in a jurisdiction and then apportioning the tax base using and agreed weighting of allocation keys such as sales, assets and employees.
Clearly, all three proposals would require changes to nexus and profit allocation rules, and a rewiring of our thinking in terms of traditional Transfer Pricing methodologies, not to mention serious considerations with respect to the actual administration and collection of the taxes worldwide.
Aside from the three proposals noted, the consultation document goes further and details proposals to address the continued risk of profit shifting to entities subject to low or no taxation.
The proposals aim to tackle this thorough the development of two interrelated rules:
- An income inclusion rule; and
- A tax on base eroding payments.
Under the income inclusion rule, this would tax the income of a foreign branch or controlled entity if that income was subject to a low effective tax rate in the jurisdiction of establishment or residence. This rule would be designed to supplement rather than replace current CFC rules. Areas identified for further work include: the determination of the minimum rate; the ability of a minority shareholder to access the information needed to calculate its liability; the design of the effective tax rate test; any safe harbours; rules for attributing income to shareholders; detailed mechanisms for avoiding double taxation; and compatibility with international obligations such as EU law.
In addition, a tax on base eroding payments would deny a deduction or treaty relief for certain payments unless that payment was subject to an effective tax rate at or above a minimum limit. Further work would also need to be done in this area.
The OECD Inclusive Framework will meet in May to agree a detailed programme of work. A consensus based long term solution is expected to be presented in 2020.
The OECD proposals would introduce significant changes and would impact many businesses, not only those in the digital economy.
There has been significant change in the international tax landscape in recent years given the OECD and EU measures, leading to changes being introduced in Ireland. However, much more change is yet to come. We are expecting to see a consultation in relation to the potential introduction of a territorial regime in Ireland. It is important that the Department of Finance continues to consult with taxpayers as changes are implemented so as to provide as much certainty as possible to taxpayers.