A few weeks ago, this newspaper reported the remarkable fact that Coca-Cola had paid tax in Ireland between 2007 and 2009 at an average rate of just 1.4 per cent. We often get glimpses into the tax affairs of companies – via dividend payments to parents or whatever – but rarely discover details like this, which emerged from US legal proceedings.
With moves to international corporate tax reform among the key issues facing the Government next year, the details of the use of Irish subsidiaries in complex structures to lower tax bills remains controversial. The Government points out that the tax rules here have changed – but with corporate tax receipts soaring as the big players move more assets here, there is no doubt that Ireland remains firmly in the spotlight.
1. The Coke story
The Coca- Cola data emerged from a recent judgement in the US Tax Court in which the company was objecting to a $3.4 billion (€2.8 billion) tax demand from the US tax authorities – the Internal Revenue Service (IRS) – for the tax years 2007 to 2009. The IRS objected to the way the company had calculated its tax, which led to more profit being booked in the Irish subsidiary than it felt was justified. Coca-Cola lost the main argument, though it did win on a subsidiary point, so how much of the tax bill it has to pay remains unclear. It has also said it may appeal.
2. How was it done?
Financial transfers within companies in relation to intellectual property are at the heart of the tax debate. IP refers to copyrights, patents and trademarks – the so-called “ intangible assets”central to a company’s business.
In the case of Coca-Cola, its key IP is the concentrate used to make its drinks, based on a secret formula. The heart of the IRS case against the company is that its subsidiaries overseas should have paid more in royalties back to the parent company in the US to account for their use of the IP behind the concentrate. By not doing so, they ensured that the US parent had less income and thus paid less tax in the US. In contrast, the overseas subsidiaries made excess profits.
The international subsidiaries were in seven countries. They manufactured the concentrate – or syrup – and sold it on to Coca-Cola bottling companies across the world. These bottling companies are usually owned independently, but the parent directly owns the concentrate suppliers. So the point at issue refers to financial transfers within Coca-Cola itself and the way it organised these.
3. The Irish link
The judgement says that while subsidiaries in seven countries are involved, 85 per cent of what it judges to be excess profit came from the subsidiaries in Ireland and Brazil.
In total, the foreign subsidiaries should have paid an additional $9.5 billion in royalties to the US parent, the IRS said. Of this, some $6.2 billion should have come from the Irish operation. This would have greatly reduced profits reported in Ireland – close to $7.2 billion over the three years – and increased profits reported in the US.
The Irish operations was owned by a company called Atlantic Industries in the Cayman Islands tax haven – and has paid substantial dividends to this parent over the years. This is the second part of the story. A very low tax rate was paid on the profits retained in Ireland because the company funnelled the bulk of it to the Cayman Islands, which is a tax haven,
The evidence before the Tax Court showed that Ireland was at the centre of Coca-Cola’s international operations, making concentrates for more than 90 markets, including ones as far away as New Zealand and Papua New Guinea.In 2001 the company had moved the production of half the concentrate for a produce called Coke Red from its Mexican concentrate operation to Ireland, from where it was then shipped back to Mexican bottlers.
This high level of activity and sales of what was the clearly highly profitable concentrate led to the Irish subsidiary reporting huge returns. The IRS commissioned a report which found that the international operations, particularly the Irish one, were highly profitable. In the Irish case there was a return on assets of over 200 per cent and a gross profit margin (before deducing business expenses) of 80 per cent.
It then compared these to the profit levels earned by the Coca-Cola bottlers across the world, arguing that these were in the same industry and faced the same risks. Not surprisingly, it found the profits earned by the concentrate suppliers were way higher – and it argued the excess should be reallocated to the US. The court agreed.
4. The Double Irish
The Coca-Cola tax structure was enabled by tax laws across the world, including in the US where the ability of companies to hold large cash piles offshore was only ended by the new tax legislation in 2017. Complex US rules relating to the treatment of IP and so-called passive income have also been central to these structures.
Ireland has come under the spotlight, as part of our tax rules meant this country was a vital link in the chain of tax avoidance. A particular focus is the double Irish, a structure which allowed overseas multinationals to register a company in Ireland but have its tax residency elsewhere, usually in a tax haven like the Caymans. This company held the IP assets for sales outside the US. Utilising a second purely Irish branch company as well, this allowed profits earned outside the US to flow through Ireland and out to offshore tax havens.
So in the case of Coca-Cola , it would appear that close to 90 per cent of the profits earned over the 2007-09 period were effectively “offshore” in tax terms in the company not tax resident here, while the Irish 12.5 per cent tax was paid on the balance, held in the Irish branch. This meant the tax rate on the close to $7.2 billion in profits was just 1.4 per cent – a small part of it was taxed at the Irish rate and the majority wasn’t taxed at all.
The IRS has argued successfully that these profits should have been recognised in the US and not in the Cayman Islands. The decision rests on complex arguments about how transfer pricing should be managed. The abolition of the double Irish structure was announced in the 2015 budget, but for existing companies it has been phased out and will finally disappear at the end of this year.
5. The bigger picture
The row between the IRS and Coca-Cola is part of a wider dispute between tax authorities and companies – and an international debate – about how big international companies shift profits between subsidiaries to lower their tax bills. There are two separate points. One is argument over what has been within the rules and what is not. As well as the Coca-Cola case and the long-running dispute over the taxes paid by Apple in Ireland, Facebook is challenging an assessment by the IRS that it must pay $1.73 billion in additional tax for 2010 in relation to its management of IP between the US headquarters and its subsidiary in Ireland.
In the case of Facebook, it transferred its IP assets related to international markets to its Irish subsidiary at a value of $6.5 billion. However the IRS said the appropriate value was $13.8 billion. Again the transaction increased the profits attributable to its Irish operate and decreased tax paid in the US, albeit using a different structure to Coca-Cola. Facebook has warned investors that if the IRS wins the case it could be on the hook for tax payments of over $9 billion, as the same logic could be used for some subsequent years.
6. The key policy points
As talks on international tax reform continue under the aegis of the OECD, there are some key takeaways for Ireland.
– The country will remain in the firing line due to its historic position as the international headquarters for many big multinationals. Ireland has implemented change in line with the first phase of OECD reforms, and more is to come in relation to the accounting treatment of IP assets next year. The Government argues that the big companies have “ substance” here – in other words they have large operations employing thousands of people. Nonetheless, the Irish regime, the capital allowances provided for the use of IP assets and the role of companies here in profit shifting will remain controversial.
- The Coca-Cola and Apple cases show how different countries can lay claim to corporate tax. In the case of Coca-Cola, the US will get the cash. The European Commission, meanwhile, had argued that Apple owed more tax in Ireland and possibly elsewhere in Europe. Where tax is paid is a big part of the debate now underway.
- A key question is the attitude of the new Biden administration. Will it sign up to the OECD process on reform , which is seen in America to target its companies? Also, Biden has, like Trump, promised to bring investment "home" to the US, particularly in areas like pharma. A recent paper by tax expert Brad Setser, appointed by Biden as part of a transition team for the Office of the US Trade Representative, points to the role of Ireland as a manufacturer of pharmaceuticals for the US market. He argues that t the Trump 2017 Tax and Jobs Act increased the incentive for big pharma companies to manufacture high value products abroad. This is not only because of the low corporate profit rate here but also because of the way the US now taxes profits from intangible assets at a low rate.