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.
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.
Professor David O’Mahony, former UCC Professor of Economics, passed away on March 10th. He was Professor of Economics in UCC from 1964 to 1988.
A highly-respected scholar, his works include The Irish economy: an introductory description (1964), Ireland and the EEC: political, legal and economic aspects (1972) and The general theory of profit equilibrium: Keynes and the entrepreneur economy (1998) (with Connell Fanning). In addition, he authored several Economic Research Institute (now ESRI) papers, in particular on collective bargaining and industrial relations.
Professor O’Mahony was widely held in great respect and affection by colleagues and students alike and will be sadly missed.
Funeral arrangements: https://rip.ie/death-notice/professor-david-o-mahony-sunday-s-well-cork/382183
Irish Economic Association Annual Conference 2019
The 33rd Annual Irish Economic Association Conference will be held in The River Lee Hotel, Western Road, Cork City on Thursday May 9th and Friday May 10th, 2019. Seamus Coffey (Department of Economics, University College Cork) is the local organiser.
The Association invites submissions of papers to be considered for the conference programme. Preference will be given to submissions that include a full paper. Papers may be on any area in Economics, Finance and Econometrics.
The deadline for submissions is Tuesday 5th of February 2019 and submissions can be made through this site.