The Republic helps big multinationals to engage in aggressive tax planning and the European Commission should regard it as one of five "EU tax havens" until substantial tax reforms are implemented. So says a report this week from the European Parliament. Ireland has long objected to this tag, but has also moved to reform or eliminate a range of loopholes in recent years as the heat is turned up under this issue internationally. So is it correct to call the State a tax haven? And what is the importance of what is happening?
1. The tax haven debate
Part of the row here comes down to semantics – and it is a bit of a distraction from the main arguments.
The Republic does not meet all the classic tests usually used to define a tax haven. Tax havens are usually seen as locations allowing people or companies to park money with zero or very low tax liability and with guaranteed secrecy. They are often associated with people hiding money from tax authorities illegally – tax evasion.
Ireland’s case is that our corporation tax rate, at 12.5 per cent, is low, but long established and that we operate as part of all the normal international tax structures. The multinationals that are the subject of controversy also in almost all cases have significant operations here and so are not just brass plates. Most employ thousands of people.
Together with the weather, this suggests that the Republic does not meet the test of being what most people would think of as a tax haven – a sunny island, with zero tax for non-residents, hidden money and a huge financial industry serving them.
So what does the European Parliament mean? Well it specifically refers to economies which have indicators suggesting they are used for aggressive tax planning by multinationals. These include a high share of foreign direct investment compared to the size of the economy and high levels of cash flowing through subsidiaries in the form of royalties, dividends or interest payments.
Here it identifies Cyprus, Ireland, Luxembourg, Malta and the Netherlands as the five culprits which it says the commission should recognise as EU tax havens, pending reforms. As well as these five countries, the commission has also previously criticised Belgium and Hungary. All seven facilitate aggressive tax planning by multinationals, it said.
These practices have led many tax campaigners and some research studies to dub Ireland and the other countries involved as tax havens. For example, Oxfam has criticised an EU blacklist of tax havens saying it should include "countries that are proven to attract profits from other countries", including the five states mentioned by the European Parliament.
It specifically highlights what it calls “pass-through” economies, through which multinationals channel cash as it moves from one part of their operations to another. Ireland is on this list. And of course the Apple tax judgement by the European Commission, finding that Ireland gave illegal state aid to the US giant via two tax decisions, also hit Ireland’s reputation, particularly given the €13 billion bill which Brussels says is owed. Ireland and Apple are appealing the decision.
Traditionally, tax havens were seen as places allowing illicit tax activity. Tax campaigners believe the definition should be extended to countries facilitating legal, but aggressive, tax avoidance. So why is the Republic in the spotlight?
2. The evidence
The State’s low 12.5 corporate tax rate has been the subject of controversy over the years, though less so recently as other countries have also reduced their headline rates. OECD data shows that the average take from firms here is close to the headline rates, in terms of taxable profits. However the real issue is not about the tax rates on declared profits, it is about how the rate of taxable profits are calculated.
Big companies have used the Republic – where many locate their European headquarters – as part of an international chain which has allowed them to reduce the taxes paid on profits earned outside the US.
The US system of taxing companies had, for many years, incentivised firms not to repatriate profits earned outside the US. Instead many built up large offshore cash piles and managed to arrange their affairs to pay low levels of tax on the profits involved. A lot of the anti-avoidance efforts in recent years has looked at how this was achieved, how the big companies used transfer pricing and other mechanisms to reduce their taxable profits – and what mechanisms were in place in national tax systems all over Europe and beyond to help them. As the European home of many of the big multinationals this put us in the spotlight.
The report by the European Parliament refers to work undertaken by the European Commission, which has looked for indicators of aggressive tax planning. These include very high levels of foreign direct investment in relation to the size of the economy and indications that high levels of money are moving through a country via royalty payments, dividends or interest payments. These are the typical devices used by multinationals to shift profits between their operations.
A European Commission study, referred to in its country reports on Ireland, said that the level of foreign direct investment into and out of Ireland “can only partly be explained by real economic activity”.
It has also highlighted the high level of royalty payments passing through Irish subsidiaries, which at around 25 per cent of GDP in 2015 and 2016 were well ahead of what occurs in any other EU country. Ireland has been seen as a “ conduit” – or a pass-through economy, as Oxfam put it – with money flowing through Irish subsidiaries for many years and out to offshore tax havens.
Royalty payments related to the use of intellectual property (IP) – the patents, copyrights and trademarks behind major products – were central to multinational tax planing. By charging their European operations for the use of this IP they reduced profits declared in Europe.
The commission has also highlighted specific aspects of the Irish tax structure for criticism, including the double Irish tax regime – now being phased out – and the lack of a withholding tax on many royalty payments. It also commented on the large capital allowances available for companies relocating their IP here, which was cut from 100 per cent to 80 per cent in relation to future IP moves in the 2018 budget .
The traditional chain of which the Republic has been a part is now changing, for two reasons. One is US tax changes which now oblige companies to pay a minimum amount of tax on offshore earnings.The other is a range of tax changes led by the OECD and EU which have made it more difficult to use tax havens and started to squeeze a lot of the measures which the multinationals used to cut their tax bills. One result of this has been that a number of big companies have relocated their IP from offshore tax havens to countries such as Ireland – where they are sitting beside real economic assets – in recent years. The big tax write-offs on this investment mean much of the resulting profit is sheltered for a period, but the trend is one factor behind the massive boost in the Irish corporate tax take in recent years.
With the double Irish – which allowed companies to register a subsidiary here but have it tax resident elsewhere – not available for new entrants and being phased out for existing players by next year, the old rules are quickly changing. How this settles down remains to be seen. The big multinationals look likely to pay some more tax. But how much more And where will they pay it?
3. What it means
The reform drive is now well underway. Ireland, like many other countries, has introduced a range of anti tax avoidance reforms in recent years, largely as part of a process led by the OECD ( the so-called Base Erosion and Profit Shifting Beps process) and as part of EU directives. Further consultations are underway as part of a corporate tax “roadmap” on transfer pricing rules and on some aspects of the treatment of royalty payments. The point of these rules is that if all countries move – more or less – together, it can cut the ability of firms to exploit gaps between jurisdictions.
The OECD is now pushing ahead with the next phase of its Beps process, looking in particular at how digital activities affect the tax take. It argues that more needs to be done to close the loopholes allowing companies to cut their tax bills. The IMF in a 2015 report estimated that this was costing exchequers internationally $600 billion (€530 billion) a year. In the background, the EU Commission is also pushing ahead with plans to reform the collection of corporate tax in Europe.
There are two different but connected trends here. One is to try to ensure multinationals and the big digital players pay more. The other is the fight for where they pay. Tax justice campaigners emphasise the former, arguing that companies are still depriving exchequers in the developed and developing world.
There is also a scrap on where tax should be paid. " The debate has moved from a "fair tax" to a "where tax" according to Feargal O'Rourke, managing partner of PwC, who said that the US reforms now ensure that minimum levels of tax are paid, but still leave it open where the payment is made.
This row on who should collect was evident in the recent EU row where big countries led by France were trying to get agreement for big digital players to pay a sales tax based on where their customers were, which would have mean paying less in countries such as the Republic where many have their EU base.
While the digital sales tax idea was parked, the new OECD work programme is also focusing on where tax should be paid, which would have a similar effect by directing more taxing rights to where digital players sell and less to where they operate from. It would be a massive change.
But after years when very little happened, changes in the US and those led by the OECD and EU are now slowly reframing the corporate tax landscape. Whether you define Ireland as a haven or not, this will mean big changes for us over the next few years.