US technology and pharmaceutical companies are some of the world’s most high-profile companies. These companies are profitable largely as a result of the fruits of their research and development efforts and this activity is almost exclusively undertaken in the United States.
Strictly speaking, this gives the US the right to tax most of the profits of these companies. If the US exercised that right, the taxation of these companies would garner few headlines.
But the US has a unique system that facilitates, and to a certain extent encourages, companies to split their taxable profit into domestic and foreign, based on the location of their customers. The location of customers does not determine where a company owes tax on its profits, but it can determine when a US company pays its US tax.
US companies pay 35 per cent corporate income tax on the profits earned from sales to US customers. However, through various means, US companies can defer the US tax due on sales to non-US customers until the profits are deemed to be “repatriated” to the US. Thus, we have the odd situation of the US not deeming these overseas “offshore” profits to be taxable in the US while other countries don’t have the activities to allow them to tax them either.
And so begins a worldwide game of “find the lady” and as soon as we get close she is whipped off the table. The profits might be in Bermuda or the Caymans, or in some instances nowhere at all. The key reason why this is possible is that the profits are linked to licences and intangible assets rather than substance.
Transfer pricing
One of the aims of the OECD’s Base Erosion and Profit Shifting (BEPS) project is to improve the alignment of profits with the substance that generates that profit. For US companies we know that this substance is in the US but as long as the US approach to transfer pricing considers the profits to be “offshore”, the shell game will continue.
Whether by accident or design, Ireland has found itself central to all of this. And is likely to become even more so. By changing our residency laws, Ireland moved against profits that were “stateless” and over the next few years the various BEPS proposals will limit the ability of US companies to shift profits to small islands with no corporate taxes which will see the end of “double-Irish” type structures.
It is now clear many of these licences and intangible assets are being moved to Ireland. From an industrial policy perspective, the decision of US companies to locate some of their intangible assets in Ireland can be considered another spoke in the wheel strengthening their presence here.
The link to future real investment is less clear but the ongoing changes at international level in how corporate income taxes are assessed mean that further substance will likely follow to the location chosen for their intangibles. Ireland should welcome companies locating their intellectual property here. But that welcome should not extend too far.
Since the ending of the ability for Irish-registered companies to be “stateless” in 2015, the stock of intangible assets in Ireland has increased by about €300 billion. These internally generated assets have been purchased by entities which are now Irish-resident. As is typical for many tax systems, companies will be able to deduct such capital expenditures from their revenue when arriving at their taxable income.
Equivalent of depreciation
In Ireland, this is achieved by a system of capital allowances which spreads the capital expenditure that can be claimed against revenue over a number of years. It is the tax equivalent of depreciation.
Figures from the Revenue Commissioners show that capital allowances claimed on intangibles jumped tenfold in 2015; from €2.7 billion to €28.9 billion. This increase in capital allowances almost exactly offset the increase in intangible-asset-related profits such that the onshoring of these assets resulted in little or no additional corporation tax being collected in 2015.
This would probably not be a significant issue were it not for the fact that these gross profits are included when our contribution to the EU budget is being assessed. It is likely that Ireland’s EU contribution is about €200 million per annum higher as a result of the gross profits associated with these intangible assets.
It is the case that the capital allowances will be exhausted at some stage and increased corporation tax may be collected in the future. There are significant risks to this. It requires the continued existence of these assets which could be affected by US tax changes. It requires these inherently mobile assets remain here while also requires the companies continue to be profitable in industries renowned for volatility. Ireland could be paying a huge price for a taxing option that could turn out to be worth far less.
To counter such risks, we can limit the amount of capital allowances that can be claimed in any year to ensure that some of the gross profit is included in the companies’ taxable income now. This doesn’t change the total amount of allowances available, but does affect the timing of when they can be used.
Corporation tax
Such a cap has been in place since the regime was introduced in 2009 and was set at 80 per cent up to the end of 2014. It was increased to 100 per cent in 2015, while October’s budget reduced it to 80 per cent again but only for transactions that take place after the date of the announcement. It is estimated this measure will result in €150 million of additional corporation tax being collected next year.
If we had so wished, we could have reduced the cap to 80 per cent for all claims and figures from the Revenue Commissioners, and estimates from the Department of Finance indicate this could have resulted in up to €1 billion of additional corporation tax being collected in 2018.
This policy choice remains open to be introduced in future years. It would provide revenue to offset the additional EU contributions that have to be made and would reduce the volatility of corporation tax receipts.
Seamus Coffey is a lecturer in the department of economics in University College Cork