Tuesday 28 March 2017

The new government may be just 'talking the talk' when it comes to entrepreneurs

Hard-pressed Irish startups still suffering in comparison to their competitors in the UK when it comes to the issue of Capital Gains Tax
Hard-pressed Irish startups still suffering in comparison to their competitors in the UK when it comes to the issue of Capital Gains Tax
Richard Curran

Richard Curran

New enterprise minister Mary Mitchell O'Connor has given a strong commitment to properly incentivise entrepreneurship in Ireland using a raft of measures which includes cutting Capital Gains Tax for those selling businesses in the future.

Perhaps that should be slightly re-phrased. She gave a strong caveated commitment to reduce Capital Gains Tax for new startups to 10pc from 2017. The caveat is that she is committed to helping secure the commitment set out in the Programme For Government.

These decisions will ultimately be made by Cabinet and only with the backing of the Minister for Finance.

Nevertheless, slashing CGT for entrepreneurs selling their businesses would be a huge encouragement and it would also make Ireland a much more attractive place to locate a new startup.

The last government began the process by introducing a special 20pc rate of CGT for entrepreneurs selling, but it has multiple restrictions. The biggest was that it applied a lifetime cap of €1m on gains. This meant the absolute maximum it could be worth to someone in their lifetime was €130,000.

It basically meant that anybody selling a business was still going to have to pay three times the Capital Gains Tax they would in the UK, unless it represented relatively small gains.

In the UK, the Entrepreneurs' Relief on CGT sees qualifying taxpayers pay just 10pc CGT on the increase in the value of their business with a lifetime limit of £10m.

Before the election here, Richard Bruton said he would like to see a 10pc rate and a lifetime limit of £15m.

It is hard to say that entrepreneurs set up companies based on how much tax they will have to pay on any gain when they sell them. Yet, in an increasingly mobile labour and business market, it can matter. Consider someone in Dundalk deciding whether to set up their new company down the road in Newry or at home.

Consider someone from anywhere in the world who has a great startup idea and is considering where to locate it. That decision will be based on location, business environment, access to market, access to skilled staff and the tax regime.

In the UK, the Entrepreneurs' Relief scheme has been credited with increasing investment and startup activity quite significantly. The UK moved from 14th in the world on the Global Entrpreneurial Index in 2013 to 4th in 2015. Some of this increase was attributed to the CGT and investor tax reliefs.

Ireland stayed at 17th during that period, but interestingly, moved to 12th in 2016.

Inevitably, any tax incentive will be scrutinised on cost to the Exchequer and taxpayers as a whole. In the UK, there had been speculation that British Chancellor George Osborne would abandon the relief after analysis showed it had cost the Exchequer £2.9bn in 2013/2014, £2bn more than was originally forecast.

Over 60pc of the total relief was claimed by around 3,000 people.

Assessing the cost/benefit analysis of this measure is not straightforward. The more successful it is in encouraging entrepreneurship, the more it will cost as people avail of it. The real question is how many of those businesses or their owners would not be in the UK if it wasn't for the relief? And how much have overall CGT receipts gone up? The real gain comes in the taxes paid by the employees of these businesses and the jobs they create.

Unfortunately, these are very difficult questions to answer. In Ireland's case, we do know that the tax system systematically discriminates against the self-employed and entrepreneurs.

The last government began the process of addressing the discrepancies, but there is still a way to go. Before the last Budget, the Irish Taxation Institute calculated that a self-employed person on €18,303 per year pays €732 in PRSI, while an employee on the same income pays zero.

In truth, many startups today are run by people earning very little income, especially in the early years. Throw in the fact that the self-employed didn't enjoy a PAYE tax credit, and the extra 3pc USC on self-employed income over €100,000, and Ireland didn't look like the best country to start a business.

Fixing these anomalies won't be cheap. Giving the self-employed the same €1,650 tax credit as PAYE workers would cost the Exchequer €470m per year.

Michael Noonan began making the change in the last budget with a €550 credit and both Mary Mitchell O'Connor and the Programme For Government say it will equal the PAYE credit by 2018.

So fixing the problems is going to cost money. But it is based on the idea that economic growth and jobs will follow if we can get more people to start and run their own businesses here.

The CGT relief is about providing a better reward for sellers. It is interesting to see how it has worked in the UK. For example, anybody can get the lower CGT rate if they sell shares in a company in which they have been an employee or officer (including non-executive directors) for at least one year.

To benefit, you don't need to have worked a minimum number of hours with the company. You do need to own at least 5pc of the business.

The existing Irish CGT relief for entrepreneurs is more restrictive in that you must have spent at least 50pc of your working time in the service of that company - in a managerial or technical capacity -for three of the previous five years.

Any new concession is likely to be heavily scrutinised within the Department of Finance.

It will also be interesting to see if it applies to startups which begin trading after a certain date or whether it will apply to the sale of shares in any company where the entrepreneurial criteria have been met.

Perhaps one of the biggest imaginative leaps for civil servants will be incentivising outside investors and not just the entrepreneurs who put money into these companies. We already have very restrictive and limited tax breaks for investment in start-ups, which are very weak compared to the UK.

The environment for funding startups in Ireland has definitely improved, but may need further incentives if it is to compete for those very mobile businesses that could go to several different locations.

Enterprise Ireland has realised the potential value of attracting startups to Ireland, and with promotional literature like: 'Start in Ireland and take on the world'. It emphasises the low corporation tax rate, the people, the startup funding and the location, but not the tax regime for the self-employed or the entrepreneur.

However, if we don't get the taxation environment in order, people may well end up going elsewhere. Our low corporation tax rate is a big advantage for companies when they reach a profit in the first place.

There are corporation tax reliefs for startups, but many of them don't have a profit in the early years. In fact, those reliefs cost the Exchequer under €4.9m in 2013, showing how few companies actually qualified for them.

We will have to see if the new minister and her Cabinet colleagues can deliver on the promised changes for entrepreneurs. And if they do, how restrictive will the small print be?

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