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Dawn of a New Era? The Personal Insolvency Bill 2012

Posted by Cormac Brown / in Articles / Link

Overview

The Personal Insolvency Bill represents a significant reform and modernisation of Ireland’s personal insolvency law, which has been a subject for discussion in recent times. After the recommendations of the Inter-Departmental Working Group on Mortgage Arrears (Keane) Report of October 2011 and the Law Reform Commission’s December 2010 Report, which urged widescale reform, the Bill was approved by Cabinet on 26 June 2012. Needless to say, passage of the Bill was accelerated because of its inclusion as one of the requirements of our IMF programme.

The Bill, which proposes the establishment of an Insolvency Service of Ireland to oversee the new legislative regime, still grants creditors a considerable level of dominance over debtors. A “triple lock” is provided for any individual seeking the protection of a DSA or a PIA (both as defined below), meaning that an insolvency practitioner, the Insolvency Service and the court need to be satisfied that the debtor qualifies. The salient test from the creditor’s perspective in the context of the DSA or the PIA (but not the DRN unusually) is that neither scheme can be unfairly prejudicial to a creditor.

Below we highlight some of the main provisions of the Bill and address some of the tax considerations that could follow the adoption of the Bill. We also give some examples of other personal insolvency regimes and give a timeline for the adoption of the Bill and the Irish personal insolvency regime.

Insolvency Service of Ireland

The Bill provides for the establishment of the Insolvency Service of Ireland (“the Service”), an entirely independent body that will participate in the delivery, monitoring and execution of the new personal insolvency arrangements provided for in the Bill and in existing legislation. The principal functions of the Service will be:

›› monitoring arrangements relating to personal insolvency,
›› considering applications for Debt Relief Notices (DRNs),
›› processing applications for protective certificates relating to Debt Settlement Agreements (DSAs) or Personal Insolvency Arrangements (PIAs),
›› maintaining registers of DRNs, DSAs, PIAs and protective certificates,
›› providing information to the public on the workings of the legislation and
›› developing policy.

Debt Relief Notice

This procedure applies only to debt up to €20,000. Any such unsecured debt can be written off by paying half of the debt or following a three-year supervision period. Eligible debtors:
›› must have qualifying debts of €20,000 or less,
›› must have net disposable income of €60 or less per month,
›› must have assets or savings of €400 or less and
›› must be insolvent with no realistic prospect of being able to pay their debts within five years of the application date.

Qualifying debts can include credit card debt, an overdraft or unsecured bank loan, utility bills or rent. They may include secured debt, but secured creditors retain the right to enforce their security once the DRN ceases to have effect. Only one DRN is permitted per lifetime, and a person may not enter into the DRN process within five years of completion of a DSA or PIA. A debtor must apply for a DRN to the Service through an approved intermediary with a written statement of his or her financial affairs. The DRN remains in effect for three years, during which time creditors subject to the notice cannot take any steps to recover their debt. This prohibition applies also to notified secured creditors.

During the three-year period, the debtor must inform the Service of any material change in his or her circumstances and must hand over 50% of any gift or payment received that is worth €500 or more and 50% of any increase in income worth €250 or more (after deductions) to the Service. The Service will then distribute
these funds to creditors pro rata to their debts. If the debtor pays 50% of the debt covered by the DRN to the Service, he or she will be relieved of the balance of the liability.

When the three-year period expires, the debtor is discharged from all of the unsecured debts specified in the DRN; however, secured creditors will still be able to rely on their security. The Service may apply to court to terminate a DRN if there has been dishonesty or non-compliance by a debtor. In this case, the debtor is liable in full for all debts specified in the DRN.

The DRN will have appeal only for those on the lowest rung of the debt ladder, given the asset threshold specified.

Debt Settlement Agreement

A debtor who owes over €20,000 in unsecured debt to one or more creditors will have the option of proposing a DSA. If the arrangement is accepted by creditors and adhered to over five years by the debtor, the balance of the debtor’s debts covered by the arrangement will be discharged.

The concept of a Personal Insolvency Practitioner makes its first appearance in the context of a DSA, and they also take a lead role in the PIAs (dealt with below). It is unclear whether members of the accounting or legal industry (or both) will be appointed to these roles. The Minister for Justice, Defence and Equality, Alan Shatter, left the issue open in his press release and said that consultations would continue between the Department and the Central Bank.

The debtor must make a proposal through the Personal Insolvency Practitioner, must be insolvent and must make a full financial disclosure by way of sworn statement. If the Personal Insolvency Practitioner is satisfied that the debtor qualifies, the practitioner makes an application to the Service for a protective certificate. If the Service is satisfied that the debtor qualifies, it makes an application to court for a protective certificate. If the court is satisfied that the debtor qualifies, it must grant the certificate.

The certificate protects the debtor from legal action by unsecured creditors for 70 days (extendable by a maximum of 40 days) subject to a creditor’s right to appeal. During the protective period, the Personal Insolvency Practitioner will develop a DSA.

Each of the DRN, DSA and PIA will be predicated on the swearing of a statutory declaration, which imposes an obligation on the person swearing the declaration and on the Personal Insolvency Practitioner, who has an obligation to advise the debtor about the insolvency processes.

There is no financial ceiling specified on the level of debt in a DSA. An individual may enter into a DSA only once in his or her lifetime. The DSA will clearly set out how creditors will be paid. Preferential debts, such as tax, must be paid in full. Only unsecured debt can be subject to a DSA.

The Personal Insolvency Practitioner acting on behalf of the debtor must convene a creditors’ meeting to vote on the proposed DSA. A total of 65% in value of the creditors (who must be present) must vote in favour of the proposed DSA. The DSA must then be presented to the court, which must confirm that no valid objection has been received and that the eligibility criteria have been met.

When a DSA is in effect, no unsecured creditor bound by it (including those who voted against it) may take action against the debtor. The terms of the DSA must be reviewed by the Personal Insolvency Practitioner at least once a year, and the DSA may be varied if the debtor’s circumstances change.

If the debtor complies with the arrangement for five years, the debts covered by the DSA will be discharged. If the debtor defaults on his or her other obligations or is in arrears for six months, the DSA is terminated and the debtor becomes liable in full for all debts covered by the DSA, including arrears, interest and charges that may otherwise have been forgone.

Personal Insolvency Arrangement

This process allows a debtor to pay creditors a portion of what is due to them over a six- or seven-year period and then to be discharged from further liability. A debtor can enter into a PIA with his or her creditors if 65% in value of the total creditors vote in favour of the arrangement. In addition, 50% of the value of the secured creditors and 50% of the value of the unsecured creditors must vote in favour of the proposed arrangement. As with DRNs and DSAs, a debtor may enter into a PIA only once during his or her lifetime. The PIA is available only where the aggregate of the secured debts is less than €3m.

As in the case of DSAs, the debtor must engage with a Personal Insolvency Practitioner, who will apply for a protective certificate from the Service, which again (as with DSAs) is for a period of 70 days extendable by 40 days. There is a “triple lock” as between the Personal Insolvency Practitioner, the Service and the court in that the court issues the protective certificate on the recommendation of the Service and, in this regard, the court must be persuaded that the debtor is unable to discharge the debts. Notwithstanding the creditor approval process, a party prejudiced by the granting of a protective certificate may apply to the court to have the DSA set aside on the grounds of unfair prejudice to that creditor.

The Personal Insolvency Practitioner seeks to formulate a PIA during this protective period, and secured creditors are prohibited from taking steps to enforce security during this period. This may prejudice secured creditors holding shares or other tradable instruments, for example. The PIA may include a lump sum payment from the debtor’s own resources or from the resources of other persons, but it
may not include terms that would mean that the debtor would not have sufficient income to maintain a reasonable standard of living. The Bill does not define what constitutes a reasonable standard of living, but it provides that a PIA shall not require a debtor to sell his or her home unless the Personal Insolvency Practitioner forms the view that the costs of continuing to reside there are disproportionately
large.

A PIA may provide that a secured property is sold, provided that the secured creditor gets the value of the security at the date of the issue of the protective certificate and there are detailed provisions as regards the valuation of the security. A PIA can provide for variations of repayments. It can also stipulate that interest-only repayments are to be made or that no payments are to be made at all. It can extend the period of a loan or defer payments for a period of time. It can also change the interest rate and permit debt-for-equity swaps, which gives rise to some particular tax considerations. The possible tax implications of a debt-for-equity swap as part of a PIA in themselves could provide sufficient material for an article. In relation to a PIA, the debt will generally be owed by an individual to another individual or a company. In the swap, the equity in the asset, whether it is shares or other property, is given to the creditor in lieu of cash. Thus the debt, or a portion thereof, is paid but not in cash. In a trading situation where the individual is providing equity in lieu of payment for the debts in cash, the equity replaces the cash. Thus the value of the equity provided by the individual enters the trader’s balance as a fixed asset rather than cash. The tax treatment would generally follow the accounting treatment, and where the value of the equity provided was less than the debt, the remainder of the balance would be written off as a bad debt to the extent that it was not recoverable. In a non-trading situation, similar principles would apply, and the equity provided by the debtor in lieu of cash is a repayment to the creditor. Section 541 TCA 1997 indicates that the disposal of a debt by the original creditor is not a transaction for capital gains tax purposes.

The transfer of the equity to the creditor by the debtor may itself have tax implications for both the creditor and the debtor. For example, if the debtor was providing equity in a building to the creditor, capital gains tax, stamp duty and VAT issues may arise, as they would for the transfer of any building. When a PIA becomes operative, it binds both the debtor and the creditors and is reviewed at least once annually. If there is a change in the debtor’s personal circumstances, payments to creditors can be increased; however, only 50% of any new assets acquired by the debtor after the adoption of the PIA will be made available to creditors.

If a debtor fails to meet his or her obligations under a PIA for more than six months, the PIA will be terminated and all debts covered by the arrangement will be reinstated unless otherwise ordered by the court. Where the term of a PIA expires, all unsecured debts stand discharged, but secured debts are not discharged unless this is specified in the terms of the PIA itself.

Both PIAs and DSAs can deal with all security rights, so this may make banks more prudent in their lending to unincorporated businesses such as doctors, lawyers or accountants.

Tax Effects of Discharge of Debt for Debtor and Creditor

The tax effects of discharging a debt will be determined by how the debts arose in the first instance. If the funds were used to pay trading expenses for which a tax deduction was previously taken, the provisions of s87 TCA 1997 will have effect. Section 87(1) provides that where a tax deduction has been allowed for a debt incurred for the purposes of computing the profits or gains of a trade or profession and the whole, or any part of, the debt is released, the amount of the write-off is a trading receipt.

Take an example of where a supplier provides stock for a publican and the latter takes a tax deduction for the cost of the stock. Where the debt is not paid by the publican and is subsequently written off by the supplier, s87(1) will apply and the publican will lose the tax deduction for the amount, as it is a deemed trading receipt of the publican. Section 87(2) would apply where the debt is written off after the trading activity of the debtor has ceased. Section 87(2) states that where such a debt write-off occurs after cessation, it is a deemed receipt of the purposes of s91 TCA 1997, which taxes post-cessation receipts under Schedule D, Case IV. If the publican in our example were to cease trading, the amount written off would be a Schedule D, Case IV, taxable receipt.

Where the debt was incurred for the purposes of acquiring or improving an asset, the write-off of the debt may have implications for the base cost of the asset. Section 552 TCA 1997 provides for the allowable cost for acquisition, or improvement, of an asset and draws a distinction between the cost of acquiring an asset and enhancement expenditure. In respect of expenditure on acquiring an asset, the amount allowable is “the amount or value of the consideration in money or money’s worth given by the person or on the person’s behalf wholly and exclusively for the acquisition of the asset”. Where a person borrowed funds to acquire an asset and the debt was subsequently written off, the base cost of the asset would not appear to be affected. The debtor still acquired an asset and provided consideration, notwithstanding that the funds were not repaid.

The position in respect of enhancement expenditure where debt is written off is not as clear. Section 552(1)(b) states that the allowable cost shall be restricted to “the amount of any expenditure wholly and exclusively incurred on the asset”. Accordingly, the issue is whether a person incurred expenditure when the funds were spent on improving the asset but not repaid.

In respect of the creditor, the most likely way that the debt arose to the debtor is in the ordinary course of the creditor’s trade or business where the credit or a loan was provided. Section 81(2) (i) TCA 1997 provides for the rules relating to a trading deduction for bad debts and requires that it has to be shown to the satisfaction of an Inspector that the debt is bad. By the definition of each of the processes set out in the Bill (whether DRN, DSA, PIA or bankruptcy), a creditor would have justifiable claims that the debt is bad and there is little, if any, chance of recovery, and thus the debt should be shown as bad. If the debt is subsequently repaid in part, or in full, the receipt would be taxable as a trading receipt.

Section 541(1) TCA 1997 provides that where a person incurs a debt to the original creditor, no chargeable gains shall arise on the disposal of that debt, provided that it is not a debt on a security. Thus the disposal of the debt through its write-off should not be an event for CGT purposes, and an allowable loss will not appear to arise.

Value-Added Tax

While the Bill does not allow for tax to be written off by a debtor, this obviously applies only when the taxes are owed by the debtor. Where the debtor owes money to a supplier, for example, that includes VAT, the issue of VAT arises on the bad debt. Where VAT is charged on an invoice basis, the supplier will be out of pocket as it would have paid to Revenue the VAT chargeable but would not have received such VAT from the customer (i.e. the defaulting debtor). Section 39(2) VATCA 2010 and Regulation 10 of the Value-Added Tax Regulations 2010 (SI 639 of 2010) provide for VAT and bad debts. Regulation 10(3) states that bad-debt relief may be claimed for the VAT charged where:
›› the creditor had taken all of the reasonable steps to recover the bad debt,
›› the bad debt is an allowable deduction for income tax or corporation tax purposes and
›› the debt had been written off in the financial accounts of the accountable person, and the person from whom the debt is due is not connected to the creditor.

The Regulations do not define “reasonable steps”, and the Revenue Information Leaflet2 indicates that it would depend on each case. Although the Revenue leaflet was published before the Bill, it states that “correspondence from a liquidator stating that there are no funds to pay non-preferential creditors would constitute such evidence and would justify writing off of a debt”. Accordingly, it would appear reasonable to conclude that debts that are affected by the Bill could be considered to be irrecoverable and thus reasonable steps have been taken, and a valid claim may be made for the refund of VAT not paid. It should be noted that such VAT relief can be claimed only in respect of specific debts and not in respect of specific or general bad-debt provision.

Each of the processes in the Bill provides for a potential recovery of set amounts over the period of the arrangement. Where such repayments include amounts in respect of which VAT was written off, the relevant proportion of VAT should be repaid upon payment.

Implications of Outstanding Taxes

None of the new processes provides for the write-off of any tax liability owing by the debtor, so it is worthwhile to consider the practical implications for the debtor of having outstanding tax liabilities.

One significant implication of having outstanding taxes, where an agreed instalment arrangement is not in place, is that the person may not be able to obtain a tax clearance certificate. Where a tax clearance certificate is not available, a person will be unable to obtain a State contract for any amount in excess of €10,000 or to draw down a State grant for the same amount. Additionally, a tax clearance certificate is required to renew a variety of State licences, for pubs, hotels and approximately 20 other areas where a licence is required. In many instances the legislation requires that the tax affairs of all partners, all company directors and shareholders with a shareholding of 50% (or more) are up to date where the trades are carried out through a partnership or company.

An additional implication of not having tax affairs up to date is where Relevant Contracts Tax (RCT) applies. In order for a principal contractor to receive permission to deduct 0% RCT, the Revenue Commissioners will require that the sub-contractor’s tax affairs are up to date. Where the sub-contractor is a company, the Revenue Commissioners will require that each director and significant shareholder is also up to date with their tax affairs. Given that the construction industry and hotel/licensed trade are very heavily exposed to the economic downturn, the fact that outstanding tax liabilities cannot be dealt with under these new arrangements may be considered a limitation of the legislation. Individuals are effectively precluded from the licensed hotel trade where they have outstanding tax liabilities and cannot get a clean start by working in the industry in which they have extensive experience. Additionally, construction sub-contractors will have to cope with the additional cash-flow cost of having up to 35% of their sales withheld. The new RCT regime has limited the ways in which a sub-contractor can obtain credit for the tax withheld.

Bankruptcy

The Bill makes a number of significant changes to the Bankruptcy Act 1988 and arguably discourages its use in general. The period in which a bankrupt will be discharged is shortened to three years unless an application is made alleging that the bankrupt has not co-operated with the Official Assignee or has hidden or failed to disclose assets. In that case, the court may extend the period up to eight years (which is still well short of the current twelve years).

The level of debt required for a bankruptcy petition to be presented will be increased to €20,000 from the current €1,900. The Bill also makes the award of costs to the petitioner discretionary and conditional on the court’s view of the reasonableness of the behaviour of the petitioning creditor with regard to any refusal to accept a DSA or a PIA. Costs are currently automatically awarded to the petitioner.

The time period preceding a bankruptcy in which the court may seek to overturn fraudulent dispositions, preferences and settlements will be increased from three months to three years. In making an order for payment against the bankrupt, the Bill will oblige the court to have regard to the reasonable living expenses of the bankrupt and his or her family. Guidelines regarding reasonable living expenses will be published by the Service once it has been established.

Comparisons with Other Jurisdictions: Canada and Australia

The proposals in the Bill mirror the personal insolvency procedures currently in operation in other jurisdictions, such as Canada and Australia. Minister Shatter, in his Second Stage speech to the Dáil, referred to the Canadian and Australian voluntary insolvency arrangements as role models that Ireland should emulate, given their emphasis on debt settlement processes that involve majority approval by creditors.

In Canada, the Bankruptcy and Insolvency Act provides for the adoption of negotiation arrangements with creditors for the compromise of debts and the reorganisation of a debtor’s financial affairs. Similarly, the personal insolvency system in Australia provides an orderly means for debtors to obtain relief from debt so that they can participate again in the financial system.

Under Australia’s Bankruptcy Act, an individual can reach an arrangement with his or her creditors under Part X. Part X is designed for debtors who have a reasonable amount of assets. The debtor makes a proposal to the creditors, which must be approved by a special majority, comprising 75% in value and 50% in number of those creditors who vote.

Another procedure offered by Australia’s Bankruptcy Act is a Part IX Debt Agreement. As with Part X arrangements, a special majority is required for it to proceed, but the voting is done by post, thereby avoiding the cost of meetings. The person administering the arrangement does not have to be licensed, but there are prohibitions on eligibility to act. Any person, including the debtor or a friend or family member, can administer a Debt Agreement, although in practice most are administered by fee-earning businesses. It is designed as a less formal, low-cost procedure and is restricted to debtors with low assets and relatively low incomes.

There has been some debate about the status of bankruptcy law generally in Australia, given the increasing numbers of individuals who are opting to take the personal insolvency route (there was a 300% increase in those seeking to enter personal insolvency arrangements between 1990 and 2009).

Some of the Australian commentary3 has questioned the efficacy of an approach that it claims prioritises the rehabilitation of debtors at the expense of genuine creditors. Personal insolvency applications are now being hailed as a “middle class phenomenon”, with the Bankruptcy Act being portrayed as a key piece of consumer protection legislation. Some Australian commentators have called for a more conservative approach to be taken to personal insolvency and have argued that personal insolvency applications should not be a method by which individuals who entered into credit arrangements on a whim and relatively ignorant of their obligations can obtain relief.

Timeline for Adoption of the Bill

The Bill passed its Second Stage in the Dáil on 18 July 2012 after a lengthy debate. The Government has made the passage of the Bill a clear legislative priority, specifically scheduling the Second Stage Dáil debate before the summer recess so as to expedite its progress. The Bill is scheduled to be discussed by the Joint Oireachtas Committee on Justice, Defence and Equality on 13 September, where a large number of amendments are expected to be tabled by Committee members, given the size and scope of the Bill. Once the Bill has cleared the Joint Oireachtas Committee, it had been thought that it would proceed to the Seanad and then on to the Dáil for its final reading, with President Higgins signing it before Christmas. Recently published correspondence between the Minister for Finance, the Central Bank Governor and the IMF/EU authorities has cast doubt on this timeline, with the licensing and regulation of Personal Insolvency Practitioners and the development of guidelines for “reasonable” household expenses for debtors being highlighted as issues that will be delayed until year end, hence slowing the Bill’s progress.

The authors would like to acknowledge the assistance of Declan Black, Partner, Mason Hayes & Curran in the preparation of this article.

Lessons from Nuttall

Posted by Cormac Brown / in Articles / Link

The July 2012 release of ‘Sharing Success: The Nuttall Review of Employee Ownership’ (the Nuttall Review) and its 28 recommendations, provide plenty of food for thought and a new framework to further discuss employee ownership with the Irish Government and the business community as a whole.
As a starting point, employee ownership is a great thing; people tend to care more for the things they own. The available academic literature is clear; improved business performance and increased economic resilience are direct consequences of employee ownership. There is also evidence that employee ownership has a role in driving innovation – enhanced performance, resilience and innovative thinking would be beneficial to any economy. However, with the loss of over 300,000 jobs since 2007, for Ireland these are vital.
Company secretaries play an instrumental role in developing employee ownership. Positioned at the centre of the decision-making apparatus, the company secretary is ideally suited to bring the evidence of the benefits of employee ownership to the board. With their deep understanding of company law and corporate governance, company secretaries have the knowledge and insight to gather and lead the multi-disciplinary teams required to launch these initiatives.

Ireland is not the UK
In late 2010, the Greek Finance minister stated that, ‘Greece is not Ireland’. Around the same time, his Spanish counterpart said that, ‘Spain is neither Ireland nor Portugal’. While some have presented these statements as evidence of a better understanding of geography over finance, it must be stressed that when it comes to employee share ownership, Ireland is not the UK.
This might seem like common sense, but the impact of high personal taxes, the need to foster more indigenous start-ups and the pervasive private company culture would have to be addressed if there was ever to be an ‘Irish Nuttall Review’.

Ireland does not have a ‘PLC monoculture’
Most Irish companies are private companies. At the end of 2010 over 86% of Irish companies were private. Notwithstanding the close link between ownership and management in these companies, many are not succeeding. Companies collapsed at a rate of more than 160 a month in the first 11 months of 2011. From January to November some 1,930 Irish companies failed. To add insult to injury, these failed companies left almost €1.2 billion in unpaid debts.
The central question that would need to be addressed by an ‘Irish Nuttall Review’ would be whether these companies are simply victims of circumstance or is something else missing? If it is the latter, could an increase in employee ownership help address this?
There is limited research on the benefits of employee ownership among Irish companies. HRM Recruit recently published, ‘Showing a lot of Promise – What matters in your Employee Value Proposition’, which reviewed the impact of various reward measures on Irish workers across multiple sectors of the economy and at various functional levels. Unfortunately, share-based remuneration measures were not well ranked, scoring a mediocre 2.99 out of five when compared to other benefits.
With all the available evidence, why is there such a lack of uptake? Like Graeme Nuttall, the Irish Proshare Association (IPSA) has received reports that there is a perception among employers that such schemes are difficult and costly, that there are also concerns among employees of the risk associated with the ownership of illiquid shares, in addition to there being a general lack of awareness among Irish employers and employees on the topic.
IPSA will continue its work with HRM to better understand the role employee ownership can play in the modern Irish economy and how best employers can use share-based remuneration to influence employee engagement and retention. The results from this collaboration will flow directly into IPSA’s engagement with the Irish Government.

Small open economy and the start-up company
There is a general acceptance that given the small open nature of the Irish economy any sustainable recovery will be driven by export-led companies. It is also widely acknowledged that this will be achieved by a dramatic increase in the number of indigenous start-ups with the potential and ambition to grow into innovative, export focused international enterprises. The 2010 Innovation Task Force report, the 2012 Action Plan for Jobs and the continued work by IDA Ireland and Enterprise Ireland have made good progress on this front. During 2011, Enterprise Ireland supported 93 high-potential start-ups, approving €20.4 million in funding and their client companies achieved a total export figure of €15.2 billion. While these achievements should not be underrated, for the Irish economy to recover and grow, more needs to be done.
The evidence that employee ownership leads to enhanced business performance and fosters a culture of internal innovation and organic growth in the companies that use it, is readily available. There is also emerging evidence that demonstrates that these enhancements are most effective in companies with less than 75 employees. Based on this, start-up enterprises are ideally suited to take advantage of the benefits of employee ownership and exploit it to the fullest potential, especially when coupled with the difficulty of raising finance to pay staff costs. Indeed, the specific recommendations in the Nuttall Review on the role of employee ownership for start-ups and expanding companies are very welcome. However, given the requirements of the Irish economy, any ‘Irish Nuttall Review’ equivalent would have to go further.
IPSA has already recognised the potential offered by employee ownership for high-potential start-ups and has, since early 2011, been in contact with various universities and incubator units across Ireland to increase awareness of the potential benefits of employee ownership. IPSA has also been in contact with, and has received positive reactions from, the Irish Department of Jobs, Enterprise and Innovation. Similar contacts with Enterprise Ireland have also proved fruitful.
The 2010 Innovation Task Force report contained a number of recommendations around share-based remuneration that could help to increase the number of start-up companies and address many of the specific challenges they face. These recommendations include:

1. the introduction of a ‘founder share option’, which would be eligible to more favourable tax treatment than options granted in established companies;
2. a reduced rate of capital gains tax where the proceeds from a sale of one innovative company are reinvested in another innovative company; and
3. the introduction of an ‘Entrepreneurial Tax Credit’, that could be granted to founders in certain circumstances.

Unfortunately, these recommendations have not been implemented and have been gathering dust, despite IPSA efforts to highlight them.
Start-ups and their founders need all the help they can get. Company founders often have to take on personal debt while they struggle to ensure returns for the providers of capital. This can lead to new companies being sold too early and for too little, rather than being floated as public companies, for example, that might eventually have a better impact on the economy. IPSA firmly believes that tax efficient employee ownership measures could address these problems and enhance the entire Irish economy.

Attracting top talent to Ireland
While there have been improvements in exports, it is vital that other sectors of the economy are not forgotten. The Irish Business and Employers’ Confederation recently launched its ‘Action Plan for Recovery: 50 Ideas to Drive Growth’. Contained in this was a warning on Ireland’s high marginal tax rate and the impact this could have on attracting top talent to Ireland. Speaking to the Economist Intelligence Unit in 2011, John Herlihy, Vice-President of Google’s Global Advertising Operations, also highlighted this danger; ‘junior talent joins a company to learn and leave; senior talent comes to build and stay’.
Without the presence of C-Suite personnel, there will always be a ceiling on growth potential. At IPSA we believe that targeted use of share-based measures can be used to offset the severity of the high personal tax and help to encourage sustained enterprise to flourish.

Conclusion
IPSA welcomes the findings of Graeme Nuttall and his team and believes that many of the recommendations are just as relevant in Ireland as in the UK. Namely, the Irish Government should promote employee ownership, engage in awareness raising and conduct consultations to gain a full understanding of the current position and future direction of employee ownership. However, due to the differences that exist between Dublin and London any ‘Irish Nuttall Review’ would have to address the issues surrounding private companies, enhanced start-up activity and attracting top level talent if it is to succeed in aiding the Irish recovery.
It is understandable for the Irish Government to maximise the generation of tax revenue in times of recession, but this should not be done at the expense of the wider recovery. IPSA would call on the Irish Government to engage with the organisation to fast-track the recommendations of the aforementioned Innovation Taskforce report, address the issues raised by Google’s John Herlihy and review the applicable recommendations from the Nuttall Review.
It remains IPSA’s aim to keep the spotlight on encouraging employees to become involved in the financial health of their organisation and to continue to work with the Irish Government to identify opportunities for revenue generation and economic growth. Finally, it is IPSA’s ambition to foster deeper links with company secretaries to ensure that the positive message around employee ownership reaches the Irish business community.

About the author:
Niall Kavanagh is the Senior Analyst at the Company Secretary’s Office at Elan Corporation, plc. He is a Chartered Secretary and Executive Council Member of the IPSA. Niall heads the IPSA private company subcommittee and is focused on initiatives for high-potential start-ups and university spin out companies.

Cormac Brown is a Director of Tax at Mason Hayes & Curran (MHC) and has a substantial practice in the employee share incentive area. He is an Executive Council Member of the IPSA and was Chair of the joint practitioner/government group that was set up following the introduction of PAYE. Cormac has a particular interest in how private company share schemes can be used as a tool of business growth.

The Wheel of Change Moves On

Posted by Cormac Brown / in Articles / Link

The 2011 Finance Act (2011 Act) in Ireland has had a significant impact on the taxation of share awards, approved and unapproved. The changes have a direct impact for UK companies with Irish employees who provide equity compensation as the employer now has the responsibility to collect the tax.
The 2011 Act, together with the related social security legislation, saw the extension of PAYE to share awards, together with the application of Pay Related Social Insurance (PRSI) (equivalent of NIC) and the Universal Social Charge (USC) to the taxable portion of share awards.

Who will the changes impact?
The changes will have a significant impact on administration of share plans which are often the responsibility of the company
secretary. Many UK companies with existing employee share plans, approved or unapproved, have Irish sub-plans that will be directly
impacted by the changes. In general, the taxation of emoluments is driven by where the employment is exercised, so it may apply to
Irish based employees, regardless of the size of the Irish workforce. A review of the list of Irish approved plans reveals that a significant number of UK listed companies, particularly in the financial services sector, have Irish approved plans.
The changes will impact every employer who offers share-related benefits to Ireland based employees. The changes apply to Irish Revenue approved plans, unapproved plans with broad based plans and plans specifically aimed at executives.

PAYE
All employers having Ireland based staff are required to calculate income tax, PRSI and the USC on an employee’s salary, and pay it to the Revenue Commissioners (Revenue) under the PAYE system. The Irish PAYE system is very similar to the UK system. In the 2011 Act, PAYE was extended to most share related benefits from 1 January 2011 (Relevant Date).
From the Relevant Date, an employer is required to calculate the taxable benefit accruing on the share award and deduct, in most cases, the tax from the employee’s salary. It should be noted that this provision does not change the taxation of share awards, but it does, very importantly, shift the responsibility for the payment of the tax from the employer to the employee. Prior to 2011, the employee was generally responsible for paying any income tax arising on share awards under Ireland’s self assessment system. Given that the employer is now responsible for paying the tax on share awards, regardless of whether it is recovered from the employee, the risk attached is significant and protocols should be put in place to ensure that the tax remains an employee cost and not an employer one.
Currently, share options are not subject to PAYE, an aspect which is covered in greater detail below.

PRSI
As part of the PAYE system an employer is also required to calculate and pay PRSI on salary and benefits. PRSI is broken down between employee and employer contributions, which are typically 4% and 10.75% respectively. Following changes of government policy it was decided that employer PRSI will not apply to share awards. However, it is not clear that the legislation which was intended to provide for an employer PRSI exemption for all share awards succeeded in attaining this objective. It is understood that the Department of Social Protection, who administer PRSI, have confirmed that an employer’s PRSI will not apply to share awards. It is hoped that this confirmation will be followed by the relevant legislative amendment.
Additionally, there was an exemption from an employee’s PRSI for share awards granted prior to the Relevant Date where the vesting/exercise occurred during 2011 only.

USC
The 2011 Act also introduced the USC – a new form of tax which applies to all emoluments including share awards and is collected through the PAYE system. The main implication of the USC is that, when combined with the application of PAYE and PRSI, it increased the marginal rate of tax on share awards to 52%.

Share options
The mechanism that applies to the taxation of share options has remained unchanged. Taxable gains on share options are not subject to PAYE, and any income tax payable is still payable by the employee under the Relevant Tax on Share Option scheme (RTSO). USC is also payable under the RTSO system. Income tax and USC arising on share option gains, normally on exercise, is payable directly to the Revenue within 30 days
of exercise.
The employer is required to remit the employee’s PRSI based on the taxable gain to the Revenue at the time of exercise. If the employee has left the company at the time of the option exercise, any PRSI liability is paid directly to the Department of Social Protection by the employee.

Revenue approved plans
The main types of approved share plans in Ireland are the Approved Profit Sharing Scheme (APSS) and the SAYE plan. The former plan is very similar to the UK Share Incentive Plans (SIP), and the latter is similar to the UK SAYE plan. While each of these plans continue to offer significant income tax benefits, these benefits do not extend to PRSI/USC.
The APSS plan operates by giving an employee shares in the employer company, or the parent company of the employing entity. In most cases, there is an employee contribution. USC and employee PRSI are now due on the value of the employer shares at the date of allotment.
Under a SAYE plan an employee saves out of net income for a minimum period of three years. Options are granted to employees to acquire shares at a discount to the market price at the start of the three-year savings period. At the end of the savings period, the employee can elect to use the saved SAYE funds to exercise the options and acquire shares at the discounted price at the start of the savings period. It is the difference between the option price and the market value of the shares at the date of exercise that is liable to the USC and employee PRSI.

Other plans
The general rule is that share awards are taxable when the shares are allotted to employees. The taxable amount is the difference between what the employee paid for the shares (if any) and their market value at date of allotment. Accordingly, a tax charge arises regardless of whether the shares are capable of being sold owing to an illiquid market (e.g. for private companies) or whether there is a lock-in period.
A timing difference can often arise anytime from when an employee is allotted stock and when it is actually settled. The settlement date is when the employee can sell shares which can finance the tax liability. In a Statement of Practice issued in April 2011 the Revenue allows an additional sixty days for payment of tax to cater for the time difference between vesting/allotment and settlement. The Statement of Practice indicates that the PAYE is now due early on in the month following the month containing the settlement date, or on the month following the month that is sixty days after the vesting date. The vesting date remains as the date that is used for the value of the share and the exchange rate, where appropriate.

International assignees
Where an executive is transferred to Ireland for a period of time and, as part of his remuneration package, is granted share awards that relate to the Irish employment, these awards should generally be taxable in Ireland. One issue that arises for assignees is where the executive’s remuneration package is tax equalised, and where the group is incurring any additional Irish tax cost on the share benefits. An additional issue is where there is a significant timing difference between the share award and the taxable event; such as allotment, where the executive is no longer resident in Ireland at allotment.
While this issue is not new to Ireland, the significant difference is that the Irish employing entity may be liable to pay any tax arising
under the PAYE system. This particular issue requires careful monitoring and tracking of international assignees.

Valuation issues
As the employer is now liable to collect the correct amount of tax on share awards, the value of the share is obviously very important. The statutory requirement, contained in Section 996(3) of the Taxes Consolidation Act 1997, is that the employer is required to use ‘…the best estimate than can reasonably be made…’ in which to calculate the tax. This is the general requirement that applies to taxable benefits, and not just share based remuneration.
While valuation issues do not typically present a problem for quoted companies, the same cannot be said for private companies. Apart from a few exceptions, the Revenue does not provide a share valuation service so it is not possible to agree a valuation in advance. In its 2011 Statement of Practice, the Revenue indicated that it would accept a bona fide valuation carried out using one of the accepted valuation methods. Regardless of the valuation method selected, it is important that the valuation is documented and records are maintained with standard payroll records.

Conclusion
The 2011 Act introduced significant changes on how tax is collected on share awards. With proper procedures and protocols in place, no additional cost should arise to the employer. Ireland now joins the list of countries that require tax to be operated at source on share awards.

About the author:
Cormac Brown is Director of Tax at Mason Hayes & Curran (MHC) and has a substantial practice in the employee share incentive area. He was Chair of the joint practitioner/government group that was set up following the introduction of PAYE. Paula Phelan is Head of the Company Secretarial Practice in MHC.