Indecon report on tax breaks (2005)

8/9/2019 Indecon report on tax breaks (2005)

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TSG PAPER 05/18

REVIEWS OF TAX INCENTIVE SCHEMES:

CONSIDERATION OF CONSULTANCY STUDIES

A. Introduction

Budget 2005 Announcement

1. The Minister for Finance announced in his Budget 2005 statement on 1December 2004 that the Department of Finance and the Office of the Revenue

Commissioners would undertake a detailed review of certain tax incentive

schemes and tax exemptions in 2005. TSG Paper 05/10 set out the

background to the reviews in some detail; and, at the TSG meeting on 8

September 2005, an outline was provided of the initial draft Reports from

Goodbody Economic Consultants in respect of the area-based renewal

schemes (viz. the Urban Renewal, Town Renewal, Rural Renewal and theLiving-over-the-shop schemes) and from Indecon in respect of certain

property-based reliefs (viz. the reliefs for multi-storey car-parks, park-and-ride

facilities, student accommodation, third-level buildings, hotels, holiday

cottages, nursing homes, private hospitals, sports injuries clinics, childcare

facilities and refurbishment of rented residential accommodation).

2. Goodbodys and Indecon have recently submitted updated Draft Final Reports.The consultants conclusions and recommendations are set out below, along

with a further analysis of the policy considerations involved.

B. Indecon Review of Certain Property-based Reliefs - Overview

3. The economic consultants Indecon were retained in April 2005 to undertake adetailed review of certain property-based tax incentive schemes. The Study

Terms of Reference are set out in Appendix 1. Indecon delivered a Draft Final

Report in early October 2005. The Report includes fourteen Specific

Recommendations (see Box A on p.iii below) and eight General

Recommendations (see Box B, p.vi) In outline, Indecon are recommending:-

discontinuation of many of the tax reliefs subject to review with, in most

cases, a five-year extension of the July 2006 construction deadline (subjecthowever to a reduced level of capital allowances)

continuation of capital allowances for private hospitals, private nursinghomes and childcare facilities, subject to some modifications, along with

relief for park-and-ride facilities (but not for associated developments)

additional public expenditure for investment in third-level buildings and inpark-and-ride facilities

mechanisms to facilitate the monitoring of tax costs, by requiringappropriate disclosure of information by relief claimants

formal assessment of the costs and benefits of new reliefs


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a maximum lifespan of three years for any new relief schemes, with thecontinuation of reliefs being dependent on a favourable assessment

re-focusing of tax reliefs away from rental income for reasons of equityand efficiency

a cap on individual allowances for reasons of equity

differential allowances as between corporate and individual taxpayers, toreflect the different Exchequer costs involved.

Schemes Recommended to be Discontinued Expiring Schemes

4. As regards those reliefs that are recommended to be discontinued, most ofthese are expiring schemes, i.e. they are already closed to new projects (since

planning applications had to be submitted before end-December 20041), and

qualifying construction expenditure must be incurred by July 2006 at the

latest. All such reliefs are recommended by the consultants to be discontinued

(apart from the relief for park-and-ride facilities see para. 10 below).However, in most cases, Indecon recommend that the July 2006 deadline be

extended by five years. The issue of extending the July 2006 deadline is dealt

with in more detail at section D below.

5. The consultants recommend that the various expiring schemes should not becontinued, for one of three reasons:-

(a)Some of these reliefs are seen by the consultants as having served theirpurpose. This applies to the reliefs forhotels and holiday camps; holiday

cottages; andstudent accommodation.

(b)Other such schemes are considered by the consultants to be too costly andinefficient as a mechanism for addressing the relevant public policy

objective. This applies to relief forthird level educational buildings, and

for residential and commercial developments associated with park-and-

ride facilities (note: the consultants are recommending that the relief

specifically forpark-and-ride facilities could be retained). In such cases,

the consultants note that public expenditure options would be a more cost-

effective route for directing State assistance towards these policy

objectives.

(c)Finally, the relief for multi-storey car parks is seen by the consultants as

serving no current useful purpose in terms of economic or transport policy.

Schemes Recommended to be Discontinued Non-expiring Schemes

6. Two tax incentive schemes without a specified end-date should bediscontinued with immediate effect, in Indecons view: these are the reliefs

for investment insports injury clinics and forrefurbishment of certain rented

residential accommodation. Both schemes have had very little uptake to date,

and Indecons view is that there is no market failure in these areas that would

justify the continuation of the tax reliefs.

1 In the case of the Urban Renewal Scheme, the requirement is that 15% of total project expenditure

must have been incurred by 30 June 2003.


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Box A: Indecon Report on Sectoral Property-based Tax Incentives:Summary of Scheme-Specific Conclusions and Recommendations

Tax Relief Conclusion and Recommendation

Hotels and HolidayCamps

Scheme has had a dramatic positive impact on the level of investment in the hotelsector and on the quality of hotel stock. Now a potential over-supply of hotel

accommodation. Discontinue subject to 5-year extension for pipeline projects only(see below).

Holiday Cottages Some potential benefits to this scheme; again over-supply is now an issue.Discontinue subject to extension.

Sports InjuryClinics

Little if any scheme take-up. Not justified by reference to any market failure.Discontinue immediately.

Third-levelEducationBuildings

Need for investment in this area is acknowledged as important for the Irish economy.However, tax incentives are very inefficient and costly and should be discontinued,subject to extension.

StudentAccommodation

Scheme has facilitated a significant expansion of high-quality student accommodation.Over-supply is now an issue. Rental market is buoyant in current economic conditions.Discontinue subject to extension.

Refurbishment ofCertain RentalAccommodation

Very little uptake or monitoring of scheme. Tax reliefs not effective or necessary toachieve policy objective: other policy interventions will be more appropriate.Discontinue immediately.

Multi-storey CarParks

No economic or transport policy case for subsidising multi-storey car parks, which tendto accelerate congestion in city areas. Discontinue subject to extension.

Park-and-RideFacilities

Park-and-ride facilities tend to reduce congestion by encouraging use of publictransport. Relief targeted specificallyon such facilities could be continued, but isrelatively unlikely to be effective in encouraging supply. Relief for associatedcommercial / residential developments is costly relative to benefits arising: this aspectshould be discontinued immediately.

Childcare facilities Positive effects from encouraging supply of childcare facilities. Continue relief subjectto some amendments (mainly: extension of clawback period)

Private hospitals Positive effects from encouraging supply of private beds. Continue relief subject tosome amendments (mainly: extension of clawback period)

Private nursinghomes

Similar conclusions as for private hospitals. Continue relief subject to someamendments (mainly: extension of clawback period)

Public Expenditurepriorities

Third levelbuildings

In view of economic benefits arising, high priority should be afforded to allocatingadditional public expenditure to investment in third-level buildings, as a more cost-efficient means of subsidising this sector.

Park-and-ride

facilities

Funds saved from ending the tax reliefs for park-and-ride facilities should be allocated

towards increased public expenditure in this area.

Extension of July2006 deadline

The July 2006 deadline for qualifying construction expenditure under certain schemesshould be extended by five years, but with relief available at 50% rate only (in the caseof individual-rate taxpayers)

7. It should be noted that the Exchequer costs arising in respect of both of theseschemes are very low, in line with the poor scheme take-up. Arguably

therefore, there is no Exchequer-based imperative for scrapping the reliefs for

the present. On the other hand, the general presumption underpinning the

review process should be that, unless there is a sound and persuasive policycase for retaining a tax relief, the relief scheme should be ended.


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8. While the discontinuation of the little-used relief for sports injury clinicsshould not give rise to any particular difficulties, it is possible that the ending

of therefurbishment relief for rented dwellings could be problematic. Recent

reports from the housing charity Threshold point to a continuing problem of

low-quality rented accommodation, and these reports are borne out by localauthority findings. Indecon argue, however, that the problems of sub-standard

accommodation are best tackled by other means principally by enforcement

of mandatory regulations by the housing authorities.

Schemes Recommended to be Continued

9. Indecon recommends that four of the tax incentive schemes under reviewshould be continued. Three of these schemes have no specified end-date at

present: these are the reliefs for investment in private hospitals, private

nursing homes and childcare facilities. Indecon argues that the tax reliefs

have had positive effects in encouraging the supply of facilities in these

sectors, and that the tax relief is justified on that basis. However, Indeconrecommend that the following amendments be introduced:-

for any new projects, the clawback period should be extended to 15 years(from 10 years at present)

non-owner-occupiers should be permitted to claim all of the capitalallowances in year one (rather than over seven years as at present), but the

relief should be restricted to 50% in such cases. This suggested

acceleration of capital allowances could, of course, have Exchequer cash

flow implications.

in the case of childcare facilities, no relief should be available for facilitieswhich secure grants under the EOCP programme.

The Indecon analysis of these three schemes is broadly supportive of

Government policy in these areas.

10. The fourth tax incentive scheme that is recommended to be continued therelief for investment in park-and-ride facilities is currently one of the

expiring schemes that is subject to the July 2006 construction deadline.

Indecon express the view that the relief is likely to have only a limited take-up

in many areas, as the capital costs (excluding site costs) of such facilities tend

to be low. A decision is therefore needed as to whether the relief for park-and-ride should be extended or should be allowed to expire.

Recommendations regarding Public Expenditure Policy

11. Indecon make recommendations regarding the desirability of allocatingadditional funds towards investment in third level education infrastructure

which they see as important for Irelands continued economic success and

for investment in park-and-ride facilities. As regards third-level buildings,

Indecon illustrate in their Report how direct Exchequer support for this area

would be more cost-effective than the existing tax relief. As regards park-and-

ride facilities, they recommend that the savings from discontinuing the relief

for associated developments (see para. 7(b) above) should be allocated

towards increased direct Exchequer support for this area.


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Extension to July 2006 Deadline

12. As regards the expiring schemes that are recommended to be discontinued,Indecon recommend that the July 2006 construction deadline should be

extended by five years in most cases (viz. reliefs for hotels, holiday cottages,

third-level buildings, student accommodation and multi-storey car parks).However, Indecon recommend that the level of capital allowances should in

such cases be restricted to 50% of total project expenditure so as to reduce the

Exchequer costs arising. The proposed extension is to apply only to existing,

pipeline projects in respect of which planning applications have already been

made before end-December 2004 no new projects would benefit from the

extension.

13. The multi-year extension is recommended by Indecon based on their analysisof the construction sector, and on the volume of projects that are still in the

pipeline. (Indecon estimate that capital expenditure of the order of 2 billion

should take place between January 2005 and July 2006 on the expiringschemes.) Their reasoning is that the current July 2006 deadline for

completion of projects will prompt a rush to complete projects, leading to

price pressure in the construction sector. Indecons analysis of the

construction sector outlook also indicates that a downturn in activity is in

prospect in any event in the coming years: they therefore see a risk that a

sudden end to activity post-July 2006 would contribute to the general decline,

or indeed could be seen as precipitating a sharper downturn in the sector.

14. Goodbodys are also recommending an extension to the July 2006 deadlinethat applies for the area-based renewal reliefs, for broadly similar reasons.

However, Goodbodys are recommending a different approach (i.e. a simple

18-month extension to the deadline, with capital allowances remaining

available at the full rate). The question of extending the July 2006 deadline is

considered in more detail at section D below.

Monitoring of Tax Costs disclosure of information by beneficiaries

15. As mentioned earlier, Indecon also put forward a number of GeneralRecommendations, applicable across all tax incentive schemes (see Box B

overleaf). The first such recommendation is that all such schemes should

require disclosure by investors / promoters of information that will be

necessary to facilitate the monitoring of the full cost and impacts of thescheme. The recommendation is intended to address what the consultants see

as a lack of data in relation to such matters, which hampers comprehensive

public policy analysis. The consultants are not specific about how such a

scheme should work: they seem to envisage that certification would be carried

out in the context of associated validation steps, necessary to claim the tax

relief, or if necessary through the use of a novel certification scheme.

16. In the course of the various reviews that have been conducted, it has becomeapparent that the lack of reliable, timely data on tax relief schemes has

impeded the assessment process. The recommendation that this shortcoming

be addressed is in line with views of the Department of Finance and the Officeof the Revenue Commissioners, and this issue should be addressed in the


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Box B: Indecon Report on Sectoral Property-based Tax Incentives:General Recommendations

(i) All tax incentives schemes should require full disclosures of key information to the Exchequer byinvestors/promoters via a certification scheme or other mechanism to enable the full cost and impactof the schemes to be monitored.

(ii) The decision to introduce any new tax incentives should be informed by a formal assessment of thelikely costs and benefits.

(iii) Where there is justification for government incentives the option of direct public expenditure as analternative to tax incentives should be considered.

(iv) Any tax incentive schemes which are introduced should have a defined lifespan of a maximum of 3years and extensions should only be considered after evaluation of the results of a formal cost-benefit appraisal.

(v) Developers/investors in any tax incentive scheme should be responsible for securing independent

certification that the conditions of the schemes have been met.

(vi) Restrictions on capital allowances which focus exclusively on shelters on rental income rather thanon personal income should be refocused.

(vii) Consideration should be given to introducing a cap on total annual allowances which can be claimedby individuals

(vii) Differential allowances in any tax incentive scheme should be introduced depending on whetherthese allowances are being claimed at corporate or personal tax rates.

design of future or continuing tax incentive schemes, having regard of courseto the costs to the taxpayer involved and the shape and nature of the schemes

themselves.

Time-limited reliefs subject to formal Cost-Benefit Assessment

17. Indecon recommend that any new tax incentive schemes should be introducedonly on the basis of a formal assessment in advance of the costs and benefits.

Furthermore, reliefs should only be introduced for a minimum of three years;

and should only be extended on the basis of a further positive cost-benefit

assessment.

18. While as much economic and cost analysis as is possible takes place undercurrent arrangements, no such formal cost-benefit assessment takes place at

present. The limited time for examination and analysis of proposed schemes

at budget time, and the need to rely upon incomplete data and guesstimates

in some cases, militates against this. Further examination of this

recommendation will require that we take into account:-

the relevance of a formal cost-benefit assessment to each proposed relief

the availability of appropriate data to undertake such a formal assessment

the practicability of a full cost-benefit assessment in all circumstancesgiven tight time deadlines.

The principle of conducting a full cost-benefit assessment is however difficult

to argue against.


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19. Indecons recommendation for a 3-year assessment period for all tax reliefsmay appear somewhat impractical. Schemes can often take two or three years

to become fully operational, and Revenue data might not generally be

available for a further year or two. Moreover, the Indecon recommendation

runs counter to Goodbodys finding that property-based schemes should be

introduced over sufficiently long periods to enable investors and developers toplan complex projects (see para. 30(f) below). Nonetheless, the purpose of the

recommendation to ensure that schemes giving rise to considerable

Exchequer cost should be regularly evaluated is clearly relevant.

Consider Public Expenditure Options as Alternative to Tax Incentives

20. Indecon note that the existence of a market failure justifying governmentincentivisation does not necessarily warrant tax reliefs in all cases: on their

analysis, public expenditure options can in some cases prove more efficient.

This general principle has long been acknowledged (similar points were made

in the Reports of the Commission on Taxation in the 1980s) and will continue

to be borne in mind in deciding on future policy measures.

Independent Certification re Scheme Conditions: Responsibility of beneficiaries

21. Indecon recommend that developers / investors should be required to secureindependent certification of compliance with the non-tax conditions associated

with some schemes (e.g. in relation to planning, health). They see this as

preferable to the existing onus on Revenue to make judgements in relation to

such matters. In general, there should be no difficulty in reflecting this

recommendation within the design of future tax schemes, having regard to the

nature and type of scheme concerned and to Revenue experience of avoidance

mechanisms.

Equity issue

22. Indecon consider that the design of the property-based schemes, with thealmost exclusive focus on sheltering rental income, has geared the reliefs

largely to high-income owners of multiple properties, and that this has

contributed to the inequity of the schemes. Indecon make some

recommendations for addressing the equity issue; this is dealt with in more

detail at section E below.

Differential Allowances for Corporate / Personal Rate Taxpayers

23. Finally, Indecon recommend that differential allowances be introduced for alltax incentive schemes, to reflect the different Exchequer costs associated withreliefs for corporate-rate taxpayers (i.e. those at the 12.5% rate, or 25% in

respect of investment income) and personal-rate taxpayers (i.e. those paying at

up to 42% rate). The issue of restricting allowances to personal-rate taxpayers

is also addressed at section E below.


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Box C: Goodbodys Report on Area-based Tax Incentives:Summary of Conclusions and Recommendations

Rural RenewalScheme (RRS)

RRS has delivered a substantial increase in housing output in participating areas.Much of the housing output has been taken up by existing residents. Relatively little

impact on commercial or industrial activity: wider economic benefits have been quitelimited. High levels of deadweight. RRS should be discontinued and is not a cost-effective model for future schemes aimed at rural regeneration.

Urban renewalScheme (URS)

URS has been successful in catalysing renewal and regeneration in targeted areas.Integrated Area Plans have facilitated the targeting of development in line with localneeds. URS has been less successful in delivering social and community benefits:much higher take-up by investors than by owner-occupiers. URS has served out itspurpose, with the market driving development at this stage and deadweight costs rising.

Town RenewalScheme (TRS)

Performance under the TRS has been patchy, with successful implementation andtake-up in some areas, and very little take-up in other areas. Poor progress attributableto lack of interest among site developers and owners, and greater focus on refurbish-ment rather than new build. Resources of local authorities were spread too thinly tomanage the TRS effectively: too many towns may have been designated. Wheresuccessfully implemented, the Scheme has had significant impact on addressing urbandereliction, but TRS has now served out its purpose.

Living-Over-the-Shop Scheme(LOTS)

LOTS has had low take-up, as the incentives available have not been sufficient toovercome lack of commerciality of development, or to overcome issues of investorapathy in some cases. However, the scheme is tightly focused on issues of urbanregeneration and should be continued, subject to sufficient Local Authority resourcesbeing committed in order to manage the scheme effectively.

Extension to July2006 deadline

The deadline for completion of projects under the Schemes should be extended by 18months to end-2007, mainly to ease pressure in the construction sector.

Equity issues Schemes (esp. URS) have had very negative equity effects. Capital allowances shouldbe available at a restricted level, and reliefs should be re-balanced in favour of owner-occupiers (rather than investors as at present).

Design of FutureSchemes

Tax incentivisation should be retained as a policy tool for addressing urbanregeneration, if necessary in the future. However, any future schemes shouldincorporate a number of structural changes to improve equity and effectiveness, and toreduce Exchequer cost.

C. Goodbody Review of Area-Based Tax Incentive Renewal Schemes

Study Terms of Reference

24. As indicated above, Goodbody Economic Consultants were retained in April2005 to undertake a detailed review of the area-based tax incentive schemes

viz. the Urban Renewal Scheme (URS), Rural Renewal Scheme (RRS), TownRenewal Scheme (TRS) and Living Over the Shop Schemes (LOTS). The

Study Terms of Reference are set out in Appendix 2. The main Conclusions

and Recommendations are summarised at Box C below.

25. In essence, Goodbodys conclude that the three main area-based renewalschemes as they stand (RRS, URS and TRS) should not be continued. While

the LOTS scheme has not been particularly effective, Goodbodys recommend

that it be continued subject to the commitment of sufficient administrative

resources by the local authorities.


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Extension of Deadline for Area-Based Schemes

26. The consultants recommend that the July 2006 deadline be extended byeighteen months until end-2007 for the RRS, URS and TRS. The reasons

adduced are similar to those raised by Indecon: the consultants envisage that

compliance with the July 2006 deadline will entail an upsurge in activity in the

construction sector, with upward pressure on construction prices. Goodbodysalso note that an extended time period would ease pressure in the planning

system, leading to better-quality decisions; and would be justified in terms of

basic fairness, since individuals should be given sufficient time to complete

projects in respect of which valid applications have been made. The issue of

extending the July 2006 deadline is dealt with separately at section D below.

Equity issue

27. In assessing the equity impact of the URS (which accounts for over 80% ofactivity under the area-based schemes), Goodbodys find it difficult to escape

the conclusion that the Scheme has had very negative equity impacts.

Goodbodys proposals for dealing with this issue are dealt with at section Ebelow.

Future Use of Tax Incentivisation

28. Goodbodys conclude that tax incentivisation, of the type used up to now inthe various area-based renewal schemes, is not a good model for rural

regeneration, but that it has proven effective in stimulating urban regeneration.

Accordingly, the consultants advise that the option of tax incentivisation

should be retained as a tool of urban renewal, and that appropriate schemes

should be considered in the light of future economic conditions.

29. However, Goodbodys recommend that any future schemes be targeted on asmall number of town and urban black spots, and that regard should be had to

the National Spatial Strategy and to the RAPID areas in assigning priorities.

In addition, the consultants recommend that the competitive nature of the

schemes be increased for example, by confining scheme status to areas that

produce the best plans in order to improve impacts, particularly on urban

design.

30. Goodbodys also recommend that any future tax-based renewal schemesshould incorporate a number of structural changes, principally to reduce

Exchequer cost and inequitable effects. The changes include:-(a)Targeting the schemes on areas where there is evidence of development

activity but where problem sites are being neglected

(b)Ensuring that adequate resources are applied to managing andadministering the schemes

(c) Incorporating structures to share experience and promote good practice

(d)Introducing measures to control abuse of the Schemes

(e)Ensuring that designated sites have a prospect of being serviced

(f) Establishing each Scheme for a sufficient period to allow developers torespond (a minimum period of five years is suggested)


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(g)Increasing the level of owner-occupation in the housing mix (see para.53(a) below)

(h)Improving the equity and cost-effectiveness of the schemes by allowingthe relief in relation to a proportion of expenditure only (see para. 53(b)

below).

D. Possible Extension of the July 2006 Construction Deadline

31. Both of the draft consultant reports call for an extension of the July 2006deadline for qualifying construction expenditure. The reasons adduced in both

cases are similar, centring on the need to ease short-term pressure on

construction prices. It should be added that a large volume of representations

have also been received in the Department of Finance, advocating an

extension to the July 2006 deadline for a range of reasons, such as unavoidable

hold-ups in the planning process, and health-and-safety concerns arising froma late rush to complete construction.

32. However, the models advocated by the consultants are different. Goodbodysare recommending a simple 18-month extension to end-December 2007

(subject to State Aid considerations, which are discussed below), with relief

otherwise unaffected. Indecon recommend a longer, five-year extension, but

with relief available at only a 50% rate (at least in the case of personal-rate

taxpayers) in respect of the entire project cost; while retaining the option of

completing projects by the existing July 2006 deadline with full relief.

Economic Considerations Significance of the Construction Sector33. In their Report, Indecon point out that the construction sector accounts for

19% of GDP and nearly 16% of employment, and note that a significant fall in

residential construction, which accounts for over half of the value of total

construction, is anticipated over the years ahead. Indecon express the view

that an immediate cessation of the property tax incentive schemes would

contribute to the decline in this sector. Indecon also note that the timing of

changes in these schemes will have important implications for inflationary

pressures in the construction sector.

34. Goodbodys in their report point out that the residential, commercial and

industrial parts of the construction sector (i.e. the parts affected by theproperty-based tax schemes) accounted for 14% of GDP in 2004, up from 8%

in 1995 and 11% in 1999. Goodbodys note that the strong performance of the

construction industry over the past five years, coupled with the increased

availability of capital, raise the question of whether there is a need for

continued intervention in the market through tax incentivisation. Equally

however, Goodbodys note that a significant peaking of building activity, as

developers seek to complete projects by the July 2006 deadline, will give rise

to upward pressure on building costs and prices.

Goodbodys Extension Model

35. At first sight, the Goodbody model for extension is the more straightforward:the extra 18 months should be sufficient to allay short-term pressures in the


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construction sector, and no new complications are introduced into the scheme.

The extension is also not too long to facilitate speculative projects, i.e.

projects for which planning was submitted before the December 2004

application deadline, but which had no real prospect of being completed (or

possibly even initiated) before the July 2006 construction deadline. The

drawback is that the volume of pipeline projects is quite considerable, andthe 18-month extension period could therefore involve a significant exposure

in terms of additional Exchequer cost.

Indecons Extension Model

36. Indecon have explained the reasoning behind their longer extension period byreference to three factors:-

The 50% relief would entail a significant Exchequer saving relative to theexisting provisions. The significantly longer timeframe is necessary to

attract a greater proportion of developers to opt for the 50% relief, rather

than try to rush projects to avail of the existing full relief. The extended timeframe would help to sustain construction activity over

the medium term, with wider economic benefits.

The extended timeframe would facilitate the delivery of scheme outputs(e.g. new hotels) over a multi-annual period, rather than all at once.

37. The essential policy choice to be made is whether projects should beobliged to incur as much project expenditure as possible before end-July

2006, or should be facilitated in phasing the expenditure over a longer

period even if that involves a larger potential Exchequer exposure. The

Exchequer implications are assessed at section E below.

State Aid considerations

38. Many of the schemes that are subject to the July 2006 deadline come withinthe scope of the EU State Aid rules, which are aimed at preventing undue

distortions to the EUs internal market. Any changes to the existing scheme

parameters such as the July 2006 construction deadline would need to be

cleared with the European Commission.

39. The URS, TRS and RRS (apart from their residential accommodationelements) come within the scope of the Regional Aid Guidelines. The

deadlines for these schemes have already been extended on three occasions,with end-dates of 31 December 2002 and 31 December 2004 previously

specified. The most recent extension to July 2006 (introduced in Budget

2004) was cleared with the Commission on the grounds of facilitating an

orderly winding-down of the schemes. (However, the rush to make planning

applications in December 2004 suggests a large proportion of speculative

projects, which would potentially stand to benefit from any further scheme

extension.)

40. As regards the sectoral property-based schemes (which have been reviewed byIndecon), only the scheme of capital allowances for investment in hotels and

holiday camps gives rise to State Aid issues. Following protracted


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consultations with the Commission, the relief for hotels was approved as

compatible with State Aid rules under the Regional Aid Guidelines.

41. The EU clearance for the above-mentioned schemes is in the context of theexisting Regional Aid Guidelines, and the associated Regional Aid Map for

Ireland, which are applicable for the period 1999-2006. During this period,the Border-Midlands-West (BMW) region is eligible to receive the maximum

level of regional aid (i.e. it qualifies as an A-region) while the South-and-

East (SE) region, which covers the rest of Ireland, is eligible to receive aid of a

lower intensity (i.e. it qualifies as a C-region).

42. Under the draft Regional Aid Guidelines for the period 2007-2013, which aredue to be finalised in coming weeks, the Commission makes clear that all

existing forms of regional aid are to be discontinued by the end of 2006.

Moreover, the Commission indicates that approval for regional aid schemes

post-2006 will only normally be considered when the new regional aid maps

have been settled these maps probably will not be finalised until March of2006 at the earliest.

43. As regards the period from 2007-2013, the BMW region will automaticallyqualify as a C-region for regional aid purposes. We understand there will

also be a safety net provision, whereby not more than 50% of the population

can lose its entitlement to benefit from regional aid. Since the BMW region

accounts for about 24% of the population, there should therefore be scope for

designating additional parts of the country, covering another 26% of the

population, to qualify as C-regions.

44. What all of this means is that it will not be straightforward to secure EUapproval for an extension of the July 2006 deadlines beyond end-2006 for the

URS, TRS, RRS and hotel relief. The Commission might view the extension

as encroaching into the new 2007-2013 regional aid round, in respect of which

no decisions are anticipated before the regional aid map is agreed early in

2006; and the extension of the schemes most of which apply countrywide

might be inconsistent with the more selective approach required under the new

regional aid map.

Other Models for Scheme Extension

45. If the State Aid issues prove too difficult, there are still other options forextending the July 2006 construction deadline. The most obvious option is ashorter extension of the July 2006 deadline to end-December 2006, i.e. to the

expiry of the existing Regional Aid Guidelines2. However, this approach

would have only minimal impact on easing pressure in the construction sector,

and would not ensure that adverse economic consequences are averted.

46. A second option is to extend the residential accommodation element of theexisting schemes to end-December 2007, while extending the non-residential

2 Any change to the existing deadline for the non-residential elements would still require notification to

Brussels; but it is not envisaged that there would be any difficulties in securing approval for anextension to end-2006, which is still within the scope of the existing 1999-2006 Regional Aid

Guidelines.


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elements (which are subject to State Aid considerations) to end-December

2006 only. The residential elements of the various schemes account for over

50% of construction activity in the various schemes: therefore this hybrid

approach could facilitate a significant volume of construction activity over the

course of 2006 and 2007, thereby easing short-term pressure within the sector,

without encroaching into the new Regional Aid period. Indeed, there is aprecedent for such a hybrid approach: the Finance Act 1999 extended the

end-December 1998 deadline that applied under the 1994 URS, but only for

residential schemes.

47. The main drawback with such a hybrid approach is that some developersmay experience difficulties in disaggregating the residential from non-

residential scheme elements of a combined project, for the purpose of

attributing costs. There could also be related administrative difficulties for

Revenue in operating the relief. However, such difficulties are unlikely to be

insurmountable, and this approach may allow some smoothing of construction

sector demand while averting state aid issues.

E. Equity Considerations

48. As indicated above, both sets of consultants conclude that the property-basedtax incentive schemes have had adverse equity effects. Goodbodys and

Indecon have put forward different, but not incompatible, proposals for

addressing the equity issue.

Indecons Proposals to Promote Equity

49. Indecon note that the design of the tax incentive schemes, whereby thebenefits of the capital allowances are largely confined to sheltering rental

income, has restricted the tax benefits to high-income individuals with

multiple rental properties, contrary to the requirements of equity. To address

this, Indecon propose that capital allowances be available for offset against

income generally not just rental income.

50. Moreover, by widening the available pool of investors, Indecon argue that thetax reliefs could be made available at a lower Exchequer cost. Accordingly,

Indecon recommend that capital allowances for individual-rate taxpayers be

available at a 50% rate, rather than 100% as at present.

51. Finally, Indecon recommend imposing a cap on the total level of allowancesclaimable by individuals. Indecon do not propose a figure for the cap, but they

indicate that the cap should not be so low as to adversely affect scheme

uptake.

Goodbodys Proposals to Promote Equity

52. Goodbodys conclude that the urban-based renewal schemes have hadsignificantly adverse equity impacts. Goodbodys note that tax-incentivised

apartments recorded a premium of between 55,000 and 70,000 according to

a 2004 survey by the IAVI; and that over 90% of residential units under theURS were sold to investors (with multiple purchase being commonplace) and


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rented out. The consultants find that the tax benefits under the URS accrued

to a relatively small number of individuals: including landowners and

developers, property investors, and (in the case of the non-residential

properties) corporate investors. However, Goodbodys note that the

concentration of benefits among landowners is an inevitable result of the

selective nature of tax designations (especially under the URS) and can hardlybe avoided.

53. Goodbodys put forward two proposals for addressing the equity issue, in thecontext of any future schemes of this nature:-

a) A re-balancing of tax incentives in favour of owner-occupiers, and awayfrom investors. This could be achieved by granting 100% relief to owner-

occupiers (rather than 50% relief as at present) over ten years, and by

restricting the investor relief to 50% (rather than 100% as at present). It is

also recommended that a minimum owner-occupation/investor mix be

stipulated for tax-incentivised residential developments.b) Reducing allowable expenditure to a proportion of that incurred. At

present, relief is calculated based on the full cost of construction or

refurbishment. Reducing the proportion of allowable expenditure would

be administratively simple and flexible, allowing for a graduated incentive

response based on different economic conditions.

54. In this context, Goodbodys also looked at the option of standard-rating the taxreliefs, as a way of reducing the scale of incentive available to marginal-rate

taxpayers. While this option has attractions in terms of equity and consistency

with other general tax reliefs, considerations of administrative ease and

flexibility led them to favour the alternative approach (b) above.

55. The equity issue, and the various proposals for addressing the matter, will beconsidered in more detail in the context of a separate TSG paper on the tax

treatment of high earners.

F. Exchequer Cost considerations

56. Indecon estimate that total expenditure to end-July 2007 under the sectoral tax

relief schemes will amount to 4.42bn, with gross tax costs of 1.49bn

3

.Goodbodys estimate total investment under the four area-based schemes of

5.46bn to end-July 2007, with associated gross tax costs of 1.8bn. In total

therefore, overall expenditure under the property-based schemes is estimated

to come to 9.88bn, with associated gross tax costs of 3.28bn (or 33.2% of

investment costs). Some 6bn of the overall scheme expenditure (or 61% of

the total) is attributable to pipeline projects, i.e. projects due to be completed

in 2005 and 2006, with associated tax costs of approx. 2bn.

3

Indecon estimate a net tax figure, i.e. after taking account of extra economic activity and associatedtax revenues, of the order of 1bn. Both Indecon and Goodbodys express the gross tax costs in NPV

terms, reflecting the fact that the capital allowances are claimable over several years.


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Estimates of Pipeline Expenditure

57. The calculations above are based upon the consultants estimates for (i) thescale of projects still in the pipeline, and (ii) the proportion of these pipeline

projects that are likely to be completed (or partially completed) by the end-

July 2006 deadline. It must be noted that both of these elements are subject to

uncertainty particularly the latter, which involves some subjectiveassumptions.

58. For example, Indecons estimate of pipeline expenditure on hotels (thelargest of the sectoral tax schemes) is based on an assumption that 37% of all

projects, which have applied for planning, will in fact proceed to completion

by end-July 2006; while for holiday cottages, the proportion used is 66%.

However, the estimate for pipeline investment in student accommodation is an

upper limit, based on the assumption that all qualifying projects will proceed.

Likewise, the estimates for future investment in private hospitals and in

childcare facilities which have no specified end-dates are based on the

assumption that all projects currently on hands will be implemented.

59. Goodbodys calculations in respect of the RRS are based on the assumptionthat 75% of the increase in planning applications in 2004 (over 2003) will

proceed. For the URS, the assumption was made that 75% of projects in

planning would be completed. For the TRS, a 50% completion rate was

assumed.

Exchequer Costs of Scheme Extension Options

60. To the extent that the assumptions used by the consultants are accurate, theyrepresent a baseline against which the Exchequer impact of various options

can be assessed. However, it needs to be borne in kind in this context that the

baseline is itself subject to some uncertainty for the reasons outlined above.

61. As regards the main policy option of extending the July 2006 constructiondeadline that applies for most of the property-based tax incentive schemes,

additional Exchequer implications would potentially arise under three

headings:-

Additional project cost: the cost arising in respect of projects which wouldnot have been initiated under the existing arrangements, but which would

be activated under the extended arrangements.

Extended project cost: the proportion of the cost of existing pipelineprojects that would have arisen post-July 2006, and that would now come

within the scope of the extended deadline. Arguably, extended project

cost is not as objectionable as additional project cost, insofar as it reflects

the cost of facilitating existing projects in overcoming unexpected delays.

Reduced relief saving: the saving arising from allowing relief at a lowerrate than would have applied under the existing arrangements (this would

only arise under the Indecon approach).

In addition, there would be Exchequer cash-flow consequences (short-term

savings offset by longer-term liabilities) arising from decisions to phase

project expenditure over a longer time period.


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62. Given the range of variables and the uncertainty attaching to each variable, itis difficult to assess the Exchequer costs associated with the different

extension options in any meaningful or robust manner. However, the

following very tentative costings can be put forward:

Under the Goodbody approach, total extra tax costs (in net-present-valueterms) may be of the order of 200m, of which 100m is due to additional

projects and 100m due to extendedprojects. This is broadly equivalent to

an annual Exchequer cost of approximately 60m-80m p.a. over a multi-

annual period (starting from 2006-2007, with the bulk of capital

allowances assumed to be claimable over a four-year period).

Under the Indecon approach, total extra tax costs (in net-present-valueterms) may be of the order of 50m, with additional project costs of

125m being offset by savings on existing pipeline projects. This is

equivalent to an annual Exchequer cost of approximately 15m-20m p.a.

over a multi-annual period.

63. It must be emphasised that the above costings are tentative and are sensitive toassumptions used. It should also be noted that the lower Exchequer cost of the

Indecon approach should be balanced against its assumed lack of efficacy in

inducing developers to deliver pipeline projects over a longer time-period.

G. Conclusion

64. The TSG may wish to discuss the consultants findings and give its initialviews on their recommendations at this stage.


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Appendix 1

Indecon Study Terms of Reference

The study should examine each of the schemes and assess the extent to which theschemes have justified their introduction and broadly assess the contribution that each

relief has made and can make to the wider policy objectives of the sector in which the

relief applies. The study should establish and assess the costs and benefits of each

scheme through a formal cost/benefit analysis having regard to guidelines issued by

the Department of Finance on this issue. Additionally, for each scheme at least one

case study should be undertaken to assess the benefits or otherwise of the tax

incentive approach as compared with alternative public expenditure which could have

been used to achieve the same objectives. These case studies should include models

of financing structures commonly used to facilitate investment in the schemes. The

study should also examine the potential impact on the effectiveness of the schemes if

additional restrictions had applied that limited the extent to which high income

individuals could use these reliefs to reduce their tax liability.

While a number of the schemes have no end date, others are scheduled to terminate on

31 July 2006. In that context, the study should also identify what elements/changes/

improvements should be considered to the ongoing schemes and, should it arise, in

any new tax based incentive schemes targeted at specific objectives, bearing in mind

changes in economic and other circumstances, the need to ensure effectiveness and

value for money and the balance within the tax system. EU State aid policy should

also be considered in this respect where necessary.

Factors to be considered in assessing the schemes include:

the level and type of investment generated;

the cost to the Exchequer of the tax incentives and gross and net impact onExchequer revenues;

the level of private finance leveraged under the scheme;

the extent of deadweight costs incurred and any displacement effects;

employment and other economic effects both temporary and sustainable;

the beneficiary profile - investor or owner/occupier.

Scheme Specific AnalysisThe study should also include the following analysis when reviewing the individual

schemes:

In relation to the schemes for hotels and holiday cottages:

the effect of the scheme in addressing regional and national tourismobjectives including its contribution to increasing the quantity and

improving the quality of Irish tourism accommodation;


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In relation to the scheme of relief for third-level student accommodation:

the contribution that the scheme has made to an increase in the supply ofresidential accommodation for third-level students and any consequent

effects on the wider housing market.

In relation to the scheme of relief for private hospitals, sports injury clinics andnursing homes:

the contribution that the scheme has made to an increase in the supply andcost of hospital beds and nursing homes accommodation.

In relation to the scheme of capital allowances for investment in Third Level

Buildings:

the impact that the scheme has had in attracting private sector investmentfor third level facilities.

In relation to the scheme of capital allowances for childcare facilities:

the contribution that the scheme has made to an increase in the supply ofchildcare places and effect on cost.

In relation to the scheme of relief for park and ride facilities:

the contribution that the scheme has made to the alleviation of trafficcongestion in the areas concerned.

In relation to capital allowances for investment in Multi Storey Car Parks:

the contribution the scheme has made to the provision of car parkingfacilities in the areas concerned.

In relation to capital allowances for investment in Countryside Refurbishment

Scheme:

the effect of the scheme has had improving the quality of rented residentialproperties and its impact on the stock of such properties and the effect on

the wider housing market.


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Appendix 2

Goodbody Economic Consultants Terms of Reference

The study should evaluate both the residential and commercial/industrial incentives asrelevant under the schemes in the following broad socio-economic and fiscal context:

The study should examine each of the schemes and assess the extent to which the

schemes have justified their introduction. The study must also evaluate the success of

each scheme in furthering the economic development and regeneration of the

designated areas. For each scheme, case studies should be undertaken to assess the

effect of the schemes. More particularly, the study should establish and assess the

costs and benefits of each scheme through a formal cost/benefit analysis having

regard to guidelines issued by the Department of Finance on this issue. The study

should include an assessment of the benefits or otherwise of the tax incentive

approach as compared with alternative public expenditure which could have been

used to achieve the same objectives. Deadweight and displacement should also be

assessed and quantified where possible. Successful and unsuccessful aspects of the

schemes should be identified and reviewed. The study should also examine the

potential impact on the effectiveness of the schemes if additional restrictions had

applied that limited the extent to which high income individuals could use these

reliefs to reduce their tax liability.

Assessment of the commercial and industrial elements of the Urban, Town and Rural

Renewal schemes should reflect the position that these incentives represent State aid

and as such are subject to the appropriate EU rules.

The study should also identify what elements/changes/improvements would be useful

in designing area-based incentive schemes, bearing in mind changes in economic and

other circumstances, the need to ensure effectiveness and value for money, the

balance within the tax system and evolving EU State aids policy.

Factors to be considered when reviewing the schemes should include:

the level and type of investment generated;

the cost to the Exchequer of the tax incentives and the gross and net impact

on Exchequer revenues; the level of private finance leveraged under the scheme;

the contribution of the schemes to regional development including:o the contribution to economic regeneration in the regions - whether

such is temporary or continuous;

o the effect of the schemes on the economic and social infrastructureof the areas designated

o the effects of designation on local employment and the consequenteffects on the local community;

o in relation to the Rural scheme in particular, the success of thescheme in halting rural population decline in the areas designated

and a general migration to urban centres within and beyond thedesignated areas;


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o the success of the scheme in terms of physical and sustainablesocial revitalisation of the areas designated;

o the success of the scheme in improving areas of dereliction anddecline;

the impact that the schemes have had on the housing market, as well as the

construction industry, and their interaction with other policy objectives inthis regard;

the beneficiary profile - investor or owner/occupier;

the contribution, if any, to combating poverty within the designated areas;

the scale, quality and appropriateness of the developments being achieved.

Documents

Indecon report on tax breaks (2005)