Foreign investors likely disappointed by property tax changes

Proposed changes to the tax regime governing property investment has brought into sharp focus the need for a coherent long-term tax policy for Irish property.

Tax certainty is a cornerstone of Ireland’s strategy of foreign direct investment. The proposed changes to regulated fund vehicles may therefore leave foreign investors disappointed. While the changes are understandable in an evolving international tax landscape, the fact remains that we need to continue to attract and, of course, retain foreign investors in order to have a fully functioning market.

The past two months have seen much engagement between key stakeholders regarding the role of regulated fund vehicles in the Irish property market. With the publication of Thursday’s Finance Bill, planned changes to the taxation of non-residents are now known.

Funds that deal and develop land for sale will no longer have tax-exempt status. Instead, they will pay tax on profits at 20 per cent, which will be collected when the profits are repatriated by way of dividends or otherwise to the non-resident.

Funds that hold property on a long-term basis will become liable for tax at a 20 per cent rate on net rental profit arising every year. Those that hold property as a long-term investment will continue to be exempt from capital gains tax, provided they hold the asset for five years or more.

An investment property sold within five years will be subject to the same 20 per cent withholding regime. The mechanism whereby the tax on fund profits is collected allows the shareholder to claim a credit for this tax in their home jurisdiction.

The changes will apply to accounting periods beginning on or after January 1st, 2017. Shareholders of European Economic Area pension or life entities, as well as other EEA-regulated investment funds, are among shareholders excluded from this tax charge. Further details are expected at the committee stage of the Finance Bill.

Driving price inflation

So, what impact will the legislative change actually have? Arguably, tax/ownership structure had begun to play a disproportionate role in driving price inflation in the market. As a result, there may be an impact on property values. These changes will remind the market that the primary focus in valuation needs to be about the fundamentals – not tax.

This is especially the case with regard to development/land-dealing activities, which will now become taxable. This change is not wholly unexpected, given that it was never intended for regulated investment funds to engage directly in property trading activities on a tax-exempt basis.

The change will level the playing field between foreign and re-emerging local players, which makes sense for the long-term balance our economy needs. It will likely result in some funds restructuring such that future development activity qualifies for the 12.5 per cent tax rate instead of 20 per cent under the new regime. A start date of January 1st allows limited time to restructure as regards existing land.

From an investment property point of view, the changes introduced for genuine investment funds ensure that a level of tax yield will be generated from this segment. The retention of the exemption from capital gains tax is welcomed.

They broadly align our regime with the UK, where net rent is taxed at 20 per cent and capital gains are exempt. Net rent will be calculated by reference to general principles, which may unfairly penalise lowly geared funds.

The exclusions also ensure that the wider EU population (in particular, prospective pensioners) are not affected.

Now, foreign investors would argue that their foreign capital, which they invested in Irish property from 2011 onwards, took on significant risks that were underpinned by a transparent tax regime, which resulted in zero direct tax leakage. They would argue that there has been no abuse.

Helped reignite market

Whether you agree or not, this sector has reason to be disappointed with the changes introduced. They can rightfully claim that they have substantially contributed to the stamp duty and VAT tax take and reignited the market. By contrast, an investor in Irish bonds continues to pay no tax on profits (which, incidentally, is greater than the movement in property values).

However, the overall global tax environment has changed significantly since 2011. In particular, the OECD's base erosion profit shifting initiative and the parallel initiative of the European Commission means that all market participants need to pay a level of taxation by reference to economic activity in a country. Viewed from this perspective, the changes introduced are more understandable.

The way in which the changes have been introduced has not been ideal, as most would acknowledge. Consultation was compressed into a very short period of time. In this situation, it is difficult to ensure that the myriad policy responses available are fully considered – and that the chosen one is proportionate in terms of impact on the funds industry and property market participants.

For now, the Minister for Finance needs to commit himself to ensuring that there will be no further changes to the existing regime.

We must ensure that our tax policy continues to underpin and encourage foreign capital to invest in the Irish market while also ensuring that the re-emerging local players flourish and multiply, so that we achieve a healthy balance in our economy from a long-term perspective.

Pádraig Cronin is vice-chairman of the board of Deloitte Ireland, as well as mergers and acquisitions services leader.