Who will be footing the bill if Apple pays more tax?

The following exchange took place at a recent hearing of the US Senate Finance Committee.

Mr Warner (D): I wanted to ask as well, I know Senator Wyden raised the question of the European Union state aid cases and the overall impact because of potential targetting of American companies and what that impact is for American taxpayers.

Mr. Stack could you kind of walk through that just of terms if a taxpayer was sitting in front of you, how does it affect me ultimately or how could it potentially affect that taxpayer.

Mr Stack: Sure Senator.  When a US company pays a tax in a foreign jurisdiction and then they bring money home they get a credit for the tax paid in a foreign jurisdiction up to a certain limit. 

Now, in the normal case that means you are actually doing some business in Germany, let's say, and you had some tax and you brought it home and you got your credit.  In this fact pattern, the EU is coming along and they're saying "Oh we think when you cut your deal with Ireland or Luxembourg or the Netherlands that in fact you, the company, should have been paying more tax to those jurisdictions." 

Now if we were to determine that those payments are in fact taxes and we were to determine that they are creditable under our rules, now when that money comes home from those companies in addition to the credit they got for the tax they originally paid in those jurisdictions they get an extra credit. And that credit to this taxpayer you asked me about means in effect the US Treasury got less money and in effect made a direct transfer to the European jurisdiction that is getting the ruling from the Commission. 

So if these turn out to be creditable taxes it is the US taxpayer that are footing the bill for these EU investigations.

The reply was given by Robert Stack, Assistant US Treasury Secretary with responsibility for international tax affairs and can be viewed beginning from timestamp 1:17:20 in the video on this page.

Here is a very very simplified set up of what Robert Stack is describing.

In both scenarios the company has foreign earnings outside the US of 1000.  In scenario ‘A’ it pays foreign tax of 100 on those earnings, while in scenario B the foreign tax is 200.

In both cases the gross US tax due is the same (35 per cent of foreign earnings) but to avoid double taxation companies get a tax credit for foreign corporate income tax.  If a US company pays more corporation tax abroad it gets a larger tax credit to offset its US tax liability.

This means that the net tax due to the US falls from 250 to 150 – there is less tax due in the US by an amount equivalent to the extra foreign tax paid.  The total amount of tax remains the same and the company’s post-tax profit is unchanged.  The increased foreign tax paid results in less US tax being due.

Of course, this is highly highly simplified and excludes one key complication – the ability of US companies to defer the US tax due on their foreign earnings – but the impact on the tax that could be paid to the US is the same.  More foreign tax paid means less tax due to the US even if it is deferred.

Naturally, this was always known but as the EU state aid investigations have progressed the US has become ever more vocal on this issue.  Maybe they felt they did not want to interfere with matters in other jurisdictions but it’s also likely that they felt the EU would not interfere with international agreements to allocate the taxing rights to corporate earnings.

Here’s Robert Stack later in the same hearing on this:

Mr Stack: We were faced with a choice as to whether speak up now before multi-billion dollar judgements are rendered against our companies or wait until the decisions have been handed down so we have been raising this issue today.

From my personal observation of these cases and study it appears to me that the Commission is attempting to tax income that really under international standards doesn't belong to any member and, I agree with you, my perception is that they are tring to tax the income that they perceive as untaxed because it has been deferred for US tax and they see it as something that is there for the taking because our system has let it set offshore without being taxed. So that's my perception of the substantive state of those cases.  They have ways to go; I could be wrong. But that's the way I see them today.

So all those suggesting that Apple should pay more tax in Ireland (with some saying we should just force them!) need to back that up with reasons why the US Treasury and US taxpayers should foot the bill.  And it needs to be more than “but the US doesn’t collect the tax”.  That is true but the US has the right to tax that income – on what basis can we take that right from them?

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Corporates in the Institutional Sector Accounts

The previous post looked at some developments in the household sector in the Q3 release of the Institutional Sector Accounts.  There we concluded that the pattern of employee compensation received by the household sector was now more plausible but there seem to be unusally large increases in mixed income (+22%) and net property income (+55%).

Here we will look briefly at the corporate sector which is divided into Financial and Non-Financial.  First the table. Click to enlarge.

What are the take-out points?  First we can see in line 7 that the increase in Corporation Tax receipts is reflected in the account.  In line with the Exchequer Statements there is an increase of more than 40 per cent in the first three quarters of 2015 compared to 2014.

There has been a lot of debate about this increase with the Department of Finance attributing it to “improved trading conditions”.  We see some evidence of that here.  Gross Operating Surplus (line 4) is up 19 per cent year-on-year.  Gross Operating Surplus is akin to earnings before income, tax, depreciation and amortisation (EBITDA) which in turn is a relation of taxable income.

But how do we reconcile a near 45 per cent increase in tax payments with a 19 per cent rise in operating surplus?  What profits are the companies paying extra taxes on?

The increased taxes could be due to non-trading factors such as the exhaustion of previous losses carried forward or the taxation of capital gains rather than trading profits.  Based on a letter from the Chairman of the Revenue Commissioners to the Minister for Finance we can rule out capital gains (as almost all of the surplus is expected to be repeated this year) but the increase in Corporation Tax seems too large to be explained by the exhaustion of previous losses (even with a 20 per cent rise in operating surplus).

A second issue is one that is in the detail behind the above table.  Line 5 gives net property income.  For the non-financial sector this is dominated by the outflow of profits earned by foreign-owned MNCs with operations in Ireland.  But the figure above is net and the constituent elements are worth looking at.  Again click to enlarge.

It can be seen that the net figure results when property income received is offset with property income paid.  In the first three quarters of 2014 the NFC sector in Ireland received €10 billion of property income and in the first three quarters of 2015 this increased to €11.5 billion.  Almost all of this is re-invested earnings on direct foreign investment, i.e. it is profits earned abroad by “Irish” companies. 

This is counted as an outflow from the countries where the profits are earned (just as MNC profits are usually counted as an outflow here) and is counted as an inflow to Ireland.  As the money remains reinvested abroad it will be counted as an outflow in the financial account so the net overall effect is nil.  This money never comes to Ireland but for ownership purposes is counted as an inflow of profits (income) and an outflow of investment (FDI).

The pattern of these reinvested earnings paid to the Irish NFC sector are worth recalling.

We know what has caused this – redomiciled PLCs with inversions from the US likely to play an even greater role in furture time periods.

What do we get from this “inflow” to Ireland? Very little.  It is unlikely that the companies are paying any additional Corporation Tax to Ireland on these profits.  As stated above the money never passes through Ireland. It is retained profits earned abroad that stays abroad.  If the companies ever decide to distribute these profits as a dividend then it will count as an outflow from Ireland (assuming the shareholders are non-resident) but that is unlikely to happen as companies do retain substantial profits for reinvestment.

Is there a cost to Ireland of this? Yes, there is.  These “inflows” are counted as part of our Gross National Income.  In a sense because of these redomciled PLCs the GDP-GNP gap is smaller than it otherswise would be. [This income also makes the current account of the Balance of Payments appear better.]  Is there anything set based on GNI? Yes, contributions to the EU.  We are paying more because of these profits.

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Compensation of Employees revisited

A recent post wondered why compensation of employees isn’t increasing in the national accounts.  The CSO have now published the Q3 2015 update of the non-financial sectoral accounts and the question seems moot – primarily because of data revisions.

In the chart above there is now a two-year upward trend which was not evident in the last version of the data.  All of the revisions relate to data before the first quarter of 2014 so it is possible the changes are result of the switch to ESA2010. 

Anyway now that we have what we would expect – rising compensation of employees – it is worth looking at the broader household sector accounts.  Click to enlarge.

For the first three quarters of 2015, gross disposable income is almost €6 billion (9.2%) higher than in the equivalent period of 2014.  This is driven by three key factors:

• a €3.5 billion rise in self-employed and mixed income
• a near €2 billion rise in wages received, and
• a €1 billion improvement in net property income (mainly dividends)

These are partially offset by a rise in social contributions paid (both to the government and financial corporations) and a reduction in social benefits paid by the government.

Although there was a €6 billion increase in gross disposable income the figures show that there has been a €2.5 billion increase in household consumption expenditure.  This means there has been a big jump in gross savings and the household savings rate for the first three quarters of 2015 stands at 12.2% compared to 7.8% in the first three quarters of 2015.

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Shares of Earnings, Transfers, Taxes and Incomes by Decile

As part of the Survey of Income and Living Conditions the CSO publish the following table of the shares of equivalised disposable income by decile.

We can use Table A2 in the release to look at the shares of each element that make up the composition of disposable income.  The following table is for 2014.  It can be seen that the final row corresponds to the 2014 column in the  first table above.  Click to enlarge.

The definitions used in the survey are in the background notes.  Of these, note that “social contributions” refers to PRSI and employee pension contributions.

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