Valuation of Work in Progress for Accounts Purposes– Tax Consequences

This topic has already been the subject of correspondence both between us, and with the Office of the Revenue Commissioners. To summarise, changes to Generally Accepted Accounting Principles in the valuation of Work in Progress can result in a once off uplift in assessable profits. We have asked that a measure of relief be available for this once off uplift by allowing it to be spread over a five year period for tax purposes (in a manner akin to the spreading allowed on uplifts arising from the transition to IFRS) and taxing the uplift accordingly.

We would point out that in the UK, where the accounting change and the tax consequences are closely paralleled, the UK Chancellor of the Exchequer has seen fit to allow a measure of spreading relief. We strongly urge, particularly in the interests of equity in our tax system for those who prepare accounts to the highest and most up to date accounting standards, to allow a similar form of spreading relief. We ask that such a measure be included in the forthcoming Finance Bill.

Pensions Matters

A discussion of the policy decisions behind the specific proposals concerning tax relief on pensions, mentioned by the Minister in his Budget Speech, is outside the scope of this submission. However, a number of practical issues do arise in the context of the budget proposals and we would like to comment upon these.

Amount of Fund Which can be Drawn Down Tax Free on Retirement

This is set in absolute terms at €1.25m–apparently 25% of the maximum value of a pension fund on retirement for tax purposes. However, the general maximum value of €5m is being indexed year on year. We feel that provision should be made for the €1.25m amount to be indexed also, or alternatively, expressed as 25% of the overall indexed amount from year to year. In addition, as a transitional measure, we would suggest it should be 25% of the fund on 7 December 2005, as this would have been the basis upon which individuals and/or companies had been funding.

Annual Contribution Limits

Given that the overall value of the fund is being capped for tax relief purposes, we can see no logic in maintaining an annual cap also, based on a percentage of net relevant earnings which tapers relative to the contributor's age. Such flexibility is particularly important for the self employed, who have fluctuating levels of income from year to year, and who should be encouraged to make adequate retirement provision in the years they can best afford it. Clearly there would be no cost to the Exchequer in so doing.

Value of the Maximum Allowable Pension Fund

There is already provision within pensions law and practice to allow for earlier retirement dates for individuals whose careers by their nature tend to be shorter then the usual 40 years. For instance, a pension fund capped at €5m would be unlikely to fund a reasonable pension for an individual obliged to retire at age 50. We recommend that regulations be put in place to allow a revised limit for certain professions, in the same way as regulations exist to permit an earlier tax effective retirement date for individuals engaged in certain professions.

Indexation of the Maximum Allowable Pension Fund

While we can see the rationale for increasing the cap every year by reference to indexation, we would point out that in the pensions context, indexation is not the only measure which would give the correct result in determining what an appropriate annual increase should be. Ireland continues to develop and prosper. Its citizens are living longer. The maximum pension amount should also be increased by reference to actuarial considerations as well as indexation to take full account of our constantly improving environment. Alternatively it could be indexed in line with CSO Public Service Average Weekly Earnings Index.

3% Imputed Distribution on Approved Retirement Funds

We feel that this notional distribution mechanism is prejudicial to the growing number of people who, very prudently, make provision for their retirement in more ways than the traditional contributions to a pension fund – the so-called “Third Pillar” identified by the National Pensions Policy Initiative.

We would be aware of instances for example where individuals fund their living expenses post retirement from sources other than their ARF, for example disposals of property, or investment income perhaps supplemented by part time professional activities – the “Fourth Pillar”. Such individuals retain their ARF for what they would regard as the very rainy day – when they are no longer able to manage a portfolio of income yielding investments and perhaps are obliged to enter sheltered accommodation or a nursing home environment.

The 3% imputed distribution, with tax levied at the individual's marginal rate, may not on the face of it seem unduly onerous. We believe however that for a great many people it will act as a disincentive to pension provision by way of ARF purchase.

Normally an individual will have more than one ARF, to diverse the investment risk, for different asset classes etc. What is the proposed mechanism to manage the 3% drawdown across ARFs? To take a flat 3% out of each fund is hardly equitable depending on the investment strategies of various funds.

For a person retiring at 60 who chooses not to start drawing down from their ARF until age 70, the cumulative tax paid will significantly erode the value in their ARF. Such individuals are likely to choose conservative investment strategies for their ARF. Where the yield is less than 3% per annum, a 3% imputed distribution mechanism in effect becomes a tax on capital.

Tax on the excess of the Maximum Allowable Pension Fund

We feel that the forthcoming Finance Bill must precisely define what is meant by the phrase in the Budget documentation “a once off income tax charge at drawdown”.

The value of a pension fund can be determined by matters other than the level of contributions which were made into the fund. Where a fund has performed well, the value of the fund should be considerably in excess of the value of the contributions made. It would seem to be inequitable to penalise monies coming out of a pension fund where the individual, within the spirit of the legislation as intended, had not claimed tax relief on contributions above the €5m provided for. Indeed it is conceivable that, following a few years of strong portfolio performance, the tax charged on the excess could exceed the tax relief granted during the contribution years.

Prior to this measure, all monies, aside from the tax free lump sum, coming out of a pension fund would have been taxed. Does the application of the excess to any ARF constitute a “draw-down” triggering the tax charge? Alternatively, where the net excess after tax is put into an ARF, will credit be given for the tax already suffered as withdrawals are made? If not, there would be significant double taxation which effectively would eliminate the use of ARFs as vehicles to manage the net excess.

At a time when every effort is being made both by Government and by the private sector to encourage adequate provision for retirement, this measure will reduce the attractiveness and perceived prudence of pension provision in the public mind.

PRSI

Are PRSI and/or levies to be applied either to:

• The surplus of the pension fund over the capped amount
• The amount assessable to the 3% levy

If so, these measures will have a particularly serious impact.

Capital Incentives

Restriction on the use of Tax Reliefs by High Income Taxpayers

We cannot see any fair basis for the imposition of what effectively is retrospective legislation when applying a restriction to the amount of the so called “specified reliefs”.

Under the current proposals the reliefs are being denied on investments that are by definition high risk. Had they not been high risk, surely the tax incentives would not have been required in the first instance? It is worth repeating that these incentives were towards opportunities identified by Government in run down and neglected rural areas and towns, along with incentives to provide facilities which otherwise might not be commercially viable, for example, student accommodation.

The investments were made in good faith on the basis of existing legislation by investors typically paying tax at 42%. The result of the curtailment is that the effective rate for such investors will be in the region of 20%, or perhaps higher when PRSI is taken into account. The introduction of this measure therefore invalidates for the tax payer the risk reward equation which had to be considered when the investment was first being made.

Tax policy is of course a legitimate tool in furthering overall Government policy. Its legitimacy however comes into question, when changes of this nature are applied. CCAB-I has no difficulty with the premise that a fair share of tax should be paid. However we do have difficulties with a policy that allows what is deemed to be a fair share to change from one year to another, for reasons which are often grounded on out of date and marginal evidence.

Aside its complexities and tax consequences, this proposed measure is unfair to all tax payers. This is because it undermines the certainty, continuity and predictability attaching to the Irish tax system which has contributed so much our economic success over the past number of years. This measure will recover no tax, if indeed “recover” is the correct phrase. The tax payments to be accelerated as a consequence of this measure are paltry compared to the retrograde and damaging impact on the tax system.

If the proposed measure is indeed to be included in the Finance Bill, we believe it is essential that arrangements be made in the legislation for the following:

• That the €250,000 limit cannot be reduced
• That the €250,000 limit be increased annually at a rate at least equalling inflation
• That the list of specified reliefs cannot be altered except to include any future property incentive schemes

These arrangements are vital to ensure that we do not follow the American experience with the so-called Alternative Minimum Tax, introduced in similar circumstances in the United States, but which has since been applied, effectively as a form of sur-tax, for an increasing number of taxpayers.

“Live and Work” style premises

Without prejudice to the phasing out of certain of the capital reliefs as announced at Budget time, a relatively recent trend in the property market is the development of dual function premises, intended for use both for residential purposes and to provide home office/ workshop/studio facilities. Because such units are not residential units in the customary sense, they may fail some of the tests for eligibility for relief, in particular under TCA97 s372AM which require premises to be used “solely as a dwelling”. Under normal circumstances, if the premises were to be used only for commercial purposes it might well be eligible for relief. Similarly, were it to be used only for residential purposes, the relief could apply. A dual role however precludes it from either a residential premises or commercial premises relief.

We would like to explore if a practice could be developed to allow relief to be claimed on such developments in appropriate circumstances.

Remittance Basis of Taxation

CCAB-I notes with some concern the proposals to eliminate the use of the remittance basis of taxation. We would point out that:

• The remittance basis of taxation was an established incentive for multinationals to bring in managerial and technical expertise, and facilitated their encouraging senior personnel to locate in Ireland for periods of time. As such, it was an important component of our incentives for inward investment.
• In the current climate of skills shortages within our economy, the reversal of any incentive which encourages highly skilled and experienced personnel to work in Ireland is counterproductive.
• The absence of any Grandfathering provision in Financial Resolution No. 2, which extinguishes the remittance basis, is unfair to individuals already on a remittance type contract, who would have had a reasonable expectation that the tax arrangements into which they had entered in good faith would persist until the termination of their contracts.
• Furthermore, whereas other (property) reliefs have been subject to review in order to test the validity of the tax arrangements and before making changes, no review is suggested. At the least, there should be a review and a deferral of any action to restrict relief till next year at the earliest.”

CCAB-I calls for this decision to be re-examined.

Close Company Surcharge

We have already pointed out in our pre budget submission to the Minister the redundant nature of the close company surcharge on undistributed income.

Without prejudice to our position in this regard it has also in recent weeks come to our attention that there may be an unexpected anomaly in the legislation. It would appear that the operation of TCA97 s440 now denies the companies with accounting periods of less than one year the traditional 18 months opportunity to pay a dividend to extinguish any close company surcharge arising. TCA97 s440(6)(a) provides that a surcharge “shall be charged … for the earliest accounting period which ends on or after a day which is 12 months after the end of the first mentioned period”. It also calls into doubt the entitlement of a company with the more usual accounting period of one year's duration to avail of the 18 month interval. CCAB-I has discussed this matter at some length with Revenue, who are conversant with the matter. It is felt that the legislation may need to be revised to restore the original position, in so far as it is still considered appropriate to maintain this anachronistic penalty.

We would suggest that TCA97 s440(6) could be amended to include a provision similar to that in s805(3), appropriately modified, which addresses a similar surcharge issue on certain trustees of estates.

Payment of Preliminary Corporation Tax

Preliminary Corporation Tax becomes due 31 days before the end of the accounting period; earlier in most instances. A computation of preliminary tax due, based on an estimation of the final tax liability in advance of the year end poses particular difficulties for all taxpayers.

This issue is satisfactorily addressed for income tax purposes because of the rule which permits a preliminary tax payment to be based on the liability for the preceding years of assessment. This option is not available for companies whose Corporation Tax for the previous period exceeds €50,000. Income tax liabilities due by the company must also be reflected in the preliminary Corporation Tax payment. The inclusion of chargeable gains further complicates the position.

Gathering the information required to estimate preliminary tax creates little or no business benefit for a company. This work would be carried out in any event prior to the filing date with the benefit of more compete records. As a result, companies are forced to factor in the additional work as an irrecoverable cost of tax compliance.

CCAB-I has already presented to Revenue a position paper arguing that Preliminary Corporation Tax payments should in all cases be based on the prior year's outcome, as is the case for Income Tax payers. We believe this would make a real difference in improving the collection mechanism both for Revenue and the taxpayer, and reduce compliance costs.

Relief for Charitable Donations

We repeat our call in our pre-Budget submission for consideration to be given to the reductions of the threshold for allowable contributions down to €100.