10.11.Calculate the surcharge on service companies
10.11.1.Meaning of service company
Up to now, we have looked at a surcharge which applies to the passive income of a closely held company.
You will remember why the surcharge was introduced i.e. to prevent the use of corporates as a planning measure in an era where the personal tax rates are far higher than the corporate rates.
It was felt that the surcharge should also be applied to “active” income where professional persons tried to avoid paying the top rate of personal tax on their fee income. This surcharge is known as the professional services surcharge and is levied on professional income at 15% after tax. Passive income is still levied at 20% after tax.
A service company is defined in Section 441(1) TCA 1997 as a close company:
a) whose business consists of or includes the carrying on of a profession or the provision of professional services;
b) having or exercising an office or employment; or
c) whose business consists of or includes the provision of services or facilities of whatever nature to or for:
(i) a company within the categories (a) and (b) described above
(ii) an individual or partnership which carries on a profession
(iii) a person who holds or exercises an employment
(iv) a person or partnership connected with any of the above.
Services provided to an unconnected person or an unconnected partnership are ignored. The term ‘service company’ applies only where the principal part of the company’s income which is chargeable under Case I and II is derived from the profession, the provision of professional services, the provision of certain services or facilities or a combination of these activities, e.g. auctioneers, journalists, opticians.
‘Professionals’ include architects, auctioneers, surveyors.
See the Revenue Precedents listed after Section 441 TCA 1997 and Tax Briefing 48, Page 19.
Section 441 TCA 1997 service company surcharge
The 15% after tax surcharge set out in Section 441(1) TCA 1997 is imposed on the amount by which
(a) the aggregate of 50% of the company’s “distributable trading income” (as defined in Section 434(5A) TCA 1997) and 100% of its distributable estate and investment income (because this portion has already been subject to the 20% surcharge) exceeds
(b) the distributions made by the company for the accounting period.
In effect, the distributions are first deemed to be made out of the distributable estate and investment income (reducing the 20% surcharge) and then out the distributable trading income (reducing the 15% surcharge).
Effective rate of tax on Case II income charged to Section 441 TCA 1997 surcharge
Tax on Case II – 12.50%
Effective Surcharge – 6.56% (100% income less 12.50% tax × 50% × 15% surcharge)
Total Tax on Case II – 19.06%
10.11.2.Close service company surcharge
Section 441 TCA 1997 provides for the formula used when calculating the surchargeable amount in respect of close service companies.
The amount on which the surcharge of a service company is levied on is arrived at as follows:
1. Calculate the distributable trading income. (Trade income less relevant trade charges and after standard rate corporation tax).
2. Calculate half of distributable trading income.
3. Add the distributable estate and investment income (net of the 7.5% trading discount). This is the same calculation as used for the Section 440 TCA 1997 surcharge, steps (i) to (iii).
4. From the figure at 3 above, deduct all distributions for the accounting period and paid during or within 18 months of the end of the accounting period to give the total surchargeable amount.
5. From the distributable estate and investment income (as calculated at 3 above) deduct all distributions for the accounting period and paid during or within 18 months of the end of the accounting period
6. Apply 20% surcharge to the total surchargeable amount at 5
7. Deduct the amount surcharged at 5 above from the total at 4 above and apply a surcharge of 15%. Add this amount to the surcharge at 6 above to arrive at the total surcharge.
B Ltd (a service company) has the following results for the accounting period ended 31 December 2018:
B Ltd paid charges of €3,000 in respect of its trading activities and claimed €4,000 of loss relief under Section 396(1) TCA 1997 for a loss which arose in AP ended 31.12.17. The company made distributions of €2,000 in the year ended 31 December 2018 and paid expenses of €400 for a participator (for the purposes of the example, assume the participator did not repay the initial DWT arising in respect of the expenses to the company).
1. The distributable trading income of the company is calculated as follows:
2. To calculate half of the distributable trading income, i.e. €25,375 divided by 2 = €12,687.
3. Add to amount at Step 2 the distributable investment and estate income (net of trading discount) of €10,929 (as calculated in Example 10.15).
5. Excess of distributable estate and investment income over distributions made
6. Surcharge at 20% on €8,429 = €1,686
7. Surcharge at 15% €
Surcharge at 15% = €1,903
Therefore, total surcharge assessed on company; €1,686 + €1,903 = €3,589.
This surcharge is payable with the corporation tax liability for the year ended 31 December 2019.
For the purposes of the exam, unless otherwise stated, assume the participator did not repay the initial DWT arising in respect of the expenses incurred by the company on behalf of the participator such that the gross-up provisions apply.