I will use my opening statement to elaborate a little on some aspects of the subject matter that may be of particular interest to the committee. I will speak first on the role and effect of investment incentive tax relief. There is little doubt that tax incentives, when properly focused, are considered by Government to be an important tool in their ability to stimulate investment in areas of the economy where such investment is deemed necessary. This tool works because a common instinct of taxpayers is to seek to reduce their tax liabilities. It is easy to understand this instinct. Governments worldwide have sought to harness it so that it is productively directed towards improving the levels of investment in under-developed and under-resourced areas of their economies and societies. The underlying economic theory is that such incentives increase the after-tax return on investments, which although desirable and valuable from a broader societal perspective, would be unattractive to individual investors without the tax incentive. Decisions in this area therefore are essentially economic and socio-political, rather than specifically inherent to the operation of the tax system.
The use of tax incentives in Ireland to encourage particular types of activities or to channel investment in a particular direction has been a feature of our taxation system under successive Governments since the 1950s. In general, availability of most of these incentives has led to economic activity that otherwise either would not have occurred at all, or would not have occurred at the same pace, or would not have occurred in the desired areas and sectors.
In the early days the general approach was focused on income exemption. The reliefs generally provided for the exemption of income from a particular source such as export sales relief and patent income. Some of these were very successful and few will argue about the effectiveness of export sales relief in the modernisation of Irish industry during the 1960s and 1970s. Over time the income exemption approach to tax relief evolved and was joined by the investment-based approach. Initially these investment-based reliefs were merely the bringing forward of available allowances and reliefs for capital expenditure on industrial buildings, plant and machinery and hotels. Most accountants would assert that these reliefs were no more than an integral part of the cost of the economic activity of the business.
In the early 1980s the first relief was introduced which was based on a deduction for capital expenditure that otherwise would not be allowable. This was done in a manner that resulted in no claw-back if the asset was held for a shorter period than its expected useful life. This was called section 23 relief and it was introduced at a time when the building trade was in a slump. At the same time, a first time buyers' grant was introduced to encourage construction of new houses and apartments. There was a dramatic turnaround in the house building industry that is generally acknowledged as having a positive correlation with the introduction of these two provisions.
Other property-based incentives have been introduced since and reliefs and incentives in Ireland now take a number of forms and have different, and sometimes numerous, objectives. I have given the committee a listing of the main reliefs and incentives currently available as well as the costs and the numbers availing of these reliefs where they are available. I emphasise that the range of reliefs is such that they are of benefit to a very wide spectrum of taxpayers. The major reliefs include exemption of child benefit from income tax; capital allowances, the bulk of which are normal business capital allowances in lieu of depreciation; employee and employer pension costs reliefs, which are very widely availed of; exemption from capital gains on the sale of one's principal private residence; special savings investment accounts, which are availed of by more than one million taxpayers; mortgage interest relief; and medical insurance and health expenses relief.
I have also briefed the committee on the reasons many reliefs and incentives are not currently costed and I will expand on this. First, I acknowledge that tax reliefs and incentives represent a significant overall cost to the Exchequer and, of course, they narrow the tax base. It is, therefore, essential that they be subject to ongoing review and the availability of figures for the tax cost of these reliefs is one essential ingredient for such reviews. The tax costs of many reliefs, however, have always been difficult to determine accurately due mainly to the absence of detailed and specific information. The current availability of cost and other information on individual schemes varies considerably and it is ascertained in a number of ways, either through tax returns, through the separate claims mechanisms used or through estimation from data available from other, sometimes non-Revenue, sources. Even so, there are many areas where information is not available and where we acknowledge it is past time it should be. Prime examples are the pensions area and the area of capital allowances.
What are we doing in response to this? As outlined in the written brief to the committee, Revenue and the Department of Finance have been working closely together recently to investigate information and data capture issues with a view to improving data quality and transparency. We are, however, trying to do this without overburdening compliant taxpayers and with minimal impact on Revenue's ongoing strategy to keep compliance costs as low as possible and to simplify forms procedures and regulations. We are, therefore, introducing a number of changes to tax returns which will yield additional information regarding the tax costs of various reliefs and incentives and also relief in regard to pensions. The additional information will be first captured in 2004 tax returns which become due late in 2005. Preliminary analysis for some categories will become available in early 2006.
I have provided the committee with a full listing of approximately 25 reliefs in respect of which we will collect additional information. This does not cover every possible relief but we have decided to focus on those tax expenditures for which the availability of cost information would make a contribution to evaluation and policy making that would justify the additional burden of collecting the information. We will continue to keep this matter under review. It is the view of Revenue that as a matter of general policy any new relief or incentive schemes should require that the credit or amount be separately identified by the claimant. It is also a fact that ongoing IT developments in Revenue will facilitate greater data capture in future without significant added burden on taxpayers. Despite our best efforts, this means that tax forms will necessarily be longer and I expect some complaints about this. Where the administrative burden on business is increased, the committee may also receive such complaints.
As there has been considerable comment on property based capital allowances I will refer for the committee's information to two aspects of those allowances, namely restrictions which have been applied and termination dates. On restrictions, the Finance Act 1998 imposed restrictions on the set-off of excess capital allowances by passive individual investors, generally lessors, against income other than rental income. A passive individual investor is now only entitled to set off excess capital allowances of €31,750 against his or her non-rental income. This restriction applies to all capital allowances due on construction or refurbishment expenditure on industrial and commercial properties excluding hotels, holiday camps and holiday cottages. The same Finance Act also restricted the set-off of excess capital allowances available to passive individual investors in certain hotels, apart from those in north-west counties, and holiday camps. A passive individual investor is only allowed set excess capital allowances against other rental income, that is, there is no set-off against non-rental income.
While these restrictions were introduced in 1998, they only apply, subject to the transitional provisions, to construction or refurbishment expenditure incurred after 3 December 1997. Capital allowances due in respect of expenditure before that date or that come within the transitional provisions are not subject to these restrictions. Therefore, unrestricted capital allowances are still available in respect of qualifying expenditure. The Finance Act 1992 restricted the set-off of capital allowances available in respect of expenditure on holiday cottages. Subject to certain transitional provisions the restrictions applied to expenditure incurred after 24 April 1992. It is important to note that many investors have substantial rental income and are still in a position to make substantial use of the capital allowances available.
On the termination dates of schemes, most of the current incentive area schemes are due to finish on 31 December 2004 subject to transitional provisions that extend that date to 31 July 2006. The termination dates relate to the date by which expenditure must be incurred on a property in order to qualify for capital allowances. Therefore, while capital allowances will not be due in respect of expenditure incurred after the termination dates they will continue to be due in respect of expenditure incurred prior to those dates. For example, if a project has met the transitional provisions so that the qualifying period is 31 July 2006, if qualifying expenditure of €10 million was incurred before 31 July 2006 and if the property is brought into use before the end of the tax year 2006, allowances could continue to be claimed as follows. In 2006, an initial allowance of 50% of the €10 million, which is €5 million, could be claimed, although I realise certain nuances surround this issue as was clear from the earlier discussion on what exactly is allowable from the €10 million. For the following 12 years, annual allowances of 4% per annum would also be available, with the balance available in the 13th year.
I will move on to the matter of residence. I have given the committee a detailed briefing on the somewhat complex set of rules that apply to residency and domicile for tax purposes. In this statement I have nothing more to add except to clarify that there is no such thing as a Revenue list of Irish citizens who are tax exiles. Tax returns did not historically request data on citizenship as the question of whether a person is an Irish citizen has no general relevance for tax purposes. There are considerable numbers of Irish citizens living abroad who make tax returns to Revenue, for example, in respect of income earned here on the rental of houses etc. However, Revenue has a general entitlement to make all relevant inquiries in regard to any tax return or statement made to it and, where appropriate, to carry out an audit to verify the accuracy of the return or statement. This applies in exactly the same way to returns or statements made by people claiming to be non-resident as it does for all other taxpayers.
All Revenue's interventions, whether they be audit or special compliance inquiries, are made on the basis of indicators of risk. The status of claims to non-residence is included in risk profiling and this is an area to which we pay special attention. We have access to a variety of sources which can assist us if we deem it necessary to make verification checks on claims to non-residency for any individual or any particular period of time. However, there are no indications at this time that Irish domiciled persons who claim non-residence are unable to demonstrate that they were outside the State for the requisite 183 days. Awareness of Revenue's general interest and audit programme in this area, together with the financial consequences of non-compliance, seems to motivate these individuals to keep their residence patterns within the rules.
There has been much comment in recent days about information provided in response to a parliamentary question which indicated that a small number of people — 11 in all — with gross incomes exceeding €1 million had no net liability to tax in the tax year 2001. It was also indicated that of those in the PAYE sector who earned €100,000 or more, less than 0.5% had a nil net income tax liability, less than 0.5% had a net liability at the standard or marginal relief rates and over 99% had a liability at the higher rate. The comparable figures for the self employed were 2.1% with a net nil liability, 1.2% with a net standard rate liability while 96.7% had a liability at the higher rate.
It may be useful to indicate that the 11 ended up, quite legally, paying no tax primarily through extensive use of property based capital allowances. However, other factors included ordinary trading losses or business losses and charitable donations.
The committee is aware that in 1997 and again in 2002, the Revenue Commissioners conducted studies of the effective tax rates of the top 400 earners, based on the tax years 1993-94 and 1994-95, the 1997 study, and the tax year 1999-2000, the 2002 study. We are in the process of completing a similar study based on the tax year 2001. The 2002 study indicated that, between tax years 1994-95 and 1999-2000, there had been an increase in the effective tax rate of high earners. While the current study is not yet complete, it would appear that this trend has continued. This indicates that measures such as the capping in 1998 of capital allowances available to passive investors are gradually having the desired effect. We expect that the study will be completed shortly and presented to the Minister for Finance. The earlier studies were placed in the Oireachtas Library.
The general matters under discussion here today, including the use of reliefs and incentives, residency for tax purposes and effective rates of tax for high earners, are all matters in which the Revenue Commissioners take a keen interest as part of our responsibility for tax administration and, in particular, tax compliance. In restructuring our organisation over recent years, we have had a particular focus on more effective policing of these areas. Many, though not all, of the individuals or entities whose tax affairs are entwined with such allowances or exemptions now fall within the remit of our large cases division and I have given the committee a detailed briefing on the approach adopted by that division in doing its work.
In recent years, the Revenue Commissioners have put significant effort into building a tax-compliant culture in this country. We have made progress but there is still some way to go. It is our business to apply the law effectively and fairly. Any perception to the contrary makes some compliant taxpayers resentful at best or at worst encourages them to consider evasion. No doubt, similar considerations apply to the structure of the tax system itself and the validity of reliefs.
