The Finance Act 2010 has changed the rules which allowed lessees of equipment to claim capital allowances on the equipment.

Transcription

1 Lessees of Buildings The Finance Act 2010 has changed the rules which allowed lessees of equipment to claim capital allowances on the equipment. Until now (s299 TCA 1997) where a lessee could demonstrate that he had the burden of wear and tear he would be entitled to the capital allowances on leased equipment, as well as getting a tax deduction for the rentals paid. This point was of importance, not alone in the specialised world of equipment leasing, but also in a typical case where an office building is let by a landlord to a tenant where the tenant is carrying on a trade or profession. Typical examples in recent years have been firms of solicitors or accountants taking up new office space for expansion. Section 36 of the Finance Act introduces (among other more welcome changes) the following changes which are negative for taxpayers: The lessee can claim allowances only where the lease is a finance lease under generally accepted accounting principles. The lessee and lessor must jointly elect for the lessee to get capital allowances (there are special provisions where there are non resident lessors: - the lessee can elect on his own in this case), and The deduction for rentals related to the equipment is limited to the amount which would be deducted under generally accepted accounting principles in the profit and loss account of the lessee. In most cases this would be the interest element only of the rental payments. The total capital allowances which can be claimed by the lessee are limited to the total capital element of the lease payments under the lease. Where the lessee is entitled to capital allowances, the lessor cannot claim capital allowances on the asset. This provision explicitly states what should have been the natural conclusion in any case in the past, as whoever claims allowances has to be the person who bears the burden of wear and tear on the asset. The section applies to companies for accounting periods commencing on or after the passing of the Act (3 April 2010). For individuals (including individuals in partnership trades) it will first apply for the tax year There is no grandfathering for existing leases. 1

2 A general comment on this legislation is that it appears to have been introduced in the context of a wider review of leasing rules, mainly to increase Ireland s attraction as a base for international leasing activities. It is unfair that taxpayers (many paying tax at very high income tax rates), may now lose allowances which were available to them under legally binding lease agreements entered into before the passing of this Act. The amounts involved could be material for some lessees. Transfer Pricing In considering the application of the new Transfer Pricing rules to small or medium sized businesses, the most important thing is whether a business could be exempt from the Transfer Pricing rules. There is a general exemption for a business which is a small or medium sized business. There is a definition in EU law which is used for this purpose (and this definition is very important generally as it is used for a wide range of matters such as eligibility for grants etc). In order to qualify as a small or medium sized business, a business must have less than 250 employees. In addition, its turnover per annum must be less than 50m or its gross assets on the balance sheet must be less than 43m. The above definition is taken from Commission Recommendation 2003/361/EC of 6 May 2003 and there are further detailed aspects of the definition which also apply in this context in Irish law now. It is not proposed to go into detail on all aspects of the definition but if you put the above reference into an internet search engine you will find the definition very helpfully set out together with a user s guide showing worked examples. All of this is on the European Commission website. There are some aspects which you might not expect. For instance: Enterprises under common control (linked businesses) must be added together. Situations where one enterprise has more than a 25% stake in the other must also be looked at together (although there are formulas as to how much of each business you include depending on the percentage ownership, etc.). For the purpose of the 250 employee threshold, employees includes partners and anybody else who in substance works full time in the business. 2

3 Transfer pricing case study Here is a case study of how this might apply in an Irish context: Joe has a land dealing business. Normally he would do this through a company but for the last few years he has been doing it in his own name because he was availing of the 20% rate of income tax which applied to residential profits. Now that this rate is no longer available he is likely to go back to his normal habit of dealing in land through a company so as to avail of limited liability. He has two others working with him in this land dealing business and he plans to transfer most of his stock of land at cost ( 20m) into a company which will continue to carry on the trade. There are one or two small projects which he won t transfer to the company because they are nearly completed and there would be legal problems in transferring them at this stage. He also controls 60% of a company which owns two hotels and some pubs. Between them the hotels and pubs employ 300 people. The analysis of the above situation would be as follows: Joe s land dealing business will not qualify as a small or medium sized business because it (together with businesses under common control) have more than 250 employees. Therefore transfer pricing laws will apply. Under the new transfer pricing rules any arrangement or transaction done before 1 July 2010 will not be subject to the new rules. Therefore if Joe transfers his land to the company before 1 July, it can be recognised at cost for income tax purposes. If he transfers it after 1 July it will need to be recognised at its market value and therefore he could end up with a significant income tax bill. Note that in this example Joe is not ceasing to trade in his personal capacity as he is retaining some small projects. If he had transferred all his trade to the company then the provisions of s89 TCA 1997 would apply. This section allows the transferor (Joe) and the transferee (the company) to elect that the price charged (as opposed to the higher market price) is taken into account for tax purposes. This election is very specific and it is submitted that it takes precedence over the new transfer pricing rules. 3

4 It will be noted that there is an exemption in the Transfer Pricing legislation for sales of undeveloped land between companies within a 75% group. This does not apply above because one of the parties (Joe) is an individual. Entertainment expenses There are no new developments in this area but it is worth looking at a point which comes up regularly on the detail of this. Section 840 TCA 1997 disallows business entertainment expenses when computing profits of a trade, business, profession or employment. The disallowance does not include anything provided by the employer for bona fide members of that person s staff unless its provision for them is incidental to its provision also for others. The above exclusion gives rise to some interesting questions. It is obvious, for instance that if a major customer is invited out to dinner and a member of the staff is acting as host, then the expenses relating to that member of the staff are also disallowed. They are incidental to the entertainment of the customer. However there may be other occasions where, even though customers, clients or other non-staff members may be involved, the amount referable to the staff might not be incidental to the provision of entertainment for others. For instance, if a professional firm hosts a table at the annual dinner of their Institute, and invites some clients, it is not obvious whether the expenditure attributable to the staff is incidental to the clients or vice versa. You would have to look at the facts of each given situation. It could be that the firm would have sent staff to the dinner anyway for the purposes of developing those staff, maintaining profile, making contacts, etc. While doing this they might have decided to invite one or two clients to fill out the table. In this case it would seem that the client expenditure is incidental to the overall expenditure. In that case the disallowed part of the expenditure would be the part relating only to the client. 4

5 On the other hand if the real purpose of the expenditure was to entertain the client, then all of the expenditure would be disallowable because the amount referable to the employees would be incidental to the entertainment of the clients. For firms who are obliged to incur high levels of entertainment expenditure it is worth maintaining appropriate records and going into the detail of these matters as the amounts could be material. 80% Windfall Tax 1. Introduction The 80% Windfall Tax applies to profits made from the rezoning of land. It was introduced as part of the National Asset Management Agency (NAMA) Act Profits to which the 80% tax charge applies: It applies to trading profits or capital gains. For capital gains in companies group relief can still apply for transfers in groups (But see 6 below). It applies only where rezoning has happened after 30 October It occurs where land is zoned from non development land use (agricultural, open space, recreational or amenity use or a mixture of such uses) to development land use (residential, commercial or industrial uses, or a mixture of uses.) It also applies where land is rezoned from one mix of development land use to another such mix. For example if land is rezoned from residential to commercial this also falls within the ambit of the windfall tax. Where planning authorities decide to grant planning permission for development which materially contravene a development plan for a particular area, this is also treated as a rezoning for the purposes of this tax. Such a material contravention is treated the same as a rezoning as above. There is an exemption for the sale of sites where the market value at the time of sale does not exceed 250,000 and the size of the site is not greater than 1 acre. As can be expected this exemption does not apply if the sale of the site forms part of a larger transaction or series of transactions. It applies to Irish land only because the definition of rezoning refers to the Irish Planning and Development Act It also applies to disposals of shares which derive the greater part of their value from land where such a profit would have been taxable to income tax under 5

6 Case IV. The background here is that Section 643 TCA 1997 applies an income tax charge under Case IV to certain disposals of shares (in circumstances where the profits arise from land). 3. Calculation of the taxable amount and other rules Only profits attributable to the value added by rezoning are taxed. Therefore, if the land is sold sometime after rezoning and further value has been added by planning permission, marketing or other factors, the taxable amount is limited only to the value added on rezoning. For the purposes of the above calculation both income and expenses may need to be apportioned. This will involve a subjective element of calculation of the value attributable to the rezoning and also the amount of expenses attributable to that particular profit. Similarly, any profits attributable to construction activities are excluded. Again apportionments will be necessary for the purposes of this calculation. Where there are losses instead of profits from rezonings (where a profit would have been taxable at 80%) such losses are ring fenced so that for traders they can be carried forward only against trading profits subject to the windfall tax. Similarly for capital gains any capital loss on a rezoning disposal (where 80% would have applied had there been a profit) can be offset against similar profits in the same year or future years if not used previously. Any profits arising from a sale to a local authority are excluded where the sale is done on a compulsory purchase order or where such an order was imminent. On the latter point the Revenue must be satisfied that the sale would not have happened without the imminent CPO. In practice, it may be necessary to get advance Revenue confirmation of this before committing to the sale. 4. Examples 4.1 Example 1 (Please note this example is intentionally different from that in the accompanying slides) John Brown died in 2007 and left land to his son Tom. At the time of the inheritance the land was valued at 1m and John immediately allocated the land for a trade of development (construction of houses). In 2010 the land was rezoned for residential purposes. In 2011 Tom got planning permission to build houses. He hired a builder and built a small development of houses which were sold in

7 The relevant figures are as follows. For the figures marked with an asterisk below valuations had to be obtained from experts. For the figures market with two asterisks below just and reasonable apportionments had to be made for accounting purposes to arrive at these figures. 000 s Turnover from sales of houses. 5,000 Construction costs (including builder, interest expense and all other costs related to the construction). 2,000 Enhancement of land value attributable solely to the rezoning. 2,000 Costs of obtaining planning permission. 300 Legal and marketing costs from sale of houses. 400 Bank interest and charges to finance construction activity s Enhancement of land value on rezoning 2,000 Value of land on acquisition <1,000> Amount subject to 80% tax 1,000 In summary, of the total profit, an apportioned amount of 1m is subject to the 80% tax. Note that if the overall profit had instead been only say 100,000 then the lower amount would be subject to the 80% tax. The amount subject to the windfall tax cannot exceed the overall gain on the land (although see below comments below at section 4.2 in relation to the anomalies that can be thrown up by following accounting rules). 4.2 Example s 1/1/2006 Land Trading Ltd buys land for... 10,000 31/12/2009 Land written down in accounts for valuation 5,000 30/6/2011 Land is rezoned residential and increases to... 9,000 (Sold for this amount in 2011) 7

8 Accounts for 2011 show a profit of Sales 9,000 Opening Stock <5,000> 4,000 Is the 4m taxable at 80%? The question of whether the 4m profit is taxable at 80% is a difficult one. For trading profits the law just says that the 80% tax applies to the extent to which the profits or gains are attributable to the rezoning of land. Profits are measured for trading business each year based on the accounts prepared under recognised accounting standards. There is no doubt that under such standards the accounts for 2011 in the above example would show a profit of 4m and therefore, applying the normal approach, and reckoning that the uplift of 4m was attributable to rezoning, this would imply that it is subject to the 80% windfall tax. A counter argument which seems to make more sense is that there could be no tax as the land was actually sold at a loss and that the intent of the legislation could not have been designed to give such a bizarre result of applying an 80% tax rate to profits which did not actually exist. This argument would be based on the fact that: - there is no similar technical problem where the 80% applies for capital gains tax purposes. It is very clear that if the above situation were a capital gain, there would be no gain chargeable where there is no profit attached, because gains are not measured like trading profits on a year by year basis as applying accounting principles. It would appear anomalous and unintended to have such a different situation between capital gains and trading profits. - for companies trading profits are measured in accordance with accounting standards (Section 76A TCA 1997) and in practice this is also followed for individuals. This provision applies subject to any adjustment required or authorised by law. It is submitted that a correct interpretation of the Windfall Tax Legislation is that it seems only to apply the tax to profits and that it cannot apply where there has not been a profit. This overrules the more general requirement to follow accounting standards. 8

9 - If the accounting measurement of profits were followed each year for the purposes of this tax so that changes in valuations of trading stock could trigger the 80% liability, then you could also have a situation where a reduction in value of rezoned land could reduce profits which otherwise might have been subject to the 80% tax. This would appear to give a very anomalous situation where variations in value throughout the years could give rise to losses or profits subject to the 80% tax without any actual disposals. This would seem highly anomalous. 5. Other miscellaneous rules Profits which are subject to the windfall tax are not subject to PRSI or levies for individuals. Profits in a land dealing company subject to the 80% tax are not subject to any further income tax (or withholding tax) when paid out by way of dividend to individual owners. Curiously, this exemption does not apply to a company which has paid 80% tax on capital gains. A windfall tax liability for companies who are trading in the land is assessed to Income Tax rather than Corporation Tax. Presumably this means that companies will be subject to the same payment dates as individuals. 6. Anti-avoidance legislation for transactions between connection parties Where the 80% windfall tax applies to capital gains the following anti-avoidance legislation applies. Where A is connected with B and sells land to B at an amount which is not market value, then the 80% tax applies to the increase in the value of the land attributable to the rezoning where the rezoning happened under the ownership of either A or B. Similarly there is further anti-avoidance legislation where land is sold in a sequence of transactions between connected parties. This provision specifies that the windfall tax applies where the land is rezoned between the latest market value transaction and the ultimate disposal of the land to an unconnected party. The wording and effect of these provisions is unclear. One possible interpretation is that these provisions ensure that where group relief applies on the transfer of rezoned land between group companies (or the similar treatment between spouses) the company which finally sells the land out of the group is subject to 9

10 the 80% tax even though that particular company may not have owned the land when it was rezoned. 10