The EU has agreed a new Anti-Tax-Avoidance Directive at seemingly break neck speed towards the end of the Dutch presidency. While the directive has been watered down from previous drafts it could still have a significant impact on the Irish tax regime.
The directive will need to be transposed into the domestic laws of the Member States by 31 December 2018 but at that point in time it could have an impact on structures already in place.
Tax Deductible Financing Cost Restriction
The first point to note is the interest deduction limitation. A 30% of EBITDA (or €1m if higher) restriction will apply to restrict tax deductible net financing costs. However, it will be open to Member States to allow financing costs be deducted in excess of this limitation by reference to the overall group leverage.
From an Irish point of view this could require a significant change to our interest deductibility rules but may be of limited practical implication since Ireland is already quite a difficult jurisdiction to leverage with group debt.
Any unused relief which is caused by reference to the financing costs cap can be carried forward, a carry back of three years may be provided as well as a five year carry forward for unused tax deductibility capacity.
Of more pressing concern for Irish investors will be the fact that many securitization vehicles, as they are currently structured, will have a net financing expense well in excess of 30% of EBITDA. While structures with debt in place prior to 17 June 2016 will be grandfathered, any changes to those loan terms may not be.
In addition many asset classes which are currently securitized in Ireland will not qualify as financing income for the purposes of determining a “net financing expense” and as such it may not be possible for such vehicles to be tax neutral from 2018 onwards.
Stand alone entities (those not subject to consolidation under the relevant accounting standards) are not subject to the restriction since the EU believes that such entities have limited capacity to engage in tax avoidance. However, under the Companies Act 2014 it may be more difficult for Irish entities to avoid consolidation than it was under previous legislation.
Finally most regulated financial services entities, including Banks, Insurers, UCITS funds etc are not subject to the rules.
The next issue relates to exit taxation. A transfer of residence is required to be subject to an exit tax. Ireland already levies an exit tax on many transfers of residence, but not all, and provides for tax payments by installments.
Foreign listed groups which fell within an exception from the Irish exit tax will need to take note that its scope may be extended. Of further note is the fact that installments may only be provided for in the event that the company trransfers its residence to an EEA Member State, so transfers of residence to a non EEA State e.g. Switzerland or the US will require immediate taxation without the possibility of installments or deferral until a future taxable transaction arises.
Unlike previous drafts Ireland no longer needs to tax a transfer from head office to branch if the branch assets remain in the Irish tax net.
The switch over clause has thankfully been removed from this final version.
General Anti-Avoidance Rule
One area where Irish law will not be required to change to reflect the directive will be in terms of a General Anti-Avoidance Rule. Ireland already has one of the broadest GAARs in the EU which should suffice.
However, it is worth noting that every GAAR relies on a test of “abuse or misuse” of a tax regime, and it is clear from Irish jurisprudence at least, that the Irish courts can only determine whether Irish tax law is being abused or misused. The Irish courts cannot determine whether e.g. Luxembourg tax law is being abused or misused, and would need to rely on expert testimony from Luxembourg advisers to that end.
Controlled Foreign Company Legislation
The directive requires Ireland to bring in controlled foreign company legislation to deal with two types of situations where income is received by a company 50% controlled by an Irish Company and are subject to a rate below 6.25%.
The first relates to certain types of passive and financing income. For companies established in an EEA State there is a Cadbury Schweppes saver, which means that the rules should not apply to companies genuinely established in another EEA state and which carries on substantive activities there supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances.
Member States may apply a similar provision to companies established outside the EEA.
The second relates to circumstances where the profits of the entity are considered to be non-genuine and for these purposes an arrangement or a series thereof shall be regarded as non-genuine to the extent that the entity or permanent establishment would not own the assets or would not have undertaken the risks which generate all, or part of, its income if it were not controlled by a company where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the controlled company’s income.
An entity which is a CFC by reference to this second test can be excluded only if its profits are de minimus or if its margins are less than 10%. This further evidences a shift towards significant people function as the test within the EU and care will need to be had that Irish subsidiaries of e.g. French or German entities do not fall to be treated as CFCs under these rules.
The final rules apply to “hybrid mismatches” and leave this author somewhat confused.
The rules define a hybrid mismatch as being a financial instrument or an entity which under the laws of two different Member States either gives rise to a double deduction, or to a deduction without a corresponding taxable profit.
The first problem is that the authors of the directive don’t appear to understand the nature of hybrid entities or instruments. A UK LLP, for example, is a body corporate as a matter of UK general law, it is a body corporate as a matter of Irish law, it is simply also tax transparent under UK tax law. It seems that if a UK LLP is Irish tax resident, only Ireland should grant relief for an expense in that entity, and the UK should not give relief at the level of the partners but this is not entirely clear.
One assumes that Member States will implement the directive by reference to the tax law categorization, as distinct from that under the general law, which could be more problematic.
In terms of hybrid instruments in so far as there is a deduction with no corresponding taxable income, the deduction should not be allowed. However, if the instrument is a profit participating note which was affected by the recent changes to the Parent Subsidiary Directive, that directive now insists that the receipt be taxable as distinct from the deduction being disallowed. So while profit participating notes are expressly included within the financing costs definition for the purposes of the interest cap, they can still be changes to the subject to either the Parent Subsidiary Directive where those rules apply, or the hybrid mismatch rules where these rules apply due to commonality of ownership.
It is interesting that the rules relating to both hybrid instruments and hybrid entities relate only to intra-EU situations, and not to situations involving third countries. The preamble states that third country situations, along with other BEPS action points relating to avoided PEs and intangibles will be dealt with by further legislative acts.
One can only hope that such future legislation is not as rushed as this.