Escaping the taxman’s clutches — for a while at least

This week, I will show you how not to pay tax. Thought that would get your attention. Let me explain.

At 9.1%, the rate of unemployment is too high. Governments don’t create jobs. Sure, they can employ people in the public service, but that’s not the same thing. Jobs are the remit of business and the markets that businesses serve.

Governments can promote an environment in which businesses can create jobs. In Ireland, we take that environment for granted.

Routine matters, like a stable legal system that secures property rights, are a given here, but not in other countries. Our third-level education system has been one of the unsung heroes of the country’s economic recovery in recent years.

High rates of taxation are often portrayed as stifling business. But aspects of the Irish tax system are favourable to new business and job creation.

This is particularly so when business is young and small, and the trick is to qualify for whatever tax breaks are available. The most useful of these is the ability to defer your income-tax liability in the first year you set yourself up as self-employed.

Self-employed people can choose to pay income tax either on an estimate of what they earn in the year, or on what they earned in the previous year. You can opt to pay no income tax in your first year of operation.

This is really a deferral of tax due, rather than having the tax forgiven, but it is one less thing to worry about when you strike out on your own.

New businesses also worry about having to account for VAT, but many startups don’t have to register for VAT until they’re fairly well-established.

Broadly, you need to sell more than €37,500 in services, or €70,000 in goods, before VAT liabilities kick in. When they do, many small businesses can arrange to settle VAT liabilities with the tax office, either every quarter or every six months.

These are standard features of the tax system which are available to all taxpayers, but are of particular relevance to startups. They don’t extinguish tax liabilities, but help with cash-flow. Cash-flow difficulties strangle a business faster than anything else.

There are also tailor-made incentives for startup businesses, one of which provides tax relief from income tax for long-term unemployed people starting a new business. Two other, special incentives for startups require the business to be incorporated; that is, established through a company.

The first of these is called SURE, an acronym for ‘startup refunds for entrepreneurs’. A new business owner can get back some of the PAYE he or she paid while a wage slave, by investing funds in their own new companies. At first blush, there’s a lot about the idea to like. The terms and conditions are so restrictive, though, that only a few dozen entrepreneurs qualify every year.

The second company-related incentive is a corporation tax relief for the first three years for new companies, up to a limit that is linked to the number of employees.

This incentive isn’t hugely popular either, again because of all the terms and conditions. The main snag is that it only works for trading companies; businesses that manufacture or buy and sell goods. Professional-services companies are excluded.

As tax reliefs, both the SURE and the corporation-tax holiday do more harm than good. Their existence blocks the introduction of useful tax incentives, because they reassure the political classes that ‘something has been done’ for new business.

The big tax incentive for companies is the low rate of 12.5%. This doesn’t amount to a reason to incorporate a business. Many entrepreneurs have been lured by the attraction of a 12.5% corporation tax rate, when compared to the going income tax rate of 40%, plus USC and PRSI.

The problem is how to get the money the business makes out of the company after incorporating the business. Salary and dividends paid out of the company to the owner all attract income tax.

As far as the taxman is concerned, the company you own is a taxpayer in its own right. No matter how you arrange matters, two taxpayers will nearly always end up paying more tax than one.

By all means, incorporate your business, but do it first and foremost for commercial reasons, rather than for tax reasons.

While the tax environment for startups in this country is relatively benign, there is plenty of room for improvement.

As long as unemployment rates stay unacceptably high, the pressure on government to make improvements should remain. OK, so I didn’t really tell you how not to pay tax. But I did show you how it might be deferred for a year.

• Brian Keegan is director of taxation with Chartered Accountants Ireland