Donohoe fails to get stamp of approval for property changes
When it comes to institutional property investors, the Budget may have been a case of closing the door after the horse has bolted, writes Dan White
THE Budget targeted the booming commercial property sector with a stamp duty increase and a tax clampdown on real estate investment funds. But with the market looking wobbly as Brexit looms, has Minister for Finance Paschal Donohoe left it too late? In the aftermath of the post-2008 property crash, the Government introduced a number of measures designed to encourage investment in the bombed-out commercial property market.
The 2013 Finance Act provided for the establishment of real estate investment trusts (Reits). These are tax-efficient vehicles whose shares are traded on the stock exchange.
The Reit pays no tax on its property rental business and must distribute at least 85pc of its property rental income to shareholders. Reits are primarily aimed at small investors.
The 2016 Finance Act followed this up with Irish real estate funds (IREFs). These have similar tax breaks to Reits but are aimed at larger investors and their shares do not have to be traded on the stock exchange. Unlike Reits, they can also purchase development land.
When delivering his Budget speech on Tuesday, Donohoe acknowledged that: “Institutional investors have an important role to play in terms of increasing supply, both of commercial and residential property.”
Unfortunately, it is now clear that institutional investors, both Reits and IREFs, have been able to structure their businesses in a manner that allows them to pay a minimum of tax.
In his Budget speech, Donohoe flagged a number of tax changes, which he hopes will result in these funds paying an “appropriate” level of tax.
Since Budget night, the amount that IREFs can borrow is effectively capped at 50pc of the price of the property asset being purchased, and the interest payments are restricted to 80pc of total rental income. Any borrowing or interest payments above these thresholds do not qualify for the IREF tax reliefs.
Donohoe also moved to tighten up the taxation treatment of Reits, particularly capital gains tax. In future, gains by Reits from property disposals will have to be immediately reinvested or else be taxed. With one of the three Irish Reits, Green, having already been sold, does this amount to closing the stable door after the horse has bolted?
Just for good measure, the minister increased the rate of stamp duty on purchases of commercial property, from 6pc to 7.5pc. He justified the increase by saying: “The commercial property market continues to perform strongly and I expect that this increase can be borne by the sector without any significant impact.”
On the face of it, Donohoe’s optimism appears fully justified. Figures compiled by property consultant CBRE show that €3.3bn of commercial property changed hands in the first nine months of 2019, and that when the Green Reit sale goes through, the total for the full year should exceed €5bn for the first time ever. This compares with less than €4bn for the whole of 2018, and a mere €500m back in the dog days of 2012.
The stronger property market is also feeding through into much higher capital gains tax (CGT) revenue, with a total CGT take of €294m for the first nine months of 2019, a 32pc increase on the same period last year.
With his Budget changes, the minister is obviously expecting the good times to keep on rolling. Others are not so sure.
“There will be huge disappointment in the property sector that stamp duty has been increased to 7.5pc. This has the effect of making Ireland a very expensive place to acquire property and is likely to slow down the interest of foreign buyers who could see our regime treating property as an easy target. It is hard to see how the expected €141m increase in yield will actually materialise as transactions will surely fall off as a result of this,” said KPMG’s head of real estate Jim Clery.
Others are not quite so pessimistic. “Dublin in particular, but also Ireland in general, is a strong market. At the end of the day, it comes back to whether occupiers need space. Ireland has a strongly growing economy,” said John McCartney, head of research at property consultant Savills.
He points out that offices have traditionally been the largest sector of the Irish commercial property market and that we are now building only half as many offices as we were in 2007.
“In 2007, most offices were being built on greenfield sites like City West. Today, most office construction is taking place in the city centre and is replacing existing stock. Leaving aside the possibility of a crash-out Brexit, the fundamentals remain strong and there will be continued strong growth, with rents well underpinned.”
McCartney believes that the commercial property market will eventually shrug off the stamp duty increase. He is far more concerned about the constant chopping and changing of the tax regime in recent years, pointing out that the stamp duty rate has been changed no fewer than four times since December 2006, while the VAT rate has been changed a number of times also.
“This creates an unhelpful impression from the point of view of stability and transparency,” he said.
Pádraic Whelan, real estate tax partner at Deloitte, is sceptical about the extra revenue the minister has pencilled in from the stamp duty increase.
Whelan points out that a €141m revenue increase from a 1.5pc stamp duty rate rise translates into more than €9bn (€9.4bn to be precise) of underlying transactions. He is sceptical about the chances of this volume of transactions being achieved, particularly at the higher rate.
Smaller businesses planning to buy a commercial property and investors hoping to switch out of the heavily regulated and heavily taxed residential property market (where the effective tax rate can run as high as 55pc) will think again when confronted with a 7.5pc stamp duty rate, he warned.
“If you want to set up a small business and buy a €500,000 property, that’s €37,500 in stamp duty. Throw in legal fees and you’re down €50,000. You can’t borrow that money. You might say, ‘will I bother?’”
Whelan is calling for a tiered stamp duty regime, similar to that which already applies to residential property, where 1pc stamp duty is paid on the first €1m of the price of a house, and 2pc on everything above that level.
In practice, the Budget property tax changes will most likely remain with us until at least next October, when Donohoe or his successor gets up in the Dáil to deliver Budget 2021. If we succeed in dodging the Brexit bullet then the changes are likely to remain in force. If not, then stand by for even more chopping and changing.
‘Leaving aside the possibility of a crash-out Brexit the fundamentals remain strong in Ireland’