Significant changes to the taxation of Irish investment funds came into effect on 1 January 2017. The new regime applies to regulated funds that invest, or may invest, in Irish real estate and related assets. It introduces a potential 20% withholding tax on certain events, including the sale of units, distributions and redemptions from such funds, and additional reporting and compliance requirements. Funds carrying on a business of renting, developing or trading in Irish real estate are the primary focus of the legislation.
The changes do not affect non-Irish funds, funds that are Undertakings for Collective Investment in Transferable Securities (UCITS), or funds that have an international investment focus, including funds holding non-Irish real estate. As a result the vast majority of Irish regulated funds continue to enjoy the traditional beneficial Irish tax regime, being broadly, tax exempt status for the fund and no Irish tax for non-Irish resident investors, subject to certain conditions being satisfied.
The new regime is primarily focused on funds authorised as Qualifying Investor Alternative Investment Funds ("QIAIFs") that have invested, or intend to invest, in specified Irish assets. QIAIFs can be formed as investment companies, Irish Collective Asset-management Vehicles (ICAVs) within the meaning of the Irish Collective Asset-management Vehicles Act 2015 or as unit trust schemes. All such QIAIF vehicles may be impacted. QIAIFs formed as Common Contractual Funds (CCFs) or Investment Limited Partnerships are tax transparent, and therefore will not be directly impacted. The legislation can also apply to funds authorised as RIAIFs (Retail Investor Alternative Investment Funds) however these are understood to represent a negligible portion of the affected funds.
QIAIFs are generally exempt from Irish tax in respect of all income, including profits or gains derived from rental, development or disposals of Irish land and buildings. Although regulated funds were used to hold Irish real estate for over 20 years, in recent years they increased in popularity, particularly amongst international investors in the Irish real estate market. Noting this increased usage, the Minister for Finance announced a period of consultation in September 2016, culminating in publication of draft legislation on 20 October. This was debated and amended during October and November and was signed into law on 25 December 2016.
Summary of Tax Changes
The new legislation affects Irish funds holding Irish real estate and related assets. These are now defined as Irish Real Estate Funds or "IREFs" for tax purposes. The key features of the regime can be summarised as follows:
(a) IREFs are Irish regulated funds that derive at least 25% of their value from Irish real estate, shares in unquoted real estate companies, Irish REITs and certain debt securities issued by Irish securitisation entities (so called "section 110 companies").
(b) In an umbrella fund, the 25% threshold is applied to each individual sub-fund. A fund will also be deemed to be an IREF if its primary purpose is the acquisition of such real estate assets.
(c) Where an IREF makes a distribution or redeems units it may be obliged to impose a 20% withholding tax on a percentage of the amount paid. The withholding tax events arise in a wide variety of circumstances.
(d) There are certain classes of exempt investor, in respect of whom no withholding tax may be levied. These are primarily Irish taxable investors (who are already subject to Irish investment undertaking tax) and, in addition, Irish pension funds, regulated investment funds, life assurance funds and their EU EEA equivalents. The application of these exemptions is subject to a number of anti-avoidance provisions which could impact investors who can select or influence the assets or business of the fund.
(e) Where an investor would have been exempt from withholding tax, but has made an indirect investment, such as through a feeder vehicle, they will be entitled to seek a reclaim of the tax withheld.
(f) Where units in an IREF are sold or disposed of, the purchaser is obliged to deduct 20% of the consideration payable and account to the Irish Revenue Commissioners in respect of it. The amount withheld may then be reclaimed by the seller.
(g) The new regime will apply to accounting periods beginning on or after 1 January 2017 but may be applicable to accounting periods commencing prior to that date.
Long Term Investment Exemption
The legislation provides a withholding tax exemption in respect of profits derived from the sale or disposal of Irish land that was held directly for 5 years. Initially this relief was available to a wide range of investors, however it has been restricted during the passage of the legislation. It is now only available in respect of investors who were unable to control or select the assets or business of the fund. Investors who do have such powers, but are regulated funds, pension schemes or life assurance companies within the EU/EEA may also be able to benefit, provided they satisfy certain criteria. The narrow scope of the exemption means it will require careful review if there is an intention to rely upon it.
The new regime is complex and Maples and Calder expects the Revenue Commissioners to publish clarificatory guidance on a number of issues in the coming weeks.
Funds that hold Irish land and related assets, and investors and managers of such funds, should seek tax advice on the impact of these changes. Funds and administrators will have to seek declarations and information from investors to calculate the tax payable under the new regime. There are also additional reporting and tax filing obligations which will require assistance from tax compliance agents.
For investors which may be exempt from withholding tax, such as EU based investment funds and pension funds, it will be critical to assess their relationship with the IREF in order to confirm whether the withholding tax exemption is available, and whether the exemption for profits derived from long term property investment applies.
Given the material changes to the taxation position, investors may re-evaluate the use of QIAIFs to hold Irish property. Given the increased taxation and compliance burden, it is possible that their usage will decline in the future, and existing investments may migrate to non-regulated corporate structures. Perhaps in a move to encourage such transitions, there are two provisions in the legislation that allow investments to be restructured:
(a) Prior to 1 July 2017, it is possible to transfer the business of the IREF, or the land development aspects of the business, to a non-regulated corporate structure. The recipient company must issue shares to the IREF investors in consideration for the property transferred. The transfer is exempt from stamp duty.
(b) Prior to 1 January 2018, it is possible to transfer the property rental business of the IREF to a company that has elected to be an Irish REIT. This will also be exempt from stamp duty. REITs are generally exempt from tax on rental income and gains, although this is subject to meeting a number of conditions.
Both measures provide some measure of tax relief in respect of the restructuring. The clear legislative intention is to facilitate and encourage additional Irish REIT structures over the coming year. It is expected that many significant investors will look closely at the REIT provisions and we may see additional activity in this area during 2017.