Monday, October 9, 2023

The aggregate Corporate Tax calculation enters an unsettled spell

In recent years when looking at the annual update from the Revenue Commissioners of the aggregate corporate tax calculation we noted that things were relatively calm, albeit it with elevated levels of receipts.  These were for tax returns filed for financial years ending during the 2018, 2019 and 2020 calendar years.

We now have the update for tax returns filed filed for financial years ending during 2021 (the last of these returns would have been filed in September 2022).  The 2015 upheaval is a well-worn track so we will just focus on the five most recent years.

The Determination of Taxable Income

We’ll start with the determination of taxable income.

Aggregate CT Calculation for Taxable Income 2017-2021

Right from the top we can see big changes for 2021.  There an increase of over €55 billion in gross trading profits recorded on tax returns for the year, reaching €250 billion.  This carries right the way down the table with the end showing that taxable income increased by over €40 billion.

However, there are some significant changes along the way. Early on, we see that after being relatively stable from 2018 to 2020 the amount of capital allowances used jumped again in 2021, coming in at just under €100 billion as a result of a €23 billion increase.

Next we see a large increase in foreign income included in the tax returns of Irish-resident companies.  For 2021, this exceeded €20 billion for the first time and was close to €10 billion more than the next highest year.  The next part of the table will show the impact of this on tax payments (answer: very little). 

Other income also saw a jump in the amount of capital gains included to reach €5 billion in 2021. This is actually a regrossed amount.  The applicable CGT rate is 33% but the gains are included in the tax return to be taxed at 12.5 per cent. Hence, the gains are regrossed and multiplied by 2.64 (= 33/12.5) to get the amount to give the necessary amount of tax.

In charges and deduction we see that trade charges, mainly certain royalty expenses, rose back to levels seen up to 2019.  This was the largest change among these items.

All told, the CT returns filed for years ending during 2021 had just over €150 billion of taxable income with €6 billion of that subject to tax at 25 per cent.  We now turn to the calculation of tax due.

The Determination of Tax Due

The starting point of this part of the calculation, Gross Tax Due is simply the amount of taxable income multiplied by the applicable rates (either 12.5 or 25 per cent).

Aggregate CT Calculation for Tax Due 2017-2021

The relative simplicity of the Irish CT regime means there isn’t a whole lot going on here.  The biggest reason for the reduction of gross tax due is because of tax already paid. 

The largest single item in the above table is double taxation relief and this was almost €3 billion in 2021.  The additional foreign tax credit of nearly €450 million can be added to this.  These reflection the foreign corporate taxes paid on the €23.5 billion of foreign income included in the top half of the table.  Little additional Irish tax is due as the amount already paid, albeit abroad, covers the gross tax due in Ireland.

The item for gross withholding tax on fees is somewhat similar but in this case it is Irish tax that has already been paid.  In some circumstances, when the buyer of services is paying them they will pay 80 per cent of the invoiced amount to the supplier and 20 per cent to the Revenue Commissioners.  The 20 per cent represents a withholding tax at the standard rate of Income Tax.  When filing their tax returns, companies will record any service fees that have been withheld from them and reduce their tax due figure accordingly.  The Revenue Commissioners will already have received the amount.

The most significant item in the table that actually reduces companies’ tax bills is the R&D tac credit.  Between the R&D credit used and the excess R&D credit refunded the total cost was just over €750 million in 2021, a slight increase on the outturn for 2021.

All told, the bottom line is a tax due figure of €15.1 billion for tax returns filed for periods ending during 2021.  There are some timing differences but we can that, in recent years, the tax due figure from the aggregate CT calculation, closely matches the CT receipts collected for the Exchequer.

We will conclude with a look at some of the tumult in the aggregate figures, with most of this seeming to concern capital allowances, in particular those for intangible assets.

Snowballing Claims for Capital Allowances

As before we will look at the total amount of capital allowances claimed, the total amount used (that is, actually offset against gross profit) and the consumption of fixed capital from the National Accounts.

Aggregate CT Calculation Capital Allowances Used and Claimed 2013-2021

Up to 2019, the most significant feature was the growth in the figures. he ratios shown were relatively stable.  Up to 2019, capital allowances used were just over 90 per cent of the amount claimed, and consumption of fixed capital (depreciation) in the National Accounts was just under 90 per cent of the amount claimed.  This stability did not continued into 2020.

In 2020, we can see that capital allowances used fell to just over 50 per cent of the amount claimed.  We also see a break in the link between capital allowances claimed and consumption for fixed capital in the national accounts.

The break of this link is interesting as it suggests that the increase in capital allowances claimed is not fully linked to assets that would be included in the capital stock for National Accounts purposes.  In the last two years, capital allowances claimed in the aggregate CT calculation have risen by over €80 billion (from €86 billion to €173 billion) while consumption of fixed capital for NFCs in the national accounts has increased by “just” €20 billion (from €78 billion to €98 billion).

A second pointer comes from looking at how the unused capital allowances, which came to almost €75 billion in 2021, show up elsewhere in the CT stats.  Typically, we might expect an increase in unused capital allowances to result in an increase in loss carried forward.  In most situations, unused capital allowances from one period are carried forward as a loss to use against income in a subsequent period.

However, changes in losses carried forward were nowhere near large enough to accommodate the scale of unused capital allowances in the above table.  The are lots of losses forward sloshing around the Irish CT system and lots of them are the result of unused capital allowances but the changes in 2021 (+€7 billion in losses forward) are of little help in explaining what is going on with capital allowances.

Of little help except it tells us where to look.  There is one instance where unused capital allowances are not carried forward as a loss but as capital allowances to be claimed again in subsequent periods (until they are eventually used).  And those are capital allowances for intangible assets.  And perhaps, unsurprisingly, this is where there have been the largest changes in recent years.

Unfortunately, the Revenue do not provide figures for capital allowances for intangible assets used but we do have figures for such capital allowances claimed.  Here they are by sector for recent years with very large growth recorded for a number of sectors notably manufacturing, wholesale and retail, and ICT.

Aggregate CT Calculation Intangible Capital Allowances Claimed by Sector 2018-2021

We can see from the total (€131 billion in 2021) that, on their own, capital allowances claimed for intangible assets significantly exceed the total amount of all types of capital allowances used in 2021 (€99 billion).  We can safely conclude that capital allowances for intangible assets are the reason those ratios broke down in the previous table.

Is there cause for concern? It is hard to know.  We know that there were significant onshoring of IP assets to Ireland in 2021 and 2022.  This would have increased the amount of capital allowances claimed.  And we know that there are now legislative restrictions on the amount of such capital allowances that can be used.

Since October 2017, new claims for capital allowances for intangible assets have been restricted to offsetting 80 per cent of the profit (before deduction of interest and these capital allowances) by such capital allowances.  Prior to this the cap was 100 per cent.  Any available capital allowances above this amount cannot be used in the current year and are carried forward to be claimed as a capital allowances in subsequent years.

The reason for the cap on capital allowances for intangible assets is to ensure that losses cannot be artificially generated for use elsewhere by a company or group.  Capital allowances for intangible assets are ringfenced for use only against profits generated by the acquired intangible asset.  If unused capital allowances could be carried forward as a loss they could be used against any profits.  All that has changed in recent years is the cut-off for the cap.

The cap will likely result in a “snowball effect”, at least initially, increasing the gap between the capital allowances claimed in any year and the amount used.  In the early years a company will have capital allowances that they can claim each year (following either the accounts or fixed rate approaches).  The cap may mean they cannot use all of these in the current year.

Then they may also have unused capital allowances from previous periods that they will also claim in the current year.  These will also be unused in the current year.  Thus the amount of unused capital allowances to be carried forward grows.  This could continue until they are no new capital allowances to be claimed and the unused capital allowances carried forward will be unwound until they are fully exhausted.

We don’t have precise figures but maybe a bit of guesswork can put us in the ballpark.  Claims for capital allowances for intangible assets have skyrocketed in recent years.  For the sake of exposition, let’s say the cap means that €10 billion of the amount claimed cannot be used.  That would mean that €10 billion would be carried forward to be claimed in the next period.

In the next period let’s assume that the cap again means that €10 billion of the amount claimed for that year cannot be used.  We than also have the €10 billion from the previous period that is brought forward and again claimed.  This means there are now €20 billion of unused capital allowances.

In the next period there’s another €10 billion of that year’s claim that can’t be used and this is added to the €20 billion from previous periods that are brought forward claimed again.  We are now up to €30 billion to be carried forward and so on.

We cannot say that this is the only thing that is going on but it does seem likely to be a large part of the story. And for the IP that was onshored in 2020 and 2021 this will go on for a few years yet. The gap between the amount of capital allowances claimed and the amount used will grow ever larger.  Down the line the full amount of the capital allowances will have been claimed and the amount available in any subsequent year will only be those which have been carried forward and these will eventually be fully exhausted.

The figures are so large that there may be something else going on but it is hard to make out. What we can see are the growing claims for capital allowances for intangible assets.  Due to the snowball effect outlined above this is likely to continue. It could be some time before calm returns to the aggregate CT calculation.

1 comment:

  1. Thanks for your articles - re capital allowances for intangible assets snowball effect, the revenue disclose the following: "The amount of capital allowances in respect of intangible assets reported as unused on 2020 returns by companies and carried forward (including amounts carried forward from earlier periods) into the 2021 returns is €54 billion. This is approximately 41 per cent of the overall amounts available to claim in respect of intangible assets on the 2021 returns. The equivalent amount reported as unused on the 2021 returns and available for carry forward into the 2022 returns is €61 billion". Per page 14 of Corporation Tax – 2022 Payments and 2021 Returns