Ireland: The Deductibility Of DSTs In Ireland: Some Clarity At Last

The delayed implementation of pillar 1 of the OECD's global tax reform deal means many multinational groups will continue to incur digital services taxes — at least in the short term. Helpfully, Irish Revenue recently published guidance accepting that DSTs may sometimes be deductible for Irish corporation tax purposes.¹

This article explores the legal basis for treating DSTs as deductible expenses for corporation tax purposes, focusing by way of example on the DSTs levied by France and the United Kingdom.

DSTs

Overview

DSTs are generally levied on gross revenues generated from the provision of specific digital services to users in a territory, irrespective of the tax residence of the digital service provider. They present several challenges for taxpayers. For instance, they can be structured differently across jurisdictions, and the introducing jurisdiction will likely argue that its DST is not a covered tax for tax treaty purposes.

U.K. and French Regimes

The table outlines the key features of the DSTs in the United Kingdom and France.

The Legal Basis for Deducting DSTs in Ireland

Overview

For taxpayers operating in Ireland that incur DST costs, the fact that a particular DST might not qualify for relief under a double taxation treaty does not necessarily mean no relief is available for the tax cost incurred. Depending on the taxpayer's circumstances and the DST's structure, the cost incurred may be deductible as a trading expense for corporation tax purposes.²

U.K. and French DSTs

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To qualify as a deductible trading expense, the DST must be incurred wholly and exclusively for the taxpayer's trade and must not be an income tax.³ It also should not be a creditable tax that can be offset against the taxpayer's corporation tax liability under Irish law.

Wholly and Exclusively for the Trade

Case Law

For an expense to be wholly and exclusively incurred for a trade, one U.K. court said it must be incurred "for the purposes of earning the profits" of the trade.⁴ The Irish Supreme Court has upheld that approach. ⁵

In determining whether a tax expense is incurred wholly and exclusively for the trade, courts have tended to draw a distinction between taxes on profits and other taxes.

The House of Lords has held that the U.K. branch of an Irish company was not entitled to deduct Irish income tax as an expense for U.K. income tax purposes.⁶ The court held that the income tax could not be treated as a deductible expense in computing trade profits because it was levied on profits after they had been earned. As such, the court held that the tax could not logically be incurred "for the purposes of earning" those profits.⁷ In particular, the House of Lords said taxes such as income tax, corporation profits tax, and excess profits tax are not wholly and exclusively laid out for purposes of a company's trade. It continued, "Taxes such as these are not paid for the purpose of earning the profits of the trade: they are the application of those profits when made and not the less so that they are exacted by a dominion or foreign government."

xacted by a dominion or foreign government." By way of contrast, the U.K. Court of Appeal considered the tax deductibility of an Argentine substitute tax.⁸ Foreign companies doing business in Argentina were required to pay the annual substitute tax of 1 percent of the value of the company's capital irrespective of whether the company earned any profits in a given year. In holding for the taxpayer that the substitute tax was a deductible trading expense, the court was influenced by the fact that the tax was paid to ensure the company could continue trading during the next and succeeding years:

Given the foregoing, when applying the wholly and exclusively test in the context of a DST, all the facts and circumstances surrounding incurring the tax must be considered together with the manner in which the relevant DST is levied. To satisfy the test, the taxpayer must be able to demonstrate a purposive nexus between incurring the relevant DST and earning profits in its trade.

In light of the scope and application of the U.K. and French DSTs, it is likely that an Irish taxpayer would be considered to have incurred the taxes wholly and exclusively for its trade. Even so, that must be confirmed case by case

HMRC Guidance

HM Revenue & Customs has published guidance⁹ supporting the deductibility of DSTs in the United Kingdom, which is based on the case law above, noting in particular:

There is no reason in principle why the same approach should not be equally applicable in an Irish tax context.

TAC Determinations

The Irish Tax Appeals Commission (TAC) issued determinations in 2018¹⁰ and 2019¹¹ on whether foreign taxes may be deductible as a trading expense for corporation tax purposes.¹²

In the 2018 determination, the TAC said foreign withholding tax incurred on royalty income (which was a trading receipt in the circumstances) could not be treated as a deducible expense for corporation tax purposes.

The taxpayer sought to treat the excess foreign tax that could not be relieved under Ireland's tax credit rules as a deductible expense. The TAC held that because the taxpayer had accepted that the tax in question was a tax on income — that is, a profits tax — for claiming credit relief, it could not treat the tax as a deductible expense in computing trading profits.

In the 2019 determination, the TAC found that foreign withholding tax incurred on dividend income (also a trading receipt in the circumstances) could be treated as a deductible expense for corporation tax purposes.

The TAC rejected Irish Revenue's suggestion that a tax on income cannot be treated as a deductible expense as a general principle of Irish tax law, saying no general principle specifically denies a deduction for taxes that "are not calculated after the ascertainment of profit." Applying the case law above, the TAC determined that the taxpayer paid the withholding tax to enable it to carry on and earn profits in its proprietary trading trade.

Those different TAC determinations led to uncertainty regarding the scope of deductibility of foreign taxes for corporation tax purposes.

Footnotes

1. rish Revenue, “Tax and Duty Manual: Part 04-06-03” (Sept. 2022)

2. In Ireland, when a company is carrying on a trade such as the operation of online platforms or marketplaces or the provision of online advertising services, when calculating its taxable profits, the company is entitled to a deduction for all expenses wholly and exclusively incurred for conducting that trade. Trading profits in Ireland are taxable at 12.5 percent. When a company is not carrying on a trade, it might still be able to claim a deduction for expenses incurred in earning its taxable income when calculating its corporation tax liability. Non-trading income is taxable in Ireland at 25 percent.

3. Section 81(2) of the Taxes Consolidation Act 1997.

4. Strong v. Woodfield, [1906] AC 448. See also Smith's Potato Estates Ltd. v. Inspector, (1948) 30 TC 267. U.K. case law is persuasive, but not binding, authority in Ireland.

5. MacAonghusa v. Ringmahon Co., [2001] 2 IR 507.

6. IRC v. Dowdall O'Mahoney & Co. Ltd., [1952] AC 401.

7. See also Smith's Potato Estates, (1948) 30 TC 267

8. Harrods (Buenos Aires) Ltd. v. Inspector, 41 TC 450.

9. HM Revenue & Customs, “DST47100 — UK CT Deductibility of DST,” Digital Services Tax Manual (last updated June 14, 2021).

10. TAC Determination 02TACD2018.

11. TAC Determination 08TACD2019.

12. Determinations of the Tax Appeal Commission do not have strict precedential authority. However, the TAC can (and, in practice, often does) have regard to prior determinations when adjudicating on subsequent appeals raising common or related issues.

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