Is it true to say Ireland is one of the world's biggest tax havens?

As talks on global corporate tax reform reach a crunch stage, the State’s reputation continues to take heavy hits. One recent report said that the bulk of the foreign direct investment here was “phantom” and driven by tax avoidance. Another said that we are one of the world’s biggest tax havens.

With a massive shake-up of the global corporate tax system under discussion at the OECD – which could hit our corporate tax revenues – this relentless battering of Ireland’s reputation leaves the country exposed. But what is the truth behind the headlines ?

1. Ireland as a tax haven?

Is Ireland is actually a tax haven. Let's look at the work of US economist Gabriel Zucman, whose forthcoming book on the issue has his analysis back in the news. A paper already published with Thomas Wright for the US National Bureau of Economic Research, entitled The Exorbitant Tax Privilege gives Zucman's analysis, featuring the Republic squarely as a tax haven.

The privilege the authors refer to is the low rate of tax paid by US multinationals operating internationally. The paper finds that the effective tax rate paid by multinationals on foreign earnings “has collapsed since the mid-1990s”.

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In part it blames US rule changes in the mid-1990s for leading to a surge in profits booked in tax havens by big US players, which rose from 20 per cent of all foreign profits in the first half of the 1990s to 50 per cent in recent years.

This has cut the tax paid on international profits from around 35 per cent to 20 per cent over the period, the authors calculate. (In passing we should say here that estimates of profit-shifting, in particular, are controversial and hard to measure.)

Ireland is one of the key locations where US firms incorporate subsidiaries which make profits subject to very little tax. Zucman calculates the rate paid on profits declared by these companies at just 4.9 per cent, making Ireland, along with Puerto Rico, central to the story of how US companies cut the tax bill on their overseas earnings.

Zucman calculates that in recent years some 15 per cent of overseas profits of US multinationals have been booked in Ireland and that the US rule change in the mid-1990s was a key factor in increasing this from previous levels of closer to 5 per cent.

2.What does this tell us about the Irish tax regime – and is Zucman’s tax haven tag justified?

First, the important caveat. The US statistics on which the analysis is based looks at where companies are incorporated, which is not necessarily where economic activity takes place. So a company could be incorporated in Ireland and have its tax residency, or much of its operations , elsewhere.

A paper from the Department of Finance argued that analysis on the basis of this US data is a poor indicator, as " there is no way of knowing where the activities of these companies actually take place".

In many cases the companies involved have been resident in tax havens where zero tax was charged, or, in the case of a pervious Apple structure, tax resident nowhere. Indeed the total sales of these companies is greater than all Irish exports – so clearly all their operations are not based here. Detailed country-by-country operations data would help to clear all this up.

There is another “ but” here, however. The figures do show the use of Ireland as a key part of the global chain used by these companies to cut their tax bills.

The controversial double Irish tax relief, being phased out by next year, was based on helping companies to be incorporated in Ireland and tax resident elsewhere. Some of the Irish rules in relation to transactions between different subsidiaries of one company have also been changed – or will change soon – as part of the crackdown on the shifting of profits to avoid tax.

Zucman and others believe that this justifies the tax haven tag. The Government and many Irish tax accountants dispute this, saying that Ireland does not meet the key tests of being a tax haven, notably zero tax and secrecy. And that companies pay the tax that is due on their actual operations here.

It is partly a semantic debate, but it is important to get the facts clear. We don’t have evidence of rock bottom tax rates on multinational profits earned in the Irish market. But most of the sales from Irish subsidiaries are to other markets. And there is evidence that Irish incorporated companies have been used as part of a chain through which profits moved to cut tax bills.

You could argue all day about whether these profits should have been taxed in Ireland or elsewhere – and to me the US seems the biggest loser. But the global consensus is that they should have been taxed at a much higher rate somewhere. And, like it or not, we are at the centre of this row.

3.Is Ireland home to billions in phantom investment ?

The second “hit” to Ireland’s reputation in recent weeks came from a discussion paper published by the IMF called The Rise of Phantom Investments, written by economists from the IMF and the University of Copenhagen. They argue that up to $40 trillion (€36 trillion) in global investment counted as foreign direct investment (FDI) is, in fact, driven by cash flowing through corporate shells as part of tax avoidance plans. On their calculations, not far off 40 per cent of the stock of global FDI falls into this phantom category.

And, you've guessed it, Ireland again features in this story, with the authors calculating that some $500 billion of our FDI capital stock may be "phantom". We are behind Luxembourg, the Netherlands and Hong Kong as a home for what they authors identify as special investment vehicles with no real presence – but as a proportion of the FDI located here the figure is obviously very significant.

So far the authors have published just a short article on their work, with the full paper, the data and the methodology still to come.* Still, wide media reporting of the IMF paper including on the front page of the Financial Times has put Ireland in the spotlight.

Irish economists raise questions about the basis of the data used. In particular, the Republic’s status as the location for the international headquarters of the major firms means that revenues earned in markets outsider the US typically flow through their Irish operations – and it appears this may distort the investment data. There is also the issue of how retained earnings held here are dealt with, often reinvested in financial instruments such as bonds. UCC economists Séamus Coffey has tweeted: “These certainly aren’t “phantom” but don’t fit the traditional idea of what we think FDI to be.”

We will have to see the detail of the methodology in the final paper to inform this debate further.

4.What about all the new investment here and the Leprechaun economics debate?

Another factor which has entered the equation in recent years goes to the centre of the argument about “ real” investment. Because new international rules discourage the use of traditional tax havens, big multinationals have been moving some intangible assets to Ireland. Specifically, a number have moved the hugely valuable intellectual property (IP)rights – trademarks, copyrights, patents and so – for international markets to Ireland. These assets have been central to their tax planning for years, as companies can charge their subsidiaries for the use of this IP in markets in which they sell and thus reduce taxable profits. These IP assets have been central to tax planing in recent years.

This has involved billions in new investment coming to Ireland from probably 15 to 20 major companies, including Apple, relocating IP assets here. This was the cause of the massive surge in GDP of over 25 per cent in 2015, also mentioned in the IMF paper, which led to Paul Krugman’s “Leprechaun economics” jibe. In turn, this will lead to huge new profits being declared in Irish subsidiaries. However as these IP moves are counted as investments, they attract a tax write-off for a period of years. So not much tax will currently be paid by multinationals here on the profits earned from the use of these assets, though if the IP remains here, this could change in future as the tax write-off are time limited.

On one hand this movement of IP assets to a country such as the Republic is exactly what the OECD rule change intended, as it moves assets to a country in which the companies involved have massive investments. Coffey has estimated that real FDI here could be worth €50 billion, with companies spending €20 billion annually in the economy.

On the flipside. these IP assets have limited links with what is actually happening in Ireland. The original research and development of products is typically conducted in the US. And the use of IP as a central part of tax planning, effectively a tool to land profits in lower tax economies, will remain controversial.

The move of the IP assets has coincided with a surge in corporate tax revenues here, though precisely why there has been such a strong rise remains unexplained, given that the direct profits from these assets remain generally sheltered from tax. The IMF paper argues that “ this strategy may be helpful to Ireland, but it erodes the tax base in other economies”. Phantom or not, the FDI surge which is pushing up our tax revenues has us firmly in the spotlight.

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The bottom line is that Ireland is now under enormous pressure to agree to the OECD tax plan, assuming there is a general consensus on this in the months ahead. We are also reforming part of our existing rules in line with previous OECD rules, notably the transfer pricing regime. But the big, unanswered, question is what impact this will have on our corporate tax revenue.

*I have asked the authors for any further available details and will update this article if these are provided.