The long awaited details of the changes to the taxation of Irish investment funds holding Irish property have been announced in the Finance Bill issued on 20 October 2016.
In summary, the proposed changes introduce a 20% withholding tax on certain property distributions from Irish Real Estate Funds (IREF) to non-resident investors.
Capital gains on investment properties are carved out from the new rules where the land is held for at least five years. In addition, various investors will be exempt from the withholding tax.
What funds are in scope?
An IREF (i.e. a fund within scope) is an Irish regulated investment fund in which 25% or more of the market value of the fund's assets derives, directly or indirectly, from what are referred to as "IREF Assets" (see below for definition).
A broader, less well defined category of funds also come within scope in circumstances where "it would be reasonable to consider that the main purpose, or one of the main purposes of the investment undertaking is to acquire IREF Assets or carry on an IREF Business". It is not clear what this limb of the definition is intended to capture, but it could potentially include funds that held IREF Assets but no longer do so.
The proposed rules will apply at a sub-fund level (i.e. within an umbrella fund one sub-fund could be in scope without impacting the other sub-funds).
What are IREF Assets and what is an IREF Business?
IREF Assets are defined as land in the State and any other assets used in carrying on an IREF Business.
An IREF Business is essentially one which carries out activities related to Irish land where, if those activities were not carried on in an investment fund would be:
- Regarded as dealing in or developing land taxable under Section 640 of the Taxes Consolidation Act 1997;
- Subject to tax under Case V of Schedule D of the Taxes Consolidation Act 1997, which would include rental income;
- Subject to Capital Gains Tax; or
- Regarded as trading in land.
What amounts are subject to Irish tax?
Distributions or other payments made to a unit holder who is not within the charge to Irish tax annually (or more frequently) are subject to a 20% withholding tax.
In addition, the payment of redemption proceeds are subject to a 20% withholding tax to the extent they are attributable to IREF Profits (which are essentially the income and gains from IREF Assets as calculated under income tax and capital gains tax principles).
What amounts are out of scope?
There is a specific carve out aimed at gains on land acquired at market value and held for at least five years, provided it is not sold to a person connected with the IREF or any of its unit holders. The exact scope of this carve out is not clear.
What unit holders are out of scope?
Irish pension schemes, other investment funds, life assurance companies and their equivalents authorised in an EU or EEA Member State will not come within the scope of the withholding tax.
When are the new provisions effective?
The new rules apply for accounting periods of the IREF commencing on or after 1 January 2017. A provision is included which is designed to discourage IREFs from changing their year ends to delay the impact of the proposed rules.
William Fry Comment
- While the proposed rules only become effective for accounting periods commencing on or after 1 January 2017, it is not clear that increases in value of IREF Assets up to that date are outside scope of the new rules. Under general tax principles, capital gains tax arises on realisation (i.e. when an asset is sold). While the IREF will not itself pay capital gains tax, the amount of the capital gain will still be calculated to determine what is in scope of the new withholding tax. For IREFs that do not develop, deal in or redevelop land, increases in value from the date of acquisition to 1 January 2017 could potentially be within scope of the new rules where disposal occurs within 5 years of acquisition. It will be important for the Minister for Finance to clarify whether this is the intention of the provisions or whether further changes are to be expected.
- With an effective date of less than ten weeks time, there will be significant administrative and operational challenges in implementing the new rules. Guidance from the Revenue Commissioners in relation to the application of the new provisions will be required as a matter of urgency.
- The carving out of gains on land held for at least five years is welcome. Clarity on the scope of this carve out will be important, in particular whether it applies to all IREF Assets held for five years.