There is widespread misunderstanding of the role of corporation tax in developing the Irish economy.
A low rate of corporation tax was undoubtedly important in attracting foreign firms to set up in Ireland in the period from 1960 to the 1990s, providing valuable well-paid jobs.
However, since then, other key drivers, like the availability of well-educated English-speaking employees and an entrée to the EU single market, have influenced businesses’ location in Ireland.
Thus, in the last 20 years, corporation tax has become a much less important part of the attraction for multinationals to come or stay here, and it is no longer crucial in the growth in employment. However, it is a very important source of revenue for the government, accounting for around 5 per cent of national income. Some of that revenue derives from quirks in the US tax system.
In most cases, domestic tax authorities do not allow their firms to separate their intellectual property (IP) from where they produce their goods and services, to move it to low tax locations. Thus, the profit rate of UK and German firms in Ireland is similar to firms in their home countries – they have not shifted profits to Ireland to enjoy a lower tax rate. They do business here because of the other attractions available.
The exception is the US, which allows high-tech companies to move their IP to jurisdictions with low tax rates. Indeed, up to 2015, much of this IP was located in jurisdictions where they paid zero tax. Shamefully, Ireland facilitated this manoeuvre, while gaining no direct benefit from this tax avoidance.
In anticipation of changes in US law, a substantial amount of this IP moved to Ireland in 2015. Under current US law, firms must pay a minimum tax rate of 10.5 per cent on foreign earnings from IP, or else pay a much higher rate of US tax. By locating some of this IP in Ireland, a few very large US companies choose to pay our tax rate of 12.5 per cent, rather than face a higher tax bill in the US.
If the US adopted rules like most EU countries have, it would collect all the tax revenue arising from US firms, rather than allowing them to pay tax on profits at a lower rate in countries like Ireland. Such a change could cost Ireland up to €6 billion a year.
However, it looks more likely that the US will choose to raise the minimum rate US companies must pay abroad to between 15 per cent and 21 per cent. Unless the new foreign minimum rate for US firms is close to the US domestic rate, US companies would have no incentive to leave Ireland.
A benefit
But there are two big unknowns – exactly what will the US do next, and what agreement might be reached at the OECD on how corporation tax is levied internationally.
If an OECD-wide minimum rate of 15 per cent is set, then Ireland should follow suit, and raise our 12.5 per cent to 15 per cent, resulting in higher Irish tax revenue. An OECD-wide minimum rate is probably not a threat, and possibly a benefit.
However, an OECD agreement could change the basis for levying tax on companies, especially those selling IT services, posing a threat to our tax revenue. The business model of companies like Facebook and Google is very different from normal companies that produce butter, or computer chips.
There is a good argument that the profits of internet companies should be treated differently and that the resulting tax revenue should accrue in countries where they do business. A proposed OECD agreement on such a change could cost Ireland €2 billion. It seems hard to argue against this, provided it is confined to internet companies.
Being seen as a tax haven has been damaging to Ireland’s reputation. A key task for the Government over the next year will be to contribute constructively to an international agreement which deals with the points of international friction, while at the same time trying to preserve much of our tax revenue.
A great benefit of Ireland’s current tax regime is it has given firms certainty. Thus, we need the outcome to the international tax debate to be something which is seen as a permanent and fair settlement.
Ireland may have to pay a price, but winning a suitable long-term deal would be worth the sacrifice of a pawn or two. Ireland needs to be seen to be part of the solution, not the problem. The government has wisely already factored in an annual loss of €2 billion in tax revenue into its forward planning.
