The key features of the Participation Exemption introduced in Finance Bill 2024 include:
- Applicable in respect of dividends or other distributions received as income from EEA/Treaty resident companies
- Optionality - elect in on an accounting period by accounting period basis. Exists in tandem with current ‘tax and credit’ regime
- Ownership requirement - 5% of ordinary share capital, profits and assets entitlements for continuous 12 month period
- It is expected that where a dividend/distribution is paid out of profits - no 626B requirement exists (Note: the current wording creates slight uncertainty around this point and clarification may be needed)
- Where dividend/distribution paid out of assets - 626B test to be satisfied
- Exclusions for S110 companies, capital receipts and, amounts in respect of which a tax deduction was or may be taken
Background
Prior to Finance Bill 2024, Ireland has generally only operated a ‘tax and credit’ approach to dividends received by Irish companies from non-Irish resident companies. The general starting point has been that dividends received by Irish resident companies from non-Irish resident companies are taxable as Case III income at 25%. However, there are currently various relieving measures of potential application to reduce or eliminate the tax payable (e.g. Section 21B) on such dividends and/or to provide credit for foreign tax against Irish tax (e.g. Sch 24).
The purpose of mentioning the existing measures at the outset is to highlight that all of the existing ‘tax and credit’ measures will continue to remain in place post the introduction of the Participation Exemption. The Participation Exemption does not replace those existing measures and exists in tandem with the ‘tax and credit’ regime.
How does the Participation Exemption work?
The treatment available under the newly introduced regime is optional and is available upon election (on an accounting period by accounting period basis) into the regime. The election is made in the corporation tax return for the period of receipt of the recipient company.
If the election is not made and the status quo remains, then no dividends will be exempted and the existing Case III treatment applicable to such receipts will continue as before with the above ‘tax and credit’ approach applying to those receipts.
If the election is made, then all income receipts which meet the conditions to qualify for the Participation Exemption will be exempted and all income receipts that do not will continue to be taxed under the existing ‘tax and credit’ regime.
To qualify for Participation Exemption treatment in respect of a ‘relevant distribution’, a ‘parent company’ must have a ‘relevant participation’ in a ‘relevant subsidiary’ and that ‘parent company’ must elect into the regime for the accounting period in which it received any relevant distributions. This essentially means that to qualify:
- a ‘parent company’ must have a direct or indirect ownership of 5% or more of ordinary share capital of the paying company (the ‘relevant subsidiary’) and have 5% or more profits and assets entitlements. However, holdings held directly or indirectly via a non-EEA/Treaty resident entity are excluded from the calculation of this 5% test as are any shareholdings in respect of which the disposal proceeds would be treated as a trading receipt.
- the ‘parent company’ must receive the dividend within an uninterrupted period of 12 months or more during which it has owned the required percentage shareholding in the ‘relevant subsidiary’.
- the ‘relevant subsidiary’ (i.e. the company making the ‘relevant distribution’) must be, by virtue of the law of a relevant territory, resident for the purposes of a foreign tax that generally applies to income, profits and gains which corresponds to Irish corporation tax and is imposed at a nominal rate greater than zero per cent. The subsidiary cannot be generally exempt from foreign tax in that territory. It must be so resident both at the time of paying the ‘relevant distribution’ and from either the time of its incorporation up to date of payment of the relevant distribution or for a 5 year period up to that date, whichever is the shorter (known as the ‘relevant period’). In addition, it must not have, within that ‘relevant period’, acquired any part of another business or the whole or greater part of the assets of another business, where the business concerned was previously carried on by another company that was not resident in a ‘relevant territory’ during that same period. Neither can the ‘relevant subsidiary’ have been formed through a merger at any time during that period, where a party to the merger was another company that was not resident of a relevant territory during the ‘relevant period’.
- a ‘relevant distribution’ must be paid or made. In this regard, a ‘relevant distribution’ is a dividend paid, or other distribution made in respect of the share capital of a ‘relevant subsidiary’ either “out of profits” or “out of assets”, as the case may be, of the ‘relevant subsidiary’ that constitutes income in the hands of the recipient which would otherwise be taxable as Case III income (or Case IV income in respect of S138 type dividends). The terms “out of profits” and “out of assets” are important and are considered below as follows:
- “out of profits” - The definition of “profits” follows that adopted in 21B as “the amount of profits, after taxation, as shown” in the profit and loss account or income statement of the company. Therefore, in effect, all ‘relevant distributions’ paid out of a reserve traceable to profits that have been shown in the income statement or profit and loss account of a ‘relevant subsidiary’ have the potential to qualify. Companies that are already availing of 9I or 21B(3) treatment will be familiar with the need to identify “profits” out of which the dividend is said to have been paid and will be familiar with having to undertake such identification and tracing exercises. However, where it is not possible to trace a dividend as being paid out of “profits” then consideration would need to be given to whether or not that ‘relevant distribution’ can instead be said to have been paid “out of assets” (discussed below). It is expected that it will not be necessary to be eligible for S626B relief in respect of shares in a ‘relevant subsidiary’ if claiming Participation Exemption in respect of a ‘relevant distribution’ paid out of “profits” - this was the understood intention but the current wording makes that position slightly uncertain. It will be seen below that such a condition does exist if a ‘relevant distribution’ is made out of “assets”. To ensure that relief is being claimed on the basis of a ‘relevant distribution’ being paid “out of profits” (and avoid the need to undertake a S626B analysis) it may be important to properly document in the paying company that the dividend is being paid out of specific profits of a period or periods.
- “out of assets” - Where a relevant distribution is not paid out of “profits” of the “relevant subsidiary” (e.g it may have sufficient reserves to make a distribution resulting from a capital reduction, the particular ‘relevant subsidiary’ may not be required to have reserves to make a distribution under foreign corporate law or the foreign law may permit a distribution from a share premium account) then it may still be possible to get Participation Exemption treatment on the receipt. Such treatment may be available where the ‘relevant distribution’ is made “out of the assets of the relevant subsidiary where the cost of the distribution, or that part of the distribution, as the case may be, falls on the relevant subsidiary”. Accessing Participation Exemption in respect of ‘relevant distributions’ made in that manner is only possible if the ‘parent company’ would be eligible for S626B on a disposal of shares in the ‘relevant subsidiary’ at the time of the receipt of the ‘relevant distribution’.
The participation exemption does not apply to receipts in the nature of capital. Establishing the receipt as being received as income should be straightforward where the mechanic employed by the ‘relevant subsidiary’ in paying the sum to the ‘parent company’ in respect of the share capital is a normal dividend mechanic.
It is welcome that the participation exemption can be applied to parts of a dividend. Complexities may arise in practice in establishing what part of the dividend can qualify for the exemption which will likely need to be addressed in Revenue guidance.
Exclusions
Certain items are also explicitly excluded from the meaning of ‘relevant distribution’. These are:
- a distribution that has been, or may be, deducted for the purposes of tax in any territory outside the State,
- a distribution in a winding up,
- any interest or other income from debt claims providing rights to participate in a company’s profits,
- any amount considered to be interest equivalent within the meaning of section 835AY, or
- any dividend paid or other distribution made by an offshore fund within the meaning of section 743.
In addition, Section 110 companies are not eligible for Participation Exemption treatment.
9i relief vs Participation Exemption
For EU resident companies, the Participation Exemption is an improvement on the pre-existing 9i treatment mentioned above as it removes the need to consider the rate per cent of tax that the profits from which the dividend was paid were subjected to in the foreign territory. It also has potential benefits compared to dividends paid out of certain profits exempted from tax in the foreign territory where those profits would have qualified for a ‘s626B type’ capital gains exemption. The reason why the Participation Exemption can be seen as an improvement to 9I in this regard is that there have been some doubts as to whether or not 9I treatment was available on such dividends given that profits which benefited from the foreign equivalent of a ‘s626B type’ regime may have been relieved by way of exemption and therefore were arguably not ‘subject to tax’ (a requirement for 9I relief to apply). Strong EU law arguments existed to counter such a view but, with the introduction of the Participation Exemption, more certainty now surrounds the tax treatment of dividends paid out of such profits where an election is made to take Participation Exemption treatment for that accounting period instead of 9I treatment.
Consequential amendments in the TCA 1997
A number of consequential amendments are made as a result of the introduction of the Participation Exemption. Some of which are considered below.
Section 129A - Dividends paid out of foreign profits
Section 129A has been amended such that the effect of S129A is disapplied in respect of distributions received from a company that becomes Irish resident where the distribution is paid out of profits arising before the paying company became resident in the State and the Participation Exemption would have applied to the distribution if it was paid the day before the company became resident.
Section 835E - Ireland to Ireland TP exclusion
An amendment applies to ensure the status of a holding company for the purposes of assessing its eligibility for S835E treatment is not altered where Participation Exemption is availed of by that holding company.
Practical issues from 1 January 2025
From 1 January 2025, Corporate taxpayers in receipt of dividends from EEA/Treaty resident companies will need to consider the following:
Should the recipient company elect for Participation Exemption treatment or rely on 9I or other relevant relieving measures in Schedule 24 (potentially in combination with 21B relief)?
If electing in, should the dividend be documented as being specified as being paid out of certain profits of a period to ensure the dividend received is considered as having been paid out of “profits”?
If electing in, should the dividend be documented as being specified as being made out of “assets” if it is difficult to identify it as being paid out of profits - if so, is the recipient eligible for S626B in respect of the shares of the paying company at time of receipt?
If the company elects in, will that have any other consequences for dividends received from that company that need to be factored into the decision to make the election?
Next year - expansion of territorial scope?
In his Budget Speech on 1 October, Minister Chambers stated “[w]ork will continue in the coming year on participation exemptions, including further consideration of geographic scope and of a foreign branch exemption.” Engagement will therefore likely continue between stakeholders and the Department of Finance in relation to the Participation Exemption as introduced and the appropriateness of amending or expanding the regime to include dividends from companies resident outside of the EU/EEA. PwC will be an active participant in any such process in an effort to improve and streamline the relief. We will invite and welcome your feedback on the regime as part of that proess.
We are here to help you
The introduction of a Participation Exemption has been a long time coming and follows an extended period of consultation. Although limited in geographic scope at present and requiring administrative exercises almost as burdensome as the existing ‘tax and credit’ regime, it is still a welcome addition to the overall holding company tax regime and it is hoped that it will be expanded upon and streamlined in future Finance Bills. If you wish to discuss any aspect please reach out to the authors or your preferred PwC contact.
