State vulnerable as screws tighten on profit-shifting by US giants

Prudent budgetary planning would regard tax take from US firms as temporary

The exceptional profitability of US companies in Ireland reflects US tax law and how it is implemented by the US administration. Photograph: Mike Segar/Reuters

The exceptional profitability of US companies in Ireland reflects US tax law and how it is implemented by the US administration. Photograph: Mike Segar/Reuters

 

Since the late 1950s, the low Irish rate of corporation tax has played a key role in the successful development of the Irish economy through attracting foreign investment. However, it has long been clear that, as well as attracting real jobs to Ireland, the low rate has been used by foreign firms to reduce their global tax bill. This issue has attracted a lot of negative comment from fellow European Union members.

While, in principle, individual countries may intend to prevent firms reducing their global tax bills through moving their profits between countries, designing tax rules that achieve that isn’t easy. Profit-shifting is particularly difficult to police in a global economy with complicated supply chains, where parts of a production process take place in many different locations.

For example, if a firm has crankshafts for cars made by a subsidiary in country A, which are then assembled into engines in a subsidiary in country B, and then built into cars in country C, it can be very difficult for tax authorities to assign the overall profit on the cars to a particular location.

By charging a high price for the engines, much of the profit could be allocated to the country where the engines were made. The company could argue that their special skill (and intellectual property) is in making good engines, a difficult issue for tax authorities to contest.

Intellectual property

This process has become even more complex as the value of intellectual property (IP) in some industries has increased. In particular, we have seen how ownership of the IP in the information technology industry can be moved from country to country.

Clearly the IP is exceptionally valuable in such industries and is responsible for much of the profit. However, it is proving difficult for tax authorities to police where the ownership of this IP resides.

A high proportion of the €8 billion a year paid in corporation tax in Ireland comes from US companies. This revenue stream is vulnerable to changes in either US or EU tax rules

One indicator of the extent to which profits are shifted is company profitability in different locations. Eurostat publishes data for Ireland on the gross profits and the value added of companies by their country of ownership. For firms located in Ireland, the data shows considerable differences according to the country of ownership of the firms.

Between 2012 and 2016, the average gross profit rate for Irish-owned companies was about 40 per cent. For subsidiaries of UK companies that operated in Ireland the profit rate was not very different at 45 per cent of value added. This is not surprising as UK tax regulations have never facilitated profit-shifting to Ireland.

For German companies the profit rate was about 50 per cent, consistent with very limited shifting of profits to Ireland. The rate for French companies was slightly higher at about 55 per cent.

Of course, the profitability of firms varies across time and sectors. One would expect that companies that are expanding their operations internationally would tend to be more profitable than firms that don’t have such opportunities. This could account for some of the higher observed profit rates for EU companies operating in Ireland.

Even so, the data suggests that, for companies based in the EU, the tax laws in individual countries did not facilitate major shifting of profits to Ireland to take advantage of the low corporation tax rate. This runs counter to public perception among many of our EU partners.

US subsidiaries

The situation is dramatically different for US subsidiaries operating in Ireland. Between 2012 and 2015 their average gross profit rate was 90 per cent of value added, as against 40 per cent for Irish-owned companies and up to 50 per cent for EU companies in general.

Clearly there is very substantial shifting by US companies of their profits on global operations to their Irish subsidiaries. Relocations of firms to Ireland in 2015 raised the profit rate for US companies in that year to almost 95 per cent.

The exceptional profitability of US companies in Ireland reflects US tax law and how it is implemented by the US administration. If the US tax law was similar to that of most EU countries, much of US multinationals’ profits, now attributed to Ireland, would be treated as arising in the US, where the tax would be paid.

A high proportion of the €8 billion a year paid in corporation tax in Ireland comes from US companies. This revenue stream is vulnerable to changes in either US or EU tax rules, and could fall dramatically in response to such changes. While we do not know if or when such tax changes could occur, it is prudent to regard this is an uncertain and possibly temporary source of income in budgetary planning.

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