The UN special rapporteur on housing, Leilani Farha, sent a letter to the Government earlier this year questioning its decision to allow unregulated global real estate funds avail of "preferential tax laws" to build up property portfolios in the State.
Subsequently, Web Summit founder Paddy Cosgrave led a campaign against these funds (often referred to as vulture funds), arguing that the Irish tax system was offering a sweet deal to foreign investors. The Government, for its part, defended such institutional investors, on the grounds that they were boosting the development of apartments.
What are the tax advantages available to these funds? And how do they compare to the tax treatment of individual landlords?
How do companies hold property?
It’s worth considering how investors typically hold property in Ireland, and how these various structures are taxed.
Irish company
First, and most straightforwardly, you can set up an Irish company. If this company has investment property, it will pay corporation tax at a rate of 25 per cent on this income, as it's passive income, as opposed to trading income, which is subject to tax at a rate of 12.5 per cent.
The company will also pay capital gains tax (CGT) at a rate of 33 per cent on any disposals of property, while the sale of shares will also be subject to capital gains tax at 33 per cent.
However, if you are a housebuilder, such as listed businesses Cairn or Glenveagh, and are involved in development, then it will be subject to the 12.5 per cent rate as this is the company's underlying trade.
If the company acquires buildings and sells them and isn’t engaged in development, it will also pay corporation tax at a rate of 25 per cent.
It's also possible to hold an Irish property in a foreign-held structure. In this case, just as rent owed to a foreign landlord is withheld at a rate of 20 per cent, so, too, will such income for a foreign-held company be subject to a withholding tax at a rate of 20 per cent. This company may also be subject to additional taxation in the home country.
Key attraction: Corporation tax at 25 per cent as opposed to income tax at up to 55 per cent.
Section 110 company
Section 110 has been in existence since 1991, and allows companies to achieve that all important “tax neutral” position – companies don’t pay any Irish tax provided that certain conditions are met.
A Section 110 company, or special purpose vehicle (SPV), holds certain qualifying assets, and is frequently used to house securitisation vehicles, such as mortgages or car loans. In its early years, it was used by the international financial services sector to attract global assets to Ireland. It became increasingly popular in the wake of the financial crash as a vehicle to hold Irish property assets.
Critically, however, such vehicles can’t hold actual property – they can only hold the loans related to these properties, be they performing or non-performing.
A key attraction of such companies was their ability to reach a "tax neutral" position, whereby they ended up with an effective tax bill of zero. For example, back in 2014, Promontoria Eagle, a Section 110 company set up by Cerberus to hold a loan book it acquired from Nama, paid corporation taxes of just €2,500, despite earning net interest income of some €50 million.
The Government moved to close such incentives in the Finance Act 2016. As a result, Section 110 vehicles formed to house Irish property assets are now fully subject to tax at 25 per cent on profits related to the specified mortgages they hold. That means they are treated in exactly the same way as an Irish company.
This means that some of these historic vehicles are being wound down, while new investors in Irish property are looking to new structures. In early 2018, for example, the Central Bank reported a €55.6 billion outflow of assets in Irish Section 110 companies on the back of the 2016 change.
Key attraction: Largely historic
Reit
The third structure, which only arrived in Ireland six years ago, is the real estate investment trust (Reit), used by listed companies such as Ires Reit, Green Reit and Hibernia Reit, to hold Irish property assets.
Reits do not pay any corporation tax on their profits and gains from rental business in Ireland. Last year, Ires Reit brought in a net rental income of some €41.2 million from its 2,500-plus strong portfolio of properties, while its total profit for the year came to €119.8 million, up from €65 million in 2017. And its total corporation tax bill? Zero.
A key feature of the Reit regime, which allows Reits to avoid corporation tax, means they must distribute to shareholders, by way of dividend, at least 85 per cent of income from property rental. If they don’t, they may be subject to a tax charge.
Proponents of the Reit regime suggest this is a way of avoiding double taxation for investors, as tax would otherwise be levied once on rental profits (corporation tax) and once on dividends (income tax). It does mean, however, that the burden of paying tax falls on investors – and not on the Reit itself.
It should be noted that this is not unusual. In the UK, Reits don’t pay corporation tax, provided they distribute at least 90 per cent of their income to shareholders each year as a property income distribution dividend.
As Minister for Finance Paschal Donohoe said in the Dáil, “the estimated cost attached to the Reit relates not to an exemption from tax, but rather to the move from direct taxation of rental income to the taxation of dividends distributed from Reit profits arising from that rental income”.
Some would argue that Reits, by virtue of their low levels of leverage, can act as shock absorbers in an economy at times of crisis.
Another tax advantage of a Reit - at least for foreign investors - is that they can dispose of their shares, as with all Irish-listed securities, without paying CGT.
And the Reit itself may not be subject to CGT. If it disposes of a newly-developed property within three years of completion of the development, it will be subject to a CGT bill, but in other disposals it won’t.
Key attraction: No corporation tax and probably no CGT.
4. Icav
The final structure – and perhaps the most controversial at the present time – is the Icav, or Irish Collective Asset Vehicle. It can be known by different names. While Icav is the legal form, qualifying investor alternative investment fund (QIAIF) is the regulatory designation, and Iref (Irish real estate fund) is the tax classification.
Regulated funds, Icavs are structured under the EU’s alternative investment fund manager directive: other jurisdictions, such as Luxembourg, will have similar regimes.
This regime applies to funds where more than 25 per cent of a portfolio is made up of Irish assets; typically, most funds established for this reason will have 100 per cent of their portfolio in Irish assets.
The fund itself isn’t subject to any tax. This means that, much like the “gross roll-up regime” where the assets of Irish investors in a life-wrapped fund are allowed grow free of tax for a period of eight years, so too are Icavs.
But each time there is any distribution out of the fund, such as a sale of shares, or a gain on redemption, 20 per cent of this gets deducted and is paid to Revenue. If the fund sells a development, and distributes these profits, tax at 20 per cent will apply.
However, some exemptions to this rule do apply. These include Irish pension schemes, Irish life assurance companies, Irish regulated funds and their equivalent European Economic Area counterparts, along with Irish charities. Moreover, some foreign investors not falling into any of these categories may also be able to claim an exemption.
US property investor Kennedy Wilson, which counts Capital Dock, the Shelbourne Hotel and the Vantage development in Sandyford among its extensive portfolio of assets here, holds these through two Irish QIAIFs. As it noted in its 2018 annual report, "during the year these funds were exempt from any direct Irish taxation on income and gains".
Another QIAIF is the Davy Irish Property Fund, which owns the Treasury Building and the Nutgrove Shopping Centre in Rathfarnham, as is Iput, Ireland's longest established property fund, with €2.5 billion in assets. It reported profits of some €190 million last year and paid no corporation tax.
Icavs can hold either property assets, or the loans associated to them. Unlike Section 110 companies, many of which had to file accounts with the Companies Registration Office, Icavs file annual accounts to Revenue and the Central Bank and are not publicly available to view.
Key attractions: No corporation tax. Withholding tax at 20 per cent may apply. Profits roll-up tax-free. No CGT. Potentially no stamp duty
PROPERTY FUND VS SMALLER LANDLORD: FOUR WAYS TAX SYSTEM BENEFITS FUNDS
Stamp duty: Typically stamp duty does not apply to the transfer of loans and, according to Revenue, stamp duty is not chargeable on various conveyances and transfers and leases involving Nama, the State agency's subsidiaries and participating institutions.
This means that funds acquiring such assets via loans aren’t subject to stamp duty at a rate of up to 6 per cent that is a liability for a smaller landlord. It’s also a reason why some of these loan sales don’t’ show up on the Property Price Register.
Gross roll-up: Investments held in an Icav are not subject to tax on an annual basis. Tax only arises on crystallisation of income or gains, which means that the funds can grow tax free. An individual landlord on the other hand must pay tax every year on their rental income.
Corporation tax: Property companies holding assets in a Reit or Icav won't pay any corporation tax. Small landlords, however, must pay income tax on their rental income, at a rate of up to 55 per cent.
Capital gains tax: When a landlord sells a property, they will face a CGT bill of 33 per cent. Funds such as Icavs and Reits, however, can typically avoid this.
