Ireland’s corporate tax take has soared over the past few years, helping to pay for a lot of extra government spending. But there are fears that international moves to change the tax rules could cost Ireland revenue in the years ahead, as well – perhaps more significantly – as making it more difficult to use the tax regime to attract foreign investment here.
Our drive to attract foreign direct investment has been based, in part, on the push given to US companies by their own tax regime to serve overseas markets from locations outside the States. Big changes in US tax law have changed this, however, and now change looks to be on the way for global rules, too.
There are huge uncertainties and questions here – and a lot riding on the outcome. Here are the key points.
1. The basics
The jump in Irish corporate tax revenues in recent years has been enormous, up from €4.6 million in 2014 to €10.4 billion last year. The first really bumper year was 2015, when receipts at €6.87 billion were 50 per cent more than expected.
A Central Bank economic letter this week pointed out that over the years 2015 to 2018, corporate tax revenue had exceeded the forecast made at the start of the year by an average of €1.5 billion. Looked at another way, IBEC, the employer's body,says that if you look at the forecasts made back in 2014, the overshoot since then has been a whopping €14 billion, more than the €13 billion landmark Apple tax judgement.
Whatever way you look at it, corporation tax has been a vital factor in the growth of tax revenues over the last few years – and thus allowed for higher levels of spending on day-to-day services and on investment. Corporation tax has become an increasingly important source of revenue, accounting for around 18.5 per cent of all tax paid last year, compared to an international average of around 9 to 10 per cent.
The multinational sector is responsible for 80 per cent of the total corporation tax revenue collected and the 10 major players pay just under 40 per cent of the total. Despite the big payments made by the multinationals, their use of Ireland as part of their network of – legal – international tax avoidance has become controversial. This has left us exposed as reform comes down the tracks.
2. Why has corporate tax increased so much?
We don’t know the full story. But the scale of the gains suggests some unusual factors must have been in play.
In a presentation to a Department of Finance conference this week, Séamus Coffey, UCC economics professor and chairman of the Irish Fiscal Advisory Council underlined one key part of the mystery.
We know that Irish GDP was inflated in 2015 by the big movement of intellectual property here by some of the multinational players. Aircraft purchases by leading firms added to the statistical mix. Remember all the stuff about leprechaun economics?
Well you might conclude that the corporation tax surge, as it coincided with this, is down to the same thing. But that, says Coffey, would be a mistake, at least as far as 2015 and 2016 are concerned. When companies move their intellectual property(IP) – trademarks, copyrights, patents and so on – to Ireland, it does mean a lot more profits are earned by their Irish operations.
But Coffey’s analysis shows that, up to 2016 anyway, all these profits were sheltered from tax by capital allowances which the companies could claim relating to their investment in bringing the IP here. And we are talking big money here – an additional €26 billion was reported in profits here related to intangible assets in 2015 alone, with a similar amount claimed in capital allowances.
Those who brought in IP before 2017 could claim capital allowances over a period of years against 100 per cent of profits earned from the asset. Since then, the rules have been changed, so only 80 per cent of annual profits can be sheltered on IP moved here after October, 2017. So the tax surge since then may be attributable in part to 20 per cent of profits on IP moved after 2017 being open to tax, but we don’t have the data so we don’t know.
So why have taxes surged? Well, the economy has been strong and this has boosted profits. Also,tax advisers say that along with the IP, companies also relocated associated parts of their businesses here. In turn these earned significant extra profits, which yielded a lot more tax.
A range of other loopholes have also been tightened. And companies are moving to close down some of their more aggressive tax avoidance strategies, fearing the impact on their reputation. But the full story of the corporate tax surge since 2015 remains quite fuzzy.
3. What are the dangers to Irish corporate tax revenues?
There is now a determined international move to clamp down on the legal avenues used by multinationals to cut their tax bills. These generally arise from their ability to move profits, cash and assets between jurisdictions and erode the profit base on which they are taxed.
The IMF estimates that, despite the changes already introduced, this still costs exchequers worldwide some $600 billion (€530 billion ) a year. Already the action plan published in2015 after the first round of the OECD Base Erosion of Profit Shifting (BEPS)process is addressing some of these issues.
For example, Ireland has changed its rules in a number of areas, phasing out the controversial double Irish tax regime and now planning, after a consultation process, to change rules on the use of complex structures and inter-company interest payments.
But more change is on the way, with the OECD due to finalise an agreement by next year on the next part of the BEPS process and fundamental issues now on the table for the first time in many years, such as where and on what basis corporate tax is collected.
The outcome of this process is still very uncertain, but the direction looks clear. It looks likely to involve more tax being paid by many big companies where digital sales are made – in other words in big economies. This will mean less is paid in economies where they have their international headquarters, like Ireland.
As this is tax, it is predictably complicated and involves arguments both about how much big companies pay and where they pay it. Presentations at the Department of Finance conference by experts from the OECD and PWC estimated, tentatively, that €2 billion to €3 billion of our annual corporate tax revenue – or between 20 and almost 30 per cent – could be lost as these measures come into force and also as companies react to major changes in US corporate tax introduced in2017. The Department of Finance is already counting some of these risks in its own long-term forecasts.
4. Without getting too complicated, what is on the table?
The latest part of the BEPS process is driven in large part by the conundrums raised by digitalisation. Where, for example, should profit be counted and taxed if a big company manages an online platform from country one, on which tens of thousands of users in country two interact and do business together? Traditionally tax would be paid from where the activity was managed, but the argument now is that this is not realistic in a digitalised economy where, in our example, the activity of the users in country two creates value.
So the key part of the new BEPS process is examining the rules of what are called profit allocation and nexus, where profit is counted and tax is paid. Presentations at the Department of Finance conference outlined the various approaches being considered, which all generally try to recognise the economic value created in the big markets and expose some of the resulting profits to tax in that jurisdiction. This would lead to less profit being declared for tax here than would otherwise be the case.
All the new approaches under consideration allocate some profits to where sales happen, with some likely to mainly affect big digital companies – based on user participation on their platforms –and others likely to have a wider scope, also catching other businesses selling online.
Among the approaches being considered are new rules on the use of intangible assets – mainly IP – and new ways to judge where companies have a significant economic presence and should pay tax.
Part two of the BEPS process looks at specific anti-evasion measures. Among the measures under consideration here are a variety of devices which would guarantee the payment of a minimum amount of tax in some cases, particularly aimed at structures where companies use charges on IP assets to avoid tax.
New US tax rules have already introduced the concept of a minimum tax on US companies – a fundamental change from past practices where companies could store overseas earnings offshore and avoid tax.
The application and implication of the new US rules remains uncertain, but it reduces the push for US multinationals to move activities offshore purely to cut their tax bill – and could thus affect flows of FDI .
5. What are the big-picture implications for Ireland?
First, pretty much all local and international advisory bodies – the IMF, the EU, the Central Bank, the Fiscal Advisory Council, the ESRI and so on – are strongly warning the Government not to rely on soaring corporate taxes to pay for day-to-day spending rises.
The risk is that the tax base is eroded for some reason leaving less cash to fund ongoing spending commitments.
Second, significant uncertainty remains. The implications of the new US tax rules remains unclear and the OECD process could go in a variety of directions. For the moment, a separate EU push on digital tax and corporate tax generally is parked, but Ireland is now committed to the OECD process.
This makes budgetary planning difficult and leaves the Government open to pressure to spend extra revenues, as the threat to revenue is impossibly to quantify accurately. Minister for Finance, Paschal Donohoe said the department is now actively assessing new ways to plan the outlook for corporation tax.
Third, how this plays out for Ireland is thus unclear. There are obvious threats to revenue and to our ability to use tax as an attraction for multinational investment. But Ireland has benefited from the movement of some multinational functions and assets away from offshore havens like Bermuda and the Caymans and Séamus Coffey has pointed out that more of this could be in the pipeline. Also, if the IP that has moved here in recent years remains, then the profits from it will become exposed to tax as the capital allowances run out.
In terms of attracting FDI this also brings obvious risks for us. However it is clear that tax is just one of the reasons companies locate here, with the skills of the workforce increasingly important.
For many years very little happened in international corporate tax. Now, massive changes are underway, first in the US and now internationally. For a country which depends on foreign investment as a key employer and generator or wealth and tax, this is bound to be important.