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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