1 Introduction

The tax system in Ireland has a central role to play in encouraging entrepreneurship.

The advice from economic authorities such as the ESRI is to encourage diversity in the source of funding for enterprises so that in addition to the traditional banking sector, Ireland develops a culture of venture capital and angel investor funding. However, the risks are substantial when it comes to investing in new start-ups and expanding SMEs but the tax system can exert a major influence in developing a new culture of third party investor and this submission sets out a number of recommendations on how this can be achieved.

Our members feel very strongly that there are little or no tax incentives available for entrepreneurs. During the years of austerity, tax reliefs such as the tax deduction for interest on funds borrowed to invest in a partnership or company were phased out of existence. In addition, the rate of CGT has increase significantly and the gap between the taxation of the self-employed and employees has enlarged.

A number of the incentives in place are in name only and are an obstacle to the introduction of effective incentives. We have participated in numerous consultations in recent years for the purposes of addressing this problem, setting out weakness and offering solutions. It is disappointing therefore, that nothing has been done to date to fix these incentives. Tax incentives for entrepreneurs are worthwhile. An entrepreneur, be it a company or sole trader will resolutely agree that tax is a burden on their business so any device which can offer a reduction in tax is extremely important.

Successive tax offerings do exist in the Irish tax system. Examples of these include the 9% VAT rate for the hospitality sector, the cash basis turnover threshold of €2,000,000 and Ireland’s commitment to the 12.5% rate of corporation tax. The key feature of a successful tax relief which encourages enterprise is that the relief is simple to access and it has an upfront benefit. These basic criteria should be to the fore in designing tax reliefs to provide genuine support for Ireland’s enterprise sector.

2 The effectiveness of the tax system in terms of starting up and expanding a new business

2.1 Under-resourced Revenue authority

A new business setting up must fulfil numerous tax obligations, such as registering for VAT, PAYE, income tax or corporation tax and then the entrepreneur must correctly operate the taxes and meet various deadlines for filing tax returns and for paying tax. Revenue-On-Line service is a computerised system which is dependent to a large extent on a well-informed user. As a result, ROS is often no substitute to actually making direct contact with Revenue and asking questions. Due to resourcing constraints, many tax districts operate restricted hours for taking telephone calls from self-assessed taxpayers. For example, City Centre/North City Business Taxes District and Dublin South City District operate telephones lines for Income Tax/Corporation Tax/RCT/VAT callers only between the hours of 9.15 am to 12.45 pm. Start-up and expanding businesses find these restrictions very frustrating and time-consuming.

Our members have also highlighted problems with long delays in VAT registrations, slow and inconclusive audits, and delays obtaining technical opinions. These problems are acutely felt by start-up and expanding business as this particular category of entrepreneur has limited time and funds to deal with tax matters. We would therefore call for more resources to be made available to Revenue to man the phone lines for self-assessed taxpayers and thereby assist them in their efforts to fulfil their tax obligations.

3 The effectiveness of the tax system in terms of starting up and expanding a new business

3.1 Costs of labour/employers PRSI

The 2011 Jobs Initiative provided for a reduction in the lower rate of employers PRSI from 8.5% to 4.25% on jobs paying up to €356 per week. This measure was in place from 1 July 2011 to 31 December 2013 but reverted back to 8.5% on 1 January 2014.

This measure reduced labour costs for employers substantially and its particular success was due to the fact that the relief it provided was upfront i.e. a direct cut of 4.25% in labour costs and it was available to all workers earning up to €356 per week, not just newly recruited employees. As a result, entrepreneurs were in a position to engage more staff and invest in the business. The rate reduction was a genuine benefit for entrepreneurs and it should be reintroduced to further support the entrepreneur sector.

3.2 Differences in the taxation of self-employed versus employees

There is a distinct bias within the tax system against the self-employed taxpayer in comparison to how employees are taxed. This bias is prevalent for all self-employed taxpayers from those on modest earnings right through to high income earners. The difference is clearly illustrated in the Budget ready-reckoners prepared by the Department of Finance. The analysis for Budget 2015 for example shows that the effective rate of tax on a single employee earning €15,000 is 1.9%. The self-employed person earning the same amount pays tax at 14.9%. This is taxation based not on how much people earn, but on how they earn it.

The consultation document accompanying this review states that “in general terms, there are more allowances available to the self-employed”. Self-employed individuals are entitled to deduct expenses in arriving at taxable income, but only if such expenditure has been wholly and exclusively incurred for the purpose of the trade and therefore such deductions are trading expenses rather than tax allowances. Revenue audits in recent years have focused on ensuring that expenditure deducted by the self-employed meets the wholly and exclusively criteria. As such, it’s misleading to state that the self-employed have more scope to claim allowances as such expenditure is a function of running a business rather than a benefit for the purposes of paying tax. A credit such as the PAYE credit of €1,650 is a benefit when it comes to paying tax. Non-application of the 3% USC surcharge to high earners taxed under PAYE is also a benefit when it comes to paying tax. Neither of these benefits are open to the self-employed taxpayer. If the government genuinely wishes to assist entrepreneurs, then such obvious discrimination needs to be addressed.

3.3 Income tax relief for capital/borrowings

Every quarter, Chartered Accountants Ireland in conjunction with KBC Bank, conducts a business sentiment survey of Chartered Accountants working in prominent positions (CEO’s, MD’s and FDs) in Ireland’s leading companies. The purpose of the survey is to track responses to changing business conditions and how companies are responding to changing circumstances. In the most recent survey for Spring 2015, access to bank funding and access to alternate funding sources was the top concern for 20% of those surveyed. Therefore it is appropriate for a tax measure to be introduced to assist start-up and expanding business in dealing with the funding concerns.

Tax relief should take the form of a tax credit for capital introduced by an entrepreneur to a new start-up business. This credit would operate on a similar basis to section 253 TCA 1997 (before the introduction of restrictions in F(No.2)A13) and section 248 TCA 1997 (before the restrictions introduced in FA 2011) which provided tax deductions for interest on loans used to invest in a partnership and companies. The tax credit for the equity investment or loan capital would be based on the commercial interest rate applicable if the investment had been borrowed from a bank. For example if the entrepreneur commits €20,000 of his own savings to his business or company, a tax credit equal to €20,000 × the appropriate commercial interest rate (say 6%) = €1,200 is available as a deduction against the entrepreneur’s income tax liability for each year his funds remain committed to the business or for a specified period, for example five years, whichever is lesser.

3.4 Capital Gains Tax measures to assist the entrepreneur

The CGT relief for entrepreneurs under section 597A TCA 1997 is aimed at owner/managers of businesses, rather than serial or angel investors. To maximise the relief, the full proceeds from the first asset disposal should be reinvested. Combining this with the requirements for investors to work full-time in the business and for subsequent investments to be made in new businesses, the bar is set high for the entrepreneur wishing to avail of this relief. Its early days yet for this relief, given the fact that it only became active this year, but initial feedback from our members suggests that many interested taxpayers find themselves falling short of the conditions necessary to access the relief.

While a CGT relief aimed at own/managers is worthwhile, a separate CGT relief to encourage angel investors should also be considered. The relief could be structured along the lines of the lower CGT rates available to fund managers under section 541C TCA 1997 (see section 4.1) and rollover relief should also be introduced for such investors to encourage continuous investment. Such a relief would help stimulate much needed funding from sources other than banks.

3.5 Corporation tax measures to assist the entrepreneur

The Three-Year Tax Relief for Start-up Companies commenced life with promising potential. However, the usefulness of this relief was severely curtailed under FA 2011 when the value of the relief was linked to the amount of employers’ PRSI paid by a company in an accounting period subject to a maximum of €5,000 per employee. The restrictions placed on qualification for the relief are so onerous that hardly any company can fit the qualification criteria. For example, the prohibition on incorporating partnerships and sole traders from qualifying for the relief removes an important cohort of the business community from this relief. Incorporating sole traders/partnerships bear the same commercial risks and challenges of carrying on a viable business in a new structure as new entrants. Companies seeking to expand its business in a new company structure are also prohibited from qualifying for this relief as are professional service companies.

Statistics demonstrate the poor take up of this relief with just 1,038 companies claiming relief of €4.9 million in 2013. The relief was projected to cost €10 million in a tax year as a result of FA 2013 amendments which allowed unused relief arising in the first 3 years of trading, due to losses or insufficient profits, to be carried forward for use in subsequent years. If the conditions for eligibility are relaxed, then take up would be far more substantial and useful for entrepreneurs and their companies. However, the inflexibility of the relief as it currently stands makes it redundant as a means of supporting enterprise.

4 Improve effectiveness of the current expenditures aimed at entrepreneurs

4.1 Expand tax incentive for Venture Capital Investors

In 2014 the ESRI prepared a report for the Department of Finance, which highlighted the need “to increase the awareness of equity financing options and steer a cultural shift amongst SMEs towards looking for equity rather than bank credit as a source of funds, it is vital to make the process of matching entrepreneurs and investors as efficient and cost-effective as possible.”1 The same report noted that the rate of success in accessing venture capital funding is low in Ireland with only 8% of applications for venture funding accepted (based on Department of Finance surveys conducted in April to September 2013 and October 2013 to March 2014).

Ireland operates a special venture capital carried interest CGT rate of 12.5% for corporates and 15% for individuals (as per section 541C TCA 1997). The special rates apply to the share of profits of an investment that a venture fund manager receives for managing an investment in a venture capital fund (this profit is known as carried interest).

Relax restrictions on eligibility under section 541C

The relief, in its current form, is quite restrictive as it only applies to carry made in certain types of businesses such as those engaged in research, development or innovation activities.

In order to encourage more sources of investment for SME sectors who do not qualify under section 541C, unconnected loans from individual investors to SMEs should be eligible for CGT loss relief. Likewise returns on such loans should be subject to CGT at a reduced rate of 12.5%, again provided that the parties are not connected. Increasing the availability of tax relief for venture fund managers would reduce the risks shouldered by such funds and would contribute to improving the acceptance rates for investment in start-up and expanding businesses.

4.2 Reform of Enterprise Investment Incentive Scheme and Seed Capital Relief

A public consultation was carried out by the Government in 2014 which called for suggestions on how the Enterprise Investment Incentive Scheme and Seed Capital Relief could be improved. On foot of that consultation, a number of amendments were made in FA 2014 which included an increased holding period from three to four years for EIIS investments, a reduction in the tax relief for investments in line with the 1% cut in the marginal rate of income tax, an increased funding threshold and extended eligibility to certain companies. Seed Capital Relief is now rebranded as Startup Relief for Entrepreneurs (SURE) with no amendments on how the relief operates. The rebranding of Seed Capital Relief to SURE has been accompanied by a marketing campaign to promote awareness of the scheme. Our members contend that such efforts are in vain as a properly functioning tax relief promotes itself and the fact that Seed Capital Relief is rebranded to SURE will not change the fact that the relief is not fit for purpose given the restrictive conditions associated with the relief.

The reason Seed Capital Relief was unsuccessful and why SURE will not improve matters is due to the fact that relief ignores how an owner/manager puts funds into the company in the first place. The same issue also reduces the attractiveness of EIIS for owner/managers.

Funding outside of Share Capital

EIIS and SURE are predicated on the requirement for the investor to purchase shares in the company and to hold those shares for a four year period in the case of the EIIS and three years in the case of SURE. While this requirement is commercially appropriate for investments aimed at third party investors, it is not a tax efficient or a commercially appropriate means for the owner/manager to invest in his company. The exit mechanism of share sale, which is the only mechanism currently permissible, does not support the owner/manager’s long term involvement with the business.

In general, owner/managers of SMEs make a personal investment in the business by way of a loan to the company. If a share investment is made then he/she must either liquidate or sell the shares in order to realise a return on the investment. SURE rules for owner/managers of SMEs require such individuals to dispose of the business they have worked hard to build up in order to get a return on their investment. Therefore the EIIS and SURE should allow for investment by way of loan to facilitate the long term development of the business and involvement of the entrepreneur.

Tax relief for loans

This could be structured by extending the definition of a relevant investment to a 15% investment made up of both equity and loan capital. Concerns on safeguarding genuine use of the relief could be addressed perhaps by linking the holding period to the loan/capital ratio. For example, a 15% investment made up of 5% equity and 10% loan might require a holding period of 5 years. Correspondingly, a 15% investment made up of 10% equity and 5% loan might require a holding period of 1 year. It may also be appropriate to introduce a preclearance mechanism to any refinancing of the loan capital, to ensure that the original funding purpose is adhered to. A clawback of relief would apply if the loan is repaid before the requisite holding period or the refinancing arrangement covers personal loans etc.

4.3 Professional Service Companies

The ESRI2 have recommended that restrictions on the types of enterprises and investors qualifying for EIIS and SURE should be eased. Professional service companies are equally capable of providing job opportunities but are excluded from the EIIS/SURE. Service companies have many uses for outside investment which would be used for equally worthy purposes as with other trading companies who can benefit from the EIIS/SURE.

There are valid and legitimate commercial reasons for professionals to structure their business using a company. However, such companies are often treated with suspicion by Revenue. Revenue has noted its successes in tackling white collar ‘non-compliance in specific sectors, including the medical profession and ‘personal services companies’’3. However, this sector review by Revenue must be put into context with the yield from non-compliance associated with the medical sector reported at €16 million in 2014 while total tax receipts for 2014 were €41.4 billion. Therefore a fair and proportionate attitude must be adopted by Revenue when judging the commercial basis for the majority of service companies and the contribution such companies make to the high level of tax compliance which generated €41.4 billion tax revenue in 2014.

Surcharge inhibits growth in service companies

CCAB-I supports the removal of the close company surcharge on professional service companies. It is very difficult for a professional service to expand and grow its trade from the re-investment of trading income due to the penal treatment of funds not extracted from the company. The simple step of removing the surcharge would place service companies on an equal footing with other trading companies and give such companies the same opportunities to expand and grow.

4.4 Tax reliefs available in the UK and Northern Ireland

CCAB-I is an all island body. Feedback from our members in Northern Ireland has indicated that a review of a number of tax reliefs available in the UK may be helpful in formulating a high performing tax relief for start-up and expanding enterprises in the Republic.

Enterprise Investment Scheme

The UK operates a tax incentive known as the Enterprise Investment Scheme (EIS). The EIS is a form of funding used by small unquoted trading companies. It tends to be used by start-ups which have limited funding capabilities. The EIS offers substantial tax incentives to investors which include:

• CGT deferral relief on gains reinvested in EIS shares. This is useful for non-business gains which would otherwise not be relieved.
• Income tax relief on 30% of an investment up to a maximum investment of £1,000,000. This relief operates as a tax reducer i.e. reduces the income tax liability and can be carried back to the previous tax year but it cannot create a refund.
• Disposals of EIS shares are exempt from CGT if the shares are held for more than 3 years.
• Losses on EIS shares held for more than 3 years can be offset against other income and the loss is not subject to any capping provision.

A company can raise funding of up to £5m annually under EIS provided that it meets specific conditions regarding its size and employee numbers (for example, gross assets must not exceed £16m after investment). Most trades qualify for EIS. Since the launch of the EIS in 1993–94, over 22,700 companies have received investment through the scheme and over 12.2 billion of funds have been raised.4 Provisional data for 2013–14 shows that 2,600 companies raised a total of £1,393m of funds under the EIS scheme. In 2012–13, 2,420 companies raised £1,024m of funds. Start-ups raised an estimated total of £715 million for 2013–14.

Seed Enterprise Investment Scheme

The Seed Enterprise Investment Scheme (SEIS) is designed to help small, early-stage companies with gross assets not exceeding £200,000, to raise equity finance by offering a range of tax reliefs to individual investors who purchase new shares in those companies. The tax incentives available to investors include:

• A CGT exemption applicable to 50% of gains up to a maximum of £50,000 reinvested in EIS shares.
• Income tax relief is available at 50% of the cost of the shares, on a maximum annual investment of £100,000. The relief is given by way of a reduction of tax, provided there is sufficient tax against which to set it. A claim for relief can be made up to 5 years after the 31 January following the tax year in which the investment was made. The shares must be held for a period of 3 years, from date of issue, for relief to be retained.
• Tax free disposal of SEIS shares held for more than 3 years.
• Losses on SEIS shares held for more than 3 years can be offset against other income.

Companies can generate up to £150,000 in funding under SEIS and must meet specific conditions relating to the size of the company and employee numbers. EIS and SEIS are not mutually exclusive so if tax relief is exhausted under SEIS, the company or investor may go on to claim tax relief under EIS. Since SEIS was launched in 2012–13, over 2,700 companies have received investment through the scheme, raising over £240m in investment5.

The success of the EIS and SEIS can be explained by the fact that both reliefs are fundamentally a suite of reliefs which cover the life cycle of investments in SMEs, from an upfront income tax relief on purchasing the shares, a tax exemption on sale of the shares, to CGT relief aimed at encouraging further EIS investment and tax relief on possible losses arising on the disposal of the shares. The availability of tax relief on losses is a very useful dimension and no doubt, this makes EIS/SEIS investments more attractive for investors given the high risk nature of investments in the types of companies targeted such as start-up enterprises.

Source: Chartered Accountants Ireland. www.charteredaccountants.ie

1.P.81, Financing SMEs in Recovery, Evidence for Irish Policy Options. ESRI, October 2014

2.P.113, Financing SMEs in Recovery, Evidence for Irish Policy Options. ESRI October 2014

3.P. 7, Annual Report, Revenue Commissioners 2014

4.P.5. HMRC, Enterprise Investment Scheme and Seed Enterprise Investment Scheme – Statistics on Companies raising funds

5.P.8 HMRC, Enterprise Investment Scheme and Seed Enterprise Investment Scheme – Statistics on Companies raising funds