The tax implications for PE & VC funds

The tax implications for PE & VC funds

What taxes apply?

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The tax implications for PE & VC funds

What taxes apply?

In Ireland, employment taxes are high by international standards, with people on relatively modest incomes paying income tax at 41 percent, a universal social charge (USC) of 7 percent and pay-related social insurance (PRSI) of 4 percent. Indeed, an employee earning no more than approximately €32,000 a year will see 52 percent of anything earned over that figure disappear into the coffers of the Revenue Commissioners.

Where an Irish resident receives a carried interest entitlement they will, in general, be subject to the full income tax-USC-PRSI deduction. It is arguable that, outside the special circumstances outlined here, where carried interest is granted in the form of shares, then the exposure to Irish income tax and ancillary levies should be confined to the upfront value of the share, and that any future increase in value should be subject to Capital Gains Tax. The Revenue Commissioners, however, can decide that all value relating to the shares should be subject to income tax and social charges. How tax is levied will, to a degree, depend on the Revenue Commissioners’ own assessment of the scheme.

There is, however, an exception to this rule arising from the introduction of a scheme aimed at incentivising venture capital funds to domicile themselves in Ireland. This exception provides that, in specified circumstances, persons holding a carried interest in PE and VC funds are entitled to Capital Gains Tax treatment at a rate of 15 percent for individuals and 12.5 percent for corporates, rather than falling under the income tax-USC-PRSI regime.

This highly attractive scheme is, however, subject to some strict conditions. For example the carried interest must be held by a partnership or a company and the carried interest must be derived from “a relevant investment” in a company which remains in place for at least six years.

What constitutes a “relevant investment”?

One of the key requirements to qualify as a relevant investment is that the company is involved in “innovation” or “research and development” in specified scientific and engineering fields.

These include:

  • Basic experimental or theoretical research to acquire new scientific or technical knowledge without a specific practical application in view 
  • Applied research in order to gain scientific or technical knowledge directed towards a specific practical application 
  • Experimental work, drawing on existing knowledge, aimed at achieving technological advances or resolving scientific uncertainty.

In addition, this special treatment is only available in respect of a carried interest which is not greater than 20 percent of the total profits of the fund.

What other tax reliefs are there?

Where the carried interest involves a grant of shares, there are some reliefs available for certain employmentrelated share schemes.

These include a reduction in the amount subject to income tax where the individual concerned is restricted from disposing of the shares for a period of time. Under this provision, the amount subject to income tax is reduced by 10 percent for each year of the disposal restriction, up to a maximum of 60 percent where the period is in excess of five years.

This is an attractive regime and is regularly used where remuneration is share-based. However, there are antiavoidance rules which provide for the clawback of the abated income tax if the conditions attached to the tax relief are broken. There are also other anti-avoidance provisions where shares granted to employees can convert into more valuable shares over time.

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