SMALL FIRMS ASSOCIATION SUBMISSION TO THE TAXATION AND ENTREPRENEURSHIP REVIEW. Presented to: Department of Finance

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1 SMALL FIRMS ASSOCIATION SMALL FIRMS ASSOCIATION SUBMISSION TO THE TAXATION AND ENTREPRENEURSHIP REVIEW Presented to: Department of Finance July 2015

2 INTRODUCTION The Small Firms Association (SFA) is the trusted partner of small businesses in Ireland, with 8,500 members and seven affiliated organisations in all sectors and parts of the country. Its mission is to deliver businessfocused advice and insights to members companies, influence government policy to the benefit of small businesses and connect its members in a thriving community. The SFA welcomes the opportunity to contribute to the Department of Finance s public consultation on taxation and entrepreneurship based on the experience, insight and knowledge of the small business community, which comprises 200,000 businesses, employing 860,000 people over half the private sector workforce. OVERVIEW Q1. What role, if any, should the tax system play in encouraging entrepreneurship? Q2. What barriers to establishing enterprises exist in the current tax system? The SFA has a vision of Ireland as the most vibrant small business community in the world, supporting entrepreneurship, valuing small business and rewarding risk takers. Currently this vision is aspirational and significant policy reforms will be required to make it a reality. Not enough companies are created in Ireland and not enough of those that are survive and scale. Tax reform is key to unlocking job creation, investment and growth. The SFA has long advocated reform of the Irish tax system to make it more attractive and rewarding to establish and operate a business in Ireland. The tax system, which today has very mixed signals for entrepreneurs, must be brought into line with the stated Government aims to be among the most entrepreneurial nations in the world and acknowledged as a world class environment in which to start and grow a business (Action Plan for Jobs). In this context, this submission outlines the input from the SFA on the issues raised in the Department of Finance s consultation document. It gives feedback and makes proposals under the following headings: Discriminatory treatment of entrepreneurs and the self-employed; Capital Gains Tax; Taxation of work; Business costs; Investment issues; Effectiveness of current schemes. Page 2 of 14

3 USABILITY OF THE TAX SYSTEM Before dealing with each of these areas in detail, one overarching point should be noted: the need to reduce the bureaucratic burden of the tax system for small firms. For those not familiar with business tax compliance obligations, it can be a complex area to navigate. This is coupled with regular tax filing obligations for VAT, PAYE and possibly RCT. Consideration should be given to the introduction of a threshold limit whereby smaller businesses will not have to file tax returns as frequently. This would free up administrative time which could be refocused upon business development. Furthermore, correspondence and forms from the Revenue and other State bodies, whether online or in paper format, should be reviewed to ensure that where standing information about the taxpayer is known to the Revenue or State body it is prepopulated to save the taxpayer time in filling it all in again. Page 3 of 14

4 DISCRIMINATORY TREATMENT OF ENTREPRENEURS AND THE SELF-EMPLOYED Q5. Given the difference in the treatment of the self-assessed and PAYE taxpayers in terms of pay & file, tax credits and allowable expenses, is there scope for greater alignment? An Taoiseach, Enda Kenny, wrote in the foreword to the National Policy Statement on Entrepreneurship 2014 entrepreneurship has never been more important to the country, its people and its future but he has also conceded that the current treatment of entrepreneurs and self-employed people in the tax system is discriminatory. This latter issue must be addressed. It is critical that there is at least equity in treatment between employees and Proprietary Directors/self-employed people in the tax system and that risk takers are afforded an equal level of protection as their employees in the event of business failure or illness, if entrepreneurship in Ireland is to flourish with all of the benefits that would follow. Specifically, the SFA recommends that: The 3% surcharge on USC, which applies only to the self-employed, should be expired (as promised at the end of 2014). This surcharge is out of line with the aim of encouraging entrepreneurship and scaling up of new businesses and sends a confusing message to the self-employed about the Government s support for them. SFA member comment: The inclusion of this surcharge brings the potential marginal rate of personal taxation to 55%. Such a high level of taxation is the product of having undertaken personal financial risk and commitment to developing a successful business. This high marginal rate of taxation does not contrast favourably with other European jurisdictions. SFA member comment: Business owners should actually be on minimum tax rates, as it s a fact that surplus funds are redirected back into growing the business by the entrepreneurs when they have it, so increasing employment. They should be transparently successful, so that others are encouraged to follow. Proprietary Directors should receive the PAYE tax credit where they pay tax on a PAYE basis. The lack of a PAYE tax credit equivalent for self-employed persons or proprietary directors means their effective income tax rates are much higher than PAYE workers at the same level. The SFA advocates prioritising the introduction of the tax credit for proprietary directors, which is estimated to cost 225 million. It would cost an additional 225 million to extend this to the self-employed. Page 4 of 14

5 SFA member comment: It is wrong that a person who quits their PAYE job to start a new business and is lucky enough to earn the same salary in their first year in their new business pays MORE tax than they would as an employee! How can this encourage entrepreneurship? No wonder it s never mentioned in any of the Government literature encouraging start-ups! A voluntary PRSI contribution should be introduced, to allow entrepreneurs and self-employed qualify for social welfare benefits similar to their employees. However, any proposal which provides social welfare benefit for owner-managers cannot be mandatory or viewed as an opportunity to impose additional taxes on small business. SFA member comment: Employers have no safety net my employees have more entitlements than I do. SFA member comment: We should be able to use PRSI contributions like all workers for dental, optical and other expenses...like our staff. Page 5 of 14

6 CAPITAL GAINS TAX Q6. Given the targeted nature of CGT entrepreneur relief under Section 597A of the Taxes Consolidation Act 1997 and the requirement to satisfy EU State aid rules, what changes could be made to the relief in that context to make it more effective in supporting small businesses and entrepreneurs? Q7. What specific aims and rationale would underpin such changes to the relief? Changing the capital gains tax regime is one of the top priorities for SFA members. CGT is a key determinant of investment in the economy, which is a critical driver of growth. - CGT rate Ireland has one of the highest rates of CGT in developed economies at 33% (except for some legacy reliefs relating to property). This puts Ireland at a competitive disadvantage when it comes to attracting and retaining mobile investment. For example, in the UK the rate is either 18% or 28% depending on the size of income and capital gains. The SFA is calling for a reduction in CGT to 20% across the board, to make investing in a business in Ireland more attractive, in particular relative to competitor countries. Most sophisticated entrepreneurs respond to high CGT rates by establishing holding company structures to defer CGT tax events. History has shown that a lower rate substantially boosts the overall tax take, so the Exchequer will also benefit substantially by such a move. SFA member comment: It is hard to ignore the fact that entrepreneurs have choices and the CGT rate is the most important factor in their personal tax planning. Before starting my current company in Dublin I lived in the UK and the US for 13 years. The UK offers an effective 0% CGT rate for entrepreneurs, and even the US currently offers considerably more favourable rates. While I ultimately decided to return to Dublin for personal reasons, I did think long and hard about the tax consequences, and came close to choosing the UK or US as the place to establish our business. - Entrepreneurial Relief The announcement of the CGT Entrepreneurial Relief in Budget 2014 was welcome; however, the SFA remains convinced that the scheme is overly restrictive and will not work in its current format. The fact that the relief is given after the sale of a second successful business means in reality that it will take a decade before the entrepreneur will see any return and, in any event, the likelihood of having two successful startups in a row is questionable. Page 6 of 14

7 The SFA proposes that this relief is amended to mirror the UK scheme, where CGT of 10% is due on the sale or closure of all or part of a business, on the condition that the entrepreneur has held the share for at least a year and is a director, partner or employee in the business. There is a lifetime limit of Stg 10mn of gains so the lifetime tax saving is limited to Stg 1.8mn. It is clear that EU State aid rules do not pose any obstacle to the changes outlined, as the same rules apply to the UK as an EU member state. SFA member comment: A CGT structure similar to the UK which distinguishes entrepreneurial gains from other capital gains makes a lot of sense. Page 7 of 14

8 TAXATION OF WORK We require a tax system that rewards work, but in reality Ireland has one of the highest marginal tax rates in the OECD. In a recent Small Firms Association survey, 41% of small business owner-managers responded that the most important thing the government could change to boost their business would be to reduce taxation on employment. The current level of taxation has resulted in an erosion in domestic spending power, a reduction in the incentive to work and an increase in wage pressures which could potentially destabilise the recovery. The Government has added to overall wage costs in recent years through changes in PRSI, illness benefit, redundancy rebate, health insurance and general taxation (which as mentioned above has an upward effect on wages over the long term). - Marginal tax rate We welcome the acceptance by the Government that the income tax burden is now too high. The SFA has identified a number of policy changes that would help to ease this burden. Conditions around the marginal tax rate are crucial marginal tax rates faced by entrepreneurs have important implications for their decisions to take on staff, grow their firms and invest in physical capital. The SFA calls for the entry point to the marginal tax rate to be increased and for the marginal rate of income tax to be reduced. - PRSI SFA members continue to report examples of the social welfare system working at odds with getting people back to work and increasing their hours of work. It is essential that action is now taken to remove these social welfare traps. For example, an employee on Class A PRSI pays 0% on weekly earnings up to 352. Once they go above that threshold, they have to pay 4% on their entire earnings, including the 352 that was exempt. This means that a person on the minimum wage who works additional hours could end up with reduced net take-home pay. For this reason, the 4% PRSI should only be charged on earnings above the 352 to incentivise employees to work more hours. To encourage job creation, a new proposal would be to reduce or phase in employer s PRSI, so that new businesses pay reduced rates of employer PRSI in their first three years on staff they recruit for example 25% for staff recruited in year 1, 50% for staff recruited in year 2, 75% for staff recruited in year 3 and then the full rate on later recruitment this would incentivise earlier hiring. SFA member comment: There are no incentives for any self-employed person to make an extra job only tax incentives aimed at the companies. I have 20 employees in my UK office at Nottingham. In 2010 a government incentive offered 10,000 per new employee directly to small business owners (up to 5 new employees per year). The employee had to be full time for a minimum of two years and the 10K was paid in arrears. This was no cost to the government, the money was saved on unemployment benefit and the worker paid tax and social insurance, plus the employer paid their portion of the social insurance. Page 8 of 14

9 OTHER TAX HEADS - Corporation tax Q8. Section 486C of the Taxes Consolidation Act 1997 provides relief from corporation tax for certain startup companies. The relief was extended in the Finance Bill 2014 until the end of 2015 in line with the New Guidelines for the Evaluation of Tax Expenditures. The Department would welcome detailed submissions from interested parties in respect of Section 486C. The SFA supports the retention of the first three years corporation tax exemption for tax liabilities under 40,000. Very few start-ups get to avail of the full 40,000 exemption but it s a valuable support, allowing start-ups to retain profits. - VAT In addition to the comments on VAT outlined below under the various existing tax expenditures, the SFA believes that minimum thresholds for VIES and VAT MOSS should be implemented. This would reduce the administrative burden on small companies with little impact on the Revenue figures. SFA member comment: As a VAT-registered business that sells electronic services online to non-vat registered customers within the EU (we sell ebooks among other things), we have had to register for VAT MOSS this year. The total tax take for our trading for Q1 was under 5, Q2 is only slightly higher. It s a lot of work (for us) for very little return (to the Revenue). The scheme is intended to capture VAT from serious online sellers smaller sellers should be exempt. Page 9 of 14

10 INVESTMENT ISSUES - Employee share options One of the changes which could have significant benefits for start-up companies is in relation to taxation of employee share options. The current situation is very inequitable and damages the ability of young start-ups to attract talent. Start-ups cannot pay salaries or offer benefits that compare to large established multinationals, so they must compete to attract talented employees by way of share options with potentially great future value. Employees who join young start-ups on these terms are every bit as much an entrepreneur as the company founders. SFA member comment: In our own company, many of our employees have given up secure employment and taken pay cuts in excess of 50% to join us. However, if our company succeeds they will be subject to ordinary income tax on their gains, whereas the company founders will enjoy CGT rates. This situation is a barrier to attracting talent. The reason this occurs is as follows: new employees cannot simply be granted ordinary shares, because that would trigger an immediate tax event for them, which they have no ability to pay for. Instead, they are granted stock options, which will be subject to income tax rates on exercise. There are some complex schemes (such as flowering shares ) which have been designed to avoid this issue, but they are too complex and expensive for a small company to implement. In short, there is currently no good way to reward early employees for the risks they are taking, and the vital contribution they are making to entrepreneurial activity in the Irish economy. Therefore, a mechanism should be available so that employees of start-up companies can be taxed on share options at CGT rates at the time when the purchased shares are disposed of. - Access to equity investment Ireland has a very short supply of experienced angel investors and venture capital when compared to the UK or the US. The lack of depth and experience in the Irish investor pool puts Irish businesses at a disadvantage, because convincing investors to invest outside of their home market is challenging. This occurs both for reasons of unfamiliarity, legal and currency risk, and due to specific home-market tax advantages such as the UK EIS scheme. Although this is probably the largest issue for Irish start-ups, it is not as easily addressed via a simple tax change. Ultimately the best way to fix this issue is through organic growth in the number of angel investors (who are typically former entrepreneurs who have sold their businesses), however it may be possible to attract some international VCs through targeted tax changes. Page 10 of 14

11 EFFECTIVENESS OF CURRENT SCHEMES Q3. What existing tax measures are effective in supporting small businesses and encouraging entrepreneurs? Q4. What existing tax measures are ineffective in supporting small businesses and encouraging entrepreneurs? How could such measures be improved or should they be abolished? The SFA recognises the contribution of each of the tax measures currently in place to the Irish entrepreneurship ecosystem and supports the retention of all of the schemes listed in the consultation document. While specific amendments are suggested below with a view to maximising the impact of particular schemes, the underlying obstacle to all government supports is low awareness and consequent low uptake. Schemes must be designed with ease of use in mind and more budget and effort is needed to communicate their availability amongst the small business community and amongst potential entrepreneurs. 1. R&D Tax Credit We believe that it is necessary to create a specific, tailored R&D tax credit scheme for small firms to encourage more R&D spend R&D Tax Credit Lite. Such a scheme should reduce the existing complexity by using pro-forma templates for R&D project management, recording of R&D activity and calculations of costs and revenue benefit. Simple on-line calculators should be developed to increase usability for small firms and targeted promotion of the scheme should be rolled out. In many cases, owner-managers who engage in R&D are not qualifying for tax credits, following tax assessments by external Revenue-appointed experts. We need certainty about what will and will not qualify for tax credit purposes, particularly in micro-enterprises, where owner-managers are likely to be engaging in R&D themselves, as this will greatly incentivise such companies who are wary of expenditure on R&D in the absence of the tax credit. 2. Foreign Earnings Deduction (FED) This scheme should be amended as follows to make it workable for small companies: Increase the scope of the scheme by extending the list of applicable countries include UK and other Eurozone countries if possible given EU State aid rules The requirement for 60-days outside the EU should be reduced to 20-days (this is more realistic for a small company); remove minimum number of consecutive days Page 11 of 14

12 Extend support to trade fairs, as it is expensive for small companies to take a stand at large, international fairs. 3. Employment and Investment Incentive Scheme (EIIS) An enhanced EIIS is essential to allow business balance sheets to recover and given the equity piece that banks need to make a positive lending decision. Our specific recommendations are as follows: Change the scheme rules: o o o o o Return to a 5-year investment term so that the businesses have the necessary time to grow sufficiently to be capable of repaying the investors. Remove employment and R&D criteria these complicate the scheme unnecessarily. By definition if the business grows these will occur, but it poses unnecessary risk up front to the investor. Evaluate the cost-benefits of extending the scheme to other specific sectors. Exempt the gain from CGT if it is held for seven years (similar to property reliefs already in place). Examine UK and international models with a view to implementing Government risk-sharing models with private investors in similar schemes. This would be important to attract nontraditional BES/EIIS type investors, and specifically other small business owners who might be interested in investing in other businesses. Return to BES as the scheme name, as this is more recognisable. Enhance publicity around the availability of the scheme. The only media reporting about the scheme tends to be with a negative tilt from the perspective of the tax write-offs, as opposed to recognising the importance of facilitating equity investment in what is viewed as relatively high risk domestic small businesses. In particular, promote the family and friends and private placement options, as well as funds option, and make it easy for companies to use the scheme without having to pay for expensive professional advice. 4. VAT thresholds for cash basis and registration extended An extension of the turnover threshold for cash basis to 2.5 million would greatly assist small businesses in managing their cashflow, particularly given the ongoing difficulties in accessing overdrafts from banks to cover the VAT payment whilst they are waiting for payment by their own customers (which can include government bodies such as local authorities, HSE, etc.) Page 12 of 14

13 5. 9% rate of VAT for tourism related goods and services The special 9% VAT rate for the hospitality and related sectors has been a resounding success. We believe that it should be retained and that there should be no increases in other VAT rates or excise duties. Page 13 of 14

14 CONCLUSION Entrepreneurs and the small business sector, given the right economic conditions, will generate the growth needed to create jobs, overcome our debt burden and deliver the prosperity and quality of life that this country can legitimately aspire to. Small business can lead the way in helping Ireland to continue to recover faster and stronger than others but in order to do this, the tax environment must cease to disincentivise entrepreneurship in the ways outlined in this submission. If Ireland is to improve on its 19 th place ranking in the Global Entrepreneurship Development Index (GEDI), a plan must be set in place for the transition to an ecosystem that supports entrepreneurship, values small businesses and rewards risk takers. SFA member comment: Why would you venture into a start-up, when you pay more taxes, give a third of the sale price achieved on selling, work longer hours and have to put everything on the line to raise capital in the first place? For further information, please contact Patricia Callan, SFA Director, on tel: or patricia.callan@sfa.ie Page 14 of 14

PRE-BUDGET 2016 SUBMISSION

SMALL FIRMS ASSOCIATION SMALL FIRMS ASSOCIATION PRE-BUDGET 2016 SUBMISSION Presented to: MINISTER FOR FINANCE, Michael Noonan, T.D. MINISTER FOR PUBLIC EXPENDITURE AND REFORM, Brendan Howlin, T.D. MINISTER