This is the second article in a 4-part series on tax avoidance in the Irish state.
1.Irish state marketed for tax avoidance since 1950s
2.Yes, we’re still a tax haven for tech giants
3.Ireland’s IP Knowledge Box – another tool for tax dodgers
4.How do vulture funds manage to pay practically no tax in Ireland?
The Double Irish is the most notorious way that the Irish tax regime has facilitated tax avoidance over recent decades, but it is far from the only way. The MNCs engaged in the most blatant and aggressive tax avoidance in Ireland are technology giants Apple, Google, Microsoft and Facebook, and pharmaceutical corporations. Use of the Double Irish has relied on Irish-incorporated companies in tax havens including Bermuda, the Netherlands and Luxembourg, which are the top three locations for both outward and inward Irish direct investment.
A Moody’s report released on May 20 this year shows that US companies have accumulated $1.68 trillion in cash, with 72 per cent of it held in offshore tax havens. This sum has increased by almost $1 trillion since 2007. Apple, Microsoft, Google, Cisco and Oracle were the five multinationals holding the largest amount of wealth, with $504 billion combined.
The top three, Apple, Google and Microsoft, have all used Ireland as the center of their tax avoidance strategy, and can continue to do so until 2021 – while the government announced in 2014 that the Double Irish was to be scrapped (by changing residency rules to make companies that are incorporated in Ireland Irish-resident for tax purposes), it will remain in place for existing companies until 2021. Transfer pricing, cost-sharing agreements, inversions and tax rulings are some of the key ways MNCs avoid tax in Ireland, and unlimited liability status under Irish law has provided them with a cloak from public scrutiny. These mechanisms are complemented by failures in the US tax code. The top three US MNCs engaging in tax avoidance in Ireland are Microsoft, Google and Apple.
Microsoft established a plant in Ireland in 1985 following the introduction of a 10 per cent rate on software export profits in 1983. Its operations remained minor until the tech boom in the 1990s. Microsoft may not have been the first US MNC to exploit the Double Irish and other tax loopholes but it was the first to be comprehensively exposed, in the Wall Street Journal’s 2005 report. The investigation revealed how Dublin law firm Matheson Ormsby Prentice’s offices hosted a letterbox subsidiary of Microsoft Corporation which was established by Microsoft Ireland Operations Ltd in 2001, called Round Island One Ltd. (Matheson Ormsby Prentice, now called Matheson, also represents Google.)
In 2005 Round Island was controlling $16 billion in Microsoft assets and had gross profits of $9 billion in 2004. Another Dublin-based subsidiary, Flat Island One – a holding company of Round Island – was used to license rights to software throughout Europe, the Middle East and Africa. The revelation of the scheme posed several questions regarding the valuing of IP contributed by offshore units. To try to meet the US arms-length requirement, US MNCs rely on cost-sharing agreements, which Flat Island had with a US-based Microsoft unit called MELLC. In 2006 the two Irish subsidiaries applied for private unlimited liability company status, which exempts companies from filing detailed public accounts.
In hindsight, the scheme revealed in 2005 actually seems naïve – it apparently only relied on exploiting a cost-sharing agreement and Ireland’s 12.5 per cent tax rate. The establishment of letterbox companies in Bermuda, Singapore and Puerto Rico soon followed. Another subsidiary was later created in Ireland, Microsoft Ireland Research (MIR). The US Senate Subcommittee inquiry into tax avoidance by Microsoft in 2012 showed that the company had avoided paying at least $6.5 billion between 2009-2012 through the use of its subsidiaries in Ireland, Bermuda, Singapore and Puerto Rico. While it was estimated that more than 85 per cent of the research and development was carried out in the US, and MIR carried out one per cent of R&D, a cost-sharing agreement gave MIR 30 per cent of the credit for R&D. The Senate inquiry memorandum stated that MIR reported making $4.3 billion profits in 2011, about $11 million per employee in Ireland, with an effective tax rate of 7.2 per cent.
These days Microsoft routes its European, Middle Eastern and African sales through three separate subsidiaries, all registered in Ireland, before the profits finally end us in Bermuda (in an Irish-registered letterbox company). The first company where sales income arrives is Microsoft Ireland Operations Ltd. MIO Ltd is owned by MIR, which is part of the cost-sharing agreement with the US parent, and licenses products to MIO Ltd. Then profits move in the form of royalties to Round Island One, which although it is Irish-registered is now based in Bermuda. Finally the profits end up in another Irish-registered Bermuda letterbox company, RI Holdings. In February 2014 it was reported that an unidentified foreign government was investigating Microsoft’s three Irish-registered Bermuda letterbox companies for tax avoidance and tax evasion through the OECD’s 2005 Tax Information Exchange Agreement.
In 2010, Bloomberg reported that Google had reduced its tax bill by $3.1 billion in the previous three years by using the Double Irish and moving profits through Ireland and the Netherlands to Bermuda. By first passing through the Netherlands, the profits were exempt from an Irish withholding tax for outgoing royalties as Irish law exempted royalties flowing to the Netherlands (and other EU-registered companies) from this tax. Google Inc. had secured an advanced pricing agreement (APA) with the IRS in 2006 after three years of negotiations, in which its intangible property for Europe, the Middle East and Africa was licensed to Google Ireland Holdings. Google Ireland Holdings owns Google Ireland Ltd, which has tangible property and employees in Dublin. Google Ireland Ltd is the entity through which the vast majority of non-US sales pass.
But while in 2009, 88 per cent of its $12.5 billion worth of non-US sales went through Google Ireland Ltd, it reported pre-tax profits of less than one per cent of these sales in 2008 because it shifted the profits to Google Ireland Holdings through royalty payments. While Google Ireland Holdings was incorporated in Ireland it was not tax resident there but in Bermuda where it based its ‘effective centre of management’. In reality it is a letterbox company with no employees located in a tax haven with a corporate tax rate of zero.
The ‘Dutch Sandwich’ aspect of the strategy – sending money first through the Netherlands and then to Bermuda or another tax haven – was used to prevent patent royalty profits from being subject to a 20 per cent withholding tax by Irish Revenue through a tax treaty but it became no longer even necessary for MNCs to use the Netherlands in this way after July 2010 when the US Chamber of Commerce successfully lobbied the Irish government to amend its tax code to get rid of the withholding tax. As revealed by the Financial Times in May 2013, the US Chamber of Commerce submission to the Irish government suggested Ireland’s attractiveness as a location for IP investment could be “significantly improved” by scrapping the withholding tax on patent royalties.
In 2012, Google Inc. transferred all of its foreign income – $8.1 billion – through Ireland and paid an effective global tax rate of 4.4 per cent, a total of $358 million, including $22 million to Irish Revenue. The British HMRC struck a deal with Google in January this year in which Google agreed to pay £130 million in back taxes that it had avoided paying on British sales through routing the money through Google Ireland Ltd. This was a fraction of the amount Google actually owed, and ending the practice was not part of the agreement. French authorities began investigating Google’s transfer pricing arrangements in 2011 and in January this year the French government announced it was seeking €1.6 billion in back taxes. In May this year French police and tax inspectors raided Google Ireland Ltd’s headquarters in Paris, as part of an investigation into “aggravated financial fraud and organised money laundering”. The French authorities also said they are seeking to prove that Google Ireland Ltd has a “permanent establishment” in France which would be subject to paying French taxes.
Apple has gone above and beyond all other MNCs in using Ireland to avoid paying tax – for a period of five years its main European, Middle East and Africa subsidiary didn’t just reduce its tax bill but avoided paying any tax anywhere. The scheme was outlined comprehensively by US Senator Carl Levin in the Senate Subcommittee inquiry into offshore profit-shifting by Apple in May 2013, in a concluding speech accompanied by a detailed memorandum.
The Senate report outlined how through the use of three Irish-registered letterbox companies, Apple Inc could claim they existed nowhere for tax purposes. Apple Operations International, or AOI, is solely owned by Apple Inc and in turn owns most offshore entities. AOI is incorporated in Ireland but not tax resident there. The second company, Apple Sales International (ASI) holds IP rights to sell Apple products in Europe, the Middle East and Asia. The third, Apple Operations Europe, is also registered in Ireland but not resident there. Sales income for ASI from 2009-2012 was $74 billion.
In 2011, ASI paid tax of 0.05 per cent – $10 million of $22 billion income – to Ireland. Levin said: “[These three ghost companies’] decision makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States. Apple’s tax director acknowledged to the Subcommittee staff that it was his opinion that AOI is functionally managed and controlled in the United States. The circumstances with ASI and AOE appear to be similar.”
More than 95 per cent of Apple’s R&D is carried out in the US. Levin outlined how through a cost-sharing arrangement on R&D between Apple Inc and ASI, from 2009-2012 ASI paid $5 billion to Apple Inc, while Apple Inc paid $4 billion under the cost-sharing agreement over the same period. But while Apple Inc declared profits of $38 billion (subject to the US corporate tax rate of 35 per cent), letterbox company ASI declared profits of $74 billion and paid less than one per cent in tax to Ireland. “Common sense says Apple would never have offered such a lucrative arrangement in an arm’s-length deal with an unrelated party.”
The Apple case demonstrates not only exploitation of the Double Irish residency rules, but also the use of supposedly informal ‘advanced opinions’ – private tax rulings – issued by Revenue to certain MNCs. In Levin’s words: “Why Ireland? Another highly successful but, until now, hidden tax strategy: Apple has quietly negotiated with the Irish government an income tax rate of less than 2 percent, well under the Irish statutory rate of 12 percent as well as the tax rates of other European countries and the United States. And as we’ve seen, in practice Apple is able to pay a rate far below even that low figure.” Apple representatives told the Senate Subcommittee: “Since the early 1990’s, the Government of Ireland has calculated Apple’s taxable income in such a way as to produce an effective rate in the low single digits …. The rate has varied from year to year, but since 2003 has been 2% or less.”
The Senate Subcommittee memorandum examines the relationship between Irish tax law on residency and loopholes in the US tax code (subpart F), specifically the ‘check-the-box’ and ‘look-though’ rules. The check-the box loophole was introduced in the 1990s and allows companies to literally check a box on its declarations to the IRS stating what kind of entity they are for tax purposes – meaning MNCs can declare offshore subsidiaries as part of one single corporation and therefore not taxable. The look-through loophole introduced in 2006 provides relief from the anti-deferral rules for Controlled Foreign Companies in the US tax code.
The European Commission opened an investigation in June 2014 as to whether the tax rulings, or advanced opinions, provided by Irish Revenue to Apple subsidiaries in 1991 and 2007 constitute illegal state aid that selectively preferenced the companies. The key points of the Commission’s preliminary findings in September 2014 were that the 1991 tax ruling appeared to have been “reverse engineered”, and that the 2007 amended tax ruling which calculated a 10-20 per cent increase on AOE’s costs was “meaningless in relation to the computer industry”. Unlike most tax rulings, which usually last for three to five years, the 1991 ruling had no end date. The Commission said there was evidence the tax rulings was “motivated by employment considerations”, and that the terms of the tax rulings did not comply with the arm’s length principle for setting conditions between companies of the same corporate group.
Three figures have been estimated regarding what amount Apple would owe in back taxes to the Irish state if the Commission finds the tax rulings were illegal. Bloomberg Intelligence has estimated $8 billion, while JP Morgan Chase & Co has estimated it may owe $19 billion. Pro-corporate lawyers reported in the media have estimated Apple will face just $200 million in back taxes.
One of the most important facts to come to light in the US Senate Subcommittee inquiry’s 2013 report, and highly significant for the European Commission’s investigation, is that the last accounts that had been filed for AOI (then called Apple Computer Inc Ltd) was in 2005 for fiscal year 2004. As Finfacts founder Michael Hennigan points out: “Irish Revenue officials must have been aware of the change of status of AOI from a tax-paying company in Ireland to a tax-exempt status?” As evidence of the “reverse-engineered” nature of the advanced opinion issued by Revenue in 1991, the Commission released the following excerpts of a note of a meeting between Apple and Revenue in 1990, where a figure of taxable profit was agreed upon without reference to the actual profits of the company, shifted to the manufacturing category with a corporate tax rate of 10 per cent (which did not expire in Irish law until the end of 2010), and then left in place until 2007 despite the massive rise in Apple’s profits over this period:
[The tax advisor’s employee representing Apple] stated that the company would be prepared to accept a profit of $30-40m assuming that Apple Computer Ltd. will make such a profit. (The computer industry is subject to cyclical variations). Assuming that Apple makes a profit of £100m it will be accepted that $30-40m (or whatever figure is negotiated) will be attributable to the manufacturing activity. However if the company suffered a downturn and had profits of less than $30-40m then all profits would be attributable to the manufacturing activity. The proposal essentially is that all profits subject to a ceiling of $30-40m will be attributable to the manufacturing activity.
[The representative of Irish Revenue] asked [the tax advisor’s employee representing Apple] to state if was there any basis for the figure of $30-40m and he confessed that there was no scientific basis for the figure. However the figure was of such magnitude that he hoped it would be seen to be a bona-fide proposal.
Continued: Ireland’s IP Knowledge Box – another tool for tax dodgers