Irish economy braced for Obama effect

The conditions under which US firms can inflate their profits by moving operations to Ireland could well change under Barack Obama, writes Arthur Beesley, Senior Business Correspondent

AMID ACUTE strain on the domestic economy, Barack Obama's ascent to power raises concern that his policy on the taxation of business profits could threaten the flow of US investment into Ireland and lead to job cuts in companies that already have operations here.

With unemployment rising sharply, any such contraction would further fuel recessionary pressure and undermine efforts by the Government and the business community to restore growth in the economy.

Although the US was the prime source of the copious foreign investment that helped bring the State into the economic fast lane in the 1990s, the conditions under which US firms can inflate their profits by moving operations here could well change under Obama.

The political system in Dublin is on high alert as a result. Ireland is the most intensive European economy for foreign direct investment. Firms backed by inward investment agency IDA Ireland employ some 152,000 people and almost half of them are from the US. With business costs rising, the relatively low rate of corporate tax is widely held to be the most crucial tool in Ireland's armoury.

"They're not happy. For foreign direct investment, it could be a disaster," said a senior figure with knowledge of thinking within the Government and IDA Ireland on Obama's corporate tax policy.

Such concern finds echoes within the business community. "Closing our tax advantage for US corporations and financial institutions would be very damaging for this economy - and, if added to our current economic issues, would have consequences that are very frightening," said Aidan Brady, chief of Citibank in Ireland.

"We need to ensure we lobby intelligently with Mr Obama's advisers to make sure we retain our tax advantage and point out that the changes suggested would put US companies abroad at a disadvantage to their overseas competitors."

On business taxation, the Obama manifesto sets out policies that would make it much more difficult for US corporations to shelter their overseas income from the US tax authorities while incentivising them to create more jobs at home.

The two-pronged logic here is to boost US public finances - Obama will be faced with a budget deficit that could yet reach $1 trillion - while stimulating economic activity on the ground.

This is in keeping with policies designed to reverse the downside in the US from globalisation, where many multinationals have outsourced operations to cheaper locations overseas at a cost of millions of jobs. Still, outgoing treasury secretary Hank Paulson warned in recent months that US multinationals would "shrivel up" if they were discouraged from investing overseas.

With US stock markets in dire condition and many companies struggling for survival, Obama will have to measure the desirability of a higher tax take against the risk of endangering company viability or competitiveness in the global market. After all, his most urgent immediate task in the White House will to be to arrest the rapid decline of the US economy, which is in the maw of a crisis comparable with the Great Depression of the 1930s.

Tax policy - a fundamental economic lever for any government - will be crucial to that effort. Specifically, Obama was co-sponsor of a Senate bill last year that aimed to bring some $30 billion of business profits into the US tax net by curtailing the use of secretive offshore tax havens.

Such jurisdictions offer zero or very low tax rates, a lack of transparency and the absence of any requirement to carry out real business. Ireland, however, was not named in the Bill.

"Ireland is not listed as a tax haven in the Obama Bill and to the extent that that is an indication of his thinking, that's very positive," said Pat Wall, international tax partner at accountants PricewaterhouseCoopers.

But there is more to Obama's policy than a clampdown on the use of tax havens, a tag rejected by IDA Ireland and others in the Irish inward investment world.

Importantly, his manifesto includes a pledge to aggressively reform the rules on the "deferral" of US taxation on business profits earned overseas.

Deferral means means corporations don't pay US tax on foreign profit from active business until the money in question is returned to the US. A reform of the rule could see a greater portion of foreign profits taxed in the year they are booked, increasing a corporation's upfront tax bill and potentially acting as a disincentive to foreign direct investment unless there is a compelling reason to be in a market.

In theory at least, an outright elimination of the system could seriously threaten US investment in Ireland.

"Unless you have a real reason to be in that market you probably might think twice about investing," said Leonard Levin, a tax attorney at New York accounting firm Weiser.

"It's a revenue measure, pure and simple. The government is looking for funding to claw back the hundreds of billions of dollars it has pumped into the banking system."

Politicians rarely fulfil all of their election promises when they take office so it remains to be seen whether the president-elect changes the deferral rules. Notwithstanding his campaign commitments, he is likely to come under political pressure to change his position in the wider interest of US commerce.

But his policy still raises important issues for Ireland, whose 12.5 per cent corporation tax rate compares very favourably with the 39.3 per cent combined average federal and state rate that applies in the US. The difference between the two rates makes it very attractive for US corporations to locate significant and small-scale operations here. Their names in many instances are well known - Microsoft, Intel, Pfizer, Dell, Google, Wyeth, Apple Computer and HP (formerly Hewlett-Packard).

Such organisations employ tens of thousands of Irish workers, but their profitability is something of an unknown quantity. Thanks to the legislation that governs companies with unlimited liability, a structure used by many of the largest US companies with Irish operations, it is virtually impossible for outsiders to ascertain the amount of profits they make.

However, official figures collated by the US Bureau of Economic Analysis (BEA) illustrate the extent to which the totality of US company net profits here has risen since the Irish authorities brought the corporation tax rate to 12.5 per cent in 2003 from 38 per cent at the start of 1997.

Figures from BEA, a branch of the US commerce department, show that the net profits by US firms here grew to $48 billion in 2005 from $8.58 billion in 1997. Such data, derived from returns from mandatory legal survey, shows that the total of US company sales in Ireland was $151.52 billion in 2005.

That equates with a net profit margin in excess of 31 per cent. This probably reflects incentives to encourage firms to locate intellectual capital assets and research here and cuts the tax on profits from the sale by Irish-based holding companies on their subsidiaries.

"We can't predict what's going to happen," said Martin Murphy, chief of HP's Irish unit, which employs some 4,000 staff. "But most American companies like HP are global players and I can't imagine he [Obama] will make changes that would make them uncompetitive in a global market."

Soon we will know.