“I don’t know how you got Apple to have so much of their business in Ireland,” Jerry Brown, governor of California, told an audience last week in San Francisco that included Enda Kenny, Irish taoiseach/prime minister. “We thought they were a California company but when you look at their tax return, they are really an Irish company. Anyway, that is part of the creativity — yeah, it’s called creative accounting. Anyway, I won’t go there.”
While Governor Brown delivered his barbed comments in a jocular manner, it wasn’t the welcome the Irish normally expect in California or in the rest of the United Sates.
This week the European Commission, the executive arm of the European Union (EU), opened an investigation into how Ireland helped Apple to cut its foreign income tax (termed corporate tax outside the United States) rate to low single digits in recent times.
Ireland’s headline corporate tax rate of 12.5% is the lowest national rate in the developed world but American companies, in particular in high tech and big pharma which have high international sales ratios, from the late 1990s took advantage of an unintended loophole in US tax regulations to avoid the high federal rate of 35% while in Ireland in 1999, legislation requested by the EU had the goal of having all Irish companies tax resident. However, under pressure from the American Chamber of Commerce in Ireland, an exemption was made where US companies could use Irish offshore companies without having to pay tax in Ireland.
US companies discovered that they could do better with Irish help and pay tax at a lower rate than the best rate in the developed world.
The calculation for Ireland was that overall Irish tax paid would not be reduced as giving the companies the facility to suck in lots of income from around the world would deepen roots in Ireland and also boost Dublin’s offshore financial services center.
The test for using the offshore entities was that these companies would be controlled and managed outside Ireland (most onshore affiliates in practice are in the same boat) — in reality they were mailbox companies domiciled in island tax havens such as Bermuda, the Cayman Islands and the British Virgin Islands, where there are no corporate taxes.
The companies were effectively tax avoidance entities and given the importance of foreign direct investment (FDI) for Ireland, the Irish Revenue had a history of being cooperative with FDI firms.
The offshore entity would charge the Irish affiliate of the US company for IP (intellectual property); the Irish affiliate would shift profits from other foreign subsidiaries by invoicing for IP and other services. There would be some tax paid in Ireland and by foreign subsidiaries but most of the income from subsidiaries would be chanelled via the Netherlands to the island tax havens and arrive tax free — the Dutch Irish Dutch Sandwich Scheme explained.
The advantage for the US company in having an Irish offshore entity was that to tax authorities around the world, funds were being moved to a sister unit in Ireland not to a tax haven.
The Irish exemption was made at a crucial time when US companies were beginning to take advantage of a tax loophole called ‘check the box’ that had been inadvertently introduced by President Clinton’s Treasury Department to simplify the tax code through allowing companies to file subsidiaries’ income with parent company income. The companies also were able to designate which units were irrelevant for tax purposes, termed “disregarded entities.”
In the four years, between 1999 and 2012, profits of Irish affiliates of US companies doubled from $13.4bn to $26.8bn (including income in Irish offshore companies). They became the most profitable in the world according to Tax Analysts, a US tax research firm.
Tax Analysts said in 2004 that for each dollar of profit taken in Luxembourg in 1999, US corporations took $4.56 of profit in 2002. The result for Bermuda was $2.96; for Ireland $2.01; and for Singapore $1.72. It said these countries were viewed as tax havens or partial tax havens. For UK, each dollar of profit taken in 1999 was equal to 67 cents in 2002; for Germany, it was 46 cents.
Corporate payments to members of Congress ensured that the ‘check the box’ loophole could not be closed — see Congressional Research Service report [pdf].
In 2005, a year after US companies were given a special amnesty tax rate of 5.25% to incentivize the repatriation of profits, The Wall Street Journal exposed Microsoft’s tax reduction strategies and reported that two of Ireland’s biggest companies by revenue had no employees and operated from the office of a Dublin law firm — WSJ report [pdf; free]
Apple like Microsoft was booking a big chunk of it global revenues in Ireland — 39% in 2004 — the first year full year that Google’s EMEA (Europe, Middle East, Africa) headquarters was operational. Google would eventually divert more than 40% of its annual global revenues to Ireland while Facebook books about half its global revenues in Ireland.
US industrial giants such as Intel and Pfizer, operate in Ireland as branch operations — Intel Ireland is owned by a Cayman Islands company and Pfizer is owned by a Dutch partnership.
Dell Computer moved PC manufacturing from Ireland to Poland in 2009 but remains Ireland’s biggest manufacturer, in a virtual sense, as it books the output of it Polish plant in Ireland.
These tax-related shenanigans make Ireland’s national accounts an unreliable measure of economic performance and almost half of reported annual services exports are effectively fake.
Apple’s Irish stateless companies
Apple opened a small manufacturing facility in Cork, Ireland’s second biggest city (population: 119,230 in 2011), in 1980. Watch clip of Steve Jobs in Cork:
Apple has now almost 4,000 employed in Cork working in a service operation with the majority believed to be foreign nationals because of the demand for a wide range of language skills.
Its principal company in Cork was Apple Computer Inc. Ltd. and its name was changed to Apple Operations International (AOI) in 2006. Apple also changed its status to unlimited to shield financial accounts from public access.
Apple treated its offshore companies as onshore when it suited or partially onshore.
There were no employees in Apple Sales International (ASI) until 2012 when 250 employees were transferred from another Irish entity and a tax return was issued to the Irish Revenue.
The US Senate Permanent Subcommittee on Investigations said in a May 2013 report:
“In 2011, for example, ASI paid $10m in global taxes on $22bn in income; in 2010, ASI paid $7m in taxes on $12bn in income. Those Irish tax payments are so low relative to ASI’s income, they raise questions about whether ASI is declaring on its Irish tax returns the full amount of income it has received from other Apple affiliates or whether, due to its non-tax resident status in Ireland, ASI has declared only the income related to its sales to Irish customers. Over the four year period, 2009 to 2012, ASI’s income, as explained below, totaled about $74bn, a portion of which ASI transferred via dividends to its parent, Apple Operations Europe. ASI, which claims to have no tax residence anywhere, has paid little or no taxes to any national government on that income of $74bn.”
J. Richard Harvey Jr. of the Villanova University School of Law, said in testimony to the Subcommittee:
- Pursuant to a long-standing cost sharing agreement, Apple recorded approximately $22bn of its 2011 pre-tax income in Ireland — the Irish government has claimed that funds received by its mailbox companies are beyond its jurisdiction but to the world, Irish companies are Irish (Finfacts).
- As a result, 64% of Apple’s global pre-tax income is recorded in Ireland where only 4% of its employees and 1% of its customers are located.
- Despite a published tax rate of 12.5%, Apple negotiated a special tax deal that resulted in only $13m of Irish tax expense being recorded with respect to the $22bn of Irish income.
- 60% of Apple’s 2011 sales were to customers in countries other than the US and Ireland, but only 6% of the consolidated pre-tax income was recorded in such countries.
Apple told the Subcommittee that ASI was stateless — not liable for tax anywhere.
Apple also told the Subcommittee that the Irish offshore company Apple Operations International, its main foreign subsidiary, was also stateless.
However, in 2004 under its previous name, Finfacts has reported that the offshore company paid tax to Ireland on its Irish and foreign income, offset by foreign taxes paid.
The Subcommittee said in its 2013 report:
“For more than thirty years, Apple has taken the position that AOI has no tax residency, and AOI has not filed a corporate tax return in the past 5 years.”
Apple told the Subcommittee that AOI’s assets were managed by Braeburn Capital. “Apple indicated that the assets themselves are held in bank accounts in New York.”
It appears that Braeburn Capital, established by Apple in 2006 in Reno, Nevada, to handle the rapidly growing resources of the firm, had decided that AOI be declared stateless with Apple’s surging foreign funds transferred directly to New York rather than using the Double Dutch Irish scheme.
Given that AOI’s accounts were no longer available for public scrutiny and of unlikely a concern for the Irish Revenue, Apple staff must have expected that it’s decision to declare the company stateless for tax purposes, would never become public knowledge.
The European Commission is investigating whether the Irish authorities gave the green light on this arrangement.
Even if there was not an official imprimatur, it would be odd despite the accommodating attitude of the Irish Revenue to multinationals, that AOI would pay tax in Ireland and then decide to stop, with no reaction from the Irish authorities.
In late 2013, Ireland closed the loophole that allowed Apple to declare that an Irish offshore company could be termed stateless — whether a loophole was involved or just old-fashioned fraud has not been tested. However, it can be said with little doubt that an indigenous Irish firm wouldn’t get away with the manoeuvre.
In fiscal 2012 Apple reported that it had provided $713m in foreign taxes on $36.8bn of foreign net income from total net income of $41.7bn giving a foreign tax rate of 1.9%.
Foreign sales accounted for 61% of the total revenues of $156.5bn but 88% of the net income was allocated overseas even though Apple does most of its R&D and design work in the United States.
The low rate of 1.9% in 2012 and 3.6% in 2013 compares with a simple average for the 34 mainly developed country members of the OECD of 25.4% and 25.5% respectively — down from 42.7% in 1989 when the organisation had 22 members and Sweden’s rate was 60.1% compared with 22% in 2013.
The Financial Times reported in 2013 that Apple would have paid a tax rate on US + foreign income of about 15% in 2012, far below the 25.2% it reported, had it not used a form of reserve accounting that sets it apart from other big US technology companies.
The rare accounting treatment has helped to distract attention from Apple at a time when the tax-avoidance strategies of other cash-rich US tech companies, notably Google, have come under public attack, according to tax experts.
The FT added that 25.2% tax rate Apple shows in its accounts is boosted by billions of dollars it sets aside each year to cover future tax liabilities, which would fall due if it repatriated part of its $102.3bn of overseas cash holdings.
These provisions added some $5.8bn to its reported taxes last year, lifting the total by 70% and reducing its profits. The figure is an accounting entry and has no effect on the actual amount of taxes paid.
It’s ironic that in recent years the United States has aggressively led the campaign against international personal tax evasion, effectively ending eight decades of Swiss banking secrecy while its leading companies are involved in massive corporate tax dodging schemes.
This month it was announced that 47 countries had agreed to an Organisation for Economic Co-operation and Development (OECD) framework that commits them to “swiftly” pass new domestic laws that will allow them to collect information on all bank accounts and automatically exchange it with other participating countries.
The signatories include the significant financial centers of Singapore and Switzerland (and besides Switzerland, the other 33 members of the OECD).
The campaign against corporate tax avoidance began in Europe as a grassroots protest at a time of austerity but it also won the support of business which had to pay tax while international giants like Starbucks could report a string of losses in the UK by ponying up a licensing charge from the Netherlands.
Local company directors would risk prison if they tried the same tax gimmicks as America’s leading companies.
Last year the G-20 group of the leading developed and emerging economies asked the OECD to update international business tax rules. It’s called the Base Erosion and Profit Shifting (BEPS) project.
The Irish government has floundered and foundered in response to the reports on Apple and other tax avoiders and evaders.
Last month, Feargal O’Rourke, the tax partner at PwC Ireland, a unit of the Big 4 accountancy firm, who has been credited as the main Irish adviser to American companies on taxation issues, in reading the prevailing winds, took a bold initiative by recommending that the Irish Government should take preemptive action and change the Irish tax residency rules.
Last April Finfacts proposed in a submission to the OECD that Ireland should embrace tax reform.
Post reform there will remain a strong case for investment in Ireland given the half century of Irish experience.
The extent of tax avoidance by US companies was illustrated this week when The Financial Times reported that 14 US tech and pharma groups, including Microsoft, Google and Johnson & Johnson, have cut their average tax rate by a quarter over the past eight years as they parked more cash offshore than all other US companies combined. Almost a half trillion dollars in cash is technically held offshore and according to an FT survey, they paid an average overseas tax rate of just 10% last year.
Over the past eight years, overall tax rates fell as their lightly taxed foreign profits grew at nearly three times the pace of their foreign sales.
The FT said that the figures are likely to be viewed by critics as further evidence of profit “shifting” from high-tax to low-tax countries such as Ireland, Singapore and Bermuda. Martin Sullivan of Tax Analysts, a US publisher, said the downward trend was “enormous.”
Wealth distribution among US corporations is becoming ever more concentrated, with the top 1% controlling 36% of the overall cash and short-term investments versus 27% five years ago, Standard & Poor’s Ratings Services said in a report published Wednesday.
In all, the top 1% increased its cash and short-term investments by 11% year over year, or more than $50bn, during 2013. The five largest cash holders belonged to the technology industry, and a total of seven technology issuers accounted for 57% of the wealthiest 1%. Health care companies placed five companies among the 1% and made up 21% of the total. As expected, the rating distribution was strongly biased toward investment grade, with 15 out of 18 issuers in the ‘A’ rating category or higher, with only one speculative-grade issuer (General Motors) among the richest 1%.
Cash hoards of the top 20% companies account for 89% of total cash. The rest — four out of five companies — control the remaining 11% of wealth.
Ireland’s love affair with American business
Henry Ford (1863-1947), the Irish-American industrialist, remains the hero of American FDI in Ireland and the peak employment at the Henry Ford & Son plant in Cork City was 7,000 in 1930, when the city had a population of 80,000. Dunlop, the rubber tyre company, opened a plant adjacent to Fords’ in 1935.
In 1919, the year that the tractors began rolling off the assembly lines in Cork, the war of independence against British rule began.
Ford had a strong affinity with his father’s homeland and he was also influenced by his mother’s adoptive father, Patrick Ahern, from Fair Lane off Shandon Street in Cork City.
The Great Depression and tariff barriers impacted the Ford plant in Cork and it was closed in 1984 [pdf].
In the period since 1945, Ireland like China later has been a clear beneficiary of globalization.
By 1961, the average tariff for manufactured imports into the United Sates was only one-fifth of its pre-war level or just over 10% according to the IMF. By 1979 after the Tokyo Round, such tariffs had been cut to 5%.
The 1950s was a grim decade for Ireland despite recoveries from wartime devastation elsewhere in Western Europe.
T.K. Whitaker (b. 1916), the head of the Irish civil service in 1957, in a memorandum to the minister for finance on the failure of economic policy and the general sense of hopelessness in the country, warned that “without a sound and progressive economy, political independence would be a crumbling facade.”
Radical proposals for economic change were put forward in a 1958 report, ‘Economic Development,’ and a new economic policy was put in place with a move away from protectionism and an embrace of open trade to take advantage of the international tariff cuts.
Patrick Honohan, governor of Ireland’s central bank, said in a speech in 2010 that:
“There is a letter in the archives of the World Bank in Washington DC on the letterhead of the Shelbourne Hotel, Dublin, dated Saturday, June 7, 1958. Benjamin King writes back to headquarters on his mission to Ireland. This was the first ever such mission sent by either of the Bretton Woods Institutions (the World Bank and the International Monetary Fund) since Ireland had joined both of them in the previous year. King was in Dublin at the invitation of T.K. Whitaker, who had asked the World Bank to help by carrying out a review of the Irish economy with a view to a possible borrowing programme for Ireland from the Bank.
But King found that much analysis had already been carried out by the Irish administration. Indeed, he had been perusing a draft of the document that would change the course of Irish policy towards its economic engagement with the rest of the World. ‘I have asked Whitaker”, he writes, “to send you by airmail his report ‘Economic Development’. It is over 200 pages and seems pretty good to me.’ And it’s not just a document of factual analysis, but addresses challenging policy issues. He notes that ‘it is also quite tough (in a velvet-glove sort of way) with some old-established practices.’”
Two years before, Whitaker as secretary of the Department of Finance had been a key policy maker in the decision to exempt profits arising from export sales from corporation tax and that was the genesis of tax as a cornerstone of FDI policy.
The Republic of Ireland’s population hit a historical low point since independence in 1922, of 2.8m in 1961 — it is now 4.6m.
A free trade zone had been established at Shannon Airport in western Ireland and a pivotal event for the country in getting the attention of American business for the modernising economic programme, was the state visit of President John Fitzgerald Kennedy in June 1963 — three generations after the Kennedys and Fitzgeralds had left famine-stricken Ireland on emigrant ships.
In July 1963, Time magazine featured Seán Lemass, Irish prime minister, on its cover, and an article ‘Lifting The Green Curtain,’ described how “for the first time in this century, most Irishmen are ready to believe that [the future] can be a bright one.[…] The signs are everywhere: in the new factories and office buildings, in the Irish-assembled cars (Fords, Austins, Volkswagens) fighting for street space in Dublin, in the new TV antennas crowding the rooftops, in the waning of national self-pity.”
The Irish government had also set a goal to join the new European Economic Community (later named the European Union), which it achieved in 1973 — it was a huge development for the poor, socially backward country, and an important selling point for FDI (foreign direct investment).
The most important decade for American FDI in Ireland was the 1990s following the key 1989 decision by Intel, the computer chip giant, to open a manufacturing plant in Ireland.
For a number of years Ireland, with only 1% of Europe’s population, attracted up to 25% of all US greenfield industrial investment in our continent.
Employment in FDI exporting firms peaked at 184,000 in 2000 — 10.3% of the workforce; at end 2013, it was at 172,000 — 7.9% of the workforce.
American firms account for over 70% of this employment.
Patrick Honohan, the central bank governor, who is a former professor of economics, said in a speech last March:
“While the importance of foreign-owned firms can be traced back to pre-independence times, the present patterns of foreign ownership dominance have emerged as a clear consequence of Government policy from the 1950s on to encourage inward foreign direct investment. The efforts of the IDA and other agencies, combined of course with the tax structure, have played a powerful role. The model has been a significant driver of Ireland’s success in achieving high average living standards, even if critics have long-noted the potential vulnerability associated with such heavy reliance on this segment of enterprise.
One hoped-for element of the policy of encouraging foreign-owned firms is the inward transfer of technology and business know-how including to locally controlled firms. As the decades passed, this transfer does seem to have happened to an increasing extent. But the reliance on foreign-owned firms has lasted a long time. Irish-owned companies have grown and prospered over the past half-century, and the most pessimistic of prognostications have not materialised. Nevertheless, this systemic dependence on foreign capital and know-how has skewed Irish development. In the interests of robust diversification, most Irish economists observers would hope for a greater convergence towards normality in this aspect of Irish economic development, with a stronger emergence of innovative Irish companies alongside those steered from abroad.
One side-effect of the heavy reliance on multinational corporations for driving employment and productivity growth has resulted from the fact that these companies generally bring most of their financing with them, thereby reducing the pressure on the local financial intermediaries and markets to innovate in the direction of designing and appraising financing packages for modern industry. While this did not discourage Irish banks from expansion, it likely contributed to their slide into a monoculture of property lending.”
Less than a third of FDI firms do even minimum R&D in Ireland. Still foreign firms account for almost three-quarters of business R&D and the indigenous exporting sector mainly depends on the UK market.
In contrast with Israel, US big pharma firms, services giant like Apple and Google, and employment in Dublin’s offshore financial services center, is in manufacturing floor jobs and sales/ administration functions.
Irish informality gels well American business but having US companies provide ready-made jobs has been more a focus for political leaders than addressing the challenge of a poorly performing indigenous exporting sector — despite the lowest corporate and employer social security taxes in Europe.
The conflation of FDI trade data with indigenous exports by policy makers is common and it masks the challenges faced by local firms in developing new export markets.
In 2013 Irish food and drinks exports only amounted to 5.5% of total headline exports.
There was a real rise of 59% in total exports in the period 2000-2013 but it was a jobless surge — see chart here.
Rising living standards
Given both FDI distortions in GDP (gross domestic product) and GNP (gross national product), Actual Individual Consumption (AIC) per capita is a better metric of Irish living standards.
Data from Eurostat, the European Union’s statistics office [pdf], show that Irish AIC in 2012 was below the Eurozone average and slightly below Italy’s.
GDP is higher than GNP because of large FDI profits but in the early 1970s for example, GNP exceeded GDP due to emigrant remittances. See more here on GDP and GNP.
Looking at data for 1972 when FDI was relatively low compared with today, Irish GDP per capita was 36% of Sweden’s level.
Sweden went from having a per capita income equivalent to 40-50? of the United Kingdom’s per capita income during the first half of the 19th century to being the fourth richest country in the world by 1970 [pdf] (after Switzerland, the US and Luxembourg).
In 1972-1990 Irish GNP per head at constant prices rose 34%.
In both 1990-2000 and 1990-2011, GNP per head rose 58%.
The penny drops…
Irish leaders have for decades too readily ‘tugged the forelock’ to American business folk while the facilitation of corporate tax avoidance was generally a taboo subject at home — risking being accused of “talking down the economy” which was the default reaction to dissenters during the property bubble.
Last March Enda Kenny, prime minister, told a group of business persons at the United Sates Chamber of Commerce headquarters in Washington DC, that anyone with any worries should contact him directly. “If you got a problem, you have an issue or anxiety or concern or a proposition or a proposal I want to hear it,” he said. “My number is a public number you can call me anytime.”
We at Finfacts were dissenters and we warned of both of the risk of a property crash and the blind facilitation of tax avoidance.
However the reaction about tax was that we were wasting our “sweetness on the desert air” as 1) Ireland had a European veto on tax harmonisation 2) political gridlock in Washington DC would ensure that there was no prospect of near-term US tax reform.
Who’s looking stupid now?
Having spent the past eighteen months claiming that Ireland does not facilitate international corporate tax avoidance despite overwhelming evidence to the contrary, the Irish Government has done a U-turn and has signalled that it is ready to prepare for the reality of reform.
Late last month, the Irish Department of Finance published a consultation document [pdf] on the OECD’s BEPS tax reform project and it announced that Michael Noonan, finance minister, “now wishes to consider options for Ireland’s tax system to respond to a changing international tax environment. The Department also said in respect of the BEPS project that “Ireland is actively engaged in this process.”
Up to then, this meant “actively engaged” in trying to undermine it with the support of business lobby groups and other vested interests.