A tax loophole, costing the Exchequer some £10 million a year, has been closed off by the Minister for Finance. Mr McCreevy is introducing a committee stage amendment to the Finance Bill, which will impose restrictions from today on the manner in which certain losses and capital allowances can be written off against tax.
It has emerged that some investors were putting funds into schemes which were creating artificial "losses", which the investors then wrote off against their tax liability. The Revenue Commissioners' analysis of the tax affairs of 400 individuals earning more than £250,000, published earlier this week, showed that losses accounted for tax deductions of £9.4 million in the 1993/94 tax year and £8.5 million in 1994/95. While the writing-off of previously incurred losses against tax would be legitimate in many cases, it has now emerged that some schemes were being set up specially to create artificial tax losses. The schemes worked in a way which allowed losses to be created and set-off against the partner's other income, leading to a tax repayment greater than the amount invested.
The schemes being marketed involve investment in films, oil and gas exploration, according to a statement from Mr McCreevy. The committee stage amendment will counter the tax advantage arising from investment in these activities by restricting the use by a "passive" partner of any entitlement to losses and capital allowances. Such losses and capital allowances will only be allowed against the partner's share of partnership profits and only to the extent of the partner's capital contribution to the partnership. They will not be available for offsetting against other income. If further similar abuses come to light in any other area of activity, the Minister said he would not hesitate to legislate against them with immediate effect. The full extent of these schemes has been uncovered since the Budget. The Department of Finance feared that, given the cut-backs in other areas of capital allowances in the Budget, the danger was that these schemes would be actively marketed by tax planners.
The schemes now being outlawed worked along the following lines. Ten investors form a partnership with a promoter and a company. The investors contribute capital of £10,000 each and the partnership borrows a further £1 million. In the first year of trading, the total funds - £1.1 million - are spent and little or no income is received. So the partnership makes a loss of £1.1 million and this loss is allocated to the ten investors as £110,000 each. Each investor, in computing tax liability, sets off this loss against other income to reduce tax, which in this case would be worth £50,600 - calculated as 46 per cent (the top tax rate) of £110,000.
Typically, many of the investors would then resign, with no further liability to partnership debts, but with no entitlement to any profits the project might yield in future. The initial outlay of £10,000 has allowed the investors to claim £50,600 from the Exchequer.
