Individuals who earn income over a specified level can be restricted when claiming certain tax reliefs. The recent Budget has made it even more difficult for these “high earners” to avail of such reliefs from 2010.

Background

The original restriction was introduced in Finance Act 2006 and took effect from 2007. It was introduced as a result of sustained political pressure for action to be taken about individuals who appeared to be paying little or no income tax due to various tax shelters. It was argued by various lobbyists that only relatively wealthy individuals were in a position to access many of these shelters and this seemed to be unfair.

Objective

The objective of the restriction was to ensure that these high earners would pay tax at a minimum effective rate of 20% on the income sheltered by such tax reliefs.

Original restriction

The restriction, as introduced in 2006, is only relevant to an individual whose “adjusted income” (taxable income after adding back the aggregate amount of certain “specified” tax reliefs) exceeds €250,000. While the restriction only partially applies where the individual's income lies between €250,000 and €500,000, it applies in full where the income exceeds €500,000.

The provision works so that the specified reliefs which are used in any one year are limited to 50% of the individual's ‘adjusted income’.

The specified reliefs include the following:

• Capital allowance schemes under the various tax incentive schemes (urban renewal etc) and accelerated allowances regarding hotels, holiday cottages, nursing homes and crèches etc.
• BES relief
• Film relief
• Patent royalty income and patent distributions
• Artists' exemption
• Interest deductions in respect of money borrowed by individuals to invest shares in certain companies or partnerships
• Exempt distributions and profits or gains relating to stallion fees, stud greyhound services, the occupation of woodlands and mining profits.
• Relief under the restoration of heritages building scheme
• Donations to certain sports bodies
• Donations to approved bodies such as charities
• Trading losses originating from specified capital allowance schemes or double rent relief.
• Amounts carried forward which result from the operation of the high earners restriction in an earlier year.

Reliefs and credits not restricted include the following:

• Pensions (limited by age and fund size in any event)
• Medical expenses, personal tax credits etc.
• Current year trading losses (provided the losses do not arise due to double rent or other specified allowances).
• Exempt employee payments e.g. termination payments and payments from Revenue approved profit sharing schemes remain unrestricted.
• Capital allowances on “traditional” industrial buildings, e.g. mills, factories, dock undertakings, airport structures etc.

The restriction of some reliefs, in particular the relief for charitable donations and the relief for interest paid in relation to investments in businesses were surprising and somewhat controversial. It will be interesting to see if any changes are made to the list of specified reliefs to exclude these or any other reliefs in the upcoming Finance Act itself.

Determining the restriction

In brief, in order to determine if the restriction applied, the following calculations are necessary:

1. Calculate S, the total amount of the “specified reliefs” used in respect of a tax year. For example, where someone would normally treat €400,000 patent royalties as exempt income and claim tax relief for a charitable donation of €300,000 in the same year, S would amount to €700,000.
2. Calculate T, the taxable income as calculated under the normal income tax legislation. For example, if an individual earned royalty income of €400,000 and trading income of €500,000 and paid a charitable donation of €300,000, T would amount to €200,000 (€500,000 less €300,000).
3. Calculate R, any “ringfenced” income, ie income taxed at 20/23/25%.
4. Calculate “adjusted income”, A. A=T+S–R. A is simply income that would be taxable at 41% if there were no reliefs.
5. Establish the threshold amount. This is generally €250,000. (However, where the individual had ringfenced income and A was less than €500,000, the threshold amount would be €250,000*A/(T + S), resulting in a lower threshold amount.)
6. Calculate the level of specified reliefs, Y, which can be used to reduce the taxable income. An individual can claim an amount equal to the greater of 50% of A and the threshold amount.
7. The new increased taxable income figure is calculated as T + (S – Y). This is taxed at the ordinary income tax rates.
8. Importantly, any relief denied as a result of the restriction can be carried forward to be used in the future.

The following points are relevant:

Where individuals are jointly assessed, they are treated as separate individuals for this restriction. Each spouse's entitlement to relief is examined in isolation.

Where the restriction applies, the individual is automatically a chargeable person who is obliged under self assessment rules to file an annual income tax return, even where no liability arises. The individual is also obliged to send a statement to Revenue setting out the calculation of his taxable income both before and after the restrictions, the tax due after the restrictions and details of the specified reliefs claimed in the year.

Where tax provisions rely on definitions of “total income” and “taxable income” in the calculation of double tax relief, top-slicing relief, 10% limit on PHI etc, these figures should be calculated in the normal way. In other words, the new high earners restric tion should be ignored for the purposes of these calculations.

The Income Levy, PRSI and Health Levy should also be calculated as if the legislation enacting the restriction never existed.

Proposed changes

With effect from 2010, the objective of the legislation will be to ensure that high earners pay an overall effective rate of 30% rather than 20%. In addition, the new legislation expands the scope of the restriction to include people with adjusted income of more than €125,000 rather than just those with income over €250,000. The full restriction will apply to people with income in excess of €400,000, previously €500,000 as mentioned above.

It will be important to review the wording of the Finance Act to see if the objective of the proposed changes is met and to determine if any unexpected changes are made.

Julie Herlihy is Tax Partner with Baker Tilly Ryan Glennon.

Email: jherlihy@bakertillyrg.ie