Project roadmap and public consultation on a territorial system of double taxation relief

Ireland’s “worldwide” method of double tax relief

Currently, Ireland applies a “worldwide” method of double tax relief. This means that Irish-resident companies are subject to tax on their worldwide income, and foreign tax paid on foreign income will typically qualify for a credit against Irish tax payable on that income (to the extent of the Irish tax that would otherwise be payable thereon). 

The primary difficulty with this approach is that its practical application is often complex. The provisions that provide for the calculation of foreign tax credits (the tax credit rules, which are contained in Schedule 24 to the Taxes Consolidation Act, 1997) are a product of many years of evolution – both in response to changes in Irish tax policy as well as to accommodate principles established in European case law. Applying the tax credit rules often involves performing a complex set of calculations, which only creates uncertainty and places a compliance burden both on taxpayers and Revenue.

Aside from complexity, other practical difficulties may arise. Companies that are resident in Ireland and that have foreign branch profits often face situations in which there are significant differences in the timing of taxable income between their head offices and their branches. This occurs because, for example, some countries have different rules for the timing of tax deductions for insurance reserves and expenses. The result is further tax uncertainty and complications.

The solution: a territorial system of double taxation relief

In a territorial regime, double tax relief is delivered by exempting the income concerned (i.e. foreign dividends, gains on disposals of shares in foreign companies or branch profits) from taxation in the state of residence. The benefits of such a system are not difficult to identify – instead of performing complex calculations of tax credits, it is much simpler to exempt the relevant income. There is generally no loss to the public purse and, in most instances, the effect of the operation of foreign tax credits is that the relevant income is not taxable in Ireland anyway.

Ireland’s competitiveness

The complexity of Ireland’s worldwide system of double taxation relief stands in stark contrast to the relative simplicity of a territorial system, which is a typical feature of the tax codes of most other OECD and EU countries. In this context, the relative complexity of Ireland’s approach to relieving double taxation is a distinct competitive disadvantage in attracting investment into Ireland.

The introduction of Pillar Two in Ireland

In addition to the substantial reform of Ireland’s corporation tax regime over the past decade, legislation to give effect to Pillar Two will be introduced in this year’s Finance Bill to take effect from next year. It is therefore of utmost importance, in order to reduce the complexity of its corporation tax regime, that Ireland ensures that its regime is consistent with international norms and best practice. Notably, under Pillar Two, foreign dividends are typically exempt for the recipient and foreign branch profits are exempt in the hands of the head office (being subject to tax at the local branch level). Consequently, the adoption of a participation exemption for dividends and an exemption in respect of foreign branch profits will be congruent with Pillar Two.

The current public consultation

The current public consultation follows a previous public consultation on the issue launched in December 2021, as well as a commitment made by the Minister for Finance in Budget 2023 that detailed work would be undertaken throughout 2023 on the examination of options relating to the introduction of a territorial regime of double tax relief. 

Unlike the previous public consultation (which was essentially a broad scoping exercise), the current public consultation:

• provides a clear stakeholder consultation plan for the period from now until the introduction of Finance Bill 2024; 
• seeks specific and detailed input on the policy considerations that would be involved in the design and introduction of a participation exemption for dividends to the Irish tax system (Part I of the consultation questions); and
• includes additional consultation questions in respect of potential options for the introduction of a branch exemption to inform further consideration in this regard (Part II of the consultation questions).

Dividend participation exemption

Part I of the consultation questions seeks input on the structural considerations involved in the introduction of a dividend participation exemption, as well as the consequential impacts thereof. Input is also sought on the anti-avoidance issues involved.

The introduction of a dividend participation exemption will be a significant addition to the Irish tax system. Its compatibility with, and/or the continued rationale for, other rules will need to be given detailed consideration. It is therefore no surprise that these questions are specific and cover a comprehensive list of issues. Moreover, the detailed nature of the questions (and their scope) would indicate that the Department of Finance has already given extensive thought to the introduction of a dividend participation exemption.

Some of the key issues, both of a policy and a technical nature, on which input is sought include the following:

• Whether or not the participation exemption should be full or partial. It is noted that while certain jurisdictions provide for a full (i.e. 100%) exemption, others adopt a partial exemption approach (where, for example, only 95% of the dividend is exempt);
• Whether the exemption should be optional, i.e. whether a taxpayer should be entitled to elect to opt out of exemption treatment, with the result that the taxpayer will be taxed in Ireland on the dividend, with credits for foreign taxes being provided (as is the case currently);
• Eligible jurisdictions: whether the exemption should be available in respect of dividends irrespective of the country of source thereof, or whether it would only be available in respect of dividends from specified jurisdictions (such as jurisdictions with which Ireland has a double taxation agreement);
• Length and nature of participation: whether, in order to qualify for exemption, there should be a minimum period of ownership of the relevant shares and/or a minimum shareholding;
• Transitional provisions: whether, depending on the design and timing of implementation of the regime, there should be any transitional measures;
• Interactions with other rules, including rules that deal with: 
  • anti-hybrid arrangements;
  • transfer pricing;
  • interest limitation; and
  • franked investment income.

Foreign branch exemption

Part II of the consultation questions seeks input on the introduction of a foreign branch exemption. These questions are not as comprehensive as the questions relating to the dividend participation exemption. However, the consultation document states that responses to these questions will inform further consideration on potential options, which would indicate that the Department intends to conduct a comprehensive review of all of the relevant issues in due course. Notably, Part II of the consultation questions requests advisors and industry representatives to refer to any sectoral and group structure-specific considerations, which will be of particular interest to the insurance industry (where the use of branches is particularly prevalent).

It is somewhat disappointing that the consultation document does not expressly make a commitment to the introduction of a foreign branch exemption (and instead has committed to “further investigation” in relation thereto). However, the statement in the consultation document that such an exemption “does merit further consideration” is welcomed. It is reasonable to accept that a foreign branch exemption would not be as “clear-cut” as a dividend participation exemption and that the introduction of such an exemption would involve additional investigation. 

We are here to help you

The transition from a worldwide to a territorial system of double taxation relief will be a significant structural change to Ireland’s corporation tax system, and will affect all businesses with foreign dividends or that have foreign branches, across all industries. It is therefore important that you are afforded the opportunity to provide input to the development process to ensure that the new legislative provisions, when introduced, will operate as intended.