Wednesday, October 6, 2021

Household savings and the changes in aggregate income during the pandemic

The CSO have published the Q2 2021 update of the Non-Financial Institutional Sector Accounts. Here we will focus on the household sector (which in the quarterly ISAs also includes non-profit institutions serving households). 

A lot of attention has obviously gone on the spikes we have seen in the household saving rate during the pandemic.  In the first half of 2018 and 2019 the household savings rate was around 12 per cent.  For the equivalent periods of 2020 and 2021 it was around 30 per cent.  This is shown in the bottom line of the table below with shows the outcomes for the first six months of the past four years.

Household Sector Current Account H1 2018-2021

While a fall in consumption opportunities undoubtedly played a role in the rise in household savings the impact of changes income has been as important.  A couple of lines up from Gross Savings is the line giving Gross Disposable Income. In the national accounts methodology used here, “gross” means before depreciation of fixed assets.

Gross Disposable Income is a measure of national income after taxes and transfers.  Looking across this for the four years shows no signs of a pandemic the public health response to which saw large swathes of the economy shut down by government decree. 

Indeed, the figure for the first half of 2021 is around €8 billion higher than for the equivalent period of 2019.  This allied to the €4 billion reduction in consumption is what gives rise to the €12 billion increase in savings.

A key reason for the lack of a pandemic effect in aggregate household income is that the government stepped in to support incomes.  One element of this is visible in the household sector current account with the row for social benefits (other than benefits in kind) received from the government sector.  These were €11.8 billion in H1 2019 but were €17.2 billion in the first half of 2021, primarily driven by the Pandemic Unemployment Payment.

There is some evidence of the pandemic shock in compensation of employees received which H1 2020 showing annual falls for wages received from non-financial corporates and other households.  However, these drops are modest relative to the scale of the sectors that were shut down. 

A key reason for this is that the wages paid by companies were supported by subsidy schemes.  In the household accounts, the money is paid from firms to households but the firms first received it from the government sector.

Figures for the non-financial corporate sector show that the sector received €350 million of other subsidies on production in the first half of 2019 (a lot of which would be public service obligation subsidies to commercial semi-states and other companies) to receiving €2.7 billion in the first half of 2021. 

The increase was due to the various pandemic-related wage subsidy schemes that have been introduced.  In the absence of these there would have been a much more pronounced fall in the wages received by the household sector from non-financial corporates.

The top line above is Gross Domestic Product.  For the household sector this is the value added of the self employed, including agriculture and the rents from the provision of housing services.  These rents include those from buy-to-lets but are mainly the imputed rents of owner-occupiers for the housing services that they provide to themselves.  The GDP of the household sector

The imputed rent of owner-occupiers counts as income but as they also consume the associated housing services the imputed rent is netted out through final consumption expenditure and has no impact of the savings rate. 

Monday, October 4, 2021

Outbound royalty payments head for €100 billion

One notable aspect of the presence of US MNCs in Ireland is the scale of outbound royalty payments. These are payments their Irish subsidiaries make for the use of technology developed elsewhere (mainly in the US itself).

Royalty Imports to All Countries 2008-2021

The latest figures to the end of Q2 2021 put the four-quarter sum of outbound royalty payments from Ireland at €95.6 billion.  It is likely that the total for the 2021 calendar year will exceed €100 billion. 

While the overall total of outbound royalties has exhibited a fairly steady increase in recent years, the  destination of those payments has changed markedly. 

Royalty Imports by Region 2011-2021

In the five years to 2019, the United States was the recipient of around 10 per cent of the outbound royalty payments from Ireland.  The 18 months has seen a huge shift and the latest figures from Eurostat show that the US was the recipient of almost 80 per cent of the outbound royalties from Ireland in the 12 months to the end of June 2021.

The chart shows the large drops in payments going to Offshore Financial Centres (Bermuda, Cayman etc.) and the Euro Area (which mainly went to The Netherlands before been subsequentlty directed to OFCs).  These payments were linked to “double-irish” type structures where US MNCs located licenses to use their technology in markets outside the Americas.

The Irish subsidiaries paid for the technology they were using (patents for pharmaceuticals, online platforms for ICT companies etc.).  This technology was almost wholly developed in the US but the US tax code facilitated US MNCs in putting the licenses to use the technology in no-tax jurisdictions where they had no substance.  This allowed the companies to benefit from the deferred payment of the US tax due on the profits those licenses were generating.

Changes in recent years have targeted these structures.  The US has moved from a worldwide system with deferral to a quasi-territorial system with payments due as the profit is earned. 

For many companies, most notable ICT companies, this has resulted in them moving the licenses for their technology back to the US. And now the payments that leave Ireland are flowing to the US.

Is this “stepping up action to address features of the tax system that facilitate aggressive tax planning, including on outbound payments” as required per the European Commission’s most recent set of Country Specific Recommendations (CSRs) to Ireland?

But if it is, what has changed? Very little.  There has been no change in the market countries being served by international HQs in Ireland.  The payments they make for the services provided by the ICT companies still flow to Ireland.  Royalty payments continue to be made from Ireland but are now being directed to the US, where the technology is developed, rather than Offshore Financial Centres.

The only place the end of the “double irish” has had any noticeable impact is in the United States.  This is not a surprise as the tax that was impacted by the structure was US tax (with companies benefitting from deferral on profits kept offshore).  Now the income flows direct to the US and is subject to immediate tax that – albeit at significantly reduced rates courtesy of the Tax Cuts and Jobs Act of December 2017.

Ireland Balance of Payments data is showing €75 billion of royalties flowing to the US in the 12 months to the end of June.  The equivalent figure two years earlier was €8 billion.  As the chart above shows this huge increase is clearly evident in the Irish data. 

But evidence of these payments remains absent in the data published by the US Bureau of Economic Analysis which show no increase in receipts of “charges for the use of intellectual property”.

Table 1 shows that total service exports from the US are around $800 billion a year so the changes noted here for payments from Ireland should have had a noticeable impact, at least in the relevant category. 

And even in the context of the entire US economy these payments are equivalent to something like 0.2 or 0.3 per cent of US GDP.  These things get huge focus when they come to attention in Irish national accounts. Will the US get to avoid such scrutiny for amounts of the same value because the relative scale will be 100 times smaller?

Friday, July 23, 2021

Google, Bermuda, and Effective Tax Rates

In its 2020 annual report Google noted that:

As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.

As a result of this change, royalty payments from Ireland which previous ended up in Bermuda, via The Netherlands, now flow directly to the United States. Here we will assess the impact the structure had on Google’s taxes over its entire duration from 2003 to 2019.

Google Foreign Domestic and Tax 2003-2019

Over the full period, Google had an effective tax rate of 21.8 per cent.  The contributions to this were a foreign tax rate of 7.1 per cent and a domestic, i.e. US, tax rate of 39.8 per cent.

Much attention has been given to Google’s foreign tax rate, particularly those of 2005 to 2011 which averaged just 2.3 per cent.  This was primarily the result of a large share of Google’s foreign profit being reported in Bermuda, which, of course, does not have a corporate income tax.

However, the full picture requires the assessments to incorporate Google’s domestic, i.e. US, and then overall tax rates.  From 2005 to 2011, when its effective foreign tax rate averaged 2.3 per cent, Google’s overall effective tax rate averaged 24.7 per cent.

The domestic tax rate for 2017 is also notable. At 120 per cent the domestic tax charge for the year exceeded domestic pre-tax income.  This is because it included the US tax due under the “deemed repatriation tax”.  This is domestic US tax but is due on foreign profit.  As the company set out in its 2018 10K report:

The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion.

Over the period 2003 to 2017 Google had a domestic tax rate of 49 per cent.  This is not because the US had corporate tax rates as high as that but because included in domestic taxes are the US taxes due on foreign profits, most notably the profits Google reported in Bermuda.

It is a numerator/denominator issue.  A focus on foreign income and foreign taxes omits the domestic, that is US, tax paid on those profits.  The effective tax rate on Google’s foreign profits was not the 2.3 per cent implied by the effective foreign tax rate.  Indeed the lower Google, and similar MNCs can get their foreign tax rate, the higher their domestic tax rate will be.  And, from 2003 to 2017, nearly 90 per cent of Google’s income tax charge was for US taxes.

The above table also illustrates the impact of the Tax Cuts and Jobs Act which came into effect from the start of 2018.  For the years shown, Google’s lowest domestic and overall effective tax rates arose in 2018 and 2019.  As a result of the TCJA, Google’s overall effective tax rate, which in aggregate terms was 25.8 per cent from 2003 to 2017, was reduced to 12.7 per cent when 2018 and 2019 are combined.

And finally a table from Google’s most recent 10K report which shows the impact of the company its licensing arrangements in Bermuda:

Google 10K 2020 Domestic Foreign Income

For 2020 there was a large rise in Google’s pre-tax income that was attributed to domestic operations and a commensurate fall in pre-tax income attributed to foreign operations.  Google’s profit is now being reported where most of it is generated: in the US. And because of the TCJA Google will have a lower overall effective tax rate than when it is was shifting tens of billions of profit to Bermuda.

What’s going on with the current account?

Ireland’s balance of payments is subject to huge volatility.  Among the reasons for this are transactions in intellectual property and aircraft for leasing as well as income flows link to redomiciled, but not Irish-owned, PLCs.  In response to this the CSO have been publishing a modified current account, CA*, which strips out the above of these issues.

Getting on a handle on a country’s underlying current account position can be an important part of determining if imbalances are building up.  As the long-run series in the chart below shows, Ireland experienced widening balance of payments deficits in the late-1970s and mid-2000s which precipitated severe problems.

Current Account 1937-2020

Last week, the CSO published the 2020 estimate of the modified current account.  The surplus of €23.5 billion was equivalent to 11.5 per cent of national income.  This is an extremely large surplus by historic Irish and current international terms.

The only time Ireland ran a current account surplus of an equivalent size was during World War II when trade restrictions and rationing were in force.  Ireland’s current account needed to improve to wash out the imbalances built up prior to 2008, but the ongoing rise to record levels seems to be overstating it.

When can get some insight into this from the Institutional Sector Accounts.  The current account of the balance of payments is savings minus investment.  The sector accounts allow us to see the contribution by sector to the current account.  The chart below takes the annual outcomes from the sector accounts for saving minus investment with the figure for the non-financial corporate sector adjusted to make the total across all sectors consistent with the modified current account.

Gross Savings minus Investment by Sector Modified 1999-2020

Immediately, we are drawn to the 2020 figures.  The household sector has been a net lender since 2009 but this increased very significantly in 2020 – due to restrictions on spending.  The support incomes the government sector moved to being a significant borrower. Financial corporations and the impact of items that are not sectorised have not had much impact on the current account in the last four or five years.

That leaves us with the red segment of the bars – the adjusted figure for non-financial corporations.  For the last few years this has been making a positive contribution to the current account and last year it was €12.5 billion.

For the time being we don’t have much insight into this.  While the modified current account is showing a significant surplus some caution should be exercised before considering it available for spending.

Later in the year when the annual sector accounts are published we will get a domestic/foreign split for the corporate sectors in 2020.  Here is what the 2019 figures showed:

Gross Savings minus Investment for Domestic Sectors 2013-2019

There wasn’t really a whole lot going on the domestic sectors up to 2019.  By 2019 all of the household, government, domestic non-financial and domestic financial sectors were net lenders.

However, the most significant changes were happening within the foreign-owned sectors – those sectors we hope would be largely stripped out of the modified current account.  Either via standard net factor flows (repatriated profits etc.) or via the CA* adjustments for IP, aircraft and redomiciled PLCs. 

But even after all those the impact of foreign-owned sectors went from –€7.2 billion in 2017 to +€0.4 billion in 2019.  This was the largest contribution to the rise in the black line (the modified current account) up to 2019.

And the recent update to the modified current account shows that the 2019 figure has been revised up.  It €16.5 billion for last year’s annual sector accounts; when this years sectors accounts are published they will reflect last week’s update which put the 2019 modified current account at €20.2 billion.

It is clear there is something going on – and that it likely to be within the foreign-owned sector. What is not clear is whether it is something that would justify a further refinement of the adjustments made to get to the modified current account. 

It could be due to “good” investment such as manufacturing plants for pharmaceuticals or processors.  Or it could be another distortion that should be stripped out.

There is no doubt that Ireland’s current account has improved relative to the large deficits that were evident up to 2008 but there must be some doubt that that improvement has led to a surplus equivalent to 11.5 per cent of national income. A surplus, yes, just not a record one. 

Wednesday, July 7, 2021

Relative Calm in the 2019 Aggregate Corporation Tax Calculation

A while back the Revenue Commissioners published the 2019 update of the Aggregate Corporation Tax Calculation.  Given recent developments in Corporation Tax revenues is it perhaps surprising to note the general stability in most items in the table.

Aggregate CT Calculation for Taxable Income 2015-2019

Two of the more notable figures are for Capital Allowances used and Foreign Income.  The rise in capital allowances is linked to the onshoring of intangible assets while foreign income is a function of the worldwide nature of the Irish Corporation Tax regime.

The lower half of the table showing how Taxable Income is translated into Tax Due is also relatively stable.  All told, the €6.9 billion increase in Net Trading Income in 2019 resulted in a €728 million increase in Tax Due

Aggregate CT Calculation for Tax Due 2015-2019

In line with the increase in foreign income reported on Irish Corporation Tax returns there has been an increase in Double Taxation Relief and for the Additional Foreign Tax Credit.  These items have by largest impact in the transition from Gross Tax Due to Tax Due. The relief is because the Irish-resident companies which have this foreign income have paid tax in the source jurisdiction so are unlikely to owe any additional tax in Ireland (as the rates paid abroad will generally exceed the 12.5 per cent rate that applies here).

Use of the R&D Tax Credit rose in 2019 with increases in both the credit itself and in the Payment of the Excess R&D Tax Credit in circumstances where a company claiming the credit does not have a sufficiently large tax liability in order to be able to fully utilise the amount of the credit they are eligible for.  Combined these came to €629 million in 2019.

A rarely-looked at item is Gross Withholding Tax on Fees which increased to €367 million in 2019.  Essentially, this is to allow for tax that has already been paid.  There are a number of instances where the person making a payment for certain services must withhold 20 per cent of the fee from the recipient and transfer it to the Revenue Commissioners. 

When a company files its tax return it will include the amount of withholding tax incurred on fees it should have received.  This item reduces the amount of Tax Due but, in a manner somewhat similar to foreign tax credits, it reflects tax that has already been paid.

In the transition from Gross Tax Due to Tax Due the only item that explicitly reduces a company’s tax bill is the R&D tax credit.  If Ireland switched to a territorial regime, the need for foreign tax credits would be removed and the gap between Gross Tax Due and Net Tax would be reduced with limited impact on the liability of companies to Irish Corporation Tax.

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