Monday, June 03, 2019

Minimum corporate tax rate to imperil Ireland's FDI model

For decades Ireland felt assured that it would maintain the tax advantage that was first provided in 1956 to lure mainly American foreign direct investment (FDI) to Ireland. On Friday (May 31) in Paris 129 member countries of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) adopted a Programme of Work laying out a process for reaching a new global agreement for taxing multinational enterprises.

Next week the secretary-general of the Organisation for Economic Cooperation and Development (OECD) will present the plan to Group of 20 (G20) economies who are expected to agree to set international rules specifying a minimum for their effective corporate tax rates, at the G20 finance ministers and central bank governors’ meeting to be held in Fukuoka, Japan on June 8-9. The plan is expected to be approved in the coming 12 months at a summit of the leaders of the world's 19 biggest advanced and emerging economies + the EU.

In a paper last year, 3 European economists estimated that "foreign firms are an order of magnitude more profitable than local firms in tax havens, but less profitable than local firms in other countries. Leveraging this differential profitability, we estimate that close to 40% of multinational profits are shifted to tax havens globally each year"; IMF economists in 2016 estimated losses of $400bn for OECD (mainly rich) economies and $200bn for lower income economies. 

The OECD said the Programme of Work will focus on two main pillars. 1) The first pillar is on potential solutions for determining where tax should be paid and on what basis ("nexus"), as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located ("profit allocation") 

Nexus: Companies now pay tax in jurisdictions where they have a physical presence called a "permanent establishment." This is going to change.

Facebook for example books about 50% of its global revenues in Ireland and it pays little foreign tax as it has few physical presences outside the US. Apple uses commissionaire structures in markets across Europe where ownership of products would be retained by Apple subsidiaries and the sale wouldn't be typically booked in the country of sale but by an Irish unit.

While the first pillar mainly deals with digital services, the allocation of IP (intellectual property) enables multinationals to book the manufacturing output of affiliates in for example the UK, Germany and France in Ireland, which are then classified as exports even though the merchandise has never arrived in Ireland — see here (section on fake exports).    

2) The second pillar will focus on ensuring that multinational enterprises – in the digital economy and beyond – pay a minimum effective level of tax. This pillar would provide countries with a new tool to protect their tax base from profit shifting to low/no-tax jurisdictions.

The second pillar has been compared with the BEAT (Base Erosion and Anti-abuse Tax) and GILTI (Global Intangible Low Tax Income) provisions in the US Tax Cuts and Jobs Act of 2017.

Ireland's headline corporation tax of 12.5% would lose its advantage if the agreed minimum effective rate would be higher. More on OECD/G20 tax reform here:

Ireland wants ‘modest’ global corporate tax reform

US companies make Ireland a tax haven

US corporate tax rates were lowered from 48% to 46% in 1981, then to 34% in 1986, and increased to 35% in 1993. Three years later in an attempt to cut red tape, the Clinton Treasury Department made a monumental blunder.

The rule announced in December 1996 that became known as “check-the-box” streamlined tax filing by enabling a company to mark on an Internal Revenue Service form subsidiaries that were designated a “disregarded entity.”

For a company and its subsidiaries operating only in the United States, the rule was not a problem when the subsidiaries’ income would be reported on the same forms as the parent company’s income.

However, tax lawyers soon spotted that this rule was manna from heaven for companies with international operations, allowing them to shift profits from operations in high-tax countries to low tax or no tax countries.

Germany and the UK protested and by early 1998 the Treasury Department said check-the-box was being used to “circumvent” anti-abuse rules.

Big Business led by General Electric succeeded in killing efforts in the US Congress to change the rule.

Profits made by US companies in Ireland doubled between 1999 and 2002 from $13.4bn to $26.8bn, while profits in most of the rest of Europe fell.

US multinational corporations had increased profits in countries with no taxes or low rates by 68% while sharply reducing profits recorded in countries where they engage in substantial business activity, a study published in the journal 'Tax Notes' showed.

A new Irish corporation tax rate of 12.5% would take effect in 2003 (see below for the evolution of the Irish tax regime) but that rate was still too high for American companies even though it was among the lowest headline rates in Europe.

In 1998 under pressure from the European Union, Ireland began to clean up the system of non-resident (shell) companies officially called an Irish registered non-resident company (IRNR) and the Department of Finance noted, "Many IRNR companies have little or no connection with the country and some may be used for tax evasion, money laundering and fraud. A number of fraud cases involving IRNR's have been covered recently in the press."

The Irish Finance Act of 1999 tightened the rules on shell companies but no restrictions were put on multinational companies.

In succeeding years Irish governments and IDA Ireland, the inward investment agency, worked closely with the American Chamber of Commerce in Ireland and the Dublin units of the Big 4 accounting firms, and big law firms, to promote the Irish advantages including on patent income, the Double Irish Dutch Sandwich loophole, and attracting headquarters of big global companies to Ireland that would culminate in the leprechaun economics year of 2015 when Irish economic output supposedly jumped over 26%.

At Dublin's offshore centre, the International Financial Services Centre (IFSC), Central Bank regulations were as lax as they were on domestic banks!

A year later JBS of Brazil, the world's biggest meat processor, moved its headquarters to Dublin, and "allocated" €30bn worth of its assets to its ultimate parent company, JBS Foods International, which shares an address with A&L Goodbody, a Dublin law firm, at the IFSC financial centre, and appears to have no staff as its operational headquarters is in the UK.

When Arthur Cox, another Dublin law firm, claimed in a 2011 brochure that, "A well-known global company recently moved the ownership and exploitation of an IP (intellectual property) portfolio worth approximately $7bn to Ireland" — this was likely just another set of leprechaunic accounting entries rather than real-world value for Ireland. 

In 2001 Matheson, a Dublin law firm, registered two Irish shell companies, Round Island One and Flat Island Company for Microsoft with addresses in Bermuda.

Thus began the Double Irish where profits shifted to Ireland would be routed tax-free via the Netherlands to shell/ letterbox companies in Bermuda and the Cayman Islands.

The funds would typically be kept in US banks or invested in US Treasuries even though they would be classified as being overseas and not subject to US tax unless repatriated.

Google, Facebook and others took advantage of the Double Irish and US Bureau of Economic Analysis (BEA) data showed that US companies using Irish onshore and non-resident companies for profits shifting had an average effective tax rate of as low as 2%.

Apple didn't use the Double Irish as it had a sweetheart deal with the Irish Government since 1991. It told US Senate Permanent Subcommittee on Investigations in 2013 that its Irish tax rate on sales to Europe, Middle East and India, had been 2% or less since 2003.

Apple had also claimed that its Irish shell companies were stateless (not tax resident anywhere) even though there was an obligation in the Irish Finance Act of 1999 to notify the Irish Revenue of the country where the Irish entities were tax resident.

The Irish authorities had been lax and accommodating for years and it was taboo for all but perceived "Trotskyists" such as myself to raise the issue of massive tax avoidance.

The Irish Times wrote in an editorial on May 22, 2013 — a day after oral evidence on Capitol Hill, from Tim Cook, Apple's CEO, on the central role Ireland had played in Apple's tax avoidance schemes:

"The charges made now need to be countered, speedily and effectively, by both political and diplomatic means. First, by Government setting out a clear narrative on corporate tax that can be easily understood — at home and abroad — and that rebuts some of the erroneous claims made. Second, through a major diplomatic initiative in the US to ensure there is a better understanding of the Irish position on corporate taxation."

A month late in June 2013 Michael Noonan, finance minister, said it was unknown how many non-resident Irish companies existed.

The US Tax Cuts and Jobs Act of 2017 cut the headline federal corporate income tax rate from 35% to 21% and Oxford Economics estimated that the effective rate for US companies in 2018 was 7%.

US corporate income tax collections fell by 31%, from $297bn in fiscal year 2017 to $204bn in fiscal year 2018, when the new law first came into effect. For the first five months of fiscal year 2019 (which commenced on October 1 2018), corporate income tax net receipts dipped 20% relative to fiscal year 2018.

These revenue falls at a time of economic growth suggest that the Trump administration will be keen to protect the tax base from contracting further as the US now has trillion dollar annual budget deficits.

I detailed in the article linked to below how Ireland further gained from tax avoidance beginning in  2015, which will make international corporate tax reform even more painful for Ireland:

Ireland’s Faustian Bargain with hyper- globalization

Evolution of the Irish corporation tax regime

TK Whitaker (1916-2017), the head of the Irish civil service, in a March 1957 memorandum for the incoming finance minister James Ryan on the failure of economic policy and the general sense of hopelessness in the country, warned that "without a sound and progressive economy, political independence would be a crumbling facade."

Ireland decided to abandon its protectionist system and it embraced the emerging globalisation that tariff reduction triggered.

Ryan's predecessor Gerard Sweetman had introduced a very important tax incentive that took effect in November 1956. The Export Profits Tax Relief (EPTR) originally provided for a 50% tax reduction on profits from increased export sales, but this was quickly raised to 100% and 1930s era restrictions on foreign ownership were eased.

According to Prof Frank Barry of Trinity College, manufactured exports, which had been flat for years, grew by 18% in 1957 and doubled between 1956 and 1960.

The EPTR was abolished in 1981 (with a grace period of up to 1990 for existing beneficiaries) and replaced with a 10% corporation tax on “manufacturing and internationally traded services.”

The standard corporation tax rate was 50% and the 10% rate was extended in 1989 to activities in the International Financial Services Centre (IFSC) in Dublin.

The current 12.5% rate was approved by the EU and applied to all companies from 2003 and by 2010 the grace period for the 10% rate ended.

From a paper by European economists cited in Paragraph 3 above