Pearse Doherty (Donegal, Sinn Fein)
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83. To ask the Minister for Finance the effective tax rate in the form of dividend withholding tax paid by Irish real estate funds as a proportion of operating and pre-tax profits respectively in each of the years 2018, 2019 and 2020; if he will consider increasing the rate of dividend withholding tax while removing exemptions for corporation tax and capital gains tax; and if he will make a statement on the matter. [31810/21]

Paschal Donohoe (Dublin Central, Fine Gael)
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The rules relating to Irish Real Estate Funds (IREF) are set out in Chapter 1B of Part 27, Taxes Consolidation Act 1997, and were introduced by Finance Act 2016. An IREF is an investment fund, or a sub-fund, which derives 25% or more of its market value from Irish real estate.

As an investment undertaking, the profits or gains of the IREF are not taxed within the fund, but instead are subject to tax in the hands of the investors, its unit holders. This avoids a double layer of taxation and facilitates collective investment. IREFs operate a 20% IREF withholding tax (as opposed to Dividend Withholding Tax (“DWT”)) on distributions to non-resident investors, who may be entitled to a refund of some or all of any tax withheld under a double tax treaty.

As the Deputy will be aware, there are a number of exceptions from the operation of IREF withholding tax such as for pension schemes and charities as they are more generally exempt from tax, provided the appropriate declarations are in place.

Unit holders in an IREF are generally subject to 20% IREF withholding tax on the occurrence of an IREF taxable event. An IREF taxable event can broadly be defined as any way in which the value of the profits of the IREF are passed to the unit holder, e.g. by way of a relevant payment (which is akin to receiving a dividend), and the IREF taxable amount in broad terms is the profit element of that payment. Information on the amount of the taxable amounts and associated IREF withholding tax deducted for various years (2017, 2018 & 2019) is published by Revenue in section 4.3 of “Corporation Tax – 2020 Payments and 2019 Returns”.[1]

IREFs are obliged to electronically file financial statements with Revenue for each accounting period (under the Investment Undertaking Electronic Account Filing Requirements Regulations 2018 SI No. 368 of 2018).

In relation to the Deputy’s request for information on tax withheld by an IREFs as a proportion of their pre-tax profits and operating profits, I am advised by Revenue that financial statements are presented in accordance with relevant accounting standards and any difference between pre-tax profits and operating profits would depend on an individual IREF’s income, expenses, profits and gains and the applicable financial reporting standards. However, Revenue has advised that generally the difference between operating profits and pre-tax profits is finance costs. Finance Act 2019 amended the IREF regime to provide that IREFs with excessive deductions for financing costs are now regarded as having income subject to income tax. For the three-month period to 31 December 2019, income tax of €6.2m associated with excessive deductions for financing costs, was paid by the IREFs.

The Deputy has asked for a hypothetical effective tax rate calculated as the IREF tax as a proportion of profits. However, such an effective tax rate would not reflect the effects of timing or the manner in which IREF tax is applied. As such, it could not be regarded as an accurate measure of an effective tax rate applicable to IREFs. There are two key timing differences which such a measure would ignore.

The first is that IREF withholding tax applies to IREF taxable events – which generally speaking is the point at which the profits are passed from the IREF to the unit-holder. The profits retained within the IREF, and not yet distributed to unit holders, will in the future be IREF taxable events and will be within the charge to IREF withholding tax at that point.

In addition, as IREFs hold real property, their operating profits and pre-tax profits will include revaluations of the property they hold. Capital gains tax on gains on an investment property would only arise where the property is actually disposed of and any revaluation gains previously booked through the profit and loss account realised.

As such, it would not be appropriate to compare the rate of IREF withholding tax as a proportion of IREF profits (either operating profits or pre-tax profits) with either the rate of corporation tax or capital gains tax. However, in Table 1 below, I have set out the profits of the IREFs, the IREF taxable amount for each year (being akin to the distributions made by the funds in those years) and the tax paid by the fund in those years.

Of note, Revenue has advised that the provision of the profit amounts disclosed in Table 1 come with a number of caveats:

Some of the figures contained in accounts are net figures – in this regard the income & losses, unrealised and realised losses and gains have been netted and therefore the figures should only be used for indicative purposes.

There can be inconsistency in the length of financial periods, with some in excess of 12 months. This was evident in 2017 filings and again last year where a number of the IREFs sought derogations from the Central Bank to prepare 18 months set of accounts for the 2019/2020 period due to impact of Covid-19. Therefore, instead of preparing financial statements to 31 December 2019, some IREFs have now prepared and filed 18-month accounts to 30 June 2020, which will form part of the 2020 filing figures.

Table 1: Profits, IREF taxable events and tax liabilities of IREFs

Proposed increased rate of IREF WHT and removal of exemptions from corporation tax and capital gains tax

The IREF withholding tax rate (20%) was not increased in Finance Act 2019 in line with the DWT rate (now 25%). I increased the rate of DWT to 25% to more accurately reflect the tax liability of Irish individuals who receive dividends from Irish companies. IREF withholding tax, on the other hand, is targeted at non-residents, who may be entitled to a full or partial refund of any tax withheld under a double tax treaty. The commonest rate to which IREF withholding tax can be reduced under such double tax treaties is 15%.

As the IREF withholding tax is levied on non-residents who may be entitled to a refund under a double tax treaty, it was not appropriate to increase the IREF withholding tax rate.

The reason that the IREF regime applies an exit tax, rather than an entity level tax, is because IREFs are collective investment vehicles. Ireland’s policy on collective investment vehicles, since 2000, has been to ensure that there is not two layers of taxation: one at the entity level and one at the unit holder level. This is achieved by exempting certain regulated collective investment vehicles from taxation. The IREF withholding tax is the alternative to an entity level taxation for a collective investment vehicle.

A number of anti-avoidance rules were brought forward in Finance Act 2019 to ensure that the IREF withholding tax was not being avoided, including both a debt cap and an income to interest ratio.

With regard to capital gains tax, when introduced in 2016, the IREF regime included a capital gains tax exemption in respect of property assets held for more than 5 years. However this exemption was removed in Finance Act 2017. As a result, where IREF property assets are sold and the gains distributed to investors, IREF withholding tax at 20% applies on those gains.

The success of the 2019 targeted anti avoidance measures , in addition to Finance Act 2017’s removal of the capital gains tax exemption, can be evidenced by the increased tax paid by IREFs as set out in Table 1.

Officials in my Department and Revenue continue to monitor the taxation of IREFs.