When CarVal successfully bid for a slice of Irish farm loans in 2019, the US vulture fund decided to try something new.

The portfolio was part of a debt pile originated by the old Agriculture Credit Corporation (ACC) and taken over by Rabobank, which disposed of it after the financial crisis. The Dutch lender sold the lot, dubbed Project Omni, for €800 million as it exited Ireland. Goldman Sachs and Cabot Financial bought some mortgages and unsecured loans, leaving CarVal to pay €159 million for “secured agricultural loans” which were – and remain – “classified as past due but not impaired”.

As it had done on many occasions before, CarVal set up an Irish special-purpose vehicle, Otterham Property Finance DAC, to own the farmers’ debt and have it service by Pepper Finance. And, as previously reported, the vulture fund applied the usual leverage, funding the transaction with just €52 million of its own investors’ money while Otterham Property Finance cheaply borrowed €108 million from Credit Suisse at a 3.3 per cent interest rate.

New financial information from CarVal subsidiaries in Ireland and Luxembourg, however, shows that the rest of the deal was organised in a new way compared to its first wave of non-performing loans acquisitions between 2013 and 2015. In the meantime, legislation had changed at the end of 2016 to restrict the tax neutrality of so-called Section 110 companies when they generate gains from Irish property.

Unlike previous CarVal SPVs holding Irish mortgages, Otterham Property Finance is not directly owned by the vulture fund. The Dublin office of the corporate secretarial services firm Intertrust formally owns its shares, making the SPV an “orphan” company in the eyes of the Irish tax code – though it declares CarVal Investors as its ultimate controlling party.

Through fund units in the Cayman Islands and a holding company in Luxembourg, CarVal does, however, own another Irish vehicle, Otterham Property Finance Holdings DAC. This is the company that funnelled €52 million in CarVal-funded profit-participating notes (PPNs) to its sister for the purchase of the farm loans.

The two SPVs have just filed accounts for 2020, their first full year of operation. Irish farmers are notoriously reliable in repaying their debts and Otterham Property Finance collected €31.6 million from them that year, as they racked up €30 million in fresh interest. As a result, the remaining book value of the farm loans was barely dented by this cash influx, standing at €154.3 million at the end of 2020.

Otterham Property Finance, which has no employees, did three things with this cash in 2020:

  • It repaid €20.6 million to Credit Suisse, including  €3 million in interest incurred;
  • It paid €2.4 million in asset management fees and €2 million in professional fees to undisclosed parties, which include Pepper Finance and probably CarVal offices overseas;
  • It repaid €4.2 million to Otterham Property Finance Holdings, covering less than half of the €8.9 million profit-participating interest declared in favour of its sister lending company that year. 

The interests and fees form the bulk of Otterham Property Finance’s current expenses for 2020, leaving it with a pre-tax profit of €13.6 million. Yet the company paid just €313 in corporation tax. This can be explained in two ways: 

  • The company deferred its entire €3.4 million Revenue bill for 2020, which indicates that it hopes to even it out with taxable losses in the following years;
  • The €8.9 million it incurred in profit-participating interest, despite being derived from Irish property, was tax-deductible because Otterham Property Finance ticks various boxes under Section 110 of the tax code, such as being an orphan company and remitting these gains to another Irish company (Otterham Property Finance Holdings).

So, what does this second SPV say? Otterham Property Finance Holdings used a different intercompany debt format to refinance itself with its Luxembourg parent, Omni Investment SARL, at the time of the 2019 deal. Some €5.7 million came from Luxembourg as a profit-participating note, and €51 million as a fixed-rate note charging 9.408 per cent interest.

Otterham Property Finance Holdings’s only revenue in 2020 was the €8.9 million in profit-participating interest declared by its sister. In turn, it booked interest expense of €4.6 million on the fixed-rate note and €2.4 million on the profit-participating note, totalling €7 million in favour of CarVal’s Luxembourg holding company.

Otterham Property Finance Holdings also holds a derivative contract with an undisclosed counterparty, which protects its balance sheet against swings in the value of the farm loans. This cost the company €1.5 million in 2019, then offset by a gain of the same amount in 2020.

This left Otterham Property Finance Holdings with a pre-tax profit of €3.4 million in 2020. Accounts show that it paid €2 million in corporation tax, mostly as a result of the €1.9 million effect of “expenses not deductible in current year”. 

These expenses are not detailed, but the figure indicates that the structure has not allowed CarVal to reap the full benefit of Section 110 eligibility. By making most of its investment as a fixed-rate loan at over 9.4 per cent, suggesting the minimum return it expects from the farm portfolio, the vulture fund might have hoped to restrict its Irish tax liability to the smaller profit-participating facility extended to mop up any gains above and beyond this.

The large tax bill arising from non-deductible expenses shows that, for reasons not detailed, this did not fully happen in 2020. The structure remained attractive that year, however, with the frontline SPV Otterham Property Finance booking gains of €22.5 million across pre-tax profit and profit-participating interest, and the two SPVs reporting a total tax charge of just over €2 million – an effective corporation tax rate of 9.1 per cent.

This does not include any fees CarVal might have paid itself above the bottom line.

In Luxembourg, Omni Investment Holdings in turn reports full deductibility for the interest it pays on the profit-participating debt it owes to CarVal funds in the Cayman Islands, leaving just over €4,000 in tax to pay after its first few months of operation in 2019.

As reported earlier this month, this was not the only attempt by CarVal to maintain Section 110 tax advantages on Irish distressed debt portfolios after the 2016 reform. A few months after its farm loans deal with Rabobank, the vulture fund set up a similar structure to acquire over 3,000 residential mortgages from Ulster Bank and securitise their value out to the bond market. In that case, early indications are that it was more successful in keeping gains out of Revenue’s reach.It will take several more years to confirm how each structure performed, as any potential deferred tax payments and the full gains made on discounted Irish debt purchases trickle into profit-participating interest paid to overseas parents. The Currency will be watching.