The importance of entrepreneurship to Ireland’s economy is beyond doubt. Economic recovery and our falling unemployment rate are some of the resulting factors of entrepreneurs establishing and growing business activities in Ireland in recent years. Unfortunately, many elements of Ireland’s taxation environment for entrepreneurs have deteriorated over the years. Entrepreneurs can and do move location based on the taxation environment. With increasing competition coming from overseas, Ireland must ensure that its tax system offering remains competitive and supportive for entrepreneurship.
The UK is our closest competitor. UK policy is, and has been for the last number of years, to “roll out the red carpet” for entrepreneurs. The results of this policy are evident in the attractiveness of the UK taxation system for entrepreneurs, which continues to improve.
Minister for Finance, Paschal Donohoe, acknowledged in his Budget 2019 address that “SMEs provide most of our employment and additional Government support for this sector is crucial in light of Brexit”. In this article, we explore some elements of Ireland’s tax system offering to entrepreneurs and SMEs, and whether Budget 2019 has taken needed steps in the right direction to improve Ireland’s taxation environment.
Corporate entrepreneurs attract the 12.5 per cent corporation tax rate on their business profits. In the 21st year since its introduction, Minister Donohoe confirmed in Budget 2019 that “our longstanding 12.5 per cent rate will not be changing”. The 12.5 per cent tax rate is internationally competitive and is notable for its long term stability. The rate has not changed in the last 20 years. While the 12.5 per cent rate is competitive, competitor locations are catching up as they are continuing to cut their domestic corporate tax rates. Competing on rate only is not sufficient.
There are other Irish corporation tax rates that must be considered by corporate entrepreneurs and SMEs. For example; a 25 per cent tax rate applies to non-trading income, such as investment and rental income, and a 33 per cent tax rate applies to chargeable gains. Closely held companies engaged in providing “professional” services can have an effective corporation tax rate of 19 per cent on their trading profits and an effective tax rate of up to 40 per cent on non-trading income. In selling Ireland as a place to do business, the 12.5 per cent tax rate is Ireland’s brand. These other tax rates tarnish that brand and can lead to anomalies and nasty surprises for inward investor entrepreneurs.
In our KPMG Pre Budget Submission, we outlined measures which we believe should be implemented to further support entrepreneurs. These included:
While these matters were not addressed by Minister Donohoe in Budget 2019, we will continue to call for the corporation tax environment to be improved for entrepreneurs and SMEs in future Budgets.
Not all entrepreneurs and SMEs incorporate their businesses. These individuals are subject to Ireland’s highly progressive personal tax regime. According to OECD data in 2017, Ireland continues to have the most progressive income tax system in the EU and the second most progressive in the OECD. We welcome the Minister’s announcement of a number of changes to Ireland’s personal tax regime including an increase of €750 to the standard rate income tax band, a reduction in the third USC rate from 4.75 per cent to 4.5 per cent and a €200 increase in the earned income credit. These are welcome reliefs for all of us working people in Ireland and are steps, albeit small steps, to addressing Ireland’s reputation as a highly progressive taxation jurisdiction.
Our high marginal rates of taxation result in increased labour costs for employers who are trying to attract and incentivise much needed and sought after skilled workers to stay in Ireland. To compete with employers at an international level, labour costs of Irish employers have had to increase to ensure net income of employees is competitive and attractive.
In addition to tax rates, attractive employee share incentive systems are widely accepted as being an effective way of enhancing employee recruitment and retention. Effective systems enable employers create an environment to attract mobile talent and investment. Such systems also serve to encourage a spirit of entrepreneurship more widely in the workforce.
In 2017, Minister Donohoe announced the introduction of the Key Employee Engagement Programme (“KEEP”). This is a share option incentive system targeted at the SME sector. Its aim is to help this sector compete with other sectors more efficiently. Where KEEP works, an employee taxable at marginal rates can benefit from an effective tax saving of up to 19 per cent and employers can save employer PRSI costs of 10.85 per cent (and 10.95 per cent from 1 January 2019) compared with a bonus system.
Following its introduction, KEEP raised certain practical issues and take up has been less than expected. In Budget 2019, the Minister acknowledged this and announced a number of changes to the rules relating to the total market value of qualifying share options which may be granted by a qualifying company to an employee or director. In our KPMG Pre Budget Submission, we called for some needed technical changes to improve the operation of KEEP in common commercial situations. While these technical changes were not addressed by Minister Donohoe in his Budget address, we are hopeful that the Finance Act will provide for these changes.
Entrepreneurs not only think about the present, they also consider the future. The future may involve a sale of business or passing of business to the next generation. High capital gains tax (“CGT”) rates can discourage investment in the first instance and can result in people holding assets for too long and forgoing other entrepreneurial opportunities which create employment. Notably, our CGT rate of 33 per cent is now one of the highest in the developed world. Over the last ten years, the rate has increased by 65 per cent (from 20 per cent).
CGT Entrepreneur Relief provides that disposals of qualifying business assets (in most productive businesses but excluding those involving dealing in land or holding investments) by qualifying individuals are charged at a 10 per cent tax rate up to a lifetime limit of €1 million on chargeable gains. In 2016, the Programme for a Partnership Government committed to review the lifetime limit in future Budgets. The equivalent UK tax relief provides for a £10 million threshold. Ireland needs to compete with the UK in this space. The low level of the relief in Ireland has the potential to stymie entrepreneurs from building second or third businesses which create employment and contribute to the economy and society.
Supporting the development and growth of small indigenous business in Ireland is a challenge. Once the business reaches a certain size, a range of factors make it more attractive for the owners of the business to sell out and realise their investment in the business by means of a capital gain. Where owners sell out to international investors, the business’s links with Ireland can be more easily reduced as the business matures. Therefore it is important to support the retention of founder entrepreneurs for the longer term in a business that they have founded.
In our Pre Budget Submission, we recommended measures to enhance the scope of Entrepreneur Relief and its effectiveness, including the following:
It is disappointing that Ireland’s Entrepreneur Relief did not feature in Minister Donohoe’s Budget address. It is hoped that future Budgets might include measures to improve the existing regime for entrepreneurs in Ireland.
Encouraging the passing of family businesses to the next generation is an important policy. The new generation bring enthusiasm, energy and new ideas but equally have the benefit of the experience of the older generation. With this policy comes the consideration of capital acquisitions tax (“CAT”) where businesses are passed by gift or for a favourable sum (in favour of the child). Minister Donohoe’s announcement of an increase in the Group A tax-free threshold (which applies primarily to gifts and inheritances from parents to their children) of €10,000 to €320,000 is small. There is a long way to go in restoring the threshold to previous levels which were in excess of €500,000 before the financial crisis.
In excess of the tax free thresholds, and absent other relief, CAT applies at a rate of 33 per cent. Valuable CAT reliefs which are often availed of when passing businesses to the next generation are agricultural relief and business property relief. These reliefs result in a reduction in the taxable value of the assets received for CAT purposes by 90%. The aim of the reliefs is to ensure that the businesses do not have to be sold to realise funds to pay CAT bills.
It was suggested in the Department of Finance Tax Strategy Group paper on Capital and Savings Taxes, in July 2018, that the scale of agricultural relief and business property relief might be reduced from 90 per cent to 80 or 75 per cent and a capping of the reliefs at €3 million. Limiting the reliefs in this way would be a retrograde measure in terms of encouraging the transfer of businesses to the next generation. Such a reduction could have a serious impact on the growth, development and success of Irish businesses. Thankfully no changes were proposed to these reliefs by Minister Donohoe in Budget 2019. It is hoped that the Finance Act confirms that the status quo will be maintained.
Ireland has a relatively unattractive regime for people taking the risk of starting a business – the entrepreneur takes the risk and creates employment but the State takes 33 per cent of the upside. The regime is uncompetitive by international standards. To encourage entrepreneurs to come to and stay in Ireland, changes to our taxation system are needed. This Budget certainly has some welcome measures, but it has been disappointing in that it has failed to include any substantial measures to improve the competitiveness of Ireland’s tax regime for entrepreneurs and SMEs.
This article appeared in The Sunday Business Post and is reproduced here with their kind permission.