The subsidiaries of US MNCs operating in Ireland have annual revenues of around €400 billion. These revenues are generated from sales of products and services that are the result of research and development that is primarily undertaken in the United States.
These include pharmaceutical medicines and computer chips which are manufactured at Irish facilities and online advertising on platforms such as Google and Facebook which have their international headquarters in Ireland.
Paying for technology
It is non-controversial that the Irish operations of these US companies have to pay for the technology they use. There are essentially two ways in which this can be achieved:
- An outright purchase with the Irish company acquiring the rights or license to use the technology;
- Recurrent payments with the Irish company getting access to the technology via royalty payments.
Historically, the latter was the main method used. And the scale of the outbound royalty payments attracts significant attention. For example, in its latest Country Specific Recommendations (CSRs) addressed to Ireland the European Commission notes:
[T]he high level of royalty and dividend payments as a percentage of GDP suggests that Ireland’s tax rules are used by companies that engage in aggressive tax planning, and the effectiveness of the national measures will have to be assessed.
How big are these outbound payments? Pretty big.
In 2019, outbound royalties from Ireland were €84 billion and on their own are enough to offset around 20 per cent of the revenues flowing into Ireland. This looks like being a high watermark. Figures for the first three quarters of the year suggest the total for 2020 will be less than €70 billion which is still a very significant sum.
The fall in 2020 is not the result of a reduction in sales leading to lower royalties. Exports from Ireland in the key categories are set to reach record levels this year.
In the first three quarters of 2019, computer services exports in Ireland’s Balance of Payments were €84 billion; in the same period of 2020 they were €92 billion. Exports of pharmaceuticals in the External Trade data were €43 billion in the first ten months of 2019; in the same period of 2020 they were €51 billion.
Of course, it might have been expected that outbound royalty payments would have being falling before now. This is because of the onshoring of intangible assets that has been ongoing for the past number of years. This has seen some companies switch from #2 above (recurrent royalties) to #1 (outright purchases).
Divergent patterns of royalty payments
It is likely that the chart above with total outbound royalties clouds some divergent patterns. This can be seen if we look at the contribution of the pharmaceutical and ICT sectors to the total in recent years.
This shows that, in 2016, the amount of outbound royalties for the ICT and pharmaceutical sectors were similar. After that though the series diverge, with outbound royalties in the ICT sector rising and those for pharmaceuticals falling. Unfortunately, data suppression by the CSO means that the quarterly series for the ICT sector does not extend beyond Q2 2019 but the general point is clear. Indeed, the annual figures which are available show that royalty payments from the ICT sector went from €40.7 billion in 2019 to €50.7 billion in 2020 (the first half of 2020 was €22 billion).
Destination matters
Of course, royalties leaving Ireland is only a part of the story. Where they go to is also relevant. By far the largest destination of these royalties are what the CSO term ‘offshore financial centres’. In their notes the CSO set out that:
This category overlaps with the regions referred to above and covers Andorra, Antigua and Barbuda, Anguilla, Netherlands Antilles, Barbados, Bahrain, Bermuda, Bahamas, Belize, Cook Islands, Curacao, Dominica, Grenada, Guernsey, Gibraltar, Hong Kong, Isle of Man, Jersey, Jamaica, St. Kitts and Nevis, St Maarten, Turks and Caicos Islands, Cayman Islands, Lebanon, Saint Lucia, Liechtenstein, Liberia, Marshall Islands, Montserrat, Maldives, Nauru, Niue, Panama, Philippines, Singapore, Saint Vincent and the Grenadines, British Virgin Islands, US Virgin Islands, Vanuatu, Samoa.
Plenty of zero-tax or no-tax jurisdictions in there. By the end of 2019 around half of the outbound royalties (around €10 billion a quarter) were going to offshore financial centres.
It can be seen that the amounts were relatively modest up to the end of 2013 after which they increased rapidly. The reason for this is that up to then Ireland levied a withholding tax on outbound royalty payments to non-treaty countries. If royalty payments were made by an Irish resident person or entity to these jurisdictions some of the payment would have to be withheld and paid to the Revenue Commissioners to cover potential tax liabilities.
There was a fairly easy workaround for companies to avoid Ireland’s withholding tax on outbound royalties to non-treaty countries. Under the EU’s Patents and Royalties directive EU member states cannot levy a withholding tax on royalty payments made to a resident of another member state.
And as is well known The Netherlands does not levy a withholding tax on outbound payments from there to locations such as Bermuda. This means the chart above does not fully represent the amount of outbound royalties from Ireland that are directed to ‘offshore financial centres’.
In Q4 2019, just over €8 billion of royalties went from Ireland to The Netherlands – and it’s probably safe to assume that via this “dutch sandwich” they were further transferred on to jurisdictions such as Bermuda.
All the companies doing this are US companies. The US tax system has allowed (and incentivised) US companies to locate licenses for the use of their technologies outside the US in low-tax jurisdictions such as Caribbean Islands.
So while the Irish subsidiaries were correctly paying for the use of technology generated elsewhere these payments were going to locations where the companies had no substance rather than where the technology was actually developed, i.e. the United States. The primary tax payments affected by these strategies are US tax payments.
There are many reasons why these strategies will no longer be effective. Actions 8 to 10 of the OECD’s BEPS I Project means that such payments to jurisdictions which lack the substance to produce the service or technology being paid for may no longer be tax deductible. The Tax Cuts and Jobs Act abolished the principle of deferral in the US tax code which was a primary motivation for the creation of these structures.
Changes to Ireland’s residence rules for Corporation Tax meant it was no longer as feasible for US companies to avail of the deferral provisions in the US tax code such as the “same country exemptions” – the basis for the “double irish” being that two companies were registered in the same country.
Google changes tack
One of the most high profile companies with the a “double irish with a dutch sandwich” structure was Google. But this time last year Google came out and said:
“A date of termination of the Company’s licensing activities has not yet been confirmed by senior leadership, however management expects that this termination will take place as of 31 December 2019 or during 2020.
“Consequently, the Company’s turnover and associated expense base generated from licensing activities will discontinue as of this date” the filing with the Dutch Chamber of Commerce added.
“We’re now simplifying our corporate structure and will license our IP (intellectual property) from the US, not Bermuda,” a spokesman said in a statement.
Can we see the impact of this in Ireland’s Balance of Payments data? It seems we can.
Eurostat don’t have a good quarterly series for royalty payments from Ireland to the Netherlands (many of the values are redacted) but there is a compete series for payments to the euro area and the available numbers suggest that payments to The Netherlands make up 90 per cent of royalty payments from Ireland to the euro area.
For example, we know that there were €8.1 billion of royalties from Ireland to The Netherlands in Q4 2019; the total for the euro area was €8.9 billion. Anyway, let’s get to it.
Pretty clear that there was a significant change at the start of 2020. This change doesn’t make a huge amount of difference to Google’s operations in Ireland – in the short-term at any rate. The Irish company must still pay for the right to use Google’s technology but these license payments or royalties are no longer going to Bermuda via The Netherlands.
Can we see where they are going? Again it seems we can. Here are outbound royalty payments from Ireland to the United States.
Note that the vertical scale of both charts are the same. It is not a huge leap to conclude that the royalty payments that went to The Netherlands in Q4 2019 went to the US in Q1 2020.
So now rather than being parked offshore in Bermuda this income will be taxed under the provisions of the TCJA (FDII, GILTI etc.) though will likely be at a rate that is less than the 21 per cent headline rate of the federal US corporate income tax.
And so does Facebook
And it’s not just Google making these changes. As we looked at previously Facebook’s outbound royalties from Ireland were paid to the Cayman Islands (with no stopover in The Netherlands). Facebook have now said that:
“Facebook International Holdings Unlimited is being wound up as part of a change that best aligns with our operating structure. In preparation for the unlimited company winding up, FIH’s assets were distributed to its US parent company.
Intellectual property licenses related to our international operations have been repatriated back to the US. This change, which has been effective since July this year, best aligns corporate structure with where we expect to have most of our activities and people. We believe it is consistent with recent and upcoming tax law changes that policymakers are advocating for around the world.”
The above chart of Eurostat data of royalty payments from Ireland to the US goes to Q2 2020. The Facebook announcement of a change in its structure from Q3 2020 means that there will be more to add to this when data for subsequent quarters are published.
Manufacturing concern
The European Commission are concerned with the level of outbound royalty payments from Ireland. Will they still be concerned as a greater and greater share of these payments, particularly for the ICT sector, flow to the United States? And what about in manufacturing where it is likely that the payments will continued to fall? Will that reduction satisfy the concerns of the Commission?
When they published the Q1 2020 national accounts the CSO said:
However, royalty imports for pharmaceutical products and preparations decreased by almost €1 billion in Quarter 1, 2020 when compared with Quarter 1, 2019 and the accumulation of the IPP relocations to Ireland in recent years may now be leading to reduced quarterly royalty payments abroad.
It seems in manufacturing, that US companies in Ireland have responded to the changes in tax rules by onshoring their licenses to Ireland with their subsidiaries here undertaking an acquisition of the license. The capital cost incurred will be deductible for tax with the eligible amounts set out under Ireland’s rules for capital allowances.
The BEPS project’s overarching objective was to try and ensure that company profits were aligned with substance. US MNCs had little or no substance on Caribbean Islands and maintaining the licenses they had there was no longer feasible..
But for US MNCs that have operations in Ireland is there a reason why ICT companies such as Google and Facebook have decided to relocate these licenses to the US while pharmaceutical companies and other manufacturing companies have onshored the licenses to Ireland?
It may come down to that BEPS objective – or, more particularly when it comes to intangible assets, DEMPE. This stands for the development, enhancement, maintenance, protection and exploitation of the intangible asset.
It seems that US manufacturing companies have decided they have sufficient DEMPE activities in Ireland (or that they could move to Ireland) to justify co-locating the license to use their intellectual property with their production facilities in Ireland. On the other hand it seems that US ICT companies have decided they do not have, and will not have, sufficient DEMPE activities in Ireland to justify co-locating their licenses here.
Should this be a concern for Ireland? Perhaps. By onshoring their licenses to Ireland the manufacturing companies are further embedding their presence here. It is another spoke in wheel solidifying their presence here. ICT companies such as Google and Facebook have not moved their IP to Ireland. As a result their international headquarters are a bit more footloose.
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