A payment made under a qualifying deed of covenant is deductible against the covenantor’s total income for income tax purposes, but not for USC and PRSI however the covenantor must satisfy a number of conditions:
The payment is for the benefit of the following individuals:
- Permanently incapacitated minor
A full deduction for is allowed where the payment is to a minor (i.e. an individual under 18 years of age and unmarried) who is permanently incapacitated. However, tax relief is not available where the minor is a child of the covenantor (such payments would fall within s795 TCA97).
For example, a Revenue precedent exists that if a person suffers from chronic back pain and the condition is permanent, the individual may be considered permanently incapacitated. Medical evidence in support of the condition would be required.
- Permanently incapacitated adult
A deduction for the full quantum of the payments under the deed is allowed where the payment is to an adult who is permanently incapacitated. There is no restriction by reference to relationship.
- Adult aged 65 or over
A deduction is allowed for payments made to an adult aged 65 or over but the tax relief cannot exceed 5% of the covenantor’s total income. Total income is considered to be gross income less certain deductions such as expenses and capital allowances.
- the deed must last more than 6 years. We recommend that you prepare a deeds for a minimum of 7 years.
- the deed is irrevocable and unconditional.
- The deed cannot be subject to the covenantee giving providing a benefit in return for the payments under the deed.
- the payments made under the deed must be paid on the date or dates stated and for the amounts documented in the deed. The payment amounts cannot change for the duration of the deed.
- Withholding tax at 20% must be withheld and paid to Revenue. A form R185 is given to the covenantee by the covenantor and this details the date and quantum of the payment and the tax deducted.
- A child can give 5% of the total income under a Deed of Covenant as above and in addition pay the medical expenses of the parent. Tax relief on the medical expenses can be claimed by the child.
- Where the above conditions are satisfied the covenantor will be entitled to a deduction against total income.
Deed of Covenant - Some Practical Points to Note
- Both parties to the deed must have a PPS number.
- The person making the payment must deduct tax at the standard rate (20%) on the gross payment and to pay this directly to Revenue.
- PAYE earners can account for the tax by adjusting their tax credit certificate.
- Self-assessment individuals can account for the tax on their annual tax return.
- A Form R185 must also be completed by the payer when a payment is made to the individual.
- The tax saving for the person making the payment is dependent on the rate of tax payable by the individual. For example, if the individual is a higher rate taxpayer they will receive tax relief at the difference between the standard rate of tax and the higher rate of tax (20%).
There is no tax benefit to an individual who pays tax at the standard rate of tax only.
Implications for the beneficiary
- Where the beneficiary’s income (inclusive of the income from the covenant) is less than the exemption limit, then a refund of the tax withheld will arise.
Claims for refunds should are as follows:
- Completed Form 54
- Copy of the Deed
- Form R185
- Evidence of the payment
It is important to note that the income from the deed of covenant forms part of the beneficiary’s income for tax purposes. Consequently, the beneficiary could lose some of their means tested social welfare benefits e.g. medical cards because the income from the covenant has pushed them over the means tested income threshold.