Tuesday, August 16, 2016

The latest Corporation Tax pot of gold

Ireland’s Corporation Tax generates a huge amount of domestic debate.  There are a couple of common themes that run through it.  One of them is that “we would collect X billion in extra tax if only we did Y.”  The latest of these relates to companies who have no liability for Corporation Tax under the headline “68% of companies paid no Corporation Tax in 2014”.

There is, of course, a pretty simple reason why most companies don’t pay Corporation Tax: they don’t make a profit.  This is because they have never started trading, stopped trading or are trading but didn’t generate a taxable profit.  There a several reasons why companies are established with trading for profits being only one of them.

However, the story doesn’t end there and goes on to say that companies with no Corporation Tax liability actually had earnings of €17 billion in the period from 2009 to 2014.

The Irish Corporation Tax regime is actually relatively straightforward.  Once a company’s taxable income is determined it is multiplied by 0.125 (or 0.25 in some cases) to get the gross tax due.  There are then a limited number of credits and reliefs available which give the ultimate calculation of tax payable.  Here is an aggregate calculation using 2011 data.

So if there are €17 billion of earnings out there that results in a tax payable of zero it shouldn’t be too difficult to work out what is going on.  And it isn’t.  First here are the annual figures:

Companies wth no CT liability

The average amount of net taxable income per company with no Corporation Tax liability is just under €32,000.  But the distribution is probably highly skewed because it requires the use of the limited credits and reliefs we have to get the gross tax due from the €16.8 billion of net taxable income to a tax payable of zero.  And indeed those making the queries were told as much:

The Department of Finance says there is a range of tax reliefs available to companies which explains much of this, such as double taxation relief, which prevents companies being taxed on profits they have already paid tax on elsewhere or tax reliefs that apply to research and investment.

But that didn’t stop some heroic conclusion jumping been made:

Sinn Féin says vital public services have suffered as a result. Employers, however, say Irish businesses already face high taxation.

TD Louise O’Reilly said: “Our estimation is that from 2009 there could potentially be 2.1 billion euro in tax revenue that has been forgone by the State through whatever means. I think when you’re looking at figures that size though, you’re not talking about simple loopholes. You’re talking about government policy.”

Yes, €16.8 billion multiplied by 0.125 is €2.1 billion but wouldn’t it be helpful to actually understand why the tax payable on this net taxable income is zero and propose to remove the provision that results in it rather than just shooting off blindly.

Here are the reliefs and credits used by the companies with nil or negative Corporation Tax liabilities over the six years in question.

Companies wth no CT liability reliefs and credits

And there is the €2.1 billion reduction of the €2.1 billion gross tax due to give tax payable of zero.  Almost 95 per cent refers to Double Taxation Relief.

Ireland operates a worldwide Corporation Tax system whereby Irish-resident companies owe Irish Corporation Tax on their earnings no matter where earned and can owe Irish Corporation Tax on dividends from subsidiaries and other passive income receipts.

However, if an Irish-resident company earns profits through a branch or subsidiary in another jurisdiction it will pay corporate income tax on those profits in that jurisdiction.  In Ireland these profits will be included in the company’s taxable income and the gross tax due will be calculated including foreign profits.  To avoid double taxation the company can apply for relief of the gross tax due in Ireland based on the corporate income tax paid in the foreign jurisdiction. 

It is fairly obvious that in this instance we are dealing with a small set of companies who have no domestic profits (which would trigger a tax liability excluding them from the above table) and have foreign earnings where the foreign tax paid exceeds the amount of gross tax due at Ireland’s Corporation Tax rates thereby giving a tax payable figure of zero.  These companies are not avoiding tax; they have already paid it.  If the amount of eligible foreign tax paid was less than the amount of Irish tax the company would have to pay the balance to make up in the difference.

So, in theory, we could have collected €2 billion of extra Corporation Tax over the last six years if we had abolished Double Taxation Relief from 2009.  And the figure would be even higher as this €2 billion only includes companies who have nil or negative Corporation Tax liabilities.  Over the past six years the total amount of Double Taxation Relief granted to all companies has been almost €4 billion (and was almost €1 billion in 2014 alone).

But getting at this latest pot of gold depends on these companies with foreign profits continuing to be Irish resident which would subject them to an additional 12.5 per cent (or 25 per cent) tax on top of the corporate income tax paid where they earned their profits.  Would companies stick around for such double taxation? And if Irish-resident shareholders move away with them we would lose the income tax collected from distributed dividends.

Double taxation relief is not just “government policy” it is international best practice in taxation around the world.  And it is probably going to get more attention in Ireland as inversions and re-domiciled PLCs increase the number (and size) of companies who are eligible for it.

Monday, August 15, 2016

A Processor Surge

Here’s yet another unusual chart extracted from Ireland’s External Trade data.


The chart gives monthly exports for category 77 in the Standard Industry Trade Classification: Electrical machinery, apparatus and appliances not elsewhere specified and parts.  In the first half of 2015 exports in this category were €1.4 billion; for the first six months of 2016 exports have surged to €3.2 billion.  The dramatic nature of the increase at the start of 2016 is apparent from the chart.

So what are we exporting over a billion and a half’s worth more of in this category.  We can get added insight from the CSO’s Trade Statistics publication (though the most recent release only gives data to the end of May).  Anyway within that our attention is drawn to subcategory 776.42: Processors and controllers.  Here is the relevant extract from the May 2016 release.

SITC 776_42

Exports in this sub-category were €421 million in the first five months of 2015 but have reached €1,958 million in the first five months of this year.  Thus processors account for the surge shown in the first chart above.  Over the full year we could be looking at an increase of around €3 billion in this category.  That the primary destinations of these exports are  Israel and the United States should not come as a surprise. 

What may be a little surprising though are the volume changes.  The Trade Statistics also give data on quantities which in the case of many commodities are measured in tonnes – signified by (t).

The quantity given for 2015 is 62 tonnes while that for this year is 52 tonnes.  The notional price of processors given by this data has gone from €7 million a tonne in 2015 to nearly €38 million a tonne this year.  Processors are obviously not a product sold by weight but this change is indicative of something going on. But what?

Monday, July 25, 2016

The size of the provision for depreciation

The key reason for the 26 per cent rise in Irish GDP was the large increase in the productive capacity of the economy as represented by the €300 billion increase in the gross capital stock.  The addition of these assets to Ireland’s capital stock hugely increased the amount of value added that the economy could produce.

We know that most of the changes are due to the actions of MNCs so most of the increase in GVA accrued to them.  Infact 80 per cent of the increased GVA came from firms in the “Industry” sector (as shown here).

If GVA formed the tax base then the provision for depreciation wouldn’t really be an issue but firms can avail of “capital allowances” for the acquisition of certain assets, i.e. they can offset (part of) the cost of the asset against their taxable income for a given period (generally eight years).  This is somewhat similar to the “consumption of fixed capital” concept in national accounts where the value of capital assets is reduced as they are used and become obselete. 

Both are generally described as “depreciation” but there are important differences between them.  We only have the 2015 consumption of fixed capital figure from the national accounts for now but there is no reason to believe that capital allowances in 2015 will not have followed a similar pattern, i.e. a massive jump up.

So although there may have been a large increase in gross value added this may not correspond into an equally large increase in the tax base if capital allowances impact on the calculation of taxable income.  It is a pretty safe assumption that the capital allowances used by companies increased broadly in line with the consumption of fixed capital shown in the national accounts.

So is this an issue?  Possible.  GDP is commonly used for international comparisons.  If the amount of depreciation is the same across countries then it gives ratios that have a value in making comparisons.  Here is depreciation as a per cent of GDP for the countries of the EU (excluding Luxembourg for which data does not seem to be available).

Depreciation to GDP

The 2015 figure is for Ireland and this puts Ireland at top of the pile and the 2014 figure shows the huge impact the 2015 figures had on our position.  In relative terms Ireland now has the largest provision for depreciation though the gap to the next country, Latvia, is relatively small.  As depreciation is removed from the corporate tax base through capital allowances this means GDP may overstate Ireland’s tax base relative to other EU countries.

We already knew that GDP overstated the Irish tax base as it includes the profits of MNCs based here.  We can have great fun with hybrids etc. but lets just put the provision for depreciation in terms of Gross National Income (seeing as this aggregate is used in the  calculation of a country’s contribution to the EU).

Depreciation to GNI

And here we can see the outlier that Ireland i2 for 2015 compared to the mid-table ranking for 2014. Within Ireland’s GNI there now is a disproportionate provision for depreciation.  And as this is value added which is not included in Ireland’s tax base we get close to little of benefit from it.

We now have a situation where using GNP or GNI as a denominator excludes the profits of MNCs that we can get a 12.5 per cent chunk out of before they leave but includes a massive provision for depreciation for these companies that we get nothing from.  If these effects offset each other then maybe GNI is a useful denominator for EU contributions and the like but with the headline data we have at the moment it is impossible to tell.

How did the capital stock increase by €300 billion when investment was just over €50 billion?

There are many mysteries in the 2015 National Income and Expenditure Accounts published by the CSO two weeks ago.  The change that had the biggest impact on the accounts and was the source of the 26 per cent GDP growth was the €300 billion rise in the gross capital stock.  The bizarre nature of this is shown in this chart from a recent NTMA investor presentation.

NTMA Capital Stock

We know very little about this €300 billion increase.   The CSO will be publishing final figures for the capital stock later in the year but it is not clear that the sectoral and type figures usually provided will be made available for 2015.

Most commentary has linked the increase to inversions by US MNCs and redomiciling by PLCs from other countries.  It is not clear that this is the cause of the increase.  A company moving its headquarters does not automatically mean that it’s stock of fixed assets are included in Ireland’s capital stock. 

If a US pharmaceutical company does an inversion with an Irish company the manufacturing plants the company has in the US and other countries will remain part of the capital stocks of those countries.  The company may move intangible assets to Ireland but that would be a move separate to the inversion.  Also the only inversion in 2015 was the Medtronic-Covidien match-up which comes no where near the scale shown above.

A key problem is that we don’t know the type of assets that made up the €300 billion increase in the capital stock.  We can take it that much of it is intangible assets (leased aircraft are also said to have played a role but that may have been overstated).  The reason for this uncertainty is that gross fixed capital formation was just over €50 billion.

So how do we get a €300 billion increase in the gross capital stock with a little more than €50 billion of investment?  This seems hard to explain.  With the scrapping and obsolescence of some existing capital we should expect the increase in the gross capital stock to be less than the level of gross investment.  And, in theory, the movement of assets between countries should be de-investment in one country and investment in another country.  The ‘G’ in GFCF refers to depreciation.  Capital formation itself is made up of the net of acquisitions and disposals of fixed assets.

So why was the increase in the capital stock nearly six times greater than the level of investment?

One reason could be that different assets are included in each but that seems unlikely as they are supposed to be related measures.  It could be that US MNCs have transferred the economic rights to exploit their intellectual property to Irish-resident entities and that these economic rights are counted in Ireland’s capital stock but as the patent is retained by the US parent there is no investment expenditure in Ireland.  Not sure.

Another possibility are valuation differences between how the assets are counted for investment and for the capital stock.  It could be that these assets are counted in the investment data on some sort of “cost-plus” basis, i.e. the amount of R&D expenditure it took to actually produce them.  While in the capital stock the assets are counted on the basis of how much they are worth.

There was a large increase in R&D expenditure in 2015 in the €54 billion GFCF total and it went from €9.6 billion in 2014 to €21.3 billion in 2015.  But is €12 billion of additional R&D expenditure enough to explain an increase of a few hundred billion in Ireland’s capital stock.  I suppose it depends on what intellectual property rights were moved to Ireland the value of which does not necessarily depend on the R&D expenditure that went to generating them.

Whatever the reason it seems we need a more nuanced story than linking the increase in the capital stock to inversions and redomicilied PLCs.  In fact, given the massive increase in external debt linked to direct investment shown in previous posts such corporate restructurings don’t seem like a useful explanation at all.

Hundreds of billions more on the stock of FDI debt but where are the interest flows?

The last post looked at the revisions of Ireland’s international investment data.  Here we look for the impact the massive changes shown there have on the flows in the current account.  As was shown there have been huge changes in the stock of debt associated with direct investment (both inward and outward).

Direct Investment Debt

Gross external debt associated with inward direct investment shows an incredible €300 billion level shift in Q1 2015 which is associated with the transfer of intangible assets to Ireland by foreign-owned MNCs.  On the other hand external debt assets which is linked to outward direct investment, and likely driven by inversions and redomiciled PLCs, has been shown a strong increase since the middle of 2013 and is up around €200 billion over the period.

But we look at the flows on income on direct investment debt in the current account we see the following:

Direct Investment Income on Debt

The flows have barely moved over the period.  The stability on the outflows seems particularly odd given the massive once-off level-shift of €300 billion that the first chart shows in the stock of debt.  So FDI entities in Ireland have massive external debt liabilities but aren’t making  increased outbound interest payments. What gives?