SMALL FIRMS ASSOCIATION

PRE-BUDGET 2017

SUBMISSION

Presented to:

MINISTER FOR FINANCE, Michael Noonan, T.D.

MINISTER FOR PUBLIC EXPENDITURE AND REFORM,

Paschal Donohoe, T.D.

MINISTER FOR JOBS, ENTERPRISE AND INNOVATION, Mary Mitchell O’Connor, T.D.

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Table of Contents

EXECUTIVE SUMMARY ............................................................................................................. 2

INTRODUCTION .......................................................................................................................... 3

CONTEXT .................................................................................................................................... 3

TAXATION ................................................................................................................................... 4

Taxation of entrepreneurs and the self-employed ................................................................... 4

Ensuring work is rewarded ....................................................................................................... 5

PRSI ......................................................................................................................................... 6

Rewarding risk takers ............................................................................................................... 7

Other tax heads ...................................................................................................................... 10

Labour market issues ............................................................................................................. 11

EXPENDITURE .......................................................................................................................... 12

Capital expenditure ................................................................................................................ 12

CONCLUSION ........................................................................................................................... 13

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1. EXECUTIVE SUMMARY

Competitiveness must be at the heart of Budget 2017. The reality is that Ireland

remains a high cost location with numerous barriers and disincentives for

entrepreneurs and established businesses. The SFA calls on the Government to place

the same importance on competitiveness over the coming years as they placed on

macro-economic stability in the period following the financial crisis.

Taxation

Following the recent vote in the UK to leave the EU, the need to improve the Irish tax

offering for indigenous business has never been more urgent.

Priority recommendations:

End discrimination against the self employed in the tax system to encourage

entrepreneurship:

o Abolish the 3% USC surcharge that applies to the self-employed

o Increase the EITC to the same level as the PAYE tax credit

o Introduce a voluntary PRSI system for the self-employed

Reward work by increasing the entry point to the marginal rate of tax and

decreasing the rate by 1%.

Review employer PRSI to fulfil the commitment that the National Minimum

Wage increase on 1 January 2016 would not penalise employers.

Reduce the CGT rate to 20%, with a 10% entrepreneurial relief up to a lifetime

limit of €15 million, to stimulate investment.

Introduce a scheme similar to the UK’s Enterprise Management Initiative for

employee share options in small firms.

Expenditure

Ireland’s poor recent record of capital investment, coupled with its evolving

demographics, is leading to bottlenecks in transport, education, broadband, water,

health and other public infrastructure. Capital expenditure must reach 4% of GDP as

soon as possible. The Government should seek flexibility in the EU fiscal rules in order

to exempt this investment spending.

Priority areas for investment:

Improving broadband infrastructure, particularly in rural areas

Developing public transport links

Building a real motorway network

Addressing housing shortages

Enhancing education and in-work training

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2. INTRODUCTION

The Small Firms Association (SFA) is the trusted partner of small businesses in

Ireland, with 8,500 members and four affiliated organisations in all sectors and parts of

the country. Its mission is to deliver business-focused advice and insights to member

companies, influence government policy to the benefit of small businesses and

connect its members in a thriving community.

The SFA has a vision of Ireland as the most vibrant small business community in the

world – supporting entrepreneurship, valuing small business and rewarding risk

takers. Currently this vision is aspirational and significant policy reforms will be

required to make it a reality. The SFA welcomes the opportunity to submit our views

on Budget 2017 based on our experience, insights and knowledge of the small

business community, which comprises over 200,000 businesses, employing half of the

private sector workforce.

3. CONTEXT

Competitiveness must be at the heart of Budget 2017. This Budget comes at a time

when the tailwinds that have propelled the Irish recovery over the past number of

years are waning. Ireland has benefited from low oil prices, exchange rates and

interest rates, but these are all factors outside of our own control and liable to change.

We must not let them distract us from the underlying issues. Instead, the focus must

be on building solid, long-lasting foundations for business to thrive. Increasing global

economic instability in the aftermath of the Brexit vote and rising domestic business

costs create a very different context for Budget 2017 compared with Budget 2016. It is

also critical to recall that while for many the fragility of the crisis years has passed, the

recovery has not been consistent regionally or sectorally. Many small businesses are

still waiting to feel the upturn.

The SFA calls on the Government to place the same importance on competitiveness

over the coming years as they placed on macro-economic stability in the period

following the financial crisis. The attractiveness of the Irish business environment

internationally determines the standard of living across the country, but the reality is

that Ireland remains a high cost location with numerous barriers and disincentives for

entrepreneurs and established businesses. This submission contains proposals for

how the Government can improve the business environment and support investment

and jobs through changes in the tax regime and taking a strategic approach to

expenditure in Budget 2017.

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4. TAXATION

The tax system has a vital role to play in supporting development at each stage of the

life cycle of a small business. It must constantly evolve to ensure that Ireland remains

an attractive place to establish and scale a business.

Following the recent vote in the UK to leave the EU, the need to improve the Irish tax

offering for indigenous business has never been more urgent. The upcoming budget

must support those industries for which the immediate fall-out from Brexit is greatest,

including small firms. Helping these sectors maintain a competitive edge will be an

important factor in overcoming the challenges that Brexit will pose.

The tax system today has very mixed signals for business. The elements that

represent disincentives to establish a business, take up employment or invest must be

addressed, as outlined below. Tax reform is key to unlocking job creation, investment

and growth and it forms an important dimension of making the Irish business

environment attractive relative to the UK.

4.1 TAXATION OF ENTREPRENEURS AND THE SELF-EMPLOYED

Budget 2016 contained some positive changes from a small business perspective. In

particular, the introduction of a modest income tax credit for the self-employed was

recognition of the discrimination that this group faces in the tax system, as the SFA

has long highlighted. The remaining discriminatory elements must be dismantled as a

matter of urgency.

In the SFA’s Summer 2016 Small Business Survey, reducing taxation on the self-

employed was identified as the most important change the Government could make to

boost small business. We welcome the commitment in the Programme for

Government to “provide a supportive tax regime for entrepreneurs and the self-

employed”. To make this a reality, it is critical that there is at least equity in treatment

between employees and proprietary directors/self-employed people in the tax system

and that business owners are afforded an equal level of protection as their employees

in the event of business failure or illness.

- USC surcharge

The 3% surcharge on USC, which applies only to the self-employed, should be

expired (as promised at the end of 2014). This surcharge is out of line with the aim of

encouraging entrepreneurship and scaling up of new businesses and sends a

confusing message to the self-employed about the Government’s support for them.

Cost: The SFA estimates that the abolition of the surcharge would cost €60 million.

- Income tax credit

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The introduction of a small Earned Income Tax Credit (EITC) in Budget 2016 was an

important gesture to entrepreneurs and the risk-takers in the economy. However, the

shortfall of the EITC relative to the PAYE tax credit means their effective income tax

rates are still higher than those of PAYE workers with the same gross income.

The SFA advocates an increase in the EITC to €1,650 for the self-employed and

proprietary directors to match the PAYE tax credit.

Cost: It is estimated that this would cost in the region of €120 million in a full year.

4.2 ENSURING WORK IS REWARDED

As the Programme for Government highlights, “high personal tax rates in Ireland

discourage work and jobs”. The current level of taxation has resulted in the erosion of

domestic spending power, a reduction in the incentive to work and an increase in

wage pressures, which currently represents one of the biggest threats to Ireland’s

competitive position.

International evidence which shows tax systems with a broad base and low marginal

rates provide the best outcomes for employers, employees and the economy. The

SFA welcomes the acceptance by the Government that the income tax burden is now

too high and has identified a number of policy changes throughout this document that

would help to ease this burden.

- Marginal tax rate

We require a tax system that rewards work but, despite the changes in recent

budgets, Ireland has one of the highest marginal tax rates in the OECD. Conditions

around the marginal tax rate are crucial – it is the main avenue through which income

taxation affects economic growth due to its impact on the incentive to work and take

on extra work, and on the attractiveness of Ireland as a destination for talent.

While Ireland has one of the highest marginal tax rates in Europe, what is particularly

damaging is that this rate kicks in at a level which is much lower than in any other

European country, even below the average wage. This, coupled with the high marginal

rate (49.5%) significantly reduces the benefit of working additional hours or receiving a

pay increase. In fact, half of all workers face losing 49.5% out of every €1 they get in a

pay rise. This especially impacts second earners whose labour market decisions are

much more sensitive to tax and benefit changes.

The SFA calls for the entry point to the marginal rate of income tax to be increased by

€1,500 for a single person with a corresponding increase for married couples and

other tax cases. Personal tax credits should be increased by €100 for all income

earners.

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Cost: These two measures combined are estimated to cost €338 million.

In addition, the SFA strongly advocates a 1% reduction in the marginal rate of income

tax.

Cost: This would cost approximately €158 million.

- Social welfare reform

SFA members continue to report examples of the social welfare system working at

odds with getting people into employment and increasing their hours of work.

Evidence points to a number of social welfare traps, as households become less able

to meet their needs when they move from unemployment to part time hours and part

time to full time hours. The withdrawal conditions for social welfare payments, such as

the one parent family payment, must be examined as part of a root and branch review

of the social welfare system.

Furthermore, the SFA calls on Government to introduce improved structures to

incentivise social welfare recipients to take up part time work. Part time work has been

shown to be a stepping stone to full time employment across Europe. However, the

Irish social welfare system disincentivises jobseekers from taking up part time work.

This situation could easily be rectified in one of a number of ways, for example by

calculating social welfare on an hourly basis rather than on a daily basis; by allowing

part time workers to work a certain number of hours per week before they lose their

entitlements; or by allowing the hours worked and social welfare to be taxed as a

whole in line with the current tax system. Another solution would be that people who

work part-time are allowed to add up their working hours in a week and only have

Jobseeker’s Allowance cut when they reach the equivalent of a full day’s work.

4.3 PRSI

A number of facets of the PRSI system also require review to ensure that they are

aligned with the aim of increasing Ireland’s competitiveness and making it an attractive

place to live, invest and establish a business.

- Voluntary PRSI for the self-employed

Owner-managers feel aggrieved that, despite contributing to PRSI, the self-employed

have no safety net in case of illness or business closure. The commitment in the

Programme for Government to “introduce a PRSI scheme for the self-employed” is

welcome, but it is critical that this is established as a voluntary scheme. A mandatory

scheme would be viewed cynically as an opportunity to impose additional taxes on

small business. Instead, the self-employed and proprietary directors should have the

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option to pay a modest PRSI top-up in order to qualify for social welfare benefits

similar to their employees.

- PRSI and the National Minimum Wage

Budget 2016 introduced certain PRSI changes, effectively ending the step effect from

an employee perspective and shifting the step effect for employers. However, the

changes to employer PRSI cannot be considered an ‘appropriate adjustment’ in the

context of the new minimum wage of €9.15, as called for by the Low Pay Commission

in conjunction with their recommendation on the rate increase. The changes offset

less than 10% of the increased labour costs as a result of the NMW increase. The

minimal level of the offset has resulted in even greater pressure on companies in

labour intensive, low margin sectors, who have very limited scope to either absorb the

cost increases or pass them on to customers. Therefore the poor alignment of the

minimum wage and the tax system has increased the likelihood of the minimum wage

increase costing jobs.

The Government must fulfil its commitment that the NMW will not be anti-employer.

These PRSI anomalies must be addressed in full in Budget 2017 to offset the NMW

increase in January 2016 and any additional increase granted for 2017.

- PRSI for new businesses

To encourage job creation the SFA proposes to phase in employer’s PRSI for new

businesses, so that they pay reduced rates of employer PRSI on staff they recruit in

their first three years – for example 25% for staff recruited in year 1, 50% for staff

recruited in year 2, 75% for staff recruited in year 3 and then the full rate on later

recruitment. This would incentivise earlier hiring.

4.4 REWARDING RISK TAKERS

Being an attractive location for investment is a necessity if Ireland is to improve its

underlying competitiveness. This includes not only being a destination for Foreign

Direct Investment but also an attractive country in which to sell assets or invest in a

small company, either through equity or employee share options.

- CGT rate

CGT is a key determinant of investment in the economy, which is a critical driver of

growth. Ireland has one of the highest rates of CGT amongst developed economies

at 33%. This puts Ireland at a competitive disadvantage when it comes to attracting

and retaining mobile investment. By comparison, the UK rate is either 18% or 28%

depending on the size of income and capital gains.

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The SFA is calling for a reduction in CGT to 20% across the board, to make investing

in a business in Ireland more attractive, in particular relative to competitor countries.

History has shown that a lower rate of CGT substantially boosts the overall tax take,

so the Exchequer will benefit from such a move.

Furthermore, a special 10% rate for disposal of sites that have been granted planning

permission should be introduced on a temporary basis for a three-year period. This

would encourage the sale of sites that current owners are not in a position to develop

and, as such, contribute to increased supply of housing.

- CGT entrepreneurial relief

Some improvements were made to the CGT entrepreneur’s relief in Budget 2016 with

the scheme being reformed and simplified.

The SFA welcomes the commitment in the Programme for Government to further

reduce the entrepreneurial rate to 10%. The statement that this will apply to new start-

ups from 2017, however, casts doubt over the fair and equal application of the

measure. Established businesses should not be treated less favourably than new

businesses, not least as this would significantly delay the impact of the initiative.

Furthermore, we believe that Budget 2017 should see Ireland improve its offering

significantly when compared with the UK by increasing the lifetime limit for the 10%

entrepreneurial rate from €1 million to €15 million.

Cost: The cost would be in the region of €52 million in 2017.

- Employee share options

Changes to the system of taxation for share based remuneration in recent years have

reduced the attractiveness of such schemes to businesses. Addressing this issue will

assist small and new firms to attract talented, experienced staff. It has the potential to

improve skills in small business particularly management capacity, which is a

persistent cause of business failure. It would also improve staff retention and

productivity in small and new firms, in particular at senior levels, by providing a long

term incentive and increasing employee buy-in.

Uptake of Revenue-approved schemes is low in small firms. These schemes should

be more flexible, in particular to allow share options to be granted in accordance with

individual/team productivity and performance. The SFA also proposes that the

€12,700 limit be reviewed. The employee PRSI and USC liabilities, which were

introduced in 2011, should be removed, as this has decreased the uptake of these

schemes.

The tax treatment of non-Revenue approved schemes must be overhauled in order to

create a workable and attractive system for both employees and companies. The

practice of taxing unrealised gains at the marginal rate of income tax must be ended.

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The SFA proposes that the rate is reduced to the ordinary rate and that payment is

spread over five years.

A scheme similar to the UK’s Enterprise Management Incentive (EMI) is needed for

new and small firms in Ireland. The SFA proposes that this scheme would waive the

income tax due on the gain between the granting and exercising of the option for

employees within start-up and small firms. Instead they would only be taxed on the

capital gain when disposing of the shares.

Cost: The total 2017 cost for all of the measures outlined above would be in the region

of €80 million.

- Employment and Investment Incentive Scheme (EIIS)

Currently, the EIIS does not function as intended and requires a rethink. An enhanced

EIIS would encourage more friends, family and experienced local entrepreneurs to

invest in small firms in Ireland. It has the potential to give small businesses financial

leeway to allow business balance sheets to recover and to address the equity gap left

by banks. Our specific recommendations are outlined below.

Change the scheme rules:

o Return to a five-year investment term so that the businesses have the

necessary time to grow sufficiently to be capable of repaying the

investors.

o Remove employment and R&D criteria – these complicate the scheme

unnecessarily. By definition if the business grows these will occur, but it

poses unnecessary risk to the investor up front.

o Evaluate the cost-benefits of extending the scheme to other specific

sectors.

o Exempt the gain from CGT if it is held for seven years (similar to

property reliefs already in place).

o Examine UK and international models with a view to implementing

Government risk-sharing models with private investors in similar

schemes. This would be important to attract non-traditional EIIS type

investors, and specifically other small business owners who might be

interested in investing in other businesses.

Return to BES as the scheme name, as this is more recognisable.

Enhance publicity around the availability of the scheme. The only media

reporting about the scheme tends to be negative, focusing on the tax write-

offs, as opposed to recognising the importance of facilitating equity investment

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in what are viewed as relatively high risk domestic small businesses. In

particular, it is important to promote the family and friends and private

placement options, as well as funds option, and make it easy for companies to

use the scheme without having to pay for expensive professional advice.

4.5 OTHER TAX HEADS

- VAT

The special 9% VAT rate for hospitality and related sectors has been a resounding

success and has provided important support to regional employment. We believe that

the economic rationale for the scheme has not changed and, in fact, support for the

sector is needed more than ever in light of the Brexit vote and its exchange rate effect.

The 9% VAT rate should be retained and made a permanent feature of the tax

system.

Furthermore, there should be no increases in other VAT rates or excise duties in order

to avoid jeopardising domestic consumption.

Shortages of housing units, especially in urban areas, are causing problems

throughout the economy, distorting the cost of living and making Ireland a less

attractive destination for FDI and mobile talent. Initiatives to encourage an increase in

the supply of residential property should be brought forward in Budget 2017. A

reduced VAT of 9% should be applied to the construction of residential property for

two years to relieve the supply shortages without further increasing house prices. A

0% VAT rate should be applied to the construction of social housing.

- Corporation tax

The SFA supports the retention of the first three years’ corporation tax exemption for

tax liabilities under €40,000. Very few start-ups get to avail of the full €40,000

exemption but it is a valuable support, allowing new companies to retain profits.

Many small companies struggle with the pre-payment of corporation tax. The SFA

proposes introducing retrospective payment for small firms and the option to pay in

instalments throughout the year.

- R&D tax credit

Smaller firms and start-ups in particular face funding constraints for R&D investments.

Despite this, the R&D tax credit’s take-up among smaller companies has been weak.

Only 1% of companies with turnover less than €1 million use the tax credit each year,

compared with 12.5% above that mark.

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In many cases, owner-managers who engage in R&D discover following tax

assessments by external Revenue-appointed experts that they do not qualify for tax

credits. They need certainty up front about what will and will not qualify for tax credit

purposes, particularly in micro-enterprises, where owner-managers are likely to be

engaging in R&D themselves. This will greatly incentivise such companies who are

wary of expenditure on R&D in the absence of the tax credit.

The SFA believes that it is necessary to create a specific, tailored R&D tax credit

scheme for small firms to encourage more R&D spend – an ‘R&D Tax Credit Lite’.

Such a scheme should reduce the existing complexity by using pro-forma templates

for R&D project management, recording of R&D activity and calculations of costs and

revenue benefit. Simple on-line calculators should be developed to increase usability

for small firms and targeted promotion of the scheme should be rolled out.

Cost: The introduction of an ‘R&D Tax Credit Lite’ along the lines outlined would cost

approximately €5 million.

4.6 LABOUR MARKET ISSUES

Irish labour costs are the tenth highest in Europe and 20% above the EU average.

Irish small firms are at a competitive disadvantage relative to firms in the UK across a

number of major business costs and total labour costs are 17% higher in Ireland than

in the UK. This is a particular problem for small firms in the services sector where the

cost of employing an individual accounts for between 72% and 86% of location

sensitive business costs (i.e. costs which vary by location rather than being set by a

worldwide market).

The National Competitiveness Council has warned against complacency in relation to

competitiveness and SFA members have highlighted wage inflation as the biggest

threat to their business in the coming year. In light of this feedback and with 7.8% of

the workforce still unemployed, it is crucial that the Government does nothing to put

additional pressure on labour costs in Budget 2017.

It is imperative for the competitive position of Ireland that wage levels are decided in

a competitive labour market. Wages should not be determined by an artificial legal

instrument such as the minimum wage. Any wage increases must be linked to

improved productivity and the profitability of the business.

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5. EXPENDITURE

5.1 CAPITAL EXPENDITURE

Ireland’s investment spend is currently among the lowest in the EU even though

Ireland has the region’s fastest growing population. In recent cutbacks, capital

expenditure was the first thing to go, leading to a decade of underinvestment. Capital

expenditure currently averages 2.2% of GDP per annum, the vast majority of which is

spent on maintenance and repair as opposed to growing the country’s social and

economic capacity.

This poor record of capital investment, coupled with Ireland’s evolving demographics,

is leading to bottlenecks in transport, education, broadband, water, health and other

public infrastructure. This economic model is not sustainable if Ireland is to maintain

its economic performance, and it is certainly not a recipe for improved

competitiveness. As was stated at the outset of this submission, it is time to place as

much impetus behind the competitiveness agenda as was behind macro-economic

stability during the term of the previous government.

On this basis, the Government must take a more ambitious approach to capital

investment, going beyond the additional €5 billion foreseen in the Programme for

Government. Capital expenditure must reach 4% of GDP as soon as possible. The

Government should seek flexibility in the EU fiscal rules in order to exempt this

investment spending.

In terms of capital expenditure, the Small Firms Association has identified clear priority

items that would improve the business environment, ensure that businesses and

citizens around the country benefit from the overall economic recovery and assist with

the attraction of Foreign Direct Investment and talent.

The SFA capital expenditure priorities are:

Improving broadband infrastructure, particularly in rural areas: The SFA

welcomes the commitment in the Programme for Government that further

funding will be made available if necessary in order to deliver the National

Broadband Plan. It is imperative that no further delays to its rollout are

permitted.

Developing public transport links: Additional Investment is needed in public

transport, in particular transport links between Dublin Airport and the city

centre.

Building a real motorway network: It is vital to continue to develop road

connections throughout the country, in particular to ‘join up’ regional cities. This

would allow increasing volumes of passenger and freight traffic to move quickly

around the country and improve access to services such as regional hospitals

and educational institutions.

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Addressing housing shortages: The current crisis in housing supply is

impacting the whole of the Irish economy and society. Provision should be

made to fast-track planning and procurement for key projects, in particular for

sites with capacity for more than 100 units where all related services are in

place. This measure, in conjunction with the CGT and VAT measures outlined

in previous sections would encourage and speed up much-needed supply.

Enhancing education and in-work training: Ireland performs poorly in terms of

lifelong learning and research shows that investment in management capacity

could reduce business failure by half. In light of falling unemployment, the

National Training Fund should be re-oriented to focus on in-work training, in

particular through Skillnets and specifically its ManagementWorks programme

targeting small business.

6. CONCLUSION

Budget 2017 will chart a course at a time when Ireland’s economic future could follow

a number of trajectories. Recent economic performance has been strong and small

businesses generally view the current economic environment positively. However,

business costs are rising, many of the fundamental policy challenges facing the

country have not been addressed and the international environment in which Ireland

operates is uncertain, in particular in light of the UK’s decision to leave the EU.

Small business can lead the way in helping Ireland to continue to broaden and deepen

its recovery – but in order to do this, the Government must create the right conditions

by putting in place an enabling tax environment, curbing the cost of doing business (in

particular labour costs) and delivering world class physical and digital infrastructure.

More than anything, Budget 2017 must deliver competitiveness improvements to allow

small business to put its best foot forward, domestically and internationally.

For further information, please contact Linda Barry, SFA Assistant Director, on tel:

01-6051626 / 087-1472811 or e-mail: linda.barry@sfa.ie. More information about the

SFA is available at www.sfa.ie or on Twitter @SFA_Irl.