Google, Bermuda, and Effective Tax Rates

In its 2020 annual report Google noted that:

As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.

As a result of this change, royalty payments from Ireland which previous ended up in Bermuda, via The Netherlands, now flow directly to the United States. Here we will assess the impact the structure had on Google’s taxes over its entire duration from 2003 to 2019.

Over the full period, Google had an effective tax rate of 21.8 per cent.  The contributions to this were a foreign tax rate of 7.1 per cent and a domestic, i.e. US, tax rate of 39.8 per cent.

Much attention has been given to Google’s foreign tax rate, particularly those of 2005 to 2011 which averaged just 2.3 per cent.  This was primarily the result of a large share of Google’s foreign profit being reported in Bermuda, which, of course, does not have a corporate income tax.

However, the full picture requires the assessments to incorporate Google’s domestic, i.e. US, and then overall tax rates.  From 2005 to 2011, when its effective foreign tax rate averaged 2.3 per cent, Google’s overall effective tax rate averaged 24.7 per cent.

The domestic tax rate for 2017 is also notable. At 120 per cent the domestic tax charge for the year exceeded domestic pre-tax income.  This is because it included the US tax due under the “deemed repatriation tax”.  This is domestic US tax but is due on foreign profit.  As the company set out in its 2018 10K report:

The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion.

Over the period 2003 to 2017 Google had a domestic tax rate of 49 per cent.  This is not because the US had corporate tax rates as high as that but because included in domestic taxes are the US taxes due on foreign profits, most notably the profits Google reported in Bermuda.

It is a numerator/denominator issue.  A focus on foreign income and foreign taxes omits the domestic, that is US, tax paid on those profits.  The effective tax rate on Google’s foreign profits was not the 2.3 per cent implied by the effective foreign tax rate.  Indeed the lower Google, and similar MNCs can get their foreign tax rate, the higher their domestic tax rate will be.  And, from 2003 to 2017, nearly 90 per cent of Google’s income tax charge was for US taxes.

The above table also illustrates the impact of the Tax Cuts and Jobs Act which came into effect from the start of 2018.  For the years shown, Google’s lowest domestic and overall effective tax rates arose in 2018 and 2019.  As a result of the TCJA, Google’s overall effective tax rate, which in aggregate terms was 25.8 per cent from 2003 to 2017, was reduced to 12.7 per cent when 2018 and 2019 are combined.

And finally a table from Google’s most recent 10K report which shows the impact of the company its licensing arrangements in Bermuda:

For 2020 there was a large rise in Google’s pre-tax income that was attributed to domestic operations and a commensurate fall in pre-tax income attributed to foreign operations.  Google’s profit is now being reported where most of it is generated: in the US. And because of the TCJA Google will have a lower overall effective tax rate than when it is was shifting tens of billions of profit to Bermuda.

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What’s going on with the current account?

Ireland’s balance of payments is subject to huge volatility.  Among the reasons for this are transactions in intellectual property and aircraft for leasing as well as income flows link to redomiciled, but not Irish-owned, PLCs.  In response to this the CSO have been publishing a modified current account, CA*, which strips out the above of these issues.

Getting on a handle on a country’s underlying current account position can be an important part of determining if imbalances are building up.  As the long-run series in the chart below shows, Ireland experienced widening balance of payments deficits in the late-1970s and mid-2000s which precipitated severe problems.

Last week, the CSO published the 2020 estimate of the modified current account.  The surplus of €23.5 billion was equivalent to 11.5 per cent of national income.  This is an extremely large surplus by historic Irish and current international terms.

The only time Ireland ran a current account surplus of an equivalent size was during World War II when trade restrictions and rationing were in force.  Ireland’s current account needed to improve to wash out the imbalances built up prior to 2008, but the ongoing rise to record levels seems to be overstating it.

When can get some insight into this from the Institutional Sector Accounts.  The current account of the balance of payments is savings minus investment.  The sector accounts allow us to see the contribution by sector to the current account.  The chart below takes the annual outcomes from the sector accounts for saving minus investment with the figure for the non-financial corporate sector adjusted to make the total across all sectors consistent with the modified current account.

Immediately, we are drawn to the 2020 figures.  The household sector has been a net lender since 2009 but this increased very significantly in 2020 – due to restrictions on spending.  The support incomes the government sector moved to being a significant borrower. Financial corporations and the impact of items that are not sectorised have not had much impact on the current account in the last four or five years.

That leaves us with the red segment of the bars – the adjusted figure for non-financial corporations.  For the last few years this has been making a positive contribution to the current account and last year it was €12.5 billion.

For the time being we don’t have much insight into this.  While the modified current account is showing a significant surplus some caution should be exercised before considering it available for spending.

Later in the year when the annual sector accounts are published we will get a domestic/foreign split for the corporate sectors in 2020.  Here is what the 2019 figures showed:

There wasn’t really a whole lot going on the domestic sectors up to 2019.  By 2019 all of the household, government, domestic non-financial and domestic financial sectors were net lenders.

However, the most significant changes were happening within the foreign-owned sectors – those sectors we hope would be largely stripped out of the modified current account.  Either via standard net factor flows (repatriated profits etc.) or via the CA* adjustments for IP, aircraft and redomiciled PLCs. 

But even after all those the impact of foreign-owned sectors went from –€7.2 billion in 2017 to +€0.4 billion in 2019.  This was the largest contribution to the rise in the black line (the modified current account) up to 2019.

And the recent update to the modified current account shows that the 2019 figure has been revised up.  It €16.5 billion for last year’s annual sector accounts; when this years sectors accounts are published they will reflect last week’s update which put the 2019 modified current account at €20.2 billion.

It is clear there is something going on – and that it likely to be within the foreign-owned sector. What is not clear is whether it is something that would justify a further refinement of the adjustments made to get to the modified current account. 

It could be due to “good” investment such as manufacturing plants for pharmaceuticals or processors.  Or it could be another distortion that should be stripped out.

There is no doubt that Ireland’s current account has improved relative to the large deficits that were evident up to 2008 but there must be some doubt that that improvement has led to a surplus equivalent to 11.5 per cent of national income. A surplus, yes, just not a record one. 

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Relative Calm in the 2019 Aggregate Corporation Tax Calculation

A while back the Revenue Commissioners published the 2019 update of the Aggregate Corporation Tax Calculation.  Given recent developments in Corporation Tax revenues is it perhaps surprising to note the general stability in most items in the table.

Two of the more notable figures are for Capital Allowances used and Foreign Income.  The rise in capital allowances is linked to the onshoring of intangible assets while foreign income is a function of the worldwide nature of the Irish Corporation Tax regime.

The lower half of the table showing how Taxable Income is translated into Tax Due is also relatively stable.  All told, the €6.9 billion increase in Net Trading Income in 2019 resulted in a €728 million increase in Tax Due

In line with the increase in foreign income reported on Irish Corporation Tax returns there has been an increase in Double Taxation Relief and for the Additional Foreign Tax Credit.  These items have by largest impact in the transition from Gross Tax Due to Tax Due. The relief is because the Irish-resident companies which have this foreign income have paid tax in the source jurisdiction so are unlikely to owe any additional tax in Ireland (as the rates paid abroad will generally exceed the 12.5 per cent rate that applies here).

Use of the R&D Tax Credit rose in 2019 with increases in both the credit itself and in the Payment of the Excess R&D Tax Credit in circumstances where a company claiming the credit does not have a sufficiently large tax liability in order to be able to fully utilise the amount of the credit they are eligible for.  Combined these came to €629 million in 2019.

A rarely-looked at item is Gross Withholding Tax on Fees which increased to €367 million in 2019.  Essentially, this is to allow for tax that has already been paid.  There are a number of instances where the person making a payment for certain services must withhold 20 per cent of the fee from the recipient and transfer it to the Revenue Commissioners. 

When a company files its tax return it will include the amount of withholding tax incurred on fees it should have received.  This item reduces the amount of Tax Due but, in a manner somewhat similar to foreign tax credits, it reflects tax that has already been paid.

In the transition from Gross Tax Due to Tax Due the only item that explicitly reduces a company’s tax bill is the R&D tax credit.  If Ireland switched to a territorial regime, the need for foreign tax credits would be removed and the gap between Gross Tax Due and Net Tax would be reduced with limited impact on the liability of companies to Irish Corporation Tax.

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