Deeds of covenant
A deed of covenant is a legally binding agreement that is written down and agreed between 2 people stating that one person agrees to pay the other an agreed amount of money without receiving any benefit in return.
You can agree to pay any amount of money under the deed, but it is important to remember that the deed must be properly drawn up, signed, witnessed, sealed and delivered to the individual receiving the payments.
Tax relief on covenants is only available where the covenants are being made to particular groups. These groups consist of permanently incapacitated minors, permanently incapacitated adults, and people over 65 years of age. (A minor is a child under 18 years of age who is not married). Parents of incapacitated minor children cannot claim tax relief on covenants in favour of their own permanently incapacitated minor child. However, tax relief can be claimed on covenants made in favour of permanently incapacitated minor children by people other than their parents. The exact tax saving depends on the amount of tax paid by the person making the payment (the covenantor) and on the amount of the income of the person receiving the payment (the covenantee).
In order for the deed of covenant to be tax effective, the deed must be capable of lasting more than 6 years. It is recommended by Revenue therefore that the period of the covenant be for 7 years.
Unrestricted tax relief can be claimed on covenants in favour of permanently incapacitated minors other than from parents to their own minor incapacitated children. Unrestricted tax relief can be claimed on covenants in favour of permanently incapacitated adults.
Tax relief can be claimed on covenants in favour of adults aged over 65 years. The amount of tax relief available on one or more covenants cannot exceed 5% of the covenantor's total income (gross income less certain deductions such as expenses, capital allowances, etc).
Making a deed of covenant
The deed must be properly drawn up, signed, witnessed, sealed and delivered to the individual. You can get a deed of covenant form (pdf) from Revenue.
The person receiving the payment (the covenantee) must have a PPS number. If they do not have a PPS number, they should get in touch with their local Department of Employment Affairs and Social Protection office and either trace their existing PPS number or obtain a new one.
Payments made under the deed must be without any benefit being received from the covenantee in return (either directly, or indirectly). In other words, the person paying the money cannot receive anything beneficial from the person receiving the money either directly from them or indirectly through someone else.
A deed can only be effective from a current date (in other words, you cannot backdate a deed).
A deed to an individual must be capable of lasting more than 6 years.
You must enter into the deed before you make any payment. You should also ensure that you are able to make all payments before the duration of the deed ends.
Payments as specified in the deed must be paid on the date(s) that are specified and for the amount that is specified. Neither the person paying or receiving the money can alter the payments during the period of the deed.
Making a payment under a deed of covenant
The person making the payment (the covenantor) must deduct tax at the standard rate from the total (gross) payment.
Individuals paying tax under the pay-as-you-earn (PAYE) system can account for the tax deducted by having their certificates of tax credits and standard rate cut-off point amended by their tax office. If you are self-assessed, you should account for the deed of covenant in your annual assessment that you submit to Revenue.
You must also give details of the payment and tax deducted on a Form R185 to the person receiving the payment (the covenantee) each time a payment is made.
The exact tax saving will depend on the amount of tax that is paid by the covenantor (the person paying the money), and on the income of the covenantee (the person receiving the payment).
If the person paying the money is liable to tax at a higher rate than the standard, then they will receive tax relief at the difference between the standard rate and the higher rate. The standard rate is 20% and the higher rate is 40%.
There is no tax benefit to the covenantor who pays tax at the standard rate only.
Regardless of the financial situation of the person paying the money (the covenantor), the person receiving the payment (the covenantee) whose tax chargeable on their total income (including the gross income received under the deed of covenant) is less than their annual tax credits would qualify for a refund of the standard rate tax deducted by the covenantor.
How to apply
Tax relief for the covenantor
The person making the payments (covenantor) should send their claim for tax relief to their own tax office remembering to quote their PPS number. For your first claim, you should send in the original deed of covenant, a copy of Form R185 (pdf) and your return of income to Revenue. For subsequent years, complete Form 185 on or after the date of payment and forward it to your nearest tax office.
Tax relief for the covenantee
The person receiving the payments (covenantee) should send their claim for tax relief Revenue, again quoting their PPS number. For a first claim for tax relief, include a copy of the deed of covenant, Form 54 claims and a Form 185 that has been completed by the person making the payment. For subsequent years, you forward Form R185 and the Form 54 claims.