Business Taxes

Chapter 4Other Charges on Income

AIM

To teach students about the reliefs available when a company incurs charges.

LEARNING OUTCOMES

Once you have studied this chapter, you should be able to:

4.1 Explain what is meant by “a charge on income” and identify when it arises 97
4.2 Conclude, based on tax law, what is meant by an annual payment and when it arises 99
4.3 Conclude, based on tax law, what relief is available for charges on income 101
4.4 Distinguish relevant trade charges and other charges and outline the relief available for each 102
4.5 Calculate the relief available for charges on income 104
4.6 Judge the optimal use of charges for a given set of circumstances 109

PRE-READING

Personal Taxes Manual

Chapter 22 - Charges for income tax purposes

MAIN LEGISLATIVE PROVISIONS

Chapters 1, 2 and 3 of Part 8, Sections 81, 97, 396, 840 and 848A of TCA 1997

FURTHER READING

Corporation Tax, Finance Act 2010, Irish Tax Institute

Chapter 4 losses

4.1.Explain what is meant by “a charge on income” and identify when it arises

Certain payments, chiefly interest on loans which are drawn down for one of the purposes set out in Section 247(2) TCA 1997 (see Chapter 4), annual payments and patent royalties are treated as ‘charges on income’ in accordance with Section 243 TCA 1997.

Deductions are not available to a company for these payments when computing Case I/II trading income (for example, payments in respect of the use of patents are disallowed under Section 81(2)(m) TCA 1997 and annual payments under Section 81(2)(l) TCA 1997). However they may be allowed as a separate deduction/charge in the accounting period in which they are made i.e. relief is granted on an actual payment basis.

Charges on income can be either “relevant trade charges” or “non-relevant trade charges”. The differences between these two categories are explained further in 4.3 and 4.4 below.

Section 243(1) TCA 1997 provides that a payment does not fall into the definition of a charge on income in so far as it is deductible in computing taxable income from a particular source. For example:

interest paid wholly and exclusively for the purpose of a trade is an allowable trade deduction against Case I income and is not a charge.

interest on funds borrowed relating to let premises is treated as an allowable Case V expense and does not rank as a charge.

Also, dividends or other distributions of a company are not treated as charges on income.

Note – Section 243(7) and (8) TCA 1997 specify that only interest on loans that meet the conditions set out in Section 247 TCA 1997 will qualify as a charge on income.

4.1.1.Conditions for relief for payments as a charge on income

Payments (for example, patent royalty payments) will not be treated as a charge on income if:

1. they are not made under a liability incurred for valuable and sufficient consideration e.g. payments in excess of the value of a patent license would be disallowed (Section 243(6)(b) TCA 1997)

2. they are made by a non resident company, unless they are incurred wholly and exclusively for the purposes of a trade carried on by the company in Ireland through a branch or agency (s. 243(6)(b) TCA 1997)

3. the payment is not ultimately borne by the company (Section 243(6)(a) TCA 1997); or

4. it is capital expenditure in respect of the user of a patent or the payment is charged to capital (Section 243(6)(a) TCA 1997). Note – contrast this provision with Section 81(3)(a) TCA 1997.

4.1.2.Additional conditions apply where the qualifying payments are made to a non-resident (Section 243(5) TCA 1997):

Payments to non-residents will not be treated as charges on income unless:

1. The paying company deducts tax at source at the standard rate of income tax in force at the time of payment (currently 20%) in accordance with the provisions of Section 238 or 246 TCA 1997. Note – there are exceptions to the obligation to withhold in these sections and where tax is not withheld because one of these exceptions applies the payment will still qualify as a charge on income;

2. The payment is one payable out of foreign income chargeable to tax under Case III i.e. it arises from securities and possessions outside the State; or

3. Withholding tax is not required as the payment falls within the domestic legislation implementing the EU Interest & Royalties Directive which you will cover in detail in your Part 3 studies.

4.2.Conclude, based on tax law, what is meant by an annual payment and when it arises

The meaning of “annual payment” is derived from case law. Initially, the concept applied to payments that were made on an annual basis but the courts have since expanded the criteria for what will be treated as an annual payment.

Annual payments are referred to in Sections 237, 238 and 243 TCA 1997.

These types of payments are relatively rare as they exclude both yearly interest and royalties. The main example of an annual payment is a payment made under a deed of covenant.

The main criteria for payments to be treated as annual payments are:

1. the payment must be one which is capable of recurring annually (for example, non-patent royalties payable for 9 months from the date of the grant of a licence would not be capable of recurring annually and therefore would not be an annual payment). The intervals at which the payments are made (e.g. monthly) does not affect the character of the payments as annual payments as long as they are capable of continuing beyond a year

2. there must be a binding legal obligation to make the payment. A payment which just happens to be made every year but where there is no binding legal agreement to make the payment is not in itself an annual payment. The payment must be something that is “paid out of” the income of the payor and not just an application of income

3. annual payments do not include payments of a capital nature as these would not constitute “pure income profit” of the recipient (see below). Therefore the payment of a capital sum by annual instalments would not mean that those payments are annual payments. Note: whether a payment is an instalment of a capital sum or part of a stream of income payments will depend on the facts and circumstances of the payor and payee and the nature of the payments

4. the payment constitutes “pure income profit” in the hands of the recipient

Case law – Re Hanbury 38 TC 588

This case developed the concept of an “annual payment” as “pure income profit” of the recipient

The case distinguished between payments which can be regarded as income of the recipient undiminished by any deductions and income which is to be taken into account in determining the profits of the recipient

For example, interest payments, annuities, etc. can be taken to be pure income profit of the recipient as he/she does not have to incur any costs/expenses in generating that income. However, an annual retainer fee paid to an accountant or solicitor would not be treated as pure income profit as the service provider would incur costs in providing the services covered by the fee.

Case law – Rank Xerox v Lane 1978 STC 449

In this case it was stated by the Court of Appeal that:

“Where the position of the payee [recipient] is such that his absolute entitlement to receive payments is wholly independent of any outgoings or expenses to which he may be liable we can see no reason in principle why the payments should not be “pure income profit” and therefore an “annual payment”.”

4.3.Conclude, based on tax law, what relief is available for charges on income

Section 243 TCA 1997 governs the tax treatment available for charges and subsection (2) states that all charges shall be allowable against the total profits of the company after all other relief from corporation tax except group relief. As set out in Chapter 2.2, “total profits” is the total income and chargeable gains of the company for the accounting period.

Section 243A TCA 1997 excludes relevant trade charges from being set against total profits as per Section 243 (2) TCA 1997. “Relevant trading charges on income” (commonly referred to as relevant trade charges) are defined in Section 243A TCA 1997 as the charges paid by a company in an accounting period for the purposes of a trade carried on by the company other than charges paid for the purposes of an excepted trade. An example of a trade charge is a patent royalty payment where the subject matter of the patent is used for the purposes of the company’s trade.

This effectively only leaves non-trade charges as being available for offset against total profits. The most common non-trade charge is interest on loans which fall within the provisions of Section 247 TCA 1997.

Section 243A TCA 1997 allows relevant trade charges to be set against trade income with any unused excess to be set against other income and profits on a “value basis” in accordance with the provisions of Section 243B TCA 1997.

See 4.4 for a full description of how both types of charges can be utilised.

4.4.Distinguish relevant trade charges and other charges and outline the relief available for each

4.4.1.Relevant trade charges

As set out in 4.3 above, “relevant trading charges on income” are defined in Section 243A TCA 1997. These are charges which are paid by the company in that accounting period which are wholly and exclusively for the purposes of a trade carried on by the company (other than payments for the purposes of an excepted trade).

The most common are patent royalties. Subject to any exemptions which may apply, income tax at the standard rate (currently 20%) should be deducted prior to payment. The income tax withheld is added to the company’s corporation tax liability and is paid in accordance with the company’s normal corporation tax payment obligations (Section 239 TCA 1997).

S. 243A TCA 1997 provides that a company’s “relevant trading charges on income” may only be offset against “relevant trading income”. This is defined as the trading income of the company for an accounting period other than income chargeable under Case III (e.g. income of a foreign trade or distributions for which an election can be made under Section 21B TCA 1997) or income from an excepted trade.

S. 243A TCA 1997 states that the charges on income which are attributable to trading income chargeable at the standard rate of corporation tax may only be relieved by set off against trading income that is charged to tax at the standard rate – this is the set off against “relevant trading income” as defined above.

The amount of the expense charged in the statement of comprehensive income must be added back in the Case I/II computation and a deduction for the total charge actually paid in the accounting period is available against the trade income (for example, in the case of a patent royalty which is a relevant trade charge, the deductible amount is the amount paid to the patent holder and the amount of income tax deducted).

Relevant trade charges can only be offset against non-trade income on a “value basis” (Section 243B TCA 1997). The term “value basis” refers to the tax value of the charges and you will see more about this in Chapter 5. Essentially, the tax value of relevant trade charges is the amount of the charges multiplied by the standard rate of corporation tax (currently 12.5%). This is the maximum amount by which the company’s corporation tax liability can be reduced by the relief available for the charges. Relief for relevant trade charges on a value basis is given as a deduction from the company’s corporation tax liability (rather than as a deduction from profits).

Example 4.1

The following information relates to the accounting year ended 31 December 2018 of Muggins Ltd:

Case I relevant trading income (before charges) 10,000
Relevant trade charges 16,000
Case III interest income 5,000

The company’s corporation tax liability for the period is calculated as follows:

Case I taxable income (Note 1) Nil
Case III interest income 5,000
Total taxable profits 5,000
Tax at 12.5% Nil
Tax at 25% 1,250
Section 243B TCA 1997 relief (Note 2) (750)
Corporation tax payable 500

Note 1 – Taxable Case I income is nil as the company’s relevant trade charges are greater than the Case I income before deduction of charges.

Note 2 – The relief under Section 243B TCA 1997 is calculated as the excess of the relevant trade charges over Case I income before relief for charges (i.e. €6,000) multiplied by the standard rate of corporation tax of 12.5%. This is the maximum amount by which Muggins Ltd can reduce its corporation tax liability on other income or profits of the accounting period.

Relevant trade charges which are not utilised under s. 243A or s. 243B TCA 1997 are carried forward as trade losses under s. 396(1) TCA 1997, as per s. 396(7) TCA 1997. See chapter 5.

4.4.2.Non-relevant trade charges

Non-relevant trade charges cover all other charges which are not incurred wholly and exclusively for the purposes of a trade (other than an excepted trade or Case III foreign trade).

They are allowed as a deduction against total profits under Section 243(2) TCA 1997. Any non-trade charges not utilised in the period cannot be carried forward and are effectively lost to the company. The exception to this is where the non-trade charges are paid by an “investment company” and the provisions of Section 83 TCA 1997 apply in computing the company’s taxable income (covered at Part 3). The most common non-relevant trade charge is interest. This is interest on a loan drawn down for one of the purposes set out in Section 247(2) TCA 1997.

Key Point

Relevant trade charges are incurred directly for the trade of the company

4.5.Calculate the relief available for charges on income

Step plan for use of charges

1. Set-up a heading for each year (noting if any period is less than twelve months and splitting any periods longer than twelve months).

2. Insert the relevant income and charges from each source under each year.

3. Set the relevant trade charges against the relevant trading income (Section 243A TCA 1997).

4. Set the non-relevant trade charges against all profits (subject to the relevant trade charge usage and after all other corporation tax reliefs except group relief) (Section 243(2) TCA 1997).

5. Claim Section 243B TCA 1997 relief against the corporation tax on total profits (calculated after deduction for non-trade charges).

6. Ensure you quote the relevant legislative section for each claim.

7. Note the unutilised relevant trade charges carried forward with s. 396(1) TCA 1997, see chapter 5.

8. Note that the unutilised non-relevant trade charges are lost.

Example 4.2

The accounts of Rogan Ltd for the year ended 31 December 2018 show income and charges as follows:

Case I 100,000
Case V 75,000
Relevant Trade Charges 150,000
Computation of Tax Liability
Case I 100,000
Less: Trade Charges (s. 243A) (100,000)
Taxable Case I 0
Case V 75,000
Total Income 75,000
CT Liability:
Case V €75,000 × 25% 18,750
Excess Charges €50,000 × 12.5% (s. 243B) (6,250)
Tax Payable 12,500

Example 4.3

Beta Ltd. had the following results for y/e 31.12.18

Case I tax adjusted profits 20,000
Charges paid: Patent royalties gross 25,000
Interest on a loan within Section 247(2) TCA 1997 15,000

The company must first reduce its trading income by trade charges (relevant trading charges e.g. patent royalties) and then by non-trading charges.

Therefore for y/e 31.12.18 Beta Ltd. has an excess of relevant trading charges over relevant trading income of €5,000 and unutilised non-trade charges of €15,000.

Beta Ltd. can carry forward an amount to future accounting periods equal to the unutilised trade charges only, i.e. €5,000. The non-relevant trade charges of €15,000 cannot be utilised in the period and are therefore lost to the company.

Example 4.4

Alpha Ltd, an Irish Resident Co. makes up accounts to 31st December each year. Its Statement of Comprehensive Income for year ending 31st December 2018 can be summarised as follows:

Statement of Comprehensive Income
Gross profit 95,000
Deposit interest (received gross) 4,000
Rental income 10,000
109,000
Salaries and wages 30,000
Patent royalties (Net) 8,000
Bank O/D interest 5,000
Interest on loan to finance new commercial premises 3,000
Interest on bank loan to acquire shares in a trading subsidiary (includes closing accrual of €2,000) 22,000
Depreciation 14,000
Customer entertainment 1,000
Other allowable admin. expenses 10,000
Sundry: 7 year covenant to local soccer club (net) 500
3 year covenant to UCD to carry out research (net) 2,000
Net profit 13,500

Other relevant information

The company has a chargeable gain of €7,000 (as adjusted for corporation tax)

Capital allowances for 2018 – total €8,000

Patent royalties were paid under deduction of tax. The subject matter of the patent was used for the purposes of the company’s trade

The company had no opening interest accrual in respect of the loan to acquire shares in the trading subsidiary

Calculate the total taxable profits of Alpha ltd. and its corporation tax liability.

Alpha Ltd

Adjusted profit and corporation tax computation for y/e 31.12.18

Net profit per accounts 13,500
Addback
Depreciation 14,000
Patent royalties (Note 1) 8,000
Int. on loan to acquire shares (Note 2) 22,000
Customer entertainment (Note 3) 1,000
7 year covenant to local soccer club (Note 4) 500
3 year covenant to UCD (Note 5) 2,000 47,500
Deduct
Deposit interest 4,000
Rental income 10,000
Capital allowances 8,000
3 year covenant to UCD gross (Note 5) 2,500 (24,500)
36,500
Less: Patent royalty (relevant trade charge) (Note 1) (10,000)
Case I 26,500
Case III 4,000
Case V 10,000
Total income 40,500
Chargeable gains 7,000
Total profits 47,500
Less: Charges (paid) (Note 2) (20,000)
Taxable profits 27,500
Corporation tax:
Passive income 14,000
Chargeable gain 7,000
Less Non-trade charges (20,000)
Taxable chargeable gain 1,000
Trading income 26,500
Taxable at 12.5% 27,500
€27,500 × 12.5% 3,438
Plus: income tax withheld on payments
Patent royalty €10,000 @ 20% (Note 1) 2,000
UCD covenant €2,500 @ 20% (Note 5) 500 2,500
Total corporation tax payable 5,938

Notes:

1) The patent royalty is a relevant trade charge as outlined in Section 4.4.1 above. A corporation tax deduction is available for the gross amount (i.e. before deducting withholding tax under s. 239 TCA 1997) of patent royalties paid in the period against the relevant trading income, with relief available for excess trade charges on a value basis (s. 243B TCA 1997). The net patent royalties of €8,000 are added back to determine the tax adjusted Case I profits, and the gross amount of patent royalties paid; i.e. €10,000 (€8,000/80%), is set-off against the trading income of the period. The company is obliged to withhold €2,000 income tax (s. 238(2) TCA 1997) from the royalty payment and pay this amount to Revenue with its corporation tax for the period.

2) The interest on the loans to acquire shares in a trading subsidiary of €22,000 is added back in the computation of the tax adjusted Case I profits. This is on the basis that this is a non-trade charge in accordance with s. 247 TCA 1997 (see chapter 4). To the extent that this interest is paid in the period it is deductible against total profits (i.e. trading income, passive income and chargeable gains). In the case of the example, only €20,000 of the interest has actually been paid (the €22,000 includes an accrual of €2,000). This amount is utilised against the total profits after relevant trade charges for the period have been fully utilised. It is utilised first against passive income subject to corporation tax at 25% (i.e. the Case III income and the Case V income of €4,000 and €10,000 respectively) in order to maximise the tax savings of the non-trade charges (see note to Section 4.6 below). The balance is set against the chargeable gain (as adjusted for corporation tax purposes).

3) Customer entertainment (or business entertainment) is specifically disallowed (s. 840 (2)(a) TCA 1997) and must be added back to determine the tax adjusted Case I profit.

4) The 7 year covenant to the local soccer club (assuming there is no advertising/sponsorship benefit) would not be regarded as an expense incurred “wholly and exclusively” for the purposes of the trade and is therefore not deductible (s. 81(2)(a) TCA 1997) and must be added back to determine the tax adjusted Case I profit. As there is no benefit in making the payment, it is not made for valuable and sufficient consideration and is therefore not allowed as a non-trade charge (s. 243(4)(a).

5) The 3 year covenant payable to UCD is an annual payment to which s. 238 TCA 1997 applies such that Alpha Ltd. is obliged to apply withholding tax to the payment and pay this over with its corporation tax liability for the period (s. 239 TCA 1997). The payment under the covenant would qualify as a relevant donation under s. 848A TCA 1997 provided the donation is provided for the sole purpose of providing funds for the institution such that the gross payment would be treated as a deductible trading expense (s. 848A(4) TCA 1997). As it is a deductible trading expense it is not a charge on income to which s.243 applies.

Task 4.1

L Ltd. generated a trading profit as adjusted for tax purposes of €40,000. It also received rental income of €12,000 in y/e 31.12.18.

During the year it took out a bank loan to acquire shares in a trading subsidiary (there is a common director). Interest paid on this loan was €9,000. The company also paid patent royalties for the purposes of its trade of €12,000 net during the year.

Calculate the CT liability of L Ltd. for y/e 31.12.18.

4.6.Judge the optimal use of charges for a given set of circumstances

Order of claims for Case I/II charges

Note: the order below is for trade charges only, see chapter 5 for the order when dealing with both trade charges and losses.

1. Section 243A TCA 1997 – Relevant trade charges against relevant trade income in the current period; any charges remaining can be used on a value basis in accordance with Section 243B TCA 1997.

2. The company may make a claim under Section 243B TCA 1997 to set any trade charges not relieved under Section 243A TCA 1997 against the company’s corporation tax liability for the period. There is no obligation on the company to make such a claim.

3. Under Section 396(7) TCA 1997, any relevant trade charges which are not utilised under Section 243A or 243B TCA 1997 in the period in which they are paid are carried forward as part of the company’s Case I losses to subsequent accounting periods under s.396 (1) TCA 1997, see chapter 5.

Note

With regard to the allocation of non-trade charges between trading and non-trading/passive income, the legislation remains silent on the allocation of charges between these two types of income (the legislation was drafted before the 25% rate was introduced). Therefore the charges can be allocated in two ways:

1. In priority against income taxable at 25%.

2. In priority against income taxable at the lower standard rate of corporation tax.

When the legislation is silent in such a manner, case law supports the view that the taxpayer is entitled to take the more favourable option from their viewpoint. This would suggest that the taxpayer is entitled to apply option 1 and first reduce passive income with allowable charges paid.

In addition, in Tax Briefing 44, Revenue state that “it is accepted that such (non-trade) charges may be claimed against income chargeable at the highest rate”.

Example 4.5

A Ltd’s results for the last 3 accounting periods are as follows:

12 months 6 months 12 months
31 Dec 16 30 Jun 17 30 Jun 18
Case I 250,000 100,000 0
Case V 100,000 20,000 25,000
Trade charges (50,000) (25,000) (50,000)
Non trade charges (30,000) (20,000) (15,000)

Solution

Note – numbers in bold indicate order of claims

12 months 6 months 12 months
31 Dec 16 € 30 Jun 17 € 30 Jun 18 €
Case I 250,000 100,000 0
S. 243A (50,000) (2) (25,000) (1)
200,000 75,000 0
Case V 100,000 20,000 25,000
Non-trade charges (30,000) (20,000) (15,000)
Income 270,000 75,000 10,000
Passive Inc - 25% 17,500 0 2,500
Trade Inc - 12.5% 25,000 9,375
Section 243B (2,500) (3)
CT Liability 42,500 9,375 0

Loss memo

1. Trading charges y/e 30 Jun 18 50,000
S. 243B used against CT on passive income for y/e 30 June 18 (€2,500/12.5%) (20,000) (3)
Balance is available to carry forward as a loss under s. 396(1) 30,000
2. Trading charges p/e 30 Jun 17 25,000
S. 243A used against Case I income for p/e 30 Jun 17 (25,000) (1)
Balance
3. Trading charges y/e 31 Dec 16 50,000
S. 243A used against Case I income for y/e 31 Dec 16 (50,000) (2)
Balance

Task Answer

Task 4.1

Case I 40,000
Less: relevant trading charges (15,000)
25,000
Case V 12,000
Total Income 37,000
Chargeable Gain Nil
Total Profits 37,000
Less: Non-trade charges
Interest as a charge (Section 247/243 TCA 1997) (9,000)
Taxable Profits 28,000
Corporation Tax Liability
€25,000 @ 12.5% 3,125
€12,000 – €9,000 @ 25% 750
Plus: Income Tax withheld on Patent Royalties
€15,000 × 20% 3,000
Total Corporation Tax payable 6,875