Irish tax law and practice: Interaction with state aid rules
The launch of an in-depth investigation by Joaquín Almunia, EU Competition Commissioner, into tax authority decisions relating to transfer pricing arrangements in Ireland, the Netherlands and Luxembourg brings a new dynamic to the debate on harmful tax competition. The timing of the investigation is unfortunate, given the reporting timeframe for the OECD’s BEPS and Ireland's active participation in that debate.
Moreover, unlike many other countries, Ireland has already taken further initiative in the BEPS debate by amending its laws to deal with concerns about stateless companies.
The desire of each CEO, CFO or global tax director to obtain certainty on the operation of a country's tax regime fundamentally drives dialogue between tax authorities and major corporates. There must be an established system whereby reliance on a ruling of a member state's Revenue authority cannot be called into question. Any lack of certainty in this connection will have a deleterious impact on the level of inward investment into the EU generally.
There are many angles pertaining to the interactions between Irish tax, competition and other laws, but for global directors with operations in Ireland, a key point is the absolute necessity for independent specialist legal advice based on a full disclosure of all facts and circumstances surrounding any ruling.
Background to the investigation
A company tax resident in Ireland, by way of incorporation or central management and control, is liable to corporation tax at 12.5%. In calculating the profit chargeable to corporation tax, Irish tax law provides a deduction for disbursements or expenses paid out or expended wholly and exclusively for the purposes of the trade. A tax deduction is not allowed for distributions of profit.
In the absence of transfer pricing, some multinationals with operations in Ireland may have sought a ruling from the Irish Revenue Commissioners (the Revenue) that certain payments from an Irish tax resident to a related party overseas were wholly and exclusively for the trade and were not a distribution of profits (and hence, tax deductible).
In accordance with best international tax practice, Ireland introduced transfer pricing legislation in the form of the Finance Act 2010. The effect of this legislation is that where such expenses are payable to a related party for arrangements entered into on or after July 1 2010, the expense is only deductible to the extent that it is set at an arm’s-length rate in accordance with OECD transfer pricing guidelines.
The corollary is that transfer pricing arrangements entered into before July 1 2010 were grandfathered and therefore enable major Irish tax resident subsidiaries of overseas groups to continue to obtain a tax deduction for expenses, where the expenses may be in excess of an arm’s-length rate.
It is the presence of the grandfathering arrangements, coupled with the nature of ruling on the tax deductibility of payments to related parties, which appears to have prompted the European Commission's investigation into one case, albeit a particularly high-profile one.
The Irish legislative basis for rulings
Under Irish tax law, there is no formal system to obtain tax rulings or for that ruling to bind either the Revenue or the taxpayer. The general administration and control of taxes is vested in the Revenue and the Revenue appoints inspectors of taxes to administer the tax arising.
Section 849(3) Taxes Consolidation Act 1997 provides:
"The Revenue Commissioners may do all such acts as may be deemed necessary and expedient for raising, collecting, receiving and accounting for tax in the like and in as full and ample a manner as they are authorised to do in relation to any other duties under their care and management and, unless the Minister for Finance otherwise directs, shall appoint such officers and other persons for collecting, receiving, managing and accounting for any duties of tax as are not required to be appointed by some other authority."
In the care and management of the tax system, Revenue officers may reach an agreement with a taxpayer that an interpretation of tax law, based on a particular set of facts and circumstances, is acceptable. It is worth noting here that the Revenue and its officers have no power to enact or create tax law; they may only administer the law.
Confidentiality and freedom of information
The inspector of taxes and other Revenue officers have an inherent obligation of secrecy. Upon taking office, it is necessary for every officer to make a statutory declaration that the officer will carry out all duties without disclosure.
The extent of disclosure relating to a taxpayer's tax affairs is, however, subject to the provisions of the Freedom of Information Acts 1997 and 2005 (FoI Acts).
The FoI Acts provide right of access, subject to certain exemptions, to records held by a public body, including the Revenue.
The Information Commissioner has held that in some circumstances, it may be necessary to encroach upon taxpayer confidentially to determine the Revenue interpretation or application of tax law.
State aid rules
It is well-established under EU law that the power to tax is one of the core competences of member states.
Member states do not, however, enjoy an unlimited discretion in the exercise of their power to tax. Case law of the European Court of Justice (ECJ) has reiterated many times that although direct taxation is a member state competence, member states must nonetheless exercise that competence consistently with EU law, including the rules on competition as set out in the Treaty on the Functioning of the European Union (TFEU).
Under Article 107(1) TFEU provides:
“any aid granted by a member state or through state resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between member states, be incompatible with the common market”.
State aid must be notified to the Commission before it is put into effect. Further, the Commission has sole competence to determine whether state aid granted illegally (where there has been a failure to notify) is compatible with the internal market. Where the Commission makes a finding that aid is incompatible, it can order a member state to recover the aid granted. Ireland regularly seeks EU approval before introducing new tax laws to avoid falling foul of the state rules.
To qualify as state aid, the following cumulative conditions must be met:
(i) the measure must be granted out of state resources and which includes a loss of tax revenue (that is, where the state forgoes the collection of revenues that would otherwise be due);
(ii) it must confer an economic advantage to undertakings;
(iii) the advantage has to be selective and must distort or threaten to distort competition; and
(iv) the measure has to affect intra-Community trade.
Any Revenue ruling permitting a deduction for an expense which under the legislation would have been deductible had it not been for the ruling, would clearly not be a use of state resources to confer state aid. The concern is whether the ruling gives an interpretation of tax law or adopts a practice that is at variance with the underlying tax legislation, viewed from the perspective of compatibility with EU law.
There is considerable legal uncertainty around whether any advantage conferred by a ruling is "selective" and distorts or threatens to distort competition. According to ECJ case law, whether a measure is “selective” depends on whether the particular measure “favours certain undertakings or the production of certain goods in comparison with other undertakings which are in a legal and factual situation that is comparable in the light of the objective pursued by the measure in question".
In other cases, however, the comparison has been stated as being “in light of the objective assigned to the tax system of the member state concerned”. It is unclear, therefore, whether the “selectivity” of a measure is to be assessed by reference to the objective of the measure in question or the objective of the wider tax system. However it is clear that “selectivity” has to be assessed against some stated or assumed objective. It is on this aspect that a detailed analysis and assessment would be required.
Nonetheless, if the presence of a ruling merely reflects a legitimate interpretation of tax law and other players in an industry can avail of such a treatment with or without a ruling, it is difficult to see how such a ruling is "selective".
Lengthy investigation process
The investigation launched into Ireland's grandfathering of its transfer pricing regime is likely to take a long time. The ability to seek access to records held by the Revenue complicates matters further.
A key feature of Irish tax law is that if a taxing law does not specifically cause a charge to tax, no Revenue official, court or other state agency may impose tax. Hence, unless the Revenue ruling specifically allows an expense that would otherwise be regarded as a distribution of profit, or disallowed as a capital expense, the Commission will struggle to demonstrate that there has been an infringement of state aid rules.
The investigation does, however, set a benchmark for Ireland to cease introducing major new tax laws with a blanket grandfathering of earlier tax planning that in the BEPS era is regarded as unacceptable and aggressive tax avoidance.
In May 2014, the Irish Department of Finance issued a public consultation document on "OECD Base Erosion and Profit Shifting Project in an Irish Context" as part of their participation in the OECD BEPS project.
It is becoming increasingly clear that payment for intellectual property located in no-tax or exceptionally low tax locations outside of Ireland, while currently legal and Irish tax compliant, has a limited shelf-life. The use of Irish incorporated companies that are not resident in OECD white-listed locations also needs to be considered.
Next steps for CFOS and groups heads of tax
In full knowledge that Ireland's 12.5% tax rate is not the subject of any EU challenge or investigation, CFO's and group heads of tax should review existing arrangements. In particular, they need to:
(i) obtain independent legal advice on the status of any existing ruling or acquiescence of a particular tax treatment;
(ii) review and obtain independent legal advice on any changes to transfer pricing arrangements which were in force before July 1 2010;
(iii) analyse the state aid risk to any arrangements with the Revenue; and
(iv) consider arrangements to restructure in a manner which avoids payments to companies resident in no-tax or minimal tax jurisdictions.
Mason Hayes & Curran is the principal Corporate Tax correspondent for Ireland.