ANDREW CULLEN, President of the Irish Taxation Institute, summarises the proposed restrictions on property-based tax incentives and considers the impact these measures may have.

The recent Budget and Finance Act brought both good and bad news for property investors. The cuts to stamp duty rates have been generally welcomed; however, investors are still reeling from the restrictions announced in respect of property-based tax incentives.

While the requirement for an economic impact assessment has brought some breathing space, taxpayers have been left in limbo and many continue to fear the significant implications these measures would have if introduced without change.

What restrictions were introduced in Budget 2011?
In his Budget 2011 speech, the then Minister for Finance announced the phased abolition of Section 23 type reliefs and certain accelerated capital allowances for passive investors. The reality, however, is that the provisions contained in the Budget day financial resolutions, and ultimately in Sections 23 and 24 of the Finance Act 2011, would in many cases result in the relief coming to an immediate end. The main restrictions announced were as follows:

Section 23 Type relief:
■ Section 23 type relief will only be available against rental income from the property giving rise to the relief. In the past this relief was available on all rental income; and,
■ any Section 23 type relief that is not used within the 10-year qualifying period would be automatically lost and cannot be carried forward.

Capital allowances:
■ where the allowances arise in respect of a building that has been let, the capital allowances are ring-fenced against the rent from that building; and,
■ the availability of allowances is to be curtailed so that any unused allowances at the end of the seven- or ten-year capital allowance period (depending on the scheme) will be lost. Where the allowance period is in excess of ten years, the period is to be shortened to seven years and unused allowances after this will be lost.

What has happened since?
The restrictions announced in the Budget were brought into the Taxes Consolidation Act; however, the Finance Act bought investors some breathing space by providing that the new legislation will be subject to a commencement order, which in turn is to follow the publication of an economic impact assessment. It is understood that preparation for the impact assessment has commenced; however, no time frame has been provided for its completion. The earliest the measures can come into effect is 60 days after the publication of the assessment.

It is understood that the impact assessment will involve a consultation process. This should provide an opportunity for all interested parties to voice concerns and make representations. This process should reveal the serious effect that the immediate withdrawal of relief would have, which would undoubtedly include financial hardship, business closure and job losses in towns throughout Ireland.

Section 23 type relief
Section 23 type relief is a generic term used to describe various types of property-based tax reliefs in respect of rented residential accommodation. A lessor who incurred qualifying expenditure was entitled to a deduction for income tax purposes for the expenditure incurred. This generally created a tax loss for the individual to carry forward for use against future rental income from any property.

Section 23 properties typically do not produce substantial rental yield. Many of the projects were located in areas being regenerated and not considered prime. Despite recent restrictions on interest deductibility, the interest payable on loans to acquire the properties is in itself typically enough to shelter the rental income from that Section 23 property. The main benefit of the relief, therefore, is the ability to shelter income from other properties. The proposed ring-fencing of the relief so that any losses arising on a property may be used only against income from that property, would in most cases remove the benefit of the relief with immediate effect. Under Budget 2011 changes, any relief that is not used within the 10-year qualifying period will be automatically lost and cannot be carried forward. Previously this loss could be carried forward for future use against Irish rental profit from any property in the State. The combined result of the above restrictions is that considerable amounts of relief would be lost to investors. The resulting increases in tax liabilities could mean that many property owners are unable to pay both their additional tax and their bank repayments, resulting in large-scale investor loan defaults.

Reliefs granted by way of capital allowances
The second method by which the property-based tax reliefs are granted is by way of capital allowances. With capital allowances, the relief is generally granted over a number of years rather than in an upfront manner, as is the case with reliefs granted by way of losses.

There are numerous different types of accelerated capital allowance reliefs and the availability of relief and conditions attaching to it can differ depending on the nature of the project. The panel summarises the affected reliefs on a sectoral basis. There are many ways by which investors have acquired property-based tax allowances. In large development cases (e.g., hospitals, hotels, nursing homes, etc.), they would typically acquire a share in the property in return for the allowances. The investor would almost never receive a profit rent from the operator, as the rent payable by the operator would be used to discharge the bank debt on the property. After the tax life has expired, the promoter/operator would acquire the property from the investors.

As with Section 23 relief, the limitation of the capital allowances to income from the property itself would effectively withdraw the capital allowances with immediate effect, as typically no income accrues to investors from these investments. Any capital allowances that are not used within the relevant qualifying period (which can be seven, 10 or 13 years depending on the nature of the project) will be automatically lost and cannot be carried forward. Previously, these allowances could be carried forward for future use against future Irish rental profit.

In many instances the promoter of large projects will have borne the commercial risk of change of law affecting the basis of investment. If the changes proceed as drafted, these promoters are now likely to face legal action from investors seeking a return of the capital invested and/or the tax benefits lost.

Many will be unable to fund both these and their banking obligations, putting businesses and jobs at risk.

In many cases, the capital allowances associated with the property are being used to facilitate the repayment of capital to the investor’s bank and loans would have been sanctioned on this basis. The ability to make capital repayments to the investor’s bank has in some instances already been impaired by the introduction of the High Earner’s Restriction. The High Earner’s Restriction was increased in the Finance Act 2010 and limits the availability to high earners (with income in excess of €125,000) of certain specified reliefs (including the property incentives) to ensure that a minimum income tax rate of 20% or 30% applies depending on income levels. The Budget 2011 restrictions on property reliefs would result in more property-based loans becoming impaired due to inability to make previously committed loan repayments, and loan-to-value covenants could be breached as the value of tax allowances attached to the property become worthless.

What now?
While the restrictions are not effective until the passing of a commencement order, investors must now evaluate the personal impact the measures would have. If introduced, the restrictions will result in additional tax for most investors, which could further impinge on their ability to fund repayment obligations to banks. Consideration should be given to restructuring debt facilities and other arrangements to mitigate the impact of the measures.

As mentioned above, promoters of capital allowance projects could be significantly impacted. The investment documentation should now be reviewed with particular focus on change of law risk and any tax indemnities. The commencement order will not issue until an economic impact assessment is finalised. It is not yet clear what form this assessment will take; however, anyone likely to be impacted by the measures should try to contribute to this process in as full and meaningful a manner as possible. Until completion of the impact assessment it is definitely a case of ‘wait and see’.

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Andrew CullenAndrew Cullen
Andrew is President of the Irish Taxation Institute, and a
Fellow of the Institute of Certified Public Accountants.
He is Head of Tax & Project Finance at Bank of Ireland
Business Banking. Prior to joining Bank of Ireland in
1998, Andrew was an Inspector of Taxes.