Finance (No.2) Act 2013 Update
21 Dec 2013
Tax in Troubled Times
Two measures introduced in the Finance (No.2) Act 2013 are of particular relevance to those involved in debt restructuring and distressed businesses. The first measure relates to debt write-offs and chargeable gains. The second relates to VAT recovery.
(a) Debt write-offs
Irish corporates and individuals borrowed significant sums to acquire capital assets (typically investment properties and Irish trading companies) in the period prior to the financial crisis which commenced in 2008. For capital gains tax ("CGT") purposes, the base cost of that asset was calculated based on the amount which the debtor had originally paid on acquisition, regardless of whether that was funded through borrowed money or not. Where the asset has suffered from price deflation, a subsequent sale of the asset would generally result in a potentially valuable capital loss.
The initial provisions contained in the Finance Bill (No.2) 2013 on this area were considered particularly difficult because they imposed a chargeable gain by reference to the amount of debt released. These have now been substantially amended and Section 40 of the Finance (No.2) Act 2013 will amend Section 552 of the Taxes Consolidation Act 1997 and reduce such capital losses. It applies where the debt used to acquire the asset has been released before, or after, the sale of an asset. Where the debt is released before or in the same tax year as the disposal, the base cost of the asset will be reduced by the lesser of:
(i) the amount of related debt which is released
(ii) the amount of the allowable loss which arose
Where the debt is released in a tax year after the sale of the asset, the debtor will suffer a chargeable gain. This will be equal to the amount by which the base cost would have been reduced if the debt was written off prior to the disposal of the asset.
The legislation is particularly relevant in the current context of debt restructuring and deleveraging, where banks and other lenders have been more willing to tolerate debt write-downs. There are a number of points which appear to be particularly significant:
(i) It is unclear how the legislation will operate in a group context. This is relevant if a holding company has borrowed funds and loaned them to a subsidiary to acquire an asset. The release of the debt of the holding company could, on one reading of the provisions, cause a reduction in the subsidiary's base cost. There is some uncertainty on this area and it is hoped that Revenue will issue some guidance on the point.
(ii) Where a disposal is exempt from CGT, perhaps through the application of the Irish participation exemption for shares, it appears that the legislation will have no effect.
(iii) If debt has not been released prior to the sale of an asset, a person may well have an allowable capital loss. If they utilise that loss against a taxable gain, and the debt is subsequently released, then they may find themselves with an unanticipated tax liability.
(iv) The provisions are equally applicable to instances where debt forms part of the base cost of an asset because it relates to expenditure used to enhance or protect the value of the asset.
It is understood that this legislation will apply to debts which are forgiven after 1 January 2014.
(b) Combatting VAT fraud
A further measure has been introduced to encourage VAT compliance in companies which are in financial difficulty. Businesses which do not pay their suppliers for goods or services within six months will not be entitled to claim an input VAT deduction for VAT on such supplies. Revenue will require repayment of the input VAT previously recovered.
This measure is designed to encourage businesses to pay their suppliers promptly and to combat situations where the supplier has claimed relief in respect of a bad debt but no corresponding adjustment has been made by the recipient of the goods or services.
The Finance (No.2) Act 2013 contains a change to Irish company residence rules aimed at eliminating the "mismatch that can exist between tax treaty partners so that in certain circumstances a company can end up being stateless in terms of their place of tax residency".
Irish incorporated companies which are not resident in Ireland are used in significant international corporate structures, and the concept of a stateless Irish company has recently drawn considerable public and media comment. This new measure can be seen as part of Ireland's proactive approach in ensuring the Irish corporation tax system is robust internationally, such as its recent work in advancing the OECD's Base Erosion and Profit Shifting ("BEPS") project and countering cross border 'double no tax' arrangements.
Irish incorporated companies – current rules on residency
In broad terms, an Irish incorporated company will automatically be tax resident in Ireland. The "place of incorporation" test is subject to two exceptions: (a) the treaty exception; and (b) the trading exception.
This trading exception is central to what is now commonly referred to as the 'double Irish' structure. By utilising the trading exception, it is possible to create a company which, although Irish incorporated, is not tax resident in Ireland and therefore generally not subject to Irish corporation tax. The company may also not be regarded as tax resident in any other jurisdiction and this has led some commentators to describe such companies as stateless.
The trading exception is only possible where a number of conditions are satisfied. As an initial step, the company must not be centrally managed and controlled in Ireland. In practical terms this means that its board of directors, as the primary source of such control, must not meet in Ireland and must not exercise their powers in Ireland. In addition, in a typical structure, the stateless Irish company will be affiliated with a company which carries on an active trade in Ireland. The company must also be controlled by persons resident in a double tax treaty partner country or be a subsidiary of an entity which is listed on a recognised stock exchange in such a country. In the most high profile cases, the companies will be part of a US or UK listed group.
Irish incorporated companies – new rules on residency
The effect of the new legislation is that if such a company is managed and controlled in a treaty partner country, and that country applies a 'place of incorporation' test of residence, then the company will be Irish tax resident if it is not regarded as a tax resident of any territory.
In many cases, treaty partners would apply a concept of residence based on 'management and control', so would be outside the scope of this test. However, to the extent that is not the case (as is understood to be the position in the US), then a company falling within these new rules would be regarded as Irish tax resident and thus fully subject to Irish corporation tax.
The legislation will become effective from 1 January 2015 for existing companies and 24 October 2013 for new companies.
Future arrangements and suggested actions
Any companies affected by these changes, or that are establishing similar structures in the future, will need to ensure that the management and control of the Irish company is located outside of the relevant treaty partner country.
That will mean it will be important to definitively locate management and control in another country under the Irish law principles of tax residence. This will generally need to be a suitable third country and not a treaty partner.
In that regard, it would be prudent and a matter of good governance for existing and new companies affected by these changes to ensure that appropriate legal procedures and protocols are put in place for the company.
VAT Changes in Relation to Transfer of a Business Relief
No VAT is chargeable on the transfer of assets and property where those assets constitute a transfer between accountable persons of a totality (or part) of a business.
Provisions introduced in the Finance (No.2) Act 2013 mean that VAT incurred by a purchaser as part of acquiring a business (such as legal and advisory services) will only be recoverable if the transfer would (but for the transfer of business relief) have been subject to VAT.
Anomalies may arise in relation to the transfer of property as part of a transfer of a business. Where a business, such as property leasing, is transferred to a purchaser and transfer of business relief applies, the purchaser may not be able to recover input VAT related to the transaction if that property was "old" property and, under the post 1 July 2008 rules, would have been exempt from VAT. In such circumstances, it may actually be to the advantage of the purchaser to agree to "opt to tax" the transfer of the property as this will allow for recovery of input VAT.
CGT Exemption Extension
The CGT exemption available on Irish and EEA commercial and residential properties held for at least seven years, introduced under the Finance Act 2013 was initially designed to apply to properties acquired between 7 December 2011 and 31 December 2013. This exemption has been extended to 31 December 2014. Therefore where a relevant property is purchased for market value (or from a relative for not less than 75% of the market value at the date the property was acquired) in the period 7 December 2011 to 31 December 2014 and held for seven years, no CGT will arise. If the relevant property is held for more than seven years then the taxable gain will be reduced proportionally to the overall time the property is held.
Real Estate Investment Trusts ("REITs") were introduced in Ireland by the Finance Act 2013 to encourage foreign investors to purchase Irish property. In order to qualify as a REIT certain conditions must be met, these include the REIT being resident and incorporated in Ireland and having its shares listed on the main market of a recognised stock exchange.
There has been no substantive change to the main REIT regime in Ireland, however, the Finance (No.2) Act 2013 contains some technical amendments to make the legislation operate as intended including a number which were suggested by the Maples and Calder Tax Group. However, it is important to note that REITs will be added to the qualifying investment options available under the Immigrant Investor Programme launched in 2012 by the Department of Justice and Equality. The investment options under this programme which allows non-EEA nationals to acquire residency status in Ireland through investment will be extended to include REITs, therefore adding to the existing five investment options. This will be subject to minimum investment levels and conditions regarding withdrawal of funds. Further information on this scheme will be issued from the Department of Justice and Equality in due course.
Deposit and Investment Income
The rate of Deposit Interest Retention Tax ("DIRT") will be increased to 41% from 1 January 2014. The 41% rate is also applicable to distributions from Irish investment funds and life assurance policies. This 41% rate is only relevant to certain Irish resident investors or investors which have not complied with the requirement to deliver a non-resident declaration. The 41% rate replaces the previous 33% and 36% rates. The rates of tax on certain personal investment funds and policies are increased to 60% and 80%.
As announced in the previous year's budget, Pay Related Social Insurance ("PRSI") is extended to certain unearned income of employees and pensioners. This means that unearned income such as rental income, investment income, dividends and interest on deposits and savings will be liable to PRSI at 4%. It does not appear that this additional PRSI charge will be levied on income from investment funds.
For further information please speak with your usual Maples and Calder contact.
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Of Counsel Dublin
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