Finance (No.2) Bill 2023 & the funds industry

The Finance Bill proposed a new provision which could result in the application of withholding tax to certain outbound payments made by Irish tax resident entities. This legislation operates by disapplying existing domestic withholding tax exemptions to certain payments made to non-resident entities, so is potentially relevant to any Irish entity which has been relying on domestic withholding tax exemptions to date in respect of such payments (including the Quoted Eurobond exemption in respect of interest).

That said, it will not apply to the long-standing withholding tax exemption which applies to distributions and redemption payments made by regulated funds to non-resident investors, which remains in place.

The legislation applies to payments of interest, dividends and royalties made by Irish tax resident companies, all of which are in principle subject to withholding tax but may qualify for a range of domestic exemptions where conditions are satisfied.

To be in scope of this legislation, which effectively switches off exemptions which would otherwise apply, the payment made by the Irish company must be made to an “associated entity” that is resident in a “specified territory”. Both of these concepts are therefore important in assessing whether an arrangement falls within scope of the rules.

• Specified territory – a specified territory is defined as (i) a territory that is on Annex I of the EU list of non-cooperative jurisdictions or (ii) a zero-tax / no-tax territory. A specified territory cannot be another EU/EEA country, so these new provisions will not apply to any payments made to any recipient in an EU country. The legislation cross-references the version of Annex I of the EU list of non-cooperative jurisdictions that was published on 21 February 2023. This list includes:
  
  American Samoa, Anguilla, Bahamas, British Virgin Islands, Costa Rica, Fiji, Guam, Marshall Islands, Palau, Panama, Russia, Samoa, Trinidad and Tobago, Turks and Caicos Islands, US Virgin Islands and Vanuatu.
  
  However, Annex I of the EU list was updated on 17 October 2023. In this revision, Antigua and Barbuda, Belize and Seychelles were added to the list, while the British Virgin Islands, Costa Rica and the Marshall Islands were removed. It is currently unclear if the legislation will be amended to reflect the October 2023 version of the EU list.
  
  
• Associated entity – two entities are considered associated for the purposes of the rules if there is more than a 50% relationship in terms of share capital / ownership interests. or in the case of an entity which does not have share capital, voting power or entitlement to profits.
  
  Two entities will also be associated in cases where one entity has “definite influence” in the management of the other entity, or where the two entities are both associated entities of another entity. The concept of “definite influence” is new and is different to the existing “significant influence” concept which can have different meanings in the context of specific rules that are applicable to many alternative fund structures.
  
  Broadly speaking, a company will be considered as having definite influence in the management of another entity where it has the ability to participate, via the board of directors or equivalent governing body of the entity, in its financial and operating decisions.
  
  As a relationship of more than 50% is required, this could result in investments in joint ventures falling outside the scope of these new measures. Transactions with unrelated third parties should not be affected by the provisions. 

As noted above, the rules operate by disapplying existing domestic exemptions however there are some nuances depending on the type of payment in scope:

Interest

Irish tax resident companies are generally required to deduct withholding tax on payments of yearly interest. However, a range of exemptions from interest withholding tax can apply, including interest paid in the course of a trade or business carried on in Ireland to a company which is tax resident in an EU member state (other than Ireland) or a country with which Ireland has a double tax treaty provided that that relevant territory imposes a tax that generally applies to interest receivable in that territory by companies from sources outside the territory, and interest payments made in respect of listed debt (the Quoted Eurobond exemption) or wholesale debt instruments where the relevant conditions are satisfied.

Where a company makes a tax-deductible interest payment to an associated entity that is tax resident in a specified territory (or a permanent establishment of an associated entity which is situated in a specified territory), the legislation will disapply the application of the existing Irish domestic interest withholding tax exemptions.

The legislation will also bring ‘short’ interest payments – interest payments on loans with a term of less than 12 months – made to an entity in a specified territory within the scope of Irish withholding tax. Each of the exclusions outlined above for royalties should equally apply for interest payments.

Notwithstanding the above, there is an exclusion from the legislation which will result in an interest payment continuing to qualify for exemption (assuming the relevant conditions are satisfied) where:

1. the recipient makes an onward payment of a corresponding amount (the meaning of which is undefined) to another entity within 12 months;
2. the corresponding amount would have been an excluded payment if it had been made directly to that entity (e.g., the payment would have been subject to tax); and
3. the payments were made for bona fide commercial purposes.

Distributions / dividends

Where a company makes a distribution to an associated entity that is tax resident in a specified territory (or a permanent establishment of an associated entity which is situated in a specified territory), existing domestic reliefs from Irish dividend withholding tax will be disapplied. However, the new withholding tax provisions will not apply where the distribution is being made out of income, profits or gains that have been subject to (i) Irish domestic tax, (ii) foreign tax at a nominal rate greater than 0%, or (iii) a CFC charge or a top-up tax under Pillar Two. In addition, the provisions should not apply to distributions made out of foreign branch profits that are subject to foreign taxation.

Similar to the comments made above in respect of interest payments, a distribution should also be excluded from the scope of the new withholding tax provisions where it is reasonable to consider that, at the level of a direct or indirect recipient, the distribution is within the charge to a Pillar Two top-up tax, a CFC charge, a foreign tax at a rate greater than 0% or a domestic tax other than the new withholding tax.

The range of exclusions included in the legislation for distributions should therefore allow a company to effectively look up and down its ownership chain when considering whether the profits being distributed have been subject to tax within the group’s corporate structure, and whether the distribution should therefore fall outside the scope of the new withholding tax requirements. 

The measures will apply to will apply to in-scope payments made on or after 1 April 2024. However, there is a deferral of this date for existing structures, as the application date is 1 January 2025 in respect of any arrangements in place on or before 19 October 2023.

From a practical perspective, the following questions should be considered in the context of existing structures (particularly complex / alternative structures):

• Is there any existing reliance by an Irish tax resident company on a domestic withholding tax exemption?
• If yes, is the recipient of the payment non-EU and located in either an EU non-cooperative jurisdiction or zero / low tax jurisdiction (including the Cayman Islands)?
• If yes, is the recipient of the payment associated with the Irish paying company.

The Finance Bill included legislation to implement the 15% minimum tax rate under the OECD’s Pillar Two agreement and as adopted in EU’s Minimum Tax Directive. The 15% minimum tax rate is also known as the Global Anti-Base Erosion (or GloBE) rules. Spanning over 120 pages of legislation, the introduction of these rules into Irish law will mark a paradigm shift for in-scope businesses. It will also represent a significant challenge as affected businesses seek to grapple with these new rules, which sit in tandem with Ireland’s existing (and increasingly complex) corporation tax system.

It should be noted at the outset that the GloBE rules will not affect the majority of Irish entities –  generally only members of multinational groups with annual turnover exceeding €750 million in two of the last four years should fall in scope

 However, Ireland’s implementation of the rules has been extended to also apply to wholly domestic large-scale groups (subject to certain deferral rules), but again such groups with less than €750m consolidated turnover should fall outside the scope of the rules.

To be a member of such a group, the entity must be consolidated on a line-by-line basis into the group’s financial results; however, certain joint ventures which are majority owned but not consolidated into an in-scope group are also caught (see further detail below).

The Pillar Two GloBE rules are designed to implement a global minimum effective tax rate (ETR) of 15% on a jurisdictional basis. This means that the financial information of each of the group members in any given jurisdiction must be aggregated, adjusted as required under the rules, and an ETR calculated for that jurisdiction. If this jurisdictional ETR is less than 15%, then top-up tax is payable to bring the ETR up to 15%.

Various mechanisms exist under Ireland’s implementation of the rules to collect top-up tax that arises in respect of a group’s Irish or foreign operations. For Irish operations that have an effective rate of tax of less than 15%, Ireland has elected to adopt a Qualified Domestic Top-Up Tax (‘QDTT’), preserving Ireland’s primary taxing rights over these profits and ensuring that any incremental top-up tax payable with respect to Irish operations should be payable in Ireland.

To calculate the amount of top-up tax payable under the Irish QDTT, financial accounting data must be taken from one of two sources – the data used to prepare the overall multinational group’s consolidated financial statements or the data used to prepare Irish statutory financial statements (provided certain conditions are met).

Unfortunately, there is no choice for Irish businesses as to which data source they would prefer to use; if the conditions are met to use Irish financial statements, these must be used. Otherwise, the data used to prepare the group’s consolidated financial accounts is used, even if that financial data is under a different accounting standard to that used to calculate the Irish corporation tax liability of the group’s Irish companies.

Ireland’s implementation of the rules also includes mechanisms that would require Irish companies to pay top-up tax in Ireland with respect to foreign group members where the ETR for a particular jurisdiction is less than 15%. The Income Inclusion Rule (‘IIR’) could apply if an Irish entity is the direct or indirect parent of such foreign group members where that tax is not otherwise collected under that particular jurisdiction’s QDTT regime. 

The Under-Taxed Profits Rule (‘UTPR’) could also apply if any top-up tax remains payable after the application of the QDTT and IIR rules, meaning the Irish entities could be subject to additional tax in Ireland on behalf of any other low-taxed foreign entity within the same multinational group, be that a subsidiary, parent or sister company.

In line with the EU Minimum Taxation Directive, Ireland will commence collection under the QDTT and IIR mechanisms for accounting periods commencing from 31 December 2023. However, the UTPR will not apply until one year later, for accounting periods commencing on or after 31 December 2024 (subject to certain limited exceptions where it can apply at the same time as the IIR). 

Exclusion from scope of rules

A key consideration for funds and fund structures is whether they fall within scope of the rules in the first instance. In this regard, there are a number of categories of entities which are specifically excluded from the rules, such as:

1. Any investment fund which is an ultimate parent entity (i.e. broadly speaking, which is not consolidated into any other entity, irrespective of whether consolidated financial statements are required to be prepared); or
2. Any entity which is at least 95% owned by an entity referred to at (i) above, that operates exclusively (or almost exclusively) to hold assets or invest funds for the benefit of the entity referred to at (i) or exclusively carries out activities ancillary to those performed by it; or
   
3. Any entity which is at least 85% owned by an entity referred to at (i) above provided that substantially all of its income is derived from dividends or gains that are excluded from the calculation of income for the purposes of the rules.

An investment fund for the purposes of the above is an entity which:

• is designed to pool financial or non-financial assets from a number of investors, some of which are not connected;
• invests in accordance with a defined investment policy;
• allows investors to reduce transaction, research and analytical costs or to spread risk collectively;
• has as its main purpose the generation of investment income or gains, or protection against a particular or general event or outcome;
• its investors have a right to return from the assets of the fund or income earned on those assets, based on the contribution they made;
• is, or its management is, subject to the regulatory regime, including appropriate anti-money laundering and investor protection regulation for investment funds in the jurisdiction in which it is established or managed; and
• is managed by investment fund management professionals on behalf of the investors.

In light of the above, in practice it is expected that many investment funds and entities within investment fund complexes should fall outside the scope of the rules. That said, it is not clear that all collective investment vehicles will automatically satisfy the above conditions (it is hoped that the Irish Revenue Commissioners will release guidance on the conditions to assist with determination in this regard). Furthermore, there are some circumstances where a fund could require consolidation such that it will not automatically fall outside the scope of the rules. On a separate note, there is no exclusion applicable to investment management entities, which need to be assessed based on the relevant facts and circumstances.

Joint venture arrangements

There are specific provisions in the rules in relation to “joint venture” entities which are defined as any entity in respect of which at least 50% is held directly / indirectly by a parent entity where its results are reported under the equity method in the consolidated financial statements.

Whilst the entities described at (i) – (iii) above are excluded from this definition, it is worth noting that any vehicle within a fund complex which does not fall within (i) – (iii) and which is considered a joint venture entity could be within scope of the rules.

In assessing whether the €750m threshold is met, there is a requirement to include turnover from entities which are otherwise excluded from the rules.

As a result, the joint venture rules could result in a non-consolidated 50%+ entity in a fund complex coming within the scope of the rules, unless it is considered exempt (e.g. further to (i) – (iii) above), once the turnover of the broader fund complex is taken into account. This could be the case even where such an entity does not itself exceed the €750m threshold.  

Although there is a broad exemption from the scope of the rules which can apply to both fund and below the fund vehicles, it should not automatically be assumed that fund complexes are fully outside the scope of the rules. In this context, the following considerations are important:

• Is the fund vehicle itself consolidated into another entity or would it require consolidation should any investor(s) prepare consolidated financial statements?
• Do below the fund vehicles meet the relevant criteria in every case, particularly where the consolidated turnover of the fund structure exceeds €750m?
• Are there non-consolidated entities in the structure which are 50%+ held, particularly where the consolidated turnover of the fund structure exceeds €750m?

If the answer to any of the above is yes, it is important to consider the extent to which the rules might apply in more detail in the context of the fund structure (in addition to considering application in respect of any management entities).

There were no fund or asset management specific legislative changes proposed by the Finance Bill, despite a number of areas where legislative change would ensure a more effective operation of certain rules e.g. extending the dividend withholding tax exemption currently applicable to other categories of Irish regulated funds to Investment Limited Partnerships.

Whilst the absence of such changes is somewhat disappointing, it is worth noting that the requirement for specific legislative changes was signalled by many different parties in response to the recent Department of Finance public consultation on the funds sector. As the responses to this consultation are still being considered by the Department of Finance, we expect it will be next year before any such changes are made.