Next Wednesday the General Court of the European Union will give the first judgement in the state-aid case against Ireland in relation to the taxation of Apple over the period 2005 to 2014. Yesterday, the OECD published the first set of aggregate statistics from the country-by-country reports (CbCR) that were introduced under Action 13 of the BEPS project. The data are for 2016.
These are linked as the subsidiaries at the centre of the state-aid case, in particular Apple Sales International, were stateless entities for the period under investigation. Changes to Ireland’s residency rules for companies introduced from the start of 2015 meant it was no longer possible to have an Irish-registered stateless company.
The data from the OECD show that in 2016 stateless entities continued to play a significant role in MNE tax structures. Here is all the data on stateless entities by the jurisdiction of the ultimate parent.
While stateless entities are a significant feature of the corporate tax landscape they really only arise from one jurisdiction: the US. In the OECD data for 2016, 99.8% of the profit linked to stateless entities is linked to companies with their ultimate parent in the US.
Stateless entities are a feature of the US tax code. See the second paragraph of this IRS note on its own CbCR statistics. As the figures above show stateless entities do not pay significant amounts of tax and the taxation of their profits can be viewed in a number of ways.
From the US perspective, the tax is due to the US and is merely deferred by being located in a stateless entity. A formal repatriation would have triggered the tax due to the US (with offsetting credits for any tax paid to other jurisdictions). Under the 2017 Tax Cuts and Jobs Act a “deemed repatriation tax” was introduced and the tax became payable to the US regardless of whether the profit was formally repatriated or not (albeit at a lower rate). This is one of the reasons Apple’s cash tax payments rose in 2019.
Central to the Commission’s state-aid case is Apple Sales International (ASI). For the period in question this was a stateless entity with a branch in Ireland. It had an effective tax rate similar that shown in the aggregate OECD figures for stateless entities (<1%). The Commission’s state-aid finding was not linked to the stateless status of ASI; it was linked to the allocation of profits between the company’s head office in the US and branch in Ireland.
Even if these companies are not deemed to be tax resident in Ireland can it be established that their profits should be taxable in Ireland? Is the presence of a branch enough to deem the profits of the parent taxable here?
There are a couple of ways of approaching this but the key aspect is the agreements granting the rights to use Apple Inc.’s intellectual property outside the Americas to these companies. All of the licensing and cost-sharing agreements were negotiated and signed in the US, at board meetings which took place in the US, and by directors and key decision-makers who were exclusively based in the US. None of the key risks, functions and assets that underpin the creation and ownership of the intellectual property had a connection with Ireland.
With the benefit of the subsequent ruling by the Commission we know that all of this is true. However, there is one qualification that should be added to the above extract – the board meetings where the key decisions were made were not the board meetings of ASI. And this is the central argument of the Commission’s state-aid finding as set out in this paragraph:
285 The minutes of board meetings provided to the Commission demonstrate that the boards did not engage in any detailed business discussion before the discussions on Apple’s new structure in Ireland, as a result of which, according to Apple, the 2007 ruling ceased to be applied to determine ASI’s and AOE’s yearly taxable profits in Ireland. The summary of the minutes presented in Table 4 and Table 5 illustrates the discussions over the period January 2009 to September 2011 for ASI and December 2008 to September 2011 for AOE. With the exception of one business decision to transfer assets from AOE’s Singapore branch to another Apple group company, those minutes show that the discussions in the boards of ASI and AOE consisted mainly of administrative tasks, that is to say approving accounts and receiving dividends, not active or critical functions with regard to the management of the Apple IP licenses.
And that is essentially the case in a nutshell. Ireland’s position is that none of the key risks, assets and functions that made ASI hugely profitable were located in Ireland. The Commission went looking for them but all they could find outside Ireland were the minutes of board meetings where it was decided what bank account to put the profits into.
De facto, the key decisions were made by Apple Inc but they were not documented in the minutes of ASI’s board. The appropriate allocation of profits would see the profits attributed to the ASI head office attributed to Apple Inc. This is the view of the OECD.
But Apple Inc. was not part of the Commission’s investigation. The Commission looked only at the allocation within ASI and determined that “only the Irish branch of Apple Sales International had the capacity to generate any income from trading, i.e. from the distribution of Apple products. Therefore, the sales profits of Apple Sales International should have been recorded with the Irish branch and taxed there.”
The Commission has actually made a pretty strong case (aided by Apple’s poor documenting of decisions) but it only holds if you limit your view to ASI. If you consider Apple Inc. as a whole you would not allocate 60 percent of the company’s profit to the activities that happen in Hollyhill on the northside of Cork City.
And that is where we are. If the court limits its view to ASI then the Commission’s state-aid finding probably has a good chance of holding up. If the court takes the broader perspective of Apple Inc. as a whole then that probability is reduced but remains above zero. The EU courts don’t have jurisdiction over the actions of the IRS.
Will any of this result in Apple paying more tax? No. If Apple has to pay more tax to Ireland then the “deemed repatriation tax” due to the US under the TCJA will be reduced by a commensurate amount.
Robert Stack, former Assistant Secretary at the US Treasury said the following to a Congressional Committee about what would happen if the state-aid decisions are upheld by the courts:
“Now if we were to determine that those payments are in fact taxes and we were to determine that they are creditable under our rules, now when that money comes home from those companies in addition to the credit they got for the tax they originally paid in those jurisdictions they get an extra credit. And that credit to this taxpayer you asked me about means in effect the US Treasury got less money and in effect made a direct transfer to the European jurisdiction that is getting the ruling from the Commission.
So if these turn out to be creditable taxes it is the US taxpayer that are footing the bill for these EU investigations.”
But it was the US tax system that allowed this profit to be deemed “offshore” in the first place through the licensing and cost-sharing agreements provisions of the US tax code. The IRS has challenged several of these, including Facebook and Amazon, in the US tax courts but has yet to be successful.
The US might be happy to accommodate stateless entities within its tax framework to try and limit the harm of its approach to transfer pricing. We know that the European Commission has not been so accommodating. On Wednesday we’ll get a look at what the courts think.
Guest post by Stephen Byrne, Central Bank of Ireland
Today the Bank published its third Quarterly Bulletin of the year. The report contains a detailed overview of developments in the economy since the publication of last Bulletin in early April as well as our latest macroeconomic forecasts out to 2022.
Given the scale of uncertainty surrounding the economic impact of Covid-19, two different scenarios for the economic outlook are outlined in the Bulletin (see featured image above).
In the “baseline” scenario, the economy reopens in line with the Government’s phased plan, allowing for a rebound in economic activity in the second half of the year. Some containment measures would remain in place meaning that activity would be constrained in some sectors for a longer period. Beyond the initial rebound, recovery is expected to be gradual, in line with a slow unwinding of precautionary behaviour as the effects of the shock on consumers and businesses lingers. The unemployment rate is set to decline from its second quarter peak of about 25 per cent as the year progresses and is projected be around half that level by the end of this year, before averaging just over 9 per cent next year and 7 per cent in 2022.
The baseline scenario sees output recovering to its pre-crisis level by 2022. However, the level of activity will be significantly below where it would have been had the economy grown in line with expectations before the outbreak of the pandemic.
In the “severe” scenario, the strict lockdown period is assumed to have a more damaging impact on economic activity and is not successful in effectively containing the virus. Stringent containment measures would remain in place, or would be re-instated, albeit not as severe as before, based on an assumption that there would be a resurgence of the virus at some point over the next year. In this scenario, there is a subdued economic recovery with a larger permanent loss of output. Unemployment remains higher for longer in this scenario and would average just below 17 per cent in 2020, while consumer spending is projected to fall by around 14 per cent and GDP by over 13 per cent this year. In this scenario, the projected recovery in growth in 2021 and 2022 would not offset the loss of output this year, leaving the level of GDP in 2022 about 5 per cent below its pre-crisis level.
Both of these scenarios assume that a Free trade agreement in goods between the UK and the EU, with no tariffs and quotas on goods, takes effect in January 2021. If such an agreement is not reached, then the EU and the UK would move to trading on WTO terms from January 2021. Box D of the Bulletin discusses the implications of such an outcome.
Finally, an accompanying signed article explores alternative long-term recovery paths for the economy and assesses the impact of fiscal and monetary policy supports. The Article considers how hysteresis – or scarring – effects could influence the pace and nature of the recovery. The paper shows that, as a highly open economy, Ireland benefits from the positive effects of monetary and fiscal policy measures implemented abroad. The assessment of the combined effects of domestic and international policy supports indicates that the actions will help to meaningfully reduce the scale of the output loss in Ireland from the pandemic.
Guest post by Reamonn Lydon (Central Bank).
[Disclaimer: this blog post represents my personal views and not those of the Central Bank of Ireland or the European System of Central Banks]
The CSO has just released an experimental analysis of Occupations with Potential Exposure to COVID-19. This is useful data for anyone who wants to understand how the Covid-19 shock interacts with the structure and composition of employment. It provides important information on which sorts of occupations and workers have been most directly affected by the restrictions to limit the spread of the virus.
Using O*NET data on the task-related content of four-digit occupations, the CSO construct an Proximity index and an Exposure to diseases index. Here, I focus on the proximity index, although a similar analysis of the Exposure index would also be of interest.
Quoting from the background notes:
In the O*NET data “Respondents score their job on a scale of one to five where, for proximity, one indicates that the respondent does not work near other people (beyond 100 feet) while five indicates that they are very close to others (near touching) … The data is harmonised on a scale ranging from 0 to 100 by using the following equation: S = ((O-L)/(H-L)) * 100 where S is the standardised score, O the original rating score between one and five, L the lowest possible score (one) and H the highest possible score (five). Under this new classification, the standardised physical proximity measure is defined by:
0 – I do not work near other people (beyond 100 ft.)
25 – I work with others but not closely (for example, private office)
50 – Slightly close (for example, shared office)
75 – Moderately close (at arm’s length)
100 – Very close (near touching)”
The CSO has constructed a proximity score for 296 four-digit SOC10 occupations. Crucially, it then maps these to total employment, percentage female, over-55 and non-Irish using Census 2016.
Using employment weights, the median proximity score for all workers is 57.6; the mean is 61.8. The four digit occupation at the median is Sales related occupations not elsewhere classified. The lowest scoring occupation (least proximate) is Artists (21.5); the highest scoring is Paramedics (97).
The chart below shows the cumulative share of employment (y-axis) by proximity score (x-axis) for the characteristics provided by the CSO. The variation across charactistics is striking: female workers are more likely to be in ‘lower proximity jobs’, almost 60 per cent are below the median score for all workers. It is hard to pin-point a single occupation that contributes to this result for females, but a relatively higher concentration in occupations like Chartered and certified accountants, Cleaners and domestics and Administrative Occupations do stand out. By contrast, male, younger and non-Irish workers are all more likely to be in high-proximity jobs, with just 40 per cent below the median. The relatively higher share of younger workers on the Pandemic Unemployment Payment (PUP) – 41 per cent of under-25s are on PUP currently, compared with 21 per cent of over-25s – tallies with the observation that more of these workers tend to be in higher proximity occupations, and therefore more impacted by the Covid-related restrictions.
For those groups with a greater concentration in high-proximity jobs – that is, male, younger and non-Irish – there is a step-jump around 70. In terms of the occupations arround this jump, for males it includes sports and leisure activities, skilled trades, constrction and protective services. For non-Irish nationals, who make up around 15% of employment (in the 2016 data, it is closer to 20% now) it is a broadly similar set of jobs, but also including a range of food services occupations.
Finally, the CSO has also published the median annual earnings by occupation. Chart 2 shows the average of median annual earnings by occupation for each quartile of the proximty score distribution (weighted by employment). Higher proximity occupations tend to lower paid. For example, in the top 25 per cent of jobs by proximity score (which also happens to be a score at 75 or above), the average of earnings per occupation is around €33,500 (in 2016). The average for the bottom 25 per cent occupations (a proximity score of around 49) is €42,300. When we control for all characteristics such as female, share of over-55s and non-Irish by population, we find that going from the least proximate quartile score (49) to the most proximate quartile score (75) is associated with earnings being around 20 per cent lower on average.
Information on the task-related content of occupation is vital for understanding which sort of jobs are affected by the social distancing restrictions put in place to fight the Covid pandemic. Similar work in Adrjan and Lydon (2020) shows how countries with a higher concentration of ‘high-proximty’ employment experienced a larger negative shock to labour demand when the crisis first hit. This includes Ireland. Analysing the occupational breakdown from the CSO highlights that younger, male and non-Irish workers are more concentrated in ‘high proximity roles’. These roles are also lower paid on average. This provides crucial insight into who is most affected by the Covid shock, and what sort of policies might be put in place to help certain groups of workers.
National accounts are useful. Yes, they have their limitations, and, particularly in the case of Ireland, can be subject to distortions but they are useful.
One of those uses is measuring changes in living standards. If the growth of the inflation-adjusted measure of national income exceeds the growth rate of the population then it is likely that living standards are rising, at least on average. This is usually taken as the real growth rate of per capita GDP (or another variant).
For Ireland, this averaged around one per cent per annum for the first three decades post independence, it rose by an average of three per cent per annum over the next thirty years and has averaged around five per cent per annum in the period since the late 1980s which is where it was before the current crisis hit. These are useful summaries of our economic performance, though as is well known, such long-term averages do belie some significant volatility that Irish growth rates have exhibited.
2020 seems set to add to that volatility but let’s consider two things that are likely to muddy the link between the change in real per capita national income (as measured by, say, GNI*), and the impact of the crisis on living standards:
- Food consumption and the exclusion of domestic household production from national income;
- Education and the cost-based approach to including public production in national income.
Restaurants have been closed for dining in since March. The CSO’s Monthly Services Index shows that the turnover value of services in Restaurants, Event Catering and Other Food Service Activities was over 50 per cent lower in April than in the same month last year. The contribution to value added and national income from restaurants will be significantly lower this year.
However, this does not mean we are eating less or even consuming fewer food-related services. The composition has changed. The CSO’s Retail Sales Index shows that our retail purchases from Food Businesses were 17 per cent higher in April than in the same month last year. The food we are not consuming in restaurants and other outlets has been replaced by food we are buying in shops.
In the national accounts, both the food and labour inputs are counted when measuring the value added of restaurants. For food we buy in the shops the domestic labour input used to turn that food into a meal is omitted from national income, but it still contributes to our living standards.
There’s no doubt there’s more to restaurants than the food we eat and the cooking and cleaning services provided to us. That is why we are willing to pay more for dining in. But we are still eating the meal we would have had in the restaurant or cafeteria so someone is still doing the cooking and someone is still doing the cleaning. It still adds to our living standards, it’s just that it has switched from market production to household production.
The drop in living standards implied by the fall in value added from restaurants in the national accounts won’t be as large as the figures suggest. We have been forced to move to something that does not have its value added included in the national accounts (nor generate as much Value Added Tax for the government which is also counted as value added when measured at market prices.)
And, separately, the employees who would have been paid from that lost value added have had a large part of their income replaced with government transfers.
For market-provided services the value added is essentially the value of the output produced less than cost of intermediate consumption.
The value of market output is estimated using the prices people for it. After intermediate consumption has been subtracted from total revenue, value added is divided between labour through compensation of employees, government through taxes on products, and capital through gross operating surplus. Net operating surplus remains after a deduction for the consumption of fixed capital (depreciation). The additional value added that goes to users above the price paid (consumer surplus) is not measured.
Still, value added is a useful concept and represents a large share of the living standards and welfare benefits of the goods and services we produce and consume in market settings.
This does not hold for publicly-produced services such as education. These are paid for from general taxation. We do not have prices and revenues to provide an estimate of the value people place on these services (nor how much they would be willing to buy). Market prices might be absent but they do contribute to living standards.
The value added for public services in national accounts is essentially the sum of compensation of employees and depreciation, that is, it is the cost not the benefit that is included.
The value added of education is simply put at the pay bill for teachers and the cost of maintained school buildings. No benefit above that is included in national income aggregates.
Schools have been closed since the middle of March. Just like restaurants there has been a switch to domestic production. Yes, some online supports have been provided but the value of this is unquestionably lower (just as we are only willing to pay lower prices for takeaway meals). The shift to home-schooling has had a huge impact on living standards.
However, the value added of publicly-provided education services will be largely unaffected. The fact that the school children aren’t in school doesn’t matter for national accounts; all that matters is that teachers get paid.
The provisional Quarterly National Accounts for Q1 2020 show that constant price gross value added in Distribution, Transport, Hotels and Restaurants was down 10 per cent compared to the first quarter of 2020. This reflects the forced closure of most of these services towards the end of the quarter.
On the other hand the gross value added in Public Admin, Education and Health was up four per cent compared to the same period a year ago. This is despite the fact that schools were closed from the 12th of March.
This isn’t necessarily an argument to change the way national accounts are compiled. Should household production be included in national income? Maybe. Should the added value of public services be more than pay and depreciation costs? Maybe. For the time being we’ll be satisfied with an understanding of what the figures as currently compiled actually mean.
The drop in value added from restaurants doesn’t mean that we are not eating. The stability in value added from education doesn’t mean that our kids are being taught. National accounts are useful and the changes in the aggregates can be a useful proxy for changes in living standards. But not always.