The report of the Commission on Pensions and other supplementary material have been published by the Department of Social Protection. They are available here.
The ongoing round of the OECD’s BEPS Project has attracted considerable attention. This has been particularly true since the foreign ministers of the G7 included a paragraph in their communiqué after a meeting in early June setting out the principles of an agreed position and following Ireland’s recent decision not to coalesce with more than 130 countries on a statement after a meeting of the “inclusive framework”.
Ireland’s position is frequently assessed in the light of profits ending up in no-tax jurisdictions such as Bermuda (as was the case with Google) or being stateless (as achieved by Apple up to 2015). These are egregious outcomes. Companies should not be able to shift their profits to locations where they have no substance and companies should not be stateless because they have to exist somewhere.
International agreements were never required to eliminate these outcomes. It has only been US companies that were involved yet somehow the US has dodged the reputational bullet that should have been aimed at it for allowing, and even encouraging, its companies to engage in such practices.
Profit Shifting – The First Step
The most high-profile example of a company shifting profits to Bermuda is Google. Google was incorporated in 1998 and sought to established an EMEA headquarters in 2003. In setting up its international tax structures the IMF set out the steps Google took:
…the first step is to transfer the patent from which the value of the service is derived to Firm H in (say) Bermuda, where the tax rate is zero. This transfer of intellectual property is made at an early stage in development, when its value is very low (so that no taxable gain arises in the United States).
After this first step, the rest doesn’t matter significantly to the outcome; the profit will end up in Bermuda. In Google’s case, “Firm H” was Google Bermuda Limited which was registered in Bermuda. As part of the first step Google Inc. entered a licensing agreement with Google Bermuda for the use of Google’s technology and intellectual property outside the Americas.
Of course, this technology is the result of R&D activities undertaken in the US. The US could require that if the license acquired by Google Bermuda is valuable most of the profit should be attributed to the R&D activities in the US.
One way to do this would be via a profit-split agreement where Google Bermuda, say got to keep 10 per cent of the profits from licensing Google’s technology outside the Americas and Google Inc. got 90 per cent of the profit because it undertook the key value-adding R&D activity.
However, the US tax code allowed Google to use a cost-share agreement. This meant Google Bermuda and Google Inc didn’t split the profit between them but shared the burden of the R&D costs between them – with the shares each paid based on the size of the market they covered.
In rough terms, the Americas made up 50 per cent of Google’s market so Google Inc. covered 50 per cent of the total R&D cost. And the international markets Google Bermuda had a license for were the remaining 50 per cent so Google Bermuda, and its subsidiaries, covered the other 50 per cent of the total R&D cost.
As Google technology turned out to be hugely valuable relative to the R&D costs it incurred Google Bermuda and its subsidiaries earned huge profits. This is no longer possible under the OECD revised guidelines for transfer pricing (see paragraph 6.42) but it was possible in 2003.
Without this first step of locating IP in Bermuda the rest of the structure is largely moot. The license had to get out of the US at low cost (relative to its value) and the ongoing payments back to the US for the license had to be low (relative to the profits generated). The US tax system allowed both of these to happen.
Profits in Bermuda – Cui Bono?
As the US system allowed the above to happen it was in the US’s interest that the license be located in a no-tax jurisdiction such as Bermuda. If the license was located in a jurisdiction with a 25 per cent corporate tax rate then US tax revenues would ultimately be lower. As Hines and Rice (1994) concluded:
Low foreign tax rates influence business behavior in many ways, making it difficult to assess their overall impact on U. S. tax collections, but one component of their impact appears to be greater tax collections as a consequence of generating fewer foreign tax credits.
This can be illustrated with the one-off “deemed repatriation tax” introduced by the Tax Cuts and Jobs Act of 2017 (TCJA) . This was introduced to allow the US collect tax on offshore profits that US MNCs had not formally repatriated to the US. In its annual report for 2017, Google set out the following:
The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion.
From 2003 to 2017, Google reported cumulative foreign profits of $91.7 billion and a cumulative provision for foreign taxes of $5.8 billion, giving an effective foreign tax rate of 6.3 per cent.
For the one-time tax imposed on those profits by the TCJA, any foreign taxes paid were credited at around 40 per cent as the rate of the tax was less than the headline rate that applied at the time the profits were earned (35 per cent).
Adding 40 per cent of Google cumulative foreign tax provision from 2003 to 2017 to the $10.2 billion estimate of the liability under the one-time tax gives $12.5 billion. This equates to 13.6 per cent of cumulative foreign profits over the period and is in line with the rates for the one-time tax, particularly the 15.5 per cent rate on foreign cash.
However, if instead of been able to achieve a foreign tax rate of just over 6 per cent, Google had a foreign tax rate of 25 per cent then its liability under the one-time tax would have been reduced to around $3.2 billion. It is because Google had a low foreign tax rate that the US tax owed under the one-time tax were $10.2 billion. The US allowed the license to use Google technology escape relatively cheaply, and ultimately it was US tax receipts that benefitted from Google locating its IP in Bermuda.
The IP Comes Home
In December 2019, Google announced that it would be no longer licensing its IP from Bermuda:
“As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.”
This has resulted in a large drop in outbound royalty payments from Ireland to the euro area (of which payments to The Netherlands make up by far the largest amount).
Although Google’s IP was located in Bermuda, Google did not make payments from Ireland to Bermuda due to the presence of an Irish withholding tax at the time. If getting profits to Bermuda in a tax efficient manner was the objective Ireland was not the place to do it.
It was achieved using the EU’s Interest and Royalties Directive and the provision in The Netherlands that did not impose a withholding tax on royalty payments to Bermuda. Thus, the ending of Google’s IP licensing in Bermuda shows up in Ireland as a reduction in royalty payments to The Netherlands.
The royalty payments continue to be made from Ireland but for the past 18 months have been directed to the US. This has meant a reduction (to zero) in the profit Google reports in Bermuda and a jump in the profit reported in the US. This can be seen in the company’s most recent annual 10K report.
The increase in profit attributed to domestic operations is clear with an associated reduction in profit from foreign operations. Has the discontinuation of Google’s Bermuda structure increased its tax bill? No. In 2020, Google had an effective rate of 16 per cent – which is lower than the effective rates it had when it was shifting billions in profit to Bermuda.
From 2003 to 2017, Google’s overall effective tax rate was 25.8 per cent, including the one-time transition tax. In the three years since the TCJA was introduced, Google’s effective tax rate has been 14.1 per cent.
The US may have recaptured the profits it let escape with the 2003 cost-share agreement but the Tax Cuts and Jobs Act is certainly living up to the first part of its name. It is the US that is the biggest tax haven for US companies.
Appel’s IP Stays Put
The US has always been a significant tax haven. This was highlighted with Apple case. Apple also set up a cost-share agreement between the parent and a subsidiary but with Apple the IP didn’t take a first step to a no-tax jurisdiction such as Bermuda. It just stayed in the US.
In his opening statement to the 2012 US Senate hearing on Apple’s tax affairs Sen Carl Levin noted that:
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 didn’t move its IP to Bermuda; it kept it in the US. And bizarrely, the US allowed a company to operate in its jurisdiction, earn huge profits and not be subject to immediate tax. As Sen. Levin set out the key functions, assets and risks that made these companies profitable were all located in the United States.
Apple didn’t have to be concerned about royalty payments and withholding taxes. It just kept the profit in the US. In its state-aid case, the European Commission argued that this profit should be attributed to the branches that these companies had in Ireland. This was rejected by the General Court of the European Union which ruled that Commission needed to do more than just stating that the profits should be attributed to the Irish branches:
228 In its primary line of reasoning, the Commission concluded that the Apple Group IP licences held by ASI and AOE should have been allocated to the Irish branches due to the lack of staff and physical presence of those two companies, without attempting to show that that allocation followed from the activities actually carried on by those Irish branches. In addition, the Commission inferred from that conclusion that all of the trading income of ASI and AOE should have been regarded as arising from the activities of the Irish branches without attempting to show that that income was representative of the value of the activities actually carried out by the branches themselves.
These companies might have been “stateless” for tax purposes but in reality their key value-adding activities were all based on the US. A country that allows companies to operate within its jurisdiction and not subject them to immediate tax is a tax haven.
The US will collect tax on those profits – via the one-time transition tax from the TCJA – and will again benefit from the IP not being in a location where foreign tax was paid. However, the amount ($37.3 billion) is much lower than what would have been collected if the US imposed the federal corporate income tax on those profits when they were earned.
The IP Escapes Scot Free
As is well known, Apple changed their structure from the start of 2015. This involved Apple relocating the IP license to Ireland for the rights to sell Apple products outside the Americas. This led to tumultuous changes in Ireland’s national accounts, including a 26 per cent growth rate.
The right to sell Apple products outside the Americas is a hugely valuable (especially when the cost of the license is based on R&D costs not profit). When moved to Ireland in 2015, the IP was probably worth something in the region of $250 billion and linked to annual profits of around $30 billion a year. This is very different to Google who moved their IP to Bermuda in 2003 before the company starting generating huge profits.
We know $250 billion of IP was transferred to Ireland. We also know where it came from – the US. How much tax did the US charge when this asset was bought by a now Irish-resident company asset? Nada. Not a cent. The US allowed $250 billion of IP to leave without so much as a nod to the IRS. It was the US being a profit sieve on a grand scale.
Maybe Ireland deserved the cheap jibes because the IP and the associated profits landed here but the US has completely escaped scrutiny for allowing the IP to escape scot free. That the IP was in the US was the essence of the case used by Ireland and Apple to have the Commission’s state-aid finding overturned by the General Court of the EU.
A statement like “the ship sank because it was overwhelmed by water” will be true but uninformative. What we need to be told is something like “the ship sank because poorly-fitted rivets led to a failure of the hull.” If I was the shipbuilder, I would much prefer the blame be loaded on the water not my poorly-fitted rivets.
Huge profits in Bermuda and companies being “stateless” are egregious outcomes. But it doesn’t matter if the ship these sailed on were in Irish, Dutch, Singaporean, Malaysian, Mexican, Peruvian or any other waters. Sure, some of these could have better policed their waters but the outcome was going to be same. The ship was holed below the waterline by the US shipbuilders. And others getting the blame suits them just fine.
Extract from White House fact sheet on the American Jobs Plan:
– – – – – – – – – – – – – – – – – – – – – – – – – –
Alongside the American Jobs Plan, the President is proposing to fix the corporate tax code so that it incentivizes job creation and investment here in the United States, stops unfair and wasteful profit shifting to tax havens, and ensures that large corporations are paying their fair share.
The 2017 tax law only made an unfair system worse. A recent independent study found that 91 Fortune 500 companies paid $0 in federal corporate taxes on U.S. income in 2018. In fact, according to recent analysis by the Joint Committee on Taxation, the 2017 tax bill cut the average rate that corporations paid in half from 16 percent to less than 8 percent in 2018. A number of the provisions in the 2017 law also created new incentives to shift profits and jobs overseas. President Biden’s reform will reverse this damage and fundamentally reform the way the tax code treats the largest corporations.
President Biden’s reform will also make the United States a leader again in the world and help bring an end to the race-to-the-bottom on corporate tax rates that allows countries to gain a competitive advantage by becoming tax havens. This is a generational opportunity to fundamentally shift how countries around the world tax corporations so that big corporations can’t escape or eliminate the taxes they owe by offshoring jobs and profits from the United States.
Together these corporate tax changes will raise over $2 trillion over the next 15 years and more than pay for the mostly one-time investments in the American Jobs Plan and then reduce deficits on a permanent basis:
- Set the Corporate Tax Rate at 28 percent. The President’s tax plan will ensure that corporations pay their fair share of taxes by increasing the corporate tax rate to 28 percent. His plan will return corporate tax revenue as a share of the economy to around its 21st century average from before the 2017 tax law and well below where it stood before the 1980s. This will help fund critical investments in infrastructure, clean energy, R&D, and more to maintain the competitiveness of the United States and grow the economy.
- Discourage Offshoring by Strengthening the Global Minimum Tax for U.S. Multinational Corporations. Right now, the tax code rewards U.S. multinational corporations that shift profits and jobs overseas with a tax exemption for the first ten percent return on foreign assets, and the rest is taxed at half the domestic tax rate. Moreover, the 2017 tax law allows companies to use the taxes they pay in high-tax countries to shield profits in tax havens, encouraging offshoring of jobs. The President’s tax reform proposal will increase the minimum tax on U.S. corporations to 21 percent and calculate it on a country-by-country basis so it hits profits in tax havens. It will also eliminate the rule that allows U.S. companies to pay zero taxes on the first 10 percent of return when they locate investments in foreign countries. By creating incentives for investment here in the United States, we can reward companies that help to grow the U.S. economy and create a more level playing field between domestic companies and multinationals.
- End the Race to the Bottom Around the World. The United States can lead the world to end the race to the bottom on corporate tax rates. A minimum tax on U.S. corporations alone is insufficient. That can still allow foreign corporations to strip profits out of the United States, and U.S. corporations can potentially escape U.S. tax by inverting and switching their headquarters to foreign countries. This practice must end. President Biden is also proposing to encourage other countries to adopt strong minimum taxes on corporations, just like the United States, so that foreign corporations aren’t advantaged and foreign countries can’t try to get a competitive edge by serving as tax havens. This plan also denies deductions to foreign corporations on payments that could allow them to strip profits out of the United States if they are based in a country that does not adopt a strong minimum tax. It further replaces an ineffective provision in the 2017 tax law that tried to stop foreign corporations from stripping profits out of the United States. The United States is now seeking a global agreement on a strong minimum tax through multilateral negotiations. This provision makes our commitment to a global minimum tax clear. The time has come to level the playing field and no longer allow countries to gain a competitive edge by slashing corporate tax rates.
- Prevent U.S. Corporations from inverting or claiming tax havens as their residence. Under current law, U.S. corporations can acquire or merge with a foreign company to avoid U.S. taxes by claiming to be a foreign company, even though their place of management and operations are in the United States. President Biden is proposing to make it harder for U.S. corporations to invert. This will backstop the other reforms which should address the incentive to do so in the first place.
- Deny Companies Expense Deductions for Offshoring Jobs and Credit Expenses for Onshoring. President Biden’s reform proposal will also make sure that companies can no longer write off expenses that come from offshoring jobs. This is a matter of fairness. U.S. taxpayers shouldn’t subsidize companies shipping jobs abroad. Instead, President Biden is also proposing to provide a tax credit to support onshoring jobs.
- Eliminate a Loophole for Intellectual Property that Encourages Offshoring Jobs and Invest in Effective R&D Incentives. The President’s ambitious reform of the tax code also includes reforming the way it promotes research and development. This starts with a complete elimination of the tax incentives in the Trump tax law for “Foreign Derived Intangible Income” (FDII), which gave corporations a tax break for shifting assets abroad and is ineffective at encouraging corporations to invest in R&D. All of the revenue from repealing the FDII deduction will be used to expand more effective R&D investment incentives.
- Enact A Minimum Tax on Large Corporations’ Book Income. The President’s tax reform will also ensure that large, profitable corporations cannot exploit loopholes in the tax code to get by without paying U.S. corporate taxes. A 15 percent minimum tax on the income corporations use to report their profits to investors—known as “book income”—will backstop the tax plan’s other ambitious reforms and apply only to the very largest corporations.
- Eliminate Tax Preferences for Fossil Fuels and Make Sure Polluting Industries Pay for Environmental Clean Up. The current tax code includes billions of dollars in subsidies, loopholes, and special foreign tax credits for the fossil fuel industry. As part of the President’s commitment to put the country on a path to net-zero emissions by 2050, his tax reform proposal will eliminate all these special preferences. The President is also proposing to restore payments from polluters into the Superfund Trust Fund so that polluting industries help fairly cover the cost of cleanups.
- Ramping Up Enforcement Against Corporations. All of these measures will make it much harder for the largest corporations to avoid or evade taxes by eliminating parts of the tax code that are too easily abused. This will be paired with an investment in enforcement to make sure corporations pay their fair share. Typical workers’ wages are reported to the IRS and their employer withholds, so they pay all the taxes they owe. By contrast, large corporations have at their disposal loopholes they exploit to avoid or evade tax liabilities, and an army of high-paid tax advisors and accountants who help them get away with this. At the same time, an under-funded IRS lacks the capacity to scrutinize these suspect tax maneuvers: A decade ago, essentially all large corporations were audited annually by the IRS; today, audit rates are less than 50 percent. This plan will reverse these trends, and make sure that the Internal Revenue Service has the resources it needs to effectively enforce the tax laws against corporations. This will be paired with a broader enforcement initiative to be announced in the coming weeks that will address tax evasion among corporations and high-income Americans.
These are key steps toward a fairer tax code that encourages investment in the United States, stops shifting of jobs and profits abroad, and makes sure that corporations pay their fair share. The President looks forward to working with Congress, and will be putting forward additional ideas in the coming weeks for reforming our tax code so that it rewards work and not wealth, and makes sure the highest income individuals pay their fair share.
Gerry Hughes was awarded a Research Fellowship from the ESRI from 1977 to 1979. He was at the ESRI from 1968 (taking secondment to the NESC in the 1970s) and retired as a Research Professor in 2006. His ESRI publications may be accessed on the ESRI web-site. Since retiring from the Institute he has been a Visiting Professor at the School of Business, Trinity College Dublin and also a Visiting Professor at the Department of Economics, University College Cork. His research is on the effects of pension financing on national savings and on the cost and distributional effects of tax expenditure on private pensions.
He remained active in retirement and was a recent recipient of the Miriam Hederman O’Brien Prize from the Foundation for Fiscal Studies for work on pensions with Micheál Collins of UCD.