Sunday 20 October 2019

Stephen Donnelly: Tax avoidance anomaly means pain for taxpayers

Michael Noonan said he would make changes if a Revenue investigation uncovers tax avoidance Picture: Fennell Photography
Michael Noonan said he would make changes if a Revenue investigation uncovers tax avoidance Picture: Fennell Photography

Stephen Donnelly

In recent weeks, I've been looking into entirely lawful 'tax neutral' schemes being used by so-called vulture funds in Ireland. And I fear a legitimate law could inadvertently lead to one of the biggest avoidance of Irish taxes in the State's history.

We could be looking at total lost taxes in the region of €20bn over 10 years.

At this point, two things are required.

First, if I'm right, ways must be found to stop any further avoidance on Irish taxes by these funds.

Second, a formal investigation must be launched to ascertain how this was allowed to happen in the first place.

If you run your business in Ireland, and you make your profits from economic activity in Ireland, then you pay taxes on those profits in Ireland. Typical taxes on profits are around 30pc, between corporation and withholding tax. That's the deal for every pub, every shop, every small business.

But not for the vultures. Because if you use something called 'Section 110' status, then you'll pay virtually no tax here.

Section 110 was introduced in 1997 to help the IFSC attract global securitisation business. The logic was that if these funds make their profits abroad, then they shouldn't be hit with 30pc taxes on those profits in Ireland.

'Normal' businesses in Ireland don't get Section 110 status, for obvious reasons. But for not-so-obvious reasons, vulture funds have been getting it. This means they can make huge profits in Ireland, from economic activity in Ireland, and off-shore those profits, often through tax havens.

So what is the scale of the issue?

Let's take the case of Mars Capital, an Irish company that bought Irish Nationwide mortgages using what Finance Minister Michael Noonan described as "funds controlled by Oaktree Capital" (a massive US-based distressed debt firm). Mars bought the mortgages at a 58pc discount (the mortgage holders weren't allowed to bid). Mars is investing €80m, and its accounts show that €80m turning into about €400m.

If we assume operating costs of €20m, Mars would see a net profit of around €300m. A non-Section 110 company would then typically pay 30pc tax, yielding the State €90m. But Mars has Section 110 status, allowing it to be 'tax neutral', as the presentations from the legal firms proudly declare. The €80m investment is in the form of a loan note.

This 'note' has a variable interest rate - so not only does the €80m loan get paid back, but so does around €300m in interest. That, of course, would leave Mars with very little profit on which it owes tax. In its first year of operation, for example, in spite of revenues of over €14m, it paid just €250 in corporation tax.

It's important to see in the example above that the amount of Irish tax (€90m) that would otherwise have been generated is close to the amount invested by the vulture fund (€80m).

Now apply that across the entire sector.

Without Section 110s, the State could be taking in taxes at a level roughly equal to the total these vulture funds have invested - which is tens of billions of euro.

The example above isn't just a statistical anomaly for Mars Capital. Vulture funds investing in Ireland target 15pc-20pc annual returns, and have time horizons of around 10 years. So if you invest €1bn at 15pc-20pc, then in 10 years you'll have more than €5bn.

The tax owed without Section 110s could then be 30pc of the €4bn profit - a cool €1.2bn.

Another twist in the tale is that Mars is owned by a children's charity, the Matheson Foundation. The foundation is controlled by the law firm Matheson, who also act as Mars Capital's solicitors.

There are various advantages to having your Section 110 owned by a charity. These include passing the Revenue's residency test and the fact that Irish charities are bankruptcy-proof.

Without Irish charities, the scheme doesn't work as well. Many Dublin law and accountancy firms have web brochures outlining - and recommending - this charity structure for Section 110s.

If you look into the accounts of these vulture funds, you'll see that a great number of them have Section 110 status. You'll see large revenue streams, offset against interest payments on these 'Notes'.

You'll see almost no profit left to be taxed. I've seen several accounts where exactly €250 is paid in corporation tax. One set of accounts actually listed over €4m for taxation - but don't get too excited, further on they listed almost exactly that amount as 'income not taxable', and paid, instead…€250.

So how is this happening?

Revenue must be notified by any company claiming Section 110 status. Revenue is one of the most able arms of the State, and knows all too well the following - if vulture funds can get Section 110 status, then any Irish company with assets over €10m should be able to get it - and then Ireland's corporation tax would essentially cease to exist.

It's hard to see how Revenue would allow vulture funds to avail of this status without political direction.

In response to parliamentary questions I put down last week, Mr Noonan stated that no assurances were given to any of the vulture funds or their advisers, from him, the Department of Finance, Nama, IBRC, Revenue, or any other agency of the State, with regard to their proposed Section 110 tax structures. It seems quite extraordinary that tens of billions of euro would be invested by international firms, that these firms would structure their investments so that they pay minimal or no taxes on huge profits in Ireland - and that none of them, nor their lawyers, nor their accountants, enquired of the State if this passed the proverbial smell test.

But that's the story, apparently.

Just as extraordinary is the second half of Mr Noonan's reply.

He states that officials are "currently examining coverage concerning the use of certain vehicles for property investments. Should the investigations uncover tax avoidance schemes or abuse, which erodes the tax base…then appropriate action will be taken...".

I would find it extraordinary if the use of Section 110s by vulture funds isn't known about in the Department of Finance.

Certainly, if they didn't know about it, they should have.

I also asked Mr Noonan if concerns had been raised by officials about potential tax avoidance by S110 funds, but he didn't address this in his reply.

He did reiterate that he was unaware of any contact by firms acting on behalf of these vulture funds, in relation to establishing Section 110 companies.

So one of two things is true.

Either nobody in Finance, or anywhere else, knew what was going on - which would suggest a worrying level of incompetence.

Or people did know, and were encouraged to facilitate it - which would suggest a worrying level of complicity. Both possibilities demand an investigation.

Businesses all over Ireland pay their taxes on their profits.

Families all over Ireland go without - every week - to make sure that they pay their mortgages. The efforts of those families are creating huge profits for the vulture funds.

These include funds that bought the mortgages at a fraction of what the families owe; funds that can turn €1bn into €5bn; funds that are using Section 110 status and Irish charities and not paying taxes in Ireland on those profits.

It needs to be stopped, now, and we need to know how it was ever allowed to happen.

Sunday Indo Business

Also in Business