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Ireland’s tax competitiveness must be maintained if we are to continue to attract strong foreign direct investment, says Liam Diamond.

In recent years Ireland has begun to emerge as a favoured onshore location for multinational companies (MNCs) establishing regional, or even global, headquarters to manage the intellectual property functions (IP) and shareholdings associated with their international businesses.

Developments to Ireland’s tax regime for holding companies, coupled with enhancements to R&D, tax and financial incentives, have further bolstered Ireland’s status as a tax advantaged location for international headquarter and IP activities. It is critical that Ireland’s tax competitiveness is maintained and indeed reinforced further, in order to sustain the significant inflow of investment from abroad as well as to support domestic industry. In this context the appointment in February 2008 of a Commission on Taxation to improve Ireland’s tax system is timely.

Irish headquarters & holding companies The establishment of a headquarters company generally involves centralising some or all of a company’s key profit drivers (i.e. functions, risks and assets) for that region. It is critical, therefore, that the chosen location’s tax regime is competitive. The following features of the Irish tax regime have been, and remain, critically important for Ireland in attracting and retaining MNC investment:

- standard 12.5% tax rate for active business profits, - tax-efficient holding company regime, - effective tax exemption on foreign dividends and branch profits, - attractive R&D tax credit regime and intellectual property structures, - no thin capitalisation, controlled foreign corporation (CFC) or domestic transfer pricing provisions, - access to EU directives and an extensive tax treaty network, and - generally no outbound withholding taxes under domestic (as opposed to tax treaty) provisions.

Of course, investment location decisions by MNCs generally depend on a host of factors of which tax is just one. It is important that any potential location is competitive on the various commercial, legal, regulatory and business environment requirements of MNCs. Ireland’s relative strengths in these areas means that when Ireland competes for investment projects with other jurisdictions, these non-tax advantages often add significant strength to the overall Irish offering.

Ireland has not typically marketed itself as a holding company location in the traditional sense, unlike many other competing locations (such as the Netherlands and Luxembourg). Despite this, some of the key attributes of the Irish tax system which are listed above have made it a suitable location from which to hold subsidiaries. Ireland’s domestic law withholding tax provisions have proved particularly attractive and have avoided the need for detailed analysis of treaty provisions in most cases.

Irish headquarters and holding companies have accordingly been used for many years, particularly for MNCs with existing Irish operations. The range and scale of activities carried on by such companies is quite diverse, ranging from small shared services centres to major investments encompassing substantially everything associated with an MNC’s international business (e.g. profit centre, intellectual property, holding company, regional management, financing and treasury, shared services, etc.). In addition, all industries are well represented in terms of MNC investment in Ireland.

The absence of a tax exemption for qualifying disposals of shares was not problematic as such MNC investments were not typically focussed on exit strategies. Similarly, the lack of a tax exemption on foreign dividends was not a significant barrier as no incremental Irish tax generally arose on foreign dividends due to the availability of foreign tax credits. The recent tax developments in the Irish holding company regime (summarised below) further enhance Ireland’s competitiveness as a locationfor doing business and establishing regional, or indeed global, headquarters or holding companies.

Recent tax developments Recent years have seen the introduction of significant enhancements to the Irish holding company regime, the outcome of which is that Ireland can now offer a tax package that compares very well with other potential holding company locations. Some of these enhancements include:

- a tax exemption on gains from disposals of qualifying shareholdings (2004), - pooling and carry forward of excess foreign tax credits (2004), - the abolition of capital duty on equity investments (2005), - double taxation relief for foreign branch profits (2007), and - an effective tax exemption on qualifying foreign dividends with the tax rate reduced from 25% to 12.5% (2008).

As noted above, the tax rate applied to qualifying foreign dividends (i.e. dividends from ‘trading’ profits of a direct or indirect subsidiary located in a tax treaty/EU jurisdiction) may be reduced from 25% to 12.5% with effect from 1 January 2007. There are also new provisions associated with streaming of foreign tax credits by reference to dividends taxed at 12.5% versus 25%. There should, however, be sufficient flexibility to ensure that no incremental Irish tax generally arises on repatriation of dividends to Ireland.

R & D incentives The Irish government has always recognised that encouraging innovation is an important strategic objective for improving Ireland’s competitiveness by developing a knowledge economy. The government, through its various state agencies, markets the advantages Ireland has to offer in this area. These advantages include a highly skilled and educated workforce, a strong technical infrastructure, significant grant incentives from domestic and EU funds and an R&D tax credit regime.

R&D grants The EU agreed a new framework for dealing with Research, Development and Innovation grants which came into effect during 2007. In Ireland, the main grant scheme available to overseas companies is the Research Development and Innovation programme (RD&I). For overseas companies operating in Ireland, this grant is administered by the government agency, IDA Ireland. Two types of support are available under the RD&I programme:

- Feasibility & training support of up to €250,000 which is designed to stimulate and develop RD&I initiatives within eligible companies, and - RD&I project support which provides support to companies at all stages of RD&I development.

Feasibility & training support The feasibility assistance provided to companies is to enable them to investigate potential RD&I projects to be carried out in Ireland while the training assistance available is to upskill a company’s staff to carry out a small pilot or a full RD&I project.

The training grants can be used to provide formal internal training to staff, send staff to formal training programmes in Ireland or abroad, or send staff to existing RD&I facilities to acquire technology and RD&I management skills.

RD&I project support The aim of the RD&I grant programme is to enable companies to move from start-up R&D, through developing capacity and adding competence, to a fully integrated RD&I function. The grant rate available varies according to the type of research being conducted, but is likely to be at a maximum of 25% of eligible costs with an extra 15% available for research projects that involve collaboration with a thirdlevel institute or other industrial partners.

R&D tax credit In 2004 an R&D tax credit was introduced to augment the many advantages Ireland already had to offer in this area. A 20% tax credit is available on qualifying incremental R&D expenditure over and above that incurred, by reference to a rolling base year. Generally, the base year is three years before the year in which the claimed expenditure is undertaken.

The 2008 Finance Act has set the base year at 2003 and this will not be altered until 2013, allowing greater scope for companies to calculate their incremental R&D spend and to be more forward looking when considering R&D projects. The credit is available to reduce the current year corporation tax liability and any unused credit can be carried forward indefinitely to future periods.

Alternatively, qualifying R&D expenditure can be allocated to other group companies in Ireland. An R&D tax credit is also available for qualifying capital expenditure on R&D building facilities and is not limited to incremental expenditure. The credit is 20% of qualifying expenditure, to be given over a period of four years. Any unused credit canbe carried forward indefinitely to future periods or surrendered to other group companies in Ireland. There is a clawback of the credit where the facility is sold within 10 years or commences to be used for an activity other than an R&D activity.

There is limited scope for subcontracting R&D activities. Sums paid to universities or institutes of education in the EEA to carry out R&D will qualify for relief up to a limit of 5% of R&D expenditure incurred by the company or group. Where payments are made by a company to an unconnected party in order for that party to carry on R&D activities the relief will be restricted to 10% of the expenditure incurred by the company itself on R&D activities and relief will only be granted where the sub contractor does not also claim the R&D tax credit.

A review of the effectiveness of the R&D credit is currently being conducted by the Department of Finance and its evaluation unit is engaged in extensive consultations with key state agencies such as IDA Ireland, Science Foundation Ireland and Enterprise Ireland, as well as business groups like IBEC and the American Chamber of Commerce.

Direct industry feedback has also been sought to understand the true impact of the tax credit on R&D investment. Given the current challenging economic climate it is critical that the review leads to an enhancement of the R&D regime to maintain current R&D investment, encourage domestic companies to shift to higher value activities and to assist the attraction of new investment into Ireland.

Commission on Taxation A significant development in the Irish tax landscape was the appointment of a Commission on Taxation on 14 February 2008. The 18 member Commission has representatives from various interests and is chaired by Frank Daly, the former Chairman of the Revenue Commissioners. The Commission of Taxation is tasked with considering how best the tax system can support Ireland’s economic activity and promote increased employment and prosperity. It is notable that the Commission’s terms of reference recognise the Government’s commitment to maintaining a low taxation burden and guarantee the 12.5% tax rate.

Unlike the previous Commission which sat in the mid 1980s, the remit is radically different due to the significantly changed economic environment. Whereas previously the original Commission operated against a backdrop of a pre ‘Celtic Tiger’ economy that was unrecognisable from today’s, the current Commission’s remit is to consider the tax system ‘in the context of maintaining an equitable incidence of taxation and a strong economy’.

The establishment of the Commission was part of the Programme for Government of the current coalition Government elected in 2007 and there is a strong belief that the recommendations will carry significant weight when the Commission reports in September 2009.

Given the success in recent years of Ireland’s low tax environment and the successive enhancements of incentives like the holding company and R&D regimes, one would expect that the Commission will look at these and other areas (for example a more competitive taxation regime for intellectual property) to ensure that Ireland remains at the cutting edge of progressive and innovative tax systems.

Liam Diamond is a Tax Partner and Inward Investment Leader with PricewaterhouseCoopers.

Very necessary