Restructuring and Deleveraging of the Irish Banks – Purchase of Loan Books through an Irish Acquisition Vehicle
The Central Bank of Ireland published its Financial Measures Programme Report on 31 March 2011 following which the Minister for Finance announced a number of steps that would be taken to restructure the Irish domestic banks.
One key aspect will be the deleveraging of the banks over the next three years through the sale of non-core assets and up to €70bn worth of loans. This note outlines the Irish vehicles which may be used for acquiring the loans.
Irish acquisition vehicle
The profile of typical buyer will be an overseas investor group or financial institution. The loan books will be made up of both Irish and non-Irish loans. The choice of acquisition vehicle will be largely driven by tax efficiency having regard to the location of the underlying loans and the investor.
In particular, a buyer will need to due diligence the loan book and loan documentation and ensure that the acquisition vehicle is not exposed to Irish withholding tax on the Irish loans and foreign withholding tax on the non-Irish loans.
An Irish vehicle will be the most suitable vehicle for the acquisition of Irish loans, and may also be the best option for the acquisition of non-Irish loans.
To the extent the loans are regarded as having an Irish source (by reason of being made to Irish borrowers or being secured on Irish property), then interest by the borrowers will be subject to Irish withholding tax of 20% unless an exemption applies.
The original Irish bank lenders would have benefited from a withholding tax exemption for interest on an advance from a bank carrying on a banking business in Ireland, but any future purchaser of the loans would need itself to qualify for exemption.
An overseas investor group or financial institution acquiring these loans could do so through use of an Irish acquisition vehicle in order to benefit from exemption from withholding in respect of a payment of interest. The two choices are an Irish "section 110 company" or an Irish regulated "qualifying investor fund".
Structured properly, both vehicles should allow the holding of the loans with no Irish withholding on the interest payments, corporation tax neutrality for the Irish vehicle, and no withholding on payments out to the investors.
Double tax treaty claims by an overseas acquirer would be complex and problematic particularly with multiple loans made to individuals.
As regards the acquisition of non-Irish loans, it would be expected that the Irish bank would have structured the original loan to ensure that there was no foreign withholding tax on the interest payments. The loans may have been made by the Irish bank from Ireland, or by a subsidiary or branch of the Irish bank based in the country of the borrower.
In the first case, while a fresh application for double tax treaty relief from withholding may be needed in the country in question and the loan documentation should be reviewed, to the extent the Irish bank was exempt that foreign withholding tax, an acquisition vehicle structured as an Irish section 110 company should also be exempt.
In the second case, again a buyer will need to due diligence the loan book and loan documentation as regards the most suitable location for the holding of the loans, but an Irish section 110 company should again be an attractive option because of Ireland's wide network of double tax treaties which reduce or avoid foreign withholding tax on interest.
Irish acquisition vehicle – the two regimes
(a) Section 110 Irish Taxes Consolidation Act 1997
Ireland's securitisation and finance company regime is well established and familiar to the international investor community.
The section 110 regime has been in existence for over 20 years. It effectively allows for corporation tax neutral treatment for Irish special purpose companies which hold and/or manage "financial assets" and meet certain conditions. The regime is widely used by international banks, asset managers and arrangers for establishing securitisations, CDOs, repackagings, investment platforms and capital markets bond issuances generally.
Financial assets are broadly defined and include shares, bonds, receivables, lease portfolios and commercial paper, and as a result of recent changes may also hold or manage commodities dealt in on a recognised commodity exchange and plant and machinery.
Section 110 companies must be centrally managed and controlled in Ireland, therefore the board of directors is typically comprised of a majority of Irish residents who are involved in the industry. The minimum asset value in respect of the first transaction undertaken by the section 110 company is €10 million.
The section 110 company is subject to tax in Ireland as if it was a trading company. Provided an appropriate structure is adopted, this treatment, together with the ability to secure a deduction for interest expense on notes which are held by investors, can result in a nominal amount of profit being retained in the company, which is then subject to tax at 25%.
There is an exemption from Irish withholding tax on payments of interest by a section 110 company where the note holders are resident in an EU jurisdiction, or a jurisdiction with which Ireland has a double tax treaty. There is also an important exemption for interest paid in respect of "wholesale debt instruments" (broadly, bonds with a maximum two year maturity) and listed securities, known as Quoted Eurobonds. These apply regardless of the location of the recipient. Quoted Eurobonds are securities, issued by a company, which carry a right to interest and which are quoted on a recognised stock exchange. The Irish Stock Exchange has proved itself to be an efficient provider of this listing and is frequently used by section 110 companies intending to avail of the Quoted Eurobond exemption.
An Irish section 110 company can typically obtain the benefit of Ireland's double tax treaties. Ireland has over 60 such treaties in force. This provides the Irish company with a significant advantage over other jurisdictions which do not have such a network, reducing the incidence of tax leakage suffered in the structure.
Provided the conditions of section 110 continue to be satisfied, there is no Irish stamp duty payable in respect of the issue or transfer of notes issued by the section 110 company. There should be no Irish VAT arising in respect of the activities of the company. There is also no charge to Irish VAT in respect of the corporate administration services provided to the company.
(b) Qualifying Investor Fund
Ireland is one of the leading European jurisdictions for regulated investment funds (UCITS and non-UCITS) with over €1 trillion of assets held by Irish funds.
Regulated funds can be structured as companies, investment limited partnerships, common contractual funds and unit trusts. Each type of entity offers different legal, regulatory and tax features to suit international fund managers and their investors. All regulated funds benefit from a range of attractive tax features:
(a) they are exempt from Irish tax on their income and gains regardless of the residence of their investors;
(b) there are no periodic tax charges on the value of the fund's assets;
(c) under Irish law, there is no withholding tax on income distributions or redemption of units to non- Irish residents, provided an appropriate residency declaration is in place;
(d) no Irish stamp duty arises on the issue, sale or transfer of shares or units; and
(e) many of the services which the fund receives are VAT exempt.
Recent helpful changes mean that a fund can avoid the burden of obtaining residency declarations from its investors. This treatment is available if the fund has procedures in place to ensure that any investor (or class of investor) is non-Irish resident, and these are approved by the Irish tax authorities.
Combining Section 110 and Funds
In certain circumstances, a combination of an Irish regulated fund with a section 110 company can prove a useful vehicle for investing in certain assets, such an loans. In these structures, the fund holds its investments through the section 110 company, which can facilitate access to double tax treaty benefits.
For further information please speak to your usual contact or the individuals listed above.