If enacted in the form proposed, the change will apply to profits earned after 6 September 2016. The amendment applies to companies qualifying under section 110 TCA (“Section 110 Companies”) that have invested in certain loans secured over Irish real estate.
The change was introduced following intense media and political debate on the tax treatment of Section 110 Companies that had acquired distressed loan portfolios secured on Irish real estate from Irish banks and the National Asset Management Agency. Announcing the change, the Minister noted “The proposed amendment targets the issues that have been raised and will ensure that the Irish tax base is appropriately protected.”
What is the change?
The change imposes a corporation tax liability on Section 110 Companies for profits arising on certain loans (and similar assets) deriving their value from Irish real estate. There are also a number of exceptions as outlined below.
Under Irish tax legislation, Section 110 Companies are permitted, in certain circumstances, to deduct interest payments on profit participating debt. This deduction will no longer be available to the extent that the Section 110 Company holds “any financial asset which derives its value, or the greater part of its value directly or indirectly” from Irish real estate (described in the legislation as “specified mortgages”).
What Section 110 Companies are not affected?
The vast majority of Section 110 Companies will be wholly unaffected by this change as it is designed to apply only to Section 110 Companies holding specified mortgages. In particular the change will have no impact on:
- Section 110 Companies which only hold non-Irish assets, provided none of those assets derive their value from Irish real estate;
- Section 110 Companies which hold Irish assets which do not derive their value from Irish real estate. For example, Section 110 Companies holding Irish aircraft, commodities or Irish government bonds will not be affected by this change.
What does the change mean for Section 110 Companies that are in scope?
Under the draft legislation, loans to which the new rule applies that are held by a Section 110 Company will be treated as a separate business. Income and expenses associated with that business will be ring-fenced. Deductions for profit participating interest payments made in respect of the ring-fenced business will be denied. The Section 110 Company will still be entitled to a deduction for such amount of the interest as equates to an arm’s length amount. After taking this deduction into account, any profits will be taxed at 25%. The change applies in respect of profits earned after 6 September 2016.
It therefore seems that a Section 110 Company affected by this change will have to carry out a valuation of its affected assets as at 6 September 2016. Any profit arising to the Section 110 Company from an increase in value after this date (and taking into account the permitted arm’s length interest deduction and other expenses) will be subject to 25% corporation tax in Ireland.
Into the future, the Section 110 Company will need to calculate the profits of this ring-fenced business by reference to current-day IFRS. The facility to use GAAP as at 31 December 2004 will not be available for such ring-fenced business.
It appears that returns paid by Section 110 Companies to investors out of the taxed profits may now be subject to Ireland’s dividend withholding tax rules, as opposed to Ireland’s interest withholding tax rules. In most cases, this will result in the same treatment – an exemption from withholding tax – but not all cases. Therefore, consideration will need to be given to the withholding tax treatment of such payments.
What are the exceptions?
There are four exceptions from this new provision. Profit participating interest will continue to be deductible if the investors receiving the interest payments are any of the following:
- Irish tax resident companies or Irish branches of foreign companies (in each case within the charge to Irish corporation tax in respect of the income received).
- Certain Irish retirement funds and Irish pension schemes.
- Certain offshore funds that have been certified by the Irish Revenue Commissioners as distributing funds.
- Investors resident in an EU Member State or an EEA country, provided that:
- the investor is generally taxed on income received in their country of residence from sources outside their country of residence;
- the investor carries on “genuine economic activities” in their jurisdiction of residence; and
- it would not be reasonable to conclude that the profit participating debt forms part of any arrangement or scheme of which the main purpose (or one of the main purposes) is the avoidance of a liability to tax.
No guidance is yet available on circumstances where the fourth exception will be applied or when the Irish Revenue Commissioners will consider a taxpayer to be carrying on “genuine economic activities”. It is hoped that published guidance may become available in due course in this regard.
What are the next steps?
The draft legislation is to be included in Ireland’s Finance Bill 2016 which is due to be passed before the end of 2016. The change is to apply in respect of profits earned after 6 September 2016. It is possible that further amendments could be made to the provision as it passes through the legislative process. Any Section 110 Companies considering restructuring their arrangements in light of the proposed change may wish to consider waiting until the proposed change is finalised before implementing any restructuring.
By Matheson
