Is Ireland’s corporation tax regime fit for purpose?
The Irish corporation tax regime has received much recent publicity – most of it not benign. This raises the question of what the purpose of the corporation tax regime is and whether it is fit for purpose. I would suggest that the key objectives of the regime are the creation of employment and the generation of taxation revenues in a way that is ethical, consistent with our international obligations and mindful of our reputation.
Ireland has become highly successful in attracting FDI. This was probably the most significant factor in transforming Ireland’s economy. Our recent woes are not because the corporation tax regime has failed us but rather because we squandered its fruits. The brightest spot on our economic horizon has been the continued large amount of FDI and it is important to remember that it is in Ireland’s, rather than the multinationals’, vital economic interest that we retain this investment.
What then of recent criticism of the Irish regime? There is a great deal of confusion on this topic. The following might help to clarify. Firstly, Ireland offers a 12.5 per cent rate of corporation tax and does not offer a lower rate for special cases. References to special tax rates or deals in Ireland seem to be based on a number calculated by blending the rate applying to the profits of an Irish resident entity (company or branch) with the rate applying to a non-Irish resident related entity (R&D credits, which are common throughout the world and EU-approved, means the Irish average effective rate is slightly lower than 12.5 per cent).
Secondly, much confusion has been caused because in some cases the non-Irish tax resident entity involved may be Irish incorporated. Our tax system, with some exceptions, takes the view that a company incorporated here does not have to pay taxes in Ireland on non-Irish profits if the company is not resident in Ireland. This causes confusion in the US where corporate tax residence is based exclusively on the place of incorporation. A US person looking at an Irish incorporated entity may, applying US principles, expect the company to pay Irish tax. For the reasons stated, it may however have no exposure to Irish tax at all.
It is the US rules on corporate tax residence which are unusual and out of line with international norms rather than ours. Irish rules on corporate tax residence have their origin in UK case law. The leading case is the “De Beers” case from 1906 where it was held that the place where a company is “managed and controlled” determines where it is resident. Interestingly, a key factor in the court’s decision was that an incorporation test for residence would, in the court’s view, have given rise to greater tax avoidance possibilities. Ireland, like many countries, has maintained a management and control test for residence ever since.
Significantly the OECD has approved the test as the deciding factor for corporate residence in conflicts between countries as to the place of corporate residence. The only major change in the last 100 years to our corporate residence rules was in 1999 when non-Irish incorporated companies based in non-treaty countries and with no connection with an Irish business were deemed to be Irish tax resident. This was an ultimately successful attempt to discourage the use of such companies by groups with no connection with Ireland where Ireland would have had no visibility on the nature of the activity carried on by the entity concerned.
The other significant item of controversy is how profits are allocated between an Irish resident entity and related non-Irish resident companies (or head office in the case of a branch) that it deals with. The answer is in accordance with OECD standard transfer pricing principles and international norms. It is normal that an Irish company would be charged a royalty and get a tax deduction for intellectual property (“IP”) crucial to its business. This is not an unusual feature of the Irish tax system. Equally it is normal where IP is held in a foreign head office, that most of the profits of an entity would be allocated to that foreign head office.
So why the controversy about the Irish tax regime? Firstly, international tax rules are complex. Secondly, the fact that Ireland, with its own transparent regime, is associated with companies resident outside Ireland which pay little or no tax. It is important to note that similar transactions arise in other countries all of the time. Because Ireland has been so successful in attracting so many iconic US businesses, our name is far more likely to crop up when these matters are examined.
It is vital that our regime remains competitive. Our income and capital gains tax rates have risen whilst the UK now undercuts our tax offering in many respects. We also need to protect our regime’s reputation even when a great deal of the criticism is unwarranted.
Conor O’Brien is the head of tax at KPMG in Ireland and author of the Institute of Taxation’s book on Double Taxation Treaties