An Interest Rate Cap (“IRC”) involves an agreement where one person (the IRC provider) agrees to compensate another (the borrower) if the interest rate on a variable loan goes above an agreed rate. In return for this agreement the borrower pays a fee to the IRC provider. An IRC can be effected as part of the loan agreement or by separate agreement.
The Revenue Commissioners have reconfirmed in a recent briefing that they will treat a payment made by a borrower for an IRC as part of an interest expense relating to a loan. Where the interest on the relevant loan is allowed as a deduction in calculating trading or rental income, the payment by a borrower for an IRC will also be allowed as a deduction.
In the recent Finance Act, a 75% cap was imposed on the amount of interest that could be deducted from rental income where the interest accrues after 7 April 2009 in respect of residential premises. Revenue have confirmed that this restriction also applies to a payment for an IRC in such circumstances.
Revenue have clarified how they tax any compensation payment made by the IRC provider to the borrower where the interest rate goes above the limit agreed in the IRC agreement. In Revenue’s view such a payment is not necessarily a payment of rent or a payment in the nature of rent and therefore is not automatically taxed as rental income. However, Revenue confirm that if the costs incurred in paying the fee for the IRC are allowable against the rental profits of the borrower, then any payment received by the borrower from the IRC provider may in practice be taken into account in computing the rental income of the borrower.
Revenue have also confirmed that once-off payments for an IRC should be spread over the term of the loan in accordance with normal accounting practice. Where the period of an IRC agreement is shorter than the loan period, the once off payment should instead be spread over the IRC period.
For example: Mr X carries on a trade. For the purposes of his trade he takes out a variable loan with Bank A. A third party agrees with Mr X that if the interest rate on the loan goes over 4.5% the third party will compensate Mr X for the additional interest Mr X has to pay to Bank A. Mr X pays the third party €20,000 for this agreement.
The €20,000 paid by Mr X to the third party would be allowed as a deduction over the period of the IRC agreement against the trading income of Mr X provided the interest paid by Mr X to Bank A would be allowed as a deduction against his rental income.
Where the interest rate goes above 4.5% and the third party has to compensate Mr X, the payment made by the third party to Mr X would be subject to income tax and be deemed to be trading income earned by Mr B.
