Saturday 16 November 2019

Hoteliers not feeling hospitable about Paschal Donohoe's half-billion hit

The finance minister's axing of the 9pc Vat rate has been greeted with dismay by the bosses of the country's hotels and restaurants, writes Dan White

The finance minister’s axing of the 9pc Vat rate has been greeted with dismay by the bosses of the country’s hotels and restaurants.
The finance minister’s axing of the 9pc Vat rate has been greeted with dismay by the bosses of the country’s hotels and restaurants.

The Budget hit the tourist sector hard, with the removal of the low 9pc Vat rate expected to cost it in the region of €500m a year. The centrepiece of Paschal Donohoe's second Budget was scrapping the special rate for the hospitality sector, with the Finance Minister reckoning that the measure will raise an extra €466m in 2019 and €560m in a full year. It is this half-billion euro raid on the hospitality sector that makes the Budget's sums add up.

Donohoe toyed with the idea of removing the 9pc rate 12 months ago, but pulled back at the last minute due to the uncertainty surrounding Brexit. Not this year. Budget 2019 mandates the removal of the 9pc rate from January 1, with the hospitality sector reverting to the standard 13.5pc Vat rate for services.

The writing has been on the wall ever since the Department of Finance published an extremely critical report on the Vat rate last July. The gist of the Department's report was that the 9pc rate had outlived its usefulness. "The ongoing and cumulative costs of the reduced rate are substantial, estimated at €490m in 2017 and €2.6bn in total since its introduction," it said.

"The scale of these costs against the limited benefits point to significant dead weight. Furthermore, with an economy at close to full capacity, further stimulus in the sector can lead to misallocation of resources (capital and labour) - further adding to overheating pressures and aggregate productivity challenges."

Despite the Department's concerns, the fate of the 9pc Vat rate hung in the balance up to last weekend. However, when faced with a choice of either scrapping the special rate or imposing a significant increase in carbon taxes and excise duties on diesel, the Government made the political calculation that antagonising the country's hoteliers, of whom are fewer than a thousand, carried less political cost than alienating commuters and hauliers.

The fact that the Government felt able to make this choice was at least partially due to soaring Dublin hotel room rates.

Everyone it seems, including rural TDs, many of whom stay in hotels when the Dail is in session, has a story of a friend or relative forced to pay an extortionate amount for a Dublin hotel room.

While many of these stories have no doubt improved with the telling, the facts are still damning. The average Dublin hotel room rate rose by 5.3pc to €158.45 in August, according to market research firm STR. With average occupancy of 90pc that translated into revenue per average room of €142.76. This compares with an average Dublin room rate of just €77 in 2010. In other words, average Dublin hotel room rates have more than doubled in just eight years.

While hotels are less expensive outside Dublin, STR estimated the average rate per room at €130.87 and revenue per average room at €111.45. So the perception that their Dublin counterparts were making unseemly profits meant that the sector was very short of friends when the critical decisions were being made.

Not surprisingly, the country's hoteliers see things differently.

"I'm absolutely shocked. While we recognise that there was a need to raise revenue, in doing so it was incumbent on the Government to nurture growth in the economy," said Irish Hotels Federation chief executive Tim Fenn. "Tourism is growing. It is giving over €2bn a year to the Exchequer, a figure that will rise to €2.7bn by 2025."

While the new 13.5pc rate for hotels and restaurants is still significantly below several other major European countries including the UK (20pc), it is well above many others including France and Spain (both 10pc), Germany (7pc) and Portugal (6pc).

"Nine per cent Vat was about the right rate. It brought us into line with our competitors in Europe. Now 26 countries in Europe have a lower Vat rate. We are expected to compete with that," said Fenn.

But what about sky-high Dublin hotel room rates? "Some of the perceptions about hotel profits are misleading. Hotels are big industrial plants. They are very expensive to run - ebitda [earnings before interest, taxation, depreciation and amortisation] is not profit," said Fenn. "Many hotels outside of Dublin are closed for four or five months of the year and struggle to make a profit."

He also pointed to a recent Failte Ireland survey which showed that there were hotel rooms available in Dublin for €120 on 90pc of all nights in 2017. The Irish Hotels Federation estimates that about €300m of the revenue that will be generated by scrapping the 9pc rate will come from outside of Dublin. "They don't understand the catastrophic impact that this will have in every country, town and village in rural Ireland," he says. "Dublin has a capacity problem. It is being dealt with as there are €1bn of projects in the pipeline."

The July Department of Finance report on the 9pc Vat rate claimed that in the seven years since it was introduced in 2011 hotels and restaurant profits as a share of total profits had increased by 17pc, hotel profit margins rose by 53pc and mark-up by 4pc.

It also argued that customer spending on hotels and restaurants was relatively price-insensitive with rising incomes being a far more important determinant.

The hoteliers disagree."The Department of Finance analysis focuses very much on [Irish] household expenditure. Eighty per cent of our revenue comes from overseas," says Fenn.

Pat McCann, the chief executive of Ireland's largest hotel group, Dalata, went even further in his criticism of the Department of Finance report.

"That report was pretty awful, a pathetic report. It failed to mention that in 2012, the first full year of the 9pc rate, it brought in €630m. It will bring in €1.1bn in 2018. Revenue from the 9pc rate is up by almost half a billion euro and 79,000 jobs have been created since it was first introduced," he said.

Dalata has almost 6,000 rooms in the Republic of Ireland and will be one of the companies most affected by the end of the 9pc Vat rate. Based on its 2017 Irish turnover of €276m the annual cost to the company could run as high as €12.4m.

In practice the actual impact will only be a fraction of this. Dalata's Irish business is split roughly 50:50 between contracted (tour operators, conferences, etc) and transient (individuals) business.

According to McCann, Dalata's contracts with tour operators and conference organisers, which can be agreed two or even three years in advance, specify that any increase in Vat will be passed on to the customer.

"The contracts are very clear: we will be writing to them in the next few weeks to let them know about the increase in the Vat rate, just we did in 2011 when the Vat rate was reduced," he said. However, Dalata won't be able to recoup the higher Vat rate from individual customers who have booked rooms after January 1, 2019. In addition, a significant proportion of Dalata's revenues come from food and beverage sales rather than from rooms, with 23pc of Dalata's first-half Irish sales of €143m being generated by food and beverages.

While the Vat rate on food sales also goes up to 13.5pc, the Vat rate on beverage sales (mainly alcohol) remains unchanged at 23pc.

Dalata and other hotel operators will also be hoping to pass on some of the higher Vat rate, on both rooms and, food and beverages to their customers - the Department of Finance report's assertion that customer spending decisions on hotels and restaurants were driven primarily by incomes rather than price indicates that this is what it expects to happen.

When it published its half-year results last month Dalata said that it expected that the removal of the 9pc Vat rate would cost it the equivalent of 2pc of sales in a full year.

Goodbody analyst Rachel Fox estimates that, in a worst-case scenario, the impact of the increased VAT rate to Dalata could reduce revenues by up to 2pc, however it is unlikely the impact will be this severe.

In cash terms that works out about €7m. However, even the full €7m would still represent less than 10pc of Dalata's 2017 pre-tax profits of €77m.

While the impact on Dalata will be limited, the Vat rate increase will almost certainly impact on new hotel building projects.

Property market analysts had been predicting that about 1,200 new hotel rooms would come on stream in Dublin each year between 2018 and 2020 to bring the total number of hotel rooms in the capital to over 22,000. That was before the Vat increase.

"The level of new supply coming on stream has been less than expected. While lots of projects have been getting planning permission, higher construction costs mean that less new supply than anticipated is actually being built", says Goodbody's Fox.

The Vat rate increase is almost certain to further reduce the development of new hotels.

"A lot of future projects were already under stress due to increased building and labour costs. Other costs such as energy and insurance also rising. There is lots of pressure coming through on pricing. The Government will more than likely live to regret this decision," said McCann.


By the numbers

€560m: How much the Government estimates hiking the Vat rate to 13.5pc will raise

€158.45: The average Dublin hotel room rate in August, according to market research firm STR

53pc: How much hotel profit margins had risen by since the 9pc Vat rate was introduced, according to the Department of Finance

79,000: How many jobs have been created since the 9pc Vat rate was introduced, according to Pat McCann, CEO of Dalata hotel group

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