Monday, January 6, 2014

Debt Charts and Tax Arbitrage

Charts like the following appear fairly regularly.


The latest occurrence was on the website of The Wall Street Journal.  There is nothing wrong with the chart.  It is 100 percent accurate in what it represents.  The problem is in how it is subsequently used and interpreted, particularly in Irish media.  And as if to keep the record intact the chart appeared in the Sunday papers to declare us to be “the most delinquent of European debtors”.

The constituent components of the figures for Ireland in the chart above are:


DEBT, €bn





Non-Financial Corporate









Ireland has a massive debt problem but the real impact on “us” needs to be understood.   The figures for the Household and Government sectors are not in dispute.  The scale and problems associated with each are fairly well understood even if resolving them is still some way off.

What remains is the massive figure for business debt.  Do Irish businesses have €330 billion in debt?  Well, businesses in Ireland do, but not necessarily Irish businesses.  We have looked at this in more detail before and here is a chart worth reproducing:

NFC Debt and GDP[3]

At the zenith of the boom in 2007, non-financial corporate debt was around €200 billion.  The banking sector seized up around then but NFC debt surged to close to €350 billion.  As the previous post explored much of this was down to the treasury activities of MNCs with operations in Ireland.

What were the MNCs doing?  They were trying to get money out of Ireland.  MNCs have been able to create “double non-taxation” on their profits using hybrid loan instruments. 

In this arrangement a MNC subsidiary in Ireland will be financed by a parent elsewhere using an intra-company loan.  The Irish subsidiary will be charged “arms-length” interest for this loan.  Naturally, the interest paid will be allowed as a deduction in Ireland to taxable income as loan interest is a legitimate business expense.  The double non-taxation arises when the MNC originates the loan from a country that does not tax the interest income from the loan (in many cases the loan will be classified by the originator such that the income received is a dividend – this is the “hybrid” instrument).  The expense generates a deduction in Ireland and the income is a tax exempt dividend distribution in the destination country.

Back in November the EU announced efforts to clampdown on such double non-taxation arrangements.  Under the proposals the income will not be tax exempt in the destination country. [These proposals will not change Irish tax law as we do not have a dividend exemption that allows these hybrid-loan mismatches.]

Here is the outflow from Ireland of Direct Investment Income: Income from Debt in the Balance of Payments Annual Series:

Direct Investment Income - Income on Debt

The years don’t exactly match up but it can be seen that there has been a massive jump in the outflow of Income on Debt for Direct Investment Income.  The outgoing payments are now almost €5 billion a year.  Once again the tax arbitrage strategies of MNCs of skewing Irish macro data.

So how much debt do “Irish” non-financial corporates have? The turmoil in the banking system means that we really don’t know.  What we do know is the lending of banks in Ireland to businesses in Ireland peaked at €175 billion in early 2008.  Of this, around €115 billion was to property, construction, development and other real-estate activities with around €60 billion to companies outside the construction sector (though a lot of this was also property related).

Thus, €175 billion gives something approaching the extent of NFC debt of Irish companies.  There have been lots of changes since 2008.  Some banks have left the market, some banks have folded and lots of loans have been transferred to NAMA.  How much of the €115 billion property-related debt still exists six years later?  How much of it will actually be repaid? 

The non-payment of huge amounts of NFC debt has added significantly to the government debt.  A large part of the €40 billion loss made by the NAMA banks when their loans were transferred to NAMA was covered by the government.  We can expect that the NFC sector won’t be repaying that much of that.  At best we can hope that the €30 billion or so paid by NAMA will be recouped.

Losses by non-NAMA banks on development loans will be substantial as well, maybe up to €20 billion.  The €60 billion lent to non-property related sectors has decreased by around €20 billion in the past six years as lending by the banks has contracted.  Conservatively, we could knock €80 billion off the peak lending to NFCs to get the current figure.

Here is a stab at end-2013 debt figures for the three sectors (estimated GDP: €165 billion)


DEBT, €bn





Non-Financial Corporate*









* Figure reflects “Irish” NFC debt of €40 billion lending to non-property-related sectors and property loans net of loss on NAMA transfers (these losses have already been counted in the gross debt of the Government sector) and similar losses outside the NAMA banks .

It’s a massive mountain of debt but not as unique as the opening chart above would suggest.  A total debt of 285% of GDP would be mid-table in the chart.

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