Day of reckoning awaits SMEs on warehoused tax debt

First the positive news: Irish tax revenues held up surprisingly well last year despite the pandemic closing down most of the economy for large periods of time.

This was confirmed in the Department of Finance’s annual taxation report yesterday, which showed that income tax revenues declined by just 1 per cent last year to €22.7 billion. Overall, tax revenues fell by just 3.6 per cent in 2020.

This was despite more than 700,000 being classified as unemployed in April last year (the first full month of the initial lockdown) as people were laid off and availed of the Pandemic Unemployment Payment.

As noted in the report, the “shock” to the labour market was concentrated in sectors that are “relatively income tax poor” – people in low paid jobs and young workers, typically in the hospitality trade and other services sectors.

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It was another stellar year for corporation tax receipts, which rose by just shy of €1 billion or 9.5 per cent to €11.8 billion

For the most part, multinational companies and exporters continued to trade strongly, a trend that has carried on into this year, hence Davy’s decision on Monday to double its gross domestic product growth forecast to 10 per cent for 2021.

It was another stellar year for corporation tax receipts, which rose by just shy of €1 billion or 9.5 per cent to €11.8 billion and now account for about one-fifth of exchequer tax revenue.

Tax reform

Of course the report noted the “significant risks” to this income stream from the international talks on tax reform, with Ireland declining to sign up recently to a draft OECD plan on corporate tax.

The other risk is the fact that a little more than half of this revenue is derived from just 10 companies. They are not named but we can assume that it is the biggest multinationals operating in the State.

That proportion has been rising in the past five years and if just one of those businesses decided to quit the Irish market, it would clearly make a significant dent in our finances, both via corporation receipts and employment taxes.

There’s no suggestion that this is about to happen but it can’t be ruled out in a scenario where corporation tax rates could be equalised across the world, and where remote working could change the dynamic around where Big Tech companies locate their activities.

This exposure to a small number of multinationals was identified some time ago by the department, with official forecasts incorporating a €2 billion loss relative to the baseline by 2025.

As noted by Grant Thornton tax partner Peter Vale, it is “incredibly difficult” to predict the impact of the proposed global changes on our corporate tax receipts, with a lot of detail yet to be agreed, and US president Joe Biden still to get it through Congress in the United States.

Vale suggests it is possible that our corporate tax receipts might increase in the future, if we are obliged to increase our corporate tax rate to the 15 per cent level being proposed, and there is no “significant outflow” of multinationals as a result. Time will tell.

Debt warehousing

The Government also needs to worry about local SMEs, many of whom have been hammered in the pandemic. These businesses have been kept afloat by a range of supports from the State, including a debt warehousing scheme to provide liquidity to struggling businesses.

Qualifying businesses are allowed to warehouse certain liabilities owed to Revenue interest-free for 12 months. According to the department’s annual report, some €1.9 billion was warehoused by about 70,000 businesses last year.

In June, the warehousing period was extended until the end of this year, which means this liability will be interest free for the whole of 2022. From January 2023 onwards, an interest rate of 3 per cent will apply to any debt outstanding.

Latest data from Revenue shows that 86,000 individual businesses were availing of the scheme, with aggregate liabilities of €2.4 billion. Half of this was VAT due with the balance of mix of employers’ PAYE, income tax, and PRSI.

On average, these businesses owed €28,000 each to Revenue at the end of June. It doesn’t sound like much but it will be a huge sum of money for a lot of SMEs to have to find, over and above their normal day-to-day expenses in a recovering economy.

A more likely scenario is that many of those SMEs with warehoused debt will struggle to survive once they are expected to pay the money back

And let’s not forget that most pubs, restaurants, cafes, cinemas, shops and the like are not operating at full capacity right now. And there are few tourists around to bolster spending.

The suspicion is that there are a lot of zombie companies being kept on life support by the various Government supports, including the debt warehousing scheme.

The economy might well take off like a rocket as predicted by Tánaiste and Fine Gael leader Leo Varadkar recently, with the result that the Revenue will get to collect all of the substantial debt that has been warehoused.

Unfortunately, a more likely scenario is that many of those SMEs with warehoused debt will struggle to survive once they are expected to pay the money back. And adding interest to the bill won’t help those just about hanging on.

The Government will have a difficult decision to make from 2023 onwards – let those who can’t repay the debt fail, or write off some or all of their debt to keep them in business to retain employment and avoid a potential backlash at the next election.