KPMG partners review the recommendations of the Commission on Taxation Report

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Taxation/Budget News
KPMG partners review the recommendations of the Commission on Taxation Report
By KPMG
Sep 15, 2009 - 9:45:14 AM

The Commission on Taxation report was published on 7 September 2009.

This is a comprehensive document that includes close to 250 recommendations. The report is likely to have a considerable impact on Irish tax policy over the next several years. The report makes recommendations in virtually every area of tax and will have significant implications for all taxpayers, both business and personal. The report does not advocate an overall increase in the levels of taxation but rather a broader and less volatile tax base.

The government will consider the content of the report in framing its budgets for 2010 and beyond. The Commission has recommended that all proposals in the report are implemented over time. Several of the recommendations are radical and will raise political sensitivities that will require full debate. The Minister for Finance is already on record that the proposed annual property tax will not be implemented.

Business will welcome the commitment to the 12.5% rate of corporation tax. It will also welcome the policy statement that Ireland should “keep taxes on labour income, and the income tax wedge, low in order to reduce the cost of employment and to sustain and stimulate demand for labour”. We applaud this objective but find it not to be consistent with recommendations to abolish the PRSI ceiling for employees, to extend PRSI to share based payments and to abolish the remittance basis. All of these recommendations will lead to higher taxes on labour and will increase the cost of doing business in Ireland. Some other recommendations will result in higher business costs. It is critical that any such changes are considered carefully and debated, particularly in the current economic climate.

We have analysed the report and have summarised our views on the key recommendations under the following headings:

Business Taxation
Personal Tax Matters
Retirement Savings
Property
Environmental Tax and other matters

1. Business Taxation

The recommendations in relation to the corporate taxation of business are broadly speaking positive in that they retain many of the key features of the corporate tax system which has made Ireland an attractive location for inward investment and propose some detailed enhancements which have been in most cases lobbied for over the last few years.

Positive recommendations include:

Retain a low stable corporate tax rate
Retain and expand measures to encourage business start-ups
Taxing corporate gains on capital assets used for trading purposes at 12.5% and the re-introduction of inflation relief in calculating gains
Introduction of a fairer preliminary tax payment system
Simplification of the close company surcharge rules
Continued expansion of Ireland’s Double Tax Treaty network
Retention of current interest relief regime
Retention and improvement in the R&D tax credits system
Retention of the 8 year capital allowances system for assets with an economic life of more than 8 years and accelerated capital allowances for energy efficient equipment.
Capital allowances on an expanded range of buildings
Improvement in treatment of royalties earned from overseas
Abolition of stamp duty on shares
Taxation of certain dividends at the DIRT tax rate

Aspects that will need to be carefully considered are:

The debate on the overall re-balancing of the tax system should not drag on for years as it could give rise to uncertainty. This would not be good for business.
The recommendation to compute taxable income in accordance with accounting income has the potential benefit of simplicity but could give rise to unanticipated consequences.
The recommended abolition of the current remittance basis regime and its replacement with a very limited form of incentive regime is not going to achieve the desired result.
The potential for increased costs of doing business e.g. an indiscriminate carbon tax; a multiplicity of local rates, if not administered and spent on an efficient basis by local government.
Imposing increased tax on transfers of businesses within families is a disincentive to the creation over many generations of large private companies that are the bedrock of the Western European economy.
The abolition of the patent exemption.

Supporting business

The existing corporate tax holiday (essentially a 3 year tax exemption on profits of up to €400,000 per annum) for start up business should be extended to businesses starting up in 2010 and 2011.
A tax holiday scheme should be introduced for sole traders and partnerships in the start up phase and where tax is payable such businesses should be afforded relief to allow for the spreading of tax payments over the first 3 years of operation.
Taxing corporate gains on capital assets used for trading purposes at 12.5%
The reintroduction of inflation relief for the purposes of calculating gains on the sale of capital assets.
Preliminary tax payments should in time be based on the prior year tax payment for all companies (currently large tax payers are excluded from this option and must pay tax on an estimate of current year profits) and this should be introduced on a phased basis.
Close company surcharge on undistributed income of professional service companies should be abolished but should be retained in respect of passive income, with an increase in the current nominal exemptions.
The continued expansion of Ireland’s Double Tax Treaty network and a retention of our domestic rules on withholding tax in respect of outbound interest and royalty payments. To deal with potential double taxation in respect of inbound royalty payments, the Report recommends the introduction of unilateral credit relief for foreign withholding taxes for all trading companies and an overall foreign pooling system for foreign withholding tax on royalty receipts.
Changes to aspects of the regulatory framework which include a recommendation that the rate of interest on overdue tax take greater account of market interest rates.

Areas of concern

The proposed abolition of the patent exemption, which is already significantly curtailed.
The potential for increased costs of doing business e.g an indiscriminate carbon tax; a multiplicity of local rates if not administered and spent on an efficient basis by local government. See environmental taxes section.
Imposing increased tax on transfers of businesses within families is a disincentive to the creation over many generations of large private companies that are the bedrock of the Western European economy. See further comments below.

Radical change in the basis of taxation

Trading and professional income should be computed by reference to the accounting profits of a business, with normal statutory disallowances. The Report recommends that a business should be allowed to transition to such a new regime at any time in a five year transitional period.
It is recommended that accounts depreciation replace capital allowances other than in respect of assets which currently secure capital allowances at a faster rate than accounting depreciation. This would apply to aircraft, which is welcome given the importance of aviation to Irish industry.
Buildings which do not currently qualify for capital allowances would not be allowed to deduct accounting depreciation. However, the Report recommends that the list of buildings that would qualify should be expanded to include more modern uses (e.g. call centres).

Share Investment

The Report recommends certain measures that will encourage share investment activity:

Stamp duty (currently 1%) on the transfer of shares in an Irish incorporated company would be abolished.
Income tax on dividends paid on ordinary shares in trading company would be restricted to 25%.

The Report rejects the possibility of a dividend participation exemption for corporates. This appears to be on the basis that such a regime would be complex to introduce and that the current reliefs for dividends from foreign and domestic corporate is broadly sufficient.

Tax exemption for start-up companies

The “start-up companies” relief from corporation tax is subject to a commencement order. The exemption is granted in respect of the profits of a new trade (commenced in 2009) and chargeable gains on the disposal of any assets used for the purposes of a new trade. Relief is granted where the total amount of corporation tax payable by a company for an accounting period does not exceed €40,000. The Commission recommends that the scheme should be modified so that companies which begin trading in 2010 or 2011 would benefit a similar form of the relief. This is welcomed.

Balancing charges on an industrial building

Where a taxpayer disposes of a building on which it has claimed capital allowances, a balancing charge cannot arise where the disposal occurs outside the “relevant period” (variously 10-25 years). The Commission recommends that this treatment be discontinued for future acquisitions.

Remittance basis

The remittance basis of taxation for non domiciled individuals was a significant measure in attracting highly skilled employees to locate in Ireland. Its recent curtailment in respect of employment income was a retrograde step and the proposal to abolish it entirely and replace it with a limited relief is unhelpful to fostering the growth of a range of industries. This measure needs serious review.

R&D and patent royalties

The Commission is of the view that the R&D credit and the tax deduction for capital expenditure on scientific research should continue. Furthermore, companies should have the option to offset R&D credits against employer PRSI. This is a very welcome move and what the industry has been lobbying for. If the recommendation is adopted proposed legislative changes will need to work from a US GAAP or home country account perspective so as to ensure the R&D credit can be factored into pre-tax comparative investment decisions. Unfortunately no recommendations were made to amend the R&D credit system from an incremental to a volume basis. The Commission recommends that the exemption for patent royalties should be discontinued.

Travel tax

The report recommends that the Air Travel Tax be reviewed to assess its impact on business generally and tourism in particular.

Farming

The Commission recommends that stock relief for farming businesses be discontinued and that the accelerated allowance for capital expenditure on farm buildings for pollution control should not be continued when it expires in 2010. A similar view was taken of tax relief for the purchase of milk quota.

Disposals of the family business

An exemption from capital gains tax applies where an individual (aged 55 or over) disposes of a business or farm or shares in a family company to a child. The Commission notes that this relief should be continued but limited so that it only applies to asset values up to €3m. Where the value of the asset transferred exceeds €3m, only the part of the gain that is attributable to the excess over €3 million should be charged to tax.
Similar reliefs apply from Capital Acquisitions Tax for business and agricultural property. The Commission recommends a reduction of no more than 75% of the value of the business be allowed before tax is calculated subject to an overall monetary limit of €3m in the amount of the reduction. This is very disappointing in that, in many instances, the business transferred may have to be sold or broken up in order to fund the tax arising. This will prevent the transfer intact of family businesses and may cause the ownership of such businesses to move outside Ireland.

Reintroduction of indexation/rollover relief

As noted earlier, the Commission recommends that indexation relief be restored. It is also recommended that rollover relief be introduced but only for disposal of farm land under CPO.

Tonnage tax

Tonnage tax is an alternative method of calculating profits from shipping activities for corporate tax purposes based on the tonnage of the fleet rather than the actual profit. It allows Irish-based companies compete with competitors benefiting from tonnage tax regimes in other countries. Sensibly, the Commission recommends that this regime be continued.

Forestry

Profits or gains from the occupation of woodlands in Ireland which are managed commercially to realise profits are exempt from income tax and corporation tax. The Commission recommends that this regime be continued.

2. Personal Tax Matters

Tax system

There are currently four taxes on income – income tax, PRSI, the health levy and the income levy. Each tax is separately computed. The Commission recommends that there should be a single system for collection of tax on income. No change is recommended to the current system of individualisation.
The Commission is also recommending that there should be a three rate tax structure but is silent on the level of the third rate. At present there are two income tax rates; 20% and 41%.

Residence rules

The Commission is recommending that the existing tax residency rules (which are based on the number of days physically present in Ireland) incorporate additional criteria for determining residence in the case of an Irish citizen. This additional criteria will include permanent home, centre of vital interest and centre of personal interest tests. This recommendation is apparently aimed at bringing some of the high profile “tax exiles” more into the Irish tax net.

Such a change is unlikely to yield much additional tax revenue. It could actually be counterproductive and lead to many of these individuals reducing their business interests in Ireland. At a minimum it will lead to adverse tax consequences for some people who live abroad and have Irish businesses.

Childcare

The Commission recommends the abolition of capital allowances for childcare facilities, the income tax exemption for childcare service providers and the exemption of employer provided childcare from the BIK charge. It also recommends subjecting child benefit to income tax.

Housing

The Commission recommends retaining mortgage interest relief for first-time buyers only and the abolition of tax relief for rental payments on private rented accommodation and for local authority charges. The Commission recommends abolishing the rent-a-room scheme, noting that this relief was enacted when rented accommodation was in short supply. It recommends the retention of the capital gains tax exemption on the disposal of a principal private residence.

Employee taxation

The Commission recommends that income tax relief for ex-gratia termination payments should continue but the amount of the exempt payment should be limited to €200,000 and the rules for Standard Capital Superannuation Benefit and top-slicing relief should be simplified. It also suggests that ex-gratia payments related to death or disability should be subject to a limit in relation to the tax-free amount permissible.

The Commission recommends that the income tax exemption for approved profit-sharing schemes (APSSs) should continue while removing the PRSI, health contribution levy and income levy exemptions. In another disappointing move, the Commission recommends discontinuing the income tax exemption for approved share options and that the taxable value of option gains should be liable to both employer and employee PRSI and to the health contribution levy and the income levy. Similarly, the Commission recommends retaining the income tax exemption for Save As You Earn (SAYE) schemes but removing the PRSI, health contribution levy and income levy exemptions.

The Commission recommends that the single lifetime deduction of up to €6,350 available to an employee who subscribes for shares in an employer company be removed.

PRSI

The Commission is recommending that the employee PRSI ceiling (currently €75,036) be abolished. The Commission is also recommending that the PRSI base be widened to include items such as investment income (e.g. rents and dividends) and profits from the exercise of share options.
Two positive recommendations, subject to the payment of a minimum annual PRSI contribution are that pension contributions made by self employed, which will qualify for relief from PRSI and trading losses should be deductible for PRSI purposes.

High earners

The Commission recommends that existing restrictions on the use of certain tax reliefs apply to those earning over €250,000 (rather than the current level of €500,000) and should apply on a graduated basis on those earning between €200,000 and €250,000.

Philanthropy

The Commission recommends that the scheme for payment of tax by means of donating heritage items or heritage property be retained (adjusted so that tax relief is limited to 50% of the value of the item or property donated) but that income tax relief for expenditure on heritage buildings and gardens should be discontinued.

It is recommended that the threshold for tax relief on individual donations to charities and other approved bodies should be reduced from €250 to €100 with an upper limit of €500,000 applying.
The Commission recommends self-employed taxpayers should be treated similarly to PAYE earners with the tax relief for donations made being paid directly to the respective charity. Similarly for corporate donations, the tax relief should be paid to the charity or approved body.

Venture capital fund managers

The Commission recommends that the tax treatment of venture fund managers should be adjusted so that in the case of an individual who is a venture capital fund manager:

where the investment return on a carried interest represents income, it should be taxed at the appropriate marginal rate, and
where the investment return on a carried interest is a capital gain, it should be subject to capital gains tax at the normal rate (25%)

Artists and sportspersons

The Commission notes that, on the grounds of equity, the exemption for the income of artists should be removed from law but that consideration should be given to a form of averaging in the taxing of such income.

Tax relief is available to certain sportspersons who are employees or self-employed on a professional basis. This relief is given by repayment of tax.

The Commission recommends that this relief should continue as follows:

The total repayment of tax for any 10-year period should be capped at €350,000 as adjusted for inflation.
The sportsperson can only select a block of 10 consecutive years for which to claim the relief as opposed to the best 10 non-continuous years.
The relief should be subject to review after five years of operation under these new arrangements.

3. Retirement Savings

Significant changes are recommended to the taxation regime for retirement savings.

Tax relief for employee and self employed contributions

The report contains very significant recommendations for those making self employed and employee contributions to pension schemes.

The report recommends abolishing tax relief for employed and self employed contributions and replacing it with a matching Exchequer contribution. The suggested rate of matching contribution is €1 for every €1.60 invested by the individual irrespective of the marginal tax rate of the individual. The Commission recommends a “kick start” provision whereby there would be a higher matching Exchequer contribution in the early years and they suggest a rate of €1 : €1 for the first five years of pension provision by an individual. An acknowledged, and it seems intended, side effect of the recommendations is that employers would lose the existing PRSI relief for employee contributions.

The effect of the matching contribution proposal is that high rate taxpayers contributing to their pension will suffer a tax cost in that the State’s matching contribution will be less than the tax (which includes PRSI and levies) which they will suffer on the income out of which they fund the contribution. Low rate taxpayers on the other hand will earn a tax benefit. High rate taxpayers may wish to consider accelerating contributions and low rate taxpayers may wish to consider deferring them.

Under the proposed new system, high rate taxpayers would need to consider whether to make any personal contributions as contributions into the pension fund would effectively only attract tax relief at 38% whereas withdrawals from the pension fund would be taxable at the individual’s marginal rate.

Retirement SSIA

The Report recommends a retirement savings scheme modelled on the SSIA scheme. The suggested Exchequer contribution is €1 for every €2 contributed by the individual. It would not apply for any year in which the employee is in an employment covered by a defined benefit pension scheme. The maximum amount which would be contributed by the individual in any one year would be €2,200. Pre-retirement access to the funds would be allowed in exceptional circumstances such as acquisition of a principal private residence or serious illness – in such cases, the Exchequer contribution would be repayable. Any return earned on the amount saved would be taxable but the principal (i.e. amounts contributed by the individual and by the Exchequer) could be withdrawn on retirement without taxation.

Standard fund threshold

The report recommends that there should be a correlation between the annual earnings limit for employed and self employed contributions and the cap on the size of pension funds at retirement.

Taxation of pension fund lump sums

The report recommends that the tax free element of pension lump sums be capped at €200,000 and that the balance should be taxed at the standard rate of income tax. Individuals who have pension funds with a potential lump sum well in excess of €200,000 may wish to consider whether they can and should arrange an early exit from the scheme.

Contributions close to retirement

It is recommended that anti avoidance legislation be introduced to prevent the manipulation of contributions and salary levels in the final years of employment where this is designed to maximise the allowable pension on retirement.

Approved Retirement Funds (‘ARFs’)

Currently ARFs are available in relation to PRSA and RAC schemes. For occupational pension schemes, they are only available to proprietary directors and holders of AVCs. The Report recommends that ARFs be made available to all members of defined contribution occupational schemes but not to members of defined benefit schemes.

4. Property

Annual Property Tax (APT)

The introduction of APT is one of the key recommendations of the report. It is proposed that APT will apply to all residential housing units (including rented property) with the exception of local authority and social housing and other limited exceptions. As the tax will apply to rented properties, second homes and holiday homes, it is recommended that it replace the €200 levy introduced this year on second homes and investment properties.

The APT will be calculated by reference to the open market value of the property using valuation bands. It will be a self-assessment tax and the report acknowledges some of the practical valuation issues that will arise.
Whilst stating that the setting of rates is a matter for Government, the Report contains examples that use rates of 0.25% and 0.30% and applies these to the mid-point of valuation bands that increase in increments of €150,000. Consequently, the owner of a house with a value of €500,000 will fall within the €450,001-€600,000 band and will therefore pay APT on the deemed mid-point of the band, ie €525,000. At the example rates of 0.25% and 0.30%, his respective liability would be €1,313 or €1,575.

It is intended that the APT should compensate for the abolition of stamp duty on residential property.

Stamp duty reform

In conjunction with the introduction of APT, it is recommended that stamp duty on properties acquired as the purchaser’s principal private residence be abolished. It is recommended that it should continue to apply to investors in residential property and on all commercial property transactions.

The Commission concluded that the stamp duty rates in Ireland “do not differ from rates elsewhere in the EU to such a degree as to merit a further reduction at this time”. It recommends leaving the rates of duty unchanged so as to provide some certainty to the commercial market for the longer term. If the Government is going to implement the residential property stamp duty recommendation, it would make sense to announce this as soon as possible as the residential property market is likely to be paralyzed pending certainty on this issue.

CGT on windfall gains

The Commission recommends that windfall gains arising from increases in land values due to rezoning decisions should be subject to an additional capital gains tax charge. However, it does not suggest what an appropriate rate might be.

Recurrent tax on zoned development land

There is a recommendation that a property tax be levied on zoned development land that is not developed. The rezoned land should not be subject to the tax immediately following rezoning but should be subject to the tax as soon as it is capable of being developed, making reasonable allowances for delays such as planning issues that are outside of the control of the landowner.

The Commission recognises the difficulties that will arise in designing such a tax. They allude to the specific anomaly of a farmer owning such property who intends to keep farming and state that such farmers should not face such a tax.

Commercial rates base

The Commission concluded that the current system of raising local authority finance from commercial rates works reasonably well although it does pinpoint the outdated basis for valuing commercial properties and recommends that the ongoing revaluation initiative should be expedited. There are also recommendations to refine the vacancy relief provisions and that the commercial rates base should be broadened to encompass the likes of State properties and the part rating of third level and professional institutions.

5. Environmental Tax and other matters

Carbon Tax

As expected, the Commission recommends the introduction of a tax on fossil fuels. The tax would be levied in the same matter as Excise Duty and the rate of tax would be linked to the market price for carbon credits traded under the EU Emissions Trading System (ETS). The report suggests an indicative tax rate of €20 per tonne of CO2.

The tax would apply to all fossil fuels including petrol, diesel, natural gas, heating oil, coal and peat. Not all of these fuels currently attract Excise Duty and new collection mechanisms would be required (e.g. natural gas).
The report proposes that there would be no preferential rates of carbon tax for different sectors of the economy. It would also appear that existing exemptions from Excise Duty (e.g. jet fuel used by international carriers), would not apply for carbon tax purposes. In addition, VAT is applied to all duties included in the price of goods and services, so that the true cost of the carbon tax will be increased by additional VAT.
The report suggests that the carbon tax would translate into retail price increases of between 4.8% and 13.9% depending on the type of fossil fuel, with petrol at the lower end of the scale and coal attracting the highest % increase in price.

The report suggests that the carbon tax included in the price of the fuel should be visible to consumers at the retail stage, although the tax will be collected in the same way as Excise Duty. The Commission recommends that the introduction of the carbon tax should be phased and that a new tax on methane and nitrous oxide emissions should be considered once it becomes possible to monitor the level of such emissions.

The Commission recommends that companies in Ireland that incur the cost of purchasing carbon credits under the EU ETS should be exempted from the new carbon tax. A system of identifying such purchasers will have to be introduced. The report also proposes that businesses given a free allocation of allowances under the EU ETS should not be taxed on any resulting gain.

The carbon tax is expected to raise c.€480m per year for the Exchequer.

Vehicle Taxes

The Commission recommends that VRT should be replaced, over a 10 year period, by increased fuel taxes and road pricing/congestion charges. The report also proposes a vehicle scrappage scheme targeted at encouraging a switch to the use of new electric and low emission vehicles.

VAT rates

The report examines the impact of change of VAT rates etc. and concludes that no such changes be introduced. The only recommendation for any VAT change on the green agenda is that Ireland should support EU efforts to introduce lower VAT rates for energy efficient goods.

Water charges

The Commission proposes the introduction of water charges to ensure that the cost of providing water services are fully recovered by local authorities. The report proposes that the water charges be phased in over time, beginning with a flat rate charge, gradually changing to volumetric billing once meters are put in place. The report also states that a waiver scheme be put in place for low income households and that water meters be installed in all new housing units.

Waste disposal

The report also includes recommendations in relation to the pricing of waste collection charges in line with the polluter pays principle.

This article can be found in full on the KPMG website: http://www.kpmg.ie/services/tax/commissiontaxation/index.htm

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