Ireland & Beps Tax Reform: Services exports to drop 50%
Ireland & Beps Tax Reform: The final proposals of the OECD Beps (Base Erosion and Profit Shifting) project that were published on Monday, are expected to be ratified by the 19 leaders of the world's biggest advanced and emerging economies, at a G-20 summit next month in Turkey. There are many implications for Ireland including significant changes in the national accounts. For example reported services exports will plunge in coming years by up to 50% in value.
In 2014 Ireland's goods exports were valued at €113bn and goods imports were at €71bn giving a huge trade surplus of €42bn. Customs data put the value of exports at €89bn and imports at €54bn giving a surplus of €35bn.
Overseas manufacturing known as "contracting" that is likely tax avoidance-related mainly explains the difference in the data. Still the lower trade surplus is high (manufacturing royalty payments are booked in services) and more realistic transfer pricing will reduce the total.
Services exports overtook goods exports for the first time in 2012 and the decade-old mantra of Irish economists lauding increasing services exports as reflecting "a rise up the value chain" seemed to have been confirmed.
It was an illusion and in 2005 The Wall Street Journal had brought attention to how a Microsoft company operating from the offices of a Dublin law firm was helping it to slash taxes across Europe. The scheme would soon become commonly known as the Double Irish Dutch Sandwich when Jesse Drucker of Bloomberg revealed how Google was using it to cut its tax bill.
In 2014 Irish services exports were valued at €102bn and imports at €109bn — royalty payments rose by €12bn and these mainly reflect Double Irish transactions.
Microsoft typically books about 25% of its global revenues in Ireland; Google books 40% or more and Facebook about 50%. We estimate the their total 2014 bookings at $54bn (€42bn). Microsoft's fiscal year ends on 30 June and we have allowed for that.
In fiscal 2014, Ireland accounted only for $212m of $22bn in revenues booked by Microsoft Ireland Operations, the software giant's principal Irish company, with $16bn attributed to the rest of Europe and $3.1bn from the UK. Google UK accounted for 15% of Google Inc.'s revenues in 2007 and 10% in 2014 — these are booked in Ireland.
There are other companies such as Oracle — it booked revenues of €8bn in Ireland in the year to 31 May 2014 — where bookings are categorised in the national accounts as 'Computer services' and 'Business services.'
The data show that at least 50% of the current value of services exports are tax avoidance-related.
There is not usually an impact on growth figures as inward flows are matched by outflows but there are distortions to productivity data and innovation indicators.
Where mainly American companies shift their headquarters and tax residency to Ireland, there is an impact on both GNP (gross national product) and the Balance of Payments. For example, Balance of Payments/ current account surpluses reported in recent years were in fact deficits — see here.
These companies are significant as "Irish" firms: Six of them have a combined global payroll of 624,500 people — Accenture (305,000); Eaton (102,000); Medtronic (92,500); Seagate (52,000); Ingersoll-Rand (43,000) and Allergan (30,000).
Dublin's International Financial Services Centre (IFSC)
The IFSC will likely to be subject to more scrutiny.
Last week we reported on research by Gabriel Zucman, a French economist, that "out of the 8,000 funds registered for distribution in Switzerland, about 4,600 are incorporated in Luxembourg and 1,200 in Ireland...On their Swiss accounts, foreigners do own some US equities, but they mostly own Luxembourg and Irish fund shares (the funds, in turn, invest all around the world)."
Switzerland in effect allows foreign tax evaders to invest in funds domiciled in countries such as Luxembourg and Ireland.
Last year a German Bundestag parliamentary committee observed following a visit to Dublin that there was “little awareness” in Dublin of the potential risk in hosting hundreds of brass-plate companies with no staff or premises yet €1.7tn in assets — almost 11 times the State’s gross national product.
In 2013 the Tax Justice Network ranked Ireland at 47 of 82 countries in its Financial Secrecy Index — it wasn't a bad result. The US was at 6th and Germany at 8th.
Knowledge Development Box/ Patent Boxes
Several countries have introduced so-called patent box regimes or are planning to launch ones.These involve preferential tax regimes to promote innovation.
The OECD Beps project requires that "these regimes only grant preferential treatment to income derived from substantial activities effectively carried out by the taxpayer obtaining the benefit. This has been achieved through the adoption of the 'nexus' approach which is used to assess whether or not there is substantial activity in IP (intellectual property) regimes."
The nexus approach uses expenditure as a proxy for substantial activity. "More specifically, it is the proportion of expenditures directly related to development activities that demonstrates real value added by the taxpayer and acts as a proxy for how much substantial activity the taxpayer undertook."
Arthur Cox, Ireland's biggest corporate law firm, said in a January 2011 tax briefing, 'Uses of Ireland for German Companies':
"There are numerous advantages for multi-national companies with large Intellectual Property (IP) portfolios who locate and manage these portfolios in Ireland. The effective corporation tax rate can be reduced to as low as 2.5% for Irish companies whose trade involves the exploitation of intellectual property. The Irish IP regime is broad and applies to all types of IP. A generous scheme of capital allowances as well as a tax credit for money invested in research and development in Ireland offer significant incentives to companies who locate their activities in Ireland. A well-known global company recently moved the ownership and exploitation of an IP portfolio worth approximately $7bn to Ireland."
It is believed that the global company referred to was Accenture, the global consultancy, which moved its headquarters from Bermuda to Ireland in 2009.
This type of scheme will not be allowed in future and while Michael Noonan, finance minister, is expected to set the rate for the KDB on Budget Day, 13 Oct, the most important issue is not whether he will opt for a low 5% tax rate such as applies in The Netherlands or higher, but the reality is that it will take many years to get a significant return from the new regime. However, that would also likely require a significant change in the role of the indigenous sector in innovation.
Tax advisers are eager for new business in this area but government data show that only a small number of firms do significant research in Ireland and 54% of IDA Ireland client companies are R&D inactive.
The big exporters do not do research that merits patenting.
In a Sunday Independent interview in 2014, Dr Craig Barrett, former chairman of Intel, a leading US investor in Ireland, was asked could Ireland attract the really valuable Google and Twitter type R&D and innovation functions as well as supplying hewers of wood and drawers of water?
"No," Barrett replied. "I think to a degree it's a matter of numbers. You can have an Intel invested here as a creator of jobs but it's primarily a manufacturing investment."
"Those are good paying jobs and I think the Irish are very happy to have them and Intel is happy to be here. Intel also has engineering applications here with 300 employed in Shannon. But that's small compared to the engineering base it has in Santa Clara or Portland or Arizona, for example, and that's just a matter of numbers.
"The multinationals are going to go where the resources are. And the bulk of resources are not in Ireland because it's a small country of four or five million people. Look at it on the positive side, at least they're putting their HQs here."
Corporate tax reform will not have a significant impact in Ireland in the short to medium term. However, it's an interesting fact that direct jobs in the FDI (foreign direct investment) exporting sector are below the level of 15 years ago despite a 20% rise in the size of the workforce - for more data see here:
Pascal Saint-Amans, director Centre for Tax Policy and Administration, OECD and head of the Beps project
Feargal O'Rourke, managing partner of PWC Ireland, was an outlier in his business sector, when a few years ago he saw corporate tax reform as inevitable.
Now it's conventional wisdom.
PwC Ireland said on Monday that through the improved alignment of tax with activity, jobs and economic substance, the OECD have also signalled an end to “Cash Box” Caribbean companies. This significant move will result in many MNCs exploring their options for bringing their IP onshore. In a post Beps world, where the sustainability of very low tax rates may be questionable, the Irish corporate tax rate of 12.5% may become even more attractive for MNCs (multinationals) looking to consolidate their operations in a location where they can demonstrate real economic substance.
PwC said that in the area of coherence, the OECD has suggested rules to address mismatches in tax systems, excess interest deductions and the taxation of foreign subsidiaries. However, all of these suggestions are “best practice” in nature and there should be flexibility for governments in relation to implementation.
Peter Reilly, PwC Beps policy leader, commented: “The release of the OECD reports will give many multinational companies much food for thought. The increased transparency requirements will add an additional layer of compliance burden and will provide tax authorities with greater ammunition to query certain tax structures. However, the further guidance on the 'arm’s length' principle will mean that companies with real substance will be able to robustly defend the returns they make. As a country attracting investment based on real substance, real activity and real jobs, the new rules have the potential to be positive for Ireland. With its highly skilled workforce, easy access to the European, US and Asian markets and a competitive tax regime, companies that seek to onshore their IP may look to Ireland as a very attractive option in a post Beps world.”
Conor O'Brien, tax partner at KPMG said: "Ireland’s attractiveness for international business has the potential to increase in a post Beps world as its transparent, law and substance-based regime is consistent with the emerging Beps framework. Still, no doubt challenges and questions remain ahead and your KPMG team is available to help you with these
Peter Vale, tax partner at Grant Thornton said: "In the post Beps future, many groups operating across borders will have higher tax bills. The easiest way to reduce their tax bill is to move activities to a country with a low tax rate. Given that Ireland was also ranked by Forbes in 2013 as the best country in which to do business, we could see the Beps project result in further increases in foreign investment here.
On the risk side, the competitiveness of our tax regime is likely to be threatened by other countries reducing their corporate tax rates. It is surprising that the UK has been one of the few large economies to reduce its corporate tax rate significantly in recent years. The reduction in the UK’s rate has allowed the UK offer a much more compelling proposition to overseas investors and we are likely to see other countries follow suit.
In this environment, we need to remain innovative in our thinking. It will be disappointing if the tax rate applicable to the new Knowledge Development Box is 6.5%, as has recently been speculated. Countries such as the Netherlands and Luxembourg offer closer to a 5% rate for the equivalent regime.
While competing regimes may not yet be Beps compliant, Ireland needs to make a statement that it is serious about attracting high value add Research and Development activity to the country. A 5% tax rate would affirm that commitment; we will find out next week on Budget Day what the Minister has decided is the appropriate level.
Brian Keegan, director of taxation at Chartered Accountants Ireland: "While Beps sets out to tackle profit shifting, it is also about tax shifting. On a high level initial analysis, many of the Beps rules won’t alter the amount of tax paid by a multinational, but they will change where the tax is paid. Generally it looks like larger economies will win out over smaller economies. Ireland could benefit from some of the measures, but overall the Foreign Direct Investment package of tax measures will in the future be more difficult to construct and sustain.
Because all the proposals are the outcome of negotiations over a two year period among OECD member states (including Ireland) along with some other countries, the expectation is that the various proposals under the Minimum Standards classification will be adopted.
We understand that the Country by Country reporting proposal, whereby larger multinationals will have to make comprehensive country by country reports on their activities, will feature in the forthcoming Finance Bill. We also understand that the new Knowledge Development Box promised in last year’s Budget, which is a special tax incentive for companies developing and using high tech methods for new products, will be put into law in a “Beps compliant” way."
Deloitte and EY had no updates on Beps on their Irish websites.
Pic on top: 15 September 2015 - Angel Gurría, OECD secretary-general, and Michael Noonan, Ireland’s finance minister, during the launch of the OECD Economic Survey 2015. Dublin, Ireland.