Finally some reward for risk takers

Finally some reward for risk takers

Irish entrepreneurs until now have not been rewarded by the Irish tax system. The Finance Bill 2015 contains the first step in readdressing this.

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Finally some reward for risk takers

Released on Budget Day, Tuesday 13th October, the Department of Finance’s Report on the Review of Tax and Entrepreneurship provides some interesting insight on the meaning “entrepreneurship” and “an entrepreneur”. In particular, the Report references the economist William Baumol as describing an entrepreneur “as an individual who organises, operates and assumes the risk of creating a new business”. These risk takers are central to the growth of our economy but they have not been rewarded by our tax system in recent years for the risks they face. However, Finance Bill 2015 contains the first cautious step in redressing this inherent inequality.

The Government identified in its National Policy Statement on Entrepreneurship an objective “to create a business environment – including the tax environment – in Ireland where it is easy to start up and grow”. In recognition of this, the Department of Finance issued a Public Consultation on Tax and Entrepreneurship in June 2015 which was responded to by 42 organisations, including KPMG.  On foot of the Government’s Policy Initiative and the consultation, a number of measures will be introduced as part of the Finance Bill:

Enhanced entrepreneurs CGT relief Corporation tax relief for start-ups extended Motor tax reduction for commercial vehicles
Introduction of an earned income credit Promoting electronic payments by reducing interchange fees and stamp duty charges

Introduction of a knowledge development box (KDB)

 
Agri-tax reliefs being extended and new relief for succession planning Enhancing film tax relief by increasing the investment cap Providing tax incentives for constructing aviation services facilities

In addition to these, the headline measure from the Finance Bill was the reduction in the universal social charge (USC) rates for those earning under €70,044, which of course will reduce the overall tax burden of entrepreneurs as well as self-employed individuals generally. In this article, however, we will focus on the measures that were introduced specifically for entrepreneurs.  

Earned income tax credit

The earned income tax credit will be introduced from 1 January 2016 and will be worth €550 in net pay terms. While this equates to only one-third of the PAYE credit available to those in employment, it represents the first step in rebalancing the tax differential between the employed and self-employed. In his Budget speech, the minister reached out particularly to the small business owners across the country, including small retailers, publicans, farmers and tradesmen. 

As can be seen from the table below, both employees and self-employed will have more net income in 2016 than 2015, but there is still a considerable bridge to cross to achieve parity. This measure had been widely forecasted, but the self-employed will wonder why they continue to shoulder a bigger fiscal responsibility than their employed counterparts who are earning the same
income.

Net pay on €150,000
Year Employed Self-Employed
Difference
2015 €83,616 €80,466 €3,150
2016 €84,518 €81,918 €2,600
Increase in net pay €902 €1,452 €550

CGT Entrepreneur Relief

Over the last number of years, our nearest neighbours in the UK have taken significant steps to reward their domestic risk takers, in particular through the UK’s Entrepreneurs’ Relief regime, whereby entrepreneurs pay a reduced rate of capital gains tax (CGT) (reduced from 28% to 10%) on the disposal of their business, up to a value of Stg£10 million. 
 
KPMG’s submission as part of the aforementioned public consultation process recommended a number of measures, including the introduction of a scheme similar to the Entrepreneurs’ Relief regime in the UK.  Following the consultation process, a similar scheme for Irish entrepreneurs was announced on Budget Day. The tax relief under the Irish scheme will reduce the CGT rate from 33% to 20% on net gains from the disposals of a business up to a €1 million lifetime limit. However, as always the devil is in the detail. In reviewing the Finance Bill, it is clear that the relief is not as generous as was hoped for by the many
interested parties who made submissions during the consultation process. In fact, the numerous conditions in the Finance Bill have made this relief unavailable to certain entrepreneurs. The following are some of the main conditions in the section as currently drafted:

  • In the case of the disposal of shares in a company, an individual must be a full-time working director in a managerial or technical capacity of a qualifying business for a period of three years prior to the disposal. This may prevent the relief applying to serial entrepreneurs or to businesses in the tech sector where founders are often involved with a range of companies in related businesses or with different stakeholders and as a result may not be regarded as working full-time in the business that is sold. 
  • An individual must be the owner of the business assets for a minimum of three years immediately prior to the disposal of the assets. 
  • The individual must hold not less than 15% of the ordinary share capital in the company that is sold. This may deny the benefit of the relief to companies operating in capital intensive sectors such as renewable energy or financial services, as founders in such sectors will often be diluted beyond a 15% holding by other capital providers in order to provide a capital base to the company sufficient to grow its business. 
  • The relief does not extend to share options or other interests held over shares or to the holding of development land or a business that consists of the development or letting of land.

Whilst the conditions above limit the application of the scheme to certain entrepreneurs, the small business owners that the minister appealed to in his Budget speech will welcome the reduction in capital gains tax payable.

The new Irish regime can be contrasted with the 10% CGT rate and Stg£10 million limit afforded under the UK regime. In addition, the conditions listed above are not as prescriptive in the UK; for example, the individual only needs to own 5% of the ordinary share capital to qualify for the UK relief. However, the UK regime has been in existence since 2008 and initially only provided for relief of up to Stg£1 million. It has since been progressively increased over time to Stg£10 million.  It is hoped that the conditions above will be revised before the Finance Bill is enacted and that the maximum Irish scheme limit will be increased over the short to medium term to encourage entrepreneurs to grow their business and produce scale, rather than encouraging individuals to sell up at an early stage when they reach the capital gains threshold.

Corporation tax start-up relief

Self-employed personnel make up 16.5% of the workforce. Whilst many entrepreneurs will not be affected by the additional 3% USC self-employed surcharge as it only applies to those earning in excess of €100,000, it creates a significant imbalance in the tax system for those that do, when compared to employees who do not pay the additional surcharge on a similar level of earnings. The justification for keeping such a measure in place is hard to reconcile but, according to the Revenue Commissioners estimates in September 2015, only 28,700 persons pay the additional surcharge so it appears likely that the political motivation was to reduce taxes elsewhere where they would have a wider numerical impact.

Other measures that did not appear

Self-employed personnel make up 16.5% of the workforce. Whilst many entrepreneurs will not be affected by the additional 3% USC self-employed surcharge as it only applies to those earning in excess of €100,000, it creates a significant imbalance in the tax system for those that do, when compared to employees who do not pay the additional surcharge on a similar level of earnings. The justification for keeping such a measure in place is hard to reconcile but, according to the Revenue Commissioners estimates in September 2015, only 28,700 persons pay the additional surcharge so it appears likely that the political motivation was to reduce taxes elsewhere where they would have a wider numerical impact.

Employment and Investment Incentive Scheme (EIIS)/Start-Up Refunds for Entrepreneurs (SURE)

It is important to develop an environment that not only encourages people to take a risk in starting a new business, but also encourages other parties to take a risk in supporting such ventures in the early stages. Such people are typically family, friends or “angel” investors, and can provide a business with much-needed funds during its infancy.
 
Steps have been taken over recent years to enhance the incentives available to such investors. However, in a number of cases these steps point largely to a re-branding of the available reliefs, rather than the overhaul many deem necessary in order to compete more vigorously with other jurisdictions. This included the recent re-naming of the Seed Capital Relief Scheme as Start-Up Refunds for Entrepreneurs (SURE), although certain conditions which are seen as inhibiting the relief remain unchanged.
 
Separately, in the Budget, the minister confirmed that the annual and lifetime investment limits in a company under EIIS are to be increased to €5 million and €15 million respectively. While this is welcome, the announcement effectively rubber-stamps the measures announced in last year’s Budget, following the required EU State Aid review.
 
A number of groups involved with the start-up sector are disappointed that these incentives do not go far enough to entice investors into very early-stage companies. A regime similar to the Seed Enterprise Investment Scheme (SEIS) in the UK was called for, as a means of providing enhanced and accelerated tax relief on smaller amounts of capital investment. The SEIS has helped to encourage a large number of investments of relatively small amounts of between Stg£5,000 and Stg£10,000. For a company at this stage in its development, such investments can be key in helping it to grow and succeed.

Mobility and entrepreneurs

On the flip side an interesting comment from the minister in his Budget statement is that small and medium enterprises account for 99.7% of all enterprises in Ireland and account for 68% of all employment. Accordingly, the remaining 0.3% of businesses will be large Irish enterprises and in the main large multinationals operating in Ireland. If this small number of enterprises account for nearly 32% of all employment, did the Government cater enough to attract talent to live and work in Ireland? Notwithstanding the reduction in USC for all income earners in Ireland, the reality is that a marginal rate of 52% (or worse still 55% for self-employed persons) remains a serious inhibiter to attracting high-calibre employees and entrepreneurs to work in Ireland. 
 
Steps were made in last year’s Budget to attract talent to Ireland through the Special Assignee Relief Programme (SARP) but, whilst a step in the right direction, it is less attractive than similar schemes in the Netherlands or
France. The National Competiveness Council stated in July 2015, that “Competition for Talent is global and intensifying”. In addition, entrepreneurs are in many cases young and mobile and can easily set up a business in a location that offers competitive income tax and capital gains tax treatment.
 
The road out of economic collapse has been long and Ireland’s entrepreneurs have been at the centre of the economic revival. The Finance Bill has brought some welcome relief for their efforts in helping to secure Irish jobs and create new business in Ireland. These new tax measures (which many argue do not go far enough) will be cautiously welcomed by entrepreneurs, but they will want to see a tax roadmap which is fair in terms of overall tax rates between employees and the self-employed and rewards them for the risks they take.

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