Foreign investors have typically used Irish regulated tax-exempt funds and section 110 companies to invest in Irish property and loans secured on Irish land. The Finance Act 2016 (the Act) introduced tax at the rate of 20% on certain Irish property profits and tax at the rate of 25% on certain profits made on investments in distressed debt. We review the new key changes that have been enacted.

Irish Regulated Funds

For many years, Ireland has claimed taxing rights over Irish real estate. However, prior to the introduction of the Act, Irish regulated funds, including ICAVs, known as qualifying investor alternative investment funds (QIAIFs) were exempt from Irish tax on all income and gains on Irish property. Also, all payments, such as distributions and redemptions made to non-Irish investors and certain exempt Irish investors, were not subject to any withholding or exit tax.

Under the Act, non-Irish investors and certain previously exempt Irish investors will now be subject to a 20% withholding tax on the happening of certain taxable events. This includes payments made by the QIAIF in respect of units held in the QIAIF or the disposal, transfer or redemption of units held in the QIAIF where the QIAIF is involved in investing in Irish real estate.

QIAIFs are only within the scope of the legislation if 25% of the value of the relevant fund, or sub-fund, is derived from Irish real estate assets and related assets or if it would be reasonable to assume that the purpose or one of the main purposes of the fund was to acquire Irish real estate or engage in the development of Irish real estate (Irish Real Estate Investment Funds or IREFs).

For IREFs involved in long-term capital appreciation strategies, payments made to an investor may be exempt from withholding tax where the proceeds relate to a capital gain arising to the IREF on the disposal of property it acquired at market value and owned for a minimum of five years provided the disposal is to a person unconnected with the fund or any of its investors. However, the exemption is only available where the investor, or a person connected with the investor, does not have the ability to influence the selection of some or all of the assets of the fund, i.e. where the fund is not a Personal Portfolio IREF.

Payments to certain categories of investors, including pension funds and other Irish and EEA regulated funds are also exempted.

The new regime will apply to accounting periods commencing on or after 1 January 2017. However, if the IREFs accounting period was changed after 20 October 2016, the new rules will apply to accounting periods commencing on or after 20 October 2016.

Section 110 Companies

Prior to the introduction of the Act, Irish tax resident special purpose companies that met the conditions necessary to avail of the provisions of section 110 of the Irish tax code (Section 110 Companies) could, broadly speaking, avail of a tax deduction for interest paid on certain profit dependent loans (PDLs) and were used to fund the acquisition of distressed debt portfolios.

Changes were introduced in the Act, which took effect from 6 September 2016, targeting section 110 Companies holding and/or managing ‘specified mortgages’. For this purpose, a ‘specified mortgage’ means a loan that is secured on Irish land or an arrangement, eg a total return swap, which, in both circumstances, derives its value or greater part of its value, directly or indirectly, from land in Ireland.

Profits from such activities are now treated as a separate business and interest which exceeds a commercial arm’s length rate of return may not be fully deductible in calculating the Section 110 Company’s taxable profits unless the beneficiary of the return meets certain criteria. When the profit dependent element of the return is not tax deductible, a charge to tax at the rate of 25% for the Section 110 Company arises.

Importantly, a tax deduction is still available in respect of interest that represents a reasonable commercial return and most normal securitisation transactions and market loan origination transactions should not be impacted by the changes.

Conclusion

The new IREF tax legislation is complicated and undoubtedly targets the short term holding of property through a tax-exempt Irish regulated fund and the long-term holding of property where the fund is a Personal Portfolio IREF by imposing tax at the rate of 20% on certain Irish property profits. However, it provides a mechanism for a non-Irish resident to use a gross roll-up fund to own Irish property and only suffer Irish tax, if applicable, on an ultimate exit. The tax collection mechanism is complex and in certain circumstances can impose an obligation on the buyer of units in a fund.

The Section 110 changes are potentially more concerning and indeed arguably retrospective as they do not permit a Section 110 Company to revalue their assets at “mark to market” on 5 September 2016. This could result in tax at the rate of 25% on unrecognised accounting gains that accrued pre 6 September in respect of investments in distressed debt. There is a limited carve out for EU or EEA holders of PDLs and approved EU or EEA pension funds but North American investors are not given such protections. Similar to the funds regime, Section 110 Companies remain an attractive vehicle for investing in financial assets other than loans secured on Irish real estate.

For more information, please contact a member of our Tax team.