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.

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!

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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.

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.

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.

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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.

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.

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.

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.

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