Is it time to scrap corporation tax?

The tax planning activities of several well known multi-national companies have been in the spotlight recently. At a time when most of us are feeling the strains of austerity these companies apparently have some sort of immunity. Various governments (UK and US in particular) have hauled some of these companies in front of parliamentary committees to explain their tax structures. Ireland has in some cases been implicated in these debates. Ireland’s tax laws seem to facilitate the shifting of profits out of higher tax countries. In some cases Ireland has been cited as a tax haven.

Is Ireland a tax haven?

Well what is a tax haven? The OECD identifies 4 indicators of a tax haven:

  1. No or nominal taxes
  2. Lack of transparency
  3. Unwillingness to exchange information with other countries
  4. No requirement for “substantial activity”

The Irish Government has strongly contested the accusation that Ireland is a tax haven. It has pointed to the 4 indicators and (rightly) declared that Ireland doesn’t display any of them.

These indicators were identified in the 1990s. Some claim that they are now out-dated and are no longer the only indicators by which a country may be regarded as a tax haven. Some claim that Ireland, by allowing itself to be used as a conduit through which profits flow from a high tax jurisdiction to a zero tax jurisdiction, is in effect a tax haven

So who is right? It’s probably a question of perspective. For example, some UK commentators call Ireland a tax haven because profits have been shifted out of the UK via Ireland to a low or no tax jurisdiction. But if Ireland is a tax haven for facilitating this, then what is the UK for allowing the profits to move to Ireland in the first instance?

The interesting thing about this whole debate is that if you look at Apple, Amazon, Google and Starbucks they are using different aspects of the tax code to book profits in other jurisdictions.

The Apple case is particularly interesting because it has 2 subsidiaries that don’t book profits (for tax purposes) ANYWHERE. How can this be? The Americans are flabbergasted that a company incorporated in Ireland isn’t tax resident in Ireland. Why isn’t it? Well the default position in Irish tax law is that an Irish incorporated company is tax resident also. BUT, there is a provision that companies that are not centrally managed and controlled in Ireland will not be tax resident.

Why? Look at tax haven indicator number 4. This provision is there (in part) because of that. It is to prevent anyone creating an Irish company that has no physical presence in terms of staff, management etc from establishing here solely to avail of the 12.5% tax rate. It has been Irish tax policy to have a low corporation tax rate to attract inward investment and create jobs. If this provision wasn’t there it could lead to an abuse of our tax system.

It is ironic therefore, that a provision which is in place to prevent abuse of our low corporation tax rate is now being used to brand Ireland as a tax haven. In my opinion, the US position is more ludicrous as its tax law allows a company to be managed and controlled in the US yet not be tax resident there. Other countries with which Ireland has a double taxation treaty specifically provides for this situation. For example, if 2 Italian residents establish an Irish company and run it from Italy it will be tax resident in Italy – there’s no such provision in the US DTA ,or seemingly in US domestic tax law.

Amazon uses a different structure to ensure its profits don’t arise in the UK. I’m reluctant to use the word “structure” in Amazon’s case as it is a fairly straightforward situation. Amazon has a huge warehouse in the UK from which it fulfils orders and ships to customers. It has no other operations in the UK. It’s head office is in Luxembourg. For profits to arise in the UK Amazon must have a permanent establishment in the UK. But what is a permanent establishment? That is also defined in double taxation treaties specifically and excludes (inter alia):

  1. the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise

  2. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery

So, even if Amazon wanted to pay taxes in the UK, it couldn’t under its current structure. The law says it doesn’t have a permanent establishment.

I think the Amazon case is a good example of structuring a business in the most tax efficient manner, ie tax planning and non-aggressive tax avoidance. Amazon could restructure its operations to create a permanent establishment in the UK, and consequently pay taxes there. If it were to do that it would be structuring its business to maximise its tax exposure, which is ludicrous. It’s like directors of an owner managed company taking profits as dividends as opposed to salary and incurring corporation tax charges (and surcharges in the case of professional services companies).

Amazon’s headquarters is in Luxembourg, but it could easily be Ireland or many other countries with which the UK has a tax treaty with the same provisions.

Google is relying on a similar DTA provision for booking its adwords sales to UK customers in Ireland. It is relying on this provision:

A person acting in a Contracting State on behalf of an enterprise of the other Contracting State–other than an agent of an independent status to whom paragraph (5) applies–shall be deemed to be a permanent establishment in the first-mentioned State if he has, and habitually exercises in that State, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise

Google is claiming that its UK marketing staff market the service but the contract or sale is not concluded by them. The sale is concluded in Ireland. Therefore the profits arise in Ireland and not the UK. This is more aggressive than the Amazon scenario, but again it is clearly set-out in double taxation treaties. This scenario would also work in reverse as the rules in the DTA work both ways. It is also applicable to any other country with which the UK or Ireland has a DTA with the same provision.

And what about double Irish and dutch sandwiches?

This is a much more aggressive tax avoidance mechanism used by US multinationals to avoid US taxes. It basically shifts intellectual property rights to an Irish incorporated company tax resident in a tax haven (such as the Caymen Islands) and charging royalties to a second Irish company which is selling the licensed goods and services. The upshot is the second company’s profits are shifted to the tax haven. Resulting in no tax paid (in respect of non-US sales) in the US and a small amount of corporation tax paid in Ireland. The Dutch sandwich comes in to avail of tax provisions in the Netherlands to further reduce the Irish liability.

This arrangement is facilitated by provisions in US tax law as well as Irish and Dutch law. It is used to avoid US tax on profits earned outside the US. One problem with it is that if the profits are brought back in to the US (ie cash) then a charge to US tax will arise. This is what has led Apple to borrow money to pay a dividend to its shareholders rather that remitting than cash back in to the US. In other words it is cheaper for them to borrow the cash rather than pay US tax on it.

We still haven’t answered the question of whether Ireland is a tax haven?

It isn’t by the OECD measure as described above. It may be a conduit through which taxes are shifted to real tax havens. There are provisions and loopholes in domestic Irish law, UK law, US law and international tax treaties which allow this to happen. The problem is not with one individual country. It is clearly a collective problem which can only be adequately addressed at international level.

The problem with that is every country wants to maximise tax revenues and be the most attractive for inward investment (and to prevent respective indigenous companies relocating off-shore). Some countries are prepared to off-set one against the other in the hope that increased economic activity will raise additional revenue through other tax streams. Others aren’t.

So how can it be fixed?

Righting all the loopholes and shortcomings in international and individual domestic tax laws would require an unfathomable amount if co-operation. Something similar to tax harmonisation at a world level. Such collaboration could be regarded as anti-competitive; akin to price fixing in the commercial world. I doubt there’s any appetite for this anyway.

Each country, whether “victim” of profit shifting or a “facilitator” has deliberately put in place tax provisions that allow this profit shifting (albeit as a by-product of the provisions’ main intentions). It is a little disingenuous of the UK and US to then point the finger at Ireland just because the Irish tax regime doesn’t facilitate theirs. For example the double Irish wouldn’t work if the US didn’t have a regime to allow non-US sales to be taxed outside the US. The US has this in place to prevent US companies relocating overseas.

They can’t have their cake and eat it.

It might be a little bit easier to address if the problem was merely about shifting profits. The domestic country would just need to put restrictions on what expenses can be deducted for tax purposes. But it’s also an issue of where turnover arises.

Corporation tax is a tax on profit. For a profit to arise you firstly need revenue. Remove one of the elements and there’s nothing on which to charge corporation tax. That makes it more difficult to tax.

I would like to see the option of a turnover tax explored. There’s an obvious problem with this in that a non-profitable company could face a tax charge which would be in equitable – or would it? We assume it is because we are accustomed to taxes being charged on profits (and if there are no profits there’s no tax).  However, the tax could be regarded as a business expense just like any other overhead: a cost of doing business.  This would require a momentus shift in mindset, by both goverments and business.  It’s unlikey to happen in my lifetime.

One thing is clear: the double taxation treaties need some rethinking.  For example, DTAs set-out how tax residence is to be determined if both countries can claim residence.  They don’t provide for situations where a company is resident in neither.  The permanent establishment rules could be changed, but how would that affect a small business with an overseas warehouse?

Just be done with it!

The value large multi-national companies contribute to an ecomony (corporation tax aside) cannot be ignored.  The creation of employment alone generates so many other benefits which possibly outway the perceived lost corporation tax revenues.

An analysis of UK budgetary data makes interesting reading. The UK treasury is forecasting the income tax take to rise by 35% between 2012 and 2018. Corporation tax is forecasted to remain static, presumably as a result of planned rate cuts. In 2012 corporation tax was 7.8% of the total UK tax take; by 2018 it will be 6%.

By contrast, in tax haven Ireland, corporate tax take was 11.5% of the total tax revenues.

A central tenet of Ireland’s corporate tax policy is transparency and simplicity.  We have a low rate but few exemptions and reliefs.  That is why the effective tax rate in Ireland is close to the actual rate.  In some other countries the effective rate is somewhat lower than the actual rate because there are numerous exemptions and reliefs available.  This makes for a less transparent and more complex tax regime.

The simplicity of Ireland’s corporate tax regime has been diluted somewhat in recent years with the introduction of additional reliefs (such as research and development relief).  This is has been done to make Ireland more competitive internationally.  If corporation taxes were scrapped altogether, countries would be able to compete for inward investment on more tangible grounds: workforce, skills and infrastucture.

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