Tuesday, March 11, 2014

Residence and the test of management and control

Ireland’s corporate tax regime continues to attract attention.  The 12.5 per cent rate is low by any standards but it is the regime around the rate that is in the spotlight.

Much of the recent attention focuses on the test of residency Ireland applies to companies.  This is an important part of any corporation tax regime.  Apple Sales International is an Irish-incorporated company but is not resident here.  Is this unusual?

Ireland’s corporation tax regime is not unusual in one way: Ireland taxes resident companies on their worldwide income.  This is in contrast to a territorial system where resident companies only pay taxes on profits earned in the country they are resident in.  Some countries, most notably France, adopt territorial systems.  The US, notoriously, has a worldwide system, but unlike the US there are no deferral provisions for Irish companies paying Irish corporation tax on their non-Irish source income.

The deferral provisions available in the US tax code are the key factors behind the tax outcomes attracting attention in the current debate.  But tax residency is also important.  If a company is not a tax resident in Ireland but has operations here it will still be subject to Irish corporation tax, but only on the profits actually sourced here.

This is a common official line in the debate.  Ireland can tax the worldwide profits of companies which are resident here and also the Irish-source of non-resident companies.  A company cannot have profits in Ireland that are untaxed.  Naturally, Ireland cannot tax the worldwide profits of companies which are not resident here.  Claims to the contrary are wide of the mark and in the case of Apple people should remember that Apple is a US company.

Ireland’s residency rules are a relatively straightforward.  In general, a company is resident in Ireland if it is either incorporated in Ireland or has its place of central management and control in Ireland.

However, there are some exceptions to this and for certain companies only the test of management and control is used to determine if they are resident in Ireland.  The test of incorporation is not applied.

Under the “trading” exemption an Irish incorporated company is not treated as Irish resident if it is a ‘relevant’ company.  A ‘relevant’ company must either carry on a trade in the State or be related to a company that carries on a trade in the State and is one that is either ultimately controlled by non-residents or owned by non-residents (based on the stock market its shares are traded on), where the non-residents are in an EU or tax treaty country.  A company will not be a ‘relevant’ company if it is centrally managed and controlled in Ireland.

Thus, only the test of management and control is applied to some foreign-controlled or foreign-owned companies to determine their residence in Ireland even if they are incorporated here.  This provision is not available to “brass-plate” operations.  There must be a trade or “presence of substance” in Ireland.  Foreign companies can have non-resident, Irish-incorporated companies but only if they have a presence, i.e. employment, here.

The fact that the residency of some companies is solely based on the test of management and control is a factor in the “double-Irish” tax strategy used by some US companies to facilitate the deferral of their US tax liability while holding the profits in a low/no tax jurisdiction.

The “double-Irish” depends crucially on the “same-country” exemption in Subpart F of the US tax code.  Without this exemption the strategy is redundant.  In general, US corporation tax must be paid on US companies’ foreign-source passive income as soon as it is earned.  However, there are a number of provisions that allow the deferral of this tax until the profits are repatriated as dividends to the US.

The “same-country” exemption is one such provision.  Transfers of certain passive income between two companies in the same country do not trigger a US corporation tax payment – the view being that a transfer between two companies in the same country would not be done for US tax purposes.

However, what the US views as two companies in the same country (based solely on the test of incorporation) and what other countries view as two companies in the same country (perhaps based on the test of management and control) may not coincide.

In Ireland’s case some US companies have two Irish-incorporated subsidiaries.  The first can be a sales operations which is deemed as resident here and the second a related holding company to which the Irish “trading” exemption applies.  Though incorporated here the holding company will not be deemed a resident here as its effective management and control does not take place here (nor any other part of its structure or operations).  In many cases the holding company will be based in a low/no tax jurisdiction in the Caribbean.

The Irish-resident sales company will make patent royalty payments (passive income) to the Caribbean-resident holding company.  This will not trigger a US tax payment as the US tax laws view the two Irish-incorporated companies to be Irish residents and then the transfer between them benefits from a deferral under the “same-country” exemption.

As stated, the most crucial part of this scheme is the “same-country” exemption in the US tax code.  There would be no “double-Irish” without it.  The second part is the interaction with another country where companies incorporated there are not automatically deemed resident there.  The use of the test of management and control facilitates this.  This allows the companies to be in operated in different countries but the US law views them as being in the same country.

Ireland applies the test of management and control as the sole judge of a company’s residency for certain companies - ‘relevant’ companies as described above.  But Ireland is not unique in applying the test of management and control to determine residency.  There are some countries which apply the test of management and control when determining corporate tax residency to all companies.  These countries include:

The residency laws in these ten countries all allow the creation of “double-Irish” type tax structures where passive income transfers between US MNC subsidiaries can be made without triggering a US corporate tax payment.  There is nothing unique about Irish tax residency rules that facilitates the “double-Irish”.  [A country’s tax treaty network and withholding tax are also factors.]

It could be equally be a “double-Cypriot” or a “double-Mexican” or a “double-Sri Lankan”, and it is almost certain that some US MNCs have set up twin-incorporated companies in these countries to avail of the “same-country” exemption.  It just seems the companies that do it from those countries haven’t been put under the glare of public scrutiny.

But they are there.  Here is a report of Yahoo using a “Double-Singapore” and it even has a “Dutch-Sandwich”.

Yahoo recently introduced another circuitous path through the Netherlands to cut the taxes on profits from its Asian sales: Royalties travel from Singapore, through Dooves’s house, to another subsidiary in Mauritius, a tax-friendly island off the southeast coast of Africa.

They may be about to set up a similar arrangement in Ireland!  But it is not because of anything unusual or unique in Irish residency rules.  As the list above shows ten countries base residency on the test of management and control on which the “same-country” exemption depends. 

There is nothing unique or unusual about Ireland’s residency rules despite much opprobrium to the contrary.  The current international corporate tax regime confers the right on the US to tax the profits earned by Apple through its intellectual property.  The fact that the US does not immediately exercise that right and allows a deferral of the tax (in theory the tax must be paid – eventually) is a matter for the US and the US alone.

Maybe the system will change and the tax rights will be assigned differently, perhaps by formulary apportionment, and it would be helpful if the debate moved to such a discussion.  But why do that when you can just shout about Ireland.

6 comments:

  1. Are US Tech companies competing on a level playing field, if the US is allowing them to defer their tax liabilities indefinitely?
    If Ireland ever produces a Tech company that will source most of its profits from R&D, will its effective corporation tax rate be approximately 12.5%? Since we tax worldwide income and don't allow a deferral of tax, like the US?

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    Replies
    1. It is not a level playing field, not between companies competing for customers or between countries competing for investment. There may be efforts made to even that out but it is not clear how successful they will be. The incentives are companies and countries to find advantages that suit them will remain.

      It is hard to know would an Irish firm be at a disadvantage relative to the US firms. For a start the Irish firm would have access to its foreign profits. There would be no incentive to keep them offshore for deferral purposes. Ireland has no deferral provisions. Ireland has a 25% corporate tax rate for non-trading income but there is preferential treatment for patent royalties paid to companies in Ireland. I don't think it is the tax system that is preventing the development of an Irish equivalent of Apple or Google.

      Delete
  2. "Though incorporated here the holding company will not be deemed a non resident" Edit?

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    Replies
    1. Indeed! One too many negatives in that.

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  3. So does the Cayman Islands.

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  4. As well, the Isle of Man.

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