The contribution of US companies to Ireland and the taxation of their profits

The contribution of US multinational companies to the Irish economy is immense.  There are around 1,000 US companies with operations here and they provide around 100,000 direct jobs.

Each year, these companies pay €6 billion in wages to Irish employees, spend €2 billion on fixed capital investment helping the construction sector in Ireland and contribute €2 billion in Corporation Tax to the Exchequer.  That is €10 billion a year, every year.

This omits other contributions which are difficult to quantify such as VAT and other taxes, indirect expenditure on security, logistics, catering, cleaning and other services, as well as thousands of agency workers used by the companies.  There are also other largely unseen things like outsourced manufacturing,  quality control and research activities, and, of course, expenditure on professional services from legal, accountancy and tax firms here.

It is difficult to pinpoint the contribution these expenditures from US companies make to the Irish economy but it is a significant amount.  Figures from Forfás show that IDA-supported companies spend about €10 billion a year on Irish services and €2 billion a year on Irish materials.

We can take it that the €10 billion a year figure from wages, capital investment and Corporation Tax is the lower bound of the contribution of US companies here.  The figure is probably closer to €15 billion.  By taking into account Income Tax, PRSI and receipts from the indirect effects noted above it likely that government revenue is a beneficiary of more than €5 billion a year from the presence of US MNCs here.

Are there risks from this? Of course there are.  The US companies are here for commercial reasons.  It is always a risk that better commercial reasons will see them move somewhere else.

Are US MNCs in Ireland for tax reasons?  Of course they are.  Ireland has one of the lowest rates of Corporation Tax in the OECD.  But it cannot be the only reason.  There are other countries that offer similarly attractive tax regimes (as it is something that is relatively easy to replicate) but the choice of Ireland means we have something more.

There is substantial commentary that US MNCs are in Ireland solely to avoid Corporation Tax.  This sometimes ignores the fact the US companies pay €2 billion of Corporation Tax here each year.  If it was so easy to avoid how do we collect so much?  Around 80 percent of Corporation Tax receipts come from foreign-owned companies.

Although we can only approximate, the taxable income of US MNCs here is around €20 billion which gives an effective rate of 10 per cent. In contrast Irish companies have taxable profits of around €9 billion and their Corporation Tax payments of around €800 million give an effective tax rate of around 9 per cent.  There is no evidence that indigenous companies are at a tax disadvantage to US companies on their profits earned in Ireland (though there is evidence that Irish companies are not very profitable).

We do know that US MNCs have complex arrangements to try and minimise their overall tax bill.  Everybody tries to minimise their tax bill and while the strategies used can appear egregious in nature none of them are illegal.

The main determinant of the strategies pursued by US MNCs is the US tax code.  The taxation of MNCs is complex but is based on a pretty fundamental principle: corporate profit taxing rights are granted on the source principle.  That is, countries can tax the profits from risks, functions and assets that are located in their countries.  Location is based on the concept of permanent establishment and transfer pricing agreements are put in place to allocate profits across these risks, functions and assets.

The gross operating surplus (GOS is an national accounting concept akin to accounting concept of EBITDA – Earnings before Interest, Tax, Depreciation and Amortisation) attributed to the activities of US MNCs in Ireland is around €25 billion a year.  This is around €250,000 per employee which appears large but the total is only a small proportion of the overall profits earned by these companies.

Apple alone has annual profits of $40 billion.  This is not attributed to Ireland because the risks, functions and assets that generate this profit are not located here.  Apple’s 4,000 employees are important for the company but they are not the reason the company makes $40 billion in annual profits.

A large amount of the profits earned by US MNCs comes from their intangible assets such as intellectual property rights on the products and services they have invented and reputation and loyalty from the brand names they have marketed.  Current transfer pricing rules rightfully attribute much of the profits of these MNCs to their intangibles and as these are developed in the US the taxing right for these profits is granted to the US.

At 35 per cent the US has the highest corporate income tax rate in the US and with state taxes this rate can be 39 per cent.  However, the US corporate tax code is incredibly complex and has numerous peculiarities.  One of these is the concept of “deferral” for corporate income taxes which means US MNCs can delay certain tax payments until the profits are transferred to US-incorporated entities in their corporate structure.

The primary objective of many of the tax strategies used by US MNCs is to engineer such a deferral, sometimes permanently.  These strategies do not affect the tax paid in countries such as Ireland, where they have manufacturing or trading operations, or countries around the world where they have their customers.  The tax paid in these countries are based on internationally-agreed standards for transfer pricing and permanent establishment.

The profits that many of these US MNCs earn are based on activities that take place in the US and assets that are held in the US.  As a result of the deferral provisions in the US tax code some companies create an artificial division between their US and non-US source profits.  The reality is that most of the profit is sourced in the US and the companies owe US corporate income tax on those profits.

The lead of the OECD’s BEPS project, Pascal Saint-Amans, appeared before the Oireachtas Finance Committee last year and said that “the tax is due in the US rather than in Ireland for the simple reason that the intangible has been developed in the US, is owned by the US and should be taxable in the US, so there is a reason not to tax profit which is not accruing in Ireland.” He added that “assuming the best action plan translates into domestic legislation in all countries, including the US, the companies in question would be taxable in the US and would not benefit from what they enjoy, which is double non-taxation.”

A quick look at Apple’s financial statements shows that the company has built up a deferred tax liability of $41 billion over the last few years.  Apple pulled a “stateless” company ruse but the biggest impact of this was to defer the payment of US taxes.  Apple’s financial statements clearly state that it owes $41 billion of tax but it will only have to pay when, or if, it transfers the profits to a US-incorporated entity in its structure.  This may never happen.

It is not the case that the profits of these companies are untaxed.  The taxing right is granted to the US.  If the US has deferral provisions that allows these companies to delay the payment of this tax that is their business.

Ireland’s rules, and residence rules in particular, are compatible with the deferral provisions of the US tax code but there is no evidence that Ireland’s rules were deliberately changed to facilitate the use of these provisions.  Ireland is perhaps guilty of sins of omission in not changing them but the rules themselves are based on historical British standards.

Ireland’s residency rules are changing but the impact on tax outcomes will be nil.  They are not important to the tax strategies of US MNCs.  The factors that matter are transfer pricing rules, the definition of permanent establishment and, crucially, the deferral provisions in the US tax code.  It is proposed changes in these that warrant attention not Ireland’s residency rules.

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