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Tax Alert: New Tax Regime proposed for Irish Real Estate Funds

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Further changes to draft legislation at Report Stage of Finance Bill
Irish Real Estate Funds Tax Changes – Latest

With the publication of the Irish Finance Bill 2016 comes the  introduction of a new fund category called an Irish Real Estate Fund (IREF), and a new 20% withholding tax which is imposed on fund distributions (either made as  dividends from or gains on redemption of the fund investment), which relate to IREF profits. The Report Stage review of the Finance Bill has made some substantial revisions to the Committee released draft of the proposed new IREF legislation.

What is an IREF?

Under the proposed legislation, a fund falls within the definition of an IREF where 25% or more of the market value of the assets of the fund are derived, directly or indirectly, from IREF assets or one of the main purposes of the fund is to acquire IREF assets or carry on an IREF business. The point in time in assessing the 25% test is the preceding year end. Please note for the purposes of this test, where there is an umbrella fund each sub-fund is treated as a separate legal entity.

IREF assets include:

  • Direct Irish property investments;
  • Indirect Irish property investments except shares quoted on a stock exchange;
  • Loans secured on Irish Property except CLOs/CMBS/RMBS and Loan Origination;
  • Shares in an Irish REIT;
  • Units in an IREF.

IREF business is defined as dealing in or developing land or a property rental business which would be generally chargeable to income tax, corporation tax or capital gains tax. There are a number of points to emphasize:

  • UCITS are specifically excluded from the new rules.
  • The vast majority of Irish Qualifying Investor Alternative Investment Funds (QIAIFs) are not significantly invested in Irish property and will be unaffected by the new rules.

QIAIFs in relation to Irish real estate more commonly take the legal form of an Irish Collective Asset Vehicle (ICAVs), an Irish plc or Unit Trust.

What is the impact?

The impact of the draft legislation is to tax investors in an IREF who currently benefit from a tax free investment into Irish property. The current tax benefits are provided through an exemption at the fund level on the income and gains earned by the fund, and also with an exemption on all distributions out of the fund if the investor has completed a relevant declaration as a non-resident or as an exempt Irish investor.

The headline change introduced is a withholding tax of 20% which applies on all dividends paid and any gains on redemption arising from the profits of the IREF. The change applies in respect of accounting periods commencing from 1 January 2017, or 20 October 2016 if there is a change in accounting period following the release of Finance Bill 2016.

While the proposed changes apply for accounting periods beginning on or after 1 January 2017, the draft legislation provides that any distributions, including gains on redemption, in respect of accumulated profits to that date, including certain realized or unrealized gains on property assets, paid after 1 January will be subject to withholding tax. Therefore, no grandfathering will apply and consequently there may be a need to look at what the impact is on any accumulated profits to date and on any potential reorganization options, before the new legislation comes into effect.

How are Irish Real Estate Funds profits calculated?

IREF profits are defined as the profits and gains of an IREF business per the financial statements profit and loss account, plus any profits on the disposal of an IREF asset not shown in the profit and loss account, less any unrealised gains on property which is engaged in a property rental business.  The exclusion of unrealised gains is designed to exempt property held for rental on the basis that if such property is held for 5 years it will be excluded from the calculation of IREF profits.  If the property is disposed of within 5 year any gain arising on disposal is included in the calculation of IREF profits.

The Report Stage has inserted an amending provision and provides that if the IREF is regarded as a personal portfolio IREF in respect of a unitholder, then the 5 year exemption in respect of gains on property held for rental will not apply to that unitholder.  This is a significant change.

What is a personal portfolio IREF?

The proposed legislation introduces connected party rules which provide for an additional category of fund within the IREF legislation, described as a personal portfolio IREF.  In basic terms a personal portfolio IREF is an IREF where the assets being held were selected or influenced by the IREF unitholder, a person acting on behalf of the IREF unitholder, a person connected to the IREF unitholder, a person connected with a person acting on behalf of the IREF unitholder, the IREF unitholder and a person connected with the IREF unit holder or a person acting on behalf of both the IREF unit holder and a person connected with the IREF unitholder.

Specifically this will include situations where any arrangements allow the exercise of options or give the IREF discretion to offer any person the right to make a selection of assets or the unitholder or any person connected with the unitholder has or had the option to appoint an investment advisor to assist in the selection of IREF assets or business or the conduct of the business.

The test is unitholder based so it does not taint all unitholders in an IREF if one unitholder fails the conditions above. The IREF is therefore deemed to be a personal portfolio IREF for that one unitholder.

What is a Taxable Event?

The draft legislation provides that a taxable event will arise in a number of situations.  They include the following:

  • the making of a distribution other than on disposal of units;
  • the redemption or repurchase of units from a unitholder including on liquidation;
  • any exchange by a unitholder of units in a sub-fund for units in another sub-fund of the IREF;
  • bonus issue of units other than by receipt of new consideration;
  • an IREF ceasing to be an IREF including ceasing to be an Irish regulated fund or the value reducing below 25%;
  • the disposal of a unit by a unitholder other than under the above, and;
  • the sale or transfer of the right to receive any of the accrued IREF profit without the sale or transfer of the unit to which the IREF accrued profit relates or where the IREF accrued profit becomes receivable other than by the unit holder.
What is the IREF Taxable amount?

A specific formula is provided in the draft legislation to calculate the taxable amount in relation to the taxable event.

Are there investors who are exempt?

There are certain categories of exempt investors who will not be subject to withholding tax, provided that they are not regarded as being a unitholder in relation to a personal portfolio IREF.

In addition the Report stage clarifies the position of exempt investors in the context of personal portfolio IREFs.

Where the investors in an “exempt investor” would not themselves fall foul of the person portfolio IREF legislation, then even though the IREF in question is a personal portfolio IREF in the context of the exempt investors, the personal portfolio anti-avoidance legislation should not apply. These investors are currently listed as:

  • Irish and equivalent European Union (EU) or European Economic Area (EEA) pension schemes, Personal Retirement Savings Accounts and EU cross-border schemes holding the IREF directly or indirectly
  • Other Irish regulated funds or equivalent funds authorized by a Member State of the EU or the EEA
  • Irish life assurance funds and equivalent overseas life assurance funds

The terms ’equivalent’ above means that such non-Irish funds must be subject to at least the same supervisory and regulatory arrangements that apply in Ireland.

In addition to the above, the personal portfolio IREF conditions are also relieved for these exempt investors if they hold their units in a personal portfolio IREF by reason of a scheme of amalgamation.

The connected person conditions applicable to exempt investors in a personal portfolio IREF are further relieved where it can be shown that the person connected with the unitholder who can select or influence the IREF assets or business cannot be influenced by that exempt investor in the performance of its duties or show any preference or consideration to that unitholder over and above any other unitholder.

If the categories of exempt investors as listed above do not fall within the relieving provisions they are then brought within the IREF withholding tax regime.

Finally it is important to note that there is an additional category of exempt investors extended at the Committee Stage Review to include Irish charities and credit unions and Irish “section 110” companies. All exempt investors must be in possession of relevant declarations which are outlined in the legislation.

Are all distributions taxable?

The Finance Bill does provide an exemption from withholding tax for capital gains realized on a directly owned property asset held for a period of at least five years where it was purchased for consideration equal to market value and subsequently sold to a person unconnected with the IREF or any of its investors. This means these gains should be excluded from the calculation of IREF profits for the purposes of withholding tax on dividends or gains on redemption. Please note this does not apply to shares in property companies.

As discussed above the Report Stage has inserted an amending provision and provides that if the IREF is regarded as a personal portfolio IREF in respect of a unitholder, then the 5 year exemption in respect of gains on property held for rental will not apply to that unitholder.

Equally there is no exemption for gains on development land as such gains would be subject to tax as trading income and not capital gains.

Taxable Irish investors will continue as before to be taxed under normal rules on dividends and gains on redemption.

What other anti-avoidance provisions are applicable?

There are a number of anti-avoidance provisions contained within the draft legislation which are aimed at preventing restructuring being undertaken on or after 1 January 2017 to avoid the new rules, including the application of the personal portfolio IREF provisions.

A number of other provisions are aimed at preventing transfers of interests from affected investors to exempt investors and similar avoidance mechanisms.

Can treaty resident investors reclaim withholding tax?

The current draft legislation includes a section which details the interaction of the new withholding tax with tax treaty relief, specifically the ability to reclaim, under a relevant tax treaty, withholding tax suffered by a unit holder. The critical definition is whether the unit holder is a “holder of excessive rights”. A holder of excessive rights is defined as someone who is beneficially entitled, directly or indirectly, to at least 10% of the units in an IREF.

Where a unit holder is a holder of excessive rights, then any distribution made to it from an IREF is to be treated for tax treaty purposes as being income from immoveable property. Where a unit holder is not a holder of excessive rights, then any distribution made to it from an IREF is to be treated for tax treaty purposes as being a dividend payment.

The above classification is critical in determining the availability of any treaty relief. While many of Ireland’s tax treaties contain relief/exemption from Irish dividend withholding tax, Ireland typically retains taxing rights over income from immovable property and so treaty relief would be unlikely to be available.

Are there restructuring provisions provided in the draft legislation?

For an IREF fund which is in the business of developing or dealing in land, the retention of such business in the IREF will likely be tax inefficient as all profits arising on such a business are subject to withholding tax including any gains on the ultimate disposal of the property.  The draft legislation allows the tax efficient transfer of such a business to an Irish company which would result in profits being subject to 12.5% rate.

The Report stage provides for the ability to transfer an IREF business to an Irish Real Estate Investment Trust (REIT) in respect of property rental business.  There are a number of conditions:

  • The transfer must be done by 31 December 2017
  • All of the business must transfer and the IREF must not engage in any further property rental business
  • Shares in REIT must be issued in proportion to unitholders units in the IREF and the IREF receives no consideration other than taking over the liabilities of the business.
  • Satisfying the conditions means that the unitholders shall not be treated as disposing of their units in the IREF and the shares in the REIT shall be treated as being acquired when the units were acquired.
  • The REIT shall be treated as having acquired all the assets and liabilities of the business of the IREF equal to the value of the assets and liabilities in the accounts of the IREF.

However the transfer will be treated as a taxable event but the IREF and the unitholder and the REIT may jointly elect that tax due can become payable the earlier of 60 days after the disposal of the shares in the REIT, the tenth anniversary of the date of the transfer, the appointment of a liquidator to the REIT or the REIT ceasing to be a REIT.

It appears all the provisions relating to the calculation of tax prior to the IREF transferring its business applies including the personal portfolio IREF rules.

While the tax rate would be similar at 20%, allowing a conversion may for certain models may be simpler and more efficient from an operational perspective.

A stamp duty relief on transfer is provided for both types of reorganisation.

What should be done now?

An impact analysis needs to be carried out to understand the following:
  • Which unitholders are potentially affected?
  • Are unitholders regarding as investing in a personal portfolio IREF?
  • Does the fund have large unrealised gains which may become subject to the new rules post 1 January 2017?
  • Which retained profits generated in the period to 31 December 2016 are subject to the new rules?
  • Will the unitholders ultimately have the ability to reclaim withholding tax under a double tax treaty?
  • Is restructuring required to ensure no inequitable situations arise for unitholders from an Irish tax perspective?

If you would like to discuss any of the issues raised in more detail please do not hesitate to contact me.

Donal O’Sullivan

FS Partner, Tax
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