1. Introduction

It is well documented that Ireland relies heavily on the multi-national enterprise (MNE) sector for corporation tax payments1 and as an employer2. In 2016, corporation tax was paid by over 44,000 taxpayers with 37% of the corporation tax receipts for that year paid by the top 10 taxpayers, and 70% by the top 100 taxpayers. The Department of Finance has voiced concerns3 on the risk posed by depending on a small cohort of large multinational taxpayers as did the Comptroller and Audit General4.

While Ireland has worked very hard to win its place as a location of choice for foreign direct investment, we also need to focus on assisting the small medium business (SME) sector because a thriving SME sector is essential to balanced and sustainable economic growth.

There is an established market failure in terms of funding for the SME sector. However the tax reliefs currently in place do not appear to be capable of generating the volume of risk investment so badly needed by this sector and so are in urgent need of reform.

2. Specific questions posed in the current consultation

We address a selection of questions set out in the consultation document as follows:

2.1 To what extent do the objectives of the EII and SURE remain valid?

The Employment and Investment Incentive scheme’s stated purpose is to encourage and facilitate investment in Irish SMEs. It is designed to provide a tax incentive to private investors to invest medium-term equity capital in companies which would otherwise find it difficult to raise such funding5.

The purpose of the Start-up Refund for Entrepreneurs (SURE) is to provide support for entrepreneurs in the form of a refund of tax paid in previous years where qualifying investments are made in new companies. The tax refund is a source of finance for new businesses which would otherwise find it difficult to raise such funding.

The market failure of accessing capital funding, which the EII and SURE were originally designed to address, continues to act as a serious inhibitor of success for the SME sector today.

Our members witness first-hand the continuous difficulties of the SME sector in accessing capital funding as part of their daily work as financial advisors to the SME sector. Research by the OECD supports the experiences of accountants working on the ground with SMEs. In its study in March this year, the OECD noted that most Irish firms have experienced declining productivity…. with the large productivity gap between foreign-owned and local enterprises having widened. The resilience of the Irish economy hinges on unblocking the productivity potential of these local businesses. This can be achieved by further improving the enabling environment for them to succeed and grow6.

Research by ESRI on investment in the SME sector found that there is “clear evidence that actual investment is below what would be expected…. The magnitude of this “investment gap” is economically meaningful and is estimated to be just over 30 per cent in 2016” 7. The ESRI concluded that financial issues were the biggest contributing factors to the investment gap.

The economic evidence is therefore consistent with the experience of accountants working on the ground. There is a definite need for funding in order to get the SME sector out of a protracted period of stagnation.

While the worthy objectives of EII and SURE schemes are not in dispute, the effectiveness of these tax reliefs is a problem. We believe that this is due to the complex conditions underpinning the legislation and the restrictions which block access to these reliefs in the first place for many SMEs in need of funding. The tax relief offering to the EII investor is not enticing given the level of risk assumed on investing in an SME.

2.2 What are the effects/implications of the EU General Block Exemption Regulations (GBER) for State Aid on the EII and SURE incentives?

The 2014 revision of EU General Block Exemption Regulation (GBER) for State Aid has greatly restricted the scope of the EII incentive and its effectiveness as a tax relief for risk investment in Ireland.

Finance Act 2015 amendments

Finance Act 2015 introduced section 494(4A) TCA 1997 into the EII legislation to reflect the requirements of the 2014 GBER. Our members report that the measures introduced had a negative impact on SMEs accessing EII funding. The main problem arises for companies more than seven years old seeking to raise EII funding for a second time. Such a company must prove that funds previously raised through EII/BES meet the conditions of GBER at the time that the original funding was put in place and the company’s business plan at the time of the original funding foresaw the subsequent funding round. It is unreasonable that a company should be blocked from raising funds through the EII Scheme due to the imposition of retrospective rules. The strict interpretation by Revenue that a business plans must be in place expressly reflecting the intention to raise additional funding is particularly unfair and difficult to demonstrate. A declaration by an officer of the company or board minute should be acceptable as evidence of the intention to apply for follow-on funding in the absence of a business plan.

Finance Act 2017 amendments

Sections 488 and 492 TCA 1997 were amended at Committee Stage of the Finance Act 2017 process in November 2017. The amendments resulted in the exclusion of early stage funders such as founding shareholders and their family from qualifying for tax relief on the start-up of the company before unconnected third parties investors get involved.

Minister Donohoe noted that the amendments were introduced on foot of advice of the Attorney General because Ireland’s EII legislation did not accord with Art 21(3) of the GBER, which requires that risk finance aid schemes such as the EII should be restricted to independent private investors and relief should not apply to persons with close connections to the undertaking.

The amendments to Finance Act 2017 are troubling as the EII legislation was subject to a State Aid review by the European Commission and the error in Ireland’s legislation did not appear to come to light until late 2017. Irish taxpayers should not have to be conversant with EU State Aid requirements when attempting to apply a scheme provided for under Irish legislation which we were told was State Aid approved.

The end result of the amendments to Irish legislation in response to the rules under the GBER is that the EII scheme can be used by a reduced cohort of qualifying companies and qualifying investors. Legislation underpinning the scheme is complex and has lost credibility due to confusion and uncertainty created by the manner and form of changes in Finance Act 2015 and Finance Act 2017.

2.3 How do the EII and SURE incentives compare with similar incentives in other EU Member States?

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.

Of course the UK is currently subject to the same GBER restrictions as Ireland i.e. the connected party rule and onerous conditions for companies operating for more than seven years. However, UK tax relief on risk investment offers a better return to the investor and is structured to complement other tax reliefs available in the UK system. The UK is free to rid itself of the GBER restrictions following its exit from the EU which will put further pressure on the Irish tax offering as investors may favour British SME investment over Irish SME investment.

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:

• Two Capital Gains Tax reliefs within the EIS; Disposal Relief, where shares in an EIS company are disposed of and Deferral Relief, where a gain arising on a disposal of any asset is deferred against a qualifying investment in shares issued by a company that meets specified requirements.
• 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.
• 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, and a maximum of £12 million in the company’s lifetime under the EIS provided that it meets specific conditions regarding its size and employee numbers. Most trades qualify for the EIS. Since its launch in 1993–94, 26,355 companies have received investment and almost £16.2 billion of funds have been raised. In 2015–16, 3,470 companies raised a total of £1,888 million of funds under the EIS scheme. Start-ups raised an estimated total of £997 million for 2015–168.

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 Capital Gains Tax exemption applicable to 50% of gains up to a maximum of £50,000 reinvested in SEIS 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 the SEIS and must meet specific conditions relating to the size of the company and employee numbers. The 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 the EIS. Since the SEIS was launched in 2012–13, over 6,665 companies have received investment through the scheme, raising over £621m in investment9.

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 lifecycle of investments in SMEs, from an upfront income tax relief on purchasing the shares, a tax exemption on sale of the shares, to Capital Gains Tax 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.

2.4 Are there ways in which the design of the incentives could be enhanced?

Tax relief for founding shareholders

As a result of amendments in Finance Act 2017 discussed in section 3.2, there is now a gap in the availability of tax relief for founding shareholders and their family in start-ups. A meaningful and effective tax relief should be reintroduced for founding shareholders to encourage people to take a risk in starting a new business and to funnel much-needed funds into a business during its infancy.

A tax relief outside of EII should be considered given the restrictions imposed by the European Commission’s GBER. Tax relief could 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 Finance (No.2)Act 2013) and section 248 TCA 1997 (before the restrictions introduced in Finance Act 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.

Concerns on safeguarding genuine use of the relief could be addressed 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 five years. Correspondingly, a 15% investment made up of 10% equity and 5% loan might require a holding period of one year.

Consideration should also be given to the full reinstatement of tax relief for loans taken out by founding shareholders to loan money to or purchase equity in a company. This tax relief was previous available under section 244 to section 252 TCA 1997. The conditions of the relief ensured that individuals actively involved in the running of the business with a material interest in the company qualified. This tax relief was effective and straight forward and encouraged capital funding flows into companies.

Professional Service Companies

Professional service companies are equally capable of providing job opportunities but are excluded from the EII. The financial model of professional service companies is currently based on running the business on an overdraft or loan. These companies have many growth focused uses for outside investment and that is no different to other trading companies who can benefit from the EII and on that basis.

Tax relief for the investor of EII

Tax relief for the EII investor in year 1 reduced from 31% to 30% under FA 2014 while the second tranche of tax relief due to the investor was pushed out from year 3 to year 4 under Finance Act 2015, subject to the fulfilment of conditions relating to staff numbers and average salary increases. This form of staggered tax relief for a high risk investment which is locked in for at least four year is not an attractive proposition for investors.

Capital Gains Tax loss relief is not available to EII investors, which further reduces the appeal of the relief. Given the risks involved in EII investment, Ireland should align its EII offering with the UK’s EIS/SEIS tax reliefs whereby losses can be offset against an investor’s other income and gains are tax exempt subject to holding conditions.

Source: Chartered Accountants Ireland. www.charteredaccountants.ie

1 An analysis of 2015 corporation tax returns and 2016 payments, Revenue Commissioners, April 2017

2 210,443 employed by IDA portfolio of FDI clients, IDA Ireland End of Year Results 2017

3 Economic Impact Assessment of Ireland’s Corporation Tax Policy: Summary Research Findings and Policy Conclusions, October 2014, Department of Finance.

4 Corporation Tax Receipts, Report on the Accounts of the Public Service 2016, Comptroller and Auditor General

5 Review of the Employment and Investment Incentive and Seed Capital Scheme, Department of Finance, October 2014.

6 OECD Economic Survey, Ireland, March 2018.

7 Measuring the Investment Gap and its Financing Requirements for Irish SMEs, joint ESRI/Department of Finance research programme on Banking.

8 HMRC, Enterprise Investment Scheme, Seed Enterprise Investment Scheme and Social Investment Tax Relief Statistics: October 2017

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