Underestimating housing consumption in the national accounts

It's not just household-level data such as the SILC where our approaches to the provision of social housing present measurement issues. In the national accounts, payments such as to HAP landlords are currently counted as a benefit-in-kind for households.  This is in contrast to the benefit-in-cash approach now applied in the SILC.

And, up to 2020, there was a further difference between the micro-data and macro-data approaches to measuring social housing.  In the national accounts an imputed social-transfer-in-kind was previously included for the 130,000 or so households who are local authorities tenants.  This has now been removed.

In the government accounts, on the revenue side, local authorities were treated as generating market output for sale.  For social housing this would be the rent contributions received from tenants plus an imputed amount to bring the value of the output in line with market values, which were based on rents in the private rental sector, using both unregulated and regulated rents.

On the expenditure side, this imputed output was used as a social-transfer-in-kind to households. There would also be expenditure incurred as compensation of employees, intermediate consumption and depreciation or fixed capital formation for the provision of local authority housing. 

This meant that the imputed value was on both sides of the accounts and netted out for the balance.  The  impact of local authority housing on the general government balance was the different between the rent contributions received from tenants and the other expenditure items incurred.

It also meant that the consumption of housing services by local authority tenants was based on the market value of the housing services they used as it is for private tenants (through actual rents paid) and for owner-occupiers(through imputed rents). 

The change introduced this year means that the consumption of housing services of local authority tenants is now treated as non-market output and the value of the consumption of that in the national accounts is based on the costs of providing it (mainly compensation of employees, intermediate consumption and depreciation) rather than an imputed market value. 

It should be recognised that most government-provided services (health, education, policing etc.) are included in national accounts on a cost rather than value basis.  The change to also do so with local authority housing had no net impact on the government’s accounts.  The imputed rents of local authority tenants were removed from both the revenue and expenditure  sides, as imputed market output for revenue and the social-transfer-in-kind for expenditure. 

Indicators like government spending to national income would have been reduced.  And so indeed would national income when the market output based on market value was replaced by non-market output based on costs. 

This change was introduced between the April 2021 Government Finance Statistics and the July 2021 Government Income and Expenditure Accounts.  The July publication included the following note:

Reclassification of local authority housing rent as non-market output

To date the provision of local authority housing was treated as a market output. This meant that the difference between the differential rent paid by the tenant and a market rent was calculated and included as P.11 (market output), with a corresponding imputed expenditure D.632 (social benefit in kind). However, Approved Housing Bodies (AHB) reclassified into the local government sector are considered as non-market producers, with no imputed rent calculation made.

On review, this approach was deemed not appropriate and thus a decision has been made to treat the local authority housing output as non-market. This ensures consistency with AHBs. This determination means that there is no longer an imputed D.632 expenditure related to local authority rent. Local authority rent payments are now recorded as P.131 (incidental sales and fees of non-market establishments). This methodology has been applied from 1995.

There can be lots of reasons for revisions between releases so attributing them solely to a methodological change may not always be correct.  Here are the figures for market and non-market output in the April and July releases.

For the three years shown (2018 to 2020), the market output of the general government sector was revised down by an average of €1.6 billion – and now takes a value of zero.  For the same years, non-market output was revised up by an average of €1.25 billion.  This suggests that around €350 million of housing consumption may have been “lost” as a result of the change in methodology.

In the greater scheme of things €350 million of consumption may not be that significant, though as a similar treatment is applied for housing by AHBs the underestimate may be slightly larger.  The underestimate is limited to the extent to which the costs of providing LA or AHB  housing is less than the market value of that housing.

In pre-COVID 2019, actual individual consumption was €133 billion, of which the consumption of housing services was €28.5 billion.  The consumption of housing services was made up of:

• Household Consumption Expenditure
  • Actual rentals for housing €5,393m
  • Imputed rentals for housing €16,459m
  • Maintenance and repair of the dwelling €289m
  • Water supply and miscellaneous services relating to the dwelling €357m
  • Electricity, gas and other fuels €3,091m
• Government Consumption Expenditure
  • Social transfers-in-kind via market producers €824m
  • Social transfers-in-kind via non-market production by Government €2,087m

A few hundred million extra in there isn’t going to make a huge difference but again maybe points to difficulties in measuring outcomes in relation to housing in Ireland.

There is no doubt that local authorities are not market establishments so deeming the goods and services they provide to be from non-market production has logic to it and imputing values is not an exact process.  However, for housing, a relatively close market comparator can be found, i.e. the private rental sector.  This can be used to give a market value for the output produced.  And up to this year that is what was done for local authority housing in Ireland.

For most EU countries, this isn’t an issue.  Almost all of the consumption of housing is the result of household expenditure.  Government spending does not go to provide housing, at least not directly.  The general government sectors don’t make payments to landlords or provide housing directly.

As the list above shows, in Ireland government consumption expenditure is responsible for around 10 per cent of total consumption of housing.  This figure is by far the largest in the EU.

For 21 of the EU27, the share of housing consumption due to government expenditure is less than one per cent (and is essentially zero for around half of those).  The closest country to Ireland is France and even then that is at a level that is less than half the outturn for Ireland. 

That is not to say there isn’t public or social housing in most of these countries. There is.  But it is happens in such a way that it is provided by entities that are outside the general government sector.  And they generate their revenues from rents paid by tenants rather than payments by government.  That’s not to say that either approach is right or wrong just that they are different.

The value of housing consumption may be underestimated in other countries to the extent that regulated or controlled rents are used in determining imputed rents for owner occupiers.  In Ireland, for around five per cent of households, the value of their housing consumption is based on the cost of providing those housing services rather than what the tenants might have to pay as private tenants. Again, neither is right or wrong. Just different.

Including HAP in Disposable Income

The CSO have published the 2020 results for the Survey of Income and Living Conditions (SILC).  There were a number of methodological changes that mean there is a series break in 2020 compared to earlier estimates.  These are set out in a useful Information Note.

The note also confirms that the Housing Assistance Payment (HAP) payments to landlords, as well as payments to landlords under the Rental Accommodation Scheme (RAS) are considered part of household income:

From 2020, social transfers in SILC are defined as the total income received from DEASP social welfare transfers (e.g. jobseekers related payments, state pension (contributory and non-contributory), family or children related allowances), income received as education related allowances (e.g. Student Universal Support Ireland [SUSI] grants) and housing related supports which include rent supplement and Local Authority contributions to landlords of SILC respondents who are Housing Assistance Payment (HAP) or Rental Accommodation Scheme (RAS) tenants.

This isn’t necessarily a change that was introduced this year but it is now clear that the rent payments made by local authorities to lands in the HAP and RAS are included in the household income of the tenants.  It does not appear that the rent paid by Local Authorities to Approved Housing Bodies (AHBs) is included in the income of AHB tenants.  These rents paid to AHBs, as with those paid under the HAP or RAS (or the smaller Mortgage-To-Rent programme) are based on market rents.  Nor is a similar social transfer to households included in the income of tenants of Local Authorities even though they benefit from subsidised rents in the same way as RAS or AHB tenants.

The rent contribution that recipients of HAP make to their local authority is calculated on the same basis as the above but the tenants may be required to make an additional payment to the landlord if the agreed rent exceeds the relevant HAP limit for that area.  For the first half of 2019 it was estimated that 28 per cent of HAP tenants were making a top-up payment to their landlord.

That the rent contributions tenants make to their local authorities under these programmes is part of those households housing costs is incontrovertible (as well as any top-up payments that may be made to private landlords in HAP). What is less clear-cut is whether the payments local authorities make landlords on behalf of tenants should be included in the tenants’ income.

In terms scaled up to national level, around €1.5 billion of housing supports are included in income in the 2020 SILC.  This includes €600 million for HAP,  €130 million for RAS and €25 million for MTR. As these are not taxable they are then also fully included in disposable income.  These payments make up close to one per cent of the aggregate disposable income of around €90 billion that is represented in the SILC.

This may not seem like a significant amount but the payments will certainly be significant for those households involved.  There are around 17,000 households in the Rental Accommodation Scheme and 68,000 in the Housing Assistance Payment programme.

The issue is whether payments that households don’t directly receive should be included in their disposable income?  There is no doubt that the payments benefit the living conditions of the households but they are not income that the households can choose how to spent. 

As of the 30th June 2019, the average monthly landlord payment was €830 per month and the average rent contribution from the tenant was €47.50 per month.  The treatment in the SILC is that the €830 is counted as household income.  It is not clear in the notes but it certainly should be the case that the €830 also be included in the household’s housing costs and not the €47.50 differential rent. 

Different definitions abound but disposable income would seem like something a household's decisions should be able to have a bearing on how it is used - even if that can be spending on necessities or long-term commitments.  The household can, to a certain extent, choose how to do these. 

If a private tenant moves to a property that has a lower rent, then the use of their disposable income will change.  With a lower rent, the household’s income after housing costs are deducted will rise. 

If a household receiving HAP moves to an area that has lower HAP limits, then the inclusion of HAP as income, would see their income fall after the move.  The decision to move to an area with lower rents hasn't changed their spending (at least for the 72 per cent not making a top-up payment).  They continue to pay the appropriate differentiated rent. But in the SILC the move has changed their income. 

It seems a little incongruent that a spending/consumption decision would change income.  But then, the HAP aids consumption and does contribute to living standards so could be viewed as contributing to income.  But should the disposable income of a household with a medical car be increased every time they attend a GP?  No.  This is a benefit-in-kind rather than a cash transfer.

Why should HAP be counted as a cash transfer rather than a benefit-in-kind?  The State is paying for housing services.  Though that is with the intention of maintaining income after housing costs for beneficiaries.

However, it is not clear why the rent paid by a local authority paid to a private landlord should be counted in the household’s income but not the rent local authorities pay to AHBs.  Perhaps it could be justified on the basis that the household under HAP can choose they property the rents are to be paid for but in either case their income after housing costs will be determined by the differential rent not the rent paid to the landlord (whether that is a private landlord or an AHB).

Consider the contrived example of two households of similar composition, similar income and living in similar properties. Both are eligible for social housing. 

One of the households is an AHB tenant and the household’s income is under the at-risk-of-poverty threshold.  The household’s income after housing costs is calculated after the differential rent, and other costs, are deducted.  Logically, the household’s income after housing costs are deducted from it will also be below the AROP threshold

The second household is a HAP recipient and rents a similar property to the first household but does so from a private landlord.  The inclusion of the rent paid to the landlord in this household’s disposable income puts it above the at-risk-of-poverty threshold.

These households are similar in almost all respects. But one is considered below the at-risk-of-poverty threshold and one is above it.  The only difference is that one is a AHB tenant and one is a HAP recipient.  Assuming no top-up payment to the HAP landlord, both households have similar income remaining after housing costs are deducted. Their living standards are likely to be similar but their income in the SILC will differ significantly.

So, it could be that the headline at-risk-of-poverty rate is being under-estimated because a cash transfer for housing that households cannot spend is included in the income for HAP and RAS tenants.  Would it be better classed as a benefit-in-kind? That is how HAP and RAS are treated in the national accounts?  Or if an income transfer is to be included in household income should it be included for all social housing tenants and not just those in HAP or RAS?

The level and distribution of income in Ireland in the 2020 SILC

Eurostat have 2020 figures for Ireland to the EU-SILC, the EU’s Statistics on Income and Living Conditions.  Ireland is one of the last countries to have provided figures to Eurostat and the national version won’t be published by the CSO for another few weeks.

Those figures won’t be much different to what is now available on Eurostat but will come with much more detailed background notes.  One such item to be explained is that all the 2020 figures Eurostat have for Ireland are marked with a “b” – for series break.  It is not yet clear what this is. It could be that was a change during 2020 with in-person interviews shelved as COVID hit.

And at the outset it is probably worth noting that although this is the 2020 SILC, the year represents when the data was collected rather than the period for which it applies to.  The CSO carry out the survey across the full year, and respondents are asked for details of their income in the 12 months prior to the survey.

Thus, if someone was interviewed in January 2020 for the 2020 SILC, the reference period for their income would almost wholly encompass 2019.  This would move one month forward for people interviewed in February and so on.  Indeed, when this data goes through the OECD’s methodology it will be assigned to 2019 when published on the OECD’s income inequality database.

Another difference worth noting is the equivalent scale used to compare households of different sizes.  The CSO apply a national equivalence scale with applies a weight of 1.00 to the first adult, 0.66 to all subsequent adults and 0.33 to all children under 14.  These are added together with the household’s income divided by the result to get income in terms of equivalent people.

Eurostat uses the OECD-modified scale which gives a weight of 1.00 to the first adult, but 0.5 to all subsequent adults and 0.3 to all children under 14.

This means that a household of 2 adults and 2 young children would have an equivalising factor of 2.32 with the CSO’s approach and a factor of 2.1 with Eurostat’s approach.  This changes the level of equivalised income within each dataset but should not have a hugely significant impact on growth rates or other relative comparisons.  So, the figures the CSO itself publishes in a few weeks could be slightly different but the overall trends will be the same.

The Level of Income

We will start with median equivalised income in nominal terms.

In and of itself the actual level is not that informative.  Eurostat’s figure for 2020 is €26,250 but income per equivalent person is not a concept we can readily relate to.  What matters are the growth rate and relative differences, both within the income distribution in Ireland and with other countries.

Eurostat’s figures show that for the SILC data collected in 2020, the change in median equivalised income was +2.8 per cent.  That matches the average nominal growth rate of the previous 15 years though the significant volatility in the outcomes that gave rise to that average is evident from the chart.

Relative to the rest of the EU15, Ireland had the fourth-highest median equivalised disposable income  - in nominal terms.  While some exchange rate conversions are made no adjustment is made for different price levels in the below chart.

The Distribution of Income

Three of the commonly used inequality measures that are applied to the SILC data are the gini coefficient, the quintile share ratio and the at-risk-of-poverty rate.  Here is the gini coefficient fir Ireland since 2004 with a higher figure representing higher inequality.

Ireland’s estimated gini co-efficient has been trending downward over the last few decades – but it should be noted that the changes are exaggerated by the truncated vertical axis used in the above chart.  The changes are small.  The Eurostat figure for the 2020 SILC is not significantly different from what it was the previous year, going from 0.283 to 0.287.

Within the EU15, Ireland’s gini coefficient for disposable income is in the middle of the pack.  Ireland stands out more for the change in the gini coefficient over the last 15 years.  This following chart shows how the average for each country from 2018 to 2020 differs from its average for 2004 to 2006. 

For most of the EU15, the gini was either unchanged or increasing over the period.  For those countries showing a reduction in their gini coefficient the fall in Ireland was the second largest, with only Portugal showing a larger fall.

The gini coefficient is a useful indicator but as an measure which condenses a population-wide distribution of income into a single number looking at other measures can also be useful.  The quintile share ratio compares the income share of the top 20 per cent of the income distribution to the income share of the bottom 20 per cent.

The pattern here corresponds to what is shown by the gini coefficient.  Over the last 15 years, Ireland’s quintile share ratio has fallen from around five in the mid-2000s to around four now.  This indicates that incomes at the bottom of the income distribution have grown faster than those at the top.

Ireland’s quintile share ratio is the sixth lowest in the EU15.

The at-risk-of-poverty rate focuses in the lower end of the income distribution and looks at how many people live in households with an equivalised income that is less than 60 per cent of the national median. 

With Eurostat putting Ireland’s median equivalised income at €26,250 in 2020, this gives an at-risk-of-poverty threshold of €15,750 for a single-person household.  If we multiple this by 2.1 we get the threshold for a 2 adult plus 2 young children household: €33,075.

Here is the share of people in Ireland who live in households with an equivalised income below the 60 per cent threshold.

This shows a similar pattern to the quintile share ratio and Ireland’s position in the EU15 is also the same (sixth lowest).

As it is a measure of inequality, the at-risk-of-poverty rate is not always a good indicator of changes in living standards at the lower end of the income distribution.  The post-2008 period in Ireland is a good illustration of this.  We know that there were very significant falls in income but this is not reflected in any noticeable increase in the at-risk-of-poverty rate in the period from 2009 to 2012.

This is because the at-risk-of-poverty rate is a relative measure.  As incomes in the economy fell, the threshold for been assessed as at-risk-of-poverty also fell.  One way to get an insight into absolute changes in living standards is to use a fixed threshold (with changes only made for inflation rather than the general trend of income in the economy).  Eurostat provide an anchored at-risk-of-poverty rate with the 2005 threshold as the anchor.

The at-risk-of-poverty rate was 20 per cent in 2005.  In the chart above, the 2005 threshold is rolled forward (adjusted for inflation) and the share of the population below that threshold is reported.  It is the changes rather than the levels that are informative here.  We can see that this anchored at-risk-of-poverty measure rose significantly after 2008.  It had been falling consistently since 2014, but was unchanged in 2020.

There’s much more to the SILC than income figures but that’s probably enough for now.

A possible explainer for Google’s recent tax settlement?

The 2020 accounts for Google Ireland Limited were published last week and showed that the company had a €218 million tax charge that arose from “the resolution of certain tax matters relating to prior years” (and there was a further €127 million of associated interest).  The group’s parent company, Alphabet Inc., had stated in its own 2020 annual report that its “tax years 2011 through 2019 remain subject to examination by the appropriate governmental agencies for Irish tax purposes.”

It’s possible we can get some insight into the nature of this issue from the table of the annual profit and loss statements which were summarised in the previous post which looked at Google’s footprint in Ireland since 2003.  Here is the relevant table. Click to enlarge.

In particular we are drawn to the column for operating profit, which forms the bulk of the company’s profit before tax.  It looks like Google Ireland Limited’s operating profit can be broken down into three time periods:

• 2003-2011
• 2012-2015
• 2016-

A post a number of years ago looked at the determination of Google’s profit in Ireland and looked at the period 2012 to 2014 which ties in with the middle time period above.  As the table shows, in 2012 there was a significant step-up in Google Ireland Limited’s operating profit compared to the previous decade – or at least an increase above that which could be explained by the expansion of the company.

The earlier post reached the conclusion that “Google Ireland’s operating profit has been around 6 per cent of its expenses excluding the license [or royalty] payment.”  Prior to 2012, it seems that the cost-plus arrangement for determining Google Ireland Limited’s operating profit only included the costs incurred in Ireland.  It seems likely that the step-up in 2012 was due to the inclusion of the costs Google Ireland Limited incurs in the payments it makes for the sales and marketing efforts to the local Google subsidiaries in the markets in which it sells.  The earlier post sets this out for a sample of countries. 

The earlier post should have been updated because in 2016 there was another step up in Google Ireland Limited’s operating profit.  It looks like the profit margin is still in the region of six to seven per cent of expenses but it now includes all expenses, most notably the royalty payment.

Here is Google Ireland Limited’s operating profit as a per cent of its administrative expenses since 2005.

The step-ups in 2012 and particularly 2016 are clear.  The outcome for the period 2012 to 2015 would be around 6.5 per cent if the royalty payment is excluded from the base, which is pretty much what it has averaged in the period since 2016 with the royalty payment included.

It is only supposition, but it is possible that the tax issue that Google Ireland Limited revealed in its accounts related to the exclusion of the royalty payment from the base for determining its operating profit using a cost-plus margin in the years before 2016.  The fact that there was €127 million of interest linked to the €217 million tax charges lends credence to the conclusion that it relates to tax due a number of years ago (with Revenue applying an rate of eight per cent per annum to such amounts).   

It is possible that Revenue began this review back in 2015 or 2016 with Google then deciding to include the royalty payments in the base for the cost-plus determination from then on.  Thus what was in dispute was the operating profit figures for Google Ireland Limited for years prior to 2016.  Of course, the change in 2016 also coincides with the time when the cage-rattling by the European Commission using state-aid cases into tax was going strong and that may have influenced the company’s decisions.

So, can we get numbers to fit the hypothesis that the tax settlement is linked to the inclusion of royalties in the case for the cost-plus assessment of Google Ireland Limited’s profit? Perhaps we can.

Looking at the amount of royalties paid, figures for which are available in the accounts of a subsidiary in The Netherlands, Google Netherlands Holding’s BV, shows that these came to €29.7 billion from 2013 to 2015.  While we don’t know the cost-plus margin applied, using 6.5 per cent gives a return of €1.8 billion.  The following table shows what happens if these returns are taxed at 12.5 per cent and the interest that would have accrued if the tax should have been paid seven, six and five years ago.

Maybe it is little more than coincidence that the figures from this scenario are close to “adjustment for corporation tax of prior periods” that Google Ireland Limited disclosed in its 2020 accounts.  These were an additional tax charge of €218.2 million and €127.3 million of related interest.  In fact, the figures are more than just close; they are almost identical.

One fly in the ointment is that the above table only includes the years 2013 to 2015, whereas the note in Alphabet’s 10k said that all years back to 2011 were under review.  But years being under review does not mean there will be a revised tax assessment for them.

We do know there has been a change since 2016 and it is possible that the move to include the royalty expense in the cost-plus calculation has added around €700 million to Google Ireland Limited’s Irish tax bill in the five years since.  The first table above shows a step-up in Google Ireland Limited’s tax charge in 2016. If this change to the cost-plus methodology hadn’t been implemented, and Revenue’s assessment held up, then Google could have been announcing a €1 billion tax settlement last week – assuming the hypothesis here is correct. 

So, as has often been the case the issue was not the tax rate applied to profits but the amount of profit to be subject to Ireland’s 12.5 per cent rate.  The suggestion here is that, up to 2016, the royalty paid by Google’s Irish subsidiary for the right to sell advertising using Google’s platform and technology was excluded from the cost-plus assessment used to calculate its taxable profit in Ireland. 

The Revenue position looks to have been that while the change in 2016 was fine it should also have applied to a number of earlier years leading to an increased tax charge for those years.  Is this a guess? Yes. But probably not a bad one.

Google’s footprint in Ireland since 2003

Google set up its EMEA headquarters in Dublin in 2003, a year before its IPO.  Initially it was a modest operation and during 2003 the average headcount was 21. By the 2020 annual report of Google Ireland Limited this had increased to 4,314.

The accounts also give the staff costs incurred.  These have increased from €0.7 million to just over €750 million in 2020.  All told, Google Ireland Limited has had €4.8 billion of staff costs since it was established in 2003, with almost three-quarters of that being wages and salaries.  For its most recent year, 2020, the average of wages and salaries per person employed was €120,000

The column for “social welfare” is almost certainly employer’s PRSI and the company has paid €360 million of this over the past 18 years.  The company has also made €121 million of payments into its defined contribution pension plan where “the company matches the employee’s contributions up to a maximum a seven per cent.”

We now turn briefly to the financial outturns for Google Ireland Limited with the numbers and the table getting a bit bigger.  Click to enlarge.

Turnover has grown from just €7.5 million in 2003 to €48.4 billion in 2020.  In cumulative terms, the company has had more the €300 billion of turnover but more than half of that was in the last four years.

The company has had a cumulative pre-tax profit of €10.2 billion and incurred a tax charge of €1.7 billion.  Of this €0.1 billion was for foreign withholding taxes leaving a charge to Irish Corporation Tax of €1.6 billion.  That gives a charge to Irish tax of 15.8 per cent of profit before tax.  This is higher than the standard 12.5 per cent that applied during the period for two reasons.

First, the company incurred expenditure that was not allowable as a deduction for tax purposes meaning its taxable income was larger than the profit reported in the accounts. Second, the company had some non-operating income, such as income received, and this is taxed at the 25 per cent of Corporation Tax for non-trading income.

There does appear to be a couple of noticeable step-changes in the accounts for Google Ireland Limited, most noticeably for operating profit.  Could these be linked to the recent tax settlement that was revealed last week.  Perhaps.  And we will look at that in a subsequent post.

What impact did the end of the ‘double irish’ have on Google Ireland Limited? None

Google ended its use of the high-profile ‘double-irish’ tax structure in 2019.  We have been tracking the impact of the revised structure in Ireland’s balance of payments data and in the consolidated accounts of Alphabet, the name of Google’s parent company.  A detailed examination of these changes is provided in this technical paper.

The financial accounts for Google’s subsidiary in Ireland, Google Ireland Limited, are now available and this allows us to see the impact the ending of the ‘double irish’ had on Google in Ireland.

And we can see that it had no impact.  The outcomes in 2020 are pretty much inline with the outcomes in 2019.  Turnover rose to reach €48.4 billion with a reduction in the cost of sales leading to a gross profit of €36.4 billion.

The main cost of sales for the company are payments to third-parties with websites on which Google’s advertising is displayed.  These increased in 2020.  The reason for the reduction in cost of sales was “a reduction in certain operating fees paid to fellow group undertakings.”

From gross profit, €33.6 billion of administration expenses are deducted which, after other operating income and expenses, leaves an operating profit of €3.0 billion.  The administration expenses include the operating costs of the company such as €750 million of staff costs and will include other running costs.

However, the main element in this item is the expenses Google Ireland Limited incurs for the right to sell advertising using Google’s platforms and technology. This technology is developed elsewhere and the Irish subsidiary pays for the right to use that technology.  This right is transferred through a licensing agreement and in return for that right Google Ireland Limited pays a royalty fee to the owner of the intellectual property. 

A breakdown with the royalty payment is not provided.  The accounts of a Google subsidiary in The Netherlands, the “dutch sandwich”, show that the royalty payments made by Google Ireland Limited in 2019 were €19.4 billion.  Given the increase in administration expenses shown in the accounts, the royalty payments in 2020 were probably around €22-23 billion.

At the 12.5 per cent of Corporation Tax, the tax on Google Ireland Limited’s €2.85 billion of profit would be €357 million.  The total tax charge for the year was €622 million with the following table setting out the reasons for the difference.

In its financial accounts, Google Ireland Limited had around €250 million of expenses which are not deductible for tax purposes.  This increases the tax charge by €32 million relative to what it would be if tax was levied on financial profit rather than taxable income.  The company also incurred withholding taxes, possibly in other jurisdictions, of €15 million.

The largest item is the result of the conclusion of a tax audit which resulted in an additional tax liability of €218 million (with a further €127 million of interest).  In its 2020 annual report, Alphabet Inc. noted that its “tax years 2011 through 2019 remain subject to examination by the appropriate governmental agencies for Irish tax purposes.”  It is likely that the above figures represent the conclusion of this examination and thus are unrelated to the ending of the ‘double-irish’ structure.

The ‘double-irish’ has ended and Google Ireland Limited continues to receive tens of billions in revenue from the sale on online advertising in markets across Europe, the Middle East and Africa (EMEA).  Some of this revenue goes to third-party sites that host the advertising, some goes to cover the staff and running costs of the Dublin office but the main cost of Google Ireland Limited continues to be the royalty expense it incurs for the right to sell advertising using Google’s technology.  None of this has changed with the ending of the ‘double-irish’.

There has been no impact, or additional tax liability, in market countries and there has been no change in how the Irish subsidiary operates.  From our previous analyses we do know that what has changed is where the royalty payments are going to.  Previously they went to Bermuda, via The Netherlands.  The 2020 accounts of the company that was in Bermuda are also now available.

Here there is a change.  The company had a turnover of nil in 2020.  In 2019, the company in Bermuda had a turnover of $26.5 billion comprising the royalties paid out by Google Ireland Limited in Dublin and also by Google Asia Pacific Pte. Limited in Singapore which covers markets in Asia for Google.  After administration expenses of $14.1 billion (the bulk of which was a $10.4 billion contribution to the R&D costs of the group’s US parent) the company in Bermuda had a profit of $13.7 billion.  With no turnover, this was not repeated in 2020.

The reason is that the royalties are now paid to the United States.

There is only one thing that has been impacted by the end of the ‘double-irish’. That is in how the company is taxed in the US.  And that is really only a change in the provisions under which the company is taxed (from GILTI to FDII) rather than a dramatic increase in the amount of tax paid by the company.

There has been a decade of headlines about the ‘double-irish’.  The pantomime villain stopped using the structure almost two years ago.  There has been no impact on the taxation of Google in Ireland or on the taxation of Google in the markets where it sells. Doubtful we’ll see a slew of headlines about that though.

Ireland in the Global Income Distribution

Here is a website that has an interactive chart showing the position of a country’s income distribution within the global distribution.  The ventiles (one-twentieths) for each country ranked along the horiontal axis where their position in the world income distribution given on the vertical axis.  The example below shows Ireland.

It shows that most incomes in Ireland are towards the top of the global income distribution (in price-adjusted terms).  Ireland’s first ventile (the bottom 5 per cent) were located at around the 65th percentile of the global income distribution with the second ventile at around the 80th percentile.

As the chart title indicates the estimates, which are based on the work of Branko Milanovic, are based on data that is around ten years old.  There have been significant changes in Ireland since then – the country is no longer facing the teeth of a deep recession – and these have led to large changes at the bottom of the income distribution.

The post-2008 crash resulted in large drops for the cut-off points of the percentiles that make up the lowest ventile of Ireland’s income distribution.  The first chart compares Ireland’s position in the global income distribution at a time when the income of the lowest ventile was unusually low.

After 2014, there was very strong income growth for these percentiles with a doubling of the incomes shown in just five years.  It is possible that average income of the bottom 5 per cent in Ireland would be placed at around the 85th percentile in the current global income distribution.

The at-risk-of-poverty threshold at 60 per cent of the national median is currently around €15,000 for a single person (or €32,000 for a 2+2 family).  This income would be at around the 90th percentile of the global income distribution.

The interactive tool can be used to make find some unusual comparisons.  There is the example of South Africa where, in the 2011 data, the average income of the top five per cent was comparable to the income of the top 5 per cent in Ireland but where the bottom five cent were amongst some of the lowest incomes in the world.  Or Nigeria where the average income of the top five per cent is lower than the income of the bottom five per cent in Ireland.

The Domestic Non-Financial Corporate Sector in 2020

The distortions in Ireland’s national accounts means that the contribution of some sectors can be overlooked as it cannot be disentangled from huge flows in the overall data due to the presence of US MNCs here.  One such sector is the domestic business sector which is lumped in with the MNCs in most national accounts releases.

The annual institutional sector accounts remedy this as they provide a very useful sectoral breakdown with one of these being for a “domestic non-financial corporate sector”.  We have previously examined the contribution of this sector to pre-pandemic growth and, while there have been some revisions to the figures for earlier years, here we will focus on the 2020 changes. First, the current account.

Summary: pretty much everything went down.  In 2020, output was down, wages paid was down, profit was down. Pretty much the only thing that went up was subsidies received, without which the drop in wages paid would have been even greater.

But the above breakdown misses some of the significant differences by economic sector. Here is a breakdown by economic sector the of compensation of employees paid by the domestic corporates (with domestic financial corporates (NACE K) also included).

The stand-out figure is the 60 per cent drop in COE paid by the Accommodation and Food Services sector.  This contrasts with the three best-performing sectors in the above table which saw their COE expenditure increase by more than five per cent last year.

If also worth noting that the domestic NFC sector includes publicly-owned non-financial corporations.  These include semi-states such as the ESB, An Post, Coillte, Bord na Mona, Rehab, Gas Networks Ireland, RTE, the Dublin Airport Authority, Dublin Bus, Bus Eireann and others. Included in others are the seven universities as they are classified in the non-financial corporate sector and are likely a significant contributor to the COE from the Education sector shown in the above table.

The impact of the pandemic on the capital account of the domestic NFC sector seems to have been a bit more muted and as with the current account there have also been revisions to earlier years.

All told, the bottom line of the non-financial accounts is that the domestic NFC sector has been a consistent net lender in recent years.  The pandemic seems to have had only a modest impact on this.

The next step would be to move to the financial accounts to see what the sector is doing with this net lending.  We don’t have a financial transactions account so we move beyond that to the financial balance sheet.  We will show all years for which data is available. Click to enlarge.

As noted before the financial balance sheet for Irish-owned NFCs has been exploding in recent years.  Total financial assets went from €167 billion at the end of 2012 to €529 billion at the end of 2020.  That far outstrips anything that could be explained by the net lending shown in the capital account or any revaluation effects.

At the same the total liabilities of the sector rose from €275 billion to €705 billion with the most significant changes on both sides of the balance sheet being for equity items. And, as can be seen with the bottom line, the financial net worth of the domestic NFC sector has significantly deteriorated in recent years. Financial net worth excludes real assets so this is not an indication that the sector is insolvent.

At the end of 2012, financial net worth was minus €108 billion.  By the end of 2020, this had deteriorated to minus €175 billion.  Again, this is in contrast to the net lending position shown in the non-financial accounts.  It be could that there activities of a small number of large Irish NFCs are distorting the financial balance sheet of the domestic NFC sector – not dissimilar to the type of thing we see with US MNCs on other parts of the national accounts.

Is something mucking up the modified current account?

The current account of the balance of payments is an important indicator of imbalances in an economy.  The historical estimates of Ireland’s current account show significant deteriorations in the late-1970s and mid-2000s which were followed be periods when real growth turned negative (the shaded regions).

The concern with the latest estimates of Ireland’s current account is not that it shows deficits that are too large but of surpluses that are too large.  When published back in the summer the modified current account balance for 2020 was put at 11.5 per cent of GNI*, with comparable surpluses only recorded for the period of The Emergency (WWII to the rest of the world) in the early 1940s.

And the large surplus in the modified current account wasn’t just something that emerged with the COVID pandemic it is something that has been growing over recent years.

We can examine some of the sectoral developments underpinning the current account with the 2020 Institutional Sector Accounts which have been published by the CSO.  We will focus on the modified current account which strips out the impact of a number of globalisation effects (such as IP transfers, aircraft leasing and redomiciled PLCs). 

Some of the extra breakdowns provided by the CSO are useful in examining the improvement in the current account since 2013.  Here is a breakdown of savings minus investment by institutional sector with the combined sum representing the total economy current account.

The published figures are taken for all sectors bar that for foreign corporations (financial, non-financial and redomiciled PLCs).  The figures for foreign corporation is a residual to fit with the estimates of the modified current account, CA*.

The improvement from 2013 to 2019 can be attributed to two factors: an improvement in government’s position from large deficit in 2013 to modest surpluses in 2018 and 2019 and a switch in the impact of foreign corporations on CA* (through the residual component) from being negative in 2013 to positive in recent years.  It is not clear what has driven this change.

Clearly, there were a lot of sectoral changes in 2020.  The government moved into significant deficit while the surplus of the household sector increased considerably with these two effects largely netting out (in aggregate terms).

Domestic non-financial corporations have been in a surplus position in recent years while the impact of domestic financial corporations has always been relatively small though did become negative in 2020 for the time in the series which goes back to 2013.

A current account surplus of 11.5 per cent of national income is unusually large for Ireland.  Are there unusual factors which could explain it? Perhaps.  Corporation tax revenues have been soaring recent years and most of this is paid by foreign-owned corporations.  But the period that has seen Corporation Tax revenues go from €4 billion to €12 billion has been the CA* improve from a deficit of €1 billion to a surplus of €23 billion.  And of course the impact of the Corporation Tax on the current account will be tempered to the extent it is used to fund (import) spending elsewhere.

Is there an adjustment missing for the foreign-owned sector?  Possibly.  Though what that might be cannot be ascertained from this data.  And what about domestic companies?  Some of the balance-sheet developments for this sector have been extraordinary but it is not clear these have impacted the current account.

There is little doubt that Ireland is running a balance of payments surplus, and a significant one at that.  But the latest estimate of 11.5 per cent of national income is certainly close to the upper limit of the range of plausible estimates, and possibly even above it. 

Anyway, concerns about the precise level of an extant balance of payments surplus are a long way from the concerns raised by the balance of deficits of the late 1970s and early 2000s.  No one will be going on television to say we are living a way beyond our means.  Indeed, there is scope to increase spending if the things that people might like to buy (such as new houses) were to be made available.

Household savings and the changes in aggregate income during the pandemic

The CSO have published the Q2 2021 update of the Non-Financial Institutional Sector Accounts. Here we will focus on the household sector (which in the quarterly ISAs also includes non-profit institutions serving households). 

A lot of attention has obviously gone on the spikes we have seen in the household saving rate during the pandemic.  In the first half of 2018 and 2019 the household savings rate was around 12 per cent.  For the equivalent periods of 2020 and 2021 it was around 30 per cent.  This is shown in the bottom line of the table below with shows the outcomes for the first six months of the past four years.

While a fall in consumption opportunities undoubtedly played a role in the rise in household savings the impact of changes income has been as important.  A couple of lines up from Gross Savings is the line giving Gross Disposable Income. In the national accounts methodology used here, “gross” means before depreciation of fixed assets.

Gross Disposable Income is a measure of national income after taxes and transfers.  Looking across this for the four years shows no signs of a pandemic the public health response to which saw large swathes of the economy shut down by government decree. 

Indeed, the figure for the first half of 2021 is around €8 billion higher than for the equivalent period of 2019.  This allied to the €4 billion reduction in consumption is what gives rise to the €12 billion increase in savings.

A key reason for the lack of a pandemic effect in aggregate household income is that the government stepped in to support incomes.  One element of this is visible in the household sector current account with the row for social benefits (other than benefits in kind) received from the government sector.  These were €11.8 billion in H1 2019 but were €17.2 billion in the first half of 2021, primarily driven by the Pandemic Unemployment Payment.

There is some evidence of the pandemic shock in compensation of employees received which H1 2020 showing annual falls for wages received from non-financial corporates and other households.  However, these drops are modest relative to the scale of the sectors that were shut down. 

A key reason for this is that the wages paid by companies were supported by subsidy schemes.  In the household accounts, the money is paid from firms to households but the firms first received it from the government sector.

Figures for the non-financial corporate sector show that the sector received €350 million of other subsidies on production in the first half of 2019 (a lot of which would be public service obligation subsidies to commercial semi-states and other companies) to receiving €2.7 billion in the first half of 2021. 

The increase was due to the various pandemic-related wage subsidy schemes that have been introduced.  In the absence of these there would have been a much more pronounced fall in the wages received by the household sector from non-financial corporates.

The top line above is Gross Domestic Product.  For the household sector this is the value added of the self employed, including agriculture and the rents from the provision of housing services.  These rents include those from buy-to-lets but are mainly the imputed rents of owner-occupiers for the housing services that they provide to themselves.  The GDP of the household sector

The imputed rent of owner-occupiers counts as income but as they also consume the associated housing services the imputed rent is netted out through final consumption expenditure and has no impact of the savings rate. 

Outbound royalty payments head for €100 billion

One notable aspect of the presence of US MNCs in Ireland is the scale of outbound royalty payments. These are payments their Irish subsidiaries make for the use of technology developed elsewhere (mainly in the US itself).

The latest figures to the end of Q2 2021 put the four-quarter sum of outbound royalty payments from Ireland at €95.6 billion.  It is likely that the total for the 2021 calendar year will exceed €100 billion. 

While the overall total of outbound royalties has exhibited a fairly steady increase in recent years, the  destination of those payments has changed markedly. 

In the five years to 2019, the United States was the recipient of around 10 per cent of the outbound royalty payments from Ireland.  The 18 months has seen a huge shift and the latest figures from Eurostat show that the US was the recipient of almost 80 per cent of the outbound royalties from Ireland in the 12 months to the end of June 2021.

The chart shows the large drops in payments going to Offshore Financial Centres (Bermuda, Cayman etc.) and the Euro Area (which mainly went to The Netherlands before been subsequentlty directed to OFCs).  These payments were linked to “double-irish” type structures where US MNCs located licenses to use their technology in markets outside the Americas.

The Irish subsidiaries paid for the technology they were using (patents for pharmaceuticals, online platforms for ICT companies etc.).  This technology was almost wholly developed in the US but the US tax code facilitated US MNCs in putting the licenses to use the technology in no-tax jurisdictions where they had no substance.  This allowed the companies to benefit from the deferred payment of the US tax due on the profits those licenses were generating.

Changes in recent years have targeted these structures.  The US has moved from a worldwide system with deferral to a quasi-territorial system with payments due as the profit is earned. 

For many companies, most notable ICT companies, this has resulted in them moving the licenses for their technology back to the US. And now the payments that leave Ireland are flowing to the US.

Is this “stepping up action to address features of the tax system that facilitate aggressive tax planning, including on outbound payments” as required per the European Commission’s most recent set of Country Specific Recommendations (CSRs) to Ireland?

But if it is, what has changed? Very little.  There has been no change in the market countries being served by international HQs in Ireland.  The payments they make for the services provided by the ICT companies still flow to Ireland.  Royalty payments continue to be made from Ireland but are now being directed to the US, where the technology is developed, rather than Offshore Financial Centres.

The only place the end of the “double irish” has had any noticeable impact is in the United States.  This is not a surprise as the tax that was impacted by the structure was US tax (with companies benefitting from deferral on profits kept offshore).  Now the income flows direct to the US and is subject to immediate tax that – albeit at significantly reduced rates courtesy of the Tax Cuts and Jobs Act of December 2017.

Ireland Balance of Payments data is showing €75 billion of royalties flowing to the US in the 12 months to the end of June.  The equivalent figure two years earlier was €8 billion.  As the chart above shows this huge increase is clearly evident in the Irish data. 

But evidence of these payments remains absent in the data published by the US Bureau of Economic Analysis which show no increase in receipts of “charges for the use of intellectual property”.

Table 1 shows that total service exports from the US are around $800 billion a year so the changes noted here for payments from Ireland should have had a noticeable impact, at least in the relevant category. 

And even in the context of the entire US economy these payments are equivalent to something like 0.2 or 0.3 per cent of US GDP.  These things get huge focus when they come to attention in Irish national accounts. Will the US get to avoid such scrutiny for amounts of the same value because the relative scale will be 100 times smaller?

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.

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. 

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.

The latest insight into Apple’s use of capital allowances

At the start of 2015, Apple revised the structure through which the company’s sales to customers outside the Americas were organised.  This was responsible for the 26 per cent real GDP growth reported for that year.

We initially examined the revised structure here and in recent years have been tracking the consolidated outcomes for the group headed by Apple’s central international subsidiary, Apple Operations International (AOI). 

• AOI’s 2018 Accounts: Some insight into Apple’s use of capital allowances
• AOI’s 2019 Accounts: Further insight into Apple’s use of capital allowances

The recent publication of the AOI Group’s 2020 consolidated accounts gives us the latest insight into Apple’s use of capital allowances.  The two posts above contain details that are not repeated here.

We will start with the consolidated statements of operations and note that this covers the holding company AOI and around 80 subsidiaries operating beneath it, with the group as a whole having just over 50,000 employees.  Most, but not all of the amounts shown, arise in or pass through subsidiaries in Ireland.

Some pretty big numbers there.  As the accounts note:

The Group develops, manufactures and markets smartphone, personal computers, tablets, wearables, and accessories, and sells a variety of related services.

It certainly sells a lot.  For the four years shown, cumulative net sales were close to $600 billion.  And it is massively profitable.  Pre-tax income summed to $165 billion over the four years and the provision for income taxes was a chunky $25 billion.

But we should check a few things before we get excited about that tax figure.  A company making a provision for income taxes in its financial accounts is not the same as a company making a payment for those taxes in cash.  The balance sheet is a useful place to look next.

For our purposes we are interested in the line for Deferred tax asset.  We can see that the AOI Group had $25.6 billion of deferred tax assets at the end of its 2016 financial year.  These reduced each year and by the end of its latest financial year stood at $10.9 billion.

Thus, while there might been tax provisions averaging around $6 billion in the income statement for each of the past four years this was not resulting in an equivalent payment out of cash reserves but in the reduction in the deferred tax asset on the balance sheet.

[As we have pointed out before it is also worth noting what this balance sheet does not contain: a huge amount of intangible assets.  Ireland’s national accounts have recognised massive intangible assets yet the consolidated accounts of the group which contains the company with that asset does not. Anyway back to the tax payments.]

The difference between the provision for tax and the payments for tax is is confirmed by a supplemental item included with the consolidated statements of cash flows.

There might have been tax provisions of $6 billion each year but, as the final line above shows, cash payments for income taxes averaged $2 billion a year over the past four years.  And a variation of the following paragraphs are included a number of times in the accounts:

The corporate income taxes in the consolidated statements of operations, balance sheets and statement of cash flows do not include significant US-level corporate taxes borne by Apple Inc., the ultimate parent of the group.

US-level taxes are paid by Apple Inc. on investment income of the Group at the rate of 24.5% (35.0% in 2017) net of applicable foreign tax credits. In addition, under changes in US tax legislation that took effect in December 2017, Apple Inc. is subject to tax on previously deferred foreign income (at a rate of 15.5% on cash and certain other net assets and 8.0% on the remaining income), net of applicable foreign tax credits.  The new legislation also subjects certain current foreign earnings of the Group to a new minimum tax.

The posts linked above that went through AOI’s 2018 and 2019 accounts go into detail on how the provisions for income taxes were arrived at and show the reconciliation with Ireland’s 12.5 per cent headline rate.  The earlier posts also discuss how the deferred tax asset came about – capital allowances under Section 291A of the Taxes Consolidated Act. 

For now, we will just focus on the evolution of those deferred tax assets using a table from the note to the accounts on the provision for income taxes.

We are interested in the deferred tax asset that arises due to Intra Group Transactions.  This likely includes the purchase by a now Irish-resident subsidiary of the license to sell Apple products in all markets outside the Americas.  That outlay (which may have been around $240 billion) will be eligible as a tax deduction with this provided via capital allowances.

At Ireland’s 12.5 rate of corporate tax a $240 billion deduction would be worth $30 billion which is probably where the value of the group’s deferred tax asset from intra-group transactions was in January 2015.

As we can see from the above table tax was being charged against that deferred tax asset.  The utilisation was $4.4 billion in both 2017 and 2018, $3.2 billion in 2018 and $3.3 billion in 2020.  This meant there was $7.4 billion remaining and at the current rate of utilisation will be fully exhausted in the next two to two and a half years.

The utilisation of capital allowances at that scale means that something in and around €25 billion of gross profit is being offset by a deduction for capital allowances.  As the transaction occurred before October 2017 no cap applies and, if sufficient capital allowances are available, the company can fully offset its profit with capital allowances and this is was happened in 2015, 2016 and 2017.  A small amount of profit may have been subject to tax in 2018.  Any unused capital allowances in the earlier years are carried forward as losses but essentially remain as a deferred tax asset.

As before, the key question is the amount of profit that will be subject to tax when the deferred tax asset is fully exhausted.  If nothing changes at that point then somewhere in the region of €25 billion of gross profit will be added to the taxable income of the Irish-resident Apple subsidiary that currently holds the license to sell Apple products outside the Americas. 

This would see tax payments in Ireland rise by €3 billion or so and that Apple subsidiary would almost certainly become Ireland’s largest taxpayer.  If nothing changes.

We have already seen a number of major US ICT MNCs transfer their IP back to the US (from which it should never have been allowed leave in the first place).  Apple have the option to do the same and maybe this becomes more likely as the amount of capital allowances available nears exhaustion.

If Apple were to do so, this would reverse the GDP surge that occurred in 2015 and the value added would be rightfully recorded where it is generated – in the US.  Changes that add 0.2 per cent to US GDP won’t make headlines in the same way a 10 per cent reduction in Irish GDP would.  But they essentially involve the same thing.

And further it probably won’t significantly change the company’s tax payments  - not in Ireland at any rate.  With capital allowances the profit is not currently exposed to Ireland’s 12.5 per cent Corporation Tax.  As pointed out above the profit is subject to tax in the US under the minimum tax on foreign earnings introduced by the Tax Cuts and Jobs Act (TCJA). 

This is the tax on Global Intangible Low Taxed Income – GILTI.  The Biden administration are proposed to double this from 10.5 per cent to 21 per cent.  If Apple relocates their IP to the US and continues to use a licensing structure (they could also decide to simply sell the products from the US) then the income from that license would be taxes under the Foreign Derived Intangible Income (FDII) provisions also introduced by the TCJA.  The Biden administration are proposing to abolish FDII.

There is lots of uncertainty.  But as shown here there is no doubt that the amount of remaining capital allowances Apple has in Ireland is reducing.  What was probably around $30 billion in 2015 was down to $7.4 billion in September 2020.  We won’t get many more insights into Apple’s use of capital allowances – because soon enough they will be gone.