Why Ireland is an EU corporate tax haven
A couple of weeks ago Nicholas Shaxson, author of Treasure Islands mentioned on his blog that the Progressive Tax blog had become defunct and that many of the important posts on it were no longer available on the web. He then took it upon himself, using Google Cache and the advice of commenters, to republish some of these posts on his blog. Following this example, and in the interests of posterity, I’m republishing one here that relates to how Ireland is an EU corporate tax haven. This version of the post, however, includes a diagram explaining the “Ireland Luxembourg intra-group on-lending structure” that hasn’t been included in the version on Nicholas‘ blog. Further reading on this can be found in Richard Murphy’s ICTUNI/TUC paper, Lowering Northern Ireland’s Corporation Tax: Pot of Gold or Fool’s Gold?, and Jim Stewart’s recent discussion paper How Important is the 12.5 % Corporate Tax Rate in Ireland?. All this is worth reading, I believe, in light of the recent figures suggesting that Ireland’s economy has grown by 1.6% in the first half of the year. This again is largely based on “export growth”, but there is little discussion about what those exports are.
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The Guardian Ireland Business Blog has published an interesting article on Ireland’s ‘real corporate tax take’. It references a report called The Economic and Fiscal Contribution of US Investment in Ireland, written by an economist at the Irish Revenue, and presented to the Statistical and Social Inquiry Society of Ireland in 2010.
The Guardian article highlights the newspaper’s own take on the report from an Irish perspective. However, I think one of the most interesting points is that in 2009, investment in the Irish International Financial Services Centre (IFSC) rose to approximately €1,800 billion. The report says:
“much of the inward IFSC investment involves the movement of capital by multinational companies to subsidiaries in the IFSC that is re-invested overseas”
The amount of IFSC investment and the frank observation of the Irish Revenue that much of this is intra-group on-lending activity appears to strongly support the view that Ireland has become a major hub for intra-group financing by multinationals. This is partially due to its 12.5 tax rate for financing businesses in the IFSC, however many other businesses can operate in Ireland and record no or only a small amount of taxable income. In this case, it is irrelevant what the headline tax rate is as the ‘tax base’ is so small. We explain how below.
Transfer pricing and why it matters
It is pretty well known that Ireland has one of the lowest corporate tax rates in the EU of just 12.5% for trading activities (including financing in the IFSC). A separate 25% rate applies for non-trading activities including financing not in the IFSC. This makes it an attractive place to invest even before you consider its specific tax rules in more detail.
However, what is so unique about Ireland compared to other countries is that it does not have comprehensive ‘transfer pricing’ rules. In general, most states treat contracts between related parties as taking place on ‘arm’s length’ terms. This means that if a company sells goods or services (including financing) to a related party, it is taxed on the market rate, even if a lower (or no) charge is actually made.
Ireland has historically had no transfer pricing rules whatsoever. This means that profitable activities have been located in Ireland and the Irish Revenue will not challenge the profit actually recorded and taxed in Ireland. With effect from 2011, Ireland has introduced transfer pricing rules but only for trading activities (and only transactions with terms agreed after July 2010). For non-trading activities, including intra-group financing activities not treated as trading transactions in the IFSC, transfer pricing rules do not apply. Funnily enough, most international tax planning has traditionally revolved around structuring tax efficient intra-group financing.
All this means that multinational groups can continue to locate their financing in Ireland and pay no corporate tax as long as they do not actually record any profit in Ireland. This in itself does not lower the group’s overall worldwide tax bill. The magic of the Irish regime is that certain other jurisdictions (including Luxembourg) apply their own transfer pricing rules symmetrically to deem transactions to take place at market rates even if the actual rate charged is more beneficial (i.e. allow an additional expense for tax purposes). Take the following example:
In this case, the parent company provides Ireland with £1 billion new equity funding, which is on-lent interest free to Luxembourg. This cash is then on-lent to other subsidiaries around the world (e.g. UK and other EU states) at market interest rates (say £50 million per year).
Ireland does not view any taxable income as arising as it does not apply transfer pricing rules to non-trading transactions (even after changes applying from 2011). Luxembourg helpfully applies its own transfer pricing rules symmetrically to deem interest as being paid at market rates to Ireland for tax purposes, meaning that only a small amount of taxable profit is recorded in Luxembourg. Meanwhile the loan to subsidiaries in other countries is at market rates meaning that interest deductions will generally be available for local tax purposes. The overall result is that the group will pay significantly less tax worldwide.
You might ask why Ireland is used in planning structures like this in place of classic tax havens such as Bermuda, Cayman Islands and Jersey. The answer is that in these cases many countries would apply withholding tax on interest paid to traditional tax havens. Ireland’s lack of transfer pricing rules combined with the symmetrical transfer pricing rules in countries such as Luxembourg allows tax treaties with these countries to be relied on to avoid withholding tax.
This example is simple but highlights a key piece of tax avoidance ‘technology’ that is being used by many multinationals, and is also relevant to other transactions including licensing of intellectual property (as long as this is ‘non-trading’ activity). Stay tuned for further discussion of an example of this in a separate post.
How does this affect the UK?
As we discussed in our post on the implications of proposed reforms to the corporate tax regime, the UK is moving towards a territorial taxation system where the general presumption is that it will not tax trading activities arising outside the UK, and will tax only one third of financing profits, as long as there is no significant tax deduction arising in the UK from the various transactions.
Once we move towards this system, there really is a carte blanche for UK multinational groups to move all of their worldwide financing (and potentially intellectual property) activities to Ireland and similar ‘respectable’ jurisdictions which have tax treaties in place but in reality facilitate tax avoidance. Territorial taxation relies on profits being recorded in the right places, and therefore requires that transfer pricing principles are respected, however Ireland is singularly failing to live up to its international obligations to tackle tax avoidance in this respect.
Will the UK and other EU member states lobby Ireland to introduce comprehensive transfer pricing rules to prevent artificial tax avoidance?
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