To tax or not to tax

The corporation tax debate goes on – and rightly so.  This is a very important issue.  It is important for Ireland; it is important globally; and, of course, it is important for the companies.

One of the problems with the domestic debate is that it is almost completely inward focussed.  It is pretty obvious that such a dependence on FDI is a significant threat to the domestic economy.  Of course, it is also an opportunity if it can be expanded.  It may be a misinterpretation but the Chinese word for “crisis” is commonly cited as being a combination of “danger” and “opportunity”.

So where are the dangers?  The lead story in today’s Irish Times suggests that they are very much domestic in origin and has a set of “effective tax rates” for a group of companies

“including US software company Novell, which paid no tax on Irish profits of $315.6 million in the 16 months to March 2012.”

The company must sell a lot of software infrastructure in Ireland to generate that level of “Irish profits”.  Novell also featured in the Irish Times Top 1000 companies recently.  The details are here.  The figures are notably different.  The turnover figure doesn’t even match the profit figure given above.

It is likely that the figures in today’s report are for a Novell company registered in Ireland but one that is not deemed tax resident in Ireland.  This distinction is not unusual or unique. 

Yesterday, The Guardian ran a significant piece on Apple featuring details on Apple Operations International (AOI) and some links to an Irish employee.  AOI featured in the recent Senate report on Apple.  The section on AOI is very instructive and is below the fold.  If you read it look for indications that this company should be liable for tax in Ireland and compare that to the number of indications that the company should pay tax somewhere else.

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Divergent trends in employee numbers

Yesterday the CSO published their latest update of the Earnings and Labour Costs Survey.  Using complementary results from the Quarterly National Household Survey the CSO provide some details of employee numbers by sector.

The figures exclude the Agriculture, forestry and fishing sector and  by definition excludes all people classified as self-employed.  The figures are number of employees rather than people at work so a person with two jobs would be counted twice.

The pattern for total employees presents a familiar pattern.  There was rapid decline in 2008 and 2009 which moderated in 2010 and the total has been going nowhere since the beginning of 2011.

However, if we get a public/private decomposition of the total since the levelling off at the start of 2011 then a slightly divergent picture emerges. 

Although the total has remained around the same the number of public sector employees has fallen from 409,000 to 384,000 while the number of private sector employees has increased from 1,107,000 to 1,144,000.  The fall in private sector employees has been offset by the rise in private sector employees.

The public sector includes civil servants, public servants, contract and agency staff with public bodies and employees of commercial and non-commercial semi-state bodies.  The figures are done on a headcount rather than full-time equivalent basis and peaked at 427,000 at the end of 2008.

The figure indicate that there has been a rise of around 35,000 in the number of private sector employees over the past three years.  It would be ideal if a further breakdown of full-time/part-time was provided for the public and private sectors.  The QNHS does provide figures for full-time/part-time employment but it does not provide a public/private sector breakdown (and also includes the self-employed as well as employees). 

A quick glance at the most recent QNHS release (Table 1a) shows the total number of people in employment (employees and self-employed) remaining relatively steady over the past two years but that a fall in full-time employment has been offset by a rise in part-time employment.  Given the partially overlapping and partially different coverage of the series it is difficult to establish exactly what is going on.  It could be that there is a reduction in full-time employment in the public sector and an increase in part-time employment in the private sector.  The figures from the CSO do not fully confirm this though.

We can say that the number of employees has been increasing in the private sector.  We can also see that the number of employees in the public sector has been decreasing.  The rise in the private sector is negligible compared to the fall that came before it but it is a small move in the right direction nonetheless.

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Evening Echo 27/05/2013

The importance of Apple to Cork city and surrounds meant the furore of last week was bound to attract the attention of the local media.  Here is a piece (continued below the fold) on Apple and the broader corporation tax debate that was carried in Monday’s Evening Echo.

Firms using US tax rules to their benefit

The intense focus this week on the tax strategies of US companies like Apple has led to speculation that there will be changes in international tax practices.

This is particularly important from a Cork perspective as not only is Apple based here but so too are many US companies in the pharmaceutical sector. These are large companies offering thousands of well-paid jobs that are hugely important for the Cork region.

There is no doubt there are some risks to having this dependence on US investment but the presence of two construction cranes in Hollyhill is an indication that Apple are not expecting any changes in the medium term.

There have been accusations that Ireland is using unfair tax competition and dodgy tax practices to attract foreign direct investment. However, most of the large companies that the IDA has attracted to Ireland are from the US. This would suggest that there is something in particular that makes Ireland attractive to US companies.

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Tim Cook talks special tax deals

Apple CEO has given a wide-ranging interview to the AllthingsD.com website (part of the Dow Jones Company).  In the ten-minute segment below he reflects on his recent appearance before the US Senate Permanent Sub-Committee on Investigations on Apple’s tax strategies.

About 5:25 into the video he says:

“I’ve seen something in the press that says that some people think that we have a deal with the Irish, a special deal with the Irish government, to pay two per cent flat tax rate.  We have no special deal with the Irish government that gives us a two per cent flat tax rate.  So let me just set that aside.”

One wonders why he didn’t say that in response to a direct question on the alleged 2% rate from Senator Claire McCaskill at last week’s hearing.  Bit late now.

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How does Elppa reduce its tax rate to just 0.125%?

US company Elppa operates in the consumer gadgets sector.  It has distribution and retail units for its gadgets in countries all around the world.  It also has a single holding company that licenses the design, software and overall intellectual property that go into its gadgets.

By dint of the design of its transfer pricing structure, Elppa’s holding company is ten times more profitable than the retail divisions.  Its sales operations in Ireland contribute 1% of its global profits (excluding the US).

Elppa’s Irish distribution and retail business generates an annual profit of €20 million.  On this it pays €2.5 million in corporate income tax (12.5% of €20 million).  Across all its distribution and retail operations Elppa has global retail profits of €2 billion.  As these individual retail units are a ‘permanent establishment’ in each country the appropriate amount of corporate income tax is paid in each country in which these retail profits are generated. 

Elppa’s holding company generates annual profits of €20 billion.  The company was registered and established in Ireland but it is based in the US. Most of its small staff are in the US, its operational activities are carried out in the US, its board meetings take place in the US and its assets (massive cash reserves) are held in the US.  Apart from its incorporation the holding company has no direct links with Ireland.

In Irish tax law companies that are incorporated in Ireland are considered tax resident in Ireland with some exceptions.  One exception is based on the standard rules produced by the OECD for tax residence based on the test of a company’s ‘effective management and control’.  Elppa’s holding company is effectively managed and controlled in the US.

If a foreign-owned company with a presence of substance in Ireland has a subsidiary that is incorporated in Ireland but effectively managed and controlled in another country that subsidiary is not considered tax resident in Ireland.  There is nothing unique or unusual about this.

As the holding company is incorporated in Ireland it is subject to Irish corporation tax on its source profits generated in Ireland.  Through its activities with the Irish retail division the holding company generates a profit of €200 million.  The holding company will pay €25 million (12.5% of €200 million) on these profits.  The remaining €19.8 billion of profits will be taxed where the company is tax resident.

This is where Elppa makes use of a kink in the interaction between the Irish and US tax codes.  The US tax code treats companies like individuals.  Just as every US citizen is subject to US personal income tax of their global income, every US-incorporated business is subject to US corporate income tax on its global profits.  US-incorporated businesses incur a 35% tax on their global profits (with tax credits given for tax paid elsewhere).

Elppa’s holding company carries out all its operations in the US.  However, because it is incorporated in Ireland it is not considered to be tax resident in the US.  As the holding company has no presence in any other country apart from its incorporation in Ireland and its operations in the US it is deemed to be tax resident in no country.  This is why the scheme works.

The company pays no further tax on the €19.8 billion of profits generated with its retail divisions around the world. 

On a total profit of €20 billion, the holding company has paid €25 million of Irish corporation tax giving an effective tax rate of just 0.125%.

Although it has paid a very small amount of tax the company does have a large outstanding tax liability.  As stated, the US levies a 35% corporation tax on global profits.  Elppa has an international subsidiary that has an annual profit of €20 billion and this will give rise to a tax liability of €7 billion (with a credit given for the small amount of tax paid in Ireland).

Using provisions in the US tax code, Elppa is able to defer the actual payment of this tax liability until the money is repatriated and transferred to a US-incorporated division of the company.  Each year the international holding company generates a €20 billion profit it also accrues a US tax liability of €7 billion.  There is no way for Elppa to avoid this but it can defer the payment of it by keeping the money “offshore”.

It can be seen the Elppa uses two things to defer this tax liability for US corporate tax:

1. The provision in the US tax code that only US-incorporated companies are considered US-resident for tax purposes.
2. The provision in the US tax code that allows it to defer the actual payment of the tax liability on the profit earned by the holding company.

Why is Ireland an attractive location for Elppa to base its international operations?

1. The interaction of the Irish and US tax codes allows companies to take advantage of the above loopholes in US tax law.  We can take it that much of this is the result of deliberate design, definitely in Ireland and possibly in the US.
2. Ireland is a very small market so the source income it earns in Ireland is very small.  This, allied to our low corporate tax rate, means that Elppa pays a small amount of tax in the international country it chooses to operate in which means that more of its profits can benefit from the scheme outlined above.

Elppa is not avoiding any Irish tax and pays 12.5% tax on both the retail and licensing profit it makes in Ireland. 

It is not avoiding tax in any other international country though the transfer pricing scheme that allows its holding company to be ten times more profitable than its retail divisions can be questioned.  If more profit is shifted to the retail divisions than Elppa will pay more corporate income tax in all the countries in which it operates.  Changes to transfer pricing rules requires international coordination.

Finally, Elppa is deferring the actual payment of a massive amount of US corporation tax but it cannot avoid incurring the liability.

The calculation of a tax rate of 0.125% for Elppa’s holding company is possible but that is only done by taking the tax paid by Elppa on its source profits in Ireland as a proportion of its global profits, most of which are not taxable in Ireland.

[Any similarity to a US consumer gadget company whose name is the reverse of Elppa is purely coincidental.]

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