The State’s corporation tax take, a huge boost to the exchequer in recent years, is facing into a period of significant uncertainty. There is a lot at stake here – the corporate tax take has grown from €5 billion a year to €22.6 billion over the last decade, representing close to €3 in every €10 of total tax receipts. The combination of the downturn in the tech sector and international corporate tax reform raises big questions – but while the focus is on the risk, there are pluses in the equation too. Here is why.
1. The OECD tax reform process
The Organisation for Economic Cooperation and Development (OECD) process breaks down into two parts, or two pillars in the jargon. Pillar One was the bit involving multinationals paying a bit more tax in major markets where they sell and a bit less in headquarters countries such as Ireland. Technically, the taxing rights on some of their profits will move to countries where they have significant sales, even if they have no physical presence there. The second part of the OECD process, Pillar Two, is the agreement that a minimum tax rate of 15 per cent should be applied on corporate profits. This is a plus for the Irish exchequer as a group of big companies who currently pay tax at 12.5 per cent will in future pay at 15 per cent.
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The Government has previously warned that the OECD process could threaten about €2 billion of Irish corporate tax revenue and a recent report in the Sunday Business Post says the highest figure at risk is now seen by officials as €4.5 billion. However, the Department of Finance has never clearly spelled out how this breaks down between the likely losses under Pillar One and gains under Pillar Two. And whether its data make any allowance for the possible longer term impact on investment flows of Foreign Direct Investment (FDI) as the international tax environment changes.
For now, Pillar One of the OECD process is stuck and there is no international consensus on how to implement the original agreement here, though talks are still progressing. In Europe, Pillar Two is proceeding and a draft EU directive is in place obliging countries to legislate for it this year.
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So it is possible that if the Republic implements a minimum effective 15 per cent rate but the reallocation of tax under Pillar One does not go ahead, there could be a boost to the exchequer, rather than a cost. It is impossible to estimate how much exactly- as we don’t know how many companies will fall under the scope of the tax – but this could lead to €3 billion to €4 billion in additional revenue. However a clean and entirely favourable scenario looks unlikely. Let’s look first at the EU politics.
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2. The EU tax plan
EU member states signed up to the OECD as a package – for the bigger countries, with tax rates already above 15 per cent, Pillar One is a key potential revenue-raiser. And the draft EU directive on implementing the minimum 15 per cent rate makes it clear that the European Commission has to report back to the member states on the progress on Pillar One. Does this mean the agreement on a minimum rate across the EU could be revisited? This looks unlikely, though some countries could cause trouble if the talks on Pillar One do not get somewhere by summer.
EU ministers could also decide to reopen the idea of a Digital Sales Tax – a kind of Pillar One applying at EU level, which would threaten revenues here by ensuring major companies paid some tax in countries with big markets, even if they have no physical presence there. Sources say that the risk of conflict with the US, who will want a say on how taxes affecting its companies would be applied, would be a consideration here. In short, while the OECD members all agreed on a deal to reform corporate tax, actually implementing it is complicated, in part because politics in the US has not allowed the Biden administration to make the necessary changes to its tax legislation.
3. The US uncertainties
With Republicans now holding a majority in the House, EU sources are not optimistic that the Biden administration will manage to get legislation through Congress to bring the US into line with Pillar Two, the minimum corporate tax rate. Part of this would involve increasing the minimum tax rate which the US applies to overseas earnings of its big companies, (the so-called Gilti rate) which currently generally apples at 10.5 per cent. Republicans object to raising this rate and to Biden’s plans for a wider rise in corporation tax.
One issue here for the US, however, is that if they do not move, they could lose tax revenue as other countries apply a minimum rate. It remains to be seen how this will affect politics in Congress.
For now, the concentration in OECD negotiations will be to try to get agreement on how to implement Pillar One across the line – this also hangs in the balance. All this is vital to transatlantic economic relations. And it’s also vital to Ireland’s corporate tax revenues, as the State is one of the big homes in the EU for the international headquarters of Irish multinationals.
4. Implementing Pillar Two – Ireland’s call
In the context of all this, Minister for Finance Michael McGrath has a significant decision to make. How does he propose to implement the minimum 15 per cent corporate tax rate for companies with turnover in excess of €750 million? Initially, it appeared that the State would have two headline corporate tax rates – 12.5 per cent and 15 per cent. But as the implementation of Pillar Two was scoped out, it became clear that countries could also implement the minimum by way of a domestic top-up tax. This may seem the same thing – major companies here would pay 12.5 per cent and then top it up to get to an effective rate of 15 per cent.
But the structure of the top-up arrangement would be different in some respects and in the US Treasury Secretary Janet Yellen has come under fire from claims that this could allow tax revenue to be collected abroad which would otherwise be collected in the US. She has denied that this is the case – but sources do believe that going the top-up route could potentially boost Irish revenues. Ireland, as the big winner from the first phase of OECD tax reform, will not want to be seen to benefit here at the expense of the US.
American companies will be concerned about the lack of clarity on how this tax could interact with the US Gilti regime. There are issues to be sorted here in terms of the route Ireland takes and the timetable of implementation – this will be discussed in a document due shortly from the Department of Finance in response to a public consultation on the 15 per cent rate last year.
5. And finally ...
So big changes are coming in how corporation profits are taxed in the Republic. But of course the level of those profits will be vital too. And the tech downturn has led to fears that some of the big payers will make less money this year, hitting Irish revenues.
Corporate tax receipts in June will be the first key indicator, according to Peter Vale, tax partner in Grant Thornton. “While corporate tax receipts for January and February were ahead of expectations, the key months lie further ahead,” he said. “ June will be critical as many companies will make their preliminary tax payment that month, based on an estimate of full calendar year 2023 profits.” If economic conditions internationally remain gloomy, these could show a dip. If the handful of major players on which Ireland relies for a large chunk of corporate tax, this could have an impact on the overall take for this year, he warns.
However if the tech sector emerges from its current problems, 2024 could see something of a bounce back – and the new minimum corporate tax rate could also boost revenues that year. A vital issue remains Ireland’s reliance on a small number of companies to pay a large share of tax, making the State vulnerable not only to sectoral issues but also to problems in key companies. The latest ESRI report points out that the percentage of overall corporation tax receipts paid by the top 10 companies increased from 30 per cent in 2015 to 50 per cent today. The top 100 companies account for 80 per cent of corporate tax revenues and half of all revenues come from the pharma and ICT sectors.
Ireland is reliant on decisions made in a few US boardrooms and these are in part driven by international tax planning – the movement of massive intellectual property assets had transformed revenues passing through Ireland, and the running down of tax allowances protecting much of this from tax may be another factor boosting revenues in the years ahead. This presumes the same level of IP remains in Ireland and does not move elsewhere, or return to the US. The Department of Finance has estimated that €4 billion to €6 billion of annual tax revenues could be at risk as they are not based on the fundamentals of business in Ireland but rather on less predictable tax driven activity.
All the concentration has to date – correctly – been on the risk to soaring corporate tax revenues. This year could see some nervousness, but looking ahead there are upsides to the outlook as well. The question is whether the wolf arrives some day and leaves the exchequer in trouble.
