Ireland caught up in US tax loophole

The pace of change in the world of globalised technology companies means the tax structures they operate are constantly in a state of review. Developments this week concerning Apple’s tax affairs have once again put a spotlight on the role played by Ireland in these companies’ ongoing efforts to drive down the amount of tax they pay.

Ireland has, for a number of decades, run a successful model for attracting foreign direct investment (FDI). The classic success story has been the multinational that establishes its main European operation here (a European HQ), employing thousands of people to make and sell the goods and/or services that are then sent to countries on the continent and further afield.

Ireland has succeeded in this regard because of its membership of the euro and the Single European Market, and its well-regarded, English-speaking workforce. Pride of place, however, has always been Ireland’s stable 12.5 per cent corporation tax rate.

In more recent times, a new element has been added. This has to do with the importance of intellectual property to companies such as Google, Facebook and Microsoft. They have set up IP (intellectual property) holding companies that charge other group subsidiaries for the right to sell their products outside the US. This means Irish HQ companies booking revenue from business from around Europe and further afield have seen their profits reduced. The money flowing to the HQ operations, the profits from which were taxed at 12.5 per cent, now flows onwards, by way of licence fees, to the IP holding companies. The amount of Irish corporation tax being paid by the HQ operations is being correspondingly reduced.

'Double Irish'
A number of the world's best- known companies have opted to have an Irish-registered company hold the IP for their sales outside North and South America. In order to avoid having to pay Irish corporation tax on the resulting income, they have organised it so that these companies are controlled and managed from outside Ireland. As, under Irish law, companies have to be managed and controlled here if they are to be subject to Irish taxation, the result is these companies escape the Irish tax net. Most are managed and controlled from tax havens.

In order to prevent payments from the HQ company to the IP company becoming liable to US taxes under what are called the Subpart F rules – which allow for the immediate taxation of the passive income of US companies, even if the money is not repatriated to the US – the Irish HQ company is usually made a direct subsidiary of the Irish IP company. Under current US tax law, this allows the multinational to choose that payments between the two entities should be disregarded for the purposes of US taxation.

It is structures such as this that have created phrases such as the “Double Irish”, and the “Dutch-Irish sandwich”, terms which are entering into common parlance and which describe tax structures used to reduce multinationals’ tax bills through Irish IP holdings.

It is an essential part of these IP companies that they have no management here. From the Irish point of view, the only direct benefit is that they create some fees for the accountancy and law firms which specialise in this area.

On the other hand, the fact that multinationals locating their European HQs here can avail of the IP holding company device adds hugely to Ireland’s overall attraction. The structure is essentially a response to the nature of the US Subpart F rules. The key to ending the practice, therefore, would appear to reside in Washington.

Meanwhile, unfairly perhaps, the structure is the focus of increasing international media comment and political controversy, leading to claims such as those made this week in the US Senate that Ireland is a tax haven. The correctness or otherwise of that view is not relevant to the fact that the reputational damage has given ammunition to those who oppose Ireland’s 12.5 per cent corporation tax rate.

The revelations about Apple this week add significantly to the pressures being created for the Irish model, even though the case of Apple is sui generis .

The extraordinary fact is that Cork-registered Apple Sales International (ASI) is the major Apple subsidiary globally outside the Americas. It buys Apple's products from a contracted manufacturer in China and sells them on to Apple distributor companies worldwide, seem- ingly without much of this product ever coming to Europe, let alone Cork. So when an Apple tablet leaves the Chinese manufacturing plant and goes to Singapore, where it is sold, the profits end up in Cork.

Tax purposes
But ASI pays no tax here because it is not managed or controlled from here. In other words, despite the tens of billions of euro in annual sales, it makes no contribution to the Irish exchequer. Two other Cork-based Apple companies – Apple Operations Europe and Apple Operations International – are used to hold the Apple IP rights, and hold onto the cash (held in US bank accounts) generated by way of the Cork-based operation.

All three of these companies are unlimited and so do not publish accounts (This tends to be the case with IP holding companies). The three companies switched from limited to unlimited status in 2007, in the run- up to their taking on the key role in Apple’s global affairs they now hold. The three are managed and controlled from the US but, because they are not US-registered, they do not feature for tax purposes there under US law. For tax purposes, they don’t exist anywhere.

The Apple arrangement is an exploitation of the difference between Irish and US tax law and of the current nature of the Subpart F rules. Claims by Apple that it conducted a deal with the Irish government back in the 1980s have been strongly disputed by the Government and the Revenue Commissioners. Certainly, in the 1980s the companies did not perform the functions they do now.

However, Apple’s claims, and the nature of the structures it has put in place, add to the reputational damage to Ireland at a time when the issue of how to prevent multinationals frustrating the efforts of governments to submit them to taxation looks set to remain a key issue on the international political agenda.

Observers believe the endgame will involve changes in US law, and in particular to the subpart F rules, to capture more of the profits of US multinationals, whether repatriated or not. A reduction in the headline US corporation tax rate may accompany any such change.

The challenge for Ireland is to protect its 12.5 per cent corporation tax rate during a time of great pressure and flux. A key part of that challenge is to maintain Ireland’s attractiveness for FDI, while resisting developments that allow companies to use Ireland in ways that provide ammunition to those who oppose its relatively low headline corporation tax rate.