Office of the Comptroller and Auditor General - Dirt Investigation - Chapter 2

Chapter 2 : Taxation of Interest

Irish residents are liable to pay income tax on deposits held by them in Ireland and abroad. Where a double taxation agreement is in force a credit is given for any foreign tax paid on the interest. While non-residents are liable for tax on interest on deposits this liability has in effect been removed for the vast bulk of non-resident depositors by virtue of Double Taxation Agreements which provide for taxation of interest in the country of residence only. Interest earned by non-residents on deposits with institutions operating in the International Financial Services Centre is, since 1995, tax exempt.

Up to 5 April 1986 interest on bank deposits by both individuals and corporate bodies was paid gross. There was an obligation on the recipient to make a return of such income for purposes of income tax assessment. In addition, gross interest paid by banks over a specified figure was liable to be reported directly to Revenue except in those non-resident cases where the banks had been given a notice requesting non-disclosure.

In the case of Building Societies an arrangement was in place under which standard rate tax was deemed to have been discharged on the individual’s behalf. Building Societies entered into such arrangements with Revenue under Section 31 of the Corporation Tax Act 1976. Under these arrangements the Societies paid tax to the Revenue Commissioners at a "composite" rate (CRT) in respect of interest and dividends paid out. As a consequence, the interest and dividends were paid without deduction of tax at source to the beneficiaries. The rate of CRT was set each year and represented tax partly at the standard rate of income tax and partly at a reduced rate. In 1985-86, the last year of operation of CRT, the rate was 28%, i.e. 80% of the Standard Rate of 35%.

CRT was calculated by reference to the total interest paid by the Societies (excluding interest paid to banks). It was not computed at individual account level. Accordingly it was levied on all accounts, including non-resident accounts. Individuals in receipt of Building Society interest were obliged to declare this interest and pay tax at marginal rates subject to a credit for tax paid on the interest at standard rate. CRT was paid on a six-monthly basis by the Building Societies. The Building Societies were not required to file returns of interest or dividends paid on individual accounts.

Reporting of Interest

Up to 1963 the assessment of interest for purposes of tax was based solely on voluntary returns by the taxpayer. In its Seventh Report on 28 March 1962, the Commission on Income Taxation had recommended

"That the law should be amended as necessary to provide that annual returns should be furnished by banks and other financial institutions of all moneys held on deposit on behalf of others and exceeding, say, ?1,000, for any one person".

The Commission specifically indicated that the return should not be insisted on where, although the funds are held in the State, the beneficial owner is not resident in the State for the year in question.

Two members of the Commission dissented from the recommendation, citing the danger of undermining confidence in the banking system and encouraging capital outflows.

In its response to the Commission’s recommendations (Second White Paper on Direct Taxation; April 1963), the Government accepted the recommendation but indicated that the principle of the recommendation might best be implemented by seeking returns of interest accruing rather than of amounts held on deposit as amounts on deposit may vary considerably from day to day.

Accordingly, section 17 of the Finance Act 1963 obliged financial institutions to make a return to the Revenue Commissioners of interest paid or credited to an individual without deduction of tax in cases where the interest exceeded ?15. The reporting threshold was increased to ?50 in 1965 and, between 1968 and 1982 was set at ?70. It has stood at ?50 since then.

Such a return had to state

the amount of interest paid or credited

the payee’s name and address.

Following the recommendation of the Commission on Income Taxation, the section excluded from the reporting requirement, cases where the person beneficially entitled to the interest was non-resident. As a result, returns to Revenue would not cover interest paid on non-resident accounts nor amounts paid to other taxpayers below the reporting threshold.

In its operation the reporting procedure did not work smoothly. In a memorandum prepared by the Revenue as background to a meeting with the Irish Banks Standing Committee (IBSC) in November 1976 these concerns were articulated as follows.

"As a result of [a review by a special anti-evasion unit] it became clear that the manner in which the provisions of section 175 of the Income Tax Act, 1967 was being operated gave rise to concern particularly as regards the attitude to it adopted by certain bank officials.

The main area in which bank officials seem to facilitate, if not encourage tax evasion, is in relation to section 175 of the Income Tax Act, 1967, that is, the section which provides for returns to the Revenue of interest amounting to more than ?70 paid by financial concerns without deduction of tax. This was an anti-evasion measure introduced by the Government in 1963, following a recommendation by the Commission on Income Taxation and one would have expected that national institutions would have been concerned to see that Government objectives would have been carried out. In this particular area, however, it appears that bank officials are deliberately frustrating this objective. Evidence of this is available in a considerable number of instances - sufficient to show how widespread the practice is. It may be that the bank managers and officials in question are taking this course without the approval or knowledge of senior bank management, in which event, it is important that the matter be brought to their notice."

In the subsequent meeting the representatives of the IBSC indicated that "the banks could not stand over situations where branch managers wantonly accept certificates by depositors that they were non-resident where they know that the individuals concerned are local residents".

One significant effect of the introduction of DIRT was to extend to financial institutions generally the arrangement for non-disclosure (non-reporting) of interest which had previously applied to the building societies. The provisions of Section 175, which relates only to interest paid gross, did not apply to interest paid under deduction of DIRT.

Introduction of DIRT

DIRT was introduced for interest paid or credited in tax years from 1986-87 onwards. It was imposed by Section 32 of the Finance Act 1986 and has remained in force since then. As a result, from 6 April 1986, all interest paid by deposit taking institutions whether banks or building societies was liable to DIRT unless otherwise exempted.

In introducing DIRT, the Minister for Finance said in his Budget Statement of 29 January 1986

"Existing arrangements for the taxation of deposit interest are unsatisfactory. They give undue advantage to some financial institutions and there have been demands for harmonisation. I propose to make a significant change in the direction of equal treatment of the main deposit-taking institutions. This will ensure more orderly tax procedures, more effective countering of tax evasion and increased revenue.

Accordingly, with effect from 6 April 1986, a retention tax, at a rate of 35 per cent, will be deducted at source out of interest paid or credited on bank and building society deposits in the beneficial ownership of residents ..."

Adjustments to DIRT 1992-93

In order to minimise the risk of capital outflows that might have arisen following the liberalisation of capital markets and the ending of Exchange Control in 1992 - under which Irish residents were allowed to maintain accounts with foreign financial institutions - Section 22 of the Finance Act 1992 made significant changes to the DIRT regime

Companies and pension funds were to be allowed hold accounts, the interest on which was not to be subject to DIRT. To open such accounts companies and pension funds had to lodge a declaration with the relevant deposit taker. The gross interest payable on the account is reportable to Revenue.

Individuals were to be entitled to open Special Savings Accounts (SSAs) subject to a lower rate of DIRT (initially 10%, increased to 15% in 1995 and to 20% in 1998). The accounts were subject to a capital limit of ?50,000, with an individual entitled to hold only one account at any one time. A married couple may, however, have two SSAs at any one time. To open an SSA a form of declaration now set out in section 264 of the Taxes Consolidation Act, 1997 must be lodged with the relevant deposit taker. This declaration requires, among other things, a declaration as to the simultaneous non-holding of other SSAs.

The tax liability of the depositor was limited

The DIRT deducted from interest on SSAs represents an individual’s total liability to income tax, PRSI and levies in respect of the interest - and does not have to be included on the individual's tax return.

The DIRT deducted at the standard rate of income tax from deposit accounts, other than SSAs, was to satisfy the individual's liability to income tax in respect of the interest. Unlike the interest on SSAs, the interest must be included on the individual's tax return and may be liable to PRSI and levies.

The distinction between non-resident funds held in Irish and foreign currency was abolished from 1 January 1993. A non-resident declaration had to be completed in respect of all foreign currency deposits from that point on.

In summary, interest which could be paid gross after 1992-93 included

interest on deposits by non-residents

interest on deposits by charities, companies and pension funds

interest paid to deposit taking institutions themselves

interest paid to the Central Bank of Ireland

interest on debts or securities issued by the deposit taking institution and listed on a stock exchange

in the case of resident institutions, interest on deposits with their branches abroad

in the case of non-resident institutions, interest on deposits which are not held by branches in the State.

Other exemptions apply to Credit Unions and to interest paid to subsidiaries of financial institutions.

DIRT Proceeds

The total DIRT returned for institutions during the period under review is set out in Table 2.1.

Table 2.1

Deposit Interest Retention Tax returned by Financial Institutions, 1986-87 to 1997-98

Year to 5 April

DIRT returned by financial institutions

SSA rate

Standard rate of income tax

Total

%

?m

%

?m

?m

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

15

15

15

10

10

10

-

-

-

-

-

-

42.99

31.28

23.37

20.86

17.04

2.06

-

-

-

-

-

-

26

27

27

27

27

27

29

30

32

35

35

35

145.27

110.00

108.27

92.86

157.99

323.43

277.41

282.13

231.90

194.25

271.39

253.11

188.26

141.28

131.64

113.72

175.03

325.49

277.41

282.13

231.90

194.25

271.39

253.11

Source : DIRT returns received by Revenue from Financial Institutions 1986-87 to 1997-98

Revisions of the DIRT provisions in 1992, which introduced a low rate for Special Savings Accounts and exempted companies and pension funds, reduced the DIRT yield. This decrease was partly offset by an increase in yield on the Corporation Tax side in the next appropriate accounting period. In fact the DIRT yield of ?175m in the first year after the change (1993-94) was substantially reduced from the yield of ?325m in 1992-93. However, in that period interest rates were also reduced substantially.

Interest Assessment

The interest giving rise to the DIRT returned by the financial institutions in the period is set out in Table 2.2.

Table 2.2

Interest liable to DIRT as calculated from returns by Financial Institutions

Year to 5 April

Interest Assessed

Total Interest

SSA Rate

Standard Rate

?m

?m

?m

1998

286.59

558.72

845.31

1997

208.53

407.42

615.95

1996

155.81

402.60

558.41

1995

208.59

343.94

552.53

1994

170.35

585.13

755.48

1993

20.63

1197.89

1218.52

1992

956.60

956.60

1991

940.42

940.42

1990

724.68

724.68

1989

555.01

555.01

1988

775.40

775.40

1987

723.17

723.17

The contents of this page were last updated on 26/09/03