In October 2019, the Minister for Finance, Paschal Donohue, announced in his budget speech the immediate introduction of new anti-avoidance measures for Irish Real Estate Investment Funds (IREFs). The Revenue Commissioners have recently published their guidance on these new rules in e-Brief No.212/20. In the article below, Gareth Bryan, Financial Services partner, examines these new rules and the newly issued Revenue guidance.

Background to IREF regime

A fund (or sub-fund of an umbrella fund) is considered to be an IREF where at least 25% of the market value of its assets is derived (directly or indirectly) from IREF assets. For these purposes, IREF assets include Irish real estate, shares in an Irish REIT, shares in a company which derives all/most of its value from Irish real estate or a REIT, units in another IREF, and loans secured on and which derive their value (or greater part of their value) directly or indirectly from Irish property. Whilst IREFs were not previously taxable in their own right, they are responsible for operating withholding tax at a rate of 20% on the occurrence of certain taxable events for in-scope investors (certain categories of investor are exempt).

Outline of the new rules

Under the new rules, IREFs are deemed to have income subject to an Irish income tax charge (i.e. a cash tax charge) where they are regarded in law as either having an excess of debt or incurring expenses that are not wholly and exclusively incurred for the purposes of their business. The latter category – excess expenses – is a “facts and circumstances” based test whereas the former – excess financing costs – is determined under two specific formulas. Therefore, the excess financing costs test is something that needs to be considered in respect of all IREFs that have any form of debt financing and is discussed further below.

When introducing these new rules in his Budget speech, the Minister for Finance acknowledged the important role that institutional investors play in terms of increasing supply, both of commercial and residential property, and noted that this type of investment is welcome at a time when increasing supply to meet housing challenges is of the utmost importance. He noted, however, that it is essential that an appropriate level of tax be paid by such investors. In this regard, the Minister noted that the Revenue Commissioners had recommended that these new measures be introduced to address certain situations where the residual profits of an IREF might have been reduced through the use of financing cost deductions and expenses, thereby reducing the amount of profits to which IREF withholding tax would apply.  Where anti-avoidance rules are introduced, it is critical that they achieve their purpose in a targeted and proportionate manner and do not create unintended consequences.  Unfortunately, the new rules can impose a tax charge in a number of situations where no IREF withholding tax would have applied in the first instance.  For example:

  • IREF withholding tax only applies to that part of an IREF’s profits arising from its Irish property related investments; whereas, the new rules apply to all of an IREF’s debt / financing costs, not just debt / financing costs associated with its Irish assets (which could be as little as 25% of its total assets thereby being an IREF).
  • The first of the two new rules which impose a tax charge (described in greater detail below) can impose a tax charge with respect to both interest-bearing and interest-free debt, even though the use of interest-free debt would not reduce the IREF’s profits and, therefore, would not have an impact on the IREF withholding tax liability.
  • While the rules provide for some relief in respect of third-party debt, there is no relief in respect of debt provided by investors who are not third-parties but who are exempt from IREF withholding tax (such as Irish pension schemes), thereby resulting in the imposition of a tax charge in situations where no IREF withholding tax would arise.  

The fact that the new rules can apply in these situations appears to be at odds with their stated objective.

The new rules were initially enacted under a financial resolution and applied from 9 October 2019 but the legislation in the Finance Act 2019 included a revised set of rules which were applicable from 1 January 2020. In their guidance, Irish Revenue have confirmed that IREFs may choose to apply the second set of these rules from the October 2019 period. This is an important concession because the revised rules contained certain exclusions from the calculations which should generally be more beneficial for IREFs as a result.

Deemed financing income

There are two tests to determine the level of excess financing costs of an IREF that should be subject to Irish income tax, namely:

  • a 50% debt threshold test; and
  • a property financing costs ratio test.

The amounts calculated under these tests are added together and treated as income received by the IREF – subject to Irish income tax at a rate of 20%, without relief for losses or allowances of any kind (i.e. the IREF will be subject to cash tax).

In theory, the amount of deemed income arising under these tests could exceed the actual financing costs in certain circumstances, however, Irish Revenue have confirmed in their guidance that the amount which can be charged to income tax in any accounting period is capped at the level of the property financing costs of the IREF in that period. The outcome of the formulae is not altogether intuitive and therefore we recommend that each IREF model out the potential impact in various scenarios.

50% debt threshold test

The first of the debt financing tests applies where the IREF’s outstanding debt exceeds 50% of the cost of the asset. For these purposes, the cost of the asset would generally comprise its original purchase price plus expenditure on construction and development along with certain acquisition expenses. Guidance confirms that costs directly associated with the purchase, development, improvement or repair of the premises such as stamp duty and legal fees can also be counted. However, financing costs (capitalised or otherwise) should be excluded from this element of the calculation. Irish Revenue’s guidance also clarifies that “debt” means any monies borrowed by, or advanced to, an IREF which might include accrued, but unpaid, interest.

Where this debt threshold is exceeded, the fund should be subject to Irish income tax (at a rate of 20%) on a proportionate amount of the financing costs of the IREF. The proportion of the financing costs which are deemed to be taxable income for these purposes is equivalent to the ratio of the IREF’s debt in excess of the 50% threshold (called its “excess specified debt”) to its total debt (called its “specified debt”):

Property financing costs x (Excess specified debt / Total specifed debt)

For example, a fund that has debt that is equal to 60% of the cost of the asset would have exceeded the 50% threshold by 10% meaning that it should have deemed income equal to 10 / 60ths (1/6th) of its total interest expense.

In applying this test, the legislation is unclear as to when and how often this test is to be applied. One interpretation is that the assessment is required on a continuous basis (i.e. the provisions apply at any point that the 50% debt threshold is exceeded). However, in their guidance, Irish Revenue confirm that the assessment of debt levels can generally be performed as at the IREF’s financial statement year-end date provided that there are no unusual movements or artificial arrangements entered into to deflate the level of debt held at year-end.  

Property financing costs ratio test

The second test targets a scenario where the ratio of the combined sum of an IREF’s annual profits (but excluding realised or unrealised capital gains) plus its financing costs relative to its financing costs is below a ratio of 1.25:1 (which would be the case where the level of financing costs payable on debt reduces profits by more than 80%). Financing costs include interest, discounts, premiums, swap and hedging costs, as well as debt arrangement and issuance costs. Importantly, however, to avoid a tax charge arising in respect of some financing costs under both tests, this second test (only) applies to the IREF’s “adjusted property financing costs” being the IREF’s financing costs less any amount of income which is deemed to be taxable under the 50% debt threshold test. The calculation is performed as follows:

(Profits of IREF+ Adjusted property financing costs) / (Adjusted financing costs ) < 1.25

Where the property financing costs ratio is breached, the IREF is treated as receiving income equal to the amount by which the adjusted financing costs of the IREF would need to be reduced for the ratio to equal 1.25:1.  In effect, the IREF is deemed to have taxable income equal to that amount of the adjusted property financing costs that accounts for more than 80% of the IREF’s profits. 

Scope of the excess financing cost tests

The IREF withholding tax rules only apply to the profits arising from Irish real estate assets. Where an IREF has Irish and foreign properties, the withholding tax rules only apply for that portion referable to Irish properties. In this regard, the new interest rules are introduced as means of counteracting perceived abuse around the withholding tax rules by extracting profits through shareholder loans which would not be subject to the same IREF withholding taxes.

However, the new rules, as written, apply to all of an IREF’s debt / financing costs, not just debt / financing costs associated with its Irish assets (which could be as little as 25% of its total assets thereby being an IREF). Where an IREF had some foreign property, it could therefore be subject to the excess financing cost rules in respect of the foreign property even though no IREF withholding tax would have applied in the first instance.

In their guidance, Irish Revenue provided some limited examples of cases where the cost of a non-IREF asset (and the profits from the non-IREF business) could be taken into account when applying the tests above. These examples cover scenarios where (i) an associated operating company is acquired as part of the acquisition of a property and (ii) certain non-Irish properties were acquired as part of the bona fide acquisition of a portfolio of real estate assets which includes Irish properties.  However, this leaves uncertainty around other situations where an IREF has non-IREF assets.  Furthermore, this approach does not seek to exclude such assets (and the profits arising therefrom) in their entirety from the new rules and, instead, only allows these assets and profits to be counted when applying the new rules to the IREF’s actual IREF business.

Relief for third-party debt

There is some limited relief in respect of third-party debt. Where this relief applies, the calculations for the tests above are re-run using only third-party debt. The amount calculated when only third-party debt is considered can be deducted from the total amount subject to tax (essentially limiting the impact of the calculation to connected party debt only). Irish Revenue’s guidance clarifies that the third-party debt relief provisions apply to both tests above.

However, it is important to note that there are numerous restrictions regarding what constitutes third-party debt, some of which serve to significantly limit the scope of the relief. 

Loan provided by an associate of the IREF

To qualify for relief, the loan must be advanced by somebody who is not an associate of the IREF. The meaning of associate is quite broad and could include, amongst others, investment undertakings which are set up and promoted by the same person, a pension scheme and members of that scheme, enterprises included in a common accounting consolidation and cases where there is a 25%+ ownership interest, voting power, or right to profits on distribution.

In their guidance, Irish Revenue clarify that, in certain specific circumstances, a loan from a third-party which is advanced to an IREF via an associated enterprise can qualify for relief. In particular, the reason for routing the loan through an associate must be solely due to the third-party lender insisting on having security over more assets than just the IREF assets. The loan repayments (subject to certain transfer pricing requirements) must also exactly mirror the loan repayments made by the associate to the third-party lender.   

The guidance also confirms that a genuine third-party loan will not cease to qualify for relief in a scenario where the third-party lender becomes an associate of the IREF solely due to the enforcement of a security (which had been granted as a genuine condition of the loan).

Use of the loan

To qualify as third-party debt, the full amount must be employed in the purchase, development, improvement or repair of a premises. There was a concern that the requirement that the “full amount” of the loan advanced must be used for a qualifying purposes could result in relief being unavailable where a portion of a loan was used for some other purpose (e.g. paying for expenses which do not form part of that purchase acquisition cost). Irish Revenue’s guidance confirms that the relief for third-party debt can apply to that portion of the debt used for the qualifying purpose (i.e. on a pro-rata basis).

The legislation for relief for third-party debt only applies in respect of “premises” and, therefore, does not apply to monies borrowed to acquire other IREF assets (e.g. shares or securities). It also appears that the relief does not apply in respect of monies borrowed to acquire foreign assets. In their guidance, Irish Revenue have clarified that only “debt associated with premises in the State” qualifies for relief. In this regard, the meaning of the term “premises” should be taken to include Irish land and buildings, it excludes any foreign real property owned by the IREF.

“At or about the time of purchase of the premises”

When considering whether debt was employed in the purchase of a premises, amounts borrowed “at or about the time of purchase of the premises” will be considered to have been so employed. In their guidance, Irish Revenue note that the term “at or about” is included in the legislation to deal with situations where, for bona fide commercial reasons, the IREF was temporarily equity funded with third-party debt introduced shortly after the acquisition of the premises and notes that, in certain circumstances, debt which is raised subsequent to the purchase of the property can still qualify for relief.

In order to qualify, it is necessary to consider the particular facts and circumstances with due regard to the actual timing of the events. Appropriate documentary evidence would also be required supporting the position that it was always the intention of the parties to raise this debt and that, for example, the reason it was raised later was due to regulatory delays. Revenue’s guidance anticipates that delays should not stretch beyond six months from the time the premises was acquired. The inclusion of the six-month time horizon could give rise to issues where delays are protracted. 

Refinancing existing third-party loans

There are also rules designed to counteract scenarios where connected party debt is routed through third parties.

Revenue guidance confirms that the refinancing of an otherwise qualifying loan can also qualify for relief provided that the financing costs are reduced as a result of the refinancing. Revenue will also accept that, where third-party debt is being refinanced and the financing costs over the life of the new loan are higher than the financing costs on the existing debt, the refinanced loan can still qualify as third-party debt provided that the increased financing costs arise from genuine market conditions which are out of the control of the IREF.

While this confirmation is helpful, issues could arise where an IREF was previously funded via a combination of equity and shareholder loans and did not raise any external debt at or about the time of purchase of the premises. The use of external debt to replace equity (as opposed to refinance a qualifying loan) is not currently addressed in Revenue’s guidance. As such, the third-party debt relief provisions need to be examined by reference to the facts of each case. In all but the simplest of cases, this relief is potentially of limited benefit notwithstanding the fact that the debt was raised from a genuine third-party.

Property acquired from an associate

Even where the loan is considered to be third-party in nature, relief can also be restricted if the property is purchased from an associate unless (i) immediately prior to the purchase, the associate carried out “significant” development work on the property (meaning the development exceeds 30% of the market value of the property at the date of commencement of the development) and (ii) the property is being acquired by the IREF for the purposes of the IREF’s property rental business.

In many cases, property can be temporarily held by an associate SPV and transferred to the IREF once the fund has been established. This could result in relief being denied for third-party debt, notwithstanding the fact that the property was held by the associate SPV for bona fide commercial non-tax reasons. 

Treatment of capitalised interest

In their guidance, Irish Revenue note that interest which is capitalised and then amortised to the income statement should be treated as interest for the purposes of the rules above. Revenue have also confirmed that unamortised interest should be included in the deemed interest calculations in the year in which the property was sold (with no account taken of any unused capacity in prior years in either the 50% debt threshold calculation or property financing costs ratio test).

The guidance states that this approach “…ensures consistency of treatment under the IREF rules for interest amounts whether they are expensed or capitalised”.  However, it does not take account of the fact that if part of the capitalised interest expense is (effectively) charged to an IREF’s income statement in one period (e.g. where the property is sold and there is some unamortised capitalised interest which is consequently included in the disposal calculation), there could be a significant deemed income charge; whereas, had the same interest expense been fully amortised in the IREF’s accounts in previous years (by being released at a higher rate), there might have been no charge (or a smaller charge) in a situation where higher rate of amortisation did not result in the financing cost limit being breached.  In short, the absence of being able to carry-forward this unused “interest capacity” means that there is an inconsistency in treatment between interest which is capitalised and expensed immediately.

Treatment of partnerships

The new rules explicitly refer to including debt borrowed by a partnership of which an IREF is a partner in the interest calculations. This makes sense where there is line by line consolidation of the partnership results into the IREF concerned. However, there are some situations where IREFs treat their interest in such partnerships as investment entities and do not undertake a line by line consolidation.

In these circumstances, the IREF could be caught by the deemed financing income rules in a very severe way as there would be no property cost on the balance sheet of the IREF for the purposes of the 50% debt threshold test and no profit included in the income statement in respect of the profit financing cost ratio test, thereby essentially causing an income tax charge in respect of the totality of the relevant share of the partnership debt, despite the fact that a line by line consolidation would have resulted in a lower charge (if any). However, Revenue confirm in their guidance that a line by line consolidation approach should be applied for the purposes of the deemed interest income tests in these circumstances.

Excessive expenses

Another new measure seeks to deal with any expenses or disbursements made by an IREF (and taken into account in computing its profits) which were not wholly and exclusively incurred for the purposes of its “IREF business”. Under this new rule, the IREF would be deemed to have income subject to Irish income tax (at a rate of 20%) on an equivalent amount. 

IREF withholding tax only applies to that part of an IREF’s profits arising from its Irish property investments – its “IREF business” – which could be as a little as 25% of its total assets.  However, this new rule imposes a charge in respect of any expenses incurred which are not wholly and exclusively incurred for the purposes of the “IREF business”. 

The rules, as written, could potentially trigger an income tax charge in respect of any expenses incurred by the IREF in respect of its assets which are not Irish property assets (or expenses incurred in respect of both Irish and non-Irish assets and hence not wholly and exclusively incurred for the purposes of the IREF business). 

However, in their guidance, Irish Revenue clarify that, where the IREF has non-IREF business (which meets the specific examples of permissible non-IREF businesses discussed above) and the expenses are incurred wholly and exclusively for the purposes of that non-IREF business, the excessive expenses charge should not apply. 

IREF compliance obligations

Where the rules impose a charge, it will be necessary for the affected IREF to file an income tax return and pay cash tax for that period. In the guidance, Revenue confirms that once an IREF is within the charge to income tax, it must continue to file a return until such a time as it ceases to be an IREF or ceases to have debt or unamortised interest costs.


Whenever anti-avoidance rules are introduced it is important that such provisions are framed so as to achieve their purpose without creating unintended consequences.  The new rules have wide-ranging consequences that will affect both domestic and international investors and they can apply to impose a tax charge in situations where no IREF withholding tax would apply.  Thus, the rules appear to reach beyond the stated objective of counteracting the reduction of IREF withholding tax.  Consequently, care is needed when an IREF has any form of debt and one cannot assume that a liability will not arise where that debt financing has no impact on the amount of IREF withholding tax to be paid.

Get in touch

If you have any questions on the above, please contact Gareth Bryan, Financial Services partner, or any member of our team. We'd be delighted to hear from you.

Further reading