This is the fourth in a 4-part series on tax avoidance in the Irish state.
The three key mechanisms for tax avoidance that have been used by multinational corporations (MNCs) in the Irish state over the past decade have been the Double Irish, inversions, and the use of Special Purpose Vehicles (SPVs) under the Irish state’s lax securitisation regime introduced in Dublin’s International Financial Services Centre (IFSC) under the Taxes Consolidation Act 1997.
Bloomberg reported in February this year that a survey by the Financial Stability Board found that the Irish state’s shadow banking sector ranked third with China as the largest in the world after the US and Britain, and at more than 2.3 trillion euros it was 10 times the size of the Irish economy. Half a trillion euros were held by unregulated SPVs, the FSB found. A Financial Vehicle Corporation (FVC) is a securitisation instrument as defined by the European Central Bank FVC Regulation, but while SPVs share many of the same features they are outside the Regulation.
The Central Bank estimated that in 2015 there were 779 FVCs holding €415 billion – required by the ECB to report quarterly data since 2009 – and 600 SPVs in 2012 holding €150 billion. In its Macro-Financial Review published in June this year, the Central Bank said there was, as of December last year, 820 SPVs holding €322 billion in assets. SPVs were not required by the Central Bank to file reports until last year. SPVs are generally used for loan origination but can also carry out securitisation activities.
Section 110 companies
The Central Bank says that tax provisions introduced in the 1991 Finance Act aimed at allowing the creation of structures that were broadly profit and tax-neutral in order to facilitate the securitisation of mortgages. This was then expanded beyond the IFSC with Section 110 of the Taxes Consolidation Act 1997, which came into effect in 1999.
The assets that could be held, managed or leased by a Section 110 company was extended by the Finance Acts of 2003, 2008 and 2011. SPVs and FVCs use “orphan companies” usually held by a charitable trust in order to keep assets off the balance sheet of their true parent companies. The originating companies of the majority of SPVs in Ireland are from the US, Britain, Germany, France, Italy and Russia. The collapse of two Dublin-based SPVs that originated from German bank Sachsen Landesbank in 2007 led to a €17 billion emergency banking bailout by the state of Saxony.
To qualify under Section 110 the company must be resident in Ireland; acquire qualifying assets of at least €10 million; and notify Revenue that it wants to fall under the Section 110 framework. The qualifying assets can include shares, bonds, securities, insurance and reinsurance contracts, hire purchase contracts, money market fund investments and more. Since 2012, qualifying assets can include commodities, carbon credits, plant and machinery.
While an SPV is a taxable entity, and should be taxed at the non-trading corporation tax rate of 25 per cent, under Section 110 its taxable profit will be measured according to the rules of a trading company – so the SPV is entitled to a tax deduction for all trade expenses, such as interest paid. As a result, SPVs “can utilise various techniques to strip profit out on its underlying investments and can reduce or eliminate the tax it is required to pay” according to law firm Dillon Eustace. The International Tax Review states that Section 110 companies are “typically structured so that income earned is matched with its expenditure resulting in minimal taxable profits”.
The result is that SPVs, in particular vulture funds buying up distressed mortgages in Ireland, are earning millions of euros annually from mortgage-holders and shifting it offshore but are paying as little as €250 in tax to Irish Revenue. According to various media reports, between 2011 and April 2016, vulture funds in the Irish state purchased loan portfolios worth €62.9 billion against the backdrop of a mortgage arrears, housing affordability and homelessness crisis.
Banks are increasingly selling off distressed mortgages to vulture funds at reduced prices, who have proven to pursue repossessions of homes even more aggressively, fuelling the housing and homelessness crisis. In May Ulster Bank announced the sale of 900 family homes with distressed mortgages as part of a €2.5 billion property loan portfolio to vulture funds. This follows the purchase in March of 200 family homes by a Goldman Sachs vulture fund in Tyrellstown, Dublin.
It has been reported that the largest purchasers were Goldman Sachs, Cerberus, Deutsche Bank, Lone Star, CarVal and Apollo. In 2014 the Irish arm of US vulture fund Lone Star, which holds distressed German mortgages, generated €1.24 billion but paid less than €1 million in tax. Cerberus’s 2014 accounts show it generated more than €140 million of revenue on its Irish assets, but paid less than €2,500 in tax.
Goldman Sachs subsidiary Beltany’s 2014 accounts show that it generated income of €44 million – but paid just €250 in corporation tax. Cayman-linked Mars Capital generated revenue of €14 million in 2014 but also paid just €250, as did Launceston Property Finance, which originates from Luxembourg-registered CarVal and generated €16 million. Some of these banks are under the direct supervision of the European Central Bank, leading Sinn Féin MEP Matt Carthy to write to the ECB in June to request it to investigate the relationship between these banks, their associated vulture funds, tax avoidance and evictions in Ireland.
Source: Grant Thornton law firm, ‘SPV taxation’, 30 September 2015
Irish tax law enables tax avoidance by Section 110 companies
The specific features of Irish tax law that enable Section 110 companies to do this include the fact that there are no ‘thin capitalisation’ laws in Ireland (there is no minimum profit required for a company for tax purposes, so an SPV can strip out all of its taxable profits if it chooses). Any costs of raising finance are tax-deductible under Section 110.
The most important provision of the law has been Section 110(4) which permits a Section 110 company to take a deduction for “profit participating interest” if certain conditions are met. The Finance Act 2011 introduced anti-avoidance provisions that sought to deny deductibility for that profit element of interest, but included exceptions that made the measures meaningless.
The anti-avoidance provisions do not apply (so interest is fully deductible) where the recipient of the interest or other distribution is either a person resident in Ireland, or a person (resident in an EU Member State or tax treaty country who is not “connected” with the SPV) who is a pension fund, government body or other person who is exempted from tax which generally applies to profits, income or gains in that jurisdiction. Just in case any of those exemptions do not do the trick, the Finance Act 2011 also introduced an exemption on withholding tax on interest paid through quoted eurobonds.
The Finance Act 2011 also expanded the list of qualifying assets from only financial assets to also to include commodities, carbon credits and plant and machinery, aimed at making Ireland more an attractive site for the aircraft leasing industry. Tax treaties can be used to reduce withholding taxes on inbound payments for lease rentals, and Irish-resident SPVs can receive incoming investment management services without being subject to Irish VAT.
Section 110 companies are allowed to calculate profits according to the old Irish generally accepted accounting principles (GAAP 2004) instead of the new Irish GAAP or International Financial Reporting Standards (IFRS). Dillon Eustace law firm, which advises Ireland’s National Asset Management Agency and Lone Star, among others, says the legislation was amended after industry successfully lobbied Revenue over concerns that International Accounting Standards “could compromise the profit neutrality of an SPV”.
The 2010 transfer pricing rules do not apply to Section 110 companies.
Total return swaps, where the SPV swaps all of its receipts with another company in its group in return for enough funds to discharge liabilities, should be liable to tax but apparently are not in practice and are used as a profit-extracting mechanism. Dillon Eustace advises clients: “There may be a technical liability to Irish income tax for recipients (i.e. the swap counterparty) who are not resident in a country with which Ireland has a double tax treaty but, in practice, this liability is not enforced by the Irish tax authorities.”
Ireland’s membership of the EU and OECD (and its ‘white-listed’ status) and the listing of securities on the Irish Stock Exchange are further incentives for SPVs to domicile in Ireland.
SPVs generally use an orphan entity ownership structure that ensures the entity is not owned by its originating bank or hedge fund but by a charitable trust. Revenue have raised concerns about the use of charities for this purpose as revealed through Sinn Féin TD Pearse Doherty‘s Freedom of Information request last month. Dublin’s corporate law firms generally establish the charitable trust or provide the use of their existing charitable trusts to SPVs.
For example, Matheson has established its own charity, the Matheson Foundation, which it regularly uses to help incorporate SPVs for its clients. Its website says: “The Matheson Foundation has two clear goals: to help children in Ireland to fulfil their potential; and to encourage corporate philanthropy in Ireland.” The Central Bank has found that most FVCs and SPVs incorporated in Ireland have no employees.
Qualifying Investor Alternative Investment Funds
A second key instrument used by international banks and hedge funds to avoid paying tax in the Irish state is the Qualifying Investor Alternative Investment Fund (QIAIF), which replaced the Qualifying Investor Fund (QIF), which was originally established by NAMA in 2012. The QIAIF is primarily a structured fund for real estate investment and is often used together with an SPV to ensure access to double tax treaties. QIAIF assets in Ireland are valued at €302 billion. They require a minimum subscription per investor of €100,000 and are subject to almost no other requirements.
QIAIFs are entirely tax-exempt from income tax and capital gains tax regardless of where the investors are resident, as well as being exempt from withholding tax for any payments made to non-Irish resident investors. Irish Real Estate Investment Trusts (REITs), a vehicle with a collective ownership structure for real estate investment established in 2013, are also exempt from income and capital gains tax from rental payments in most conditions.
The Irish Collective Asset Management Vehicle
The Irish Collective Asset Management Vehicle (ICAV) Act 2015 came into effect in March last year. It introduced a fifth type of corporate fund structure, alongside the investment company, unit trust, common contractual fund and investment limited partnership, and appears to have been established with the explicit goal of facilitating tax avoidance by US investors.
Matheson law firm describes the ICAV as “the culmination of a joint government and industry project to make available to promoters a legal framework for a corporate fund vehicle that is specifically designed for investment funds. Matheson partners were extensively involved in the industry project to introduce the ICAV.” It adds that “it is expected to become the vehicle of choice for UCITS and Alternative Investment Funds in Europe”. If the government’s reaction to accusations it was facilitating tax avoidance by SPVs was disingenuous, its claims to be unaware of the use of the new ICAV structure for tax avoidance is ludicrous.
The ICAV has several features that distinguish it from other fund vehicles:
*An ICAV can classify itself as transparent under the US check-the-box rules in order to avoid taxation that may apply in the US to passive foreign investment companies.
* An ICAV has its own legislative code that will allow it to avoid compliance with several Irish and EU company law requirements.
* It is not required to spread risk, unlike an investment company.
*An existing Irish investment company can convert to an ICAV easily, and a foreign corporate investment fund can domicile in Ireland and convert to an ICAV without incurring Irish tax in either case. Matheson suggests the jurisdictions where migration to Ireland will occur are the British Virgin Islands, the Cayman Islands and Jersey.
Despite the Irish government’s formal support for the OECD-BEPS process and its limited moves to respond to international pressure since 2014, there are a large number of significant legislative gaps that remain in place in the Irish state that not only allow tax avoidance by MNCs and global financial giants, but actively encourage it. Each step forward has been accompanied by “exemptions” that serve to make the reform ineffective, and appear to have been directly designed by the US Chamber of Commerce, the Big Four accounting firms and the major Dublin corporate law firms: Matheson, Arthur Cox, William Fry, Dillon Eustace and others, in a stark illustration of the “captured state” concept applying in Ireland.
Some of these legislative problems will be addressed to a certain extent by the transposition of the European Anti-Tax Avoidance Directive over the next period (though certain provisions, such as exit taxation, won’t take effect until 2020). There are a number of issues that will not be addressed by the ATAD, and a number of glaring loopholes that need to be closed in the meantime – Section 110 being the most urgent of all.