The Irish Revenue Commissioners (Revenue) were successful in arguing before the Appeal Commissioners that no general trading deduction should be available for excess foreign tax incurred on royalties where an Irish tax credit was claimed for part of the foreign tax withheld. The decision is being appealed to the High Court.
Under Irish tax law, credit is generally available for foreign tax withheld on royalty payments (regardless of whether the payment is received from a tax treaty partner jurisdiction or otherwise). However, the credit available is capped at the Irish tax that would be paid on the profit (calculated under Irish rules) attributable to the foreign royalty. This approach can often result in part of the foreign tax being unrelieved. The Appeal Commissioners in this case considered whether a general trading deduction is available to an Irish taxpayer for the excess unrelieved foreign tax.
The facts of the case
In this case, the taxpayer incurred foreign tax on a royalty received from a treaty partner jurisdiction. A tax credit was available under Irish law for part of the foreign tax incurred. The taxpayer sought to deduct the excess unrelieved foreign tax on the basis that the tax was part of the cost of doing business in the foreign country.
Revenue denied the deduction, arguing:
- the withholding tax was in the nature of a tax on income and therefore could not be deducted; and
- the tax was not "laid out or expended for the purposes of the trade", a basic requirement for trading deductions to be permitted under Irish law.
The taxpayer appealed the decision of Revenue to the Appeal Commissioners. By way of background, the Appeal Commissioners is an independent statutory body whose main task is hearing, determining and disposing of appeals against assessments and decisions of Revenue. Most Irish appeals on tax matters are first heard by the Appeal Commissioners.
Taxes in the nature of income tax not deductible
The analysis included in the decision of the Appeal Commissioner on this point is not entirely clear. There is some old case law in Ireland and the UK that concludes that foreign taxes on profits (or 'income taxes') are not deductible when calculating taxable profits. The taxpayer argued that as the foreign tax withheld from the royalty was calculated on the gross amount, it was not a tax on profits (or an 'income tax') and therefore that older case law did not apply.
The Appeal Commissioner rejected this position pointing to the claim for partial relief under the credit system as an acceptance by the taxpayer that the foreign tax was in the nature of an income tax. In addition, the Appeal Commissioner referred to a UK case that confirmed that a Venezuelan turnover tax could be regarded as a tax on profits even though the tax was applied by the Venezuelan authorities on a gross basis.
The Appeal Commissioner's analysis on the nature of the tax (which is critical to the outcome of the case) is somewhat opaque and it is hoped that when the case is considered by the High Court an in-depth review of this point will be included in the decision.
Not laid out or expended for the purposes of the trade
In determining whether the withholding tax was "laid out or expended for the purposes of the trade", the Appeal Commissioner had regard to Harrods (Buenos Aires) Limited v Gooby (HM Inspector of Taxes)  41 TC 450. That case concerned an Argentinean tax on the capital of a UK business which was held to be deductible. Failure to pay the tax could have resulted in the taxpayer being precluded from carrying on business in Argentina.
The Appeal Commissioner distinguished the Harrods case noting that the foreign withholding tax in the instant case did not "constitute a mandatory pre-condition to carrying out business in the source State the way the capital tax did in Harrods; it is simply a consequence of having carried out business in the source State." Overall this appears to be a very high threshold to meet in order for any foreign tax to be treated as deductible and it will be interesting to see the High Court's position on the point.
High Court appeal
No date has yet been set for the High Court appeal. However, it is likely to be a case that will be closely watched by many corporate taxpayers operating in Ireland.
Originally published in International Tax Review on Tuesday, 29 May 2018.
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