The issue of effective tax rates, especially for the corporate income tax, rightfully continues to attract a lot of attention. The front page of The Irish Times features a story by Carl O’Brien which is based on a recent paper produced by Prof. Jim Stewart. The paper argues that:
“data from the US Bureau of Economic Analysis gives a more accurate estimate of effective tax rates for US subsidiaries operating in Ireland and elsewhere. This data shows that for 2011, US subsidiaries operating in Ireland have the lowest effective tax rate in the EU at 2.2%.”
The paper provides a useful critique of the World Bank/pwc report on effective tax rates but to argue that the BEA data tells us anything about effective tax rates in Ireland is wide of the mark.
For Ireland, the BEA data indicate that, in 2011, US companies here had $144 billion of net income and paid an affective tax rate of 2.2 per cent. The low effective tax is correct but it wasn’t achieved in Ireland.
There is nothing close to $144 billion of US MNC profits in Ireland. Such massive profit figures do not appear in the statistics produced by either the CSO or the Revenue Commissioners. The gap between GDP and GNP is large but it is not that large.
The post continues below the fold. Apologies for the length.
For 2011, the Revenue Commissioners report that the gross profits of all companies in Ireland was €74 billion. After capital allowances, losses carried forward, trade charges and other adjustments net taxable income was €40 billion. This table shows the calculation for 2010 data.
On page 36 of their Business in Ireland 2010 release the CSO say the following:
Foreign multinationals in Ireland – the story for 2011
It is estimated from the Structural Business Surveys that over 3,300 or 2.1% of the 155,600 enterprises in the business economy in Ireland were foreign-owned in 2011.
Despite the small number of foreign-owned enterprises, they were very significant in terms of employment, turnover and GVA. Foreign-owned enterprises employed over 250,000 or 21.8% of the 1,151,000 persons engaged in the business economy. Foreign-owned enterprises generated almost €176.9 billion or 55.9% of the €316.2 billion in total turnover. Foreign-owned enterprises generated over €48.9 billion or 57.4% of the €85.2 billion in total GVA.
So foreign-owned enterprises generated around €49 billion of Gross Value Added (GVA). To get Gross Operated Surplus (GOS) remuneration of employees would have to be subtracted (250,000 times say €40,000 is €10 billion). That gives around €39 billion of Gross Operating Surplus for ALL foreign-owned companies in Ireland.
“Gross Operating Surplus” as recorded by the CSO is a different measure, though somewhat similar in principle, to “Net Income” reported to the Revenue Commissioners. The point is simply that nothing in Ireland gets us close to the $144 billion income figure reported by the BEA.
The CSO’s Balance of Payments gives us a measure of “repatriated profits” out of Ireland. Here are the income outflows attributed to “Direct Investment Income: Income on Equity” for the past four years, which are recorded in the time period they are earned.
2009: €33.2 billion
2010: €36.1 billion
2011: €38.0 billion
2012: €38.8 billion
In 2011, direct equity investment in Ireland (where one foreign shareholder owned more than 10 per cent of the company) had earnings of €38.0 billion. Again this is for ALL foreign nationals not just US MNCs.
So is the $144 billion profit figure reported by the BEA incorrect? No. But it is important to know what it actually represents. Here are two extracts from the BEA methodology for the statistics they produce:
If an operation or activity is incorporated abroad—as most are—it is always considered a foreign affiliate.
[.] if a business enterprise that is incorporated abroad by a U.S. person conducts its operations from, and has all of its physical assets in, the United States, it is treated as an incorporated foreign affiliate in the country of incorporation, even though it has no operations or physical assets there. This treatment ensures that the foreign entity is reported to BEA.
Why are these important? They highlight that for companies, US residency rules are based on paperwork rather than activity. Under US law, the tax-residence of a company is the country where it is incorporated. All companies registered in Ireland are thus considered “Irish-based” under US law.
Ireland is similar in many respects but we have a slightly more intricate approach when it comes to determining corporate tax residency. Historically, the rule was (from revenue.ie):
All companies whose central management and control is exercised in Ireland (whether it is incorporated in Ireland or not) is regarded as resident in Ireland for tax purposes.
This was revised in the Finance Act, 1999, and now:
in general, companies incorporated in the State are resident in the State.
One of the exceptions to this is:
a company that is ultimately controlled by persons resident in the EU or in a country with which Ireland has concluded a double taxation treaty or is is related to a company the principal class of the shares of which is substantially and regularly traded on one, or more than one, recognized stock exchange in an EU Member State or in a tax treaty country.
Thus, some foreign-owned, Irish-incorporated companies will not be viewed as tax resident in Ireland if they are not centrally managed and controlled here. Prior to 1999 this was also possible for companies owned by Irish residents but the changes in the Finance Act 1999 tightened up the exceptions to the test of incorporation to foreign-owned companies only.
So what is at play here is that there are Irish-incorporated companies who, for want of a better word, “live” somewhere else. Just like our income tax system does not levy income tax on Irish nationals who live abroad, our corporation tax system does not levy corporation tax on (some) Irish corporations who carry out their activities abroad.
There is little that is unique or unusual about this. The issue is how our rules interact with rules of other jurisdictions, and the US in particular.
When the US Bureau of Economic Analysis says that US-owned, Irish-based companies had $144 billion of profits in 2011 we actually have to go to Hamilton, Bermuda to find a good chunk of it (where Google Ireland Holdings is managed and controlled from) or Cupertino, California (where Apple Operations International is managed and controlled from).
Apple has been reporting annual net income of around $40 billion for the last few years. The company was the subject of a very information US Senate investigation in May. Here is an extract from the opening statement given by the committee chairman Sen. Carl Levin (D) to the hearing about three Irish-incorporated Apple subsidiaries:
Take AOI. AOI has no owner but Apple. AOI has no physical presence at any address. In thirty years of existence, AOI has never had any employees. AOI’s general ledger, its major accounting record, is maintained at Apple’s U.S. shared service center in Austin, Texas. AOI’s finances are managed by Braeburn Capital, an Apple Inc. subsidiary in Nevada. Its assets are held in a bank account in New York.
AOI’s board minutes show that its board of directors consists of two Apple Inc. employees who live in California and one Irish employee of Apple Distribution International, an Irish company that AOI itself owns. Over the last six years, from May 2006 through the end of 2012, AOI held 33 board meetings, 32 of which took place in Cupertino, California. AOI’s lone Irish-resident director participated in just 7 of those meetings, six by telephone, and in none of the 18 board meetings between September 2006 and August 2012.
ASI’s circumstances are similar. Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in Cupertino.
In short, these companies’ decision makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States. Apple’s tax director acknowledged to the Subcommittee staff that it was his opinion that AOI is functionally managed and controlled in the United States. The circumstances with ASI and AOE appear to be similar.
According to the Senate report, Apple Sales International (ASI) reported pre-tax earnings in 2010 of $12 billion. As the statement from Sen. Levin makes clear ASI carries out all its activities in the US. In the BEA statistics this income is attributed to Ireland because the companies are Irish incorporated company.
These companies are not resident in Ireland for either Revenue or CSO purposes or any purposes. Attributing their effective tax rates to Ireland is disingenuous. Yes, their effective tax rates are low but as the companies are not tax resident in Ireland they are not subject to Irish corporation tax. It is not appropriate to calculate effective tax rates on tax actually paid here using profits in the denominator that are not subject to tax here.
The structures of other US companies provide similar conclusions. Companies such as Google and Microsoft have large sales operations in Ireland but these operation do not report very large profits. Why? Because they pay patent royalties for the rights to use their parent company’s intellectual property. Ireland is a low-tax country for corporations but it is not low-tax enough for them to shift the economic rights of their intellectual property here and it is to the IP that most of the profit is attributed.
Here is a chart from the CSO’s Balance of Payments on patent royalty flows in and out of Ireland.
What does it show us? There are massive outflows of royalty payments (nearly €30 billion in 2011) and much smaller inflows (€4 billion in 2011). There have been efforts in recent Finance Acts to make Ireland more attractive for holding companies but the effect is small compared to the outflows of royalty payments. The outflows hugely reduce the profitability in Ireland of the MNCs operating here.
In 2011 there was a €23 billion outflow “other business services”
Where does this money flow to? Much of it flows to small island nations like Bermuda and the Cayman Islands. Google book massive advertising sales revenues in Ireland but the profit is attributed to intellectual property that is held in Bermuda. The holding company, Google Ireland Holdings is Irish incorporated but the royalty payments made to it are outflows in the Balance of Payments and the profit is not taxable in Ireland. Microsoft’s Round Island One is also resident in Bermuda though Irish incorporated.
In recording massive sales for US MNCs in Ireland the BEA is correct. These are also evident in the CSO data. However, the profit from these sales is shifted out of Ireland in the form of patent royalty payments. The BEA attribute these profits to Ireland as the holding companies are Irish incorporated.
Google, Apple and all US MNCs are liable for US corporation tax at 35 per cent on their worldwide profits (with offsetting credits given for corporate income tax paid in other countries). Because of the structure of their businesses and the nature of their profits (passive income generated by intellectual property) they do not have to pay this tax liability until the profits are repatriated to the US. In the case of Apple the profit is already in the US as highlighted by Sen. Levin and is managed in Reno, Nevada by Braeburn Capital while being kept in US banks. However, because it is controlled by an Irish-incorporated company it is still deemed “offshore” under US law. There is nothing to indicate that this money ever even passed through Ireland.
The reality is that the non-US profits of these MNCs are booked in low-tax or no-tax jurisdictions (or sometimes even no jurisdiction at all). Bermuda has a corporation tax but the rate is zero. The change announced in last October’s budget means that Irish incorporated companies will, from January 2015, no longer be able to make themselves tax resident no where. It is likely that this will mean even more profits being booked in the Caribbean.
The discussion should be about putting in place measures to curb the ability of MNCs to shift their massive profits to locations where they have no substance but can pay very little tax. In many cases Ireland is part of the chain but we are not at the end. Attributing effective tax rates to profits that don’t accrue here gets the issue on the front page but adds little to the debate.