Tax Update: Tax and International Investment in Irish Real Estate
07 February 2019
Last year saw the continuing recovery of the Irish commercial property market, a trend that’s set to continue apace in 2019. However, a range of domestic and international tax measures that impact the real estate industry have been introduced in recent years. These factors have led to changes in the types of Irish property structures used and may require further consideration going forward.
Despite the challenges, Ireland’s tax system ensures that Irish real estate remains an attractive option for foreign investors. We will now explore some of the structures currently used and consider some of the recent international tax changes that may impact those structures and the Irish real estate market going forward.
Collective investment fund
In recent years many international investors chose to invest in Ireland through a tax efficient qualifying investor alternative investment fund (QIAIF). Up until 31 December 2016, income and gains arising on Irish real estate earned by QIAIFs and distributed to non-Irish-resident investors were outside the scope of Irish taxation. However this position changed dramatically in Finance Act 2016, with a new 20% withholding tax applying to profits paid out of Irish real estate funds (IREF) to overseas investors (although certain classes of investor still benefit from no withholding tax). As Ireland typically retains taxing rights over income deriving from Irish real estate, treaty relief should not be available to unitholders in respect of the IREF withholding tax.
Despite the new withholding tax on distributions made to foreign investors, the QIAIF is still exempt from tax at fund level and remains a popular vehicle for large scale projects in excess of approximately €50 million.
Non-Irish resident company
Due to the recent IREF changes and the resulting move away from the QIAIF by some smaller and medium sized investors, the non-Irish resident company has become a favoured vehicle for international investment in Irish real estate. While the equivalent capital gains tax and stamp duty rules apply equally to investments by Irish resident companies and non-Irish resident companies, the non-Irish resident company is only subject corporation tax on rental profits at 20% (where an Irish collection agent is appointed) instead of the 25% rate. In addition, interest incurred by the non-Irish resident company on a loan used to acquire Irish real estate should be fully tax deductible. Care will need to be exercised to ensure withholding tax of 20% is not an issue on interest repayments.
Irish Limited partnership
Irish limited partnerships (LPs) have proven very attractive entities for obtaining substantial tax benefits and given their flexibility have emerged as a useful tool to assist in structuring international investment in Irish real estate. LPs can be utilised with other forms of Irish investment vehicles and are commonly found sitting under regulated fund structures.
LPs are treated as “look through” entities from a direct tax perspective with the partners of LP instead being subject to tax on their profit share, as provided for in the LP deed and not by the amount of his/her capital contribution.
LPs are also used in investment structures as they help create a separate security in a sub-fund structure where financing is being provided. Many of the recent large scale real estate projects have used a combination of funds and LPs in their structure.
6% stamp duty - application to interests deriving value from Irish real estate
Pursuant to Finance Act 2017, the rate of stamp duty on the transfer of non-residential property increased from 2% to 6%. The new legislation includes a rebate scheme refunding a portion of the stamp duty paid where development of residential dwellings commences on non-residential property within 30 months of acquisition.
While the transfer of shares in Irish companies is subject to stamp duty at 1%, where certain conditions were met, the increase in the rate of stamp duty now extends to include the transfer of units in an IREF and also the transfer of shares in companies and interests in partnerships that derive their value or the greater part of their value from non-residential land or buildings in Ireland.
The increased charge will only apply where there is a change in control of the company, partnership or IREF and it is reasonable to consider that the underlying real estate was acquired or is being developed by that entity with the sole or main aim of realising a gain on disposal. Where there is a change in control of the company, partnership or IREF and the underlying real estate relates to trading stock, the increased rate should also apply.
Significantly, the new changes mean that stamp duty could be payable on transfers of shares in non-Irish incorporated companies where the conditions referred to above are met. In addition, transfers of units in Irish regulated funds are generally exempt from stamp duty but the recent changes now extend the charge to cover the transfer of units in an IREF. These changes represent a major departure in the Irish stamp duty regime that will impact the resale value of Irish real estate and could impact the ability to adapt real estate structures going forward. Considering these issues at the outset of an investment is essential to ensure that any potential stamp duty leakage is minimised.
International tax changes
In addition to the OECD’s BEPS action plan, the EU has also taken steps to tackle tax base erosion, and in 2016 it published the Anti-Tax-Avoidance Directive (ATAD). The main action contained in ATAD that should impact investors operating in the Irish real estate market is the interest limitation/borrowing costs deductibility rules. The interest limitation/borrowing costs limitation provisions seek to discourage multinational enterprises from reducing their tax base through inflated debt financing. The provisions limit borrowing costs deductions to 30% of EBITDA and thereby prevent the use of excessive leveraging and interest payments to shift profits to other jurisdictions (often low tax states). “Group” financing is commonly used in real estate holding structures and these rules may have significant consequences for such structures.
The provisions are due to be implemented and take effect from 1 January 2019. A derogation can apply however where an EU Member State can demonstrate that it has domestic rules for preventing BEPS risks that are “equally effective” to the ATAD limitation ratio of 30%, in which case implementation can be delayed until 1 January 2024. Ireland has taken the position that its interest restriction rules are “equally effective”. However, the Department of Finance has recently confirmed that the transposition deadline of end-2023 may be brought forward and could potentially advance to Finance Bill 2019. In preparation for the introduction of such interest limitation rules, the Department of Finance has published a consultation paper with the intention of obtaining views from various stakeholders.
Also in the international space, it appears that the recently introduced US federal tax charge on Global Intangible Low Tax Income (GILTI) is having an impact on the Irish real estate market. Under the GILTI regime there is an exemption for a 10% routine rate of return on tangible business assets. This means that US parented groups with Irish subsidiaries can avoid US tax on their Irish operations to the extent they can demonstrate that the amount attributable to the Irish subsidiary is 10% or less of the return on their tangible assets, including real estate. Therefore, as GILTI will heavily impact any foreign business where profit is high relative to the fixed asset base, many multinationals with operations in Ireland have increased their real estate foothold in Ireland. In addition, an increased Irish real estate presence will help to mitigate international transfer pricing considerations.
In recent years, there has been a steady upturn in the Irish real estate market. However, we are seeing a significant number of tax policy changes that will undoubtedly impact investors in the industry. While we continue to deal with tax changes implemented domestically, we must also consider how international tax policies will be implemented from 2019 onwards and the resulting impact on tax structures. These changes will affect the bottom line for real estate investors investing in Ireland.
Despite these challenges, Ireland maintains a favourable tax regime (especially when compared to other states who are also subjected to these international tax changes) and combined with a high demand and continuing high yields, Irish real estate remains a very attractive investment for international private equity.
For more information, contact a member of our Tax team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.