Ireland, FDI and the Free Lunch (Irish Soda Bread with Edam Cheese Sandwich)

In Economics any academic will tell you, that there was no such thing as a free lunch. The theory goes that while the lunch may be free in the present, it has to be paid for – often with interest – in the future. Ireland's corporate tax rate (CTR) could be viewed as being a free lunch. Before it was lowered Foreign Direct Investment (FDI) in Ireland was very low, since the lower rate was introduced it has boomed. As there was very little FDI before the reduction, the low levels of CT it accrues does not matter. What does matter is the vast amount of employment (over 100,000 directly employed) it creates. But is this free lunch being paid for by other countries and will Ireland have to pick up the tab?

In last week's budget which I previewed here, Michael Noonan announced that Ireland would put an end to the ability for Irish companies to be stateless. This section of the finance bill is aimed at preventing large multinational companies (MNCs), like Apple from setting up an Irish registered company, that is in fact incorporated nowhere, in a bid to reduce their tax bill. Noonan did not do this out of a sense of social responsibilty, rather he did it because there is growing pressure on MNCs to pay their fair share of tax in the country where they sell their goods. Let me explain and in doing so, I will explain the name of the post.

A number of large American MNCs (Apple and Google being 2 of the more infamous) have big operations in Ireland - they route their sales from other countries through these Irish offices. As the sales are made in Ireland the tax bill falls due there. Ireland, as I am sure you will know has a 12.5% CTR, one of the lowest in the world. So you would think these companies, would therefore pay the tax on 12.5% in Ireland, rather than paying the rates in other European countries that are in the 20-40% range, right? In reality they don't pay anywhere near 12.5%.

What they do is they shift the taxes to a Dutch entity (a letterbox essentially) and from there they charge a royalty payment - which is tax deductible - from an Irish registered company that is incorporated in Bermuda, where CT is 0 (or in Apple's case nowhere*). CT is paid not on revenues but on profits and given that the profit generated can be substantially reduced by the royalty payment, the amount due to be paid at 12.5% also falls significantly - to approximately 2% of profits. This is where the Double Irish Dutch Sandwich name comes from, or as I refer to above the Irish Soda Bread with Edam Cheese Sandwich.

There is a sizeable loophole in Irish and American company law that lets these companies get away with this. An Irish company that is managed from the US is considered to be non resident for tax purposes in Ireland, while a US managed company that is not based in the US does not have to pay its taxes in the US - until such time as it repatriates the profit. Apple, Gooogle and others have aggressively targeted this strategy for many years, saving billions of dollars in taxes. This is by no means a new phenomenon. Apple has been operating in Ireland since the 80's, with Google coming to town in 2003. The financial crisis and the subsequent austerity imposed by Western Governments, has brought this practice to the fore in recent months and people are not pleased with the way these firms are doing business.

An important question in all of this, is are the companies doing anything illegal? The answer is most definitely no. They are more than entitled to and some would say obliged to minimise their tax bill. A public company is mandated to maximise its profits for its shareholders. The problem here is more of an ethical one. The question is are these companies doing something that is morally wrong? Evidently people think the answer to this question is yes. I however am a believer in free markets, if you don't like how a company operates, then don't buy it's products. The fallout from this does not seem to have affected Apple and Google to any great extent as profits are booming at both companies and Google's share price recently passed the $1,000 dollar mark .

Interestingly though, governments like the Tories - who are meant to be free marketeers - want to put an end to this practice using legislation - admittedly this comes on the back of public anger. An angry public who are still buying the latest Ipad it would seem!

So.... what does all of this mean for little old Ireland?

Well any multilateral move to pass legislation to stop this practice could mean that companies may have to pay the full 12.5% due in Ireland. Or, it may be taken one step further and CT would have to be paid in the country where the revenue is generated. Britain, France and the US are leading the pack on this - which is ironic given that Bermuda and the Channel Islands are UK crown dependancies - and are trying to bring in legislation to close the loophole. 

In an attempt to appease these larger nations, Noonan has announced that he will put a stop to Apple's stateless subsidiary but this is not going to change the status quo. Apple may simply choose to move it's stateless "Irish" company to Bermuda, which would put it in the same boat as Google. So in essence Noonan's gesture is a step in the right direction but a very small one.

Now if it no longer behoves a company to have a presence in Ireland for tax purposes, will they leave? This is in fact the million dollar question. I will try to answer it but in essence no one really knows.

First of all the gesture, Noonan says he has spoken to executives at these big MNCs about the change. He claims that they support the legislation, as they do not wish for their reputations to be harmed. Tim Cook made a similar suggestion at a Senate Committee hearing which means that Noonan's claim may be plausible. Another positive is that the Irish government have taken note and have acted first - albeit in a small way - and this may ease the pressure on the debate somewhat. 

Will a company stay in Ireland if a big change is made to worldwide legislation? 

Reasons that they would

• Google and Apple alone employ 7,000 people in Ireland, this is not a requirement for the low CT rate and is an endorsement of the skills of Irish employees and our flexible labour laws.

• Ireland has become somewhat of a tech hub and, as has been seen in Silicon Valley success breeds success and tech companies like to locate themselves amongst their peers.

• Ireland, like the UK, has a common law system which makes for a stable legal environment.

• Scotland is due to have a referendum on independence next year which could have far reaching consequence for the UK if a yes vote is passed.

• Ireland uses the Euro, thus there is no foreign exchange risk with other Euro countries.

• Ireland is pro Europe and there is no uncertainty about it's membership of the EU and the single European Market, unlike the UK which may have a referendum on EU membershion in 2017.

• The workforce is well educated and any skill shortages can easily be filled by other EU residents where required.

• English is the first language and we have a lot in common with the American's in terms of culture and heritage.

• Even after the furore began re the CT debate, Google announced it was opening a new innovation centre in Dublin and has invested heavily in data centres here.

• Ireland is a believer in free trade and is pursuing - along with the EU - a free trade agreement with the US, which would be worth billions to the Irish economy.

• Stability, Ireland has not budged from the 12.5% rate even in the face of pressure. MNCs will take note of this.

•  Companies may not want to damage their reputation further by moving operations just because Ireland is no longer 'tax efficient'.

•  If Labour are voted in at the next UK election, they will reverse the rate reductions made by the current UK government

Reasons why they would not

• Ireland's income tax is very high making it more expensive to attract the best talent from Europe.

• It is a small country and do not necessarily have the resources to fill all the open positions. There are 4,500 tech jobs open in Ireland at the moment.

• There is currently a brain drain due to the economic problems facing the country and the punitive tax rates

• Other countries are reducing their CT rates to become more competitive, the UK being a notable example.

• Venture capital is still a budding enterprise in Ireland when compared to bigger countries, this affects start ups more so than the big players but is still important.

• Ireland is a relatively rich country and wages here are much higher than in other countries like Spain, Portugal and the Eastern European block 

In summary there is a long way to go in this debate and only time will tell whether politicians will have the will to keep fighting. In the US, the debt ceiling debate could over-shadow the CT debate and it may fade to nothing. In the UK the increasingly left leaning Labour party are most definitely anti big business and would send shivers down any CEO's spine**. Any change will also have to be global, as a country that moves unilaterally will put itself at a disadvantage. It also appears that the Irish government knows that all its job creating eggs are in one basket and one would hope to see a change in strategy, towards making indigenous firms more prosperous. In my opinion Noonan has done well thus far with the limited resources he has available, the next step needs to be to reduce income tax however and level the playing field...... just in case.

Who will end up paying for the sandwich remains to be seen, for now though its business as (un)usual. 

*CT doesn't exist in nowhere, but if it did it would probably be 0 as well!

**See the UK energy price freeze debate