Monday, March 8, 2021

Why exaggerate when the reality is bizarre enough

The taxation of US multinationals is always good for a headline and given that many of them organise their international operations through Ireland a headline including Ireland is usually within reach.  A few weeks ago The Currency grabbed one and ran a story where the headline (and also the concluding sentence) was:

What does it say when a multinational can book a $3.6bn profit in Ireland and not pay any tax here?”

This certainly would be a story to raise outrage – if it were true.  The headline is about a subsidiary within Dell/EMC called EMC International Company but what the story fails to mention is that this company is based in Bermuda.  The accounts for EMC International Company state that "[t]he administrative office address is Clarendon House, 2 Church Street, Hamilton HM11, Bermuda.”

While it is true that the company did not pay any tax in Ireland (which is true for the vast, vast majority of companies around the world) it is not true that the company “booked” its profit in Ireland (which is also something that is true for the vast, vast majority of companies).  It is a glaring omission to leave out that the company is based in Bermuda and simply wrong to say that its profit is booked in Ireland. 

Up to April 2019, EMC International Company was part of a typical “double-irish” type structure.  This is old ground but it well-known that this type of structure involves a trading company operating in a low-tax jurisdiction such as Ireland and a holding company based in a no-tax jurisdiction such as Bermuda.  The choice of either location is not central to the overall effectiveness of the structure. 

EMC International Company was that holding company within the Dell/EMC group and this is even stated in The Currency piece:

The company was part of Dell/EMC’s Double Irish structure, a tax efficient strategy that is now being wound down.

The profit this company earns is tax-free in Bermuda because Bermuda doesn’t have income taxes but all the profit subject to tax in the United States - which is the source of most of the profit in the first place.

The United States has a complicated system. It was changed with the Tax Cuts and Jobs Act of December 2017, but it essentially remains a worldwide regime.  All of the profits of US MNCs, wherever earned, are subject to US tax with, most of that paid by the parent company. 

US MNCs cannot generate tax-free profits with a variety of provisions now in place to collect US tax on profits that might appear low taxed in Ireland or completely untaxed in Bermuda.  And the US does not want their companies paying any more tax outside the US then they have to. 

Indeed, the IRS requires US MNCs to minimise their foreign tax payments if they wish to avoid double taxation when claiming foreign tax credits in the US.

The United States taxes income on a worldwide basis. To prevent double taxation, under the Internal Revenue Code (IRC) U.S. taxpayers are allowed a credit for foreign income taxes “paid.” However, the ability to credit foreign income taxes paid is limited. The Treasury regulations prevent U.S. companies from obtaining credits for foreign taxes they are not legally compelled to pay. Treas. Reg. § 1.901-2(e)(1). A system under which the U.S. Treasury allows foreign tax credits (FTCs) without requiring that U.S. taxpayers effectively and practically reduce their foreign tax payments as legally imposed would potentially create a hazard. Taxpayers would otherwise have no incentive to challenge any foreign tax whether or not properly imposed, thereby transferring the foreign tax cost to the United States. Taxpayers are required to exhaust all “effective and practical” remedies (including competent authority procedures provided under applicable tax treaties) to reduce, over time, its liability for (foreign) tax.

So what the rest of the world sees as aggressive tax avoidance can be seen in the US as maximising US tax payments.  Of course, the US didn’t have a great record of actually collecting these tax payments with companies easily able to engineer a deferral of the US tax due.  The deferral of US tax on passive income was the outcome double-irish type structures were designed to achieve.

None of this was news to the IRS and the IRS set out how it works here (emphasis added):

Generally, the US shareholder of a foreign corporation is able to defer taxation of the corporation’s income until it has been distributed to the shareholder. However, in the case of a controlled foreign corporation (“CFC”), certain types of income are subject to current inclusion (“subpart F inclusion”) by the US shareholder under IRC 951. One such type of income is Foreign Personal Holding Company Income (FPHCI), which includes income of a CFC such as dividends, interest, rents, and royalties. The FPHCI rules eliminate the deferral of US tax on income earned by certain foreign corporations from portfolio types of investments, i.e., where the company is merely passively receiving investment income rather than earning active business income.

Another exception that looks to the payor of the income for eligibility requirements is the same country exception from FPHCI under IRC 954(c)(3). Under the same country exception, FPHCI does not include dividends and interest received by a CFC from a related CFC payor which is incorporated in the same country as the recipient CFC, and which has a substantial part of its assets used in its trade or business in that same country. Similarly, under this exception, FPHCI does not include rents and royalties received by a CFC from a related CFC for the use or privilege of using property within the same country as the recipient CFC’s country of incorporation.

The same country exception was originally enacted in 1962 as a part of the broader subpart F legislation. The Kennedy administration and Congress were concerned with tax haven deferral – the shifting of income earned in one country to a tax haven jurisdiction. Because payments between related parties located in the same country don’t shift income to another jurisdiction, such same-country payments were excluded from the definition of FPHCI.

The “double-irish” is to avail of the “same country exception” in US tax law.  The payment of royalties between to companies registered in the same country (it could be any country) means that the Subpart F requirement that the US tax due on those profits be paid in the current period could be deferred. 

That is why US MNCs had trading companies and holding companies registered in the same country, with the use of two companies leading to the “double” part of the moniker.  The royalties could be paid to the holding company without triggering the current US tax payments that Subpart F required.  And although the holding company had to be registered in the same country as the trading company, the holding company could actually be based anywhere – and Bermuda was a popular choice. 

It was a huge deficiency of US tax law that only assessed the location of a company of the basis of it place of incorporation.  There is an extract here of Sen. Carl Levin’s opening statement to the 2012 US Senate hearing on Apple where he rightfully calls this an absurdity.

The general issue of deferral of US tax on passive income was removed with the passing of the TCJA and now such profits are subject to immediate taxation in the US under provisions such as the aptly named Global Intangible Low-Taxed Income – GILTI!

Of course, there is also the issue of how these valuable IP rights got out of the US in the first place but again that is a matter of US tax law which allowed them to leak out  – cost-sharing agreements are the culprit here.  But back to Ireland.

A day after the story about EMC International Company, The Currency, ran a similar piece under the headline:

A monster payment: How a global energy drink giant made €1.2bn in Ireland tax-free

Once again the headline is misleading but at least time there is a recognition in the piece that the no-tax outcome for the company is not generated in Ireland:

“And the profits were entirely tax free. Filings show that Monster Energy International was “tax resident in Cayman Islands and not subject to corporation tax” in Ireland. Indeed, its company secretary is a vehicle called Maples Secretariat (Cayman) which lists an address PO Box Address at Ugland House in Georgetown in Grand Cayman. Essentially, the company was operating a Double Irish structure.”

But why the disconnect between the headline which talks about tax-free profits “in Ireland” and the text which states the company was “tax resident in Cayman Islands”?  Of course, this company didn’t pay any tax in Ireland; it is not in Ireland.  By a similar logic we could say that the Collison brothers are earning huge sums tax-free in Ireland, despite they actually living in Southern California.

And what if we check the first sentence of the above paragraph: “And the profits were entirely tax free.”  To so we can check the consolidated accounts of Monster Beverages Inc.  Subsidiaries are helpful guides but nothing can be hidden in the consolidated accounts: everything must be included. 

Here is the group’s income statement for 2017 to 2019 which was available at the time The Currency piece was published.

Monster Beverages 10K Income Statement

This information is easily accessible and can be found in seconds unlike the accounts for subsidiaries which can be much harder to locate and usually mean incurring a cost to get access to. Yet, the information that is readily and freely available is rarely presented.

These show that Monster Beverages had an average pre-tax profit over the three years of around $1.3 billion and an average tax provision of $330 million, giving an effective tax rate 25.3% which is somewhat removed from “entirely tax free”.

The accounts also show that most of the group’s provision for income taxes is made of current federal taxes, i.e. US taxes:

Monster Beverages 10K Income Taxes

On the GILTI provision the company includes the following note:

The Company evaluated the various provisions of the Tax Reform Act, including, the global intangible low-taxed income (“GILTI”) and the foreign derived intangible income provisions. The Company will treat any U.S. tax on foreign earnings under GILTI as a current period expense when incurred.

The tax due on apparently low-taxed foreign income will appear as current federal tax in the company’s consolidated accounts. Within the group it will be in the accounts of the parent company and not in the accounts of subsidiaries in countries like Ireland.  Of course profit can appear “entirely tax free” when you leave out the tax actually paid on it.

Any reports on the taxation is US MNCs should set out how much tax the company pays.  This information can be found in seconds from the filings publicly-quoted companies in the US must make to the Securities and Exchange Commission (SEC). 

The most relevant of these is the 10K report which provides the annual financial statements of listed companies.  Yet, almost no reports on the taxation of US MNCs include that information which you would think is most important: the amount of tax they actually pay.

And there is actually no need to exaggerate or leave out important details.  The reality of the operations of US companies in Ireland is bizarre even without the need to claim that profits in Bermuda or the Cayman Islands are in Ireland.  Here are a couple of illustrations.

First, the gross operation surplus in 2018 of US-controlled enterprises operating in what is now the EU27 from figures published by Eurostat.

Gross Operating Surplus of US Companies in the EU27 2018

Gross operating surplus is the measure of corporate profits that is counted in a country’s GDP.  In 2018, the gross operating surplus US-controlled companies had in Ireland was greater than the gross operating surplus US-controlled companies had in the rest of the EU27 – combined!

And as with corporate profits in most low-tax or no-tax jurisdictions it is all about companies from one country – the US.  Again from Eurostat, here are the gross operating surplus by controlled country for enterprises operating in Ireland.  The figure for the US makes the rest of the chart pretty much unreadable. 

GOS in Ireland by Controlling Country 2018

In 2018, the gross operating surplus of US MNCs operating in Ireland was €117 billion; companies from the UK are next with €5 billion of gross operating surplus.  The gross operating surplus of US MNCs was responsible for 35 percent of Irish GDP in 2018. A version of the above chart excluding the US is here

We can also scale the chart by the GDP of the home country.

GOS in Ireland by Controlling Country GDP 2018

Four observations stand out: Cyprus, Luxembourg, Malta and the United States.  The combined gross operating surplus in Ireland of companies controlled in the first three sum to less than €500 million.  Significant perhaps in the scale of their small economies but not in the broader scheme of things.

The gross operating surplus of US companies operating in Ireland is equivalent to 0.7 per cent of US GDP.  Our nearest neighbour is the UK and their companies generate the equivalent of 0.2 per cent of UK GDP in Ireland – and most of that is from companies serving the domestic Irish market such as British retailers with stores in Ireland. 

UK companies do not shift profits to Ireland, or more accurately UK companies can’t shift profits to Ireland.  The US system does enable US companies to shift profits abroad and many US companies do just that.

If the gross operating surplus of its companies in Ireland was a state, in 2018 it would have had a GDP larger than around a third of US states.  When ranked by GDP, Kansas is the 33rd ranked state and accounts of 0.8 per cent of the national total.  The profits of US companies in Ireland can nearly match that.

Of course, these figures are in “gross” terms which in context of gross operating surplus means before depreciation.  And there are plenty of odd things going on with depreciation in Ireland again without the need to make things up.

For example, here we considered figures from the Revenue Commissioners showing how companies with €50 billion of Gross Trading Profits ended up with zero Net Trading Income to tax.  From €50 billion to zero in the first five rows of this table.

Corporation Tax Computation for Companies with No Trading Income

US companies have moved very significant amounts of IP licenses to Ireland in recent years and their Irish-resident subsidiaries that have bought these licenses can use capital allowances to offset the acquisition costs against their trading profits.  That is how €50 billion became zero.

Such extreme outcomes are not possible for transactions bringing IP to Ireland since October 2017.  Since then a 80 per cent cap is in place for the amount of gross trading profits that can be offset by capital allowances for intangible assets in any one year.

The bizarre outcomes in Ireland aren’t limited to gross profits and depreciation.  The unwinding of “double-irish” structures means there are significant changes in the nature of outbound royalty payments from Ireland. 

As shown above some of the IP has been bought by Irish-resident companies but other companies have moved their IP back to the US which has led to a huge spike in outbound royalty payments from Ireland to the US which could potentially add 0.1 per cent to US GDP.

Royalty Imports to United States 2008-2020

And we can also show some bizarre outcomes when it come to the taxes paid by US MNCs.

The latest IRS statistics from the country-by-country reports filed with them show that of the cash taxes paid by US MNCs to the countries of the EU27 in 2017, more tax was paid to Ireland than any other country.  Table version here.

IRS CbCR for the EU27 Tax Payments 2017

This is obviously not as bizarre as Eurostat’s figures for gross operating surplus with the figure for Ireland exceeding the sum of the rest of the EU27.  However, it can still be seen that for the set of US MNE groups in the IRS country-by-country reporting data their largest cash tax payments in 2017 for the EU27 were to Ireland.

In 2017, US MNE’s in the IRS data made $28.2 billion of cash tax payments to the countries of the EU27.  Of this, $5.2 billion (18.4 per cent) was paid to Ireland.  Around 1-in-6 of every dollar of corporate taxes that US MNEs paid in the EU27 in 2017 was paid to Ireland.  Their payments in Ireland were larger than their payments to the bottom 19 countries in the above chart combined.

On these matters it is always worth noting that the headlines are almost exclusively about US MNCs, even when they are wrong.  From the OECD’s country-by-country data here is the profit in a set of low-tax and no-tax jurisdictions (including stateless) by the country of the ultimate parent.

OECD CbCR data for 13 jurisdictions

In 2016, US companies had almost $350 billion of profits in the set of jurisdictions set out at the bottom.  No other country comes close to the scale of profits US MNCs report in these locations.

The taxation of US MNCs is certainly worthy of attention.  But given how much we know about them, it should also be possible to report on them in an accurate fashion.  There is no need for exaggeration, half-truths or the omission of key details.  The reality is more than bizarre enough for catchy headlines. 

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