Tales from Tax Haven Ireland: Irish Property Stuck on Repeat

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“The economy returned to growth in 2011, continued to grow in 2012 and my Department are forecasting continued growth in 2013. In my two Budgets I introduced a number of sector specific initiatives to support this recovery and I am pleased to say that we are starting to see a number of these bearing fruit. Take the commercial property sector for example, recent reports show activity in the first half of this year surpassing transaction in 12 months of 2012. Interestingly, over 50% of the investment is international money coming into the country. We have also just seen the launch of Ireland’s first REIT and I would expect more activity in this area in the years ahead. This is welcome and is supported by Capital Gains Tax incentives in Budget 2012 and the legislation underpinning REITs introduced in Finance Bill 2013.”

–          Minister Michael Noonan’s speech to FSI Annual Lunch July 4th, 2013

I’m sure people think we’re cracked saying Ireland is a tax haven, again and again.

One of the fundamental characteristics of a tax haven is that much of the economy is structured around the managing of hot money from international clients with other elements ignored or neglected. It is essential, if such an environment is to be valuable to their foreign customers, that the vast majority of the money ‘invested’ remains untouched. That is, the quantity of investment going in has to be the same as that going out. However, there is an additional qualification over this movement: the money going out has to be free of any tax obligation – it cannot incur any additional expense once it leaves. This is done in two ways: the first is by nominally taking in money through an opaque structure of sovereign laws backed by OECD credentials and a ‘regulated’ stock market and thereby washing its profits to avoid almost all of its global tax bill. This is complex and requires certain restructuring of the investors’ financials. It also involves buying substantial and expensive advice from suitably qualified tax lawyers. The second, less complex route is to avail of various tax credits and other profit washing mechanisms that are available through property acquisition.

Up to 2008 this washing of profit money via property acquisition occurred largely through Anglo Irish Bank, although the other banks became heavily, and aggressively involved too. Anglo Irish Bank and AIB, and to a lesser extent Bank of Ireland and Irish Nationwide (who were more focused on local rentiers) provided the means of washing profits through the commercial property market in Ireland, the UK and the US. The means of doing this was provided in part by the shadow banking system, mainly based in the UK. Irish regulation had a reputation of not wanting to know too much about the business that international clients were involved in. After all, the business model is based on ensuring that the money that is brought in is able to get back out again in the same condition it entered. They guarantee it will never be taxed while in Ireland. This form of regulation was designed primarily to transform the IFSC into a powerhouse for the management of international financial capital. International investors were also incentivised to invest, either directly or through an SPV, in large Irish properties during the property frenzy where upward only rent reviews and multinational companies as tenants (whether they are highly profitable global software companies or the Irish outlets of large retail chains) provided a state guaranteed return. After all, upward only rent reviews are protected by the constitution! Their usefulness as a financial asset then was assured, as they provided collateral on future rounds of debt creation and profit. And, of course, all of it was tax free and unmonitored.

Since the crash in 2008 this side of the tax haven economy has been in rehab while the one on the other side, in financial services, as well as Treasury and IP tax arrangements for MNCs, continued to expand massively.

However, through the creation of NAMA, the absorption of banking debt without default (to maintain ‘investor confidence’) and the reselling of valuable properties at prices considerably below the price that the Irish state paid for them (via recapitalisation) the second pillar is being slowly being built up again.

If we are to think of a phrase that could be used to describe the preoccupation of the government for the last year it is about the need to ‘build confidence in Ireland for the international investor’. The means of building this confidence is to do everything required to give the appearance that the economy is starting to right itself. That requires fiddling the budgets, ignoring the temporary anomalies in the employment figures and downplaying the stagnation that remains the dominant characteristic of the Irish economy. Regarding the fiddling of budgets, the Sunday Business Post has already revealed that the so called €2.5 million adjustment in Budget 2014 was in fact a €3.1 billion adjustment.

In addition, the government is using money allocated to capital investment to plug holes that are appearing elsewhere. In a recent note Conall Mac Coille, chief economist at Davy said:

“As in previous years, failure to control current spending is being met with aggressive cuts in capital expenditure. Capital spending in health is €76m below budget, or a massive 22.3%.

The expenditure overrun in health is being compensated for by weaker current spending in other departments. Gross current spending in Education is €79m under budget, and €11m in Social Protection, no doubt benefitting from the fall in the unemployment rate. Total gross capital expenditures are an enormous €389m, or 13.9%, under budget. Overall gross current expenditure is 0.5% below the Budget 2013 plans due to these actions.”

This lack of capital spending has an obvious economic impact, but it’s not immediate. The problems of underspending will occur later, just like the benefits of increasing public spending now would also be felt later.

The emphasis on ‘building confidence’ is about attracting that hot money from foreign investors to re-build the second pillar of Ireland’s Tax Haven economy. Each time ‘investor confidence’ is mentioned the reference is made to those who choose whether or not to buy Irish government bonds. But the real ‘confidence’ that the government is interested in building is the one that encourages equity investors to buy property.

We were told that exiting the bailout was all about getting back into the markets and that this somehow provides a political freedom from the yoke of the Troika. Yet, the terms and conditions demanded of the ‘market’, those who buy government bonds, are as onerous as those demanded by the ECB/EU/IMF. Ireland has also signed up to the Fiscal Compact with its emphasis on budgetary restraint, monitoring and privatization. The government will soon publish its medium term plan which will outline a program of continuing low level public investment and austerity.

The banks remain in a weakened state and are unwilling to lend. They are currently in a process of deleveraging and are unable and unwilling to re-engage with the level of property speculation that acted as a conduit for foreign capital in the past. In the new environment foreign capital is arriving in the form of equity firms and vulture capital funds and rather than sitting across the table from bank executives they are now sitting down with NAMA and Reits companies.

Two articles in today’s newspaper highlight this:

“The National Asset Management Agency (Nama) will bring “several prime Dublin hotels” to the market shortly after Christmas to capitalise on significant international interest in the sector, according to a senior Nama executive.

“The focus will be on prime Dublin assets in the short term,” he said.

Nama has received inquiries about its hotels mostly from “private equity, funds and high-net worth individuals”, he added.”

And this

“Hibernia REIT is following Green REIT, the first trust to float since the passage of last year’s Finance Act paved the way for the establishment of these property investment vehicles here.

REITs are quoted companies that own or operate commercial property. They are not taxed on the rental income as long as they pay 85 per cent of it to their shareholders as a dividend.

Hibernia REIT’s objective is to assemble a portfolio of income-producing properties mainly in the commercial space and in the greater Dublin area, the company said last month.”

When GreenReits launched on the Irish Stock Exchange earlier this year it was hailed as an indication of that return of investor confidence as the vast majority of Irish companies that had been on it have actually delisted from the exchange in recent years The exchange itself is seen as little more than a vehicle to establish the presence of financial companies, often brass plate ones, who are based in London, but use Ireland as a conduit to registered trustees based in a top-end secrecy jurisdiction.

As Jim Stewart outlines in Low tax Financial Centres and the Financial Crisis: The Case of the Irish Financial Services Centre:

“Apart from Bear Stearns and Lehman Brothers, most if not all large banking and insurance companies have securities quoted on the Irish Stock Exchange. For example. AIG had three funds listed in Dublin with a value of $1298 billion) and one debt security; Merrill Lynch had one investment fund and 2 debt funds; Goldman Sachs had 31 investment funds and 2 debt funds; UBS has numerous quoted debt instruments on the Irish Stock Exchange.

German banks in particular had considerable connections with the IFSC. Deutsche Bank had quoted notes and trust certificates to the value of €160 million, the trustees of which are registered in the Cayman Islands; Deutsche Bank (Luxembourg) also had €433 million in debt instruments quoted on the Irish Stock Exchange, and Deutsche Investment Managers had three funds quoted on the Irish Stock Exchange (February 2009). Commerzbank has three debt securities quoted on the Irish Stock Exchange with a value of €1.30 billion, and £800 million. All three are domiciled in Delaware.”

In a note he points out that, although Ireland is a peripheral economy within the EU, the Irish Stock Exchange was at the centre of the recent financial crisis:

“Reports relating to the financial crisis rarely refer to the fact that many funds that were forced into liquidation or closure were quoted on the Irish Stock Exchange. For example, a front page article in the Financial Times citing a plan to restructure an SIV called Cheyne Capital after 10 months of negotiations, and further restructuring at four other SIVS (Golden Key, Mainsail, Whistlejacket and Rhinebridge), neglects to note that in all cases the funds were quoted on the Irish Stock Exchange. There is also no reference to any management functions being undertaken in Dublin (Sakoui, 2008). The Financial Crisis Inquiry Report (2011), has extensive discussion of the failure of IKB and to an off balance sheet financial vehicle (Rhineland), but does not refer to a key Dublin based vehicle (Rhinebridge). The Liikanen Report also has extensive discussion of failed banks such as Depfa Bank and the German Landesbanken, but does not refer to the location in Dublin of subsidiaries where most losses were incurred.”

Writing yesterday about the recent RTE program, Who Is Buying Ireland? which looks at the interest that Irish property has for foreign equity firms, Richard Curran asks some additional yet fundamental questions that those being taxed by this changing situation appear to have missed:

“It is extraordinary, that what people call a “vote of confidence” in Ireland Inc has happened in property and bonds, but not real businesses.

This is where the real questions have to be asked. If all of the investors interviewed by Ian Kehoe, for his excellent programme, were so bullish about Ireland, did they need to be subsidised with property tax breaks to come in and make the purchase? If it was so compelling, could the Irish exchequer not have got a little more out of the deal?

And if Ireland’s economic story is so compelling, then why are so few businesses changing hands.”

I could tell Richard the reason but I don’t want to sound like a broken record, with the needle stuck in the groove repeating ‘Ireland has a tax haven economy’ over and over again. but at least I am not the only one repeating myself.