Chartered Accountants Ireland, under the auspices of the CCAB-I, responded to the public consultations on the EII, SURE, KEEP and CGT Entrepreneur relief last month; many of which have been consulted upon several times in the past few years. In addition to reducing some of the entry restrictions for potential claimants, the CCAB-I called for proper engagement with the consultative process. Respondents need tangible evidence that the comments and suggestions provided are being listened to and are considered in the process of making policy decisions.

Introduction

Over the past five years, there have been several public consultations on the role of the tax system in encouraging entrepreneurism and supporting Ireland’s SME sector. The consultation papers on the most recent tax consultations, including that on CGT Entrepreneur Relief, the KEEP and Employment and Investment Incentive Scheme reflect past feedback. In presenting the consultations’ starting point for comments for this year’s re-examination of the reliefs, the current papers have summarised some of these suggestions for changes to policy or to technical aspects of the regimes.

CCAB-I responded to all of the invitations for comment over the past few years. Our comments in response to this consultation will reflect many of the points we have made in the past. The summary in the consultation document notes a number of suggestions that have been made in the past for improvements to the regimes – many of which echo those in CCAB-I submissions. Our enclosed response to this year’s submission will make the same points again as we consider that the points of concern we have raised in the past remain barriers to the effective operation of the relief.

CCAB-I believes that in order to secure proper engagement with the consultative process, respondents need tangible evidence that the comments and suggestions provided are being listened to and are considered in the process of making policy maker decisions. It would be useful to better understand the basis for policy makers’ choices in decisions taken as part of these regular review processes of reliefs. One improvement to the process could be the introduction of a code of consultation principles, similar to the one which operates in the UK which provides undertakings on time limits, responses and actions. In acting upon these principles, policy makers publish notes which outline the balance of considerations that have contributed to choices made in changing or not changing aspects of the reliefs under review.

Comments on CGT Entrepreneur Relief

CGT entrepreneur relief needs to meet its objective of encouraging a strong competitive environment to attract and retain scaling SMEs particularly in the context of a changed business environment post Brexit. CCAB-I as part of its pre-Budget submission for 2018, 2019 and 2020 has called for the several changes to CGT entrepreneur relief which are considered to operate to limit the effectiveness of the relief. These requests for change are set out below:

1. The lifetime cap of qualifying gains should be increased from €1 million to €10 million.
2. The technical definition of a qualifying group of companies needs to be amended because at the moment relief is disallowed on the sale of shares in many standard commercial corporate structures. For example, a holding company “A” has two subsidiaries “B” and “C”. A is a pure holding company, B a trading company and C is a dormant company or an investment company. This group currently fails the “qualifying group” test because all subsidiary companies must be trading. This is the case even though the non-trading company may be worthless or it may hold assets of nominal value. We suggest that the qualifying group test should be amended to mirror the tests for recognising a trading group as per other established CGT reliefs such as section 626B TCA 1997 that recognise that businesses operating through companies often carry on trading activities through a corporate group structure.
3. The current relief does not make any provision for periods of ownership of assets by spouses for the purposes of the ownership test. The relief does not apply to assets personally owned by the shareholder but which are used by the company nor does it apply to assets used by sole traders or partnerships prior to incorporation. The relief is therefore inconsistent with the qualifying conditions for other reliefs such as retirement relief, business relief and relief for the incorporation of a trade by a sole trader.

Comments on the Employment and Investment Incentive (EII) scheme

The EII and the Seed Capital Scheme (subsequently replaced by SURE) were examined by way of public consultation in 2014 and in 2015 through a consultation on the role of the tax system in encouraging entrepreneurship. In 2018, the EII scheme was examined again.

The CCAB-I’s pre-Budget submission ahead of the 2017, 2018, 2019 and 2020 Budgets consistently highlight two central issues with the EII scheme:

4. The need for EII to meet a market gap in the access to finance for early stage companies and for SMEs that are seeking to raise equity capital for major expansions in their business. The broader challenges of accessing finance across the SME sector are even more acutely faced by early stage companies or those seeking to raise equity capital for significant new expansion; and
5. The complexity of the conditions underpinning the legislation and the restrictions which block access to these reliefs in the first place for many SMEs that are in critical need of funding.

The 2014 revision of EU General Block Exemption Regulation (GBER) for State Aid greatly restricted the scope of the EII scheme and its effectiveness as a tax relief. Finance Act 2018 (FA 2018) did respond to concerns raised by businesses on the impact of compliance with the EU GBER for State Aid on the availability of the EII scheme in recent years; however there is still some way to go in the re-adjusting the operation of this tax incentive so that it can fulfil its purpose of encouraging investment in early stage and small business with limited funding options.

Among the measures introduced by FA 2018 is self-certification for qualification for EII scheme purposes on both the company and the investor. This means, in effect, that potential investors’ perceptions of risk of investment are adversely impacted. Without more robust external assurance as to the preservation of relief claimed, investors perceive that they face greater uncertainty than in the past that relief they may claim in relation to their investment will be clawed back by the company having to use its resources to pay additional corporation tax, interest and penalties in amounts that are linked to the tax relief claimed by the investors. Money used by the company to fund a relief clawback means that there is less available to the company to fund its business which reduces the likelihood of business success and the eventual return of equity to EII investors.

This dynamic also affects the analysis of the risk associated with future investment by current investors in the SME in that their assessment of the future returns from their existing investment in the company is also adversely affected by the perceived risk that the SME may have to use its assets to fund repayment of tax reliefs granted to new investors – instead of deploying these resources in funding the planned expansion of the business. A great deal of additional financial risk is introduced as a result for a start-up operation or small scale company already exposed to high risk. The present model of self-certification reduces the likelihood of securing new investors and also reduces the likelihood of retaining existing investors for the longer term.

For example, if a company makes an incorrect statement of qualification, as per the tax legislation, the company is liable to corporation tax on an amount 1.2 times the initial 30/40ths of the relief given or such part of that amount that does not qualify for relief. A high degree of interest exposure also arises in the case of a claw back of relief due to an incorrect certification along with penalties. This risk is separate to the risk of an investor not meeting conditions for the relief. The investors must also certify that they have met the various investor conditions, and relief is clawed back from the investor if he/she incorrectly self-certifies.

The risk of getting self-certification wrong is too high for many and based on views expressed to our members, the potential reliefs available under the EII scheme is simply not sufficient to offset the greater long term uncertainty and risk of exposure to Revenue challenge and potential clawback of relief and consequential interest and penalties.

In an effort to counter the impact of the restrictions imposed by GBER and the added risk of self-certification, the capital gains tax treatment of gains and losses on EII investment should be reconsidered. For example, a capital loss arising on the disposal of EII shares should be available for offset against other gains arising to the investor in addition to the income tax relief he/she receives on making the original investment.

Furthermore, professional service companies should not be excluded from availing of the EII scheme as such companies are equally capable of providing job opportunities. Many professional service companies operate a model whereby the business operates on an overdraft or a loan. These companies wish to grow and expand, not unlike other trading companies and should be able to benefit from the EII scheme.

As part of its pre-Budget Submission for 2020, CCAB-I is calling for tax relief for equity investment by company founders. With the exception of micro-companies qualifying under the start-up capital incentive, company founders and connected parties are generally precluded from claiming tax relief under the EII. This restriction closes the door on tax relief for the traditional early stage investor and some alternative tax measure should be considered to encourage investment for start-ups who face very limited finance options at inception.

The CCAB-I suggests that founders and connected parties of start-up SMEs could benefit from a reduced rate of income tax on dividends paid by their companies once the company has been trading for a set period of five years, for example. This incentive would encourage the founder and his/her friends and family to invest equity on a new start-up, retain funds in the company for growth and development during the start-up phase and provide a mechanism for a tax efficient reward in return for risk while still retaining shares and ownership of the company.

In terms of the proposals for changes to EII/SURE not yet acted upon as laid out in the most recent consultation document, the following should be introduced as a matter of priority:

1. The annual investment limit should be increased for longer term EII investors and higher risk sectors and capital losses should be allowable for such investors.
2. Confirmation that a company is eligible for relief should be final if information provided is correct and complete.
3. A simplified process involving less restrictive conditions should apply for start-ups who are raising limited investments.

Comments on Key Employee Engagement Programme (KEEP)

KEEP is a share option incentive scheme with the aim of incentivising employees to hold shares in their employer company. This scheme is particularly important in helping SMEs in attracting and retaining employees; which is critical to the future success of the Irish economy.

CCAB-I raised concerns with the KEEP legislation as part of its 2019 Pre-Budget submission. Our main concern is the limited, and in some cases lack of a market for the disposal of shares in small Irish companies. Many companies who may wish to operate KEEP will not be on the stock exchange or may not have any market for the sale of shares and therefore cannot provide liquidity for these shares. Without visibility as to how they can potentially realise value for KEEP shares, employees do not value the award of a KEEP share option, thereby reducing its effectiveness as a tool to attract and retain key employees. This is a substantial challenge for these companies and in many cases deters companies from operating the KEEP scheme.

To assist in resolving this significant problem and to allow companies to participate in granting KEEP awards who may not otherwise be able to provide an external market for their shares, we suggest that companies should be facilitated in providing liquidity in their shares by using mechanisms such as making arrangements with the employees to buy-back shares over time. This should be available to provide greater certainty to the employee that their share award can be realised where there is not otherwise an opportunity for another party to purchase the shares from employees. Perceived certainty that there is an opportunity to realise value for the shares should enhance the value to the employee of a KEEP share option and promote uptake of the scheme.

To support this, we suggest that the buy-back provisions in section 176 TCA 1997 should accommodate an employer buyback of KEEP shares. Such a buy-back should also satisfy the trade benefit test for the purposes of CGT treatment.

There are a significant number of conditions that must be satisfied in order to implement KEEP, resulting in minimal uptake of the scheme during 2018. CCAB-I acknowledges the changes made in FA 2018 in terms of the limits on qualifying share options granted to employees. However concerns still remain. Some of the more pertinent concerns are listed below:

1. The non-application of the scheme to SMEs who operate under a group structure and either have more than one trading subsidiary in the group or have a group holding company that lends to or otherwise supports its subsidiaries and does more than merely hold shares in a single trading company.
2. The requirement that an employee must work full time for the qualifying company throughout the entire relevant period is inflexible. It is impractical to restrict an employee who works for a group of companies to only work for one single company within the group. For example an employee may work for the holding company and one or more subsidiaries. If an employee transfers between group companies, their KEEP options should be transferable provided all other conditions are met.
3. The current legislation does not allow for CGT treatment to apply to KEEP shares when the SME undergoes a corporate reorganisation during the period in which the KEEP share option rights are outstanding. CCAB-I recommends that the KEEP legislation is adapted in line with the Revised Entrepreneur Relief legislation to say that a qualifying individual with shares in a qualifying company continues to meet the requirements of the KEEP when a reorganisation takes place.
4. The amendments introduced by Finance Act 2017 to section 135 TCA 1997 by inserting a new section 135 (3A) are causing concern for companies wishing to operate KEEP. The new provisions, which apply to close companies (which include the vast majority of non-listed Irish SMEs), impose a charge to income tax rather than capital gains tax in the sale of certain shares. Therefore there is uncertainty as to whether KEEP is impacted by these extended anti-avoidance provisions of section 135 TCA 1997. Unclear anti-avoidance provisions erode the effectiveness of tax incentives which are designed to support and sustain equity investment in SMEs such as KEEP and also the EII scheme.

CCAB-I’s 2019 pre-Budget Submission asked that tax law is clearly written and operate as intended without the necessity for supplementary guidance from Revenue. Anti-avoidance measures in particular should be free from any doubt that bona fide transactions are not the target of the provision and this should be clear based on the wording of the law in its own right. At present, if a close company that does not have a market in its shares puts in place arrangements with employees to create liquidity in its shares which draws from the company’s resources, the buyback of the shares falls within the scope of the anti-avoidance provisions and operates effectively to deny the capital gains tax treatment set out in the KEEP provisions. The only remedy is to ensure that this provision is corrected in Finance Act 2019 with the addition of a bona fide test in section 135 TCA 1997 with stated policy intent that it is not intended that employer buyback arrangements to support the operation of share awards under a KEEP scheme are intended to fall within scope of these provisions.

Conclusion

CCAB-I would like to consult on the above points and wants to see the reliefs to support entrepreneurship fulfil their roles and looks forward to active engagement by policy makers in these important consultations on incentives to support business growth by SMEs in Ireland.