Finance Bill 2016 was published today and contains some important clarifications to the proposals published on 6 September 2016 to amend Ireland's Section 110 regime in respect of profits derived from Irish real estate. A summary of the updated proposals is set out below.
What was clarified?
The clarifications confirm the targeted nature of the proposals which are intended to tax gains on Irish mortgage loan portfolios acquired through Section 110 companies.
Section 110 companies that have no exposure to Irish real estate remain unaffected by the proposed amendments. In addition, consistent with the announcement when the proposals were first published, securitisation transactions involving Irish mortgage loans such as CMBS and RMBS, as well as CLOs, are now expressly excluded from the scope of the provisions. Loan origination by a Section 110 company has also been expressly excluded.
The Finance Bill will be debated over the course of the coming weeks. Once enacted, it is proposed that the new provisions will apply to the Irish real estate related profits of a Section 110 company for accounting periods commencing on or after 6 September 2016, with a deemed split for tax purposes where an accounting period straddles that date.
What is proposed?
The proposed amendments seek to amend the tax treatment of Section 110 companies investing in loans secured on Irish real estate by ring-fencing the Irish real estate related business and restricting the level of interest which may be deducted for tax purposes.
Irish real estate ring-fence
The business of holding and/or managing loans secured on, and which derive their value or the greater part of their value directly or indirectly from, Irish real estate (referred to as "specified mortgages"), is to be treated as a separate business of a Section 110 company, referred to as a "specified property business". Certain derivatives which provide exposure to such loans and to Irish real estate are also to be treated as a specified mortgage and therefore part of the specified property business. The type of assets within scope has been narrowed to reflect the targeted nature of the proposals. Thus, shares or units in an Irish REIT or other Irish real estate vehicle and unsecured bonds are now outside of the scope of the proposals.
The ring-fenced business will continue to be taxed under the provisions of Section 110 but will be subject to a new restriction on the ability for the Section 110 company to deduct profit participating or excessive interest. Subject to certain exclusions, an interest cap will apply such that a Section 110 company will only be entitled to deduct against the profits of its specified property business, the amount of interest which would have been payable had it entered into a loan on reasonable commercial terms. Any excess interest above this rate will not be deductible against the profits of the business, which profits will be subject to corporation tax at the 25% rate applicable to Section 110 companies.
In keeping with the statement made by the Minister for Finance on the importance of the securitisation industry to the Irish economy, certain types of activities are now specifically excluded from the scope of the provisions.
While CLO transactions involving loans secured on Irish real estate should generally not have fallen within the scope of the provisions as initially proposed, a "CLO transaction" as defined is now expressly excluded from the specified property business of a Section 110 company. A CLO transaction for these purposes is a securitisation transaction within the meaning of the Capital Requirements Regulation1 ("CRR") where the prospectus, listing particulars or a legally binding offer document provides for:
- a warehousing period not exceeding three years, during which time the Section 110 company is preparing to issue securities; and
- investment eligibility criteria that govern the type and quality of assets, and where based on the relevant document and the activities of the Section 110 company, it would not be reasonable to consider that the main purpose, or one of the main purposes of the Section 110 company was to acquire specified mortgages.
These criteria should be satisfied in the context of a typical CLO transaction.
In recognition of the importance of securitisation to the banking industry generally, a CMBS/RBMS transaction is also now expressly excluded from the scope of the proposed amendments. A CMBS/RMBS transaction for these purposes is a securitisation transaction within the meaning of CRR where:
- the originator (within the meaning of paragraph (a) of the definition of originator in Article 4 of CRR) retains a net economic interest in the credit risk of the securitisation in accordance with Article 405 of CRR; or
- the originator (within the meaning of paragraph (b) of the definition of originator in Article 4 of CRR) retains the net economic interest as above and is a financial institution or credit institution regulated by a competent authority in an EU/EEA member state or is authorised by a country authority recognised by the European Commission as having supervisory and regulatory arrangements at least equivalent to those applied in the EU/EEA to carry out similar activities (e.g. a US or Canadian bank engaging in securitisation transactions involving Irish real estate loans).
Provisions to exclude warehousing in preparation of a CMBS/RMBS are also included in the updated proposals.
Loan origination business
The intended scope of the provisions in targeting gains on Irish real estate loans acquired by Section 110 companies is also further clarified by the exclusion of loan origination from the scope of the proposed provisions. This exclusion should avoid any unintended impact on the availability of credit for the Irish real estate development sector, with non-bank lending providing much needed liquidity in this area.
"Excluded persons" exception
Where a Section 110 company is carrying on a specified property business, the proposed new interest cap will not apply to interest paid to certain categories of excluded persons, namely:
- persons within the charge to Irish corporation tax or an individual within the charge to Irish income tax in respect of the interest;
- certain types of Irish and EU pension arrangements (including cross-border pension schemes); and
- certain non-resident persons, being an individual who is a national of an EU/EEA Member State (other than Ireland) or a company that is formed under the laws of and is registered in an EU/EEA Member State (other than Ireland), where the interest paid is subject to tax in an EU/EEA Member State (other than Ireland) and where it would be reasonable to consider that (a) the interest is not payable as part of any arrangement or scheme to avoid tax, and (b) where the non-resident person is a company, it is carrying on relevant "genuine economic activities" in any EU/EEA Member State (other than Ireland).
Additional anti-avoidance provisions have been included in the non-resident person exclusion which provide that interest will not be regarded as subject to tax in an EU/EEA Member State where the recipient has obtained a deduction for profit participating interest. The use of hybrid financing arrangements such as convertible preference equity certificates is also specifically mentioned.
Subject to complying with the normal rules applicable to Section 110 companies, profit participating interest paid to an excluded person will continue to be deductible in full for the Section 110 company against the profits of its specified property business.
The initial proposal for the compulsory application of IFRS in the calculation of the taxable profits of a Section 110 company's specified property business is no longer included in the updated provisions and the ability to apply Irish GAAP as at 31 December 2004 should continue to be available.
The proposed amendments also compress the timeframe within which a Section 110 company must notify the Irish Revenue in writing of its intention to be a Section 110 company to within eight weeks of acquiring qualifying assets of €10 million, or where the information requested is not available at that time, without undue delay.
The proposed amendments are to apply to the Irish real estate related profits (if any) of a Section 110 company for accounting periods commencing on or after 6 September 2016, with a deemed split for tax purposes where an accounting period straddles that date. It is disappointing that no provision has been made for a Section 110 company investing in Irish mortgage loans to obtain a step up in base cost to market value on 6 September. Depending upon the accounting policies adopted by the Section 110 company, this may bring unrealised gains prior to 6 September 2016 within the scope of the proposals.
The implications of the proposed amendments (where relevant) will require careful consideration.
1 Regulation (EU) 575/2013.
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