ANALYSIS:The president plans not only to increase US tax take but to encourage domestic job creation

US PRESIDENT Barack Obama’s proposed reform of the corporate taxation regime in Washington is a clear threat to Ireland’s lustre as a location of choice for investment by large US multinationals.

While many of the sophisticated means used by multinationals here and in other foreign locations to cut their tax by billions of dollars will remain intact, Obama’s resolve to increase Washington’s tax return from profits made abroad by US companies is also designed to encourage them to create and protect jobs in their home market.

The case is all the more compelling from his administration’s standpoint given the pressing need for cash to finance its $787 billion (€590 billion) economic stimulus package and efforts to prop up US banks and motor manufacturers.

That the president specifically mentioned Ireland in relation to his tax reform package says much about the extent to which this country is on the radar of the US.

IDA Ireland chief executive Barry O’Leary adopted a relaxed stance yesterday in the face of this attention, but he has already sent one of his top officials to the US to deal with the issue. Kieran Donoghue, head of the IDA’s international financial services unit, is now based in the Irish embassy in Washington.

The Obama plan will not take effect until 2011 and its precise parameters will be fleshed out by Congress. This may prove tricky for Obama, given the strength of business lobbies in Washington and the relatively lukewarm response from influential Democrats such as senator Max Baucus, chairman of the Senate finance committee. “I want to make sure that our tax policies are fair and support the global competitiveness of US business,” Baucus said.

Though the proposed measures are not as severe as feared in some quarters, the negative response from US business interests demonstrates that they have the potential to inflict a high degree of fiscal pain on major corporations.

Two aspects of the plan will have particular implications for companies already based in Ireland and companies that might be wooed here.

First is the reform of the rules of “deferral”, under which US corporations are not at present obliged to pay US tax on foreign profits from active business until the money in question is returned to the US. While not eliminating this system outright, Obama proposes to alter the rules that enable them to take deductions from their US tax for the expenses that support their overseas operations.

In future, companies would only be able to take such deductions for foreign expenses when they also pay US taxes on their foreign profits. The big exception is research expenditure, an area specifically promoted by Ireland’s taxation regime.

Second is the closure of loopholes in tax havens, an aspect of the plan overlooked in much of the Irish commentary on it.

The current system enables US companies to avoid US tax and tax on profits made by subsidiaries in Europe and other foreign locations through loan transactions with related legal entities in havens such as the Cayman Islands. Interest on loans from the entity in a tax haven is deducted from tax to be paid in the foreign jurisdiction.

Thanks to extraordinary rules that enable parent companies to “disappear” entities based in havens from the US authorities, interest income received by the vehicle in the haven that might otherwise be subject to US tax is untaxed. Obama will seek to change that.

Ireland is not listed as a tax haven by international authorities such as the Organisation for Economic Co-operation and Development. However, this change may well have a big impact on US groups whose Irish operations have legal entities based in tax havens as their immediate parent.

The two entities that own shares in Google Ireland Holdings, for example, are located in Bermuda. The same is true of Microsoft’s Irish subsidiary, Round Island One.

For all that, Obama does not propose to change the tax rules on transfer pricing between US corporations and their foreign subsidiaries. Large transactions between certain Irish subsidiaries and their parent companies have in the past come under scrutiny by the US tax authorities.

The financial operations of many US multinationals here are famously opaque, often hidden behind the rules on unlimited liability. Whatever the ultimate shape of the new rules, the plan will make it more difficult for US corporations to keep tax from Washington. Given Ireland’s deep reliance on US investment, the plan may well undermine efforts by the Government and the business community to restore stability to Ireland’s ailing economy.

American companies here

WITH CONSIDERABLE success, Irish governments have long combined the appeal of tax advantage and Ireland’s deep cultural connections with the US to pursue investment.

Policy in the 1950s enabled foreign corporations to export Irish-manufactured products free of tax. In modern times, the low-tax IFSC was followed by the decision of the rainbow coalition in 1997 to cut corporate tax to 12.5 per cent from 36 per cent.

This manoeuvre – allied with later incentives and exemptions – led to a huge increase in US multinational investment in Ireland. While IDA Ireland supports a total of some 150,000 jobs, about 48 per cent of the companies it assists are US-based. These include many well-known international operators. Their total investment here runs to billions of dollars – greatly boosting economic activity. With no small help from the low corporate tax rate, Ireland is second in Europe only to the Dutch subsidiaries of US firms in terms of profitability. Net profits of US corporations here rose to $48 billion (€36 million) in 2005 from $8.58 billion in 1997, according to the US bureau of economic analysis.

The big question now is whether Barack Obama’s efforts to reform the US corporate tax regime will result in any disinvestment from Ireland.