The current account: where do we stand?

Here are the estimates of the current account of the Balance of Payments as currently provided by the CSO:

As we have explained before the recent changes of the current account are telling us close to nothing about the underlying external position of the economy.  Making the * adjustments used to determine GNI* doesn’t offer much and only gets us to this:

The modified current account adjusts for the net income of redomiciled PLCs (which ultimately doesn’t accrue to Irish residents) and the depreciation of foreign-owned aircraft for leasing and intangible assets (which accrues to non-residents through the repayment of debt rather than income).  These adjustments may have given us a better level indicator of national income, GNI*, but still left us with a current account that offered little insight.

In our previous effort, we made a further adjustment for the acquisition of these aircraft for leasing and intangible assets.  That is because these items are imported but the purchases are not funded from domestic sources so any deficit that results from these is not reflective of the underlying position of the economy.  Any such deficits are funded by intra-company lending.  Using figures for the investment in these assets gets us to:

This is undoubtedly an improvement and the orange line reflects what we might expect an underlying current account to do.  It deteriorates up to 2008, then shows some improvement and returns to balance in 2014.  However, it is what happened then that suggested all was not what it seemed to be.  Yes, we probably would have expected the underlying current account to continue improving in 2015 and 2016 but the improvements here seemed too large and by 2016 the orange line is showing a surplus of €13 billion.

The issue seems to be related to imports of R&D services and we tried to explore the implications of this for GNI* here.  The issue is whether expenditure on R&D activity should be treated as intermediate consumption (thus reducing profits) or a capital item (investment).  The move to new national accounting standards sees R&D spending treated as a capital item but certain issues remain in the introduction of a consistent treatment across the national accounts and the balance of payments.

Although R&D spending is treated as a capital item in the national accounts it is still treated as intermediate consumption for balance of payments purposes.  The previous post runs through this in more detail but when a consistent treatment is taken it is likely the outflows of profits will increase by the amount of spending on R&D service imports (as almost all of this is undertaken by foreign-owned MNCs.)

It’s all becoming messy now but if we make a further adjustment for imports of R&D services this is what we get:

That looks about right.  The balance has been adjusted down for all years but this difference increases for 2015 and 2016 when R&D service imports really ramped up.  The green line reflects what we would think an underlying current account balance would look like and has steady improvement to a small surplus in 2016 unlike the rapid increases of the earlier attempt.

So let’s put this underlying measure relative to GNI* to see what we get (though we have some issues over how R&D service imports are influencing that).

 

As the label shows it is quite the journey from the official estimate of the current account to this derived underlying measure.  There may be some issues here and there but it seems to fit the bill.  The current account deficit that began to open in 2004 and 2005 and looks like it returned to something close to balance last year after a number of years of sustained improvements.  We’ll take that.  For now.

Here is a table showing the adjustments made. Click to enlarge.

And to conclude here is something which may or may not change the underlying position – R&D exports.  All the focus has been on onshoring of IP but it seems like there is also IP going in the other direction with a surge in IP exports in recent years (albeit at a scale much much smaller than what has been happening in the other direction).

Effective Tax Rates in the C&AG Report-Companies

Comparing effective tax rates across countries may be difficult but comparing them across companies using the same system should be insightful.  And we get significant added value from the C&AG report chapter on Corporation Tax Receipts in the analysis provided of the “Top 100” companies.

The C&AG place companies in the “Top 100” using their Taxable Income and Tax Due figures for 2015.  The table below gives the outturns for these, and the steps between them, in the aggregate Corporation Tax computation published by the Revenue Commissioners.

For 2015, we can see that €65.1 billion of Taxable Income resulted in €6.2 billion of tax due or 9.6 per cent of Taxable Income.  There is lots going on before we even get to Taxable Income (capital allowances, loss relief and trade charges) which is where most previous attention has focused.  The C&AG report gives some insight into what happens lower down the calculation. 

The table shows that before any reliefs or credits are applied the 12.5 per cent and 25 per cent Corporation Tax rates gave rise to €8.4 billion of gross tax (12.9 per cent of taxable income) with the reliefs and credits leading to the €6.2 billion tax due figure.

Of the two ranking used by the C&AG the ranking of companies by Taxable Income is probably the most informative as it gives the position before the application of credits and reliefs.  It should also be noted that the unit of analysis is individual companies of which there may be many in a group. One company or subsidiary in a group having a low effective tax rate does not mean that the group has a whole has a similarly low rate.

The distribution of effective tax rates (tax due as a percentage of taxable income) for the top 100 companies by taxable income is given in this useful chart:

The overall rate for the top 100 is put at 9.3 per cent but there is significant variability within the group.  Reassuringly, depending in your perspective, 79 of the 100 companies had effective rates (using the tax due as a proportion of taxable income approach) of between 10 and 15 per cent with 57 companies having rates of 12.5 per cent or above (likely reflecting the 25 per cent CT rate on non-trading income).  At the other end, though, 13 companies have effective rates of less than one per cent with eight being zero or negative which unsurprisingly is where attention was drawn.

How can this be?  Well, the C&AG report (and the table above) tell us:

Of the 13 taxpayers with an effective rate of less than 1% for 2015, they had availed either of double taxation relief to offset Irish corporation tax or of the research and development tax credit or of both these reliefs. The other 43 taxpayers with an effective rate of less than 12.5% had also availed of various reliefs.

There are no loopholes here.  Double tax relief and the R&D credit are central parts of the Irish Corporation Tax regime.

Ireland uses a worldwide system so profits earned abroad are included in an Irish-resident entity’s taxable income.  There was €7.5 billion of “foreign income” included in Ireland’s Corporation Tax base in 2015.  To allow for the tax paid on that in the source country Ireland grants a credit to avoid double taxation.  Total relief for tax incurred abroad amounted to €1,195 million in 2015 (double tax relief was €947 million and the additional foreign tax credit was €238 million).

We don’t get a break down of companies using double tax relief but any Irish-resident companies whose taxable income is derived from activities outside of Ireland will have an effective rate of Irish tax (which is what the C&AG has looked at) close to zero as the relief available for tax paid abroad will almost always fully offset the tax due at 12.5 per cent in Ireland.  The effective tax rate of the company will be higher as it will reflect the tax paid abroad.  And if these companies do have Irish-source income it will have an effective tax of around 12.5 per cent  - unless, that is, they use the second major relief available in Ireland which is the R&D tax credit.

In 2015, claims under the R&D tax credit amounted to €708 million (of which €349 million was used and €359 million was the payment to firms of excess R&D credit).

If double tax relief can be viewed as relief for tax incurred abroad, the R&D credit can be considered relief for (a particular) an expense incurred in Ireland.  Claims that the zero per cent rates reflect tax avoidance are a little wide of the mark given that to achieve them the company must either pay tax abroad or spend money in Ireland.

Of course, what the R&D credit does is subsidise that expense and whether that is justified is an important policy question which was addressed by this 2016 evaluation published by the Department of Finance while Ireland’s approach can be compared to that used internationally in this  OECD review of R&D incentives published a few weeks ago. 

Spending 100 to get back 37.5 (12.5 from the standard deduction of the expense and 25 via the credit) does not make sense unless the company expects the R&D activity to lead to increased profitability in the future.  The amount of expenditure undertaken for recent years was provided in this PQ:

• 2012: €2,448m
• 2013: €3,646m
• 2014: €4,581m
• 2016: €4,234m (prov.)

In the absence of the credit companies will undertake some R&D and the 2016 evaluation found a 40 per cent deadweight from the scheme.  That is, while 60 per cent of the associated R&D activity was a result of the scheme, 40 per cent would have taken place anyway and these companies benefitted from partial public funding of R&D they would have fully funded privately anyway. 

On the repayable component of the scheme (i.e. instances where the tax credit is greater than a companies computed tax bill) which were the subject of a recent set of parliamentary questions the evaluation finds:

Analysis of the firm characteristics of the R&D tax credit show that it is mainly older, larger and non-Irish firms who derive financial benefit from the scheme, although it is typically Irish firms who benefit more from the repayable credit element of the scheme.

Should we be concerned with the zero per cent effective rates shown in the C&AG report? Not unless we think companies are paying tax elsewhere or incurring R&D expenditure to avoid Irish taxes. Between them these two elements, which were highlighted by the C&AG account for €1.9 billion of the €2.2 billion between gross tax and tax due.

Granting relief for tax paid abroad is something we should do unless we move to a territorial system in line with most other countries in which case the foreign income of Irish-resident companies would not be counted as part of taxable income while granted relief for R&D expenditure is a deliberate policy choice designed to encourage such activity which we can change if we wish.

If anything, when looking at these useful figures the focus should be on the other end of the range published by the C&AG but “79 of top 100 companies have tax rate of 10% or above” is not what the headline writers are looking for.  And, as stated earlier, most of the action happens above the starting point of taxable income used by the C&AG.

Effective Corporate Tax Rates in the C&AG Report–Countries

The Office of the Comptroller and Auditor General has published its Report on the Accounts of the Public Services 2016 which includes a chapter on Corporation Tax Receipts.  One issue which the chapter addresses is effective rates of Corporation Tax.  For a variety of reasons this is rarely straightforward.  Here is a chart included by the C&AG

The chart is an effort to compare effective rates with statutory rates.  The statutory rates are taken from the OECD with the effective rates taken from the Paying Taxes 2017 report from pwc.  Two paragraphs are provided as commentary to the chart:

20.22 In 2015, Ireland had the lowest statutory rate of corporation tax of all OECD countries.1 Based on the PwC/World Bank report, Ireland’s estimated effective rate of corporation tax was 12.4%, which was just 0.1% below the statutory rate. 12 OECD countries had an effective rate of corporation tax which was lower than this; one had a rate which was equal; and 21 had an effective rate which was higher.

20.23 In 2015, the United States had the highest statutory rate of corporation tax in the OECD at 39%, coupled with the second highest effective rate of 28.1%. France had the second highest statutory rate at 38% but the lowest effective rate at just 0.4%. The OECD reported that for 2015, France’s corporation tax as a percentage of total taxation was 4.6%.

The French example should give pause for thought. Could they really have an effective corporate income tax rate of 0.4 per cent?  Well in the case of the model company used in the pwc report it would seem so but that is hardly representative of the French tax system.  And it is not clear what the final sentence is supposed to add.  The proportion of total tax in France that is raised from Corporation Tax tells us nothing about the effective rate.

Of course, what the chart is trying to address is a legitimate question: how do effective rate for corporate income tax compare across countries?  The advantage of the pwc report is that it allows such cross-country comparisons but highlighting the outcome for France shows the approach used may not give the best insights in all cases.

We can try to do something similar with Eurostat national accounts data though it gives a smaller sample size.  The following table gives taxes on income paid as a proportion of net operating surplus for the non-financial corporate sectors of the EU28, where available.  (Click to enlarge).

The averages provided are unweighted, arithmetical averages and for the ten years shown an overall average of 18.8 per cent results.  Ireland comes in at 10.4 per cent with France showing a much more plausible result of just over 30 per cent.  Three countries have a lower average than Ireland for the period shown, Estonia, Latvia and Lithuania.

For what it is worth, the reason for the high rate for Cyprus (44.7 per cent) is the inclusion in D51 of items that would not necessarily be considered a profits tax such a defence contributions based on dividends and taxes collected from offshore companies.  What would typically be considered Corporation Tax makes up around 30 per cent of the amounts included under D51 for Cyprus which would bring to effective rate rate close to the headline rate which is similar to Ireland’s. 

Maybe this just highlights the difficulty in making such comparisons but looking at aggregates is likely to give a better reflection of what is going on in general than using a hypothetical individual example.

What do we conclude? Ireland has an “effective rate” that averages just over ten per cent.  This is low by EU standards but, of course, that is deliberately so.  No country in the EU has an effective rate of 0.4 per cent.