Finance Act 2011 – Personal Tax

The Memorandum of Economic and Financial Policies agreed between Ireland and the IMF in December 2010 provided for an ‘income tax-led revenue package – sized at over €2 billion in a full year’. Tax changes introduced in Finance Act 2011 reflect this agreement and whilst top rates of tax remain unchanged, the tax base has been widened with resultant painful increases in effective tax rates for most individuals.

Finance Act 2011 contains comprehensive measures to increase the tax base. These changes, which will affect virtually all taxpayers, are outlined below:

  1. The Universal Social Charge (“USC”) – the USC applies from 1 January 2011 and effectively replaces the Health Levy and the Income Levy. The USC is levied at rates of up to 10% and applies to income before deduction of any pension contributions. A key feature of the USC is that the maximum rate of 10% applies once income (of certain taxpayers) reaches €100,000 whereas the top-rate of combined Health and Income Levy did not apply until income of almost €175,000 was reached.
  2. Termination Payments – the Act contains new rules to cap the tax exemption on termination payments at €200,000. Previously employees and directors with lengthy service periods and high annual salaries could avail of substantially higher tax-free amounts on retirement.
  3. Pensions – quite drastic changes have been introduced which limit the tax benefits of pension funding and may lead to reduced levels of contributions to pension funds in the future. The changes include the following:
    • The earnings cap for contributions by employees and the self-employed has been reduced to €115,000. The maximum amount of pension contributions that can qualify for tax relief will be a percentage (based on a person’s age) of this amount. For example for a person aged 45 the percentage is 25% therefore the maximum level of contributions attracting tax relief is €28,750.
    • Whilst Income Tax relief on qualifying contributions will remain at 41% in 2011 the rate of relief will fall gradually to 20% by 2014.
    • No relief is available from employee PRSI or the USC.
    • Employer PRSI relief on contributions is reduced by 50% (i.e. relief will be available at 5.37% rather than 10.75%).
    • A cap of €200,000 has been placed on the maximum tax-free lump sum that a person can avail of on retirement.
    • The Standard Fund Threshold (“SFT”) has been reduced to €2.3m (subject to limited exceptions). Where a person has a fund valued at more than €2.3m on retirement a charge to tax at 41% arises on the excess of the fund value over €2.3m. Further tax arises when the fund is drawn down by the individual.
    • From 2010 onwards a ‘deemed distribution’ of 5% of fund value will apply to the Approved Retirement Funds (“ARFs”) of retired individuals. The amount of the deemed distribution (less actual distributions) will be subject to income tax in the hands of the pension fund holder.
  4. Property Reliefs – Significant restrictions on relief for property based investments were announced in Budget 2011. These restrictions included limiting the range of income that allowances can be offset against and eliminating relief for allowances carried forward from previous years. The restrictions have not come into legal effect as the Government has commissioned and is awaiting an assessment of their likely economic impact.
  5. Patent Royalties – Finance Act 2011 contains legislation to abolish the exemption from Income Tax on royalties and certain dividends received by certain patent holders.

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