Vulture funds rub salt into the carcass of this country

Last week, my colleague Jack Horgan-Jones revealed in this paper that vulture funds, leveraged outfits that have already benefited enormously at the expense of you, the Irish taxpayer, are now using a loophole to pay no tax at all on their earnings here.

As you shoulder some of the highest marginal rates of taxation in the western world, consider that the foreign funds which swooped on the carcass of this country are now paying nothing and squirreling their Irish earnings out of the country.

Wounds and salt come to mind.

Sometimes you could be forgiven for feeling that the best qualification to participate profitably in this Irish recovery is not being Irish. Nama has sold off large chunks of the Irish economy, billions of euro of assets, cheaply to foreign funds. And at every stage of these transactions, the Irish taxpayer has lost out. Now, we discover that rather than paying tax on their earnings here, these funds are using a loophole to avoid tax.

A question worth considering today is whether Nama sold to these funds knowing that the funds would use a loophole to avoid tax? This is impossible to answer, but it’s a question worth asking.

In order to give you a feel for what is going on, let’s create a fictitious but very realistic example in order to follow the money because following the money is what this is all about.

So let’s go back to the beginning, to 2007.

An Irish developer borrows €100 million from an Irish bank to build an office block in Dublin. He builds a high-spec block which is part of his property empire that also encompasses development land, houses and apartment complexes. He’s a big fish.

The bank books the €100 million as an asset on its books and the interest as revenue. The bankers are smiling. The bank’s share price rises. High-fives all around.

Then the crash slams into this trade. The banks didn’t have the money in the first place, they had been borrowing the money they lent to yer man from a German bank by issuing IOUs to the Germans. Once the Germans get windy about Ireland, they panic and refuse to roll over the credit. They demand their money back. The bank doesn’t have it. The developer is approached for margin cash because the banks need to get money somewhere. Property prices are falling and suddenly what was regarded as an isolated case turns out to be systemic.

The price of assets fall and the bank’s balance sheet implodes.

The office block is now worth €50 million. There is a €50 million hole. Nama is created to make sure that these assets are sold to someone who has the cash and is prepared to take a risk on Ireland. This is where the funds come in. They buy up the asset for €50 million. However, the difference between the price they pay and the original sum lent to the bank goes on to the national balance sheet. The taxpayer is already in a hole for €50 million.

Now consider the income on the office block. Let’s say there was a rent roll of €10 million on the building in 2007. This dips a bit but not much and by 2010 is back up to €10 million. Now the vulture fund is making €10 million annually in its €50 million investment. This is a 20 per cent return. The fund is in clover. More high-fives!

This is how capitalism works.

Whoever takes a chance when everyone else is nervous or broke or both, wins. We should not complain because this is the system, but typically the taxpayer doesn’t subsidise this trade. But we did via the bailout. The banks’ losses were transferred onto the national debt.

That’s the first loss for the taxpayer. However, had the banks been allowed to go bust straight away, the run on the banks would probably have wiped out more of people’s deposits. Once you allow your banking system to get out of control and wreck the national balance sheet, the choices faced are not between bad and good, but between bad and awful.

But let’s follow the new money.

The rent from the building paid by companies doing business in Dublin goes to the new owners, the vulture funds. If the landlord were a normal Irish company, the owner should pay tax. Therefore, the tax man would get his cut.

But this is where the Irish taxpayer loses out again.

Several large vulture funds are using this structure called section 110 to avoid paying tax on revenues from their Irish operations. The S110 was set up in 1997 to enable IFSC companies avoid tax, quite legitimately, on revenues which were gathered elsewhere in the world. It is usually done via a profit-participating note, a type of funding advanced by a parent company or a lender controlled by a parent company. Repayments on this loan are garnered from repayments on the underlying asset, and shifted offshore.

But the repayments in the case of the vulture funds/landlords operating in Ireland are Irish income. These are rents paid by Irish businesses and tenants to their new landlords and the money is leaving the economy directly. The Irish state gets nothing.

The problem with this story – apart from the lack of fairness of it all – is that if these funds are allowed to move their money out of the country, the Irish tax base gets narrower. When your own state actively narrows the tax base, if the state wants to maintain the level of public services, it has to tax those who can’t avail of these tax avoidance schemes much more.

Therefore, you pay twice. During the bailout because the national debt rose. Now that the economy is moving along at a decent rate, the foreign fund owner wins again because he gets another tax break. You end up paying more.

How does that make you feel?