A clear misstep in the Finance Bill
Minister for Finance Paschal Donohoe before he presented his generally pro-business Budget in October. Picture: Moya Nolan
Open market value is the touchstone of many commercial arrangements. It indicates how much a product or service should sell for if there is a willing vendor and a willing purchaser.
There is good cause to be suspicious if something is selling for less than what you might expect the price on the open market should be. The product or service may not be quite as good as it is represented to be, or it could suggest that the bargain is not at arm’s length because the parties are connected.
This inherent suspicion of a transaction which doesn't appear to be at arm's-length has long extended into the tax rules. For example, the arm’s length principle is used to ensure that if something is sold between family members for less than it is worth, Revenue can insist that the tax due is based on an open market profit rather than what was actually paid.
When a multinational group of companies operates in many jurisdictions, with group companies buying and selling from each other, the temptation is for companies in high tax jurisdictions to sell cheaply to their counterparts in low tax jurisdictions. This results in there being more profits taxed in low rate jurisdictions than are taxed in high rate jurisdictions, a practice known as transfer pricing.
In common with all strategies designed to create a tax advantage, there are rules against it.
While anti-transfer pricing rules can make sense in an international context, where one government would lose money in favour of the exchequer of another government, anti-transfer pricing rules usually don't apply within countries. That's because most countries operate a single tax rate.
However, in this country, while the 12.5% Corporation Tax rate is the best known, there is also a 25% rate levied on the profits of companies from their investments, including rental properties. This year's Finance Bill looks to apply transfer pricing rules between Irish companies in the same group operating within Ireland.
The effect of new rules introduced in this year's Finance Bill will greatly increase the volume of paperwork that companies must produce to show that the amounts they are charging each other correspond to market conditions, even though all the businesses concerned have common ownership.
It has often been highlighted that a disproportionate amount of corporation tax in this country comes from a very small number of multinational or publicly owned companies. This is true, but it is not just because the larger companies tend to make the most profits. Irish indigenous industry pays its tax, not via the corporation tax rules, but via the income tax rules when profits are distributed out to stakeholders as dividends or salaries.
This is because there is a tax penalty to stop tax avoidance by privately-owned companies which don't distribute out their earnings or pay them as salaries to their owner-directors. That is why these internal anti-transfer pricing rules were estimated in October’s budget to yield less than €10 million. That additional yield has to be seen in the context of the overall corporation tax yield which even in this terrible year is estimated to exceed €10 billion.
The additional state benefits for businesses in the Finance Bill are useful but will generate paperwork and compliance. This new anti-transfer pricing measure is an anti-avoidance rule layered on an already effective anti-avoidance rule. It will increase that compliance workload for many indigenous Irish companies with little purpose.
In what was a generally pro-business Finance Bill, this was a misstep.
Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland
