It seems to be the season of public consultations on tax matters in the Department of Finance; with four launched last month alone. This brings the total to 14 in the past two and a half years. Many of the consultations during this time focused on the role of the tax system in encouraging entrepreneurism and supporting Ireland’s SME sector and the consultation papers on CGT Entrepreneur Relief, KEEP and EIIS/SURE are no different. But problems with the reliefs still remain. The purpose of this article is to examine some of these issues and provide some suggestions on how they could be improved.

CGT Entrepreneur relief

Entrepreneurs who dispose of certain business assets may be able to avail of a reduced rate of CGT under CGT Entrepreneur relief. The relief was originally introduced in Finance (No 2) Act 2013 and was revised by Finance Act 2015 with some improvements to encourage entrepreneurs to establish new businesses. Since 1 January 2017, if an entrepreneur sells qualifying business assets, up to a life time limit of €1 million, capital gains tax at the rate of 10% applies on this disposal. The objective of the relief is to encourage a strong and competitive business environment to attract and retain scaling SMEs.

Since its introduction however, there have been many calls to change aspects of the relief that limit the effectiveness of the relief. For example:

1. The lifetime cap of qualifying gains is very low at €1 million and should be increased to €10 million. In the UK, where problems also exist with the equivalent relief, the cap is £10 million.
2. The current relief does not make any provision for periods of ownership of assets by spouses for the purposes of the ownership test unlike retirement relief does for example.
3. The relief also does not apply to assets personally owned by the shareholder but which are used by the company nor does it apply to assets used by sole traders or partnerships prior to incorporation. The relief is therefore inconsistent with the qualifying conditions for other reliefs such as retirement relief, business relief and relief for the incorporation of a trade by a sole trader.
4. In order to qualify for the relief in a group situation, all companies within the group must be trading companies. Many standard commercial corporate structures in Ireland are not able to meet this requirement given that many groups contain holding or investment companies.

For example, a holding company “X” has two subsidiaries “Y” and “Z”. X is a pure holding company, Y is a trading company and Z is a dormant company or an investment company. This group currently fails the “qualifying group” test because all subsidiary companies must be trading. This is the case even though the non-trading company may be worthless or it may hold assets of nominal value. Section 626B TCA 1997 exempts from CGT certain sales by parent companies of shares in subsidiaries. Non-trading companies are often contained within these group structures that qualify for relief.

Employment and Investment Incentive (EII) scheme

The EII scheme is a tax incentive which provides for tax relief of up to 40% for investments made in certain trading companies. The EII allows an individual investor to get income tax relief on investments for shares in certain companies up to a maximum of €150,000 per annum in each tax year. The relief has the potential to meet a market gap in the access to finance for early stage companies and for companies that wish to expand and critically need finance to do so.

In an era where the traditional methods of finance are hard to come by, there have been calls to reduce the complexity of the conditions underpinning the relief which block access to potential investors.

While Finance Act 2018 did address some of the concerns with the relief, particularly in relation to the additional compliance introduced with the 2014 revision of the EU General Block Exemption Regulation (GBER), improvements are still needed.

For example Finance Act 2018 introduced a substantive (and not necessarily positive) change with the move from pre-clearance to self-certification when claiming the relief for both the company and the investor. This means that firstly applicant companies must self-certify that they have met the “company conditions” and “qualifying investment conditions.” And once a company has spent 30% of the funds raised or a period of 2 years has passed since shares were issued, the company must issue statements of qualification to investors.

If certification is incorrect or relief is withdrawn, penalties could be imposed on the company and this can have severe financial implications. Previously the investor was the accountable person.

For example, if a company makes an incorrect statement of qualification, the company is liable to corporation tax on an amount 1.2 times the initial 30/40ths of the relief given or such part of that amount that does not qualify for relief. In the case of an incorrect statement, a high degree of interest exposure also arises in the case of a claw back of relief because the tax will be due and payable from the date the shares were issued.

An investor must also certify that they have met the conditions of an investor and if the conditions are not satisfied, any relief claimed will be clawed back.

The aim of the new self-certification is to address the delays that existed for some applicants when claiming the relief. It was hoped that without having to apply to Revenue for relief in advance, the speed at which relief is granted and therefore take-up is improved.

This self-certification could however have an undesired effect. Without more robust external assurance as to the preservation of relief claimed, investors could perceive that they face greater uncertainty than in the past in relation to their investment which could be clawed back by the company. The company would have to use its resources to pay additional corporation tax, interest and penalties in amounts that are linked to the tax relief claimed by the investors. Money used by the company to fund a relief clawback means that there is less available to the company to fund its business which reduces the likelihood of business success and the eventual return of equity to EII investors.

The risk of getting self-certification wrong is too high for many and for some, the potential reliefs available under the EII scheme is simply not sufficient to offset the greater long term uncertainty and risk of exposure to Revenue challenge and potential clawback of relief and consequential interest and penalties.

Other issues with the relief are the unavailability of a capital loss arising on the disposal of EII shares against other gains. This loss should be available for offset against other gains arising to the investor.

Furthermore, professional service companies should not be excluded from availing of the EII scheme as such companies are equally capable of providing job opportunities. Many professional service companies operate a model whereby the business operates on an overdraft or a loan. These companies wish to grow and expand, not unlike other trading companies and should be able to benefit from the EII scheme.

With the exception of micro-companies qualifying under the start-up capital incentive, company founders and connected parties are generally precluded from claiming tax relief under the EII. This restriction closes the door on tax relief for the traditional early stage investor and some alternative tax measure should be considered to encourage investment for start-ups who face very limited finance options at inception.

KEEP

KEEP is a share option incentive scheme with the aim of incentivising employees to hold shares in their employer company. This scheme is particularly important in helping SMEs in attracting and retaining employees; which is critical to the future success of the Irish economy.

One main concern about the relief is the limited, and in some cases lack of a market for the disposal of shares in small Irish companies. Many companies who may wish to operate KEEP will not be on the stock exchange or may not have any market for the sale of shares and therefore cannot provide liquidity for these shares. Without visibility as to how they can potentially realise value for KEEP shares, employees do not value the award of a KEEP share option, thereby reducing its effectiveness as a tool to attract and retain key employees.

To support this, the buy-back provisions in section 176 TCA 1997 could accommodate an employer buyback of KEEP shares from employees. Such a buy-back should also satisfy the trade benefit test for the purposes of CGT treatment.

It has been reported that there was minimal uptake of the scheme during 2018. Finance Act 2018 did amend the terms of the limits on qualifying share options granted to employees and it remains to be seen whether this will help with the uptake.

For example, the requirement that an employee must work full time for the qualifying company throughout the entire relevant period is inflexible. It is impractical to restrict an employee who works for a group of companies to only work for one single company within the group. For example an employee may work for the holding company and one or more subsidiaries. If an employee transfers between group companies, their KEEP options should be transferable provided all other conditions are met. Furthermore the current legislation also appears to prevent an employee who has been temporarily absent from work, due to maternity or paternity relief, from qualifying for the relief.

The current legislation also does not allow for CGT treatment to apply to KEEP shares when the SME undergoes a corporate reorganisation during the period in which the KEEP share option rights are outstanding. This is impractical and relief should be allowed in these instances.

Conclusion

It would be a hugely positive step to see tangible evidence of some changes to the reliefs suggested by the various stakeholders following the most recent public consultation in order to support entrepreneurship and business growth by SMEs in Ireland. Otherwise what’s the point of having a consultative process?

Cróna Clohisey is a Manager in the Public Policy & Tax team at Chartered Accountants Ireland.