Monday, December 11, 2017

Getting somewhere with the Current Account

As part of its response to the 2008 crisis the EU has set up the Macroeconomic Imbalance Procedure which “aims to identify, prevent and address the emergence of potentially harmful macroeconomic imbalances”The identification is done via a scoreboard of indicators with various thresholds

Our concern here isn’t on the choice of indicators, the thresholds chosen or the one-sided nature of the adjustments but on the work done by the CSO to make some of the indicators logical from an Irish perspective.  We know that lots of macro aggregates in Ireland are distorted and unless this is identified a scorecard with arbitrary thresholds could lead misleading conclusions and adjustment requirements.

The CSO first published its version of the Macroeconomic Scorecard for 2013As we considered at the time this provided a very useful breakdown of private sector debt with debts of the NFC sector broken down by Irish-owned and foreign-owned parents.  There were lots of wild claims that debt in Ireland was four, five or more times national income.  The CSO’s work via the macroeconomic scoreboard was important in helping to get the actual position set out.

The work has continued with scorecards produced for 2014 and 2015 with the latest one for 2016 published last week.  The graphics have got flashier and the insights into things like the current account and net international investment position have got better.

The work on the Balance of Payments current account is particularly useful given the importance of this measure.  A distorted current account offers few insights.  Here is Ireland’s headline current account from the Balance of Payments.

BoP Current Account Unadjusted

Over the past few years the breakdowns provided by the CSO focused on the impact of redomiciled PLCs and the changing treatment of aircraft for leasing.  However, the extraordinary recent jumps in the balance are due to the impact of intangible assets and it was clear that this would have to be addressed.

This started with the publication of the modified national income measures back in June which included a modified current account, CA*.  As the CSO explained:

CA* is the current account balance (CA) adjusted for the depreciation of capital assets sometimes held outside Ireland owned by Irish resident foreign-owned firms, e.g. Intellectual Property (IP) and Aircraft Leasing, alongside the repatriated global income of companies that moved their headquarters to Ireland (e.g. redomiciled firms or corporate inversions).

The size of these adjustments was shown in this table (click to enlarge).

BoP Table 1 Original

So if we subtract the depreciation of foreign-owned IP and aircraft for leasing as well as the net income of redomiciled PLCs the outcome is:

Bop Current Account Star Adjustments

The 2016 figure shows that all is not well with this approach and as we discussed here the issue was likely related to the acquisition of aircraft and intangible assets.  These were being bought by Irish-resident entities but being funded by intra-company loans so any deficits arising from these acquisitions are of little concern to the rest of us. 

The CSO have included an updated approach to the modified current account in their 2016 macroeconomic scoreboard that takes this into account.  As they say in a revised version of their note on the modified current account:

Since the original publication the CSO has made a further change to CA* to exclude the cost of investment in aircraft related to Leasing and the cost of R&D related IP from the current account balance. Some firms borrow money abroad to finance their investment by purchasing IP from their parent company. In the long term this debt is repaid from the profit on the IP or the aircraft being leased. It means that this borrowing is not a liability of residents of Ireland and the purchase of this IP needs to be excluded when deriving CA*.

A couple of extra columns have been added to the table showing the adjustments (again click to enlarge).

BoP Table 1 Updated

As before the adjustments for depreciation and redomiciled income are subtracted while now  adjustments for imports are added back in to give the updated version of the modified current account.  The headline and modified current account balances are:

BoP Current Account CA versus updated CA star

This is much better and there is no doubt that this modified current account gives a much more informed view of the underlying position of the economy relative to the headline current account.  This is further evidence of the work being undertaken by the CSO to provide meaningful indicators of the underlying conditions of the Irish economy.

As discussed here there may still be some concerns that the figures for recent years are a little high.  The modified balance is a surplus of €13 billion for 2016.  This may be related to the treatment of expenditure on R&D services as intermediate consumption for Balance of Payments purposes and gross fixed capital formation in the National Accounts. 

If this is an issue it may be remedied in due course and it does not require any changes to the adjustments now proposed to get the modified current account, CA*, as any revisions to the headline balance will automatically apply to the modified balance.  It may have taken a while but there’s no doubt that we’re now getting somewhere with the modified current account and as with other indicators of the Irish economy this is showing that we’re in pretty good shape.

Friday, December 1, 2017

The Aggregate Corporation Tax Computation for Companies with Net Income of More than €10 million

The last post looked at the corporation tax computation for companies with no net trading income.  Here we look at the other end of the scale and consider the aggregate outcome for companies with net trading income of more than €10 million.  Companies in this category make up about 500 of the 145,000 or so companies who filed tax returns for accounting periods ending in 2015.  It should also be noted that the composition of companies in the subgroup may differ across years.

Again, we will show a comparison between the figures for all companies and those in the chosen subgroup.    

Corporation Tax Computation for Companies with 10m Trading Income

Unsurprisingly these companies with the largest net trading income are the source of most on the net trading income in the economy.  Around 88 per cent of net trading income in 2015 (€72.4 billion out of €82.7 billion) arose in companies with a net trading income of more than €10 million.  

Perhaps surprisingly these companies only generated 56 per cent of the starting point: gross trading profits.  These reflects large use of capital allowances and previous losses by other companies especially, as we saw, companies with no net trading income.  The companies here has 16 per cent of the available capital allowances and, for 2015 at least, has less than two per cent of the available prior losses carried forward.

Of other income, these companies reported less than ten per cent of the total amount of rental income and foreign income but did have more than 40 per cent of the capital gains included in the Corporation Tax returns.

Unfortunately we are not given a breakdown of trade charges and group relief by range of net income but it is clear that the vast majority of these arise in these companies.  Before deductions and charges these companies had a Total Income of €74.2 billion in 2015 which after those items translated in a Taxable Income of €45.9 billion. 

Trade charges primarily refers to certain royalty payments.  We would usually expect such expenditure to be included as a deduction when Gross Trading Profits are being derived but Irish legislation set out that certain payments may not be deductible but rather should be deducted as a ‘charge on income’.   Hence we get Trade Charges between Total Income and Taxable Income.

Anyway, our companies with net trading income of more than €10 million had €45.9 billion of Taxable Income in 2015 and 0n this €5.1 billion of Corporation Tax was due giving tax due as a proportion of taxable income of 11.2 per cent in 2015.

The main reason for this being below the heading 12.5 per cent is the use of the R&D credit.  We don’t get a full breakdown of this but we can see that about 85 per cent of the R&D credit used against tax in the current year goes to these companies.  A split of the €359 million for the payment of the excess R&D credit would be nice but it is not provided.

To conclude, perhaps surprising is the amount of Double Tax Relief granted to these companies.  In 2015, they reported Foreign Income of €343 million but were granted €155 million of Double Tax Relief – €155 million is 31 per cent of €497 million (being the sum of the (after-tax) foreign income and the double tax relief).

Thursday, November 30, 2017

The Aggregate Corporation Tax Computation for Companies with No Net Income

Among the Corporation Tax Statistics provided by the Revenue Commissioners is a breakdown of a number of the items that make up the aggregate corporation tax computation by range of net income.  Here we will look at the recent outturns for companies reporting “nil or negative” net trading income.  With no net trading income it might suggest that there is little going on from a tax perspective but that is far from the case.

The table below provides the aggregate computations for “All Companies” and for “Companies with no Net Income”.  Some items are not provided in breakdown used but more than enough is provided to see what is going on.  It should also be noted that this breakdown is done by individual entity so while a company or group may have an entity with no net trading income this does not mean that the group as a whole does not have net trading or other taxable income with tax liabilities associated with that.  Anyway here they are: 

Corporation Tax Computation for Companies with No Trading Income

In the panel on the right we can see the line of duck eggs in the row for Net Trading Income but there is a lot going on both above and below that.

At the top we can see that companies with no Net Trading Income had Gross Trading Profits of just over €40 billion, a rise of €26.5 billion.  Net income is derived by subtracting capital allowances and previous trading losses carried forward.  The dataset gives the amount of these that are available rather than used but the effect of them is to reduce the starting figure for gross trading profits to a net figure of zero. 

Most of the losses likely relate to financial institutions and a large portion of them will likely never be used as some of the companies are in liquidation.  The use of previous losses is only possible if there are current gross trading profits against which to offset them.

The changes for capital allowances are more interesting.  In 2015, the amount of capital allowances available for all companies increased by €27.8 billion.  We can see that of that €25.6 billion was related to companies with no Net Trading Income. 

Thus we have an increase of around €26 billion in the gross trading profits offset by an increase of around €26 billion in capital allowances resulting in a net trading income of nil. 

Moving down the computation we can see that while these companies might have no net trading income they do have significant amount of other income and in particular foreign income.  In 2015, the Total Income of companies with no net trading income was over €10 billion with almost €8 billion of this being Foreign Income.  The remainder is made up of capital gains (regrossed to reflect the difference between the rate of Corporation Tax and Capital Gains Tax) and net rental income.  Since 2011, around 70 per cent of the income in these categories has arisen in companies with no net trading income.  In most years,  these companies had limited deductions to use against this and in 2015 the €10 billion of other income translated into a Taxable Income of €9.3 billion.

We don’t get a breakdown of gross tax due by range of net trading income but applying the 12.5 per cent rate would give a rough approximation of around €1.1 billion.  We can see from the bottom line that the amount of Tax Due was €177 million and that almost all of that reduction is the result of €730 million of Double Taxation Relief granted to these companies in 2015.  The €177 million of tax due likely arises due to rental, capital gains and other income earned by companies in this group.

The foreign income included in the table relates to external activities of Irish-resident companies.  This is in the Corporation Tax computation as Ireland has a worldwide regime and remitted branch or related company dividends are included in the Taxable Income base.  To avoid double taxation a relief is granted in the form of a foreign tax credit.  This credit is one of the main reasons the tax due as a proportion of taxable income is below 12.5 per cent (as shown it was 9.6 per cent in 2015)

The data by range of net income shows that almost 80 per cent of the €948 million of Double Taxation Relief granted in 2015 was to companies with no net trading income.  In overall terms there are ten of thousands of companies in this category but Double Taxation Relief was granted to just 413.  In 2015, there was also €213 million granted under the Additional Foreign Tax Credit.  This is included under “Other Tax Relief” in the table above but is only available for all companies as a breakdown by range of net income is not provided.

It is likely we are dealing with a small group of Irish-resident companies.  These companies may have no or limited domestic trading activities though other companies in the group may have significant operations, and tax liabilities, here.  These companies have large amounts of foreign income included in their Taxable Income in Ireland but the application of the various double tax reliefs will significantly offset their gross tax due in Ireland.  The end point of tax due as a proportion of taxable income was 1.9 per cent for for the group of companies with no net domestic trading income in 2015.

As a result of these large foreign profits and small tax amounts due in Ireland it is likely that these companies make up a significant proportion of the 13 companies from the Top 100 ranked by Taxable Income identified by the Comptroller and Auditor General as having effective tax rates of 1 per cent or less.  We looked at this at the time here

While the Irish tax due on these foreign profits may be nil it will be the case that the companies will have paid amounts of foreign tax on these profits (that it why they are getting the foreign tax credit) so that the effective tax rates of the companies (as opposed to just their effective rate of Irish tax) will much higher. 

If we want to remedy some of the near-zero effective tax rates identified by the C&AG one solution would be to move to a territorial which would take large amounts of foreign income out of the Irish tax base and negate the need to provide a foreign tax credit.  This would reduce companies Taxable Income to that generated by their Irish activities (or any income attributed to their Irish activities by any CFC rules Ireland might introduce) and the effective tax rate would be much closer to 12.5 per cent.  The C&AG report that 79 of the Top 100 companies had effective tax rates above 10 per cent with 59 having effective tax rates greater than 12.5 per cent.  Moving to a territorial system would increase those numbers.

The second main reason for the low effective tax rates identified by the C&AG is the R&D tax credit.  We do get a breakdown of the R&D credit used against tax in the current year by range of net income.  As shown above just €2 million of the €349 million of the credit used in this manner in 2015 was for companies with no net trading income and this was spread across 94 companies.  The figures show that €302 million went to 99 companies with to net trading incomes greater than €10 million.

When looking at low effective tax rates it would probably be much more informative to look at the distribution of the €359 million of the R&D tax credit that was paid to companies as the credit they were entitled to exceeded their tax liability. Unfortunately a breakdown of this component of the R&D tax credit is not provided in the Revenue statistics. 

The very fact that this is a payment of an excess credit means that these companies will have a negative effective tax rate.  We do not know how many such companies  are in the Top 100 as set out by the C&AG but again note, that like the foreign tax credit, it is a logical explanation, and deliberate policy choice, behind the low effective tax rates identified by the C&AG. 

So, if we want to further remedy the low effective tax rates the solution in this instance is to abolish the R&D tax credit.  Do that and even more of the Top 100 will have effective tax rates close to 12.5 per cent. 

The Revenue Commissioners have actually considered this and in recent evidence to the Public Accounts Committee, the Chair of the Revenue Commissioners said:

…if the effective tax rate of each of the 13 companies is calculated before taking account of double tax relief and the R&D tax credit, each would have an effective tax rate in excess of 12%.

So this really is only something to get excited about unless we think companies are paying tax elsewhere or incurring R&D expenditure to avoid Irish taxes.  If anything the C&AG report confirms that the Taxable Income of companies is taxed at close to the 12.5 per cent rate.  It is in the determination of that Taxable Income where most of the action is.

Friday, November 24, 2017

Very Low Work Intensity by Household Type

Ireland’s rate of people living in households with very low work intensity has received increased attention over the past few years.  It’s not hard to see why.

Very Low Work Intensity 2015 2

It could be that this is an issue of composition.  That is, maybe our population structure is such that we have a greater proportion of households with a higher tendency in general towards the end of the work-intensity scale.  Looking at very low work intensity by household type should throw some light on this.

Very Low Work Intensity EU28

So is it an issue of composition? No.  There is no household type for which Ireland are better than fourth last.  We have very low work intensity across the board.

Thursday, November 23, 2017

Computation and Concentration of UK Corporation Tax

Ireland’s Corporation Tax statistics get a fair bit of attention.  Similar statistics are produced for the UK by HRMC.  First up the aggregate Corporation Tax computation.

UK CT Comp

The common origins of the two systems mean that many of the descriptions are similar and it follows a form similar to the Irish version (the most recent update of which can be seen here).

For the UK we can see that the starting point of Gross Trading Profits and after subtracting capital allowances and other deductions and adding Other Income & Gains we get to Total Chargeable Profits.  The applicable rates are set against this to give the Total Tax Charge and after allowing for reliefs and set-offs we get to the bottom line: Corporation Tax Payable.

The sequence of numbers shown above don’t necessary add to the outcomes shown as in some cases (such as capital allowances) the amounts are those available in the year rather than those actually offset against profits in the year as losses brought forward are not included in Net Trading Profits.

The majority of Chargeable Profits are taxed at the Main Rate.  This has been reduced over the past decade (it was 30 per cent in 2008) and for the period shown in the table above there were reductions every year as it fell from 26 per cent to 20 per cent.  This has the effect of reducing the “tax payable as a % of chargeable profits” figure in the final row. 

This figure is fairly close to the Main Rate for all years and it can be seen that the largest item reducing the Total Tax Charge is Double Tax Relief which relates to non-UK tax already paid on non-UK profits included in the Chargeable Profits of companies.  This is also a key reason why this measure of below the 12.5 per cent headline rate for Ireland though it has been joined by the R&D tax in recent years as explored here

A second issue of relevance to Ireland is the concentration of payments.  Statisticians from the Revenue Commissioners have done excellent work on this recently and we now know that 10 companies account for around 40 per cent of Irish Corporation Tax payments.  For the UK the key points on concentration made in the HMRC report are:

Key points:

1. The distribution of companies’ tax liabilities is highly skewed. In 2015- 16 about 7,000 companies (under 1 per cent) had liabilities of £500,000 or more, between them contributing around 54 per cent of total Corporation Tax payable.

2. Companies with liabilities of less than £10,000 comprised about 65 per cent of the total number of companies liable for corporation tax in 2015- 16, but owed only around 7 per cent of the total Corporation Tax payable.

3. In 2015-16, around 50 companies had more than £50 million each in Corporation Tax liabilities (totalling £5.4 billion or 12 per cent of the total Corporation Tax payable). The figures for 2014-15 were around 60 companies paying £6.9 billion or 16 per cent of the total Corporation Tax payable.

4. There was an increase of around 140 thousand in the number of companies with any liability between 2014-15 and 2015-16. This increase was largely concentrated in companies with a Corporation Tax liability of under £50,000.

So the receipts are concentrated but not anything near to the same extent as they are in Ireland.

Finally, the HMRC report has lots of detail on the use of capital allowances – but there is no mention or breakdown provided for capital allowances for capital expenditure on intangible assets. Pity.