Innovative scheme cut tax bills of the rich, writes Cliff Taylor, Economics Editor

Property investment - and the allowances associated with it - have been the main vehicle used by the rich to reduce their tax bills in recent years, as highlighted by the closing of a major loophole this week.

For many years, tax advisers have been directing wealthy clients to a range of investments offering significant tax benefits. Many investors were using schemes in much the way the tax relief had been intended. However, in some cases the reliefs were used in ways never foreseen by legislators.

In the cat-and-mouse world of tax "shelters", the Revenue and the Minister for Finance have moved to close off successive reliefs in recent years, only to see new ones emerge.

The amounts of money involved are significant. A recently-published survey by the Revenue Commissioners showed that almost one in five of the top 400 earners had an effective tax rate of 15 per cent or less in the 1999-2000 tax year and - incredibly - 29 of these individuals avoided paying tax altogether. Property-related allowances were by far the dominant method used to achieve these low tax bills.

Many of these schemes were effectively closed off in 1998 by a capping of the amount that property investors could claim in allowances. From that date, only about €32,000 of property-related allowances could be written off against income, except against income coming from property rental.

However, the scheme closed off by Mr McCreevy this week found a way around this cap. Under certain conditions, it has emerged, a group of up to 13 property investors could purchase a building from a company and take over the capital allowances associated with that building. Provided the deal was structured in a particular way, the investors could use the tax allowances not only to reduce the tax paid on their rental income, but could also use them to reduce the amount of income from their business or profession liable to tax.

The investors could deduct the allowance from their taxable income and thus cut their tax and PRSI bills. The cost to the Exchequer was thus about 47 per cent of the original allowance ( the 42 per cent income tax rate plus the 5 per cent PRSI rate).

In the case of the AIB building in the IFSC, currently on the market, the associated capital allowances were €55 million. The potential tax benefit to the investors was thus almost €26 million.

For example, by investing in the scheme, a consortium of a dozen investors with annual incomes of somewhere over €300,000 would have been able to pay pretty much no tax at all for the next 12 years of so. Wealthier investors would have received a substantial reduction in their bills. In turn, this would have encouraged investors to pay a nice price for the building.

Following Mr McCreevy's action, where allowances are transferred in this way in future, investors will only be able to use them against the rental income of the property they were buying.