Friday, July 22, 2016

Revisions to Ireland’s International Investment Data

Back in March we looked at the FY2015 International Investment Data with a post showing that Ireland’s net external debt was zero at the end of 2015.  Although most of the attention over the past ten days has been on the revisions to GDP and related measures there were also massive revisions to the international investment and external debt data which were published on the same day. 

Most of the changes are linked to the take-out chart from the CSO presentation on the national accounts revisions.

Gross Capital Stock

This shows that Ireland’s gross capital stock increased by an incredible €300 billion in 2015.  GFCF was a little more than €50 billion so there must be a lot of reclassifications going on.

At the headline level it now appears that saying that Ireland’s net external debt was zero was out by the little matter of €200 billion or so.

External Debt

It’s pretty clear when all of the action happened – Q1 2015 when Ireland’s gross and external debt rose by around €300 billion.

The sector that this additional borrowing resulted from is fairly easy to identify.

Gross External Debt by Sector

All of the increase was associated with direct investment.  This is debt associated with the assets transferred to Ireland in 2015.  The Irish-resident entity which now holds the assets owes a debt liability to an external entity based on the value of those assets. 

This would suggest that most of the asset transfers are not linked to inversions because in that instance there would not be an external debt as the asset would be owned by the now Irish-resident parent of the company.  And the fact that the shift happened in Q1 raises issues about the number of firms involved.  If it was a large number of firms would they all have been in a position to make the transfer at roughly the same time?

Inversions and redomiciled PLCs are part of the overall story but do not seem to have been significant in the massive level-shift seen in Q1 2015.  If we look at external assets in debt instruments (i.e. money owed to Irish-residents) we see the following:

External Assets in Debt by Sector

There is a rise in external debt assets related to direct investment but that began in the middle of 2013 and has continued at a relatively steady pace since then.  The number of inversions of US companies to Ireland has been relatively small and there was just one in 2015 (Medtronic and Covidien).

What this means is that the scale of the figures for the NFC (non-financial corporate) sector is now approaching the realm of the IFSC as we will have to begin counting them in trillions.  However, one significant different to the IFSC is that the overall net position is not close to zero.  Here are the total foreign assets and liabilities of Irish-resident NFCs.

Foreign Assets and Liabilities of NFCs

We can see the massive gap that opened up in 2015.  The gap is largely explained by the huge amount of intangible assets that Irish-resident entities now hold domestically which obviously don’t appear in international investment figures.

So where does this leave us in trying to determine the underlying net international investment position of the Irish economy?  Well, here are the net external debt positions by individual sector.

Net External Debt by Sector

The stand-out figure is obviously for direct investment which shows a bizarre pattern.  The net position associated with direct investment became more negative (debt assets exceeding debt liabilities) from the middle of 2013 through to the end of 2014.  There was than a massive level-shift of €200 billion in Q1 2015 after which the previous downward trend resumed.

The two effects can be better seen here which gives the external debt liabilities and assets associated with direct investment.  The net position is as shown in the previous graph.

Liabilities and Assets of Direct Investment

We can see that gross external debt for direct investment is relatively stable save for the massive level-shift in Q1 2015.   This is linked to the transfer of intangible assets to Ireland.

External debt assets associated with direct investment begin rising in mid-2013 and has continued at a relatively steady pace since.  This is related to inversions and redomiciled PLCs.

It is pretty clear that these don’t really reflect the underlying position of the economy so it would be better exclude direct investment from the total economy figures (while excluding the IFSC at all times!).

External Debt ie

These outcomes can be compared to those shown in the second chart above and better reflect the improvement in Ireland’s underlying external debt position.

And we include all financial assets and not just debt instruments we get this final picture for our overall net international investment position.

Net International Investment Position

The total economy figures are polluted by the direct investment effects outlined above.  The underlying position is better identified if we exclude NFCs and we see that Ireland has a small positive NIIP (excluding NFCs).  The government sector’s external debt of €150 billion is roughly offset by financial intermediaries (mainly Irish pension funds) external assets of a similar amount.

So what do all the revisions tell us?  It is hard to  know but it does seem that asset transfers played a greater role to what happened in 2015 than corporate inversions.

Why did the assets transfers happen?  A key factor seems to have been the BEPS project which has the underlying objective of linking profit to substance and increased transparency through country-by-country reporting.  We know that lots of US MNCs already have substance here but that doesn’t really explain why the assets were transferred here rather than through outright purchases (which would appear in GFCF).  Another factor is that it is possible that the assets were held by Irish-registered but non-resident entities.  Making these entities Irish-resident would bring the assets with them. 

So companies may be continuing to avail of the ‘double-irish’ but now actually have the two companies in Ireland (as opposed to having both registered here but one managed and controlled in the Caribbean). How will Uncle Sam feel now that we are taking a 12.5% chunk out of these profits?

Wednesday, July 13, 2016

26% GDP Growth: Where did it come from and who got it?

The reaction yesterday to the publication of the National Income and Expenditure Accounts showing 26 per cent real GDP growth was as one would expect given that such a growth rate was completely unexpected.  There was lots of talk of the numbers not reflecting the reality of the Irish economy but I didn’t come across anybody who said they did while talk of “leprechaun economics” was just derogatory.  The underlying growth rate of the Irish economy is probably somewhere around six per cent which is just fine, thank you.

Yesterday’s figures show that real GDP expanded by 26 per cent in 2015. We have known for a long time that GDP is a problematic measure for Ireland and recent developments just accentuated this. 

What change resulted in the transfer of €300 billion of assets to Ireland?  We can safely assume that much of this is related to tax but the Irish corporate tax regime has hardly changed over the past few years.  The Knowledge Development Box only applies to intellectual property that is developed here and, if it was in any way effective at all, would show up through increases R&D activity in Ireland rather than the transfer of assets to Ireland.

What has changed is the international tax environment.  The OECD’s BEPS project has an underlying goal to align profit with substance and the aim of providing more information for tax authorities through country-by-country reporting.  It is clear that one consequence of this has been for companies to move more risks, functions and assets to Ireland.  There may have been the view that Ireland was a target of the BEPS project but, for now at least, it is clear that we are a beneficiary of it.

And the benefits are massive.  Increased profits in Ireland means increased taxable income subject to our Corporation Tax.  We know the Corporation Tax receipts rose from €4.6 billion in 2014 to €6.9 billion in 2015 with a good likelihood of a further increase in 2016.  €2.3 billion is a massive amount of money.  If the cost of collecting an extra €2.3 billion in tax is a few days of headlines about bizarre growth rates sign me up.

So where did the growth come from?  Well the standard Y = C + I + G + (X – M) isn’t very helpful as the level of noise between the components makes identifying underlying trends almost impossible.  To be fair consumption is unaffected by much of this and grew by 4.5 per cent in 2015 which is a good clip.

To get a better picture we should look at the output method and the gross value added generated by the different sectors of the economy.  Here are the gross value added in nominal terms for the six sectors used by the CSO.

Gross Value Added

As can be seen gross value added increased by €61.5 billion in 2015 and when we add in the €1.1 billion increase in net product taxes we get the €62.7 billion increase in nominal GDP.

The sectoral data show that over 80 per cent of this came from the Industry sector.  We are usually provided with a further breakdown of this into sub-sectors such as chemical and pharmaceutical, computers and instruments, and medical and dental devices but this was not published by the CSO on this occasion.

There has been a lot of attention on the impact of aircraft leasing on the figures but the impact of this sector on the growth outcome seems to be overstated.  Aircraft leasing is included in the broad category of “Other services”.  This sector accounts for only ten per cent of the increase in gross value added and aircraft leasing will only be a portion of that.

Next we turn to the beneficiaries of this growth surge and look at the wage and profit gains from net value added and also the important changes to the provision for depreciation.

Net Value Added

We can see that of the €62.6 billion increase in GDP only €30.9 billion went to households and firms in the form of wages, profits or mixed income.  Another €1.1 billion went to the government in the form of product taxes but the most notable change in the €30.7 billion rise in the provision for depreciation.

It is pretty clear that most of this applies to companies in the industry sector.  In this sector alone gross value added rose by €50.7 billion while the profits of all companies rose by €23.1 billion.  There are two ways to cut the reconcile this difference of €27.6 billion. 

The first is employee remuneration which is up but only by €4 billion or so.  The second is depreciation which is subtracted from gross value added to get net value added.  The provision for depreciation in the Industry sector must make up a large part of the overall €30 billion provision for depreciation.  And foreign companies will dominate this.  In a bit of a simplification companies are making gross profits (sales minus cost of goods sold) and a large portion of this is going to cover the reducing value of assets that they hold.

The €23 billion rise in company profits before tax is roughly in line with the €2.3 billion rise in Corporation Tax (suggests an effective rate of around 10 per cent which is before financing costs above FISIM are accounted for).  It can also be seen that the net factor income outflow roughly corresponds to the increase in company profits which is what we would expect.

Gross National Product strips out most MNC profits but it does not account for depreciation and it is now clear that most of the provision for depreciation in our national accounts accrues to foreign firms.  We should be counting this as an outflow as well which may be angle the CSO might take if looking to provide some auxiliary economic indicators.

So if we look at the €62.7 billion increase in nominal GDP we can break it down as:

  • Households
    • €4.2 billion of employee remuneration
    • €1.5 billion of self-employed/mixed income
  • Companies
    • €23.1 billion of company profits (mainly foreign companies)
  • Government
    • €1.1 billion of product taxes
  • Non-Sectorised
    • €30.7 billion for depreciation (mainly foreign companies)
    • €1.9 billion for stock adjustment/statistical discrepancy

Tuesday, July 12, 2016

The IRS are investigating the crucial component of Facebook’s tax structure

The ongoing investigation by the US Internal Revenue Service into Facebook’s 2010 tax return attracted some renewed attention last week when the IRS filed a court petition in California looking for further documentation from Facebook.

The investigation relates to the most crucial aspect of the international tax structures used by US MNCs – getting the global rights to their intellectual property outside the jurisdiction of the US.  In 2010, Facebook Ltd transferred the global rights to its IP to Facebook Ireland Holdings.  The IRS are investigating the nature of this transfer and whether the correct price was paid for the assets transferred.

We know that Facebook has a trading company here, Facebook Ireland Limited, and that this company collects substantial revenue from selling advertising and other services on the Facebook platform.  However Facebook Ireland Limited doesn’t own the rights to the IP and must pay royalties for the right to use the Facebook platform.  These royalties are paid to Facebook Ireland Holdings who obtained the rights from Facebook Ltd.

We know that other US companies (Google, Apple etc.) have somewhat similar structures and that these companies have R&D cost-sharing agreements whereby their offshore subsidiaries are granted the non-US rights to their IP in return for making contributions to the cost of their development.

It is likely that Facebook has a similar arrangement in place but this can really only apply to new or ongoing IP development.  When the transfer was made in 2010 the Facebook platform was already in existence and Facebook Ireland Holdings would have to pay based on the value of this existing technology at the time rather than the historical cost of its development.  Although few details are available it seems that it is this price paid in 2010 that the IRS is investigating.  It is also possible that the outcome will affect subsequent tax years if the R&D cost-sharing agreement is found to be inappropriate.

From an Irish perspective almost all reports on the court petition state that the rights to the IP were transferred to Ireland.  However, this is not correct.  Facebook has its international operating company in Ireland but the holding company is not based in Ireland – even though it is called Facebook Ireland Holdings.

Facebook Ireland Holdings is registered in Ireland but it is not managed and controlled in Ireland nor has it any risks, functions or assets in Ireland so it is not liable for Irish Corporation Tax.  They have been some reports linking Facebook Ireland Holdings to the Cayman Islands but with no corporation tax or filing requirements there it is hard to tell.  And, of course, as we have seen in the case of Apple this holding company could be managed and controlled in the US and still generate the same tax outcome.

Anyway the central element is to get the global economic rights to Facebook’s IP outside of the US.  If the holding company has to pay a high price to the parent then the profit becomes subject to the US corporate income tax.  However, even if the price is low it shouldn’t really matter as the US has a worldwide corporate income tax regime with all profits of US companies being subject to US tax regardless of where they are earned so a bit more than just getting the IP outside the US is required.

For this we look to the the deferral provisions in the US tax code where the payment of the corporate income tax due on foreign profits does not become due until the profits are formally repatriated to a US-registered entity in the company’s structure.  There is a general deferral for trading profits.  This means the profits earned by Facebook Ireland Limited are not subject to US tax until they are repatriated.

However, Facebook Ireland Limited is not a massive profit generator.  It collects large revenues (€4.8 billion in 2014) but most of this is paid out in royalties as it is granted to rights to sell on the Facebook platform through a cost-plus agreement with Facebook Ireland Holdings.

Facebook Ireland Holdings receives significant royalty payments from Facebook Ireland.  There is no general deferral provision from the US tax due for passive income so, in theory at least, Facebook would have to pay the 35 per cent US corporate income tax on the royalties received by Facebook Ireland Holdings.

There are, however, a number of exemptions that grant a deferral of the US tax due on passive income.  One of the most crucial of these is the “same-country exemption”.  Under this provision passive income transfers between companies in the same country do not trigger the payment of the US tax due on the profits from such transfers.

The US tax system judges this on the basis of country of incorporation.  Thus if two companies are registered in the same country a passive income transfer between them does not trigger a US tax payment until the profits are repatriated.  Both Facebook Ireland Limited and Facebook Ireland Holdings are Irish incorporated so the transfer between them is eligible for this exemption. 

The IRS are not investigating this transfer and the cost-plus arrangement between the Facebook subsidiaries would be a matter for our Revenue Commissioners (while the European Commission have taken up investigating some of the cost-plus arrangements entered by Apple).  The IRS are investigating how much money gets from Facebook Ireland Holdings (possible in the Cayman Islands) back to the parent in the US.

This is the crucial component of the tax structure.  If Facebook Ireland Holdings pays most of the profit back to Facebook Ltd in the US then the rest of the structure is largely moot as the US tax becomes due anyway.  But if Facebook Ireland Holdings pays a substantially lower price relative to the royalties it receives then the structure can successfully defer the payment of significant corporate income tax payments to the US.  And it does!

It is the IRS that matters in all of this and they are clearly not satisfied with the size of the transfer between Facebook Ireland Holdings and Facebook Ltd.  There isn’t really a lot that other countries can do about it.  Countries can look at the activities US companies carry out in their jurisdictions and determine whether they are taxed appropriately.  In the UK, HMRC completed a six-year audit of Google earlier this year and accepted the basic principles of Google’s structure.  And no matter how many times it is erroneously linked the location of customers is not a taxable activity of a company!

Monday, June 27, 2016

At-Risk-Of-Poverty Rates and Work Intensity

The following table gives at risk-of-poverty rates (disposable income less than 60 per cent of the median) for people aged 60 and under by the work intensity of the households.  The countries are ranked from lowest AROP rate to highest for each work intensity level (very high to very low) with Ireland’s position highlighted.

AROP by HH Work Intensity

In this, albeit limited, view of poverty rates Ireland is the best-performing EU country.  Across the five work-intensity categories Ireland’s average ranking is 2.6.  The next best countries are Denmark and The Netherlands with an average ranking of 5.2.  Sweden has an average ranking of 20.6.

Tuesday, June 21, 2016

Repossession orders received by the Dublin City Sheriff

Just over a year ago we looked at a presentation given to Dublin City Council on the arrears and repossessions associated with their mortgage loans.  We can now expand this a bit with data from the Dublin City Sherriff on possession orders received and then subsequently executed or withdrawn.  The data is summarised in the following table:

Repossessions Orders Dublin City Sheriff

What do we see?

1 Orders Received From

Over the past five years the Dublin City Sheriff has received 561 possession orders for residential property.  Of these 320 (57 per cent) came from Dublin City Council, 195 (35 per cent) came from banks or building socities, with a small residual classed as “Private” (most of these arise from rental situations and the Residential Tenancies Board).

2 Outcome of Orders Received

The data indicate that around 60 per cent of possession orders are executed (342 out of 544).  The remaining 40 per cent are mainly instances where the situation is settled prior to repossession (possible because the borrower and lender have entered an alternative repayment arrangement) with a small number of instances where the order is withdrawn because they have expired (possession orders usually have a 12- month shelfl life).

Dublin City Council has the lowest execution rate for orders (though does present the most orders).  Around two-thirds of orders presented by banks and building societies are executed with this rising to almost four-fifths for orders listed as “private”.

3 Orders Executed For

In the past five years DCC has had 178 possession orders executed by the Dublin City Sheriff.  This compares to 128 for banks and building societies.  Possession orders sought by DCC will be for a range of situations such as loan delinquincy, rent arrears or anti-social behaviour.  The presentation linked to above states that:

At the end of 2014, a total of 251 accounts are categorised as unsustainable with 154 being assessed for mortgage to rent and the balance of 97 being assessed for possession (there are 25 properties due for repossession in 2015, 12 of which are abandoned).

In terms of DCC repossessions, to date there have been 16 cases of voluntary surrender and 93 District Court repossessions (a total of 109 properties have therefore been taken into DCC’s possession). The vast majority of these (n=100) relate to shared ownership including ‘affordable’ shared ownership. Repossessed properties are located across the city, with the majority in Dublin 10 and Dublin 11.

To date, only TWO households entered homeless services as a result of possession. Both departed to PRS.

So we have 93 loan-related repossessions by DCC up to the end of 2014.  In the four years to the end of 2014 there were 84 repossession orders executed for for banks and building societies in Dublin City.

The presentation also showed that DCC have issued loans to around 2,600 households.  Census 2011 showed that there were 53,000 households in Dublin City who were owner-occupiers with a loan or mortgage.  This suggests that around 50,000 households have loans with bank/building socities/lenders other than DCC.

Thus the 93 repossessions by DCC represenent about 3.5 per cent of the households they have lent to while the repossessions by banks and building socities are about 0.3 per cent of the households they have lent to.  As a percentage of the number of households they have lent to, the repossession rate of DCC is ten times greater than that of banks and building societies.

DCC have around 600 households who are 12 months or more in arrears so the 93 repossessions represents 15 per cent of that figure.  We don’t have regional arrears data for banks and building societies but for the country as a whole 6.3 per cent of accounts are more than 12 months in arrears.  If this holds for mortgaged households in Dublin City then around 3,200 households in Dublin City have mortgage arrears of 12 months or more with repossessions by banks and building societies over the past five years being four per cent of that figure.  Thus as a percentage of households in arrears of more than 12 months, the repossession rate of DCC is around four times greater than that of banks and building societies.

You can look for mentions of local authority repossessions in the report issued last week by the Housing and Homelessness Committee. You won’t find any.  But you will find a recommendation for a moratorium on repossessions. Go figure.