Tuesday, October 3, 2017

The current account: where do we stand?

Here are the estimates of the current account of the Balance of Payments as currently provided by the CSO:

BoP Current Account Unadjusted

As we have explained before the recent changes of the current account are telling us close to nothing about the underlying external position of the economy.  Making the * adjustments used to determine GNI* doesn’t offer much and only gets us to this:

Bop Current Account Star Adjustments

The modified current account adjusts for the net income of redomiciled PLCs (which ultimately doesn’t accrue to Irish residents) and the depreciation of foreign-owned aircraft for leasing and intangible assets (which accrues to non-residents through the repayment of debt rather than income).  These adjustments may have given us a better level indicator of national income, GNI*, but still left us with a current account that offered little insight.

In our previous effort, we made a further adjustment for the acquisition of these aircraft for leasing and intangible assets.  That is because these items are imported but the purchases are not funded from domestic sources so any deficit that results from these is not reflective of the underlying position of the economy.  Any such deficits are funded by intra-company lending.  Using figures for the investment in these assets gets us to:

Bop Current Account Acquisition Adjustments

This is undoubtedly an improvement and the orange line reflects what we might expect an underlying current account to do.  It deteriorates up to 2008, then shows some improvement and returns to balance in 2014.  However, it is what happened then that suggested all was not what it seemed to be.  Yes, we probably would have expected the underlying current account to continue improving in 2015 and 2016 but the improvements here seemed too large and by 2016 the orange line is showing a surplus of €13 billion.

The issue seems to be related to imports of R&D services and we tried to explore the implications of this for GNI* here.  The issue is whether expenditure on R&D activity should be treated as intermediate consumption (thus reducing profits) or a capital item (investment).  The move to new national accounting standards sees R&D spending treated as a capital item but certain issues remain in the introduction of a consistent treatment across the national accounts and the balance of payments.

Although R&D spending is treated as a capital item in the national accounts it is still treated as intermediate consumption for balance of payments purposes.  The previous post runs through this in more detail but when a consistent treatment is taken it is likely the outflows of profits will increase by the amount of spending on R&D service imports (as almost all of this is undertaken by foreign-owned MNCs.)

It’s all becoming messy now but if we make a further adjustment for imports of R&D services this is what we get:

Bop Current Account R and D Adjustment

That looks about right.  The balance has been adjusted down for all years but this difference increases for 2015 and 2016 when R&D service imports really ramped up.  The green line reflects what we would think an underlying current account balance would look like and has steady improvement to a small surplus in 2016 unlike the rapid increases of the earlier attempt.

So let’s put this underlying measure relative to GNI* to see what we get (though we have some issues over how R&D service imports are influencing that).

Bop Current Account Underlying to GNI star 

As the label shows it is quite the journey from the official estimate of the current account to this derived underlying measure.  There may be some issues here and there but it seems to fit the bill.  The current account deficit that began to open in 2004 and 2005 and looks like it returned to something close to balance last year after a number of years of sustained improvements.  We’ll take that.  For now.

Here is a table showing the adjustments made. Click to enlarge.

Bop Current Account Adjustments Table

And to conclude here is something which may or may not change the underlying position – R&D exports.  All the focus has been on onshoring of IP but it seems like there is also IP going in the other direction with a surge in IP exports in recent years (albeit at a scale much much smaller than what has been happening in the other direction).

Bop Current Account R and D Exports

Monday, October 2, 2017

Effective Tax Rates in the C&AG Report-Companies

Comparing effective tax rates across countries may be difficult but comparing them across companies using the same system should be insightful.  And we get significant added value from the C&AG report chapter on Corporation Tax Receipts in the analysis provided of the “Top 100” companies.

The C&AG place companies in the “Top 100” using their Taxable Income and Tax Due figures for 2015.  The table below gives the outturns for these, and the steps between them, in the aggregate Corporation Tax computation published by the Revenue Commissioners.

Revenue CT Comp 2011 to 2015

For 2015, we can see that €65.1 billion of Taxable Income resulted in €6.2 billion of tax due or 9.6 per cent of Taxable Income.  There is lots going on before we even get to Taxable Income (capital allowances, loss relief and trade charges) which is where most previous attention has focused.  The C&AG report gives some insight into what happens lower down the calculation. 

The table shows that before any reliefs or credits are applied the 12.5 per cent and 25 per cent Corporation Tax rates gave rise to €8.4 billion of gross tax (12.9 per cent of taxable income) with the reliefs and credits leading to the €6.2 billion tax due figure.

Of the two ranking used by the C&AG the ranking by Taxable Income is probably the most informative as it gives the position before the application of credits and reliefs.  The distribution of effective tax rates (tax due as a percentage of taxable income) for the top 100 companies by taxable income is given in this useful chart:

C and AG ETR by Taxable Income

The overall rate for the top 100 is put at 9.3 per cent but there is significant variability within the group.  Reassuringly, depending in your perspective, 79 of the 100 companies had effective rates (using the tax due as a proportion of taxable income approach) of between 10 and 15 per cent with 57 companies having rates of 12.5 per cent or above (likely reflecting the 25 per cent CT rate on non-trading income).  At the other end, though, 13 companies have effective rates of less than one per cent with eight being zero or negative which unsurprisingly is where attention was drawn.

How can this be?  Well, the C&AG report (and the table above) tell us:

Of the 13 taxpayers with an effective rate of less than 1% for 2015, they had availed either of double taxation relief to offset Irish corporation tax or of the research and development tax credit or of both these reliefs. The other 43 taxpayers with an effective rate of less than 12.5% had also availed of various reliefs.

There are no loopholes here.  Double tax relief and the R&D credit are central parts of the Irish Corporation Tax regime.

Ireland uses a worldwide system so profits earned abroad are included in an Irish-resident entity’s taxable income.  There as €7.5 billion of “foreign income” included in Ireland’s Corporation Tax base in 2015.  To allow for the tax paid on that in the source country Ireland grants a credit to avoid double taxation.  Total relief for tax incurred abroad amounted to €1,195 million in 2015 (double tax relief was €947 million and the additional foreign tax credit was €238 million).

We don’t get a break down of companies using double tax relief but any Irish-resident companies whose taxable income is derived from activities outside of Ireland will have an effective tax rate close to zero as the relief available for tax paid abroad will almost always fully offset the tax due at 12.5 per cent in Ireland.  If they do have Irish-source income it will be taxes at 12.5 per cent unless they use the second major relief which is the R&D tax credit.

In 2015, claims under the R&D tax credit amounted to €708 million (of which €349 million was used and €359 million was the payment to firms of excess R&D credit).

If double tax relief can be viewed as relief for tax incurred abroad, the R&D credit can be considered relief for (a particular) an expense incurred in Ireland.  Claims that the zero per cent rates reflect tax avoidance are a little wide of the mark given that to achieve them the company must either pay tax abroad or spend money in Ireland.

Of course, what the R&D credit does is subsidise that expense and whether that is justified is an important policy question which was addressed by this 2016 evaluation published by the Department of Finance while Ireland’s approach can be compared to that used internationally in this  OECD review of R&D incentives published a few weeks ago. 

Spending 100 to get back 37.5 (12.5 from the standard deduction of the expense and 25 via the credit) does not make sense unless the company expects the R&D activity to lead to increased profitability in the future.  In the absence of the credit companies will undertake some R&D and the 2016 evaluation found a 40 per cent deadweight from the scheme.  That is, while 60 per cent of the associated R&D activity from the result of the scheme, 40 per cent would have taken place anyway and these companies benefitted from partial public funding of R&D they would have fully funded privately anyway. 

On the repayable component of the scheme (i.e. instances where the tax credit is less than a companies computed tax bill) which were the subject of a recent set of parliamentary questions the evaluation finds:

Analysis of the firm characteristics of the R&D tax credit show that it is mainly older, larger and non-Irish firms who derive financial benefit from the scheme, although it is typically Irish firms who benefit more from the repayable credit element of the scheme.

Should we be concerned with the zero per cent effective rates shown in the C&AG report? Not unless we think companies are paying tax elsewhere or incurring R&D expenditure to avoid Irish taxes. Between them these two elements, which were highlighted by the C&AG account for €1.9 billion of the €2.2 billion between gross tax and tax due.

Granting relief for tax paid abroad is something we should do unless we move to a territorial system in line with most other countries in which case the foreign income of Irish-resident companies would not be counted as part of taxable income while granted relief for R&D expenditure is a deliberate policy choice designed to encourage such activity which we can change if we wish.

If anything, when looking at these useful figures the focus should be on the other end of the range published by the C&AG but “79 of top 100 companies have tax rate of 10% or above” is not what the headline writers are looking for.  And, as stated earlier, most of the action happens above the starting point of taxable income used by the C&AG.

Effective Corporate Tax Rates in the C&AG Report–Countries

The Office of the Comptroller and Auditor General has published its Report on the Accounts of the Public Services 2016 which includes a chapter on Corporation Tax Receipts.  One issue which the chapter addresses is effective rates of Corporation Tax.  For a variety of reasons this is rarely straightforward.  Here is a chart included by the C&AG

C and AG ETRS

The chart is an effort to compare effective rates with statutory rates.  The statutory rates are taken from the OECD with the effective rates taken from the Paying Taxes 2017 report from pwc.  Two paragraphs are provided as commentary to the chart:

20.22 In 2015, Ireland had the lowest statutory rate of corporation tax of all OECD countries.1 Based on the PwC/World Bank report, Ireland’s estimated effective rate of corporation tax was 12.4%, which was just 0.1% below the statutory rate. 12 OECD countries had an effective rate of corporation tax which was lower than this; one had a rate which was equal; and 21 had an effective rate which was higher.

20.23 In 2015, the United States had the highest statutory rate of corporation tax in the OECD at 39%, coupled with the second highest effective rate of 28.1%. France had the second highest statutory rate at 38% but the lowest effective rate at just 0.4%. The OECD reported that for 2015, France’s corporation tax as a percentage of total taxation was 4.6%.

The French example should give pause for thought. Could they really have an effective corporate income tax rate of 0.4 per cent?  Well in the case of the model company used in the pwc report it would seem so but that is hardly representative of the French tax system.  And it is not clear what the final sentence is supposed to add.  The proportion of total tax in France that is raised from Corporation Tax tells us nothing about the effective rate.

Of course, what the chart is trying to address is a legitimate question: how do effective rate for corporate income tax compare across countries?  The advantage of the pwc report is that it allows such cross-country comparisons but highlighting the outcome for France shows the approach used may not give the best insights in all cases.

We can try to do something similar with Eurostat national accounts data though it gives a smaller sample size.  The following table gives taxes on income paid as a proportion of net operating surplus for the non-financial corporate sectors of the EU28, where available.  (Click to enlarge).

ETR on NOS

The averages provided are unweighted, arithmetical averages and for the ten years shown an overall average of 18.8 per cent results.  Ireland comes in at 10.4 per cent with France showing a much more plausible result of just over 30 per cent.  Three countries have a lower average than Ireland for the period shown, Estonia, Latvia and Lithuania.

For what it is worth, the reason for the high rate for Cyprus (44.7 per cent) is the inclusion in D51 of items that would not necessarily be considered a profits tax such a defence contributions based on dividends and taxes collected from offshore companies.  What would typically be considered Corporation Tax makes up around 30 per cent of the amounts included under D51 for Cyprus which would bring to effective rate rate close to the headline rate which is similar to Ireland’s. 

Maybe this just highlights the difficulty in making such comparisons but looking at aggregates is likely to give a better reflection of what is going on in general than using a hypothetical individual example.

What do we conclude? Ireland has an “effective rate” that averages just over ten per cent.  This is low by EU standards but, of course, that is deliberately so.  No country in the EU has an effective rate of 0.4 per cent.

Monday, September 25, 2017

Explaining the rapid growth in GNI*

When modified Gross National Income, or GNI*, was published by the CSO in July it was welcomed as a step forward in our understanding of the underlying performance of the Irish economy.  There is no doubt it gave a better measure of the level of the Irish economy but there was some disquiet about the growth rates it implied.  The nominal growth rates of GNI* for 2014 , 2015 and 2016 are estimated to be 8.0 per cent, 11.9 per cent and 9.4 per cent which were “too hot” for many tastes.

We poked around this and unsurprisingly the issue seems to arise in the non-financial corporate sector as shown in this table looking at Gross National Income since 2011 making the * adjustments for depreciation on certain foreign-owned assets and the net income of redomiciled PLCs to the NFC sector.

GNI star by sector

The 9.4 per cent nominal growth rate for 2016 is shown in the bottom right hand corner.  We can see that reasonably plausibly growth rates are estimated for the household, government and financial corporate sector but the 22.5 per cent growth rate for the non-financial corporate sector does not seem right.  Looking a longer series of GNI* for the NFC sector shows how rapid the recent growth has been.

GNI star for NFCs

In 2016, nominal GNI* for the NFC sector was twice what it was at the peak of the boom.  It is probably worth noting what is not in GNI*. In rough terms GNI* is got from:

  • Value of Output
    • less Intermediate Consumption
  • equals Gross Value Added
    • less Compensation of Employees
  • equals Gross Operating Surplus
    • plus net factor flows
  • equals Gross National Income
    • less net income of redomiciled PLCs
    • less depreciation on foreign-owned IP assets
    • less depreciation on aircraft for leasing
  • equals modified Gross National Income, GNI*

So GNI* should not include the profits of foreign-owned MNCs (which will be picked up by net factor flows – distributed profits and retained earnings) and also gross income attributed to Ireland through redomiciled PLCs or the depreciation of certain foreign-owned assets.  GNI* should give a good indication of the gross income of the “Irish” business sector. 

It might be instructive to pull a few measures out of the national accounts to try and see what is going on.  From the national accounts we will look item 4 from Table 1 of the NIE  which is the domestic trading profits of companies (including corporate bodies) before tax and from the Balance of Payments we will take the Current Account outflows of direct investment income on equity.

Domestic Profits v Outflows of Income

So in general terms we have the profits (after depreciation but before tax) generated by businesses in the Irish economy and the outflows of profits attributed to direct investors.  We won’t be too prescriptive about what the difference represents but in rough terms it gives us the net profits generated in Ireland that stay in Ireland and, as such, are included in GNP and GNI.  So why has this exploded recently?

The key problem is that of scale and concentration.  Issues in the statistics that would be little more than noise for most countries are amplified in the case of Ireland because of the nature of the MNC presence here.  And for the past few years the issues have all affected the figures in the table in the same direction: they have increased the growth in the difference between them which in turn has increased the growth of GNI*.

The first issue is one of data and coverage.  The Balance of Payments estimates are the result of survey data from the companies while the National Accounts figures come more from administrative date (from sources such as the Revenue Commissioners etc.).

The second issue is the treatment of depreciation.  Both of the figures above are measures of profit after depreciation but the National Accounts use the “perpetual inventory method” as the basis for the depreciation figure used whereas depreciation for Balance of Payments purposes is more closely aligned with the accounting treatment in the companies’ accounts.

Although these could impact the figures in any direction it seems for 2014 they increased the estimated outflows of profits in the Balance of Payments relative to the estimate of profits shown in the National Accounts.  This drove down the level of the difference shown above for 2014.  These data and depreciation issues unwound somewhat by 2016 and the difference moved closer to what it “should” be but this, of course, meant the growth is higher than would otherwise have been the case.

Between 2014 and 2016 the difference in the measures shown above increased by about €18 billion (from €18.3 billion to €36.6 billion).  According to the CSO around €4 billion of this was the result of issues with the data coverage and depreciation methods outlined above but there is nothing systematic about these impacts and there is no reason their impact could not have been in the other direction.

There are two issues that are systematic – the impact of taxation and the treatment of research and development expenditure.

The National Accounts measure shown in the second table is profit before tax while the Balance of Payments gives a measure of the profit attributed to direct investors after tax.  It is only natural that the absolute gap would increase as profits increase due to the impact of Corporation Tax.  This accounts for a further €1 billion of €18 billion change in the difference.  GNI has been growing because we are collecting more Corporation Tax.

The final issue is probably the most serious and results in a systematic error in the figures.  The error arises from the internationally-agreed methodologies rather than anything idiosyncratic that the CSO are doing.  The reasons are not clear but the National Accounts and Balance of Payments methodologies have different treatments for expenditure on research and development activities.

In the Balance of Payments R&D spending is treated as intermediate consumption while in the National Accounts R&D spending is considered a capital item.  The difference is between a cost that reduces profits versus a subsequent use of profits generated for investment.  As a result of this, the Balance of Payments will give a lower estimate of profits compared to that which arises in the National Accounts and if R&D spending grows the difference between them grows. 

So has R&D spending from Ireland on activities elsewhere being growing? Yip. 

Research and Development Imports

The table starts with total imports of R&D from the Balance of Payments.  This figure has been incredibly volatile recently and most of this is due to the lumpy nature of acquisitions of intellectual property products (intangible assets).  We can get the figures for these outright purchases of intangible assets in Annex 4c of the Quarterly National Accounts.  The residual approximates imports of R&D services, that is payments made from Ireland for R&D activities that take place somewhere else.  Almost all of this is undertaken by foreign-owned MNCs.

We can see that this grew by €5 billion between 2014 and 2016 and stood at €11.5 billion in 2016.  This figure is subtracted as a cost from the profit estimate used in the Balance of Payments.  In the National Accounts it is not taken as a cost but appears as a capital item much further down the accounts.  There is a substantial, and growing, difference between the National Accounts and Balance of Payments profit measures.

What does this mean for the figures? Well, go back to the schema for GNI* outlined above.  The estimate of profits generated (Gross Operating Surplus) comes from the National Accounts and the estimate of net factor flows is taken from the Balance of Payments.  So the National Accounts profits generated in Ireland are higher to the extent they don’t subtract R&D spending as a cost and the Balance of Payments outflows of profits to direct investors are lower because they do. 

This means that in 2016 around €11.5 billion of R&D investment was counted as coming from “Irish” income even though it was funded by MNC profits and any resulting profits will not benefit Irish residents outside of any tax that may be collected on them.

It is a hard circle to square.  One approach would be to estimate profit outflows for Balance of Payments purposes before accounting for R&D spending on activities elsewhere, thus making outbound profits higher.  Doing this through retained earnings would lead to an inflow of direct investment in the financial account and those monies could then be treated as been used to fund the R&D spending.  This would have no net impact on the overall Balance of Payments but would reduce the current account balance.  Outbound factor flows should reflect monies that are distributed or available for distribution but that is not the case here as the money is being used to fund R&D activities.

However, it does not seem right that imports of R&D services by foreign companies should be counted as coming from national income but that is what is implied by the current inconsistency between the National Accounts and Balance of Payments methodologies.  This holds for all countries not just Ireland but again scale and concentration amplifies the impact in the case of Ireland. Correcting this anomaly would knock a couple of percentage points of the recent growth of GNI* and would also bring down the level of GNI* (how’s that debt ratio??).  This may happen if the different treatment is as a result of paragraph 1.51(a) of the ESA2010 manual.

1.51 (a) the recognition of research and development as capital formation leading to assets of intellectual property. This change shall be recorded in a satellite account, and included in the core accounts when sufficient robustness and harmonisation of measures is observable amongst Member States;

As well as looking at the growth of GNI* we also had a poke around for an underlying current account balance.  Adding an adjustment for the acquisition of IP assets to the * star adjustments gave us this:

Adjusted Modified Current Account Annual

As we said then, this seemed plausible up to 2014 but the improvements since then did not.  Well now we know.  There are some data and depreciation issues having an effect but the biggest issue is the treatment of R&D spending by MNCs.  The figure above shows a surplus of €13 billion for 2016 but included in that was a large amount of MNC profits that were used for R&D spending.  Accounting for that would hugely erode the surplus shown above but there still would be some improvement in the current account as all years would be pushed down.   The macroeconomic position is improving, just not to the extent that the current estimates of GNI* might imply. 

We started off with an €18 billion increase in the difference between profits generated in the economy and those attributed to non-resident direct investors.  What we have seen here is that about two-thirds of that is the result of data and methodological issues, of which the most significant is the treatment of spending on R&D activities. 

That still leaves one-third of that €18 billion as a real increase.  The profits of Irish companies have increased in the past few years and Corporation Tax receipts from all classes of company have increased and these account of maybe €6 or €7 billion of the increase we have been trying to explain.  The impact all this would have on the growth rates of GNI* is hard to tell but real rates of around six per cent would seem likely. Goldilocks would be pleased.

Tuesday, September 19, 2017

How much tax do GAFA pay?

Google, Apple, Facebook, Amazon.  The debate on corporate income tax in the EU is fixated on.  Earlier this week Dutch MEP Paul Tang, and member of the European Parliament’s TAXE committee, was co-author of a short report which looked at potential tax revenue losses from Google and Facebook.

The conclusions require a complete re-working of existing tax law.  The tax losses are based on estimated customer revenue shares in EU countries and the global profitability of the companies.  That is, if a customers in a country generate 10 per cent of a company’s net sales that country should be able to tax 10 per cent of the company’s total profit.  Of course, that is not how the system works but it is indicative of the approach some would like introduced.

What this report has in common with many other reports is that it is difficult to determine how much tax the companies are currently paying.  If the argument is that something is “too low” surely we should be told what it is and what it should be.  This is rarely shown.

The table here gives the consolidated income statements for Google, Apple, Facebook and Amazon aggregated over the five financial years that ended between 2012 and 2016.

GAFA Aggregate Income Statements 2012-2016

There are a couple of different ways of measuring how much tax a company pays but that one that matters is surely cash tax payments – how much are companies actually paying over to fiscal authorities in corporate income tax payments net of any rebates or refunds received.  This is given in the second last line of the above table.  From 2012 to 2016 Google, Apple, Facebook and Amazon paid $63.4 billion of corporate income tax.

The companies made provisions to pay around $105 billion of corporate income tax over the period but due to a number of issues (mainly the deferral provisions in the US tax code but also the use of previous losses and tax credits carried forward) the actual amount paid was about one-third less.  Still $68 billion is quite a chunk of change.

Of this, the bulk was paid by Apple which is unsurprising as it generates the largest profits.  For financial years ending between 2012 and 2016 Apple made $52.9 billion of net corporate income tax payments.  Cash tax paid was equivalent to 18 per cent of income before income taxes.

On this measure Facebook comes lowest with cash tax payments equivalent to just 7.2 per cent of income before income taxes.  The reasons for this are that Facebook built up substantial losses prior to 2012 and was able to offset these against the positive income it began to generate from 2012.  This have been exhausted and of the $1.9 billion of cash tax paid over the five years over $1.2 billion was paid in 2016 alone.  In the accounts Facebook indicate that tax payments will rise in further years as offsetting losses are no longer available to be utilised.

The lowest tax payments over the period were made by Amazon but the reason for this is pretty straightforward – Amazon had the lowest profits.  Amazon is a prodigious spender on research and development.  Of the five year period Amazon used 34 per cent of its gross margin for research and development.  This compares to a spend of 15 per cent of gross margin across the other three companies.

Do these companies pay enough tax?  That is not what we are trying to answer here.  What we can say is that between 2012 and 2016 these companies paid $68.4 billion of corporate income tax which was equivalent to 16.4 per cent of their income before income taxes.  What tends to be true of most studies of these companies is that the authors want the companies to pay more tax in certain countries which will almost certainly result in less tax being paid in others. 

Who got most of the $68 billion that the companies paid? The US, of course, because that is where most of the profits were generated.  And if the US didn’t allow deferral or have rules that allowed US-source income to be treated as “offshore” it would collect even more.  And no matter what formulas are used the EU will not simply be able to go and take that taxing right.

The annual income statements for the individual companies are reproduced below.

Google Income Statements 2012-2016

Apple Income Statements 2012-2016

Facebook Income Statements 2012-2016

Amazon Income Statements 2012-2016

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