1.3.Interpret legislation to apply income tax principles to allocate the income of corporates to the appropriate Schedule or Case
As with income tax, corporation tax is based around allocating the various sources of income to different categories.
Similar to income tax, corporation tax also uses the income source known as Schedule D which contains the five cases, I – V.
The concept of Schedule E, employment income does not exist for a company as a corporate cannot be an employee.
The Schedule F income of an individual, Irish dividends, does not apply to companies. When an Irish company receives a dividend from another Irish company it is called Franked Investment Income (FII) and is exempt from tax, s.129 TCA 1997. See chapter 9 for further discussion.
Therefore, for a corporate the main taxable sources of income are schedule D cases I – V.
1.3.1.Schedule D case I/II
As with income tax, cases I and II tax trade and professional income, section 18(2) TCA 1997.
As you will see from section 1.6, the corporation tax rate for trading and professional income at 12.5% is half that of investment income (25%) and therefore it is generally in the interest of a company to have its activities classified as trading.
In most cases this is very obvious, for example the trading rate will apply to all building companies, retail outlets, incorporated professionals such as accountants, doctors etc.
The situation is not as clear-cut when the company’s activities might not be high volume or match many, or indeed any, of the badges of trade characteristics, which you covered in your personal taxes manual.
Therefore, due to the difference between the rates, the distinction between whether a company’s activities are trading or investment based is an important one. There is a risk that low substance businesses (sometimes called “brass plate” operations) will try to exploit this low 12.5% tax rate.
Revenue have offered published guidance on the trading-v-passive question in:
■ Tax Briefing 57 (available at www.revenue.ie),
■ Revenue Statement of Practice on Classification of Activities as Trading (available at www.revenue.ie),
■ Revenue List of Opinions on the Classification of Activities as Trading (available at www.revenue.ie).
Example 1.15: Licensing of intellectual property
At one end of the scale, and almost certainly passive (i.e. non-trading), is the company that owns a brand or trademark and licences it at a pre-determined price to a single affiliated company.
At the other end of the scale are companies engaged in distribution of cinema and TV films. These acquire the rights to the films from producers and in exchange for the payment of distribution royalties permit the films to be shown by cinemas, TV stations and video distributors. It is hard to see how this activity would not constitute trading.
Factors supporting the existence of a trade in the context of a licensing activity will include the number of customers dealt with, incurring promotional or marketing expenditure in relation to the licensed property, and managing a diverse portfolio of products for licensing (including, where relevant, commissioning new or developed products on a subcontract or direct basis).
Example 1.16: Financial services companies
A trading company will use financial instruments to earn a commercial return but an investment company will take on limited financial risk.
At one end of the spectrum is a company that puts funds in an interest earning deposit account (clearly passive) and at the other is a bank or insurance company whose interest income is undoubtedly active.
If the transactions have a limited purpose, there is a low volume of transactions or the transactions involve holding only income generating debt instruments, then the company’s income is passive, not trading.
It is likely that holding shares will (unless the portfolio is actively dealt with on a regular basis - turning over the portfolio a number of times per year) normally constitute a passive activity and holding shares in subsidiaries will invariably be passive.
Example 1.17: Venture capital investment
Venture capital companies generally invest in order to realise a profit on the sale of their investment, but the holding period may be a number of years. Generally venture capital companies in Ireland are charged to corporation tax on chargeable gains on the disposal of their investments, with dividend income on investment subject to the passive corporation tax rate.
Depending on the level and frequency of turnover of the portfolio, it might alternatively be possible to sustain an argument that the company is trading, with all transactions taxable at the trading rate.
Example 1.18: Rental income
Irish rental income will always be Case V regardless of the level of management or number of properties.
Example 1.19: Leasing income
The activities of a leasing company would generally be treated as Case I if the company was actively involved in acquiring the assets to be leased and then charged with leasing them to third parties. It should have its own staff or subcontractors who are knowledgeable in the industry and would conduct its own leasing contracts.
Xpert Limited is an Irish resident member of a multi-national software development group. The activities of Xpert Limited involve the acquisition of intellectual property from certain group members and the licensing of such intellectual property to other EU based group members. The company has asked your advice on the steps it should take to seek to ensure that the profits arising from these activities would be subject to tax in Ireland at 12.5%.
Set out the advice you would give Xpert Limited.
Case study solution
To successfully secure trading status in Ireland and qualify for the 12.5% tax rate, Xpert Limited needs to be actively carrying on a trade.
Because of the nature of the activities, there is a risk that the activities could be, or be perceived to be, passive and therefore chargeable to corporation tax at the rate of 25%.
In considering this matter, it is important to consider relevant case law in this area as well as the badges of trade.
There is no comprehensive definition of what constitutes a trade in Irish tax legislation. The term trade is statutorily defined to include “every trade, manufacture, adventure or concern in the nature of a trade” (s. 3(1) TCA 1997).
Reliance is also placed in interpreting the term ‘trade’ on the UK ‘Badges of Trade’ and on UK case law which, though not binding, is of persuasive authority in Ireland. The badges of trade are as follows:
■ the matter realised - whether the property acquired was (e.g. commodities, manufactured articles) normally the subject of trading or investment.
■ The length of period of ownership - generally property meant to be traded or dealt in is realised within a short time after acquisition.
■ The frequency and number of similar transactions by the same person.
■ Supplementary work on or in connection with the property realised – there would be evidence of trading if, for example, the property is worked on in any way during the ownership so as to bring it into a more marketable condition or if any special exertions are made to find or attract purchasers.
■ The circumstances that were responsible for the realisation.
■ Profit motive - this can be inferred from the surrounding circumstances in the absence of direct evidence of the seller’s intentions.
Xpert Limited should:
■ engage a number of Irish based employees to carry out its work;
■ maximise the functions of the Irish employees;
■ specify the functions of the Irish employees in their contracts of employment;
■ secure an Irish premises from which the Irish employees operate and incur related costs;
■ add value to the product and incur research and development costs;
■ be seen to accept commercial risk in its business dealings;
■ if possible, enter contracts with customers other than related group companies.
The company must be genuinely trading to avail of the 12.5% tax rate.
1.3.2.Schedule D Case III
There are two main components of schedule D Case III –
As with an individual, all income received from outside of Ireland is treated as being case III, section 18(2) TCA 1997. This includes income from trades, rent, investments, dividends etc. Therefore a company with a branch in Belfast and Berlin would allocate the income to schedule D case III, even though the branches are earning trade income.
Schedule D case I or II only applies to trade and professional income earned in Ireland.
Interest received gross
Unlike individuals, companies are entitled to receive deposit interest gross, without deduction of dirt, s.257 TCA 1997. See chapter 9 for the conditions necessary to receive interest free of DIRT. This income is then taxed under schedule D case III.
1.3.3.Schedule D case IV
As with individuals, companies are taxed on interest subjected to DIRT under schedule D case IV, section 18(2) TCA 1997.
In this situation, the gross interest payable by the bank would have DIRT at 37% deducted. The bank would pay the DIRT to the Revenue and credit the company’s deposit account with the net 63% (100% of the interest due less 37% DIRT).
The company must then re-gross the net amount received and charge the entire amount to schedule D case IV. They will receive a credit for the DIRT withheld.
Example 1.20: Interest income
Florence Ltd places €100,000 on deposit with X bank Ltd for one year at 10% interest payable.
At the end of the year the bank owe gross interest to Florence Ltd of €10,000 (€100,000 × 10%). Florence Ltd will receive €6,300 after 37% (€3,700) DIRT is deducted.
In Florence Ltd’s corporation tax return the net interest is regrossed back to €10,000 and taxed under schedule D case IV. The company will also receive an allowance for the DIRT deducted.
You will recall that an individual is only entitled to a refund of DIRT where the DIRT deducted is greater than his or her income tax liability in certain circumstances (i.e. if the taxpayer or his/her spouse is aged over 65 in the tax year or either are permanently incapacitated). Apart from these circumstances any excess DIRT is not refundable.
However, in the case of a company a refund of DIRT is available, regardless of the status of the company. Therefore, any excess DIRT over and above the corporation tax due by the company will be refunded.
Schedule D case IV is also used to tax all other sundry income not taxed under any other specific schedule/case.
1.3.4.Schedule D case V
Schedule D case V is similar for both individuals and companies and taxes Irish rental income, s.18(2) TCA 1997. Income from each separate Irish property is calculated and combined to give one source of income.
Rent from outside Ireland is schedule D case III and not case V.
Dividends or other distributions received by an Irish resident company from an Irish resident company are not subject to corporation tax (Section 129 TCA 1997). This is a fundamental difference between income tax and corporation tax.
“Franked investment income” is the term which is given to dividends received by an Irish resident company from another Irish resident company.
If Mr. X an Irish resident individual receives a dividend from Smurfit Plc he will be subject to income tax under Schedule F on the gross dividend and will be entitled to reduce his income tax liability by the tax credit attaching to the dividend (in respect of the dividend withholding tax paid).
However, if the dividend in Smurfit Plc is received by ABC Limited (an Irish resident company) the dividends will be franked investment income and exempt from corporation tax.
Therefore, a company will never be subject to tax under Schedule F. A charge to tax under Schedule F only exists in relation to income tax, section 20 TCA 1997.
X Limited (an Irish resident company), pays a dividend of all of its profits to its shareholder, Y Limited, an Irish resident company. X Limited has profits available for payment of a dividend in respect of the year ended 31 December 2018 calculated as follows:
|Tax @ 12.5% (say)||(12,500)|
|Profits Available for Dividend||87,500|
Y Limited will not be subject to tax on the dividend of €87,500 it received from X Limited. This income is Franked Investment Income as X Limited has already paid tax on the profits which were distributed i.e. €12,500.
It is not necessary that there be a minimum shareholding relationship between the parties in order for a dividend to be franked investment income. In the example above, the dividend of €87,500 would be treated as franked investment income even if it was split between 10 different Irish resident companies.
A company is not entitled to a deduction (in its corporation tax computation) for any dividends or other distributions paid by it. This is because such dividends are an appropriation of profits and not an expense related to the generation of profits (dividends paid are below ‘profit before tax’ in the Statement of Comprehensive Income so in practical terms won’t affect the paying company’s corporation tax computation). See also chapter 8 for a further discussion on this.
So, in summary, franked investment income is not taxable by a corporate shareholder, and similarly a deduction is not available to the company paying the dividend.
DEF Limited (an Irish resident company) generated taxable profits of €100,000 in the year ended 31 March 2018. It decided to pay a dividend of €50,000.
It will not be entitled to a deduction for this dividend payment i.e. it will be liable to corporation tax on €100,000.
Cases I/II/III/IV and V are the same for income tax and corporation tax.