Finance Act 2010 – Commentary

The Finance Act 2010 was signed into law on 3rd April 2010 bringing into effect a number of much needed provisions intended to enhance the attractiveness of Ireland as a centre for investment, to assist in our economic recovery and to promote a positive future outlook.

The main features of Finance Act 2010 which are of interest have been summarised below:

Islamic Finance – Section 35 FA2010

Legislation has been introduced to facilitate Islamic finance which should encourage international fund raising operations. Islamic funds currently have to comply with the principles of Shari’a law and the amendments in the Finance Act 2010 extend the tax treatment applicable to conventional finance transactions to Islamic finance. Examples of the products to which the legislation applies are loans, bank deposits and investment bonds known as “sukuk”.

Interest payments to non-residents – Section 36 FA2010

An exemption from income tax on interest payments made by an Irish company or investment undertaking to a non-resident company has been provided for. The payment must be made in the ordinary course of business and made to a company resident in a country with which Ireland has a double tax treaty (“relevant territory”) However, this non-resident company must be liable to tax in its relevant territory.

Transfer Pricing – Section 38 FA 2010

The introduction of the long awaited transfer pricing regime in the Finance Act 2010 will now ensure that arms length prices will apply to trading transactions between associated persons. Transfer pricing describes the process by which members of a group set prices on the goods, services etc that pass between them and the new transfer pricing rules effectively enforce the charging of “arms length” prices. The arms length concept asserts that the prices charged between group members are to be equivalent to those that would be charged to an independent person.

Although Ireland had not adopted formal transfer pricing rules in prior years, the concept of the arms length principal does exist in Irish legislation which can allow the Irish Revenue Commissioners to impose arms length prices. However, the rules need to be formally brought in line with our European and International counterparts. Otherwise, the Irish economy will continue to lose revenue in that the profit of group companies can potentially be understated through the overstatement of expenses and understatement of sales prices.

The transfer pricing rules introduced in Finance Act 2010 will apply for chargeable periods beginning on or after 1st January 2011. The new legislation can be summarised as follows:

• The rules apply to domestic and cross-border trading transactions between associated persons i.e. members of a group.
• The rules have been modelled on the OECD transfer pricing guidelines.
• The provisions apply to large businesses only – small and medium enterprises (“SME’s”) are excluded. A company is an SME where the group as a whole employs less than 250 employees and has either a turnover of less than €50m or assets of less than €43m.
• Companies that are in the scope of transfer pricing legislation are required to have records available to demonstrate compliance with the rules. If original documentation is complete this should suffice.
• The provisions will apply to transactions based on terms agreed on or after 1st July 2010. Therefore, arrangements which are agreed prior to this date will not be subject to the rules. This leaves an opportunity for group companies to perform a review of agreements in place with other members, assess how current inter-company arrangements may be impacted and arrange for new or amended agreements.

Intellectual Property – Section 39 FA2010

Following the much anticipated introduction of a tax allowance for “specified intangible assets” in 2009, the Finance Act 2010 made a number of additional amendments which will no doubt prove to be attractive for many international businesses looking for a holding company destination. The relief introduced in 2009 provides that companies carrying on a trade are entitled to a tax write off for the costs incurred on purchasing/developing the asset. The period in which the allowance spans can be based on the company’s accounting policy for depreciation/amortisation or for 15 years if elected. The following are the main amendments introduced in Finance Act 2010:

• To avoid a clawback of allowances claimed, the period in which the intangible asset must be held before disposal has been reduced from fifteen to ten years.
• The term “specified intangible assets” has been expanded to include the costs for grant applications or registration of the assets.
• The definition of computer software has been augmented to include software acquired for the purposes of the company’s commercial exploitation.
• Relief for pre-trading expenses for the acquisition of the asset will be granted.
• Clarification on whether tax relief would be available on the impairment charge of an asset was made. The legislation has now been amended to allow for relief on impairment charges.
• Finance Act 2009 had introduced rules restricting the level of tax allowance available to 80% of the gross income derived from a “separate trading activity” relating to managing, developing or exploiting specified intangible assets on which allowances can be claimed. Finance Act 2010 has clarified “separate trading activity” to include any activities involving a specified asset on which relief has been claimed.

Unilateral credit relief on foreign royalties – Section 42 FA2010

Trading companies can now enjoy an extension of unilateral credit relief in respect of foreign withholding tax on royalty income received from non-treaty countries. Unilateral credit relief is currently granted to companies entitled to manufacturing relief but this will cease on 31st December 2010. This legislation relates to all trading royalty income received on or after 1st January 2010. Charges on income and expenses of management can be deducted from the profit. Again, this is an effective relief which will promote Ireland as an attractive location for exploitation of intellectual property.

Foreign branch tax credits – Section 43 FA 2010

The Act has allowed for the carry forward of unused foreign tax credits which can be set off against Irish corporation tax on foreign branch income in subsequent years. Previously, where an Irish resident company with foreign branches paid tax in both countries on the branch profits, a credit for the foreign tax would be allowed. Unilateral credit relief was then introduced in Finance Act 2007 for taxes paid by foreign branches in non-treaty jurisdictions and excess credits could also be pooled and used against other branch profits in that period. However, any unused credits not utilised in that period were lost. This amendment now allows these unused foreign tax credits to be carried forward and credited against corporation tax on foreign branch profits in future periods.

Foreign branch losses carried forward – Section 44 FA2010

Prior to the enactment of Finance Act 2010, Irish legislation allowed for a small number of companies carrying out certain qualifying activities in listed overseas territories to be exempt from Irish tax on their foreign branch profits and capital gains. This exemption is due to expire on 31st December 2010. Finance Act 2010 provides that any excess losses of the foreign branches, which would have previously been disregarded for Irish tax purposes, may be carried forward against profits of the foreign branch arising after 1st January 2011.

Dividends from Irish resident subsidiaries – Section 45 FA2010

This anti-avoidance provision relates to the current exemption from corporation tax on dividends received by an Irish company from its Irish resident subsidiaries. It now denies the exemption where the subsidiary was non resident and then became Irish resident within a ten year period before the payment of the dividend. Such dividends will now be treated as foreign dividends.

Taxation of foreign dividends – Section 46 FA2010

Another welcome provision is contained in Section 46 Finance Act 2010. This section enhances the attraction of Ireland for economic activity and can be seen in three amendments in relation to the tax treatment of dividends. Firstly, the section has introduced the extension of the 12.5% rate on foreign dividends to include dividends paid from certain non-treaty countries which are usually taxed at 25%. The dividends which have to be paid out of underlying trading profits must be paid by a company that is owned directly or indirectly by a publicly quoted company in an EU or tax treaty country. Secondly, it provides clarification on how to identify the underlying profits out of which the dividends are paid. Lastly, an exemption is provided for foreign dividends received by an Irish company where the dividends are classified as trading income from portfolio investments i.e. portfolio investor companies with holdings of less than 5% of the share capital and voting rights of the foreign company.

Patent royalty payments – Section 51 FA2010

Another beneficial amendment for the holding company regime is that patent royalty payments can be made free of withholding tax provided the recipient is resident in an EU or treaty country and is liable to tax in respect of the royalty in it’s country of residence or the country in which is has its permanent establishment. The royalty payment must also be tax deductible, not part of any tax avoidance arrangement and made for bona fide reasons...