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Finance Act 2010 - some welcome changes
PRACTICE AREA GROUP: Tax
The Irish Finance Act 2010 (the“Act”) was signed into law in April 2010. The Act notably introduced formal transfer pricing rules for the first time in Ireland, but also contained several very welcome provisions which should ensure that Ireland continues as a leading choice of jurisdiction for foreign direct investment.
The Act introduced transfer pricing legislation (“TP Rules”) aimed at regulating arm’s length pricing between associated companies. Broadly speaking, the TP Rules endorse the OECD Transfer Pricing Guidelines and apply the arm’s length standard to certain intra-group transactions. The TP Rules apply to accounting periods commencing on or after 1 January 2011 but, importantly, arrangements entered into prior to 1 July 2010 are grandfathered and such arrangements will be outside the scope of the TP Rules. Non-trading activities are also outside the scope of the new rules. The TP Rules are not perceived as a mechanism to raise further funds for the Irish Exchequer, but should provide the Irish tax authorities with an additional resource to defend the Irish tax base from possible transfer pricing adjustments initiated by other tax authorities.
Taxation of Foreign Dividends – Extension of 12.5% Rate to Foreign Dividends
In a move that greatly enhances Ireland’s holding company regime, the Act extended the availability of the 12.5% rate of corporation tax to certain foreign dividends that were previously taxed at the higher 25% rate. In the past, only dividends received from subsidiaries carrying out trading activities and resident in the EU or another treaty jurisdiction were entitled to the 12.5% rate of corporation tax. The most recent change provides that foreign dividends received from a company will now also qualify for the 12.5% rate of corporation tax where the principal class of shares of the paying company, or its 75% direct or indirect parent, are substantially and regularly traded on a recognised stock exchange either in Ireland, an EU Member State or a country with which Ireland has a double tax treaty or such other stock exchange as approved by the Irish Minister for Finance. This is an important change as Irish holding companies (which are listed on a recognised stock exchange or with sufficient nexus to a company so listed) in receipt of dividends from underlying trading subsidiaries in non-treaty jurisdictions will now be subject to corporation tax at the lower rate of 12.5%. The availability of generous foreign tax credits to offset against the 12.5% corporation tax on such dividends and the ability to mix or pool excess foreign tax credits between different dividend sources within the same trading basket, should mean that no Irish tax should arise on dividends received in most holding company structures. This amendment is particularly helpful for listed entities wishing to redomicile to Ireland.
The Act also simplified the rules for identifying the underlying profits out of which dividends are paid for the purposes of determining whether or not such dividends are paid out of trading profits (which affects the rate of tax to be applied to those dividends).
Taxation of Foreign Dividends – Exemption for Portfolio Dividends
In another welcome measure, foreign dividends received by portfolio investor companies (companies with a holding or voting rights of less than 5 per cent) are now exempt from Irish corporation tax.
Exemption from Dividend Withholding Tax – Relaxation of Administrative Requirements
Broad domestic exemptions from Dividend Withholding Tax (DWT) have existed for payments of dividends to certain non-resident shareholders since the inception of DWT. However the procedural process for establishing an entitlement to an exemption from DWT has been simplified in the Act. Previously, non-resident companies receiving dividends from Irish resident companies had to provide a certificate of tax residence and/or auditor’s certificate in order to obtain exemption from Irish DWT at source. The Act has removed this requirement and instead DWT exemptions now apply in accordance with a self-assessment system. A non-resident company will simply have to provide a signed declaration and certain information to the dividend paying company or intermediary to claim exemption from DWT. The declaration will endure and cover future dividends for a period of up to six years after which a new declaration must be provided in order for the relevant DWT exemption to apply.
Exemption from Withholding Tax on Patent Royalties – Introduction of Domestic Exemption
Royalties paid by an Irish resident company in respect of the use of a patent (but not other forms of intellectual property) are subject to a withholding tax of 20 per cent. While relief from this withholding tax exists under a number of double tax treaties which Ireland currently has in force, some treaties provide for a reduced rate rather than a zero rate. The Act introduced an exemption for patent royalty payments paid to EU and treaty residents or permanent establishments based in those jurisdictions. The recipient of the patent royalty must be subject to tax in respect of such royalties in that territory in order to avail of the domestic exemption.
Royalty Income – Unilateral Credit Relief
In a measure that further enhances Ireland’s position as a leading IP holding jurisdiction, unilateral relief is now also available in respect of withholding taxes suffered in non-treaty jurisdictions on royalties paid to Irish trading companies. Previously, this unilateral foreign credit relief was only available to Irish companies entitled to the manufacturing relief regime (which is due to expire at the end of 2010).
Intangibles Regime / Research & Development Tax Credit
In the Finance Act 2009, a widely welcomed tax depreciation regime was introduced in respect of the capital cost of acquiring qualifying intellectual property and other intangible assets for trading purposes. The Act contains a number of significant improvements to this regime which widen the scope of its availability. The list of qualifying intangible assets has been expanded, the definition of know-how has been amended and expenditure on certain software will now come within the ambit of the new regime. In a move welcomed by many multinationals, the claw-back period in respect of allowances granted where the relevant qualifying intangibles are subsequently disposed of has been reduced from fifteen to ten years.
The Irish government has enhanced and improved the Research & Development tax credit regime almost every year since its original introduction in 2004, most notably in 2008 with the introduction of a provision allowing for a refund of unutilised Research & Development tax credits. The Act contained a number of further refinements to the regime. In addition to the introduction of certain claw-back measures, the recent changes allow for greater flexibility in terms of the manner in which the tax credit is calculated and includes clarification on the treatment of a company which incurs relevant Research & Development expenditure but has not commenced trading.
Ratification of Six Further Double Taxation Treaties
The Act provided for the ratification of a further six Double Taxation Agreements which were signed in 2009 with: Bahrain, Belarus, Bosnia and Herzegovina, Georgia, Moldova and Serbia. Ireland now has a rapidly expanding network of 56 Double Taxation Agreements and it is expected that another eleven treaties will be finalised in the near future.
Since the inception of the International Financial Services Centre in Ireland, Ireland has developed a sophisticated financial services infrastructure, particularly with respect to investment funds and finance transactions. In an effort to further enhance Ireland’s position as a leading financial services centre, the Act introduced a number of provisions aimed at attracting Shari’a compliant Islamic finance transactions to Ireland. The Act broadly follows a briefing previously issued by the Irish Revenue Commissioners which confirmed that certain Islamic products (Shari’a compliant investment funds, Ijarah, Takaful and ReTakaful transactions) would be taxed in a similar manner to equivalent traditional financial products and transactions. The Act extends the list of Islamic products which will be treated in a similar manner for Irish tax purposes to their traditional equivalent and includes Sukuks (Islamic bonds), Shari’a compliant bank deposits and Shari’a compliant lending and asset backed financing arrangements (including mortgages).