Thursday 21 February 2019

James Fitzsimons: Taxpayers could foot bill for Dr Debt-style schemes

The real crime is that risky investments were allowed to spiral out of control, writes James Fitzsimons

Last week James Reilly, the Minister for Health, got himself into hot water when his name was published in Stubbs Gazette for unpaid debts. He was part of a syndicate that invested in a nursing home to get tax relief.

He put up £60,000 of his own money (about €76,000). There were 13 members in the syndicate and they raised about €2.25m to set up a nursing home. Apart from what they put in themselves, they borrowed €1.9m from Bank of Ireland.

Five of the original investors, including Dr Reilly, agreed from the start to buy out the others. When they failed to pay they were taken to court, where they were ordered to pay up. With nothing paid, James Reilly's name appeared in Stubbs Gazette.

This is typical of the type of tax scheme that helped fuel the property bubble and is leading to disputes all across the country as commitments are not honoured. Tax relief for nursing homes is given by way of capital allowances (annual deduction) for expenditure on buildings. Fifteen per cent of the cost can be claimed annually in the first six years and 10 per cent in the seventh. The price of the site cannot be claimed as a tax deduction. Cleverly structured schemes maximise what is treated as qualifying building costs for tax purposes.

In most cases the property would be bought by a group of investors who then rent it to the nursing home operator. Structured tax schemes of this type were often set up so that rent would just cover the basic property expenses, such as insurance, repairs and interest on the loan. Capital repayments were often deferred until the end of the investment period. If the investors pulled out within 10 years, or if the property ceased to be used for a qualifying purpose, their tax relief was clawed back. Usually there would be some arrangement at the end of the tax life for the nursing home operator, or the original promoters, to buy out the investors.

These schemes exist because they cut tax. While they could shelter unlimited amounts of rental income, even passive investors can use up to €31,750 of the annual losses to shelter any type of income. Even the taxable pay and pensions of politicians can be sheltered. Some partnership schemes were devised to shelter unlimited amounts of income of well-heeled individuals. But they were also used by those on relatively modest incomes too.

By leveraging the investment it was even possible to get back as much in tax as was invested in cash. With income tax relief at 41 per cent, nearly half the investment was subsidised by the Revenue Commissioners. If you put in 40 per cent of your own cash and the scheme borrowed the rest, you would get as much back in tax as you invested. A prearranged buyout plan would normally take care of the rest. That was the plan in the case of Dr Reilly's nursing home until the property bubble burst.

The less you know about how these schemes work, the more likely you are to let the faceless promoters off the hook. There is nothing illegal about tax-based investments. But maybe they need to be reconsidered. The real crime is that risky financial structures such as these were let spiral out of control without effective regulation. If the promoters and those who devised these schemes get off the hook, vulnerable taxpayers will foot the bill.

Government policy was to encourage these schemes at every opportunity. It's not a coincidence that Dr Reilly's investment syndicate had 13 investors. As a rule, the number of members in a scheme was limited to 13 in order for the Revenue Commissioners to give it its seal of approval.

Charlie McCreevy set about wiping out relief for tax-based investments in 2006. When Brian Cowen became Minister for Finance he extended them until 2008. This had no small part to play in the country's financial collapse and wiping out the construction industry. Tax-based property incentives had great merit. If they were regulated properly and not abused by an elite few, we would not be in the trouble we find ourselves today.

So-called experts came up with the ideas. The government made it possible. And the banks funded a financial nightmare. But it was not just our own banks. We couldn't have done it without funding from Germany and other foreign banks. There are too many vested interests for anyone in power to make the right decision now. We've let the foreign banks off the hook.

Those who are responsible for this mess are represented on every government board and quango. We even pay them for the advice that best serves their own interests. They are the cushioned elite who call the shots behind the scenes. The rotten system that let unscrupulous bankers and developers off the hook is working overtime to protect the cushioned elite. A strong administration would intervene to protect its citizens. There is nobody in government who understands what is going on. How could there be? They are not qualified or trained for this job. Neither are the experts who advise them and if they are, they are not doing a very good job.

Dr Reilly's predicament highlights the trauma that so many other investors are facing as the cushioned elite duck for cover, and their "guaranteed" investments unravel. Because of the leveraged structure, Dr Reilly's €76,000 investment probably got him as much back in tax. But he and the four remaining investors are saddled with impaired bank loans, devalued property and court instructions to pay back the other eight.

There are more of these cases where negotiations are proceeding. Investors, who optimised this tax relief, might think differently about these schemes in the future.

James Fitzsimons is an independent financial adviser specialising in tax and financial planning

Sunday Independent

Today's news headlines, directly to your inbox every morning.

Don't Miss