International and Irish Tax Update - March 2016
The pace of change in international tax is dramatic. Each month brings new initiatives and developments at both national and supra-national levels. In this update, we focus on recent changes which are relevant to our clients.
The OECD Base Erosion and Profit Shifting ("BEPS") reports were finalised in October and endorsed by the G20 in November 2015. The implementation phase has now begun and we are seeing this across a range of areas. If BEPS is ultimately about aligning tax with substantive economic activity, Ireland's attractiveness as a well-developed fully functioning economy seems destined to increase. We are not yet close to a conclusion on BEPS; however we are, in the words of one commentator, at the "end of the beginning".
The OECD's Common Reporting Standard ("CRS") and Country by Country Reporting ("CbCR") initiatives have arisen out of the overall BEPS project. Implementing rules for both CRS and CbCR came into effect in Ireland at the start of 2016. Clients should assess whether they have the systems and processes in place to deal with these new reporting regimes.
The EU's Anti Tax Avoidance Package was published in January 2016 and is described briefly. EU VAT rules continue to evolve. The recent decision of the European Court of Justice in the X NV case is significant for investment funds and managers in Europe. Although the case will be welcomed by investors using Irish regulated funds for property investment, it should be considered as to how it may affect non-regulated fund and special purpose vehicle ("SPV") structures.
Tax litigation is increasingly common. The recent high profile EU State Aid cases are merely one aspect of this, and tax authorities are increasingly seeking to challenge historic tax planning. We highlight some of our recent experiences in this area and outline how Maples and Calder's approach can benefit clients.
EU Anti Tax Avoidance Package
The European Commission's release of an Anti Tax Avoidance Package on 28 January 2016 has attracted significant comment. The proposals could be viewed as an attempt to ensure that EU Member States implement the OECD BEPS final reports (5 October 2015) in a co-ordinated manner. The form of the proposals is likely to change as they are reviewed by the European Parliament and the European Council, and would generally require unanimous consent from all EU Member States. Hence, while we will highlight some of the elements of the package over this and future updates, it is too soon to recommend any definitive action.
The proposed Anti Tax Avoidance Directive will, if implemented in its current form, result in legally binding measures including interest limitation rules, provisions on exit taxes and a general anti avoidance rule. The interest limitation rules would restrict interest deductibility, in some circumstances, where the interest accrued exceeds a yearly maximum of 30% of EBITDA (or, if higher, €1m per year). Any excess interest above the maximum may be deductible in future years. This interest limitation rule does not capture financial undertakings, such as investment funds, although they may be subject to review at a later time. In our view, many of these proposals are novel and will require consideration as they evolve.
OECD Common Reporting Standard Implementation - Implications for Irish Investment Funds and SPVs
On 18 December 2015, the Regulations implementing CRS in Ireland were approved by the Irish Parliament. The CRS automatic exchange of information regime has, to a large extent, been inspired by the US FATCA Model 1 IGA mechanics and it should be possible for relevant Financial Institutions (as defined in the legislation) to capitalise on the on-boarding and accounts classification processes that were put in place for FATCA.
The detail relating to CRS is contained in the OECD Standard for Automatic Exchange of Financial Account Information in Tax Matters (the "OECD Standard"). CRS became effective from 1 January 2016 for early adopters (including Ireland) and the regime obliges Financial Institutions to collect certain information in relation to investors ("Account Holders") and report that information to the Irish Revenue Commissioners. This information will then be passed to the tax authorities of the participating jurisdiction where the investor is resident. Unlike FATCA, there are no withholding requirements under CRS.
CRS applies to Financial Institutions. The definition of Financial Institution is similar to the definition under FATCA. It includes depositary and custodial institutions as well as investment entities. Irish regulated investment funds and companies qualifying under section 110 of the Taxes Consolidation Act 1997 ("Section 110 Companies") would typically constitute Financial Institutions as investment entities and will, therefore, need to comply with the CRS diligence and reporting requirements. There are very limited exemptions available for investment entities and none are likely to apply to a widely held or regulated entity.
The next steps for Irish investment and financial entities are to confirm the entity's classification for CRS purposes in order to determine whether CRS applies.
If the entity is a Financial Institution for CRS purposes, they should put in place due diligence procedures to gather the relevant information. For regulated Irish investment funds, the Irish funds industry representative body has published self-certification forms which can be tailored for a client's application form. Self-certifications must be collected and validated as regards new investors at the time of opening of the account or within 90 days of the opening of the account, at the latest.
For Section 110 Companies, an assessment should be made based on the structure and circumstances in each case as to what information must be collected and reported.
The fund or SPV should also confirm whether its current FATCA due diligence and reporting servicer will also be able to take on any CRS due diligence and reporting requirements of the Financial Institution. Servicing and administration agreements may need to be updated to allow for the performance of CRS services.
VAT and Investment Funds – Significant New Case
The European Court of Justice ("ECJ") case of Staatssecretaris van Financiën v Fiscale Eenheid X NV cs [C-595/13] (the "X NV Case") is significant for investment managers and funds across Europe. We highlight the key points with respect to real estate investment funds and non-regulated SPVs.
The X NV Case involved Dutch property companies which had raised capital from a number of investors in order to acquire and manage real estate. The profit was to be returned to the investors in the form of a dividend. The companies received certain services which were described as management and administrative in nature and included property management. The questions before the ECJ were:
(a) whether these property companies were special investment funds; and
(b) if they were special investment funds, whether the service of actual management of real estate including letting and maintaining the properties were exempt from VAT.
Special Investment Funds
The court identified the key characteristics of a special investment fund, including raising capital from investors, making investments and being subject to specific state supervision. The requirement for specific state supervision is novel. It appears to be satisfied if the entity is subject to licensing and oversight rules, including authorisation by public authorities and control, with the aim of protecting investors. Some Member States have extended the VAT exemption for investment funds to entities which are not subject to the same level of state supervision as regulated investment funds or pension funds. This may now need to be considered in light of the X NV Case.
Property Investment Funds
For property investment funds, the most important element of the decision is the conclusion that the investment in real estate is not a barrier to an entity being a special investment fund. The VAT Directive refers generally to ‘special investment funds’, without mentioning any specific form of investment or making a distinction on the basis of the assets in which the funds are invested. There is thus nothing to indicate that the exemption applies only to investment in securities. This decision will be welcomed by the many investors and managers involved in Irish property funds which are typically formed as Central Bank of Ireland regulated Irish investment companies, regulated unit trusts or Irish Collective Asset-management Vehicles ("ICAVs"). Under Irish law, such entities are entitled to certain VAT exemptions for management and administration services provided to the fund. This remains the case and is unaffected by the decision.
The court drew a distinction between what might be termed "high-level" management tasks, such as selection of property, and raising capital and "operational management", namely letting, management and maintenance of properties. The management exemption must be limited to transactions which are essential to the business of special investment funds. The selection and disposal of the assets under management, but also administration and accounting tasks are covered by the concept of ‘management’ of a special investment fund for these purposes. Mere material or technical supplies, such as the making available of a system of information technology, are not covered.
The court took the view that the actual management of properties is not specific to the management of a special investment fund. It is inherent in any type of investment. Accordingly, the standard rules apply to determine whether VAT applies. This finding may lead some managers of property funds to reconsider whether they need to separately charge for services which are associated with the different elements of the service they provide.
This finding is consistent with the approach taken by many Irish property funds, where a distinction is drawn between an asset management fee (which is subject to VAT) and an investment manager fee (which is VAT exempt).
Irish Loan Sales – Capital Gains Tax
Section 980 of the Irish Taxes Consolidation Act 1997 will be familiar to all those involved in Irish real estate transactions. In broad terms, it provides that a vendor must produce a tax clearance certificate prior to the sale of Irish real estate or securities relating to Irish real estate. If the clearance certificate is not produced, the purchaser is obliged to deduct 15% from the gross consideration and pay it to the Irish Revenue Commissioners to discharge any capital gains tax liability of the vendor.
Section 980 applies to direct interests in land and to shares and securities (such as debt securities) which derive their value from Irish land. In an Irish context, significant commercial activity occurs through the trading of debt securities (through loan sales) and disposals of units in collective investment undertakings. The application of section 980 to such transactions has been the source of some confusion. The Irish Revenue Commissioners have sought to confirm their view of the law in a note issued in October 2015.
Helpfully, they confirm that there is no requirement for a section 980 clearance certificate where the disposal is not a chargeable gain, such as a disposal by an investment undertaking or charity. This will simplify transactions for Irish regulated funds, who are engaged in large scale property transactions. In our view, the provisions should also generally operate to exempt investors in Irish regulated funds where they dispose of units in the funds.
In relation to sales of loans secured on Irish real estate the position is more complex. Loan sales by financial institutions in circumstances where any profit on the sale would be treated as a trading receipt of its trade are not within the scope of section 980. This is in line with the historic treatment of large scale loan sales. However, in all other circumstances, Revenue's view appears to be that loans which are secured on Irish land are interests in land for the purposes of section 980 and securities for the purposes of that section. It follows, therefore, that the provisions of section 980 will have application.
It is arguable that Revenue's confirmation has led to greater uncertainty in relation to loan sales. The concept of a financial institution is not defined in the context of the note. It is arguable that investment companies (such as companies qualifying under section 110 of the Irish Taxes Consolidation Act 1997) are financial institutions, however this is not clear. The Revenue's position is also contrary to many case specific confirmations which Revenue has produced in recent years. We recommend that those involved in loan sales or other dealings in Irish loans should consider and take advice in respect of the application of the revised guidance to their particular structures and transactions.
Country by Country Reporting - Irish Adoption
CbCR is the latest in a series of international information exchange provisions to which multinational groups must adhere. CbCR is relevant to multinational corporate groups which have a group turnover of over €750m. Ireland's status as an early adopter of the CbCR regime is significant. In the absence of another group entity undertaking the reporting, any Irish group entity will be obliged to complete a modified report in respect of 2016. Groups with an Irish presence will need to prepare to implement the rules in 2016 and generate reports in 2017. There are penalties of up to €19,045, with additional daily penalties of over €2,000 for failures to comply. Maples and Calder has liaised with the Irish authorities in respect of CbCR through its participation in industry groups and is very familiar with the practical aspects of implementation.
Navigating the Legislation
The Irish CbCR legislation, which came into effect at the start of 2016, is heavily reliant on the OECD Model Legislation published on 5 October 2015 (the "OECD Model"). During 2016, Irish entities and groups with an Irish presence will need to:
(c) define the multinational group (the "MNE Group") to which CbCR obligations will relate;
(d) establish the reporting entity within the group; and
(e) comply with a series of notification requirements and prepare for delivery of relevant reports.
Defining the Group
The OECD Model, and the Irish legislation, defines an MNE Group as a collection of connected enterprises which is required to prepare a consolidated financial statement under applicable accounting standards or would be so required if equity interests in any of the enterprises were traded on a public securities exchange. This is a test of consolidation under accounting standards. In many cases it will be clear whether an MNE Group exists, such as in the case of wholly owned subsidiaries. In other circumstances, such as entities classified as investment entities under International Accounting Standards, the question of consolidation will require greater scrutiny.
CbCR only applies to MNE Groups, but a single company can comprise an MNE Group if it has a taxable presence in more than one country.
If total consolidated group revenues do not exceed €750m, there are no reporting requirements. The threshold is measured in the year prior to the year to which the report relates. If an MNE Group did not exceed the threshold in 2015, it would have to prepare a report for 2016. However, it would have to review its group revenues again in 2016 to determine whether it must prepare a report in 2017.
The reporting entity is required to file the CbCR in its jurisdiction of tax residence. The reporting entity can be the ultimate parent entity of the group, a surrogate parent entity, or, in certain circumstances, a member of the group who will be obliged to report.
The surrogate parent entity is an alternative reporting entity. It can only be appointed where the ultimate parent entity is not required to file a CbCR, or if there are inadequate information exchange provisions with Ireland. The surrogate must be in a suitable alternative jurisdiction.
In the absence of another reporting entity, the Irish resident member of the group must provide the Revenue Commissioners with a modified version of the Country by Country ("CbC") report (an "equivalent country-by-country report"). The Irish entity need only provide information which is within its custody or possession, or which it can obtain or acquire. Where there is more than one Irish entity, a single member of the group may be nominated to provide the information to the Revenue Commissioners.
This aspect of the legislation requires close review. It may not be clear who the group reporting entity will be in 2016. Some jurisdictions, such as the US, may not adopt CbCR until 2017. Where the US parent is not required to report, the reporting obligation in respect of 2016 can pass to a subsidiary group member in another jurisdiction. Some jurisdictions are deferring the commencement of CbCR to allow the US to adopt the rules. Others have stated that they will require local subsidiaries to deliver reports in respect of 2016.
Irish Legislation – Reporting Obligations
If an Irish resident entity is a reporting entity, the Revenue Commissioners must be notified of the status of the entity by 31 December 2016. The first CbC report must be filed by end of 31 December 2017 (i.e. 12 months after the end of the period to which the report relates). If the Irish entity is not the reporting entity, the Irish entity must notify the Revenue Commissioners of the identity and jurisdiction of the reporting entity by 31 December 2016. Again, this illustrates how, on a group-wide basis, the decision as to reporting status is required in 2016.
Delivery of Reports
The reports will contain a wide array of information with respect to each jurisdiction in which the group operates and includes figures on revenue, profits and losses, tax paid and number of employees. The competent authorities shall exchange the information in the CbC report. If an Irish reporting entity delivers a report to the Revenue Commissioners, they shall share that report with each jurisdiction within which members of the MNE Group are resident or taxable based on a permanent establishment.
The OECD Model states that the CbC reports should be used by tax authorities to identify high level transfer pricing risks and other BEPS related risks. It specifically states that countries cannot rely on the CbC reports alone in order to make a transfer pricing adjustment.
Other OECD Proposals
CbCR was just one element of a three-tiered approach to transfer pricing which the OECD recommended in its 2015 Final Report on Transfer Pricing Documentation and Country-by-Country Reporting. The other two recommendations related to the preparation of so-called 'master files' and 'local files'. There has been no indication that Ireland will amend its existing transfer pricing legislation to incorporate the master file and local file requirements. Both the Netherlands and Spain included the master and local file requirements in their implementing CbCR legislation.
Tax Litigation – the Maples Perspective
Recent high profile audits and investigations into the financial affairs of individuals and corporates in Ireland are a reminder of the importance of taking appropriate advice in the litigation and settlement of tax disputes.
In many instances, on notification of a tax audit query or investigation, the first point of contact for a client is their historic tax advisor, due to their familiarity with the client and structures. However, taxpayers increasingly retain separate advice from an independent advisor as part of their engagement with the tax authorities. This allows a client to receive an impartial assessment of the original advice, and also to monitor and manage the engagement with the tax authorities more appropriately. The independent advisor will review the case history and will manage the case going forward in the way that is most expedient.
In a recent case, Maples and Calder was instructed by a large group of individuals who had been in dispute with Revenue for over ten years. Historically, the individuals were represented by another adviser who had been involved in the original arrangements. We engaged in an extensive review of the case history, advising the clients on the merits of the case in an independent manner and ultimately negotiated an acceptable settlement with Revenue within six months. Our expertise as lawyers with both litigation and tax knowledge and our management of the matter with Revenue was crucial in obtaining this outcome.
For many clients, the prospect of engaging additional advisors may seem burdensome. However, the additional advice is beneficial. It provides an independent assessment of the matter, allows for case management separate to the original advice and gives the client a full picture as to all of the legal approaches available to them to resolve the matter.