To start 2015

Some observations on some recent issues are below the fold:

1. The NTMA’s purchase and cancellation of €500 million of FRNs from the Central Bank
2. The passing in the US of The Tax Increase Prevention Act of 2014 which extends the “look-through” rule
3. The recent falls of the price of motor fuel which mean the pre-tax price of petrol is below 40 cent/litre

1. The NTMA bought €500 million of Floating Rate Notes from the Central Bank

Without adequate detail it is hard to be conclusive on this one.  This is the NTMA statement on the transaction:

22 December 2014 – The National Treasury Management Agency (NTMA) announces the cancellation of €500 million of the Irish Floating Rate Treasury Bond due to mature on 18 June 2038.

The bonds, which were issued in connection with the Irish Bank Resolution Corporation Act 2013, were purchased today from the Central Bank of Ireland. Following the cancellation the total nominal outstanding for this bond will decline to €1.5 billion.

As we know the €25 billion of the FRNs were taken on by the Central Bank as part of the restructuring of the Promissory Notes.  The FRNs have maturities ranging from 2038 to 2053 and the interest coupons on the notes are at fixed margins ranging from 250 to 268 basis points the 6-month Euribor rate.

The Central Bank also received €3.5 billion of the 5.4 per cent 2025 rate government bond as part of the transaction undertaken to make the 2012 cash payment on the Promissory Notes.

As long as the Central Bank holds the FRNs and bonds the net interest cost to the overall government sector is the ECB’s main refinancing rate (currently 0.05 per cent).  The NTMA pays out the interest but as it is paid to the Central Bank it is not a loss to the State.  In fact most of the interest would likely be recycled back the Exchequer as part of the Central Bank surplus (though the Bank does have some building works ongoing).

In its 2013 Annual Report the Central Bank said:

The Bank intends to sell the combined portfolio of the FRNs and the fixed rate bond as soon as possible, provided conditions of financial stability permit. As a minimum, the Bank will sell securities in accordance with the following schedule: to end 2014 (€0.5 billion), 2015-2018 (€0.5 billion per annum), 2019-2023 (€1 billion per annum), and 2024 on (€2 billion per annum until all bonds are sold).

And it was noted that:

As part of this strategy, the Bank sold €350 million of its holdings of the Government 2025 Fixed Rate Bond in 2013.

So now we know that the Central Bank has sold (at least) €850 million from the combined portfolio.  This is ahead of the schedule which indicated that €500 million of sales would be made by the end of 2014.

If the €500 million of FRNs were to be sold anyway it is probably beneficial that the NTMA bought them.  The interest on the FRNs was the variable six-month Euribor (currently around 0.2 per cent) plus 250 basis points.  Back in November the NTMA issued a 15-year bond at a yield of 2.49 per cent.  The annual coupon is 2.4 per cent.  A similar sale in early 2015 could likely be done at a yield below 2 per cent. [For what it’s worth the yields on all German government bonds out to 5 years were negative today.]

If we assume that the actual price paid by the NTMA for the €500 million of FRNs doesn’t matter much (like the interest any surplus would remain in the wider government system) then it would appear that this transaction has some interest benefits, even if that is only moving from a variable to fixed rate on €500 million of debt.  The transaction reduced the gross general government debt (Maastricht criteria) by €500 million though net debt is little changed (depending on the amount of cash used to buy the €500 million FRN that was cancelled).

As a result of the €850 million of sales there is now additional interest being paid to someone than if the original €500 million schedule was adhered to.  Although money is fungible we could assume it to be either the holders of the 2025 bond who bought from the Central Bank in 2013 or those who took the 2030 bond from the recent NTMA issue.  It doesn’t really matter.  We know that interest that would have been paid to the Central Bank if it has held on to the bonds is now being paid to someone else.  So the question is why were an extra €350 million of the bonds sold ahead of the schedule set out in spring 2013?  And will these accelerated sales continue?

2. The US Congress passed H.R. 5771 extending numerous tax provision

House Resolution 5771 is The Tax Increase Prevention Act of 2014 and in the middle of it there is:

Sec. 135. Extension of look-thru treatment of payments between related controlled foreign corporations under foreign personal holding company rules.

(a) IN GENERAL.—Subparagraph (C) of section 954(c)(6) is amended by striking ‘‘January 1, 2014’’ and inserting ‘‘January 1, 2015’’.
(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable years of foreign corporations beginning after December 31, 2013, and to taxable years of United States shareholders with or within which such taxable years of foreign corporations end.

Nice and simple.  The expiry date of S.954(c)(6) is extended to tax years including 01/01/15 or alternatively the provision applies to all tax years that end before 31/12/15.  The “look-through” rule applies for another year.

The “look-through” rule was introduced in 2006 and gave legislative effect to many of the effects the resulted from the “check-the-box” administrative provision introduced by the IRS in 1998.  The “look-through” was introduced for two years and has now been extended four times.

The May 2013 US Senate report on Apple stated that

Apple avoided U.S. taxation for the entire $44 billion through a combination of regulatory and statutory tax loopholes known as the check-the-box and look-through rules.

Using the “look-though” rule Apple was able to defer the payment of $12.5 billion of US corporate income tax in 2011 and 2012.  With “check the box” and the “look-through” rule Apple is able to treat its Irish-incorporated subsidiaries such as ASI and AOE as disregarded entities for US tax purposes.  This means that the royalty and dividend transfers between these companies are not seen for US tax purposes and therefore the anti-deferral provisions of Subpart F for such passive income flows are not triggered.

Instead the IRS looks through these companies and sees Apple received active income from distributors, wholesalers, retailers and ultimately customers on its global sales.  All the intra-company passive income transfers are ignored and the US tax code has a general deferral principle for the US corporate income tax due on non-US active income.  Apple gets the US to look through the company’s royalty and dividend transfers which would generally trigger a US corporate income tax payment.

Of course, tax systems around the world see these royalty and dividend payments and the amount of profit remaining in their jurisdictions is relatively small.  Under the current system this is correct as distributing, wholesaling and retailing are not very profitable activities.  The issue is that the royalties that have to be paid to the US to sell Apple’s US-designed products are not triggering a tax payment in the US.

The Tax Increase Prevention Act of 2014 was passed 76-24 by the US Senate. And yes, the senior member from Michigan did vote “yea”.

We don’t have to be entirely sceptical of this move to allow Apple, and other companies, to reduce their tax payments.  It could be that the one-year extension (and the previous three extensions were for two years) is to allow the removal of the “look-through” rule from the US tax code to be formally negotiated and organised in 2015.  That is one possibility.  It could be that the provision will be extended again for tax years ending in 2016 and further.  And we could even see the “look through” rule become a permanent feature of the US tax code.  Either way it won’t be an issue for Carl Levin who has retired.

These are the important changes; not changes of Irish law introduced for PR effect.

3. The pre-tax price of a litre of petrol is now less than 39 cent

The prices of petrol and diesel are falling rapidly.  For petrol prices below €1.30/litre are now commonplace with prices as low as €1.239 now seemingly available.

The per unit taxes on top of the Excise Duty of €541.80 per 1000 litres of petrol are provided here. Thus the per litre duties on petrol are:

• Excise Duty: 54.18c
• Carbon Tax: 4.59c
• Strategic Stockholding Levy: 2.00c
• Better Energy Levy: 0.6c

The Strategic Stockholding Levy is used to finance the National Oil Reserves Agency and I assume the Better Energy Levy is used to fund activities undertaken by the Sustainable Energy Authority of Ireland.

The above per unit taxes come to 61.37c per litre. VAT at 23 per cent is applied on these to bring the subtotal to 75.49c.  This is the lower-bound price that applies before the cost of the product itself is factored in.

Subtracting 75.49c from the pump price of 123.9c leaves 48.41c.  This is the VAT-inclusive price of the fuel excluding the per-unit duties.  The VAT component is 9.05c giving a pre-tax price of 39.36c.

• Price + 23% VAT = 39.36 + 9.05 = 48.41
• Per-unit taxes + 23% VAT = 61.37 + 14.12 = 75.49
• Total = 123.9 (of which 84.54c (68.2%) is tax)

It is probably also worth noting that regulations under the Biofuel Obligation Scheme require road transport fuel suppliers to use a minimum of 6 per cent biofuel in their overall fuel mix.  This is estimated to add around 0.8c to the cost of a litre of petrol.  Although not significant, the carbon tax (€45.90 per 1000L of petrol) is not recalculated to reflect the amount of biofuel in the mix (on which the carbon tax should not be payable).  Absent this obligation it is likely that the pre-tax price of petrol in the above calculation would be around 38.5 cent/litre.