Ireland - The Domicile of Choice For Structuring Distressed Asset Deals
By Eleanor MacDonagh, Fergus Gillen & Mark White
Posted: 12th November 2012 09:03
Since 2008, US private equity funds, among other investors, have been seeking to invest in distressed debt portfolios in Ireland and elsewhere. In the past 10 months in Ireland, however, there has been a marked increase in the number of deals completing. Interesting trends are emerging in connection with the structures explored and employed for the purposes of housing the target assets in such transactions, demonstrating Ireland's continued position as a domicile of choice for special purpose vehicles in structured finance transactions, whether target assets are located in Ireland or abroad. The most popular structure to date in these transactions has been the establishment of a qualifying company within the meaning of section 110 of the Taxes Consolidation Act 1997 of Ireland, as amended (a 'Qualifying Company') in order to acquire the target assets. Another Irish domiciled vehicle that is sometimes considered for this purpose (and often in addition to a Qualifying Company) is a Qualifying Investor Fund (‘QIF’). A summary of the key features relating to each vehicle, from an Irish tax perspective, is provided below.
Taxation of Qualifying Companies
Qualifying Companies are companies that are designated as such solely because they meet certain conditions outlined in Ireland's tax laws (see below), so as to be capable of enjoying tax-neutrality in Ireland. Qualifying Companies can access Ireland's extensive network of double taxation agreements and are not subject to regulation by the Central Bank of Ireland.
Section 110 provides for a special tax regime for a ‘Qualifying Company’. A ‘Qualifying Company’ is a company that meets the following conditions whereby:
(a) it is resident in Ireland;
(b) it acquires qualifying assets from a person, holds or manages qualifying assets as a result of an arrangement with another person or has entered into a legally enforceable arrangement with another person which itself constitutes a qualifying asset;
(c) it carries on in Ireland a business of holding qualifying assets or managing qualifying assets, or both;
(d) apart from activities ancillary to that business, it carries on no other activities;
(e) in relation to which the market value of qualifying assets held or managed by the company or the market value of qualifying assets in respect of which the company has entered into legally enforceable arrangements is not less than €10,000,000 on the day on which the qualifying assets are first acquired, first held, or a legally enforceable arrangement in respect of the qualifying assets is entered into (which is itself a qualifying asset); and
(f) it has notified the Revenue Commissioners in the prescribed format that it is, or intends to be, a Qualifying Company. Also, a company is not a Qualifying Company if any transaction is carried out by it otherwise than by way of a bargain made at arms’ length, apart from where that transaction is the payment of consideration for the use of principal that meets certain conditions. A ‘qualifying asset’, in relation to a Qualifying Company, means an asset which consists of, or of an interest in, (1) any financial asset (e.g. loans and other debt obligations), (2) plant and machinery or (3) commodities.
Tax on Profits
Where a company meets the conditions to be a Qualifying Company, expenses that are wholly and exclusively incurred in the course of the company’s business are generally deductible in calculating the company’s taxable profits. Also, provided that interest payments meet certain conditions, such interest payments will be tax-deductible even if the interest is profit-participating, in excess of an arms’ length rate or both (i.e. profit-strip interest). Accordingly, transactions can be structured to be tax-neutral for a Qualifying Company, and transactions involving the investment by investors in distressed debt portfolios can be facilitated on a tax-efficient basis by using a Qualifying Company. In such transactions the Qualifying Company issues debt securities to investors and uses the subscription proceeds raised by the issue of those securities to acquire the target assets. The Qualifying Company can then make payments of interest on those debt securities to investors (or accrue for liabilities to make such payments in the future) out of net income so that negligible profits arise and therefore negligible corporation tax is payable.
Payments by borrowers to a Qualifying Company may be made without any obligation to deduct an amount on account of Irish tax, while, in relation to foreign taxes, if applicable, the Qualifying Company can access Ireland's extensive and expanding network of double tax treaties to reduce or eliminate such taxes. In relation to the payment of interest by a Qualifying Company on securities issued, a number of exemptions from Irish withholding tax are available. These include a ‘quoted eurobond’ exemption for securities which are listed on a recognised stock exchange and a separate exemption in respect of payments to persons resident in European Union Member States (other than Ireland) or countries with which Ireland has signed a double tax treaty, provided that the securities are not held through or in connection with a branch or agency in Ireland. In addition, in many circumstances, interest on securities that mature within two years is not subject to Irish withholding tax. Also, Irish withholding tax does not arise on ‘short interest’ (i.e. interest on an obligation that matures within one year) or discount.
There is an exemption from Irish Value Added Tax (‘VAT’) for companies that are Qualifying Companies with respect to fees paid in respect of investment management, investment administration, corporate administration and marketing services. In particular, this would generally include fees paid by the Qualifying Company for the servicing of loans meaning that the Qualifying Company should not suffer significant irrecoverable VAT on costs and expenses.
Irish Stamp duty will not apply on the issue or transfer of securities issued by a Qualifying Company. There are also various exemptions from Irish stamp duty that apply to the acquisition of debt and loan portfolios so that significant Irish stamp duty charges should not arise.
For the above reasons, Irish Qualifying Companies provide a neat solution when structuring distressed debt transactions. In some cases, due to investor demand or for tax reasons, another Irish vehicle is often considered in the context of these types of transactions; the Qualifying Investor Fund (‘QIF’).
Qualifying Investor Funds (‘QIFs’)
A QIF is authorised by the Central Bank of Ireland and is subject to on-going regulation and supervision. A regulated investment vehicle can often be an important feature for certain classes of institutional investors who wish, in a post-Madoff world, to invest in a well-regulated fund authorised in an EU Member State with an independent custodian which has responsibility for the vehicle’s assets. The benefit of a QIF is that although it is subject to regulation and oversight by the Central Bank of Ireland, the investment and borrowing restrictions which apply to retail funds are automatically disapplied. In return for the disapplication of such retail-type restrictions, a QIF can only be sold to ‘Qualifying Investors’ (as defined below) who are prepared to invest a minimum subscription amount of €100,000 (or its equivalent in another currency).
A ‘Qualifying Investor’ for these purposes is:
(a) a ‘professional client’ within the meaning of Annex II of Directive 2004/39/EC (MiFID Directive); or
(b) an investor who receives an appraisal from an EU credit institution, a MiFID firm or a UCITS management company that it has the appropriate expertise, experience and knowledge to adequately understand the investment; or
(c) an investor who certifies that it is an 'informed investor'.
In addition, certain conditions apply in relation to certain service providers to a QIF and, in certain circumstances, the services that they provide. Consequently, albeit a regulated vehicle, the QIF provides great flexibility in terms of investment structure.
Taxation of QIFs
QIFs are fully exempt from tax on their income, profits and gains, enjoying a tax-free gross roll-up of income, profits and gains. Instead, an exit tax regime applies, whereby Irish tax arises upon the making of payments to investors, unless otherwise exempt. However, by virtue of an exemption, no Irish tax arises in connection with investments held by any person that is not Irish resident (irrespective of where that person is resident) provided that certain simple procedures are followed.
Also, no Irish stamp, capital or other duties apply to the issue, transfer or redemption of investments in a QIF.
In addition, there is an exemption from VAT for QIFs with respect to fees paid in respect of investment management, investment administration, corporate administration and marketing services. In particular, this VAT exemption would generally include fees paid by the QIF for the servicing of loans. Custodial services are also generally exempt from VAT.
Because of the tax exempt nature of QIFs, however, access to some of Ireland's double tax treaties may not be available. Each jurisdiction typically needs to be reviewed on a case by case basis to determine whether access is possible at that time.
Comparing Thethe Tax Benefits Ofof a Qualifying Company & a QIF
In favour of a QIF, we note that no Irish tax arises on payments made by QIFs to non-Irish resident investors irrespective of where those investors are resident. However, unless the debt securities issued by a Qualifying Company are listed on a recognised stock exchange, investors in a Qualifying Company generally must be resident in a European Union Member State or a country that has signed a double tax treaty with Ireland in order to be entitled to receive interest payments gross. Also, because a QIF is tax exempt, no tax arises for the QIF irrespective of how the investment is structured. Whereas, in connection with the business of a Qualifying Company, it must be ensured that expenses in each accounting period are tax-deductible and sufficient in amount so as to shelter all of the Qualifying Company's income from tax.
However, if access to Ireland's network of double tax treaties is required to mitigate foreign taxes, a Qualifying Company may be a better solution as the QIF may not be eligible to enjoy the benefits of the relevant treaty.
Whilst there are no differentiating tax factors, we note that the costs of establishing and running a QIF are generally higher than the costs of establishing and running a Qualifying Company, which are generally quite low. As noted above, a Qualifying Company is not subject to supervision or regulation by the Irish Central Bank, whereas a QIF is so regulated (which may be seen as a benefit or a burden, depending on investors’ preferences).
Combining the Qualifying Company & the QIF
There are, of course, cases where the QIF may be preferred (for example, where certain classes of investors have a requirement that the investment vehicle be regulated). In that scenario, the tax exemption that applies to the QIF regime may be enjoyed by the investment vehicle and no Irish tax will arise on payments to investors irrespective of where that investor is resident. However, in order to mitigate foreign taxes on income arising to the investment vehicle, access to Ireland's network of double tax treaties is required. In such scenarios a combination of: (1) investors investing in a QIF; and (2) the QIF investing in a Qualifying Company that in turn invests in the target assets, may be the solution. Such structures have been established to achieve multi-jurisdictional tax efficient structures for investors in various asset classes over the past number of years, and could equally provide an excellent solution for investors investing in portfolios of distressed debt in Ireland and abroad.
Accordingly, Ireland is currently one of the main domiciles of choice for a number of private equity and distressed debt managers and investors, both for the acquisition of assets as they become available for sale, and the structuring of onshore investment platforms to facilitate such acquisition in Ireland and abroad.
Eleanor MacDonagh specialises in taxation law and practice and, since joining McCann FitzGerald in 2001, has led the expansion of the firm’s tax advisory services to both domestic and international banking and financial services clients. She has developed particular expertise in relation to international tax structuring through Ireland, the taxation of capital markets products including derivatives, securitisation and structured finance and establishing investment funds and other tax-based investment products.
Eleanor is a member of the Tax Committees of each of the Irish Securitisation Forum and the Irish Funds Industry Association.
Eleanor MacDonaghcan be contacted by phone on +353 1 611 9174 or alternatively via email at Eleanor.MacDonagh@mccannfitzgerald.ie
Fergus Gillen focuses on a wide range of debt finance work, with a particular emphasis on debt capital markets (public and private), restructuring, securitisation, structured finance and secured lending transactions. Fergus advises many financial institutions (Irish and international), non-financial corporates and state-owned entities.
Fergus Gillen can be contacted by phone on +353 1 611 9146 or alternatively via email at Fergus.Gillen@mccannfitzgerald.ie
As Head of the McCann FitzGerald Investment Management Group, Mark Whiteadvises a wide variety of clients who are engaged in the promotion and management of investment funds (including Qualifying Investor Funds). Mark has particular expertise on structuring alternative funds such as private equity funds, distressed debt funds and hedge funds. Clients include some of the largest fund managers in the Irish and international funds market, institutional seed investors and some of the large prime brokerage houses. Mark also advises on investment business regulation and financial services law.
Mark has been a member of the Legal and Regulatory Committee of the Irish Funds Industry Association for the past five years and is a member of the IFIA Council.
Mark White can be contacted by phone on +353 1 607 1328 or alternatively via email at Mark.White@mccannfitzgerald.ie