Vital for investors to know new tax rules before entering into any debt release plan
Published 08/06/2014 | 02:30
WE are almost half way through the 2014 tax year and the capital gains tax (CGT) filing deadline is getting closer. It suffices to say that in recent times, CGT has not been a major issue for many taxpayers, particularly those who had invested into the property market and have accumulated significant tax losses.
However, 2014 has brought about some notable changes as regards how these losses are treated and the tax position may not now be as straightforward as one might think.
New CGT rules have recently been introduced on the back of the 2013 debt release rules for land dealers and developers which restricted or eliminated income tax losses. The new rules were effective from the start of this year and will reduce, or in some cases potentially eliminate, capital losses in circumstances where there has been, in fact, no economic loss, ie. where a loan has been partially or completely released by the lender. Debt release has become more commonplace in recent years generally following the global crashes in the late 2000s followed by an influx of lenders buying discounted loan books, resulting ultimately in write-offs for many borrowers.
Taxpayers, who were previously home and dry with no CGT to pay due to the availability of tax losses, may find that they are hit with an unexpected tax bill for 2014 as a result of these new rules.
To put this into context, take "Matthew" who borrowed €800,000 and bought a property for €1m in 2007. In 2013, Matthew sold the property for €500k and repaid the bank with the proceeds. The bank agreed to release the remaining loan balance of €300k. Under the "old rules", Matthew filed his tax return for 2013 and claimed a capital loss of €500k (the proceeds of €500k minus cost of €1m). Matthew now has a capital loss available to set off against current or future capital gains.
However, if Matthew were to sell the property in 2014 instead for €500k, the new rules would mean that Matthew can only claim a capital loss of €200k (i.e. proceeds of €500k minus the actual monetary cost of €700k, being the original cost of €1m minus the debt released of €300k).
The situation can become compounded if Matthew sold the property but the bank does not release the debt in the same year. For example, Matthew sold the property in 2013 and claimed a capital loss of €500k against other capital gains in 2013. In 2014, the bank then agrees to release the outstanding loan balance of €300k. This €300k is treated as a capital gain in 2014 and will be fully taxable at 33 per cent, assuming he has no other capital losses available for set-off.
On the surface, these new rules appear fairly straightforward and even logical given that the tax loss is being simply restricted to the monetary loss. However, in the world of a property investor, circumstances can be complicated with many individuals owning multiple properties in multiple jurisdictions and often having refinanced loan packages. This makes it difficult to identify clearly which loan relates to which property and therefore how much of a gain or loss is actually being realised in situations where not all of the properties are being sold. Bearing in mind that the rules are still in their infancy, they would appear to deal only with a one asset/one loan scenario, but in practice, this can make the rules difficult to apply and so far it would appear that they have not been designed to deal with these more complex scenarios.
To date, Revenue have managed to clarify some issues in their recent guidance documents. The guidance has specifically dealt with issues such as how to determine when and what constitutes a debt release. For example, Revenue would consider the write-off of both recourse and non-recourse loans as a debt release. Interestingly, it would appear that for a bankrupt, the debt release date is the date of discharge from bankruptcy and therefore any tax liability is considered to arise post-adjudication. This could give rise to a situation where tax liabilities arising immediately post-bankruptcy could force an individual back into bankruptcy!
Although, these new rules primarily affect the borrower, there are other stakeholders who may be faced with issues, for example the owner of the loan or a receiver.
For the lender, consider a scenario where multiple loans have been made to the borrower. If the borrower is hit with a large tax bill following the release of a loan, that borrower may have diminished funds available to service his other loans which could ultimately mean even more loan arrears for the bank.
The position of a receiver can also be complex as their role would involve them stepping into the shoes of the borrower for tax purposes. The receiver will need to fully understand the borrower's tax history (including tax losses) in order to be able to appreciate any knock-on effect of a debt negotiation. In practice, this may be difficult due to a lack of cooperation by the borrower.
Given the potential complexity in the world of a property investor, it is more important than ever for all parties involved in debt negotiations to seek professional advice and consider the full commercial implications which could arise from the ensuing tax liabilities before entering into any debt release agreement. Unlike before, tax could now be a pivotal factor in any debt release negotiation.
Marie Flynn is Tax Director with PwC
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