The future of the Eurozone

Eurotower

Below is an abridged version of a speech I gave on behalf of Sinn Féin at a GUE/NGL conference on the ‘Future of the EU’ in Donostia/San Sebastian on 5 June 2017.

Last week the Commission released a ‘reflection paper’ on deepening the Economic and Monetary Union (EMU).

There is one positive element of this reflection paper – the Commission finally admits that the status quo, and the divergence it has led to, is unsustainable and has to change.

But the proposals to deepen the EMU entirely fail to address the problems caused by the structural flaws of the euro, which are becoming clearer and clearer and are now acknowledged by mainstream economists.

The reflection paper is not so much a new proposal from the Commission as it is the product of a political compromise between German chancellor Angela Merkel and French President Emmanuel Macron arising from their recent discussions.

Reading between the lines, we can see that the longstanding French demand for some limited financial transfers is proposed, in exchange for not taking any action against the massive and destructive German current account surplus, and for handing over yet further economic powers to the Commission.

The German surplus is the cause of existing debt crises in the Eurozone and will be the cause of future crises. If one country is constantly exporting more than it imports, other countries – in this case, the EU peripheral countries – will have to import more than they export.

This doesn’t just hurt the so-called periphery, or the South – German workers are also suffering the consequences of this strategy as their wages are kept permanently low, often at poverty level.

But while the EU’s “rules” set a limit for current account balances of plus-six per cent of GDP, no sanctions have been imposed against Berlin despite the fact Germany has exceeded this limit for 21 consecutive quarters and for 31 out of 40 quarters since the start of 2007.

The idea that every Eurozone country should adopt an export-led growth model should not only be rejected because it’s based on exploitation, but also because it’s just not economically possible.

Ireland, poster child for austerity

The Irish state is the poster child for the memorandum countries in terms of its recent economic recovery. The narrative goes that the Irish state followed all of the EU rules, swallowed the structural reforms and experienced export-led growth.

Leaving aside last year’s ludicrous 26% growth rate in GDP, based on Ireland’s facilitation of massive levels of corporate tax avoidance, there has been a certain of level of growth in employment over the past two years.

It’s important to note that these growth areas for jobs have not come from FDI or the Irish government’s tax-haven strategy.

Growth took place in the agriculture and food sectors, and in accommodation and tourism.

This growth was based on two related factors. The first was the devaluation of the euro as a result of the crisis, and the second was the relatively higher economic growth in Britain and the US, the Irish state’s two largest trading partners.

Devaluation of the euro was critical to the recovery experienced in the Irish indigenous sector.  The relative growth in the US and Britain was also influenced by the fact that these two states are not constrained by the Fiscal Compact rules – borrowing in the US and Britain did not fall below 3% since 2008.

But the specific circumstances of the Irish state also mean that this recovery cannot be transposed or replicated in other member states of the EU.

It also poses significant risks, especially the risk of a significant devaluation of sterling as a result of Brexit. The devaluation of sterling post-Brexit would likely have a devastating impact on this fragile recovery.

The Irish recovery happened in spite of, not because of the EU austerity recipe.

What Ireland is actually a poster child for is the role currency devaluation can play in recovery, when you’re trading predominantly with other currencies.

Transfers in exchange for rights?

Despite acknowledging that the status quo of the EMU is unsustainable, the Commission declares its firm support for the continuation of the European Semester and the Fiscal Compact.

Probably the three most significant aspects of the reflection paper from our point of view – all of which have been floated before – are its proposal of the creation of a European Unemployment Insurance Scheme, the proposal for an EU finance minister, and for an ‘investment protection programme’ to ensure public investment is maintained during an economic downturn.

In typical Commission fashion, the idea of a European Unemployment Insurance Scheme is dangled to gain public support – while the trade-off is the ‘harmonisation’ of labour relations and anti-worker reforms.

As for the proposed ‘investment scheme’, it is contradictory nonsense to create a scheme to protect investment during economic downturns while at the same time insisting on keeping the macroeconomic straitjacket of the Fiscal Compact firmly in place.

Limited transfers would require permanent structural reforms for Member States under the supervision of an EU finance minister.

We don’t oppose redistributive transfers to the so-called peripheral states to correct the imbalances that damage our economies, and of course we’re in favour of protecting investment levels in the crisis-hit countries.

But the point is that these measures are both utterly insufficient to address the underlying structural problems in the EMU, and they all demand trade-offs in rights, democracy and popular sovereignty.

So there will be a deepening of two major discussions in the EU in the near future – one on the EU budgetary capacity and one on improving social rights, linked to the Social Pillar but also linked to these proposals in the reflection paper, such as the unemployment insurance scheme.

We don’t oppose transfers to correct imbalances caused by the euro – but we will definitely oppose them if they are linked to conditionality. Social rights cannot be dependent on economic performance or a state’s following of the fiscal rules. Rights are rights.

The left in Europe shouldn’t fall for the trap of surrendering more ground to the Commission in exchange for these crumbs from the table.

New drive towards deregulation

 At the same time as you have these plans for deepening and completion of the EMU based on permanent austerity, and the dubious economic model of export-led growth, we also have a drive to dismantle the limited financial regulation that was enacted after the crisis.

We have a new drive too for the public to bail out the banks – we can see it both in the Commission green-lighting the Italian bailout last week using a loophole in the Banking Union legislation that you could drive a truck through, and through the EBA and ECB recently pushing the idea that public funds should be used to solve the ‘non-performing loan’ problem.

So taking all of this into account, the challenges for the left in the coming period will continue to be on the one hand defensive in order to try to halt the march of permanent austerity. We need to prevent the deepening and expansion of the EMU.

In the short term we need to campaign for effective sanctions against current account surpluses; for investment to be excluded from the fiscal rules; to try to reject the attempt to incorporate the Fiscal Compact into the Treaties at the end of this year; and for a real public investment plan to stimulate growth. We’re open to examining options for fundamental reform of the euro towards flexibility mechanisms or other possibilities. Some of the ideas outlined in Joseph Stiglitz’s book on the future of the euro are definitely worthy of consideration by the left.

But the option of an exit from the eurozone should also be viable and supported for member states that choose to do this as a result of their economic circumstances, just as states who want to remain within the eurozone should not be blackmailed or kicked out of the common currency against their will.

I’ll finish with a few comments on some recent and current election campaigns. We’ve all seen the elites across the EU celebrating the election results in the Netherlands and France, fostering a sense of triumphalism and complacency when what we should all be experiencing is alarm at the growth of the far right. But it is not inevitable that popular anger at the status quo is channelled into the far right.

We face the urgent challenge of developing, communicating and organizing around a programme that can win popular support, and the effective, bold and principled Labour campaign in Britain under the leadership of Jeremy Corbyn is something we can learn a lot from across Europe. Corbyn successfully managed to shift the debate from a narrow discussion on the terms of the British exit at the start of the campaign to one about what kind of country do people want to live in, what kind of world?

Gernika: The beginning of aerial terror

Gernika Belfast

A mural of Pablo Picasso’s Guernica in Belfast

The following excerpt on the 1937 attack on the Basque village of Gernika is taken from an incomplete history piece on the Basque Country, from a chapter on the Second Republic and civil war. Tomorrow (April 26) is the 80th anniversary of the bombardment.

In early 1937, with Madrid still putting up a stiff resistance, Franco set his sights upon Bilbo with the aim of capturing the city’s iron ore and heavy industry to support his war effort. The Francoists quickly planned a northern offensive to be led by General Emilio Mola, who issued an ultimatum on 31 March in broadcast and printed leaflets dropped on Bizkaian towns saying: “If submission is not immediate, I will raze Vizcaya to the ground, beginning with the industries of war. I have the means to do so.” Most of the infantry on Franco’s side were raised from Nafarroa. The 50,000 heavily armed troops in four Nafarroan brigades were backed up by two Italian divisions, the Spanish Air Force, the Italian Aviazione Legionaria and the Condor Legion of the German Luftwaffe. Mola had 120 aircraft and 45 pieces of artillery at his disposal. The Republican Army in the North had almost as many troops but far less firepower, half the artillery and just 25 ineffective aircraft. The offensive began with an act of brutality when the village of Durango – not on the front line and undefended – was bombarded for four days by the Luftwaffe, with 248 civilians killed. Republican positions were falling fast and on 20 April 1937 a new Francoist offensive began in Bizkaia.

Gernika has long had a sacred status among Basques as the site of the ancient Basque parliament of Bizkaia, the Casa de Juntas, and of the legendary Gernikako Arbola (Tree of Gernika), an oak tree that has been a symbol of Basque sovereignty and the rights of the Basque people for close to a thousand years. In 1937 the town had a population of around 7,000 people, and Monday 26 April was a busy market day in the town centre. At 4.40pm the Luftwaffe’s Condor Legion and the Italian Aviazione Legionaria launched an aerial bombardment of the town that lasted for three hours, with waves of planes hitting the town centre every 20 minutes with high explosives and incendiary bombs of up to 1000lbs. each. Those who tried to run from the town or hide in the fields were machine-gunned. At 7.45pm, after the last planes had dropped their bombs, the centre of the town was destroyed. The assault killed 1,654 of the town’s 7,000 inhabitants. Gernika was 30 kilometres from the front. The Casa de Juntas and the Tree of Gernika had incredibly survived untouched.

A report by British journalist George Steer, war correspondent for the London Times, was published in the Times and the New York Times on 28 April. Steer had rushed to the town the evening of the attack to interview survivors and witness the devastation firsthand, and reported: “The most ancient town of the Basques and the centre of their cultural tradition, was completely destroyed yesterday afternoon by insurgent air raiders.”  His report from Gernika was all the more significant because Franco’s forces claimed the Basques had burned the town themselves as a propaganda stunt; then they claimed the Communists had bombed it. Franco denied that German forces were even participating in Spain’s Civil War. In response to the Nationalist propaganda, Basque lehendakari (president) José Antonio Aguirre made a public declaration : “I maintain firmly before God and History, who will judge us, that during three and a half hours German planes have bombarded the defenceless civilian population of the historic town of Gernika, pursuing women and children with machine-guns, and reducing the town itself to ashes. I ask the civilized world whether it can permit the extermination of a people who have always deemed it their duty to defend their liberty as well as the ideal of self-government which Gernika, with its thousand-year-old Tree, has symbolized throughout the centuries.” Franco replied: “Aguirre lies. We have respected Gernika, just as we respect all that is Spanish.” Mola was more forthright, saying: “It is necessary to destroy the capital of a perverted people who dare to oppose the irresistible cause of the national idea.”

Basque priest Father Alberto Onaindia witnessed the carnage in Gernika and wrote in desperation to the Primate of Spain, Cardinal Gomá: “I have just arrived from Bilbao with my soul destroyed after having witnessed the horrific crime that has been perpetrated against the peaceful town of Guernica… Senor Cardinal, for dignity, for the honour of the gospel, for Christ’s infinite pity, such a horrendous, unprecedented, apocalyptic, Dantesque crime cannot be committed.” He begged the Cardinal to intervene to sure the Francoists’ threat – that Bilbo was next – was not implemented. Gomá responded by insisting that Bilbo must surrender. Referring to the Basque Nationalist Party’s (PNV) loyalty to the Republic, he added: “Peoples pay for their pacts with evil and for their perverse wickedness in sticking to them.” Francoist forces viewed the scene a few days later, and a Carlist soldier reportedly asked a senior officer in Mola’s staff: “Was it necessary to do this?” The lieutenant colonel replied that it had to be done in all of Bizkaia and Catalunya. In 1970  PNV member Joseba Elosegi, one of the Basque soldiers from the Battalion Saseta which had withdrawn to Gernika for a period of recuperation and was present on the day of the bombing, carried out an act of self-immolation in a protest against Franco in Donostia, shouting “Gora Euskadi Askatuta!” (Long live the free Basque country!). Elosegi was badly burned but survived and described his protest as the desperate act of a man who had “obsessively remembered” for more than three decades the scenes he witnessed at Gernika.

Steer immediately understood the significance of the attack on Gernika, and in his Times article he wrote:  “In the form of its execution and the scale of the destruction it wrought, no less than in the selection of its objective, the raid on Guernica is unparalleled in military history. Guernica was not a military objective. A factory producing war material lay outside the town and was untouched. So were two barracks some distance from the town. The town lay far behind the lines. The object of the bombardment was seemingly the demoralization of the civil population and the destruction of the cradle of the Basque race.” His report was reprinted in the French communist newspaper L’Humanité on 29 April, where Pablo Picasso read it. The artist captured the international outrage over the attack in his world-renowned painting. He had been commissioned earlier that year by the Spanish Republican government to paint a mural for the Spanish government building at the World Fair in Paris. On 1 May 1937, he dropped his original plan and produced his most famous work, Guernica, instead.

How do vulture funds manage to pay practically no tax in Ireland?

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This is the fourth 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 three key mechanisms for tax avoidance that have been used by multinational corporations (MNCs) in the Irish state over the past decade have been the Double Irish, inversions, and the use of Special Purpose Vehicles (SPVs) under the Irish state’s lax securitisation regime introduced in Dublin’s International Financial Services Centre (IFSC) under the Taxes Consolidation Act 1997.

Bloomberg reported in February this year that a survey by the Financial Stability Board found that the Irish state’s shadow banking sector ranked third with China as the largest in the world after the US and Britain, and at more than 2.3 trillion euros it was 10 times the size of the Irish economy. Half a trillion euros were held by unregulated SPVs, the FSB found. A Financial Vehicle Corporation (FVC) is a securitisation instrument as defined by the European Central Bank FVC Regulation, but while SPVs share many of the same features they are outside the Regulation.

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The Central Bank estimated that in 2015 there were 779 FVCs holding €415 billion – required by the ECB to report quarterly data since 2009 – and 600 SPVs in 2012 holding €150 billion. In its Macro-Financial Review published in June this year, the Central Bank said there was, as of December last year, 820 SPVs holding €322 billion in assets. SPVs were not required by the Central Bank to file reports until last year. SPVs are generally used for loan origination but can also carry out securitisation activities.

Section 110 companies

The Central Bank says that tax provisions introduced in the 1991 Finance Act aimed at allowing the creation of structures that were broadly profit and tax-neutral in order to facilitate the securitisation of mortgages. This was then expanded beyond the IFSC with Section 110 of the Taxes Consolidation Act 1997, which came into effect in 1999.

The assets that could be held, managed or leased by a Section 110 company was extended by the Finance Acts of 2003, 2008 and 2011. SPVs and FVCs use “orphan companies” usually held by a charitable trust in order to keep assets off the balance sheet of their true parent companies. The originating companies of the majority of SPVs in Ireland are from the US, Britain, Germany, France, Italy and Russia. The collapse of two Dublin-based SPVs that originated from German bank Sachsen Landesbank in 2007 led to a €17 billion emergency banking bailout by the state of Saxony.

To qualify under Section 110 the company must be resident in Ireland; acquire qualifying assets of at least €10 million; and notify Revenue that it wants to fall under the Section 110 framework. The qualifying assets can include shares, bonds, securities, insurance and reinsurance contracts, hire purchase contracts, money market fund investments and more. Since 2012, qualifying assets can include commodities, carbon credits, plant and machinery.

While an SPV is a taxable entity, and should be taxed at the non-trading corporation tax rate of 25 per cent, under Section 110 its taxable profit will be measured according to the rules of a trading company – so the SPV is entitled to a tax deduction for all trade expenses, such as interest paid. As a result, SPVs “can utilise various techniques to strip profit out on its underlying investments and can reduce or eliminate the tax it is required to pay” according to law firm Dillon Eustace. The International Tax Review states that Section 110 companies are “typically structured so that income earned is matched with its expenditure resulting in minimal taxable profits”.

The result is that SPVs, in particular vulture funds buying up distressed mortgages in Ireland, are earning millions of euros annually from mortgage-holders and shifting it offshore but are paying as little as €250 in tax to Irish Revenue. According to various media reports, between 2011 and April 2016, vulture funds in the Irish state purchased loan portfolios worth €62.9 billion against the backdrop of a mortgage arrears, housing affordability and homelessness crisis.

Banks are increasingly selling off distressed mortgages to vulture funds at reduced prices, who have proven to pursue repossessions of homes even more aggressively, fuelling the housing and homelessness crisis. In May Ulster Bank announced the sale of 900 family homes with distressed mortgages as part of a €2.5 billion property loan portfolio to vulture funds. This follows the purchase in March of 200 family homes by a Goldman Sachs vulture fund in Tyrellstown, Dublin.

It has been reported that the largest purchasers were Goldman Sachs, Cerberus, Deutsche Bank, Lone Star, CarVal and Apollo. In 2014 the Irish arm of US vulture fund Lone Star, which holds distressed German mortgages, generated €1.24 billion but paid less than €1 million in tax. Cerberus’s 2014 accounts show it generated more than €140 million of revenue on its Irish assets, but paid less than €2,500 in tax.

Goldman Sachs subsidiary Beltany’s 2014 accounts show that it generated income of €44 million – but paid just €250 in corporation tax. Cayman-linked Mars Capital generated revenue of €14 million in 2014 but also paid just €250, as did Launceston Property Finance, which originates from Luxembourg-registered CarVal and generated €16 million. Some of these banks are under the direct supervision of the European Central Bank, leading Sinn Féin MEP Matt Carthy to write to the ECB in June to request it to investigate the relationship between these banks, their associated vulture funds, tax avoidance and evictions in Ireland.

SPV structure

Source: Grant Thornton law firm, ‘SPV taxation’, 30 September 2015

Irish tax law enables tax avoidance by Section 110 companies

The specific features of Irish tax law that enable Section 110 companies to do this include the fact that there are no ‘thin capitalisation’ laws in Ireland (there is no minimum profit required for a company for tax purposes, so an SPV can strip out all of its taxable profits if it chooses). Any costs of raising finance are tax-deductible under Section 110.

The most important provision of the law has been Section 110(4) which permits a Section 110 company to take a deduction for “profit participating interest” if certain conditions are met. The Finance Act 2011 introduced anti-avoidance provisions that sought to deny deductibility for that profit element of interest, but included exceptions that made the measures meaningless.

The anti-avoidance provisions do not apply (so interest is fully deductible) where the recipient of the interest or other distribution is either a person resident in Ireland, or a person (resident in an EU Member State or tax treaty country who is not “connected” with the SPV) who is a pension fund, government body or other person who is exempted from tax which generally applies to profits, income or gains in that jurisdiction. Just in case any of those exemptions do not do the trick, the Finance Act 2011 also introduced an exemption on withholding tax on interest paid through quoted eurobonds.

The Finance Act 2011 also expanded the list of qualifying assets from only financial assets to also to include commodities, carbon credits and plant and machinery, aimed at making Ireland more an attractive site for the aircraft leasing industry. Tax treaties can be used to reduce withholding taxes on inbound payments for lease rentals, and Irish-resident SPVs can receive incoming investment management services without being subject to Irish VAT.

Section 110 companies are allowed to calculate profits according to the old Irish generally accepted accounting principles (GAAP 2004) instead of the new Irish GAAP or International Financial Reporting Standards (IFRS). Dillon Eustace law firm, which advises Ireland’s National Asset Management Agency and Lone Star, among others, says the legislation was amended after industry successfully lobbied Revenue over concerns that International Accounting Standards “could compromise the profit neutrality of an SPV”.
The 2010 transfer pricing rules do not apply to Section 110 companies.

Total return swaps, where the SPV swaps all of its receipts with another company in its group in return for enough funds to discharge liabilities, should be liable to tax but apparently are not in practice and are used as a profit-extracting mechanism. Dillon Eustace advises clients: “There may be a technical liability to Irish income tax for recipients (i.e. the swap counterparty) who are not resident in a country with which Ireland has a double tax treaty but, in practice, this liability is not enforced by the Irish tax authorities.”

Ireland’s membership of the EU and OECD (and its ‘white-listed’ status) and the listing of securities on the Irish Stock Exchange are further incentives for SPVs to domicile in Ireland.

SPVs generally use an orphan entity ownership structure that ensures the entity is not owned by its originating bank or hedge fund but by a charitable trust. Revenue have raised concerns about the use of charities for this purpose as revealed through Sinn Féin TD Pearse Doherty‘s Freedom of Information request last month. Dublin’s corporate law firms generally establish the charitable trust or provide the use of their existing charitable trusts to SPVs.

For example, Matheson has established its own charity, the Matheson Foundation, which it regularly uses to help incorporate SPVs for its clients. Its website says: “The Matheson Foundation has two clear goals: to help children in Ireland to fulfil their potential; and to encourage corporate philanthropy in Ireland.” The Central Bank has found that most FVCs and SPVs incorporated in Ireland have no employees.

Qualifying Investor Alternative Investment Funds

A second key instrument used by international banks and hedge funds to avoid paying tax in the Irish state is the Qualifying Investor Alternative Investment Fund (QIAIF), which replaced the Qualifying Investor Fund (QIF), which was originally established by NAMA in 2012. The QIAIF is primarily a structured fund for real estate investment and is often used together with an SPV to ensure access to double tax treaties. QIAIF assets in Ireland are valued at €302 billion. They require a minimum subscription per investor of €100,000 and are subject to almost no other requirements.

QIAIFs are entirely tax-exempt from income tax and capital gains tax regardless of where the investors are resident, as well as being exempt from withholding tax for any payments made to non-Irish resident investors. Irish Real Estate Investment Trusts (REITs), a vehicle with a collective ownership structure for real estate investment established in 2013, are also exempt from income and capital gains tax from rental payments in most conditions.

The Irish Collective Asset Management Vehicle

The Irish Collective Asset Management Vehicle (ICAV) Act 2015 came into effect in March last year. It introduced a fifth type of corporate fund structure, alongside the investment company, unit trust, common contractual fund and investment limited partnership, and appears to have been established with the explicit goal of facilitating tax avoidance by US investors.

Matheson law firm describes the ICAV as “the culmination of a joint government and industry project to make available to promoters a legal framework for a corporate fund vehicle that is specifically designed for investment funds. Matheson partners were extensively involved in the industry project to introduce the ICAV.” It adds that “it is expected to become the vehicle of choice for UCITS and Alternative Investment Funds in Europe”. If the government’s reaction to accusations it was facilitating tax avoidance by SPVs was disingenuous, its claims to be unaware of the use of the new ICAV structure for tax avoidance is ludicrous.

The ICAV has several features that distinguish it from other fund vehicles:
*An ICAV can classify itself as transparent under the US check-the-box rules in order to avoid taxation that may apply in the US to passive foreign investment companies.
* An ICAV has its own legislative code that will allow it to avoid compliance with several Irish and EU company law requirements.
* It is not required to spread risk, unlike an investment company.
*An existing Irish investment company can convert to an ICAV easily, and a foreign corporate investment fund can domicile in Ireland and convert to an ICAV without incurring Irish tax in either case. Matheson suggests the jurisdictions where migration to Ireland will occur are the British Virgin Islands, the Cayman Islands and Jersey.

Despite the Irish government’s formal support for the OECD-BEPS process and its limited moves to respond to international pressure since 2014, there are a large number of significant legislative gaps that remain in place in the Irish state that not only allow tax avoidance by MNCs and global financial giants, but actively encourage it. Each step forward has been accompanied by “exemptions” that serve to make the reform ineffective, and appear to have been directly designed by the US Chamber of Commerce, the Big Four accounting firms and the major Dublin corporate law firms: Matheson, Arthur Cox, William Fry, Dillon Eustace and others, in a stark illustration of the “captured state” concept applying in Ireland.

Some of these legislative problems will be addressed to a certain extent by the transposition of the European Anti-Tax Avoidance Directive over the next period (though certain provisions, such as exit taxation, won’t take effect until 2020). There are a number of issues that will not be addressed by the ATAD, and a number of glaring loopholes that need to be closed in the meantime – Section 110 being the most urgent of all.

Ireland’s IP ‘Knowledge Box’ – another tool for tax dodgers

ipaid_my_taxes_credit_steve_rhodes_flickr_CCBYNCND2.0_503

This is the third article in a 4-part series on tax avoidance in Ireland.

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?

US technology and pharmaceutical giants in the Irish state have benefited from varioustax credits, incentives and loopholes specifically relating to intellectual property and research and development, in addition to the low Irish corporation tax rate. But very little actual R&D is carried out in Ireland as a result of FDI, with US MNCs preferring to base R&D centres in Israel, China and India.

R&D tax credits against corporation tax were introduced in 2004 and expanded in Budget 2015 as the news that the Double Irish was to be phased out was announced. A 25 per cent tax credit is available on all qualifying R&D expenditure in addition to a 12.5 per cent tax deduction – so, a total of a 37.5 per cent tax deduction on such expenditure, or in other words, a corporate tax rate on R&D activity of around 3.3 per cent. Any company which trades in the Irish state and carries out R&D activities in Ireland or in the European Economic Area and incurs expenditure is eligible.

Before 2015, a base year of 2003 was in place – ie, a company could only claim credit for expenditure over and above what it incurred in 2003. This was to be a rolling base year in order to incentivise companies to spend more but the year didn’t change, and the base year was abolished altogether in Budget 2015. Under a Freedom of Information request, the Irish Times found in January 2015 that Department of Finance officials “expressed concern that changes to tax breaks in Budget 2015 would cost at least €50 million in foregone taxes annually and reward a relatively small number of companies” – just 15 firms, in fact, including one that would benefit by €14 million. The names of the companies were blacked out in the FOI release, but according to the Irish Times, “records indicate many of the firms that stood to benefit lobbied in favour of the move”.

There were no audits carried out on the tax credit scheme for the first decade of its existence. It was reported in September 2015 that 200 audits carried out in 2013 found “several multinational firms have been found to be aggressively and improperly claiming tax credits for research and development to lower their corporation tax bills” and resulted in firms being made to repay €21 million in back taxes. Revenue has identified the tax credit as a “significant risk” and used scientists and technical experts in its audits to determine if the companies were genuinely carrying out R&D.

The OECD modified-nexus regime

Also announced in Budget 2015 (with the phasing out of the Double Irish), and introduced in Budget 2016, was the Knowledge Development Box, a corporate tax rate of 6.25 per cent for profits arising from certain forms of IP. Ireland had already introduced the first “patent box”, a lower rate of tax on IP-related profits, in 2000 before the introduction of the 12.5 per cent corporate tax rate. A British patent box with a rate of 10 per cent from British and/or European patents was introduced in 2013. Luxembourg, the Netherlands, Cyprus, Spain, France, Portugal, Belgium and Malta have all introduced special low tax rates for profits from patents.

Patent boxes have been described as mechanisms for tax avoidance. The OECD-BEPS project proposed action to reduce the potential for profit-shifting abuse through patent boxes by ensuring there was a genuine link, or nexus, between the lower tax rate and R&D that was initially developed in the home state. A German-British compromise in November 2014 resulted in the so-called modified nexus approach being adopted by the OECD, which retained requirements for genuine local initial IP development but added concessions for Britain including a transition period and a 30 per cent “uplift” in what counts as qualifying expenditure to reflect outsourced intra-group research activities and costs.

While the Irish government initially opposed the modified nexus approach publicly during the German-British negotiations, and actively sought the advice of US MNCs in drafting its own legislation, Finance Minister Michael Noonan clearly saw the writing on the wall. Part of the OECD agreement was that all new entrants into existing patent box schemes that did not comply with the modified nexus approach would have to cease by 30 June 2016 and be abolished by 2021. When introducing the KDB in Budget 2016, Noonan stated that it would be the first and only patent box in the world to be fully compliant with the OECD’s modified nexus approach. Following the adoption of the German-British modified nexus approach, the European Commission withdrew its investigation into patent boxes.

Ireland’s Knowledge Development Box

The Irish KDB took effect on January 1 this year. It will apply a 50% allowance in tax relief to “qualifying profits”, resulting in a 6.25% tax rate. Qualifying profits arise from specified trade in “qualifying assets”, being intellectual property resulting from research and development carried out in Ireland or an EU member state. The intellectual property forms that can be qualifying assets are defined as being copyrighted computer software, inventions protected by patents and supplementary protection certificates, and plant breeders’ rights. The formula for calculating the qualifying profits under the KBD is below:

Qualifying Expenditure + 30% Uplift Expenditure  x  Qualifying Asset = Qualifying Profit
Overall Expenditure

Qualifying expenditure is expenditure incurred in R&D activities that lead to the development, improvement or creation of the qualifying asset. Cost-sharing agreements where costs are outsourced to intra-group parties are excluded, but such intra-group expenditure and acquisition costs can be added as uplift expenditure up to 30 per cent. The overall expenditure is the full amount of costs incurred in the R&D and acquisition of the IP, so the qualifying expenditure is measured as a proportion of this. The qualifying asset is the profits made by the specified trade in the IP product and can include any royalty or other sum received in respect of the use of that qualifying asset – including sales income attributed to the qualifying asset on a “just and reasonable basis”.

The specified trade in the qualifying asset can include:
– the managing, developing, maintaining, protecting, enhancing, or exploiting of the IP;
– the researching, planning, processing, experimenting, testing, devising, developing or other similar activity leading to an invention or creation of intellectual property; or
– the sale of goods or the supply of services that derive part of their value from the activities described  above.

KBD open to abuse

The corporate lobby initially expressed disappointment about the government’s use of the modified nexus approach, with one lobbyist saying: “What the Government could have done is waited longer to produce it. If they waited a few years more the temperature could have dropped and there would have been less focus on international tax, and they may have been able to pick up ideas from other countries… It has certainly impacted on how effective the KDB will be for the future in terms of an incentivisation vehicle.”

The Big Four accountancy firms and some corporate law firms have been more optimistic – while they have criticised the “onerous” tracking and tracing provisions that require a separate profitability stream to be accounted for each asset, they have nevertheless welcomed the KBD as a means to reduce tax bills that will specifically benefit the technology and pharmaceutical MNCs provided they jump through a few extra hoops. For example, the pharmaceutical sector generally uses “serialisation” features that correspond with the tracking and tracing provisions, but these would need to be developed in the technology sector.

Deloitte stated: “In our view, the introduction of the Irish KDB regime is welcome, although the narrow scope of IP assets that will qualify for the regime ultimately will result in limited uptake [ie, not trademarks] outside of the pharmaceutical and technology sectors.” William Fry law firm has said: “Overall, the KDB is to be welcomed as it bolsters Ireland’s competitive tax regime and complements existing tax benefits for IP such as research and development relief and the capital allowances available in relation to intangible assets. Given the limitations where research and development is carried out by group companies, in the first instance, the KDB relief may be more beneficial to indigenous companies. However, with proper planning, the relief may also prove to be of benefit to multinational enterprises.”

There is no doubt that the KBD will benefit MNCs disproportionately and that the KBD is wide open to abuse. The definition of R&D activities is identical to the definition in the R&D tax credit legislation, and it too can be self-reported by corporations when filing their accounts. The hugely problematic nature of measuring the value of intangible assets remains. The weak existing transfer pricing regulations on the arm’s length principle from the 2010 legislation will be applied. There is a right for Revenue to consult with experts on the R&D being claimed if it wishes to, as under the R&D tax credit regime, but a corporation can appeal against such consultation on the grounds that disclosure would be prejudicial to its business.

Put simply, there is nothing in the KBD legislation to prevent it from being used to concentrate profits offshore. The Double Irish system where all non-US sales pass through Irish subsidiaries to dramatically reduce the tax bill can continue but in a simplified way, with both Irish subsidiaries being tax-resident in Ireland, with one that can collect sales profits and another that holds IP rights and receives royalties that are taxed at the 6.25 per cent rate.

Inevitable profit-shifting – a theoretical example

Here is just one theoretical example of how the KBD can be exploited: a technology MNC, Pear Inc, is headquartered in Silicon Valley where 90 per cent of its overall R&D is carried out. It has two subsidiaries in Ireland called Pear Ireland Ltd and Pear Ireland Holdings. Pear Inc develops a software programme, called iThing, with 100 per cent of the R&D carried out in San Francisco. Pear Ireland Ltd then works on the next generation of the product – iThing 2.0.

It could claim to spend 70 per cent of the relatively small amount of R&D expenditure needed to make a few changes or improvements to the original iThing programme in Ireland, resulting in the creation of iThing 2.0. The new programme would not need to be patented with the Irish Patent Office because computer programmes are generally excluded from patentability but are specifically included in the qualifying asset IP definition in the KBD.

Because the new variation of the programme is in itself a qualifying asset, the overall expenditure does not necessarily need to include the original expenditure incurred in San Francisco, only the 30 per cent of expenditure not attributed to Ireland. As intra-group cost-sharing agreements are not allowed under the KBD, Pear Ireland Ltd can under certain circumstances add 30 per cent uplift, equaling 100 per cent of overall expenditure.

To be sure, Pear Ireland Ltd can simply obtain an advanced opinion from the compliant Irish Revenue to affirm its calculation that it incurred 70 per cent of the R&D costs, as the track and trace provisions are only required to be checked by the home state. Pear Ireland Ltd then licenses the IP to Pear Ireland Holdings, which collects all of the non-US sales profits from iThing 2.0 but reduces its taxable income through paying royalties and/or licensing fees to Pear Ireland Ltd under the clearly ineffective existing arm’s length legislation.

Then 100 per cent of the royalties and licensing fees received are attributable to the R&D expenditure carried out in Ireland, calculated as qualifying profit under the KBD and taxed at 6.25 per cent (this is on top of the 37.5 per cent tax deduction available for R&D expenditure through the combined R&D tax credit and the 12.5 per cent R&D tax deduction). This is an extremely simplistic example of a structure but it could obviously be improved in terms of tax avoidance through the more creative use of royalty payments and subsidiaries around the world including in tax havens.

No evidence that patent boxes stimulate R&D

There is little evidence that patent boxes do anything to increase genuine R&D or attract FDI in the productive economy in the states they exist in. Speaking in Dublin in March this year, the head of the OECD’s centre for tax policy Pascal Saint-Amans, said the development of knowledge or patent boxes does little to actually foster innovation and the creation of intellectual property.

This was followed by an OECD report in June this year which said Ireland’s public financial support to R&D businesses was “skewed” towards R&D tax credits that benefited MNCs, and explicitly called for public resources to be redirected away from MNCs to local SMEs, where there was little growth, in order to develop indigenous enterprise and increase productivity. Despite more than a decade of generous R&D tax credits and other tax incentives to promote FDI, less than one-third of IDA Ireland companies invest in R&D at all.

But despite its limitations and potential for abuse, a system of R&D tax credits, targeted towards SMEs and indigenous enterprise, has a broader economic and social value if implemented correctly – whereas there is no such corresponding social and economic benefits arising from a patent box regime. A research paper on patent boxes in 2014 argued: “Tax incentives for R&D expenditure reward firms for the societal benefits from innovation that they themselves are unable to appropriate. It is hard to make the argument that a patent box serves the same purpose: patent boxes introduce a preferential rate for income from innovations that are already protected by Intellectual Property Rights (IPRs). IPRs enable firms to capture a large part of the societal benefits, such that the need for a tax incentive for protected innovations becomes unclear.”

The supposedly limited opportunities the modified-nexus compliant KBD presents for US MNCs to reduce their tax bills makes it all the more likely that it has been introduced in the full knowledge that it will be exploited, while the government will turn a blind eye. Based on the form of successive Irish governments in relation to tax avoidance, we can guess that the government had two goals with introducing the KBD: to send a political message to US MNCs that the Irish government remained committed to ensuring the Irish state could continue to be used as a conduit for tax avoidance despite the phasing out of the Double Irish; and to introduce yet another mechanism that is wide open to abuse in order to please MNCs.

In the context of the phasing out of the Double Irish and an international crackdown on the use of offshore tax havens, the Irish KBD is an attractive mechanism for creative “onshore” tax avoidance. Matheson law firm advises its clients that offshore tax havens such as Bermuda and the Cayman Islands don’t have “the necessary economic infrastructure to which value and ultimately profits can justifiably be attributed”, whereas Ireland on the other hand can construct “profit-generating centres defensible by reference to functions, risks and tangible assets of the Irish operation,” advice that has become all the more relevant in the post-BEPS context.

Continued: How do vulture funds manage to pay practically no tax in Ireland?

Yes, we’re still a tax haven for tech giants

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Irish Taoiseach Enda Kenny with Apple CEO Tim Cook

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

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.

Google

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

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.

Apple structure.jpg

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

Irish state marketed for tax avoidance since 1950s

Revenue

This is the first in a 4-part series on tax avoidance in the Irish state, and focuses on the history of the relationship between corporation tax rates, avoidance and foreign direct investment.

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 Irish state has pursued an economic development policy based on attracting foreign direct investment since the 1950s. A low rate on corporate income and profits tax and loose financial regulation have been features of the state since this time, though for decades they were unsuccessful at attracting FDI. In 1956, the Export Profits Tax Relief provided a rate of zero corporation tax for manufactured exports. This system of tax exemptions for certain areas and industries developed over the following two decades. In the 1970s, the Industrial Development Authority (IDA) “started aggressively marketing Ireland’s tax system internationally, under slogans such as ‘no tax’ and ‘double your after-tax profits’.”

After the Irish state joined the European Economic Community in 1973 it was forced to turn this system of specific exemptions into a single rate across the whole manufacturing sector to comply with EEC rules on non-discrimination. As a result, the Fianna Fáil government introduced a corporate tax rate of 10 per cent for all manufacturing companies in 1981, followed by a 10 per cent rate for financial services in 1987, with the creation of the International Financial Services Centre (IFSC) in Dublin’s docklands. Other sectors of the economy lobbied for a reduction in the corporate tax rate applicable to them, and in 2003 the single corporate tax rate of 12.5 per cent for all companies’ trading profits was introduced, while passive income and company capital gains were to be taxed at 25 per cent.

A significant part of the debate surrounding Ireland’s corporation tax regime has centered on the role of the 12.5 per cent rate in generating the Celtic Tiger economic growth spurt in the 1990s and 2000s. The dominant narrative expounded by establishment political parties, media and state institutions is that the introduction of the 12.5 per cent rate was the single biggest factor that contributed to the boom. But the surge in growth in GNP began in 1993, a decade before the introduction of the 12.5 per cent rate, and more than a decade after the introduction of the 10 per cent rate in manufacturing. This was the year the Irish state joined the European Single Market, with Irish citizens gaining easy access to housing finance with no exchange rate risk from the mobile financial capital available for the first time. The resulting property boom and spike in consumption were the key factors contributing to the sharp rise in GNP from 1993 onwards. Barry Eichengreen wrote: “Claims on the Irish banking system peaked at some 400 per cent of GDP… It reflected the freedom with which Irish banks were permitted to establish and acquire subsidiaries in other EU countries.”

The graph below from the Fools Gold blog (by the Tax Justice Network and Warwick University) is a visual illustration of the timing and factors associated with the boom.

Ireland-GNP-graph

Irish GNP from 1955-2012

FDI inflow into Ireland expanded on a huge scale during the 1990s. It rose from 2.2 per cent of GDP in 1990 to 49.2 per cent of GDP in 2000. There were many contributing factors to this, with accession to the single market – and the growth in GNP and consumption that this prompted – being the most crucial. Other often-cited factors include Ireland’s joining of the single currency in 1999, its geographical location and its skilled, low-waged and English-speaking workforce. Currently foreign (mainly US) multinational corporations (MNCs) account for around 90 per cent of ‘exports’ and employ an estimated 150,000 people, around 8 per cent of the workforce. There is no doubt that FDI has since the 1990s played a dominant role in the Irish economy. The low corporate tax rate has certainly contributed significantly to this inflow of FDI, in addition to the factors outlined above. The two policy factors that have been equally or even more important than the low corporate tax rate are the large number of other ‘peculiarities’ of the Irish corporate tax regime, and the creation and promotion of the IFSC in Dublin as a centre for global finance that is almost totally unregulated.

Public debate on the corporate tax regime in Ireland

There are extreme economic and social costs associated with this model of economic development, in Ireland and internationally. The costs associated with the lack of regulation in the IFSC, and its promotion of the shadow banking system, have been demonstrated clearly and painfully in the €70 billion financial collapse of the Irish banking sector of 2008. The costs associated with Ireland’s corporate tax regime are also enormous. Public policy debates around Ireland’s corporate tax regime in recent years have centered on two key issues: domestically, whether the 12.5 per cent rate is sufficient, and whether it is in fact the effective rate paid by US MNCs; and Ireland’s role in the global chain of tax avoidance. A third, more neglected, issue of debate is economic over-dependence on US MNCs and the long-term poor performance of Irish indigenous industry, though this has now come into the public domain to a certain extent with the publication of this year’s 26.3% growth in GDP as a result of distortions largely caused by MNCs’ inversions and other accountancy tricks.

Throughout the 2000s it became clear that the nature of Ireland’s corporate tax regime meant mainly US-based MNCs were using the state in conjunction with offshore tax havens to massively reduce their global tax bills. A study by tax expert Martin Sullivan published in Tax Notes in 2004 showed that Ireland was the most profitable country in the world for US corporations. The following year, an investigation by the Wall Street Journal revealed that Microsoft was using a subsidiary based in the offices of a Dublin law firm to reduce its annual tax bill by at least $500 million. In 2009, in response to plans by the incoming Obama administration in the US to tackle tax avoidance, state agency Industrial Development Authority (IDA Ireland) hired a lobbying group in Washington DC to support the status quo.

Since the rise in international tax justice activism in 2010, successive Irish governments have been at pains to insist, “Ireland is not a tax haven”. Government representatives have stated that Ireland’s low tax rate is the “cornerstone of our economic policy”; that it is statute-based and effectively enforced. A still-running debate on the effective rate paid by US-based MNCs was sparked in 2011 when Finance Minister Michael Noonan claimed the effective rate of tax in Ireland was 11.9%, while in France it was (he claimed) only 8.1 per cent. Speaking in France in 2014, Taoiseach Enda Kenny quoted a PriceWaterhouse Coopers/World Bank report (2014) that stated Ireland’s effective corporate tax rate was 12.3 per cent. He was speaking in response to questions over Yahoo’s decision to transfer finance operations to Ireland from France. Kenny also claimed that the effective rate in France was 8 per cent (in fact, this rate refers only to SMEs and the effective corporate tax rate for MNCs in France is 33 per cent). A paper from Prof Jim Stewart from Trinity College Dublin pointed out that the PwC study was based on a small, domestic company that makes ceramic flowerpots and has no imports or exports. He wrote: “These assumptions automatically rule out tax planning strategies which are widely used by subsidiaries of MNCs.”

Using data from the US Bureau of Economic Analysis, Stewart showed that: “US subsidiaries operating in Ireland have the lowest effective tax rate in the EU at 2.2%. This tax rate is not that dissimilar to effective tax rates in countries generally regarded as tax havens such as Bermuda at 0.4%.” The Department of Finance commissioned an official study later in 2014 by economists Kate Levey and Seamus Coffey to reject Stewart’s findings, which excluded in their calculations the $144 billion in profits that US MNCs move through Ireland to other jurisdictions, saying it was not taxable in Ireland as though these entities may have been incorporated in Ireland they were not ‘resident’ and therefore the money was not taxable. Tax justice activists said this was precisely the point. Meanwhile, the Irish Times carried out a survey of the top 1,000 corporations operating in Ireland that found an average effective tax rate of 15.5 per cent – which has no bearing on the debate as it was a measurement of the companies’ overall global effective rate. Finfacts has reported that the largest corporate law firm in Ireland, Arthur Cox, said in a 2011 briefing on ‘Uses of Ireland for German Companies’: “The effective corporation tax rate can be reduced to as low as 2.5% for Irish companies whose trade involves the exploitation of intellectual property… A generous scheme of capital allowances as well as a tax credit for money invested in research and development in Ireland offer significant incentives to companies who locate their activities in Ireland.”

It was of course not only tax credits that provided for the low effective rate for US MNCs but massive transfers of wealth using IP-related mechanisms. Even Coffey, author of the government-commissioned refutation of Stewart’s claim of a 2.2 per cent tax rate of US MNCs, separately explained that the relatively low rate of taxable profits made by Irish subsidiaries of US MNCs resulted from profit-shifting from Ireland to Bermuda and the Cayman Islands through the payment of massive patent royalties, which amounted to nearly €30 billion in 2011. The US BEA “attribute these profits to Ireland as the holding companies are Irish incorporated”. The Tax Justice Network reports that studies using various ways of calculating the overall effective corporate tax rate in the Irish state found rates of between 2.5 per cent and 4.5 per cent. In 2014, a study by Eurostat on the implicit corporate tax rate (a backward looking measurement of the average effective tax burden) found an effective rate in Ireland of 6 per cent in 2012, down from 9.3 per cent in 2002, while the implicit tax rate on labour was 28.7 per cent in 2012, up from 26 per cent in 2002.

Continued: Yes, we’re still a tax haven for tech giants

Social dumping and the revision of the Posting of Workers Directive

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The current proposal from the European Commission to revise the Posting of Workers Directive will not establish ‘equal pay for equal work in the same place’ nor effectively combat social dumping, and it needs to be significantly strengthened in order to have any impact.

The European Commission adopted a proposal for a Directive amending the 1996 ‘Directive on the posting of workers in the framework of the provision of services’ (Posted Workers Directive) on 8 March 2016. This ‘targeted revision’ of the PWD was announced as part of the Labour Mobility Package in the Commission’s Work Programme for 2016. The other two items in the Labour Mobility Package are a Communication on labour mobility and the revision of the Regulation on social security coordination – and the latter has now been postponed until after the British referendum on EU membership scheduled for 23 June 2016.

The Commission proposal for a Directive amending the PWD was referred to the European Parliament’s Employment and Social Affairs Committee. Since then, the ’yellow card’ procedure has been invoked by certain Member States against the revision of the PWD.

The stated goal of the 1996 PWD, which came into force in 1999, was to combat social dumping and prevent distortions of competition in the context of expanded European integration and increased posting of workers. Its central principle was that the pay and working conditions in effect in a Member State should be applicable both to local and posted workers.

The limitations of the original PWD, together with a very narrow interpretation of the rights it conferred by the European Court of Justice (ECJ), combined to make sure that the PWD only provided posted workers with a legal right to the basic minimum rights and conditions, and was largely ineffectual as a measure to combat social dumping.

Campaigns, in particular by the ETUC, for a revision of the PWD in light of the ECJ rulings were long ignored by the Commission, which eventually proposed an Enforcement Directive containing only marginal improvements to reduce abuse of posted workers in 2014. The deadline for the transposition of the Enforcement Directive by Member States is 18 June 2016.

A push in 2014 by several Member States for a revision of the PWD to establish the principle of ‘equal pay for equal work in the same place’ led to the current Commission proposal for a Directive amending the PWD.

Yellow card procedure invoked

By 10 May 2016 – the deadline for the ‘subsidiarity’ check by Member State parliaments on the Commission’s legislative proposal to amend the PWD – enough Member States had objected to the proposal on the grounds of subsidiarity for the ‘yellow card’ procedure to be invoked.

Under the yellow card system introduced as a protocol to the Lisbon Treaty, each Member State parliament can review draft EU legislation within eight weeks of receiving a proposal and produce a “reasoned opinion” objecting to the draft legislative act if it is believed the proposal breaches the principle of subsidiarity.

One-third of the total votes (at least 19 out of the total 56) is the threshold required to invoke the yellow card. In this case 11 Member States cast 22 votes for a review of the proposal. These were: Bulgaria, Croatia, Czech Republic, Denmark, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Slovakia. Five of these states also claimed the proposal was in breach of the principle of proportionality. Their submissions can be read here.

The Commission as the author of the draft legislation is now required to review the proposal, after which it may proceed to maintain, amend or withdraw the draft, and it must provide reasons for its decision. The EP’s rules of procedure mean it cannot move forward with the proposal until the author has stated “how it intends to proceed”. There is no time limit on the review.

Posted workers and social dumping

A ‘posted’ worker is one sent by his/her employer to work for that employer on a temporary basis in an undertaking the employer has established in another Member State.  The Commission claims that these are citizens “providing a service” in another Member State, and that they do not integrate into the labour market of the host state. A posted worker is paid by the company they were recruited by in their home state, and their social security contributions continue to be paid to their home state.

According to the Commission’s 2014 figures, there are more than 1.9 million posted workers in the EU, up by 10% from 2013 and up by 44% since 2010. Germany, France and Belgium were the top three destination states, receiving more than half of all posted workers, with EU-15 Member States the destination for 86% of all posted workers.

Poland, Germany and France are the top three states posting workers to other Member States. Construction accounts for more than 40% of all postings. There are three cross-border situations that the PWD covers: subcontracting, intra-corporate transfers and posting of temporary agency workers.

There is not an agreed definition of social dumping in the EU institutions but Eurofound (2012) defines it as “a practice involving the export of goods from a country with weak or poorly enforced labour standards, where the exporter’s costs are artificially lower than its competitors in countries with higher standards, hence representing an unfair advantage in international trade”. An alternative definition from the ETUI (2014) defines it as “the practice, undertaken by self-interested market participants, of undermining or evading existing social regulations with the aim of gaining a short-term advantage over their competitors”.

The tendency is for companies to use posted workers for labour-intensive jobs in low value chains, particularly in construction and transport, and for the company to pay only the minimum rate of pay legally required in the host Member State (or to illegally avoid observance of the host state’s labour laws and standards). As well as wage dumping, companies reduce other working conditions to make savings and require employees to pay high charges, for example for housing.

Concerns over the use of posted workers for social dumping within the European market became a political issue in the late 1980s and early 1990s as cross-border service provision expanded following the incorporation of Greece, Spain and Portugal. The first major ruling issued by the ECJ on the rights of posted workers versus the right to provide services was Rush Portuguesa, in which a Portuguese company posted workers to France under Portuguese pay and conditions, and was challenged by the French government for doing so without its authorisation.

The court ruled that the Company had the right to post its own workers to France under the ‘freedom to provide services’ contained in the Treaty of Rome, but also that France had the right to enforce the application of French labour laws.

Posted Workers Directive

The 1996 Directive was introduced as a result of the public debate and concerns of trade unions and some Member States regarding unfair competition on wages and working conditions arising from the posting of workers. It established a set of regulations aimed at ensuring minimum protection in destination Member States. Specifically, it guarantees the application of the host Member State’s statutory and regulatory provisions relating to:

*maximum work periods and minimum rest periods;
*minimum paid annual holidays;
*the minimum rates of pay, including overtime rates (excluding supplementary occupational retirement pension schemes);
*the conditions of hiring-out of workers, in particular the supply of workers by temporary employment undertakings;
*health, safety and hygiene at work;
*protective measures with regard to the terms and conditions of employment of pregnant women or women who have recently given birth, of children and of young people; and
*equality of treatment between men and women and other provisions on non-discrimination.

There are exceptions to the right to these minimum provisions for postings lasting less than a month, for the crew of merchant ships, for staff involved in the initial assembly, and where the amount of work to be done is “not significant”. The “temporary” nature of the posting was not defined by a time limit in the Directive.

In the construction sector “collective agreements or arbitration awards which have been declared universally applicable” must also be applied.

Interpretation of PWD as a maximum directive

While the 1990 Rush Portuguesa ruling suggested EEC members could actually extend all employment laws and regulations to posted workers, the ‘minimum’ rights outlined in the PWD and subsequent rulings by the ECJ in the 2000s enabled companies to exploit “the difference between minimum and standard levels of protection”.

The court has held that host Member States cannot require posting employers to comply with standards that go beyond the terms of the PWD – ie, posting employers cannot be required to pay wages at rates higher than the legal minimum, and cannot be required to adhere to standards not included in the minimum list of provisions above. It has also held that the right of workers and union to take collective action, including the right to strike, is subject to the right to freedom to provide services and freedom of establishment.

Some of the most significant cases include:

Laval: In 2004, Latvian firm Laval posted Latvian construction workers to Sweden and refused to acknowledge the existing collective agreement with the Swedish Building Workers’ Union. As Sweden had a well-functioning collective bargaining and agreement system and did not have an across-the-board minimum wage bound in law, Laval claimed that it was not obliged to pay the rates collectively agreed in the building sector.

The Swedish building union took collective industrial action. Laval claimed to the ECJ that it was being discriminated against on the grounds of nationality and that the Swedish union was infringing upon its right to provide services.

The court found that companies or “service providers” from another EU state are obliged to abide by the host agreement but collective action must be “proportional”. This means that the ECJ believes workers do have the right to take industrial action – but only when the minimum wage or conditions of the host country, or the minimum working conditions set out in the Posting of Workers Directive are being breached by the employer. The Laval case is viewed as the moment the PWD switched from being viewed as a minimum to a maximum directive.

Viking: In order to cut costs, the Finnish shipping company Viking Line attempted to re-flag its ships as Estonian and operate out of Estonia. When two Finnish maritime unions organised a blockade of Viking Line, Viking took its case to the ECJ: again, the claim was that the company’s right to freedom of movement was being restricted by the industrial action of the workers. In December 2007, while the court found that collective action to protect posted workers from exploitation was legal, the unions had restricted Viking Line’s right of establishment.

Rüffert: German company Objekt und Bauregie employed a Polish sub-contractor to employ Polish building workers, posted to Germany, on less than half the minimum wage agreed by German trade unions and employer associations. In 2008, the ECJ ruled that O&B should not be bound by the local Lower Saxony law that states public building contractors must abide by the existing collective agreements.

The court found that while member states may impose minimum pay rates on foreign companies posting workers in their state, the local law restricted the “freedom to provide services” and was not justified by the aim of protecting the workers because workers in the private sector were not covered by such protections.

In essence, this ruling prevents above-minimum wages and conditions being included in public tender contracts, conflicting with ILO Convention 94, which takes the approach that  public procurement contracts should not be used to exert downward pressure on wages or conditions.

Luxembourg: The European Commission took Luxembourg to the ECJ claiming that by imposing its labour law provisions – especially the mandatory indexation of wages – on all workers, including posted workers, the Luxembourg government was going beyond what was allowed under the PWD. The Luxembourg government argued that the application of these laws to posted workers was in the interests of ‘public policy’.

The court held that for public policy reasons to justify enforcing above-minimum standards, such standards must be “crucial for the protection of the political, social or economic order (in such a way) as to require compliance by all persons present on the national territory, regardless of their nationality”.

However, in February 2015 the ETUC welcomed the ruling in Sähköalojen ammattiliitto ry, which diverged from Laval and found that a host Member State can require posting companies to pay holiday allowances, daily flat-rate allowances to compensate workers for posting, and compensation for travelling time, on equal terms as local workers; and that if binding collective agreements set different pay levels for different groups of employees, these should be considered as being in line with the PWD.

Impact of ECJ’s PWD case law on right to take collective action

Overall the case law (with the exception of the more recent Sähköalojen ruling) highlights the following problems with the PWD in relation to collective action:

The right to take collective industrial action, including the right to strike, is not in fact guaranteed in the EU as it is subject to “Community law and national laws and practices”, which means it can be restricted.

The right to take collective action to prevent the exploitation of posted workers by foreign service providers is subject to the company’s right to freedom of movement and establishment under the EU Services Directive – a right which the ECJ has repeatedly and consistently upheld as being superior to workers’ rights. The Court now says that the freedom of establishment “may be relied on by a private undertaking against a trade union or an association of trade unions”. This means employers can take unions to court for any collective action by arguing it is violating their economic freedoms.

The collective action of workers and unions taken against posting companies is only deemed legitimate if it is “proportional” – that is, in defence of the most basic minimum conditions agreed on by EU bodies or set in law by the host country. The higher-than-average conditions that may be included in public sector agreements are an infringement of the right to establishment.

Enforcement Directive 2014

In response to calls for a revision of the PWD in light of the ECJ jurisprudence, the Commission claimed up until 2014 that such a revision was not necessary due to the introduction of Better Law-Making and REFIT, and that an Enforcement Directive on the PWD would resolve outstanding issues. The deadline for transposition of the Enforcement Directive is 18 June 2016.

The Enforcement Directive:

*lists criteria characterising the existence of a genuine link between the employer and the Member State of establishment (to combat ‘letterbox companies’)
*defines Member States’ responsibilities to verify compliance with the rules on posting of workers
*lists national control measures that the Member States may apply when monitoring compliance with the working conditions applicable to posted workers
*sets requirements for posting companies to facilitate transparency of information and inspections
*empowers trade unions and other parties to lodge complaints and take legal and/or administrative action against the employers of posted workers, if their rights are not respected
*ensures the application of administrative penalties and fines across the Member States if the requirements of EU law on posting are not respected.

The Enforcement Directive partially addresses a key problem with the application of the PWD in relation to subcontractors by introducing joint liability on the main contractor. This will set out who can be held liable for payment of wages, but does not determine what the wage of posted workers within a subcontracting chain should be.

The fundamental problems with the design of the PWD and its interpretation by the ECJ that have been outlined above were not addressed in the Enforcement Directive, which limited its scope to addressing fraud, circumvention of rules, and exchange of information between the Member States.

Commission’s new proposal has many limitations

In 2014, a group of Member States led by France campaigned for a revision of the PWD. Austria, Belgium, France, Germany, Luxembourg, the Netherlands and Sweden  signed a joint letter to the Commission calling for such a revision in order to establish in EU law the principle of ‘equal pay for equal work in the same place’, a demand supported by the ETUC and most European trade union federations. In response to this pressure, the Commission brought forward its proposal for a targeted revision of the 1996 Directive in March.

In doing so, the Commission finally admitted the existence of social dumping in the EU and its relationship with the PWD. In its Impact Assessment on the new proposal for a Directive amending the PWD, the Commission admits: “The 1996 Posting of Workers Directive establishes a structural differentiation of wage rules applying to posted and local workers which is the institutional source of an un-level playing field between posting and local companies, as well as of segmentation in the labour market,” and states that “the existing Directive has an in-built structural wage gap between posted and local workers”.

The key aspects of its proposal are:

*The ‘limited time’ a posted worker counts as a posted worker is defined as being 24 months or less, after which s/he will be covered by the labour law of the host state.
*The same rules on remuneration will apply to local and posted workers – but only if these are set by law or by universally applicable collective agreements.
*The rules set by universally applicable collective agreements become mandatory for posted workers in all economic sectors.
*Within sub-contracting chains, Member States will have the option to apply to posted workers the same rules on remuneration that are binding on the main contractor and even if these rules result from collective agreements that are not universally applicable.
*The principle of equal treatment with local temporary agency workers will also be applied to posted temporary agency workers, aligning the current legislation on domestic temporary agency work.

The key limitation of the Commission’s proposed revision is that it will not establish equal pay for equal work in the same place. The ‘same rules’ on remuneration will apply only when the standard is enshrined in law or in a universally applicable collective agreement, which is some Member States excludes the vast majority of collective agreements.

The two-year period before assimilation into the local labour market means most posted workers will be excluded as 90 per cent of posted workers are posted for less than 24 months at an average of 4 months.

It does not address the conflict between the right to take collective action and the right to freedom to provide services.

It also does not address the tension on the role of public procurement contracts between the Rüffert  case, the Public Procurement Directive  and ILO Convention  94, which states that conditions  under  public procurement contracts should not be less favourable than those established  for  the  same  work  in  the  same  area  by  collective agreement  or  similar  instrument.

The proposal does not make the general contractor liability at all stages of the subcontracting chain binding, and it does not require adequate proof of a pre-existing labour relationship before posting providing a service of similar nature.

All of these issues should be addressed through the process of revising the PWD in order to ensure it actually finally becomes an effective instrument to combat social dumping.