Eagle's potential loss bigger than £190m
Making a few important changes to the Finance Act could mean huge gains for the state, writes Stephen Donnelly
The potential loss of £190m to the state from Project Eagle is getting much attention. But there's a much bigger loss to the state from Project Eagle… about £500m in potential tax avoidance. And unlike the £190m, that £500m can be brought in, if we just make a few important changes to the Finance Act in October.
Project Eagle was Nama's sale of its entire Northern Ireland loan book to Cerberus, a New York-based private equity firm specialising in 'distressed investing'. Also the name of the multi-headed dog preventing the dead from leaving the underworld.
The whiff surrounding Project Eagle became an unignorable stench when BBC's Spotlight programme aired footage of businessman Frank Cushnahan in a car park allegedly accepting £40,000 in cash from one of Northern Ireland's wealthiest people. Mr Cushnahan was a member of Northern Ireland's Nama committee, and the gentleman with the money was a Nama borrower.
To make matters worse, the Comptroller and Auditor General (C&AG) has concluded that Nama sold Project Eagle for about £190m less than it was worth. So Minister Noonan is to appear before the Public Accounts Committee, the Irish Government will likely announce a formal investigation, the FBI is taking a look, as is the Northern Ireland Assembly - £190m is a chunk of cash, so all good so far.
But what about the £500m in potential tax avoidance?
Cerberus's Promontoria Eagle Limited, is the Irish Section 110 company that houses Project Eagle. It paid £1.2bn for loans with a par value of £4.6bn. The 2014 accounts show this £1.2bn coming from loans from a Japanese and an Austrian bank, and from £439m of Cerberus's own funds. It's structured as 'internal' loans from a Cerberus entity in Luxembourg. Critically, the interest rates on these 'internal' loans can be varied to equal whatever profits Promontoria Eagle makes… leaving it with little taxable profit in Ireland.
In 2014, Project Eagle borrowers made £112m in interest payments to Promontoria Eagle (this doesn't include any capital repayments). After £27m in interest payments to the Japanese and Austrian banks, Promontoria was left with a net gain of £85m (a very healthy 19pc return). A 'normal' Irish company would deduct some operating costs, then pay 30pc in tax, between Irish corporation tax and Irish withholding taxes. But not here.
And then there's capital gains. Many Dublin commentators believe the underlying assets of Project Eagle are worth over £2.2bn today, suggesting £1bn in capital gains already. For 'normal' Irish companies, this would be taxed at 25-33pc, when the gains are realised. But not here. Distressed debt investors typically target 10 year investment periods. So let's roll those 2014 figures forward for a decade. The £85m would turn into £850m, if we're conservative. Add the £1bn in capital gains to that (again let's be conservative and say the underlying assets don't gain any further in value). So that's about £1.85bn in gains.
A 'normal' Irish company would pay about £500m tax. That's about €580m, or one children's hospital, 1,500 new teachers for a decade or 4,000 in social housing. It's a huge amount of money. It's close to the entire fiscal space being allocated to additional spending in the upcoming budget.
In fact, the total taxes avoided would exceed the amount Cerberus invested to buy the loan book. Having already taken a multi-billion euro hit on the loans, the Irish people should, at least, get these taxes back on the huge profits being made… but not as thing stand.
But as with so many so-called vulture funds, Promontoria Eagle Limited is not a 'normal' Irish company. It's a Section 110 company. It can, legally, write off all of those gains against loan notes located abroad. In 2014, for example, in spite of its multi-billion pound asset base, generating tens of millions in gains, the company paid exactly £1,947 in tax. Were this to continue for 10 years, instead of the Irish State receiving about €580m in taxes, it would receive about €0.02m.
And that's for just one Nama sale. Scale this up to the total assets sold to Section 110 companies and you quickly get a figure for avoided taxes of €10-20bn. And that's on assets the Irish people have already incurred losses for in the tens of billions of euro, and will be repaying for generations.
Minister Noonan has proposed an amendment to close down this behaviour, but as it stands, it won't work. It allows Cerberus revalue (mark-to-market) the Project Eagle assets to September 5, 2016 at the 0pc, Section 110 rate. With Irish sovereign debt yields at 0pc, a large accounting firm could produce a comprehensive document for Revenue, showing the Project Eagle assets to now be worth £2.2-2.8bn. This would allow hundreds of millions in capital gains taxes be avoided.
The amendment also allows Cerberus use the S110 structure of classing its £439m investment as an internal 'loan', as long as the interest rate is 'arm's length'. Again, a large accounting firm could produce a document for Revenue justifying a 19pc "mezzanine" rate - exactly what's required to wipe out interest gains of £85m, for example. As this 'internal loan' is owned by another Cerberus vehicle in Luxembourg, all the income would be sheltered from Irish taxes.
As several accounting firms advised their client base on the proposed amendment, "don't panic... there will be minimal taxes paid".
To Minister Noonan's credit, he restated in committee earlier this week that he's open to changing the amendment. The solutions are relatively simple. For example, insert the following sentences into the amendment:
1. Assets may not be mark-to-market to shelter unrealised capital gains.
2. Only interest on valid third party bank debt financing will be deductible against income.
Those two sentences, with a few other tweaks, could save Ireland €10-20bn in lost taxes in the next decade.
So will we get the changes? Hopefully. But smoke bombs are already being dropped. During committee proceedings this week, when I pressed on why Cerberus would be allowed revalue its assets, 'advice from the Attorney General's office' and 'the Constitution', were intoned. In other words, there is secret legal advice we aren't allowed show you, that we must follow.
No 'normal' Irish company, and no 'normal' Irish citizen, gets to revalue their assets to avoid capital gains taxes. In fact, if this approach was correct, then almost every change in Irish corporation tax or private tax rates has been invalid, as everyone should have been allowed to mark-to-market.
In addition, no 'normal' Irish company, or citizen, is allowed set up 'variable rate' loans to themselves from Luxembourg, in order to show that they have no taxable income after interest payments. It's a nonsense, and it needs to be stopped, right now.