Tuesday 21 January 2020

How did the Government shaft mortgage holders and taxpayers in one fell swoop?

The State may well have missed out on huge tax profits through its sale of distressed home loans

Questions to answer: Finance Minister Michael Noonan - the Government refused to let people bid on their own distressed mortgages Photo: Tony Gavin
Questions to answer: Finance Minister Michael Noonan - the Government refused to let people bid on their own distressed mortgages Photo: Tony Gavin

Stephen Donnelly

The Irish Government could be complicit in wholesale tax avoidance by foreign investment firms, which are generating huge profits in Ireland off the backs of Irish mortgage holders.

Sarah and Dominic (not their real names) live in Kilkenny with their two children. They bought their home in 2007.

The shop Sarah worked in closed during the recession - she lost her job and they started to fall behind on their mortgage payments.

They're getting back on their feet now, but with lower wages, they're struggling to make full payments. Their mortgage was with Irish Nationwide, which was nationalised, so it ended up in state ownership, along with about 13,000 other mortgages.

Two years ago, the Government sold these mortgages at big discounts, mainly to US investment funds. The Government refused to let individual mortgage holders bid on their mortgages. Sarah and Dominic's mortgage was bundled with about 1,400 others and sold to Mars Capital. According to finance minister Michael Noonan, this was done with "funds managed by Oaktree Capital Management".

Oaktree is a very large US-based distressed-debt firm that has bought up many of the mortgages sold by the Government.

Until recently, we didn't know how big the discounts were that the State was selling people's mortgages at. Mars Capital's newly filed 2015 accounts show they paid 42 cent in the euro.

Sarah and Dominic's mortgage was about €350,000, so Mars Capital got it for about €140,000 - an amount the couple could have afforded. Instead, they still owe the full €350,000 to Mars Capital and face the prospect of eviction.

It gets better (or worse if you are Sarah and Dominic, or an Irish taxpayer). Mars bought these 1,400 mortgages for €155m. About half of this was financed by a loan from Citibank, with the remaining €80m being, presumably, the "funds managed by" Oaktree Capital. The 2015 accounts of Mars Capital forecast that this €80m investment will harvest almost €400m (net of the Citibank loan) in mortgage interest and principal repayments (so that's the €80m back, plus almost €320m extra, less administration costs). And this is just Mars Capital's first estimate. It assumes a level of non-payment on the mortgages they bought. But as the Irish economy recovers and payment rates improve, profits could become much higher.

In May 2014, Ireland was borrowing 10-year money at 2pc. Mars Capital's accounts show them earning 14pc on their €80m, just taking into account mortgage interest payments, from the likes of Sarah and Dominic. Why sell an asset yielding 14pc when your cost of funds is 2pc? The Irish State could have given every one of those Irish mortgage holders a 60pc discount on their loan and still have made 14pc per annum in repayments. Wasn't Nama set up to do this?

However, it gets even better (and definitely worse, if you are an Irish taxpayer). The "funds managed by Oaktree Capital Management" seem to be accounted for in Mars Capital as "notes".

Essentially, the €80m was loaned to Mars Capital, and Mars must pay it back, plus interest. The interest on these notes is set at "10pc + variable residual".

In other words, the interest payable on the €80m can be hiked to soak up any, and all, profit Mars Capital makes.

The accounts of Mars Capital clarify that these notes will suck nearly all of the profits (interest and capital) from the company in excess of the Citibank loan. The 2015 accounts claim exactly €1,000 as taxable profit, while paying millions in interest on the notes.

This tax-management structure is similar to what is used by some multinationals based in Ireland. Often, such notes are registered in an offshore zero-tax location such as the Cayman Islands, where their "note interest" payments are made and accumulate tax-free, and get lent back to the parent as needed. As such, the profits are taxed neither in Ireland, nor in the US.

Irish accounting and legal firms provide the expertise to the multinationals to help them minimise their tax obligations. So what? Sure aren't they providing jobs here? Well yes, they are.

But if that same expertise is now being used to help foreign investment firms suck huge profits out of Ireland without paying tax on them, then we're all worse off.

We don't know where are the loan notes of Mars Capital located. We do know, from Oaktree's US SEC annual filings, that many of their funds linked with European distressed debt (ie Sarah and Dominic's mortgage), are listed in the Cayman Islands.

So, if the Mars Capital notes happen to have been issued by an Oaktree Capital fund located in the Caymans (and we have no evidence that they are), and if the interest on the notes is adjusted in a way that leaves Mars Capital with very little taxable profit (say the €1,000 filed for 2015), then not only will the State have missed the opportunity to retain hundreds of millions of euro of value (and maybe spare Sarah and Dominic's family the threat of eviction), it would also be the case that none of the profits will be taxed in Ireland.

To be clear - tax avoidance is, by definition, legal (as opposed to tax evasion, which is illegal). There is no suggestion that Mars Capital, or Oaktree Capital, have done, or are doing, anything illegal. They are clever investors who saw an opportunity and took it - if they are structuring their investments to minimise tax obligations, then they are acting rationally. The Irish Government, however, is not.

If very little tax ends up being paid in Ireland on the Mars Capital deal, the tax leakage could reach well over €50m. And this is a very small deal in the scheme of things - if other investment firms have structured their affairs to avoid paying taxes here, the total missed tax take will be in the hundreds of millions, conservatively.

Why did the Government not seek assurances from all foreign bidders that their structures would ensure they pay fair Irish tax on their Irish-generated profits? If some bidders organised themselves to move their profits offshore, did the Irish Government know? Did the investment firms seeks assurances from the Government that any proposed off-shoring of profits would be acceptable? Just how complicit is the Government in what could be large-scale tax avoidance on profits earned off the backs of ordinary families trying to recover from the collapse?

Best little country to do business in? I doubt Sarah and Dominic would agree. Neither would those using our underfunded public services and infrastructure.

Sunday Independent

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