On July 28 last, the Government was dealt a serious body blow when the European authorities rejected its plan to keep Irish Water off the State's balance sheets.

For 12 months, the Coalition had pinned its hopes on the much-maligned super-quango remaining off the books, in order to allow it borrow without affecting the national debt.

Today, the Irish Independent reveals the chaos behind the major climbdown by the Government on water charges, how the Department of Finance was forced into a major U-turn and how desperate the attempts were to pass the test.

Documents from the Department of Finance, the Department of the Environment, the Central Statistics Office and Irish Water, obtained under the Freedom of Information Act, reveal just how the Government's plan blew up in their face.

Last November, there was a major clash between the Department of Finance and the CSO in relation to the capping of charges, just days before Environment Minister Alan Kelly announced the new revised charging structure on November 17 last. "Capping is a big problem for the CSO. Nine months as per regulator is a strong maybe, going beyond that is difficult. To 2018 would appear to be impossible," wrote senior Finance official John Palmer to his Secretary General Derek Moran.

"Hard to see solution that meets political needs and keeps Irish Water out of General Government Balance," Palmer wrote.

Moran responded sharply: "This seems counter-intuitive. If the charges are economically significant, make up more than 50pc of Irish Water's income, then I find it difficult to see the problem of duration. Surely it is simply de facto commercial!," Mr Moran wrote.

The next day, Moran again wrote to his key officials and resisted any thought of including Irish Water on balance sheet.

"There are some people that want us to pre-fund 2016 capital expenditure in 2014 as a hedge against Irish Water coming on balance sheet. To be clear I am not in favour on the basis that: these are not matured liabilities, we will be signing the cheque and finally it undermines the core 'commerciality' narrative," he said.

But later on there was an acknowledgement within Mr Noonan's department that passing the test was at best touch and go.

Paul Bolger, Michael Noonan's special adviser, sent out a memo for Cabinet to other officials which said: "Compliance with the key Market Test is finely balanced and there is a real risk that Irish Water could fail the test."

For months, Finance Minister Michael Noonan's officials had maintained the need for Irish Water to remain off balance sheet.

In July 2014, Eamon Phelan, from the Department of Finance, emailed his colleagues in his department and the Department of the Environment, setting out the importance of the Government strategy of Irish Water being "off balance sheet".

"A significant component of the strategy to establish Irish Water is that it be classified as a Market Corporation under Eurostat rules, and as a result, will not be included in the calculation of the General Government Balance (GGB)," he wrote.

In September 2014, Paul Bolger spelt out the dangers if Irish Water was to fail the market test.

"It would increase the deficit by approximately €550m in 2014 and 2015 and by up to €500m in 2016. If the [water] charges were deferred, this would obviously have to be made up and would add another circa €300m to the deficit," he wrote in a secret email to Enda Kenny's economic adviser Andrew McDowell, Tanaiste Joan Burton's adviser Paul O'Brien and others.

"Take your pick of income tax increases but it's like 3 to 4 points on higher rate or across the board on USC or nearly a doubling of property tax," Mr Bolger added.

As the post-Budget furore over Irish Water erupted, Finance official Nico Petris explained to the NTMA how precarious the Government's strategy on Irish Water was.

"We are already pushing the envelope and putting a lot of money via subvention in order to keep water bills down," Mr Petris wrote.

Four days later, John Palmer sent a warning to Derek Moran and Ann Nolan, another top-level official in the department.

"The big risk is that the linkage of the €100 compliance payment to, as the name suggests, compliance is going to make it difficult to justify to Eurostat that it is a separate payment. If they consider it to be a subvention to IW, then the market test will be failed," he wrote.

The day after Mr Palmer's warning, Maria Graham, an official in the Department of the Environment wrote to senior colleagues as to the latest state of play.

At this stage, she said there was a strong belief still that Irish Water would pass the Eurostat market test but warned of the danger of failing a separate "equity test".

She also said they would seek to "back-solve" the limits to which they could push the capping of charges while remaining off balance sheet.

In a briefing note sent to Derek Moran on October 23, the officials still hoped Irish Water would be cleared by Eurostat. But then a few days later, officials had concluded that capping the charges at the previously higher level of €278, the numbers weren't working and that Irish Water was bound to fail. Official Niall Feerick wrote to colleagues: "Basically the cost of capping the charge at €278 will cost more than expected and will see us fail the market test. This is before the 'compliance credit' is even considered."

After several different models were considered, the officials looked at waiving commercial rates for Irish Water. "Environment would look at feasibility of Irish Water not paying commercial rates (€59m). This would most likely lead to State Aid issues and as such this is most likely not a runner…Secondly, we have more or less accepted that we fail the equity test," Feerick wrote to his superiors.

Irish Independent