The tax system on corporate profits from international trade evolved over the last century as the business environment changed. Decades ago, things were fairly straightforward. When goods produced in one country were sold to a retailer in another country, the producer was taxed in its home country on its profits, based on the export price. The retailer’s tax on its profits was paid in the retailer’s jurisdiction.
Things are now more complicated where goods are produced by a company’s subsidiary in a foreign country. For example, a subsidiary of Volkswagen that produces cars in Slovakia makes profits in Slovakia, which are taxed in Slovakia. The after-tax profit is sent back to the head office in Germany. In turn, the profits of the Volkswagen head office in Germany are taxed in Germany. This gives rise to a risk that the profits of foreign subsidiaries will be taxed twice.
To avoid paying on the double, for most countries double taxation agreements ensure that tax paid by a foreign subsidiary is credited against tax in the home country. Thus, while Ireland has a very low corporation tax rate compared with Germany, there is no incentive for a German company to shift profits to Ireland as they would end up paying a top-up in Germany. That means the low Irish corporation tax rate hasn’t negatively affected Germany.
However, the operation of the internet has opened up new channels for commerce, which affects where profits are earned by businesses. With internet sales of goods and services, profits only arise in the country where the internet sales company is located, because local retailers are bypassed when people buy online. Thus purchases through Amazon don’t generally generate corporation tax receipts where the buyers actually live (unless that’s also Amazon’s base). Because Ireland is a major centre for such ecommerce, Ireland has gained tax revenue at the expense of our European colleagues.
An agreement has now been reached at the OECD to reallocate the tax on profits from internet sales to the countries where the purchases are actually made, which seems fair. If and when this agreement takes effect, Ireland will probably lose more than €2 billion in tax revenue, most of which will transfer to other EU countries. It’s still a small fraction of our expected corporation tax take of almost €30 billion this year. The latest Central Bank Quarterly estimates the “exceptional” share of this tax at about €15 billion.
Our bumper tax revenues are largely due to the quirks of the US tax system. Since at least the 1990s, US companies were allowed to indefinitely postpone repatriating profits. This meant they never had to pay a top-up tax in the US, and could thus benefit from the low corporation tax rate in Ireland. The last Trump regime made this permanent in 2017, when it abolished any liability for a top-up tax on profits, whenever repatriated. Hence, US companies have an incentive to maximise their profits in Ireland by shifting ownership and profits on their intellectual property here, to benefit from our low tax rate.
As a result, in 2021 the profits of US companies in Ireland represented 93 per cent of their value added here, compared with 61 per cent across the EU 27 as a whole, because our corporation tax rate is more attractive than elsewhere in Europe.
The US is the loser from its unusual tax treatment of the foreign subsidiaries of its multinationals, as a recent paper in the Journal of International Economics shows.
Trump has promised to dramatically cut corporation tax, which would add to the huge government borrowing requirement. However, unless US rates were cut to 15 per cent to match Irish rates – which would involve a massive loss of US tax revenue – there would still be no incentive for US multinationals to shift their profits on intellectual property back to the US.
Instead, if the US taxed foreign profits like domestic profits, they would capture Ireland’s “exceptional” tax revenue, though the gain would be very small relative to the US budget deficit. However, the journal paper also suggests that, under these circumstances, the multinationals would invest less, due to the higher tax take, leading to a small reduction in US (and world) output. As such a tax change would impact negatively on very powerful US companies, they would lobby hard against such a change.
It remains to be seen what the Trump administration decides and whether Ireland will eventually lose its “exceptional” corporation tax revenue. This threat provides an ominous Christmas present for the next Irish government, to be formed shortly.
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