Wednesday, July 18, 2018

When can we expect the next wave of IP onshoring?

The 2017 National Income and Expenditure Accounts will be published by the CSO on Thursday.  In a detailed information note the CSO have set out some of the updates and revisions we can expect.  Some of updates relate to the treatment of expenditure on imports of R&D services and tally with a lot of what we said here.

While these welcome updates are likely to be the most significant changes introduced by the CSO they are unlikely to be headline grabbers.  But they will significantly improve the usefulness of key measures of the economy such as the modified current account balance in the Balance of Payments, CA*, and the level and recent nominal growth rates of modified Gross National Income, GNI*. 

It is a bit of a punt but it is possible that for 2017 we will see CA* record a surplus somewhere in the range of 2-4 per cent of GNI*, while the recent nominal growth rates of GNI* may fall in the range of 5-8 per cent per annum.  These are impressive, and plausible, numbers.

But impressive and all as these might be it is likely that more attention will be directed at seeing how this pointer in section 4.1 of the CSO information note plays out:

The CSO’s Large Cases Unit (LCU) continues to work with data providers on their R&D-related activity. As part of this work, additional purchases of R&D-related IP assets have been identified in recent years and will be included as imports of services in the upcoming National Accounts and Balance of Payments results, with offsetting additions to the capital stock in the National Accounts. As a result of these new additions to the stock of intangible assets, the GNI* indicator will also include revisions to its depreciation adjustment for R&D-related IP assets in recent years.

We don’t have a GNI* depreciation adjustment for 2017 so that can’t be revised, thus it could be that these newly-identified onshoring events relate to years up to 2016.  And we do have another data source which now goes up to 2016 where these transactions are likely to make an impact – the aggregate Corporation Tax calculation published by the Revenue Commissioners.

The table below shows the national accounts depreciation adjustment for MNC imports of intellectual property products from last year’s NIE release and the capital allowances claimed for intangible assets under Section 291A of the Taxes Consolidated Act which was introduced with the Supplementary Budget of April 2009.

IP CFC and S291A CA

While these obviously are related concepts the figures do not have to match each other but they are strongly correlated which is best shown by the change in 2015 when both series rose by €25 billion ± €1 billion.  Conceptual differences aside it looks like there is some scope in most years for the national accounts version to be revised up.

This seems particularly true for 2016.  In last year’s NIE the CSO increased their depreciation measure for these IP products by €2.7 billion.  The recently-released aggregate CT calculation from the Revenue Commissioners shows a €6.9 billion increase in 2016 for the amount of capital allowances claimed for intangible assets.  There is a €4 billion difference between the changes.

It should also be noted that the time period covered by each series is different.  The CSO data covers activity that happens in a calendar year; the Revenue data reflects the details in CT returns filed for accounting periods ending during the calendar year.  So, for example, a company with a June 30th year-end will have the figures from its CT return included for one year even though the figures reflect activity that happened in the second half of the previous calendar year. 

This is only a minor wrinkle and should wash out between the series over a couple of years.  But it should be noted that changes in the Revenue data for a particular year could relate to activity that began the previous year and if a June 30th company introduced a change from July 1st 2016 it won’t appear in the Revenue data until 2017 but it could affect the revised 2016 data the CSO is set to publish this week.

So while little more than an enlightened guess we could see a couple of billion added to the national accounts depreciation measure in question here for years up to 2016. 

So what would a €4 billion increase in any year mean for the national accounts?  If we assume a 10-year lifespan then we could be looking at an increase in the capital stock of these intangible assets of around €40 billion.  Given recent developments it is likely that the upward revision to GDP (and GNP) would be around €4 billion.  This could add 1.5 to 2.0 percentage points to the growth rate of each.  GNI* will largely be unaffected as the upward movement in GDP will be offset by the increase in the depreciation adjustment that is subtracted to get this modified measure of national income.

So while the improvements to CA* and GNI* will be main source of added-value from this release they will have to fight for attention if tens of billions of intangibles are further added to the estimates of Ireland’s capital stock of intangible assets.

And, of course, we have absolutely no idea what could be introduced for 2017.  It is possible that the recent wave of IP onshoring was linked to “stateless” companies who would have been impacted by changes introduced to Ireland’s residency rules in the 2014 Finance Act that became effective from the start of 2015 and the implementation via the OECD’s BEPS process of country-by-country reporting by MNCs to the tax authorities in the countries in which they operate.  A country report for “Republic of Nowhere” would probably have raised a few eyebrows.  Maybe we have a few laggards but one would have thought that most of the impacted companies would have restructured before the end of 2016.

Of course, a second wave of onshoring is likely in response to the 2015 Finance Act changes to Ireland’s residency rules which become fully effective at the start of 2021 and, more importantly, proposed changes to Ireland’s transfer pricing rules which would see the latest OECD guidelines based on BEPS Actions 8 to 10 incorporated into Irish legislation. 

This would see royalty payments for IP disallowed as a tax deduction if the recipient of the royalties does not have sufficient DEMPE functions to warrant receipt of the royalties (DEMPE functions are the development, enhancement, maintenance, protection and exploitation of IP).

Up to now Irish legislation has been blind to the location, residence and substance of entities receiving outbound royalty payments but if BEPS Actions 8 to 10 are incorporated into Irish transfer rules (and it has been recommended that this should be done before the end of 2020) then the substance of such entities will matter.  Companies can continue to make royalty payments to them but they would only be eligible as a deduction for Irish Corporation Tax purposes if the receiving entities have sufficient DEMPE functions.  Cash-box entities in the Caribbean are unlikely to satisfy the criteria.

So either companies reroute the royalty payments to an entity that has the required DEMPE functions – such as the parent company in the US that undertakes most of these MNCs R&D activity – or restructure their operations in Ireland.  If recent events are anything to go by this restructuring will involve the onshoring of the IP licenses previously located with the cash-box entities in the Caribbean or other offshore financial centres..

Thus, the taxable income of the Irish operating company will move from being reduced by “renting” the IP and making annual royalty payments for the use of the IP to being reduced by “buying” the IP and claiming capital allowances each year based on the cost of acquiring and maintaining the IP.

Could we have seen a few early movers in 2017 even though such a change could have been delayed until 2021? Maybe, but it seems unlikely.  There was a reasonably-flagged change to S291A that became effective from midnight on the night of Budget 2018.  This saw that amount of capital allowances that could be used in any one year limited to 80 per cent of the relevant taxable income. 

This guarantees that some of the intangible-asset-related profit will be exposed to tax each year though if the cap is binding it means it takes a longer period for the capital allowances to be exhausted as the full amount is still available to be used.  It seems unlikely that a company would have moved in advance of the introduction of this change when they could continue with the royalty-based structure until the end of 2020. 

And it seems even more unlikely when the alternative is a capital-allowances-based structure that is essentially limited by the amount that can be claimed arising from the initial acquisition cost versus the open-ended and virtually unlimited amounts that can be used in the royalty-based structure.

But maybe it would be a consideration with a particular profit outlook and risk appetite. Such risk assessments could include the possibility of an EU State-aid investigation (and maybe the risk appetite of national tax authorities for the same could also be a factor).  If you were a typical US MNC availing of the “double-irish” to defer your US tax liability you might get the heebie-jeebies when reading the full version of the Amazon-Luxembourg state-aid case.

Even with that it is more probable than not that the second wave of IP onshoring to Ireland will not be seen until nearer to 2020.  Although the analysis is preliminary it does not appear that the Tax Cuts and Jobs Act passed by the US Congress last December will significantly change the incentives involved for existing IP that companies have moved offshore.  

And with over €70 billion of outbound royalty payments currently being made from Ireland the potential scale involved is huge. However, section 5.1 of the CSO information note indicates that this will be revised down by some amount but it should be remembered that this is on the basis of a national accounting interpretation of what is going on not a tax interpretation. 

This issue aside it could be that the total value of the assets involved is of the order of something approaching a trillion euro while the associated gross profits / capital allowances could be double the levels seen by the end of 2016 bringing the annual amounts to something around €100 billion. 

Could any of this have arrived in 2017? Maybe.  Just as it’s a possibility that there were some late first-wave movers that only got around to getting their affairs in order in 2017.  As flagged by the CSO there will be changes to the national accounts with revisions to the data relating to onshoring that took place up to 2016. 

At this stage the rest of us really are blind as to what could have happened in 2017.  Maybe the NIE release on Thursday will see us stunned like startled earwigs again, and then again maybe it won’t, but IP onshoring is something we should be expecting to see much more of as we move towards the end of the decade.  Buckle up!

Tuesday, July 17, 2018

Capital Allowances and companies with Net Trading Income that is negative or nil

The previous post went through the overall outturns from the 2016 aggregate Corporation Tax calculation which was recently published by the Revenue Commissioners.  As detailed there the figures for capital allowances are worthy of attention.  The amounts of capital allowances used against gross trading income for the last four years for which we have data are:

  • 2013:  €15,955m
  • 2014:  €18,621m
  • 2015:  €46,153m
  • 2016:  €59,254m

Additional research from staff of the Revenue Commissioners tells us that a large part the increased claims for capital allowances are linked to intangible assets.  Here are the amount of capital allowances claimed for expenditure on intangible assets from 2014 to 2016.

  • 2013:    €2,522m
  • 2014:    €2,652m
  • 2015:  €28,871m
  • 2016:  €35,737m

It is worth noting that capital allowances claimed as shown in above figures is not the same as capital allowances used which were shown in the first set of numbers.  A company may claim capital allowances but unless it has income against which to offset those capital allowances the capital allowances remain unused and can be carried forward as a loss for use in subsequent period when there may be income to use them against.  There is a story here but it doesn’t relate to intangibles which is the focus here and is something we may land on in future.

The CSO host a databank from the Revenue which provides some distributional details of income, deductions and allowances used for Corporation Tax purposes.  The next table shows claims of capital allowances for plant and machinery (which includes intangible assets) by range of net income since 2013.

Plant and Machinery Capital Allowances by Range of Net Income

It can be seen that two income ranges are responsible for almost all the capital allowances claimed: companies with net incomes greater than €10 million and companies with negative or nil net income.  And of these, most of the action is within companies with negative or nil net income.  Since 2014, the amount of capital allowances claimed by such companies has gone from €12.6 billion to €47.5 billion.

The distributional data has been made available much quicker by the Revenue this year and we can put together a rough CT calculation for companies with negative or nil net trading income.  There are some missing items but there enough to allow us to see what is going on.

Corporation Tax Computation for Companies with No Trading Income

The fifth row gives the duck eggs for Net Trading Income (0 0 0 0) but above that we can see that these companies had significant amounts of Gross Trading Profits.  These profits went from €13.5 billion in 2014 to €40.0 billion in 2015 to €49.9 billion in 2016.  These gross profits are included in GDP but it is Taxable Income that matters for CT payments. 

And we see that after the application of losses, and most importantly, capital allowances, the resulting net trading income of these companies with almost €50 billion of Gross Trading Profits in 2016 was zero.  It doesn’t matter what the tax rate is, the tax due on trading incomes of zero is zero.   Some companies in this category do pay Corporation Tax but that is due to Other Income such as rental, foreign or capital gains rather than Trading Income.

The Gross Trading Profits shown in the above table are responsible for a large part of the recent surge in GDP.  But they have no role in explaining the recent rise in Corporation Tax.

The 2016 Aggregate Corporation Tax Calculation

Ireland’s national accounts cannot be accused of being dull and the latest update to the National Income and Expenditure Accounts due this Thursday looks like it will offer plenty to chew over.  Of course, all the CSO are doing is reporting on what is going on.  The main reason for the lack of dullness in the accounts is the corporate sector, and in particular, the impact of foreign-owned MNCs.

We know tax is a factor behind a lot of what goes on so the tax data provided by the Revenue Commissioners is a useful complement to the national accounting data published by the CSO. 

The Revenue have now published the 2016 update of the aggregate Corporation Tax calculation.  This might seem a bit sluggish but the deadline for CT returns is nine months after the end of the financial year to which they apply to CT returns for tax years ending in December 2016 would have been filed up to September 2017 and the process of compiling the aggregate figures means we get the data about half way through the following year.

So, now that we have the aggregate CT calculation for 2016 what does it tell us?  Essentially, we can divided the calculation into two parts:

  1. The determination of Taxable Income from Gross Trading Profits, and
  2. The determination of Tax Due from Gross Tax Due

We’ll start with the determination of Taxable Income.

Aggregate CT Calculation for Taxable Income 2012-2016

In relative terms (i.e. compared to 2015!) the changes in 2016 were relatively modest.  The starting point of the table, Gross Trading Profits, had a massive surge of almost €50 billion (and 50 per cent) in 2015.  The 2016 increase was €15 billion or “just” 10 per cent.

From 2014 to 2016, Gross Trading Profits increased from just over €95 billion to almost €160 billion.  Over the same period the bottom line here, Taxable Income, increased from €50 billion to €71 billion.  This suggests there is a lot going on in between when a €65 billion rise in Gross Trading Profits translates into an increase in Taxable Income of around one-third of that amount.

It also suggests that caution should be exercised when drawing a link between the 2015 surge in GDP and the 2015 surge in Exchequer Corporation Tax receipts.

There is a lot going on and it is almost all due to just one item: Capital Allowances, i.e. the tax treatment of expenditure linked to the acquisition or maintenance and development of fixed assets.  The fourth row of numbers in the table shows what happened.

Back in 2012, firms used €8.5 billion of capital allowances against their gross trading profits (though this could have been affected by lower profits) and by 2016 the amount of capital allowances used had risen to almost €60 billion. Most of this increase has happened in the latest two years for which data is available, 2015 (+€27.5 billion) and 2016 (+€13.1 billion).

The only other notable change in 2016 was the €6 billion or so reduction in Trade Losses Carried Forward used though all this has done is brought this item back to its 2014 level.  There is lots to be learned in the table but when it comes to recent changes, and finding links to developments in the national accounts, it really is all about capital allowances.  The next post will look at these in more detail.  For now we will looks at the second part of the aggregate CT calculation which shows how Tax Due is reached from the starting point of Gross Tax Due.

Aggregate CT Calculation for Tax Due 2012-2016

Applying Ireland’s two Corporation Tax rates shows that the Taxable Income reported by companies for tax years ending in 2016 resulted in a Gross Tax Due amount of almost €9.5 billion. Ireland does have a third tax rate paid by companies, that on capital gains, but these amounts are regrossed based on the difference between the CGT rate on the CT rate of 12.5 per cent and the 12.5 per cent rate is applied to these regrossed amounts to give the amount of tax due.

We can see that the €9.5 billion of Gross Tax Due results on a Tax Due amount of €7.2 billion once we reach the bottom line.  The reduction is due to credits and reliefs available under Irish CT legislation.  These are actually pretty limited in number and we can see that the bulk of the reduction is due to two sets of items:

  1. Double Taxation Relief and the Additional Foreign Tax Credit
  2. The R&D Tax Credit used against tax this year and the Payment of the Excess R&D tax credit.

Between them these factors account for €2.0 billion of the €2.3 billion difference between Gross Tax Due and Tax Due.  Earlier posts considered the impact of these features of Ireland’s CT codes on effective tax rates here and here.  Without them the effective tax rate on Taxable Income would essentially be 12.5 per cent.

Finally, it is worth comparing the figures for Tax Due shown here and the cash receipts for Corporation Tax recorded by the Exchequer.

CT Tax Due and Exchequer CT Receipts

For the five years shown the two series roughly sum to the same aggregate amount (c.€27 billion) but reach the 2016 amount of c.€7.25 billion by difference routes.  As is well known Exchequer CT receipts spiked by almost 50 per cent in 2015.  On the other hand the increase is Tax Due as shown in the aggregate CT calculation is more evenly spread across 2014, 2015 and 2016. 

This suggests there may have been a timing issue at play when it comes to the surge in cash receipts in 2015 with some receipts due on activity that occurred in 2014 delayed until the final CT return was filed nine months after the end of the companies’ accounting periods. 

And, again it highlights, that although the surge in CT receipts may have happened in the same year as the jump in GDP, they are not necessarily directly related.  As with lots of things lately, capital allowances play a central role in this and it is to them that we will turn next.

Monday, June 18, 2018

Who shifts profits to Ireland?

Eurostat’s structural business statistics give a range of measures of the business economy broken down by the controlling country of the enterprises.  Here is the Gross Operating Surplus generated in Ireland in 2015 for the countries with figures reported by Eurostat.

Ireland Business Economy by Controlling Country - Profits 2

In total companies reported around €125 billion of Gross Operating Surplus in Ireland in 2015.  Of this 90 per cent arose in companies controlled from just two countries.  These were companies “controlled by the reporting country” (i.e. Ireland) and companies controlled from the United States.  Much smaller amounts of profits are reported for companies controlled from all other countries.

Although there are problems with it we can get some insight into the profitability of companies by comparing their gross operating surplus to their personnel costs.

Ireland Business Economy by Controlling Country - Profitability 2

Again, there is one stand-out figure – that for the United States.  There are other countries which do seem to have companies in Ireland with “excess” profits (Australia, Japan, Italy and Belgium) but as shown in the first chart the amounts in question are relatively small and some of the high rates are one-offs rather than showing up consistently in the data.

Do these charts show:

  1. Profits being shifted out of large market countries such as France and Germany, etc. or
  2. Profits being shifted out of their source in the United States?

And if it is #1 why is it only US companies that seem to be able to do it?  Why don’t French or German companies shift their profits to Ireland?  Of course, the answer is that the charts actually show #2 to be key issue but that seems unlikely to get a foothold in the debate anytime soon.

Wednesday, May 9, 2018

Why is the Irish “average wage” in the OECD Taxing Wages so low?

A few weeks ago the OECD published the 2018 update of their Taxing Wages publication.  There is plenty in the report worth chewing over but one minor issue that arises is the level of the “average wage” benchmark used for Ireland.

OECD Taxing Wages Average Wage Ireland 2000-2017

It doesn’t really appear to be anything too noteworthy.  It rises fairly rapidly up to 2008 (the figures are nominal so no account is taken of inflation), drops in 2009, has been edging upwards for the past three or four years or so, and is put at €36,800 for 2017.

But what about when we look at it in a comparative context?  OK, an international comparison  isn’t as straightforward as looking at a single country through time but we can overcome some issues if we look at countries that share a common currency. 

Here are the nominal average wages used for 2016 for a group of euro-area countries.

  • Netherlands €50,120
  • Germany €48,300
  • Belgium €46,528
  • Austria €45,073
  • Finland €43,716
  • France €37,906
  • Ireland €35,430

So, we still haven’t adjusted for prices but some of the gaps here are very large.  Is the nominal average wage in Ireland 27 per cent lower than Germany and 29 per cent lower than The Netherlands?

The OECD also has an Annual Wages publication which uses aggregate data from the national accounts to work out an average wage.  As the notes say:

Average annual wages per full-time equivalent dependent employee are obtained by dividing the national-accounts-based total wage bill by the average number of employees in the total economy, which is then multiplied by the ratio of average usual weekly hours per full-time employee to average usually weekly hours for all employees.

So what does this tell us?  Here are the 2016 averages from this dataset.

  • Ireland €51,336
  • Netherlands €46,709
  • Belgium €43,097
  • Austria €41,421
  • Finland €41,209
  • Germany €38,302
  • France €36,809

Of the selected group Ireland has gone from last to first with a 44 per cent rise in the estimated annual average wage as measured using the national accounts versus that used in Taxing Wages.  For most of the other countries the difference is only a few per cent – bar Germany where the national accounts show an average that is over 20 per cent lower.  Still by far the greatest absolute difference is for Ireland.

So,what explains it?  Perhaps it is coverage.  The national accounts cover the entire economy where the Taxes Wages figure is derived from NACE sectors B to N, i.e. the business economy which excludes state-dominated sectors such as education and health. But this coverage is the same for all countries.

The answer lies in the annex of the Taxing Wages report

Table A4 shows the method used to calculate the average wage.  One piece is the type of workers covered.  There are columns which show whether supervisory or managerial workers are included.  There are 36 countries covered in Taxing Wages and 34 of them include both of these types of workers, many of which we can assume would be in the top half of the earnings distribution. 

Which countries do not have them included when the average is calculated? Turkey and Ireland.

Part-time workers are another category that get varying treatment across countries.  Some countries leave them out altogether and only include full-time employees when working out the average.  Other countries include them but do so on a full-time equivalent basis such that their earnings are included but are scaled up as if they were a full-time employee.  There are six countries who include part-time employees in the calculation but do so on the basis of their actual annual earnings as part-time workers.

In their notes the OECD say:

The worker is assumed to be full-time employed during the entire year without breaks for sickness or unemployment.  However, several countries are unable to separate and exclude part-time workers form the earnings figures (see Table A.4). Most of them report full-time equivalent wages in these cases.  In four countries (Chile, Ireland, Slovak Republic and Turkey), the wages of part-time workers can neither be excluded nor converted into full-time workers (for example, an OECD Secretariat analysis of available Eurostat earnings data for selected European countries has show that include part-time workers reduces average earnings by around 10%).

So, the Irish figures used in Taxing Wages exclude supervisory and managerial staff, and include part-time workers on an unadjusted basis. 

What would the Irish figure be if it was estimated in line with the practice for most other countries?  Figures on that basis are available from Eurostat’s Structure of Earnings Survey though it is only available every four years.  The averages (with part-time employees given on a full-time equivalent basis) for sectors B to N are given as:

  • 2002: €33,320
  • 2006: €40,761
  • 2010 : €42,111
  • 2014: €44,700

This would put Ireland pretty much in the middle of the set of countries used above. 

Would it make a difference if the 2017 average wage used for Ireland was €45,000 rather than €36,400?  It probably would.

The OECD show that a single person on the average wage in Ireland has taxes and social insurance deductions of just under 20 per cent of their gross wage.  If this calculation was done using an average of €45,000 then the deductions would be 25 per cent of gross wage. 

This is part of an infographic the OECD used to promote the publication of Taxing Wages

OECD Taxing Wages Infographic

The OECD average is given as 25.5 per cent for 2017 and Ireland is included in the group of “low-tax” countries with tax rates for a single worker on the average wage of less than 20 per cent.  If an average wage was used that better reflected the actual outcomes in Ireland, in line with the methods used for other countries, then Ireland would be pretty much bang on the OECD average and would not be flagged (literally) on such infographics. 

Such a change would probably have limited impact on the estimated progressiveness of the Irish income tax system but it would change the range of values that are currently included in the analysis.  The OECD analysis extends up to earners on 167 per cent of the average wage.  This is around €60,000 with the average currently used but would be €75,000 if that was increased to the value proposed here.

If €45,000 was used for the Irish average wage (which the available data would support) then Ireland would not be down towards the bottom of charts like this.  This calculator puts the tax rate on a single person earning €45,000 in 2017 at 25 per cent.

OECD Taxing Wages Tax Rate on Average Wage

If a more realistic average wage was used, Ireland would pretty much be the same as the OECD average (and rise maybe ten places higher) in the above chart.  So why is such an unrepresentative average wage used for Ireland in this important report?

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